Global credit funds & CLO's
June 2020
| Issue 224
Published in London & New York.
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I take strength from the composure investors have shown when told their payments are being deferred
June 2020 | Issue 224
We all want to go to the beach, we all want to play in the waves. But to serve the greater good during this crisis we must exercise the stoic restraint of CLO equity investors and give up our individualism to the will of a higher authority.
In preparation for what 2020 might throw at us next, last month I dusted off a copy of 1976 bestseller Night of the Crabs by Guy N Smith. As books on the invasion of horse-sized crustaceans go, it’s a triumph, even if little insight is given into the origins of the deadly army, and the heroes battling them are thwarted by an ineffectual, disbelieving government, which would rather move sideways than tackle the problem head on. Crafted with the literary sensibilities of a 12-year old, the novel also has some of the most electrically charged sex scenes ever committed to print. “They were getting out of control,” Smith writes. “Nothing else mattered... not even the giant crabs!” Well imagine my joy at discovering that this tale of King Crab (“the most cunning enemy the world has ever met”) was set in Wales — indeed not 20 miles from the Welshcake bunker, in the seaside village of Llanbedr. Strange they don’t mention it on the council website. This really got me thinking about how nice it would be to cast lockdown constraints asunder and drive to the beach. Maybe buy an ice cream and shout at the seagulls. But I didn’t. I stuck to the plan and kept it together. Unlike Conservative MP for Shrewsbury Daniel Kawczynski, who, when told last month that he couldn’t trundle down to his closest Welsh beach, called for the devolved Welsh parliament to be scrapped. If the MP knew his history he’d understand we take beach invasions very seriously in Wales. It’s not just the crabs and the English. The last invasion of mainland Britain came in 1797 via a French landing at Carregwastad Head, leading to the quickly resolved Battle of Fishguard. The Welsh stay prepared. We are ever suspicious. Nourishing my selfless resolve to stay home and stay alert (or at least semi conscious), I derived strength from the composure third-party investors in CLO equity have shown in recent weeks when managers told them their payments were being deferred. It would be all too easy for these risk-hungry types to say, “Hey, that’s my cash and I want it back so I can invest it the way I want into all these fantastically lucrative market dislocations I’m seeing right now.” But they haven’t. Partly because some can’t (the documentation may allow managers to decide when investors get their money). But mainly it’s a recognition that CLO managers — the people they entrusted management of their money to in the first place — have an opportunity to redeploy that money on their behalf into deeply discounted loans. This will make manager returns and over-collateralisation tests work out a bit better. It could also help negotiate workout agreements as defaults spike. That’s really in the spirit of getting through this thing all together. And when I say all, it does look like being a big chunk of equity guys who will be asked to do the right thing. Creditflux reported last month that half of US CLOs could miss equity payments because of OC test breaches, with some 192 US CLOs failing at least one OC test. A handful of CLO issuers have taken matters into their own hands by deferring equity payment in their performing CLOs. This requires a reconceptualisation of CLO equity investment. It will be a long-term play on principal, where investors may be asked to forego the immediate benefit of interest payments for the longer-term gain when cheaply sourced loans reprice at par. It is a leap of faith, given the uncertainty of corporate casualties along the way and where the market cycle may take prices, but it could also be offset by a discount in mezzanine tranches. Now is not the time to get salty. Let’s not call it a missed payment, or a missed trip to the beach, but rather a gained opportunity. No-one really knows where this is going or when we will get there. If giant crabs emerge again from the waves, all bets could be off — just imagine UK and US government messaging then. Remember that longevity means showing unity and support just as the market is doing for CLOs. It means creating a fearsome defence force that will throw its weight against any crisis and grab it by the pincers — if we’re allowed on the beaches.
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It’s tempting to head to the beach or grab a CLO distribution, but investing is all about playing the long game
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