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News in brief
January 2021 | Issue 230
Napier Park flexible credit fund powers to 17.8% gains in 2020
A European credit fund run by Napier Park Global Capital is up 17.8% in 2020 through to the end of October to sit atop of the list of funds by that metric.

The strategy has the flexibility to invest across European loans and CLO tranches, and underlines how important flexibility has been this year, with CLO-only funds producing high returns in the second half of 2020, but still lagging other credit assets.
The best performing funds in October invest exclusively in CLOs, but several are down double digits on a year-to-date basis. Creditflux’s CLO fund index is down 4.59% in October.
Alongside Napier Park, a CIS CLO fund has outperformed, with 11.54% returns in 2020.
New valuation rules to ‘severely limit’ fixed income cross trades
Law firm Practus believes that new SEC rules will limit a fund’s ability to cross-trade fixed income investments after the regulator adopted fund valuation rules in December.
Under these fair valuation rules, funds must value their investments using the market value when market quotations are ‘readily available’. If market values are not readily available, the investment must be fair valued. But cross trades require readily available quotations and the SEC has a new definition to determine what this means.
The US regulator said readily available market quotations must be determined solely by ‘level one inputs’, which are observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets.
Valuations based on level two inputs, however — which are typically based on various inputs, such as Trace data, broker quotes, matrix pricing or other valuation models — are not consistent with this definition. Most fixed income assets are typically valued by pricing vendors using evaluated prices, which count as level two. This means credit funds could be hampered in cross trading between funds.
In a public note, Practus partner Karen Aspinall, based in Newport Beach, says firms engaged in cross trades based on level two inputs should review their history and see if any level one alternative pricing methods exist. If that is not possible, Aspinall says firms should “evaluate whether these instruments are appropriate for cross trades”.
The SEC has had its focus on cross trading this year with Palmer Square Capital Management settling an illegal cross trading charge in September.
CLO managers gain time with Libor deadline extension
US CLO issuers have been given legroom ahead of the transition away from Libor, but as one CLO investor puts it: “While it’s an important development for the CLO market because it alleviates some of the Libor stress, it does not make the problem go away.”
Regulators announced on 30 November that the cessation of three-month USD Libor has been extended to June 2023, granting CLO managers some leeway for legacy deals.
The UK’s Financial Conduct Authority welcomed and supported the extension, while the Alternative Reference Rates Committee said the extension would lead to a “smoother transition” for legacy deals, as it would allow time for them to mature before the cessation of Libor.
Stipulations in CLO documentation make it likely that recently issued CLOs will start referencing a different base rate before June 2023 anyway, say sources.
CLOs issued since late 2017 typically have benchmark transition language in their documentation, whereby a clause is triggered if more than 50% of underlying loans refer to a base rate other than Libor.
Equity investors call time on CSAM bond-flex CLOs
Two of Credit Suisse Asset Management’s three bond-flex CLOs were called by their equity investors in October, according to notices seen by Creditflux, despite both deals being within their reinvestment periods.
The 2017 and 2018 vintage deals were both failing at least one over-collateralisation test in September; One Eleven Funding I was failing its class B and C tests for the first time, while One Eleven Funding II had been failing some form of OC test since May.
Despite this, neither deal failed its market-value OC test, a collateral quality test designed exclusively for bond-flex CLOs and the volatile price fluctuations of their underlying assets.
Neither deal has fully repaid its principal. One Eleven Funding I had an original equity tranche of $192.4 million and has so far repaid $178.29 million. One Eleven Funding II has made cumulative distributions of $118.8 million against an original tranche size of $212.8 million.
Although both CLOs have been redeemed for over a month, they each still hold assets, and are likely be able to make further distributions to equity investors.
These bond-flex CLOs are the first to have been called since the structure was reintroduced by Anchorage Capital in 2015.
Little room to move in IG’s vice-like grip
The absolute tightness of credit has left investment grade specialists a tough challenge to find value in the coming year, with neither scope for spread improvement nor encouragement to go short. Achieving returns will require bold calls on specific names and for managers to go outside their comfort zone, managers say.
CDS indices iTraxx Europe and CDX IG illustrate the impasse, having become sticky in December around 46 and 50 basis points — levels unvisited since late February. High yield indices converged amid the roll-out of covid vaccines, which also sapped dispersion.
“The risks are more asymmetric now,” says Jeffrey Glenn, co-head of portfolio management at Breckinridge Capital Advisors. “The [US cash bond] index could tighten another 10bp from here, but it would test resistance. And there is a chance there will be a short-term pick up of volatility going into 2021, as the Fed’s programme of unemployment benefits ends.”
Few areas stand out as offering value and it is hard to buy dips. Investors will increasingly seek to improve returns in one of three ways, says Glenn. “They might dip down in credit quality or extend their investment horizons, as 10-year bonds look more attractive. Thirdly, some of the credits that have been identified as names to short could be good earners for those willing to go long.”
High yield/IG compression (bp)
Zombies demand brain work from tranche traders
Outperformance of junior tranches and underperformance of senior was the big theme in CDS index tranches going into December. But the picture began to change as Creditflux went to press, with traders highlighting the threat of near-term reversal and zombie companies creating idiosyncratic risk in 2021.
Old series of CDX IG equity tranches especially gained from fallen angels improving, which also aided on-the-run CDX HY. According to one dealer, this brought two to four points of IG equity performance versus delta.
iTraxx Europe equity, which is less exposed to fallen angels, did not enjoy the same aggressive rally, but still rose one to two points versus delta. Crossover equity in series 32 and 34 also outperformed, along with 10-20% junior mezzanine tranches. This was despite constituent Europcar defaulting, an event alleviated by its strong recovery expectations. According to one investor, prolonged life support for wide-end names is a bigger concern.
CDX HY tranche flattening was not pronounced, but risk demand was strong in November and early December. Having lost 10% of subordination to defaults, old series 15-25% tranches trade more like 5-15% pieces.
“It’s unlikely there’ll be as many defaults in 2021 and 2022, but investors are reticent about adding much risk at these levels, especially in HY,” says a market maker. He sees going long mezz as a way to navigate 2021 blips.
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Global credit funds & CLO's
January 2021
| Issue 230
Published in London & New York.
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