Global credit funds & CLO's
May 2020
| Issue 223
Published in London & New York.
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May 2020 | Issue 223
CLO managers seek to defer and redirect equity distributions
Hugh Minch headshot
Hugh Minch
Half of US CLOs are due to miss equity payments as downgrades and defaults resulting from the lockdown economy trigger overcollateralisation breaches across the market, according to the latest bank research estimates. But some managers are being granted the flexibility to redeploy cash that would otherwise be distributed to equity investors into discounted loans. The capital can also be used to negotiate workout agreements in case defaults spike.
For PineBridge Investments’ CLO tranche investor Laila Kollmorgen, based in Los Angeles, deferring equity payments and reinvesting is the right decision.

“What you want a manager to do is add value, and in this market that means buying loans at a significant discount to par. If I was an equity investor I would much prefer my manager to keep that equity distribution as it improves the calculation for overcollateralisation.”

One source at a CLO manager told
his firm was reinvesting 50% of all equity payments as well as deferring 50% of the subordinate management fee, noting that most CLOs are fully invested and therefore cannot profit from loan market dislocation.
The strategy is most common in situations where managers are retaining the majority equity position themselves, but third-party CLO equity investors may take an opposing view.

Equity investors that actively trade their portfolio — such as those who invest via hedge funds — may prefer to receive a distribution and reinvest into assets that are even more discounted than loans, such as CLO mezzanine tranches.

Some CLO documentation allows managers to defer equity payments without investor consent, although this flexibility is uncommon, says Allen & Overy partner Larry Berkovich.

“In some deals a certain percentage of the equity has the right to redirect all or a portion of a payment that would otherwise be payable to it as a capital contribution to the deal, but most deals don’t give the manager the discretion to do this,” Berkovich says.

CLO equity trading has all but ground to a halt since the market sell off in March, when the net asset value of many funds that invest in first loss tranches fell 50% or more.
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“Adding value means buying loans at a significant discount to par”
Laila Kollmorgen,
CLO tranche investor | PineBridge Investments
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