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US bank treasury desks hesitate to embrace CLOs amid global triple A frenzy
by Paul Conley
Global demand for CLOs is rising, spreads are tightening and new issuance has risen, as banks in Japan, Korea and Europe show increasing interest in the investment vehicle (see cover story). Yet while US banks have certainly not abandoned the market, a good portion of them are sitting on the sidelines during the recent frenzy.
The reasons are multiple: growing competition for investment-grade bonds by ETFs, a surge in refis and resets, and the possibility of new regulations in the near future.
According to a recent report from Bank of America Global Research, US bank holdings in CLOs dropped to USD 199bn in the first quarter, a decline of USD 6bn, or 2.93%, from Q4 of last year.
Investors say the drop in bank holdings is to be expected given market conditions. “That doesn’t surprise me at all,” said one investor. “Triple A issuance for most guys is down this year. There are more calls than there are new issues, and more longer-term investors are losing bonds to shorter investors via refis and the like.”
Complicating matters is that there are new competitors for the limited debt that is available, with one new giant standing out for triple A debt in particular: the ETF industry. Janus Henderson AAA CLO ETF (JAAA) fund is the largest CLO exchange-traded fund and represents more than 90% of all triple A CLO ETF assets. In June it passed USD 10bn in AUM.
The BofA report, citing data from S&P Global Market Intelligence (formerly SNL Financial) and company filings, points out that while net triple A supply for the first quarter was down by USD 1bn, demand for triple As by ETFs rose by USD 5bn.
That has created a situation where banks can’t get the investments they want and are holding their powder, according to a different investor.
US BSL CLO 1Q24 triple A flows ($bn)
“I think in the short run, banks might just let their holdings shrink until they find a better entry point. They may be seeing their relative value shrink over time and may not think it’s the right time to enter the CLO market,” a third investor said, noting that banks may also be waiting until the industry gets final word on how the Basel IV regulatory regime will view risk.
“They are probably waiting for some more clarity on regulatory reform,” the investor said, noting that “they might expect some positive treatment for triple A products”.
Final guidelines from Basel IV aren’t expected until January. Much about how the regulatory reforms will view the risk in bank holdings of CLO debt tranches remains open to debate.
The BofA Global Research report suggested the Q1 decline in holdings is temporary and that since “CLO amortisations and deal calls accelerated in Q2”, bank holdings are expected to continue to decline through this quarter, before bouncing higher in the second half of the year.
Investors, however, say they don’t think US bank holdings will necessarily rise again in the second half of the year. “I don’t know if that will be true,” the first investor said. “There’s no telling as to what the market will do over that period. It depends on loan prices more than anything else. Right now it’s still refis and resets that are dominating the market versus new issues. If we start to see more new issue loans, that could change things.”
Meanwhile, one section of the CLO market has grown more popular with US banks: loan tranches for triple As.
In August 2023, the US Second Circuit Court ruled in Kirschner v JP Morgan (known in the CLO industry as the Millennium Health case) that a syndicated term loan is not a security, giving US banks some relief from balance sheet regulations.
The BofA report said that Q1 2024 issuance of loan format tranches stood at USD 3.8bn versus USD 6.8bn in all of 2023.
