European CLO managers aim for bigger bond bucket fix

Michelle D’souza

Reporter

European CLO managers are eyeing larger fixed rate bond allocations amid dislocation and lower loan supply. This has, in turn, led to an increase in fixed rate tranches.

Sources say recent European CLO new issues have increased fixed rate bucket limits from the typical 10% to 12.5%, 15% or even 20%. Meanwhile CLO managers ramping warehouses have also requested larger fixed rate allocations.

Dushy Puvan, head of Emea CLOs at BNP Paribas, says events in February accentuated the dislocation between loans and bonds. This had first opened up in January amid the impact of rising rates.

“Where there are senior secured loans and bonds from a single issuer that rank pari passu, a strategy we are seeing CLO managers employ is selling the loan at a higher price and buying the bond at a lower price, and locking in that gain,” he says.

The flip side of that trade, of course, is that bonds move with rates, so when markets rally, CLO managers can sell the bond at a higher price and then take advantage of other opportunities.

“It’s about optimising liabilities versus assets”

Dushy Puvan, Head of Emea CLOs | BNP Paribas

With CLO managers looking to increase utilisation of bond buckets, CLO structures could require additional fixed rate liabilities.

“It’s about optimising the amount of fixed rate needed on the liabilities side versus the utilisation the manager expects to use on the asset side, while making sure they are given enough flexibility to manage to their strategy,” Puvan says.

European CLOs prior to the war in Ukraine typically issued double A fixed rate tranches at 2.2%, versus 175bp for an equivalent floating rate tranche. But the impact of rising rates and the invasion has seen fixed rate double A tranches jump to 3%, while floating rate tranches priced around 230bp. Fixed rate tranches are still being issued at a premium.

Other options to hedge fixed rate risk could be to delever the structure (but that would be costly to equity returns) or include some form of derivative, such as a cap or a swap, say sources. The CLO fixed rate tranche buyer base has been small but consistent, with most demand from European insurance companies.

Those CLO managers that have opted for a smaller fixed rate bucket (of around 5% to 7.5%) could make do without fixed rate liabilities.

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Global credit funds & CLO's

May 2022 | Issue 245

Published in London & New York.