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November 2020 | Issue 229
CLOs census
Chin up – it’s been a pretty good effort
Robin Armitage
CLO managers did well to survive the covid-19 crash in loan valuations — but they failed to fully capitalise on the ensuing volatility, say participants in the Creditflux CLO Census 2020
It’s not always media headlines you have to look out for (see above) because sometimes CLO managers are their own fiercest critics. In Creditflux’s 2020 CLO Census, 59% said they did not take full advantage of the volatility in credit this year.
This concession from managers is not a one-off: as part of the 2019 census we asked whether CLO managers took advantage of the late-2018 loan market volatility and the result was largely the same, with almost two-thirds of managers believing they could have done better then.
However, one CLO investor told Creditflux that CLO managers outperformed loan default rates this year by a distance, so perhaps the frustration is directed at the various rules which CLOs must abide by and which can limit investment flexibility.
“CLOs have significant restrictions, so most managers have taken advantage to the extent possible,” said one CLO manager.
No holding back on ESG CLOs
An even more emotive topic is ESG and its place in the CLO market. Opinion is swaying towards incorporating ESG frameworks within CLOs, with 59% of respondents agreeing that CLOs should adopt ESG investment guidelines, an increase on the 44% of respondents in 2019. However, ESG provokes a strong reaction from those for and against the concept. One CLO manager, for example, responded to this question with: “ESG is a terrible idea — leftist garbage which hurts investors. No fiduciary should be investing in ESG.”
The argument that limiting investments to ESG-approved assets is a breach of a CLO manager’s fiduciary duty is often used by those ranged against the concept. ESG advocates say merely that an “ESG compliant CLO will outperform in the long term”. For those in between, the issue of how to quantify the ESG-ness of a CLO is cited as problem that still needs to be solved.
In general, CLO service providers and arrangers agreed that CLOs should adopt ESG guidelines: 66% of service providers and 67% of arrangers viewed ESG investment positively. Things were closer for CLO managers and investors, as 55% and 49% respectively voted for ESG.
Survival is biggest positive this year
If ESG CLOs still divide our survey participants, there are at least clear positives in terms of how CLOs have withstood a pandemic which has decimated many businesses. Overall, 43% of respondents said that the resilience demonstrated by CLO structures was the industry’s stand-out achievement this year. This was also the most popular view among CLO managers and service providers. But CLO investors were more inclined to see volatility and the opportunities it afforded to skilled managers as the most positive aspect of 2020.
The least popular choice in this category was that media coverage of CLOs has improved — only 1% of participants agreed. This figure was unsurprising given press coverage of a CLO warehouse unwind and the scale of CLO over-collateralisation test breaches. But let’s not forget, an OC breach is supposed to happen when loans are downgraded to triple C and valuations slump (as they did indiscriminately in March). OC tests are part of a self-correcting mechanism, which has proven its worth.
The first batch of CLOs that priced after the March sell-off were short-dated deals, out of necessity rather than desire. But our survey shows that market participants still believe longer-dated CLOs are the best structures, with 43% voting for five-year reinvestment US CLOs as being ideal. In Europe, 30% went for four-year CLOs.
However, there was division between the various sectors of the industry. CLO managers (32%) and service providers (28%) preferred five-year tenors, while arrangers were split between three, four or five years (22% each) and investors preferred three or five years (33% each).
When it comes to CLO warehouses, many are happy to say that they are performing as expected, with no tweaks needed: 56% of arrangers, 46% of investors and 44% of service providers agreed, making up 44% of the overall vote. CLO managers instead believe that warehouses are generally OK but draw-stop triggers/mark-to-market provisions need to be loosened (44% voted this way, while 39% believe warehouses perform as expected). Generally, the consensus puts CLO warehouses in a positive light, as the main gripe was from 28% of CLO arrangers who claim that warehouses are not lender-friendly enough.
When we asked CLO market participants what they would like to change about CLO infrastructure, most of the comments were directed at improving secondary market practices. Globally, people have become increasingly reliant on technology this year, especially for shopping and communication. Perhaps this will be a catalyst for a tech-based solution to trading CLO tranches.
  • The 2020 CLO Census was an online survey open for two-weeks in early October.
  • We received 222 responses, compared to 201 in 2019.
  • We asked respondents to indicate if they were a CLO manager, investor, arranger, or service provider. We vetted responses and eliminated all cases where companies voted for themselves.
  • We would like to extend our sincere thanks to the CLO community for supporting this initiative.
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Global credit funds & CLO's
November 2020
| Issue 229
Published in London & New York.
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