How Does Investor Demand Affect CLO Creation, Firm Borrowing, and Investment?

Abstract

The collateralized loan obligation (CLO) market has grown drastically, with the amount outstanding rising from $100 Billion in 2005 to $650 Billion in 2020. We examine the effect of investors' demand on new CLO deal formation as well as on corporate borrowing and investment. We do so by using detailed data from insurance companies, which are the largest group of CLO investors. We present three main findings. First, when insurers experience favorable operating cash flows, they are more likely to invest in CLO deals, especially deals by CLO managers that they previously invested with. Second, when CLO managers are more exposed to insurers' favorable cash flows through past relationships, they are more likely to launch new CLO deals. Third, among borrowing firms, those more affected (through CLO managers) are more likely to receive new loans, as well as increase leverage and investment. Our results imply that investor demand affects CLO deal formation, as well as corporate borrowing and capital structure decisions. We also present evidence that insurers' aggregate demand for CLOs, proxied by their cash flows, is important for the growth of the CLO market segment that is exposed to insurers through past relationships.

Keywords: Collateralized Loan Obligation (CLO), Securitization, Insurance Companies, Corporate Borrowing, Loans, Capital Structure

JEL Classification: G22, G23, G32