CLOs Are ‘Sticky Lenders,’ Will Limit Leveraged Loan Volatility

(Bloomberg) -- While volatility has infected U.S. leveraged loans, extended price drops next year will be checked by strong investor appetite for collateralized loan obligations, the biggest buyer of the asset class.

"CLOs are the lasting sticky lenders," said Rishad Ahluwalia, head of CLO research at JPMorgan Chase & Co. , said in a Nov. 28 interview. "We expect to to see some more new investors, particularly in the AAA and equity tranches because CLOs should return better than some other fixed income products next year."

CLOs, which buy between 50 percent to 60 percent of leveraged loans, are on the cusp of breaking the record issuance of $124 billion set in 2014. JPMorgan is forecasting another record-setting year at $135 billion. At the bearish end, Morgan Stanley is predicting $90 billion as the base case.

The benchmark S&P/LSTA Leveraged Loan Price Index has dropped dramatically this month to its lowest level in almost two years as jitters in equities and bonds took its toll. Given this volatility and worries about growth, CLO spreads will likely widen making it difficult for managers to arbitrage. But the same volatility would eventually lift leveraged loan prices and ease that impact.

"Investors will price in macro-risk more than they will be attracted to rising floating-rate risk. So we expect CLO spreads to widen modestly," said Ahluwalia. Still "I expect total returns to be positive for CLOs."

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