(Bloomberg) — For a fleeting moment this month, investment bankers in leveraged finance — the lucrative lending that oils the wheels of M&A and feeds the $1.3 trillion market for collateralized loan obligations — had rare cause for cheer. Company valuations were enticingly low for dealmakers, the US Fed looked closer to reversing punishing rate hikes, loans were getting done.
A realization that Federal Reserve Chair Jay Powell isn’t ready to turn quite yet has put those Wall Street hopes on ice. Financing packages are stalling again. A CLO industry that boomed in the cheap money era, by bundling up slices of loans and selling them as bonds, looks particularly vulnerable to the freeze.
Through a decade of low rates, bankers turned CLOs from niche securitizations into a capital markets pillar and one of the hottest finance products around. Now, much of the industry’s shrinking, starved of its usual feedstock of loans in a moribund M&A market. Demand from big US commercial banks for the largest tranche of CLOs has also cratered; better returns are on offer elsewhere.
About 40% of the securities’ issuers have yet to price a new deal this year, according to data from Citigroup Inc. “The CLO market has been gummed up for a while,” says Andrew Lennox, an investor at Federated Hermes Limited.
This isn’t just a tale of woe for finance whiz kids. The impact from any prolonged shutdown — especially on extending the life of existing bundles of loans — would hit the real economy, too, making it tougher for lower-rated businesses to refinance at a time when traditional lenders are pulling back.
“Lower CLO creation will lead to lower demand for leveraged loans,” says Wayne Hosang, portfolio manager at alternative credit firm Crescent Capital, which “means underwriting banks will find it harder to place new leveraged buyout paper and borrowers will find it more challenging to refinance.”
Companies have roughly half-a-trillion dollars of leveraged loans coming due in the next three years, and CLOs control about 70% of the US corporate-loan market. It’s more than that in Europe.
Slow Lane
Nor are there signs of rescuers on the horizon. Bank appetite is starting to return and the leveraged loan market is open, but for “higher-quality issuers,” says Dan Hayward, a portfolio manager of US liquid credit at Ares Management. CLOs are mostly made up of riskier lending.
“The CLO market right now is like the ‘ole family station wagon, it’s plodding along,” says Scott Macklin, head of leveraged-loan strategy at AllianceBernstein LP, “To shift the CLO creation machine back into the fast lane will take the nitrous oxide of a material tightening of AAA spreads and/or widening loan spreads.” In short, premiums on other investment-grade bonds look better.
This is all bad news for investment bankers, who built a Wall Street profit machine during the buyout boom years by arranging and underwriting money-spinning loans to private equity-owned companies — and then helping create the securities that gobbled up slices of that debt.
Read More: Junk Loan Sales in Europe the Weakest Since 2010
Many CLO management firms are suffering as well. Falling demand makes it difficult to refinance their existing securities. In happier days some managers hoped their ability to “reset” existing loan bundles, extending repayment into the future, had put them on a path to investment’s holy grail: permanent capital. The new trend is the opposite: investors closing, or “calling,” CLOs.
“It could start to look as it did before the financial crisis, when calling CLOs was the norm,” says Simon Gold, a senior trader in the bonds at Chenavari Investment Managers. “After 2008, managers started doing more resets extending the life of the securities and taking advantage of the low interest-rate environment. But now that isn’t such an easy path.”
The total issuance of new deals and the refinancing of old ones has dropped to roughly $102 billion so far this year in the US, according to data compiled by Bloomberg. That compares with about $134 billion in the same timeframe last year and almost $350 billion in 2021, the height of the buyout boom.
Buyers Beware
CLOs are divided into tranches, with the senior portion rated as investment grade, the mezzanine part below that and an equity slice making up the riskiest layer. Recently big buyers of the senior tranche — more than 60% of the instrument’s structure — have backed off, happy with the returns they can get from other, more vanilla, assets at a time of normalized central bank rates.
The chief acquirers of that senior AAA portion have been US commercial banks including JPMorgan Chase & Co., Citi, Wells Fargo & Co., and to a lesser extent Bank of America Corp. They’ve stopped buying, or cut purchases to the bone. Mired in new US capital rules and spooked by the failures of Silicon Valley Bank and Credit Suisse, there’s little sign they’ll return any time soon.
Representatives for JPM, Citi, Wells Fargo and BofA declined to comment.
“The lack of CLO creation is a lack of demand for AAAs,” says Joshua Easterly, co-founder of Sixth Street Partners, speaking at the recent Bloomberg Credit Forum in London. “A lot of that AAA demand came out of US banks who had a lot of excess liquidity. They’re no longer buyers at the moment given their balance-sheet issues.”
Normally, this falling demand would be offset by a drop in prices for leveraged loans. But the shortage of supply is keeping prices elevated, shrinking the so-called “arbitrage” earned by CLOs — essentially what’s left after the monthly interest payments on their bundle of loans — to a more than three-year low of about 175 basis points in August, according to Citi, although it’s picked up slightly since then.
A welcome late-summer tightening of spreads for the AAA portion of CLOs and rise in refinancings was short-lived. The market for these securities “remains challenged by macro uncertainty and interest rate volatility,” says Tetragon portfolio manager Dagmara Michalczuk.
Some managers are being told by their equity investors to sell instead. About $3 billion dollars of loans were sold from CLO structures in July, according to BofA Securities. Meanwhile, just 20 resets have been done in the US so far this year, compared with 33 in the same period last year and 208 in the equivalent 2021 timeframe, according to data compiled by Bloomberg.
Private Saviors
One crumb of comfort for corporate borrowers is private credit, which has gladly stepped in to plug gaps left by reluctant leveraged-loan investors.
Direct-lending behemoths including Oak Hill Advisors and Blue Owl Capital provided a $4.8 billion fully funded loan as part of Vista Equity Partners’ refinancing of fintech firm Finastra Group Holdings Ltd.’s debt, according to Bloomberg. That deal was struggling for traction among the traditional leveraged-finance crowd.
Private credit firms are also creating their own version of CLOs, yet another threat to the leveraged finance bankers’ money machine. However, for all their burgeoning strength, it’s yet to be seen whether direct lenders can fill all of the space left by departing CLOs and their US bank backers.
“I think the CLO market’s more of the tail and the loan market’s more of the dog,” says Ian Smith, a colleague of Hayward’s at Ares. “You need the loan market to be functioning more so than the CLO market.”
Any leveraged-finance bankers seeking a swift return to the halcyon days of abundant buyouts will need patience, according to their bosses. A dealmaking revival still looks “a little further away,” Barclays Plc’s Chief Executive Officer C.S. Venkatakrishnan told Bloomberg’s In the City podcast recently.
Morgan Stanley’s James Gorman, who’s been anticipating a rebound in M&A and capital raising, told his bank’s earnings call last week that he’d loved a comment he’d heard: “For all the talk of green shoots, somebody’s got to water them.”
OTTAWA – Canada’s unemployment rate held steady at 6.5 per cent last month as hiring remained weak across the economy.
Statistics Canada’s labour force survey on Friday said employment rose by a modest 15,000 jobs in October.
Business, building and support services saw the largest gain in employment.
Meanwhile, finance, insurance, real estate, rental and leasing experienced the largest decline.
Many economists see weakness in the job market continuing in the short term, before the Bank of Canada’s interest rate cuts spark a rebound in economic growth next year.
Despite ongoing softness in the labour market, however, strong wage growth has raged on in Canada. Average hourly wages in October grew 4.9 per cent from a year ago, reaching $35.76.
Friday’s report also shed some light on the financial health of households.
According to the agency, 28.8 per cent of Canadians aged 15 or older were living in a household that had difficulty meeting financial needs – like food and housing – in the previous four weeks.
That was down from 33.1 per cent in October 2023 and 35.5 per cent in October 2022, but still above the 20.4 per cent figure recorded in October 2020.
People living in a rented home were more likely to report difficulty meeting financial needs, with nearly four in 10 reporting that was the case.
That compares with just under a quarter of those living in an owned home by a household member.
Immigrants were also more likely to report facing financial strain last month, with about four out of 10 immigrants who landed in the last year doing so.
That compares with about three in 10 more established immigrants and one in four of people born in Canada.
This report by The Canadian Press was first published Nov. 8, 2024.
The Canadian Institute for Health Information says health-care spending in Canada is projected to reach a new high in 2024.
The annual report released Thursday says total health spending is expected to hit $372 billion, or $9,054 per Canadian.
CIHI’s national analysis predicts expenditures will rise by 5.7 per cent in 2024, compared to 4.5 per cent in 2023 and 1.7 per cent in 2022.
This year’s health spending is estimated to represent 12.4 per cent of Canada’s gross domestic product. Excluding two years of the pandemic, it would be the highest ratio in the country’s history.
While it’s not unusual for health expenditures to outpace economic growth, the report says this could be the case for the next several years due to Canada’s growing population and its aging demographic.
Canada’s per capita spending on health care in 2022 was among the highest in the world, but still less than countries such as the United States and Sweden.
The report notes that the Canadian dental and pharmacare plans could push health-care spending even further as more people who previously couldn’t afford these services start using them.
This report by The Canadian Press was first published Nov. 7, 2024.
Canadian Press health coverage receives support through a partnership with the Canadian Medical Association. CP is solely responsible for this content.
As Canadians wake up to news that Donald Trump will return to the White House, the president-elect’s protectionist stance is casting a spotlight on what effect his second term will have on Canada-U.S. economic ties.
Some Canadian business leaders have expressed worry over Trump’s promise to introduce a universal 10 per cent tariff on all American imports.
A Canadian Chamber of Commerce report released last month suggested those tariffs would shrink the Canadian economy, resulting in around $30 billion per year in economic costs.
More than 77 per cent of Canadian exports go to the U.S.
Canada’s manufacturing sector faces the biggest risk should Trump push forward on imposing broad tariffs, said Canadian Manufacturers and Exporters president and CEO Dennis Darby. He said the sector is the “most trade-exposed” within Canada.
“It’s in the U.S.’s best interest, it’s in our best interest, but most importantly for consumers across North America, that we’re able to trade goods, materials, ingredients, as we have under the trade agreements,” Darby said in an interview.
“It’s a more complex or complicated outcome than it would have been with the Democrats, but we’ve had to deal with this before and we’re going to do our best to deal with it again.”
American economists have also warned Trump’s plan could cause inflation and possibly a recession, which could have ripple effects in Canada.
It’s consumers who will ultimately feel the burden of any inflationary effect caused by broad tariffs, said Darby.
“A tariff tends to raise costs, and it ultimately raises prices, so that’s something that we have to be prepared for,” he said.
“It could tilt production mandates. A tariff makes goods more expensive, but on the same token, it also will make inputs for the U.S. more expensive.”
A report last month by TD economist Marc Ercolao said research shows a full-scale implementation of Trump’s tariff plan could lead to a near-five per cent reduction in Canadian export volumes to the U.S. by early-2027, relative to current baseline forecasts.
Retaliation by Canada would also increase costs for domestic producers, and push import volumes lower in the process.
“Slowing import activity mitigates some of the negative net trade impact on total GDP enough to avoid a technical recession, but still produces a period of extended stagnation through 2025 and 2026,” Ercolao said.
Since the Canada-United States-Mexico Agreement came into effect in 2020, trade between Canada and the U.S. has surged by 46 per cent, according to the Toronto Region Board of Trade.
With that deal is up for review in 2026, Canadian Chamber of Commerce president and CEO Candace Laing said the Canadian government “must collaborate effectively with the Trump administration to preserve and strengthen our bilateral economic partnership.”
“With an impressive $3.6 billion in daily trade, Canada and the United States are each other’s closest international partners. The secure and efficient flow of goods and people across our border … remains essential for the economies of both countries,” she said in a statement.
“By resisting tariffs and trade barriers that will only raise prices and hurt consumers in both countries, Canada and the United States can strengthen resilient cross-border supply chains that enhance our shared economic security.”
This report by The Canadian Press was first published Nov. 6, 2024.
