CLO Rule Change Clouds Outlook for Bank Loans

CLO Rule Change Clouds Outlook for Bank Loans

CLO Rule Change Clouds Outlook for Bank Loans by Gershon Distenfeld, AllianceBernstein 

Retail investors fell out of love with US bank loans this year, but demand from issuers of collateralized loan obligations (CLOs) has remained strong. New regulations may change that. Should investors be concerned? We think so.

First, a bit of background. In recent years, investors large and small have poured money into bank loans. Most were attracted by loans’ relatively high yields and their floating-rate coupons, which would provide insulation against an eventual rise in interest rates. At one point, loan mutual funds—a good gauge of retail demand—pulled in fresh money for 95 weeks in a row.

That streak ended earlier this year. Since then, retail investors have pulled money out of loans for 23 weeks running. At the margin, the reversal may have had something to do with concern about credit quality. As we’ve noted before, high demand for loans has allowed companies with fragile credit profiles to borrow on favorable terms without offering traditional protections to lenders.

What Investors Need To Know When Choosing A Private Equity Manager

investor 1652197064It's no secret that this year has been a volatile one for the markets. The S&P 500 is down 18% year to date, while the Nasdaq Composite is off by 27% year to date. Meanwhile, the VIX, a key measure of volatility, is up 49% year to date at 24.72. However, it has spiked as Read More

But the bigger culprit, in our view, was changing interest-rate expectations. As it became clear the Federal Reserve would likely hold rates low for longer than many thought, it became less attractive to sacrifice the higher yields available on high-yield bonds for loans’ promise of floating income.

CLO Investors Play a Large Role in the Loan Market
A shift in demand as abrupt as the one loans experienced this year would normally cause considerable volatility. But the market weathered the change well. The reason? Issuers of CLOs—l