In their search for higher yields, institutional investors and the wealthy of Asia are snapping up private credit opportunities in the US.
According to experts, interest from the region and particularly China has been growing, focused in large part on the collateralised loan obligation (CLO) market. Large institutional investors such as sovereign wealth funds and banks are increasingly lapping up new CLO issuances in the US, the largest market for such leveraged loans.
CLOs are financial vehicles containing packages of ‘leveraged loans’ that have been sliced into different levels of risk. The vehicles use these debts as collateral to issue bonds at different ratings and yields, based upon the riskiness of the underlying loans.
Interest from Asian investors has helped support a surge in supply this year. Credit rating agency Standard & Poors said leveraged loan issuance was $512 billion for the first nine months of 2017, over $160 billion higher than the same period of 2013, the previous peak year.
“The really interesting story from Asia is that over the past 12 months, we have seen the emergence of the large Chinese investors, who are the latest entrants from this part of the world,” Oliver Wriedt, co-chief executive officer at CIFC Asset Management, a US-headquartered private debt manager told AsianInvestor. CIFC manages about $15.5 billion invested in CLOs, corporate credit and structured credit funds, including $3 billion in Asia Pacific.
Chinese investors are mostly banks, asset management platforms and sovereign wealth funds. While many have had their offshore investing activities crimped by China’s capital restrictions, where they can use offshore currency they have been active CLO buyers, he said.
Japanese institutional investors have also been major regional players since 2010. Others include insurance companies in Hong Kong, Singapore and Taiwan, which tend to invest primarily in investment grade tranches, said Wriedt.
Korean insurers are even more aggressive, buying all the way down to equity tranches.
Even private banks in the region are showing appetite: “For high risk clients, we like CLO equity and junior mezzanine debt, and for medium risk appetite clients, we prefer double B and triple B CLO bonds,” agreed Bryan Goh, chief investment officer for Singapore at Swiss private bank Bordier and Cie.
He told AsianInvestor that he prefers investing in markets that are non-retail and institutional investor-dominated.
“Institutional investments are not based on liquidity or momentum but on default rates and recovery rate outlook. These markets tend not become as highly overvalued as momentum and retail driven assets,” he added.
Attempting a makeover
In the aftermath of the global financial crisis, rating agencies have spent years tightening scrutiny of securitised products such as CLOs, eager to avoid another embarrassing failure to identify structural weaknesses.
“Esoteric assets are not included and credit enhancement limits in recent CLOs are higher than those of pre-crisis CLOs. CLOs are also well diversified across industries nand have a wide range of concentration limits,” said Jian Hu, managing director for the structured finance group of Moody’s Investors Service.
According to Moody’s data, the 12 month (trailing) impairment rate for both investment grade and speculative grade categories of CLOs is zero percent.
Nevertheless, CLO investments are not entirely without concern, despite low default rates to date.
“There are other risks [beyond credit rating risks] and investors need to be mindful of those,” said Hu.
These include liquidity risk, market value risk and early payment or extension risk, he added.
Rival ratings agency S&P has also flagged signs of extreme risk-taking in the US leveraged loans market, while the level of investor demand for CLOs has allowed some issuers to weaken their deal covenants, or the voluntary constraints placed upon their financial behaviour to assure the financial health of CLOs.
“Although liquidity remains healthy, negative market signals have appeared, like the rising share of riskier 'B' rated loans, the near record-high leverage levels, or the continuing proliferation of borrower-friendly terms—over 70% of this year's institutional issuance are covenant-lite,” it noted in an October 16 report.
This leaves the US leveraged loan market increasingly vulnerable to external shocks such as China's rebalancing, the UK's decision to leave the European Union, and the Federal Reserve's interest-rate normalisation, the report said.