Markets & Finance

New Signs of Life for Collateralized Loans


JPMorgan, BofA, and Citi are poised to lead a comeback in the market for collateralized debt obligations backed by high-yield, high-risk loans

By Pierre Paulden and Kristen Haunss

(Bloomberg) — The three largest U.S. banks are preparing for a comeback in the market for collateralized debt obligations backed by high-yield, high-risk loans, two years after issuance tumbled when credit markets seized up.

JPMorgan Chase & (JPM), Bank of America (BAC), and Citigroup (C) are approaching managers of leveraged loans to offer terms for new collateralized loan obligations following a record rally this year in the debt, according to people familiar with the discussions who declined to be identified because the talks are private. The highest-rated portions of CLOs have climbed to 89 cents on the dollar from a record low of 69 cents in April, according to Morgan Stanley data.

The $440 billion market for CLOs, which pool loans and slice them into securities of varying risk, largely disappeared at the end of 2007 as losses on subprime mortgages led investors to flee bundled debt. While new sales would signal Wall Street's return to investments that contributed to $1.7 trillion of writedowns and credit losses worldwide, they may help companies refinance $1.5 trillion of high-yield loans and bonds maturing by the end of 2014.

"Market conditions have improved dramatically over the course of this year, which we see carrying on into 2010," said Philippe Roger, JPMorgan's global head of structured credit trading. "We are actively discussing the market environment with our clients, and think that they are going to be increasingly attracted both to the leveraged-loan asset class and securitization technology and applications related to the high-yield space."

Less Volatile

Roger, who is based in London, declined to comment on specific dialogue the firm has had in creating CLOs.

Frankfurt-based Deutsche Bank AG, Germany's biggest bank, is also considering creating CLOs with loan managers, said the people, all of whom had direct talks with the banks. Spokeswomen for Citigroup of New York, Deutsche Bank and Charlotte, North Carolina-based Bank of America declined to comment.

JPMorgan Chase, Bank of America and Citigroup are the three largest U.S. banks as ranked by assets, according to data compiled by Bloomberg.

Leveraged loans have returned a record 49.3 percent this year after losing an unprecedented 28.2 percent in 2008 following the failure of Lehman Brothers Holdings Inc., according to the Standard & Poor's/LSTA U.S. Leveraged Loan 100 Index. Leveraged loans are rated below BBB- by S&P and less than Baa3 at Moody's Investors Service.

New issues of CLOs may reach $3 billion to $6 billion next year, Wells Fargo Securities LLC senior analyst Dave Preston in Charlotte, North Carolina, wrote in a report yesterday.

CLO Sales Swelled

For banks to be able to create new CLOs, leveraged-loan prices need to be less volatile and financing costs for the top-rated portions must be lower, said David Yan, a Credit Suisse Group analyst in New York, who predicts issuance may return in the first quarter of 2010.

CLO sales swelled to about $100 billion in both 2006 and 2007, from $32 billion in 2004, according to data from Credit Suisse. Investors bought the securities because they had higher returns than similarly rated debt, boosting demand for the leveraged loans packaged inside them.

The increase enabled CLOs to finance almost two-thirds of the loans that backed the record $616 billion of leveraged buyouts in the first half of 2007, Standard & Poor's LCD data show.

Demand for loans began to slow in July 2007, when bankers couldn't find investors for the credit they provided to New York-based KKR & Co.'s 11.1 billion-pound ($18.1 billion) purchase of British drugstore chain Alliance Boots Ltd.

'Stress Scenarios'

By April 2009, amid the worst financial crisis since the Great Depression, the slices of CLOs with BBB ratings plummeted to 6 cents on the dollar, while the safest portions fell to 69 cents, Morgan Stanley data show.

As the U.S. has lent, spent or guaranteed $11.6 trillion to rescue the financial system and pull the economy out of recession, prices on the S&P/LSTA loan index rose to 86.31 cents on the dollar from the record low in December 2008 of 59.2 cents.

Banks need to make "an extraordinary commitment" to help rebuild the economy, President Barack Obama said yesterday, after the government bailed them out of a crisis "largely of their own making."

Even as bond issuance soared this year as borrowers took advantage of record-low interest rates and investor demand for higher-yielding assets, sales of leveraged loans to high-yield, high-risk companies has declined 45 percent from the same period in 2008.

Junk Bond Sales

Companies have sold $152 billion of junk bonds in the U.S. in 2009 compared with $64 billion for all of 2008, Bloomberg data show. JPMorgan and Bank of America led banks arranging $147.7 billion of leveraged loans this year.

Issuance this quarter has exceeded the prior three quarters, and since November at least a dozen companies, including Ronald Perelman's Revlon Inc. and Booz Allen Hamilton Inc., have asked lenders to change the terms of debt agreements to allow bond sales, extend loan maturities or pay dividends to private-equity firm owners, Bloomberg data show.

That's boosting confidence the number of high-yield companies defaulting globally will decline to 3.9 percent by November 2010 from 12.7 percent last month, Moody's Investors Service said Dec. 7.

The value of CLOs with the BBB portions has climbed to 55 cents on the dollar, Morgan Stanley data shows.

"This solid performance in a majority of CLOs should increase investor confidence, raising the probability that newly issued CLOs will be received favorably by the market," said Matthew Natcharian, the head of Babson Capital Management LP's structured credit team that has bought the securities this year. The Springfield, Massachusetts-based firm manages $112.5 billion of assets.

To contact the reporters on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Kristen Haunss in New York at khaunss@bloomberg.net


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