No, you haven’t missed the fixed income rally
Norinchukin Bank is preparing a return to the global CLO market, Bloomberg reported last week.
For those that spend a little less time than us in the world of CLOs, Norinchukin Bank (more popularly known as Nochu) is a Japanese cooperative bank mainly serving farmers and fishing cooperatives, which also happens to be one of the country’s largest institutional investors. To cut a long story rather too short, between 2017 and 2019 Nochu became known as the CLO ‘whale’ after becoming the single biggest buyer of AAA CLO notes globally.
One new or returning investor wouldn’t be worth talking about, but Nochu and other Japanese banks dominated the senior tranches of the global CLO market to such an extent that they didn’t just help to tighten pricing dramatically (given the sheer size of the investments), they were also a driving force for more bondholder-friendly CLO documentation.
Even though these investments (in the most senior and safest tranches of CLOs) gave Japanese banks and their clients much needed income at a time when yields were slim everywhere and Japanese government bonds were mostly paying zero, from 2019 they faced growing pressure from regulators to explain the oversized holdings and ultimately paused investments. Many of the CLOs these banks would have invested in 4-6 years ago have now amortised or been refinanced with alternative investors, and this really should have provided the regulator with the proof of concept.
According to Bloomberg Japanese banks slowly started buying CLOs again from 2021, starting in the US, but they paused again in 2022 amid growing recession fears and the fallout from the UK’s mini-Budget. At that time UK pension funds were forced to sell CLOs in significant size, with US banks and European insurance firms picking up the pieces at very attractive levels.
The market has recovered sharply in the months since, with AAA CLO spreads now trading in the Euribor plus 160-190bp range and recent primary deals getting done at 185bp versus a peak of around 275bp in early Q4 2022. We have now retraced over half of the CLO spread widening seen since the start of the war in Ukraine, but spreads are still three times wider than the tightest prints seen post-2008.
It goes without saying that euro yields of around 4.5% for AAA rated assets (and with most or all of that coming from coupon income) should be extremely attractive for risk-averse investors like banks (especially Japan’s), but it is easy for the market to get ahead of itself. Reports or rumours of investors like Nochu coming back to the market as an active buyer have been going around for some time, but we’re yet to see the first deal come to market with the AAAs all being anchored and preplaced with ‘a Japanese bank’.
If these buyers were to re-enter the market, and for now we would assume it would be in smaller size than in 2017, then that could create a very interesting technical for AAA CLO spreads to rally further. Unintentionally, that could create good support for leveraged loan prices and corporate funding costs, which could in turn result in more older CLOs being refinanced in the next two years, a big potential boost to mezzanine CLO bondholders as most of these bonds are still trading at significant discounts to par.
For now we see no reason to get overexcited, but watch this space if the whale is ready to make another splash in CLOs.