Another option is a partial liquidation. One US CLO portfolio manager says that margin calls can force CLO managers to sell off assets from the warehouse to prevent full liquidation. “If you can generate proceeds to pay back the bank’s loan then less margin is required.” However, this approach is not usually attractive to a warehouse equity provider, which would be hit by low proceeds from sales of assets at low prices. Another factor is the amount of assets ramped in the warehouse before the draw stop. “The smaller the warehouse, the smaller the top-up amount,” says a European CLO manager. The real problem is not the loan dip, it’s the rapidity of the fall, says a CLO PM. “In 2016, there was volatility for months, giving CLO managers the opportunity to sell in and out, and maintain the portfolio test.” Barclays research estimates there are $12-13 billion of loans held across 120-130 US CLO warehouses. Europe’s 40-50 warehouses hold €4-6 billion of loans.

These provisions — which put a stop to all warehouse trading when the market value of the underlying portfolio dips below a level set by the senior lender — safeguard against warehouses being unwound. But they also prevent CLO managers from ramping up just as loan valuations are at their lowest. As of 22 March, US loan prices are averaging 78.4, while European loans are at 80.4. A Barclays research report on 20 March estimated that average loan prices would need to recover nearly 13 points in the US and 11 points in Europe for warehouses to regain the ability to purchase assets. Another path out of a draw stop is for the warehouse equity investor to add sufficient capital to cure the test. But for some CLO managers that retain equity in their deals this is not compelling. “We were able to buy loan assets cheaply in early March before hitting our draw stop. But we’ve got over two years left on the warehouse and we’re better off sitting on these to maturity rather than putting more equity in,” says a New York-based CLO portfolio manager. A CLO manager in Europe says it’s easier to negotiate warehouses if the manager is also the equity in the vehicle. “Usually warehouses are a bilateral relationship, so it is possible to come to a consensus. If there is third-party equity, they might be hesitant to provide money to a declining vehicle.” A triggered draw stop results in various outcomes, depending on negotiations between the senior lender, equity holder and CLO manager. One warehouse equity investor says that the bank can liquidate the warehouse, though this is unlikely to be the first choice for any of the parties involved.