The market for collateralised loan obligations is on track for a record year of issuance, as managers package leveraged loans into structured vehicles at a pace not seen before. The CLO machine is the largest single buyer of leveraged loans, and its appetite shapes the terms on which companies can borrow.
A CLO bundles a diversified pool of loans and sells slices of the resulting cash flows to investors with different risk appetites. The structure has proven remarkably durable across cycles, and demand for its highest-rated tranches remains strong even as the underlying loans carry more risk than a label might suggest.
Why issuance is surging
Record issuance reflects both supply and demand. On the supply side, a reopening buyout market is generating new loans that need a home. On the demand side, investors hunting for yield in a higher-rate world are drawn to CLO tranches that offer attractive spreads with the comfort of structural protection.
The risk is that a record year of issuance soaks up loans of declining quality, as the pressure to fill new vehicles tempts managers to accept weaker credits. The CLO structure can absorb a degree of stress, but it is only as sound as the loans inside it. A record year built on careful selection is a sign of health. One built on reaching for volume is a setup for the next cycle's disappointment.