Global credit funds & CLO's
January 2020
| Issue 219
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Issuers fashion new outfits for junior mezz
Charlie Dinning
Data journalist
January 2020
|
Issue 219
Analysis CLOs
Junior CLO tranches have lost around five points in the past quarter. In response, new issue desks are dressing up junior debt in two piece suits and designing a range of protective styles
Mezzanine CLOs have long been the easiest tranche for syndication desks to place. But loan market dispersion has meant that bids for CLO triple Bs and double Bs are shrinking fast in the primary and secondary CLO markets.

Often, the secondary CLO market is an indicator of how tranches will price in primary in the near future. When cover bids are not disclosed, it usually means the bid-ask spread is too wide and market participants do not want to move the market.

For triple and double B US CLOs in the secondary market the percentage of covers released and the average trading price has dropped. Across August and September, $1.2 billion of triple B and double Bs were put on b-wics; covers were not released on 43% of them. In October and November, $1.8 billion of junior mezzanine was made available on b-wics, but the cover-less count rose to 64%.

From observable prices, it’s apparent that, in some cases, junior CLO tranches have lost over five points. Specifically, in the first nine months of 2019 the average cover on US CLO triple Bs was 97.6. In October and November that figure dropped to 94.7. For US double Bs the decrease was from 95.1 to 89.7.
US discounted junior mezz 2019
The cause of this steep decline in prices can be traced back to dispersion in the loan market. Chandrajit Chakraborty, chief investment officer at Pearl Diver Capital in London explains that US loans have widened from 300-325bp last year to 380-400bp.

“The drop in loan trading prices from around par to around 96 has caused a corresponding drop in the MVOC [market value OC] of CLO tranches,” he says. “This has resulted in lower CLO trading prices.”

In Europe, the effect on the secondary market has been less extreme, but bids on single B bonds have dropped to 87 cents — similar to levels in January 2019.

Spreads for four-year reinvestment CLO triple Bs have shot up by 13% from September to November in the US, with some pricing as wide as 507bp. Double Bs have increased by 15%, topping 825bp in November. In Europe double B spreads have increased by 14%, with the benchmarks in the 480bp area by late November.
A makeover for junior CLO debt
In the primary market, the belly of the capital structure is being dressed up in all sorts of new ways. It’s common for arrangers to attempt to lock in anchor orders on senior CLO tranches and the equity before going out to market the mezzanine notes to complete the capital structure. But in the past few weeks structurers have had to work extra hard to entice investors.

For instance, AB, Churchill, Octagon and TCW are among the issuers that have split their triple B-rated notes into senior and junior components. But the alterations lower down the capital stack have been more dramatic.

On 1 November, PGIM priced Dryden 80 CLO (a new US deal) with an unfunded double B-rated tranche. These class E notes can be drawn at any time after the CLO closes. The tranche has presumably been structured in such a way because double B spreads are too expensive from the perspective of equity investors — they’ve widened from the low 700s to the low 800s over the second half of 2019.

Credit Suisse Asset Management, GSO Capital Partners and Be-spoke Capital have taken a different approach in Europe: they have issued single B tranches with a fast-track amortisation profile. These turbo tranches are not dependent on performance; instead they delever based on a schedule.
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US CLO trenche dispersion 2019
13%
Three-month rise in four-year reinvestment US CLO triple Bs
It’s not just dispersion that is affecting corporate loans. Market sources say that another bout of outflows from retail funds has weighed loan prices down and this has filtered through to CLO tranches.
Issuance still looking good
Despite the ensuing volatility, new issue CLOs are still being priced at the same pace as in 2018. Through 15 November, global CLO new issuance totalled $145.3 billion, compared to $144.7 billion at the same stage in 2018.

But there’s no doubt that arrangers have to work extra hard to get deals over the line in late 2019. Whichever way you dress it up, even the largest CLO managers have had to adapt to widening CLO liability spreads.
US triple B and double B secondary covers 2019
European double B and single B secondary covers 2019
*New issue CLOs with more than 4 years of reinvestment
“The drop in loan trading prices from around par to around 96 has caused a corresponding drop in the market value OC of CLO tranches”
Chandrajit Chakraborty,
Chief investment officer | Pearl Diver
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