High-risk portions of collateralized loan obligations have fallen 50% over the past six months. These structured bonds are similar to the collateralized debt obligations that triggered the housing bust during the financial crisis, raising concern amid the failure of several credit funds.
A re-proposed risk-retention rule could prompt the development of a two-tiered loan market because the bigger collateralized loan obligation managers are effectively favored by the change. Below-investment grade deals could see higher borrowing costs and deal volume is expected to decline.
After a falloff in July, issuance of collateralized loan obligations picked up substantially, totaling $2.62 billion in the week ended Aug. 14, according to S&P Capital IQ/LCD. The pace of issuance is down from a highly active first quarter, but for the year so far, the total of $50.1 billion nearly matches the $54 billion for all of 2012.
Collateralized loan obligations managers now believe that spreads on their deals are wide enough, compared with commercial MBS spreads, that insurers will soon return to CLOs. Many major insurers had shifted to commercial MBS after the bond market rout in June, hoping to lock in high yields.
A hoped-for revival of the European market for collateralized loan obligations, loans and other debt instruments bundled into securities, could be cut off before it begins due to proposed new credit market rules. Some asset managers are worried that a requirement that they hold a fixed 5% stake in their offerings will make it difficult to complete many deals because they are thinly capitalized.