Fund Redemptions No Deterrent to Loan Rally

Surge in new collateralized loan obligations helps push prices to five-month high.

Not even investors fleeing mutual funds that buy junk-rated U.S. corporate loans is enough to keep Cerberus Capital Management LP from tapping the market to finance its $9.2 billion bid for Safeway Inc.

Cerberus will begin raising $6.7 billion in loans today to fund its buyout of the grocer and merge it with Albertsons. Less than a week ago, mutual funds that invest in the debt posted their biggest withdrawals in almost three years, bringing redemptions since mid-April to more than $3 billion.

While small investors flee and U.S. regulators are stepping up pressure on banks to refrain from underwriting deals deemed too risky, those with the most at stake are plowing ahead in a market that has delivered returns of almost 100 percent since the end of 2008.

“We are advising clients that they shouldn’t get caught offsides by selling loans,” Frank Ossino, a money manager in Hartford, Connecticut, who oversees $3 billion of loans at Newfleet Asset Management LLC, said in a telephone interview. “A strategic allocation within loans is still warranted as the long-term investment thesis hasn’t changed.”

The outflows have been dwarfed by a surge in new collateralized loan obligations that have helped push prices on the debt to a five-month high. Last week, Leon Black’s Apollo Global Management LLC raised $1.5 billion in the biggest CLO this year, and JPMorgan Chase & Co. forecasts a record $100 billion will be raised this year.

The average price of the S&P/LSTA 100 index, which tracks the largest first-lien loans such as those for personal-computer maker Dell Inc. and hotel chain Hilton Worldwide Holdings Inc., climbed to 98.82 cents on the dollar yesterday, the most since Jan. 24. That’s not far from a seven-year high of 98.9 cents reached earlier this year.

In the aftermath of the worst financial crisis since the Great Depression, loan prices fell as low as 59.2 cents in December 2008, based on the index.

Loan mutual funds and exchange-traded funds expanded about 137 percent since the end of 2011 to $171 billion as retail investors sought to get in on the recovery, according to the Loan Syndications & Trading Association. That’s about 25 percent of the buyer base in the market, according to the trade group.


Hedges Sought

More recently, the funds drew investors seeking a hedge from the potential for increasing interest rates, as loans typically have rates that rise and fall with benchmarks. The latest redemptions in retail funds followed a streak of 95 continuous weeks of deposits.

“There was a tremendous consensus around higher interest rates this year,” Bill Housey, a money manager at First Trust Advisors LP, which manages $90 billion in assets, said in a telephone interview. “With what’s happened with rates, what you’ve seen is some of the less stable money moving out of the asset class.”

The yield on the benchmark 10-year Treasury note has dropped about 0.4 percentage point this year to 2.64 percent. At the start of 2014, the median end-of-year yield forecast was 3.44 percent, according to estimates compiled by Bloomberg.

Investors began to pull out of loan funds as Federal Reserve Chairwoman Janet Yellen signaled the central bank, which has held its interest-rate target near zero for more than five years, won’t increase borrowing costs for a “considerable time.”

Banks and other asset managers buying up portions of CLOs aren’t easily dissuaded as the issuance of the funds that repackage loans accelerates.

“Institutions are clearly saying they don’t want to be lulled into a false sense of security,” Housey said.

More than $46 billion of CLOs have been sold through the first five months of the year in the U.S., according to Royal Bank of Scotland Group Plc. That compares with $82 billion in all of last year. CLOs pool high-yield corporate loans and slice them into securities of varying risk and return, typically from AAA ratings down to BB.

The growth in the market for speculative-grade corporate loans has spurred warnings from regulators with the Fed and the Office of the Comptroller of the Currency asking lenders last year to improve lax underwriting practices. Todd Vermilyea, a Fed official, said May 13 that standards have continued to deteriorate in 2014’’ and that “stronger supervisory action” may be needed.


‘Quickly Oversubscribed’

“The comeback in loan prices is driven by the support away from retail,” Newfleet’s Ossino said. “So much so that we’ve started to see deals become quickly oversubscribed again, which leads to tighter pricing and an increase in opportunistic transactions.”

The loans being raised for Cerberus’ purchase of Pleasanton, California-based Safeway include a $4 billion portion coming due in seven years, a $2 billion slice maturing in March 2019 and a $700 million one-year piece, according to data compiled by Bloomberg.

Peter Duda, a spokesman for Cerberus at Weber Shandwick, didn’t immediately respond to an e-mail seeking comment on the financing.

Apollo’s $1.5 billion CLO was arranged by JPMorgan, the same lender that increased its 2014 forecast for the funds from as much $70 billion.

“Continued demand from CLO issuance provides support to the broader loan market,” David Mazza, head of ETF research at State Street Corp., said in a telephone interview. “As we move toward the end of the year, investors will likely move back into leveraged loan funds as they think about the end of the Fed’s tapering.”


Bloomberg News

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