One day you’re holding a perfectly ordinary performing loan priced in the 90s and the next you are left with a distressed asset worth no more than 10 cents. Idiosyncratic risks are the stuff of nightmares for CLO managers and the Deluxe Entertainment saga underlines how difficult it can be for managers to avoid such pitfalls.

More often than not, loan prices slip down in stages, going from par to the mid 90s, then into the 80s and then perhaps the mid 70s, before a sharp descent into distressed territory. This gives loan managers time to assess a credit and its prospects for recovery. Deluxe, however, was a rare example of a loan dropping like a stone.

Sound Point Capital Management and CIFC Asset Management have the largest exposure to Deluxe Entertainment through CLOs, according to CLO-i. For first lien term loans, Sound Point holds $81.1 million in 17 deals, while CIFC holds $70.5 million across 21 deals, as per the most recent trustee reports.

Deluxe had a $783.5 million senior secured term loan paying Libor plus 550 basis points, which has since been swapped for 65% of the equity. Out of the original senior secured loan, $467.8 million (or 59.7%) sat in CLOs over the course of the third quarter of 2019. Including other types of credit funds, Sound Point has the largest secured claim of $115.7 million, while CIFC takes second spot with $114 million. Invesco, Sculptor and MidOcean trail with $71 million, $57.1 million and $47.8 million respectively.

Deluxe’s slump coincided with an earnings call on 31 July, when the company received a commitment of $73 million for a priming term loan facility from existing lenders. This came about as its previous plans to spin off its creative service business and amend its term loan B fell apart.

A Moody’s rating report from 16 August highlighted that Deluxe’s decision to abandon the spin-out of its creative services division was the prime reason for downgrading the credit to Caa2. The report goes on to say that “the prior proposal also included amendments to downsize the ABL, tighten certain covenant provisions and extend debt maturities by two years”.

Idiosyncratic risks are harmful to equity and junior debt investors in CLOs and there is evidence to suggest that the Deluxe bankruptcy has wiped a handful of points off the value of CLO tranches.

Sound Point CLO III-R, which has the third largest exposure to Deluxe, saw its debt appear in the secondary market before and after the fateful 31 July price drop. On 27 June, $5 million of double B notes from this deal traded on a b-wic with a cover bid of 94.3 — in line with the market average. But on 6 August and 28 October the same bond traded at 90.38 and 81 respectively — below the prevailing market average of 94.7 and 87.06, respectively.