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By Marine Cole
Collateralized loan obligations are slowly making a comeback, judging from the faint stirrings that are visible in the market.
Investors in CLOs were the primary buyers of leveraged loans between 2005 and 2007, and along with investors in high yield bonds, helped fuel the boom in hugely leveraged buyout deals private equity firms put together in that period.
But as the housing market began collapsing, issuance of collateralized debt obligations made of mortgages froze and the CLO and high-yield bond markets followed suit.
Since the beginning of the year, the high-yield bond market has recovered, but new issuance in the leveraged loan market has stayed quiet with almost no new loans. Corporations are either amending loans and extending maturities or replacing leveraged loans with longer-dated bonds.
Still, the refinancing and repayments of existing leveraged loans have returned some money to CLO buyers, who could start lending again and revive the primary leveraged loan market, a lawyer who works on highly leveraged financing transactions told CFOZone a few weeks ago. It hasn't happened yet, he said, but he noted that he’s seeing signs of life in the secondary market.
Other observers second the notion. Only about $19 billion of new leveraged loans has been issued this year, according to a Securities Industry and Financial Markets Association report put out in the past week. But the report also found that demand in the secondary loan market has grown during the past several months, partially driven by CLO buying.
Meanwhile, the supply has been kept low thanks to repayment by companies of more than $50 billion in leveraged loans so far in 2009, according to SIFMA. That has reduced the total amount of loans outstanding by 7 percent, to $550 billion based on the S&P/LSTA Leveraged Loan Index.
The thin supply of such loans, coupled with increased demand from CLOs that are starting to receive fresh money to invest, create a solid basis for the leveraged loan market’s revival, analysts say.
Of course, it remains far from the golden years, when buyers of CLOs were gobbling up every leveraged loan they could find. And much depends on the economy’s continued recovery, as many existing CLOs issued during the boom are still facing trouble. Within the past week, Standard & Poor's downgraded $10.47 billion of existing U.S. CLOs because of asset deterioration due to defaults.
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