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News in brief

August 2022 | Issue 248
CLO arrangers take down triple As to get European deals completed
European CLO arrangers are taking down large chunks of triple A paper to get deals over the line amid market volatility, according to market sources. Others, meanwhile, have committed to investing in triple As to secure future mandates.
Barclays, for example, is understood to have taken nearly half of the triple A tranche in Permira Credit’s Providus CLO VII, which it arranged in June, and Deutsche Bank took a sizeable portion of Sound Point’s Sound Point Euro CLO IX in early July.
NatWest Markets, on the other hand, has begun to reinvest in triple As. Sources indicate the bank is serving as co-placement agent and investing in the triple As on an upcoming Napier Park Global Capital deal. It is also understood to have had conversations with other managers to take down €50 million to €100 million in deals, with the expectation of winning future European CLO arranging mandates. Creditflux first reported on the development in April.
“Bank appetite for triple A paper, given where levels are, makes sense from a return perspective,” says one source. “CLOs offer highly rated liquid paper and there’s always a department of a bank that has cash to deploy. As volatility has increased, it has made sense for arrangers to use that relationship.”
European CLO triple As have widened to around 220-230 basis points over Euribor for primary deals as Creditflux goes to press (aside from Blackstone’s Clonmore Park at 170bp).
However, at 250bp to 270bp, sources say European CLO triple A secondary paper offers better value than primary.
CLO arrangers race to place as bid countdown begins
US CLO arrangers are scrambling to print deals as investors across the capital stack place time limits on their bids. In particular, say market sources, some junior debt investors are stipulating their bids are only good for 24 hours.
“Smart investors know the worth of their order,” says a CLO capital markets specialist. “They are happy to invest in the secondary market if their levels are not met in primary.”
CLO arrangers are placing triple A tranches first, in order to give a deal a reasonable chance of getting over the line.
The marketing process for senior notes can take several weeks, and sources say this means triple A prints at pricing are reflective of levels a few weeks previously.
Even senior CLO investors are putting deadlines on bids, although they are typically good for a few weeks, says the New York-based CLO specialist.
Once the CLO first-pays are accounted for, an arranger will focus on placing the remainder of the debt stack.
Despite CLO syndication desks facing changeable conditions, there has been a healthy amount of US issuance.
$13.24 billion and $9.7 billion of US new issues priced in June and July respectively. In Europe, just $1.91 billion of CLOs priced in those two months combined.
Cheyne looks to uncover value in sponsorless loans
Cheyne Capital Management is eyeing sponsorless direct lending opportunities for a fund launch later this year.
The London-headquartered firm is understood to be targeting €750 million for the vehicle. It will invest across the capital structure (from first lien loans to preferred equity) in European companies with between €10 million and €100 million in earnings, and will target 15% returns. A spokesperson for Cheyne declined to comment.
Cheyne is going against the grain: at Creditflux’s US mid-market forum in July, panellists from direct lending behemoths Blackstone, Golub and Churchill noted the value of private equity sponsors — which are present in the majority of transactions.
“We prefer them [private equity sponsored deals] because sponsors do a good job of picking companies. If we’re making a loan there are two eyes concluding it’s a good company,” said David Golub.
However, direct lending giants tend to target upper-middle market companies, so there may be an opportunity for boutique firms such as Cheyne.
UBS says modelling suggests upcoming recession won’t bite
Likely global recession scenarios look mild according to strategists at UBS, who have run four models.
Inflation pressures will continue, but UBS says it is optimistic about how quickly disinflation will start to show up because of the dramatic improvement in bottleneck stress indicators, although it doesn’t expect that to happen until at least late 2023. For its baseline model, UBS expects 3% global growth (versus historical 3.6%) for this year.
“It’s no surprise we are coming off high growth level because of covid reopening tailwinds, but the speed of the slowdown is spectacular,” says Arend Kapteyn, global head of economics and strategy research at UBS.
The first model is a consumer-led recession. In the second, UBS has modelled the Fed and ECB overtightening because inflation doesn’t come down, so rates are hiked further than what’s priced in. Cumulatively, this financial shock could create a recession.
The final two scenarios model the effect of Europe struggling with gas supply. In scenario three, Europe starts to pre-emptively ration and control its own supply. That could lead to serious disruption with a couple of negative quarters.
On the other hand, if Russia cuts all gas deliveries to Europe, and Europe is not in control of the timeline, a severe recession would follow.
All scenarios except the last look manageable, say the strategists. “We looked at all the recessions between 1980 and the pandemic (over 40 countries and 147 recessions) and... you end up at the 25th or 30th historical percentile relative to a ‘normal’ recession,” UBS officials said.
Pattern of loan sell-off implies widespread uncertainty
A quirk to the June loan dip was that industries and rating bands sold off in parallel. This implies the sell-off was almost exclusively driven by mutual and exchange-traded fund redemptions, and not by investor worries about the fundamentals of individual credits.
Loan prices in June generally tracked the level of distress in the 2016 energy sell-off, according to a note published by Capra Ibex’s chief investment officer Michael Kurinets.
“All loan types moved down in near unison, implying that the market was worried about the future, but it did not know where the problems would occur,” Kurinets says. “In 2016, the dislocations in the negatively affected industries were significant, leaving credit tails in CLOs much larger than they are today.
“Because of this tail risk, tier one CLO double Bs traded in the mid 60s in March 2016, whereas at the end of June 2022, tier one double Bs were trading in the mid 80s.
“The market’s forward view suggests that even though the future may see a recession (or we are already in one), defaults will not jeopardise the money goodness of CLO debt or cash flows to equity.”
The view correlates with forward-looking models from a number of market analysts who point to the volume of loan refinancing activity in 2021. This means the maturity wall for the bulk of the loan market comes after the generally accepted range in which a recession is expected to take place.
CLO equity arb gets squeezed but investors eye recovery swing
The CLO equity arbitrage endured a wildly volatile first half of 2022, but observers say the time could be right to buy into the asset class.
Generally, 2022 has seen leveraged loan spreads lag the widening in CLO liabilities. But this trend has been bumpy, leading to brief periods of attractive equity arbitrage and others when the spread differential between assets and liabilities is squeezed.
“In 2021 the equity arbitrage looked strong for the entire year,” said Ian Gilbertson, co-head of US CLOs at Invesco, speaking at the SFVegas CLO conference in July. “One of the differences this year is how things are jumping about. Both liability spreads and asset spreads are widening, but it hasn’t been consistent.”
In April the equity arbitrage tightened to just 1.75%, which was close to its five-year low — largely driven by the blow-out in CLO triple A spreads around the same period. Loans only began to sell off in May.
Research from Wellington Management, published in July, argues that loan fundamentals through the likely coming recession bode well for CLO equity performance.
“Even with deteriorating fundamentals, if defaults remain range-bound, we believe the high loan spreads associated with a recessionary environment will offer opportunities for credit selection to offset realised defaults,” wrote portfolio manager Alyssa Irving, investment director Andrew Bayerl and credit analyst Neil Delap.
July research from Oxford Funds concluded the current vintage of CLO equity should deliver attractive returns based on data from previous recessions.
Wide spreads lead managers to plump up CLO par subs
Widening CLO spreads are causing rating agencies and investors to push for additional par subordination in CLO tranches, sources say. CLO funding costs have risen above 300 basis points in Europe and above 275bp in the US.
US CLO double B tranches with at least three years of reinvestment were attaching at an average of 9.45% in July. In Europe, the figure for June and July combined was 11.91%.
Two years ago, as the pandemic rocked financial markets, European CLO double B tranche par subordination was on average 11.77% and funding costs 233.7bp. US CLO double Bs attached at 10.13% and cost of debt averaged 226.28bp across May and June 2020.
When CLO spreads are wide and the market is stressed, there is a high expectation of defaults and thus a higher chance of coverage test failures, sources say. When CLOs fail coverage tests, CLOs delever to cure the failing tests by paying the principal and interest on the CLO liabilities, starting at the top.
If these interest payments are higher as CLO tranches are more expensive, this leaves the CLO with limited excess spread to delever the CLO bonds, so more par subordination is required.
Last year as CLO volumes set records, US CLO double Bs on average attached at 8.2% and European double Bs at 9.75%.
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Global credit funds & CLO's
August 2022 | Issue 248
Published in London & New York.
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