LONDON, June 17 (LPC) - Slowing investment by Japanese financial institutions has pushed pricing on the most senior tranches of European CLO funds to its widest point in nearly three years as investors such as Norinchukin Bank scale back multibillion-dollar investments.
Japanese banks account for about 10% of the US$750bn global CLO market, according to a Bank of England estimate. But no Japanese investor acted as an anchor investor for a Triple A tranche of a European CLO in May, sources said.
Partly as a result, average spreads on European Triple A tranches, the largest and most senior portion of CLO funds, widened to 113bp in May, the widest level since 115bp in September 2016, according to LPC data.
“The market has moved away from its reliance on Japanese anchor Triple A investors,” a London-based CLO investor said.
Norinchukin Bank, or Nochu, has been in the spotlight due to its rapid expansion in the asset class. The bank almost doubled its CLO holdings to ¥7.4tn (US$68bn) in March 2019 from ¥3.8tn a year ago, according to the bank in May.
“We have seen one particular Japanese investor step away,” the CLO investor said.
Nochu normally invests with top-tier CLO managers by buying whole Triple A tranches at a 4bp-6bp discount on the broader buyer base, which has dragged average pricing in the CLO market lower.
But Nochu has recently asked for higher spreads in both the European and US CLO markets, although the precise level will not be known until a CLO anchored by the bank is issued.
“In the past few months, they wanted 108bp-108.5bp for Triple A, and now they want to widen on that,” a fund manager said.
CLO managers can syndicate deals without Japanese anchor investors to a broader investor base by widening the pricing of the top-rated tranches.
“The bank invests in various assets while controlling the risks of our overall portfolio under the concept of ‘globally diversified investments’,” a Nochu spokesperson said in an email.
The pullback and subsequent widening in CLO spreads was prompted by the Japanese Financial Services Agency’s proposed amendment to regulatory capital requirements relating to investments by Japanese financial institutions in securitisations in December. The amendment means most CLOs attract much higher risk weightings for Japanese banks.
The changes caused a rapid spread widening in the larger US CLO market at the start of the year, but European spreads were slower to respond and started to widen in the second quarter.
As Japanese banks pulled back from the European CLO market in recent months, other investors, including global insurance companies, have stepped forward to fill the gap.
This rotation of the investor base is supporting European CLO issuance, and could even be healthy for the market. At €12.4bn so far this year, CLO issuance volume is 19% higher than 12 months ago, despite a reduced supply of leveraged loans in which the CLOs invest.
“There doesn’t seem to be any lack of demand for Triple A, and I don’t think over-reliance on any one large investor is a healthy thing,” said Andrew Lennox, an ABS portfolio manager at Hermes Investment Management.
The US CLO market is five times bigger than its European counterpart. US CLO pricing quickly widened earlier this year immediately after the JFSA’s proposal, but spreads have tightened again as new investors have come forward.
Average spreads on US Triple A CLO tranches tightened to 131.7bp in May, from the highest level this year of 138bp in February.
“Despite the fact that Japanese investors didn’t buy, syndicate desks did their job. They actually syndicated the transactions, and we saw investors more interested in purchasing CLO Triple As,” said Laila Kollmorgen, a managing director at PineBridge Investments in Los Angeles.
“The investor base has developed away from the Japanese buyers.” (Editing by Tessa Walsh)