Global credit funds & CLO's
May 2020
| Issue 223Published in London & New York.
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May 2020 | Issue 223
Analysis CLOs
Credit pickers need luck to avoid OC trap
Charlie Dinning
Data journalist
Tanvi Gupta
Head of data journalism
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GoldenTree had an average triple C bucket of 8.95% in its two 2019 European CLOs, GLM Europe 2 and 3.
But GoldenTree’s 2018 CLO, GLM 1, registered an even larger triple C bucket of 10.9%. This was highest figure among European CLOs in our data — and it contributes to the firm’s average triple C bucket of 9.6% across its three European CLOs that went effective in 2018 and 2019: again the highest number in Europe.
* rated by Fitch
We know what you’re thinking: is my CLO failing its OC test? The truth is, in all this volatility, it can be hard to keep track, unless your deal has high quality liquid loans
It didn’t take much to get caught. Around 20% of loans held in the $600 billion CLO market have been downgraded, according to Bank of America analysts. This figure is especially significant when you consider that the CLO market started 2020 with a record proportion of loans in portfolios rated B- or B3 — just one notch above the dreaded triple C level.
A wave of leveraged loans being downgraded to triple C is bad news for CLO managers. Once a CLO breaches its portfolio limit of 7.5% of triple C rated assets, any extra triple C rated loans must be marked at market value instead of par. This could lead to the deal failing its junior overcollateralisation (OC) test, so the CLO is unable to trade and cannot pay its equity holders. According to a US CLO equity investor, a fifth of US CLOs have now tripped some form of test.
2019 CLOs are close to the edge
Across US CLOs that went effective in 2019, the average triple C bucket for each deal sits at 6.87%, according to the latest trustee reports, leaving an average of just 63 basis points of wriggle room. For European CLOs that went effective last year the average triple C bucket is 4.73%. CLOs that went effective in 2018 have 7.97% triple C exposure in the US and 5.42% in Europe.
Golub Capital in the US and GoldenTree Loan Management in Europe recorded the highest average triple C buckets across deals that went in effective in 2019. Golub has an average triple C bucket of 13.41% across four US CLOs. All four are failing their triple C bucket tests, with Golub 40(B) registering a bucket of 16.71%.
CIFC has smallest US triple C bucket
“We had marked three loans as potential default risks, but that has grown to 20”
Zais Group has the most triple C exposure among US CLO managers. It has an average triple C bucket of 14.07% across its three CLOs that went effective in 2018.
At the other end of the spectrum, some CLO managers are well positioned to take advantage of the current loan climate with low triple C buckets and high OC cushions in their 2018 and 2019 deals.
CIFC Asset Management has the lowest average triple C bucket for US CLO managers, with an average of just 2.43% across 10 CLOs. The manager also recorded a strong OC cushion, averaging a junior OC score 5.13% above its trigger. That’s the fourth highest amongst US CLO managers.
Fair Oaks Capital has the lowest triple C bucket in Europe. The manager launched its only CLO in June and this deal has just 1.1% of its portfolio in triple C rated loans. Fair Oaks I also has a below average junior OC cushion: 4.19% above its trigger.
GSO Capital Partners has the most wriggle room on its junior OC tests, averaging 5.14% above its trigger across four of its European CLOs.
The current high levels of triple C assets in CLOs may, in part, reflect managers’ strategies. According to a European CLO portfolio manager, very few managers have sold triple C loans in their portfolios to manage the test, as they are unwilling to accept a loss. He says sales are a trade-off between the short-term equity payment versus the long-term value of the loan, with most managers choosing the latter.
We’ve got a breach in the OC
Medalist Partners Corporate Finance’s JMP V CLO, which went effective in 2018, has 15.6% of its assets rated triple C. JMP V is one of 11 US CLOs that went effective in 2018 that is failing its junior OC test in its most recent trustee report. Only one 2019 CLO is failing its OC test: Apex 2018-II, which recorded a triple C bucket of 14.5%.
Of the 12 CLOs that have breached their junior OC test in April, seven have paid nothing to their equity investors at their April payment date.
Zais has the most US CLOs that are failing their OC tests. Zais 8, 9 and 11 went effective in 2018 and missed their April 2020 payments. The average most junior OC cushion the manager has to work with across its four US CLOs in the data set is -1.61%, with only its 2019 CLO, Zais 13 passing its most junior OC test in April. The New Jersey-based firm has made a habit of holding on to out-of-favour loans in the belief that these will ultimately provide value, either through a recovery in the loan, or through a restructuring (see page 27).
Not one 2018 or 2019 European CLO is failing its most junior OC test. But once again it is GoldenTree that looks to be the most exposed. The manager’s European CLO arm has the lowest average junior OC cushion of its peers, with its CLOs recording a cushion of just 2.39%.
The CLO situation is expected to get worse before it gets better. One European CLO portfolio manager says that in March they had marked three loans as potential default risks, but “that number has grown to 20; and we expect it to get worse”.
According to market sources, European CLO triple C buckets are forecasted to rise to between 15 and 20%, with the most pessimistic estimates putting the figure at 25%. The European CLO market has yet to see a manager miss an April payment, but market sources indicate that we will start seeing missed payments to equity holders in July.
Ratings are sector dependent
Several market sources have indicated that the level of exposure a CLO manager has to covid-19 affected sectors has been the defining factor in how they are faring, rather than the actual credits they hold.
One area that has been especially hard hit has been business and consumer services, which includes entertainment and leisure, and gaming and hotels.
The most widely held loans in the US and European CLO market downgraded in March came from this sector. In Europe, Norwegian cruise operator Hurtigruten Group, which is held in 123 European CLOs for a total of €411.3 million, was downgraded by S&P from B- to CCC+ on 20 March.
In the US, the downgrade of services holding company AVSC Holdings, which has been hit by event cancellations, had the biggest impact: $1.1 billion of its loan is held across 487 US CLOs. Its parent company, PSAV was bought by Blackstone in August 2018, but Blackstone’s CLO arm, GSO, does not own any of AVSC’s loan.
AVSC’s loan was trading above par in January but dropped from 100.2 on 20 January to 60.0 on 23 March. Ares Management has the largest exposure to the loan with $82.6 million across its CLO portfolio. CBAM 2018-5 has the largest single deal exposure. It holds $9.9 million.
2.39%
GoldenTree deals have lowest average OC cushion in Europe
- Triple C buckets for deals have been extracted from CLOs’ most recent trustee reports. The recorded figure is the larger of the percentage exposure recorded by Moody’s and S&P in US and Moody’s and Fitch in Europe.
- Junior OC cushion indicates the difference between the result and the trigger value of the overcollateralisation test for the most junior debt class.
- US loans rated B3 by Moody’s or B- by S&P are counted as B3/B- (irrespective of other ratings), so long as the lowest rating applied is above triple C. In Europe, Fitch ratings are used instead of S&P.
Methodology
Data
- Data is as of latest trustee reports and includes all CLOs that went effective in 2018 and 2019. Triple C flex deals are excluded from the charts.
- Deals with most recent reports prior to 15 March are excluded.
- Bond flex CLOs, reissues and static deals are excluded.
- Data is sourced from CLO-i and Moody’s Analytics.
European CLOs: triple C (%) vs junior OC cushion (%)
US CLOs: triple C (%) vs junior OC cushion (%)
AVSC Holdings vs US Leveraged Loan Index
“Pure luck”. That is how, according to one European CLO portfolio manager, some managed to avoid the bulk of loan downgrades in March and April. He goes on: “It is less about strategy and credit picking right now; rather it’s about who got caught and who didn’t.”
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