June 22, 2024

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A Shrinking $1.3 Trillion Securities Market Is Bad News for the Economy

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(Bloomberg) — For a fleeting moment this month, investment bankers in leveraged finance — the lucrative lending that oils the wheels of M&A and feeds the $1.3 trillion market for collateralized loan obligations — had rare cause for cheer. Company valuations were enticingly low for dealmakers, the US Fed looked closer to reversing punishing rate hikes, loans were getting done.

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A realization that Federal Reserve Chair Jay Powell isn’t ready to turn quite yet has put those Wall Street hopes on ice. Financing packages are stalling again. A CLO industry that boomed in the cheap money era, by bundling up slices of loans and selling them as bonds, looks particularly vulnerable to the freeze.

Through a decade of low rates, bankers turned CLOs from niche securitizations into a capital markets pillar and one of the hottest finance products around. Now, much of the industry’s shrinking, starved of its usual feedstock of loans in a moribund M&A market. Demand from big US commercial banks for the largest tranche of CLOs has also cratered; better returns are on offer elsewhere.

About 40% of the securities’ issuers have yet to price a new deal this year, according to data from Citigroup Inc. “The CLO market has been gummed up for a while,” says Andrew Lennox, an investor at Federated Hermes Limited.

This isn’t just a tale of woe for finance whiz kids. The impact from any prolonged shutdown — especially on extending the life of existing bundles of loans — would hit the real economy, too, making it tougher for lower-rated businesses to refinance at a time when traditional lenders are pulling back.

“Lower CLO creation will lead to lower demand for leveraged loans,” says Wayne Hosang, portfolio manager at alternative credit firm Crescent Capital, which “means underwriting banks will find it harder to place new leveraged buyout paper and borrowers will find it more challenging to refinance.”

Companies have roughly…

2023-10-23 00:00:16

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