Call it the power of packaging.
Bankers say collateralized loan obligations, in which syndicated loans are repackaged and sold as asset-backed securities, are suddenly proliferating-and drawing new investors into the corporate loan market.
In just the last week, four new CLOs were taking shape. Fleet Financial Group, Foothill Group Inc., J.P. Morgan & Co., and SunAmerica Inc. were putting together packages that combined could own as much as $4 billion of bank loans.
Carolyn Thomas, managing director and head of loan distribution for BankBoston Corp., said that CLOs have the power to transform the way the bank loan market operates and is perceived.
"What's going to happen to this market in the next two years is going to be extremely interesting," she said. "There's $1 trillion in the bank loan market originated each year," making it one of the largest capital markets.
CLOs, which use a technology pioneered in the mortgage and bond markets, are basically funds that buy existing or new loans. The funds then sell securities which offer varied rates of return and credit risk. The first CLO, launched by Britain's National Westminster Bank, appeared less than two years ago.
"It's definitely helping the market for new issues," said Steve Hickey, who heads loan distribution for Donaldson, Lufkin & Jenrette in New York. "CLOs coming on line are helping to speed recovery of the market from its low point in October."
What makes CLOs such a powerful addition to the corporate loan market is the broad range of investors to which they can be sold. As Mr. Hickey explains, pension and insurance fund managers can buy CLO securities without being "experts in the bank loan market."
Bank loans have long appealed to fixed-income fund managers because they generally offer better yields than bonds, and their returns are hedged- rising and falling with interest rates.
CLOs are also being used by banks to manage their own portfolios. Because investors take on the risk of the loans, banks can free up capital. When NationsBank Corp. and BankAmerica Corp. merged on Sept. 30, credit risk managers at the combined bank struggled to diversify its portfolio.
The answer was a $4 billion CLO launched as the deal closed. That CLO came amidst a flood of CLO issuance in the second half of 1998 from banks including Bank of Tokyo Mitsubishi, Bank of Montreal, and National Westminster Bancorp. Those banks also secure fees when the CLO securities are offered.
Moody's Investors Service reported recently that of $81 billion in CLOs and collateralized bond obligations it rated in 1998, more than $63 billion, or 78%, was used to manage bank balance sheets. Moody's predicts 1999 CLO volume will be as much as 30% higher than last year's total.
The only drawback for investors in CLOs, according to some analysts, is that they are given the credit ratings of borrowers but not their names or any other financial information.
But that risk isn't slowing the CLO boom. BankBoston's Ms. Thomas said CLOs have become so popular that she fears loans may be in short supply to feed the CLO beast.
In fact, the announced issuance for new loans to below-investment-grade companies-the kind favored by CLO managers and investors-is running about 40% below the levels predicted a year ago, according to Loan Pricing Corp.
"At this point, just given the current supply conditions, the challenge is to get product," Ms. Thomas said.
One banker estimates that $7 billion in cash is being stashed away by fund managers and CLOs that have yet to commit their full amounts to bank loans.
Nevertheless, Ms. Thomas says, BankBoston is considering launching another CLO. Last year the bank built a $2.18 billion CLO that invested solely in loans on its balance sheet. The proposed new CLO would buy loans in the market.
Like many new CLOs, the BankBoston fund will most likely invest in overseas loans, a process made easy by the introduction of the euro. Mr. Hickey at DLJ said most new CLOs have a 25% "basket" of European loans.
"There's no reason not to do euros," Mr. Hickey said. "You can buy institutional tranches of European loans that give a CLO diversity and protection."
Ed Forst, a managing director of loan syndications for Goldman, Sachs & Co., said the firm is looking at launching a CLO this year, calling it a "a significant growth area for the firm."
"We believe it will enhance both the new issue loan product and secondary product," he said.
