CLO Market Continues to Surge

Between the increasing number of new CLO programs coming to market in the first two months of 2012 and the projected US$70 Billion in reinvestment capacity scheduled to build through the year, CLO managers and arrangers have much to be smiling about.  Demand seems to be back!

Over the past several days, a variety of reports covering the Collateralized Loan Obligation  industry have begun to compare statistics for new issuance activity which rivals some of the best months of the pre-credit crisis years.  In February 2012 alone, S&P projects that more than US$2.5 Billion in new programs will have priced before the end of the month.  Combined issuance levels for the first two months of 2012 are nearly 300% above what we saw for the same period in 2011.  As issuance levels in March of 2011 were virtually zero, the expectations for the 1st Quarter 2012 are simply a blowout over the previous year’s activity.

Many are projecting the 1st Quarter 2012 to exceed the strong US$4.4 Billion in issuance that we saw in the 4th quarter of 2011, which was itself a strong performance over the US$2.1 Billion issued in the 3rd Quarter of 2011.

On the side of capacity for new loans among the existing CLO programs, JP Morgan projects some US$60 Billion in pre-payments and US$8 Billion in principal proceeds which will provide existing CLO Managers with some US$70 Billion in “buying capacity” and JPM beleives that managers will favor new loans over the secondary market to replenish their programs.

All in all, some great news for both the corporate loan market and the rapidly improving CLO marketplace.

Will FDIC’s “Clarification” of Safe Harbor Rules Make a Difference

Earlier this month, the FDIC provided the American Securitization Forum a formal response to the ASF’s  interpretive request from August 2011 in connection with the FDIC’s final “Securitization Rules” published in September 2011.

The lack of clarity for how securitizations issued by “Insured Deposit Institutions” will be treated in cases of FDIC conservatorship or receivership has been vexing the structured finance markets since the beginning of the credit crisis.

On February 7th, the FDIC provided clarification to several key provisions or standards in the Securitization Rules; Disclosure, Servicer Best Practices, Reserve Funds for Repurchases, Underwriting of Obligations, Six Credit Tranched Limitation and Limitations on Advancing.

The basic premise is that the FDIC will agree not to utilize its powers to seize assets that have been pledged to a securitization issued by an insured institution, if the issuer can demonstrate that they have met each of the standards in the Securitization Rules, including the six  mentioned above.

Prior to the credit  crisis, most investors took for granted that assets pledged to an off balance sheet financing would be treated separately by the FDIC in cases of receivership or conservatorship.  However over the last several years, in word and some cases in deed, this “conventional wisdom” was challenged by the FDIC.  New powers granted to the agency under Dodd-Frank and the general climate for more aggressive interpretation of existing powers created increasingly higher levels of uncertainty among investors about their abilities to exert a lien on collateral which they believed was theirs.  This uncertainty has had a significantly detremental effect on the recovery of several key securitization markets, most notably RMBS.

We hope that these clarifications have the desired effect and they help investors to return to the market but we are not sure we are there just yet.  While these clarifications seem to close some gaps, it seems to us that the rules still leave too much room for interpretation.  Something more along the lines of a “firm policy statement” from the FDIC as to their projected treatment of securitizations against which these individual rules could be applied would be a bigger step in the right direction.

Banks May Be Telegraphing Return to ABS Investing

Over the past ten days, there have been several articles indicating that leading banks are increasing their tolerance for risk and are returning to both asset-backed securities and high yield bonds in search of increased performance in their investment portfolios. 

We highlight the word tolerance mostly as a means of signaling that we do not mean tolerance for risk in the classic sense but rather in the context of tolerance for “headline risk”.  The movement to conservative investment principles, on so many different levels over the past several years, is almost unprecedented.  However, as with any downturn and contraction in risk taking that we have been through before, when the market does start to come out of it, the reason is usually groups of investors attempting to outperform their competition and the pressure to keep up with competitors tends to feed off itself.

Last week, the Financial Times ran a piece on the growing number of banks that are returning to investing in “bundled mortgage” products, mostly in the form of CMO’s backed by GSE securities.  While the trend is still small and the number of banks involved is similarly small, we would project that this trend will grow and will likely expand to “non-managed” bundled programs which include private mortgage securities.  We’re not so bold as to predict that the return of CDO’s is around the corner but we remain bullish on the return of at least a segment of the “managed” market over time.

This week has illuminated the return of the high yield bond markets with the announcement of three flagship transactions by Caesars Entertainment, Realology and Energy Future Holdings totaling nearly US$3B.  This could breathe new life into the high yield markets as banks may lead the way in the charge to improve overall portfolio performance.  If this recent activity does turn into a trend, as many expect it will, this will likely have a very positive impact on the CLO market.  We believe it will begin to loosen up what has, up until now, been a relatively small group of institutional investors that have shown a willingness to get back into high yield, either directly or via a CLO structure.

In both cases, the return of more investors to the market will increase the confidence of still other investors and so on and so on…….

Market signals like these are a long time coming for structured finance and there can be any number of false starts along the way.  Nevertheless, we’ll take this double dose of good news as a positive sign that the securitization markets are on the road to recovery.