Fund managers keen to restart the lucrative collateralized loan obligation-making (CLO) machine are having to stretch the bounds of what counts as collateral behind these deals, Bloomberg News reported. The CLO machine broke down last year as the supply of leveraged loans dried up. Loans typically emerge from private equity led buyouts — but many M&A deals were stranded in Europe earlier this year as valuation expectations diverged. CLOs in Europe are now backed by a record 16% of junk bonds, according to data by Morgan Stanley. Nine percent of those portfolios have fixed-rate coupons, double the allocation from just three years ago. That’s left CLO managers with a dearth of collateral, after demand returned for CLOs themselves. So they’re resorting to junk bonds outside their usual remit. The trend is much more eurocentric given limits on US deals, where the Fed restricts pools to a 5% allocation to bonds. The European Commission has looser limits, and CLO managers can typically allocate up to 30% to bonds. Some are looking to push it even higher. “Some managers are pushing those buckets up to 35% versus 30%,” said Laila Kollmorgen, a portfolio manager covering European CLOs at PineBridge Investments. “We’re seeing a lot of that.”
