Sunday, February 9, 2014

Why JPMorgan is back in the CLO market

JPMorgan is once again hunting for primary CLO bonds. The bank made enormous profits since 2009 buying the higher rated tranches that provided great spreads above the bank's funding costs. After the "London Whale" fiasco the bank pulled back on its CLO buying, but now JPMorgan appears to be back.
Asset-Backed Alert: - J.P. Morgan is again showing interest in the senior pieces of newly issued collateralized loan obligations. The bank, which had been among the world’s largest buyer of those securities, retreated from the market early last year. But in the past two weeks, it has resumed discussions with managers that have deals in the works.
Why is this renewed interest in CLO paper? Here are some possible explanations:

1. New CLO bonds are still coming to market with attractive pricing. According to LCD, a recent CLO deal from ING (see press release from Fitch) priced the AAA (the largest tranche) at LIBOR + 150bp. A regular AAA corporate bond would typically price at (equivalent of)  L+20 to L+40bp. While there is clearly more risk with structured paper, the discount is attractive on a relative basis. CLOs also look attractive relative to other structured credit bonds (see post).

2. There is speculation that when it comes to CLOs, the US regulators may provide some Volcker Rule relief (see discussion - Item # 6). Below is the video from the latest congressional hearing on Voclker Rule implementation below.
Asset-Backed Alert: - ... some industry players believe J.P. Morgan now is part of a contingent that expects the Commodity Futures Trading Commission, Comptroller of the Currency, FDIC, Federal Reserve and SEC to ease Volker Rule restrictions for CLOs in the coming weeks.
3. JPMorgan is in effect hedged on its CLO holdings. If the new regulatory framework ends up being damaging to the CLO market by restricting banks' participation, the CLO bond issuance would decline materially.
BW: - Morgan Stanley cut its collateralized loan obligation [2014] forecast by as much as 27 percent to $55 billion as issuance slowed last month because of questions about the Volcker Rule’s impact on the funds that finance buyouts.
This reduction in supply would over time result in strong secondary demand for the highest-rated tranches. And banks will be given ample time to reduce their holdings. Either way, JPMorgan comes out ahead on this.

Hearing:  “The Impact of the Volcker Rule on Job Creators, Part II”
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