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News in brief

June 2022 | Issue 246
Hopes of full recovery quashed as credit funds struggle
Optimism about a prolonged recovery after credit hedge funds bounced back in March was dashed as 60% of funds in our database recorded negative returns in April.
Structured credit and CLO funds were the runaway outperformers and the only categories to generate positive returns, averaging 0.60% and 0.66%, respectively. In year-to-date returns, CLO strategies stand alone. They gained 0.48%, while all other types of credit funds lost ground.
CLO funds managed by Lupus Alpha, FlatRock, Napier Park and CIFC were among the best performers in April, with returns ranging from 5.5% (Lupus Alpha CLO Opportunity Notes II) to 1.78%.
Credit investors look to outsource as risks begin to add up
Institutional investors and managers are outsourcing to third parties as credit and macro­economic risks mount.
Credit management firm Mount Street Group has had an influx of mandates recently as investors look to cut costs in response to growing uncertainty around asset valuations and the ongoing war in Ukraine.
The London-headquartered company has picked up a £30 billion outsourcing mandate from a large European institution covering commercial real estate debt and corporate debt, Creditflux understands. Mount Street is tasked with servicing and surveillance of the portfolio. As part of the transaction, the institution has transferred some of its staff to Mount Street.
Investors are also mindful of investing in assets that are linked to Russia amid the widening web of sanctions imposed on the country.
“We are seeing more concern around ownership structures tied to Russian entities and whether these are sanctioned,” says Paul Lloyd, chief executive officer at Mount Street. “We have a KYC [know your customer] team that is constantly reviewing this.”
On the servicing side of its business, Mount Street has a team which looks across various credit asset classes, from aviation and shipping financing to non-performing corporate loans. Lloyd says fund managers are looking for an outside perspective on asset values.
“Heightened regulatory scrutiny means fund managers are finding it more difficult to mark their own books so some are outsourcing this. They’re either made to do this by auditors, or they realise they do not want to invest in the infrastructure for the long-term,” says Lloyd.
Pemberton finds direct lending edge in NAV financing
NAV financing for private equity sponsors is gaining popularity, with Pemberton Asset Management the latest manager getting in on the act.
The London-headquartered manager hired former 17 Capital partner Thomas Doyle to lead the new strategy, and sources say the firm is the first direct lender globally to launch a dedicated strategy for NAV financing.
In an interview with Creditflux, Doyle says direct lenders are in prime position for NAV financing from a relationship point of view.
“We speak to general partner sponsors at the fund level and management company level day-in day-out, and can create additional relationships with these sponsors,” he says.
“Not only can we speak to them as they are forming the portfolio during the investment period, we can now track the companies through the life­cycle/exit and we can do management company level.”
There are four pillars to NAV financing, says Doyle. The first is at fund level (typically post-investment period) with capital used for add-on financing for existing portfolio companies, or for lending against the NAV of portfolio companies to allow for a dividend recap.
It can also be used at the management company level (lending against fees, carried interest pools or GP co-investment pools); in secondary markets (helping PE sponsors buy positions in the secondary market); and for lending against LP commitments if they need liquidity.
ESG investors bemoan corporate greenwashing
US CLO market participants have complained of loan issuer ‘greenwashing’ that aims to circumvent environment, social and governance (ESG) portfolio restrictions. For example, some oil and gas companies are being reclassified as renewable energy producers to make themselves ESG eligible.
The ESG movement continues to advance through the CLO market, with some European deals now incorporating ESG-linked collateral quality tests. Meanwhile, ESG considerations are of growing importance to US CLO investors.
However, the movement has come under increased political and media scrutiny in the US amid claims of widespread greenwashing, while other critics question whether ESG investing can be impactful and even whether it negatively impacts returns.
Columbia Threadneedle head of US bank loans Jerry Howard says his CLOs include positive screening, which rewards companies that actively address ESG.
“You can’t be in the fossil fuel industry and say you’re a green company,” says Los Angeles-based Howard. “But fossil fuel companies are not going away, and if you’re going to have exposure to that industry then you want to be in the company that’s leading the industry in addressing ESG risks.”
Euro loan slide hits ramped warehouses as Carlyle eyes print and sprint deal
European loans tumbled in May, leaving CLO warehouses under pressure and causing a slowdown in primary issuance.
Sources say managers with ramped CLO warehouses are sitting uncomfortably. “It’s a difficult market. Managers may be able to sell €1-2million of loans, but that’s about it,” says one investor.
“Bank distressed debt desks typically used to take a back bid so they knew, despite loans being 3-5bp down, that the distressed desk could step in, but that’s not been the case. That reduces liquidity further.”
Sources say banks are open for CLO warehouses, but some are being selective about asset approvals.
Although ramped warehouses face pressure as loan valuations drop, low valuations could signal an opportune moment to ramp a fresh CLO. But one European CLO investor says low liquidity in the loan market isn’t conducive to print and sprints.
“We need to see much more of a primary loan market come in to build assets,” he says.
“We’ve had enquiries from managers around print and sprints with 25% of portfolio ramped, but that’s pointless. There’s lots of volatility in the loan market and you can get caught badly with expensive liabilities and a portfolio where you either cannot buy, or need to buy at better levels.”
However, Carlyle Group is said to be contemplating a print and sprint deal as Creditflux goes to press.
Four European CLO new issues priced in May as Creditflux goes to press and the pipeline is thin. KKR, NIBC and Permira, among others, are waiting on the sidelines, having initially marketed in April.
US managers open new CLO warehouses at rapid rate
US CLO managers are opening new warehouse facilities at a rapid pace, with some sources suggesting the rate of new warehouse formation to be the fastest in years.
Market lawyers have told Creditflux that new warehouse lines are making up an increasing portion of client requests.
With the US loan market down around three points from the start of May, yet with liabilities remaining stubbornly wide and decreasing new CLO issuance, sources say managers are using the opportunity to buy into their warehouses.
There are thought to be around 220 warehouses open in the US. Many of the new facilities are intended to form so-called ‘print and sprint’ CLOs, with managers filling the portfolio with cheap discounted assets.
But the spread premium managers can expect to pay is steep. An Ares Management print and sprint currently in the market has a target triple A print of 183 basis points — that is almost 30bp wide of the market average.
Despite the flurry of warehouse openings, some legacy ones are under pressure, particularly if they are highly ramped. CLO issuers may have to split these up, as they did after the coronavirus shock in 2020, in order to manage risk.
While loan price declines can put pressure on CLO warehouses, the current three point dip has not caused significant pressure across the market, Creditflux understands.
Wide yields mean high times again for corporate hybrids
Prolonged disruption in financial markets has painted an ever-bleaker picture for credit fund returns and flows in 2022. But allocators have a growing sense some assets now offer good value — with corporate hybrids one area that looks oversold.
Corporate hybrids have had a tough time in 2022, moving ahead of central banks’ plans to begin scaling back purchases. As of 16 May, JP Morgan marked euro paper as having suffered a 5.63% loss. This is in stark contrast to the sweet spot it enjoyed during the prior regime of extensive quantitative easing. But the wheel is turning once again.
“We like corporate hybrids for many reasons, not least as we would rather take structural risk over credit risk at this juncture,” says one Paris-based portfolio manager. “You get similar volatility and return outlook to high yield, but these are IG borrowers for which you don’t have to worry about capital loss or market access, and the yields are already very wide.”
The average spread on an IG euro corporate hybrid note was around 4% at time of press — out from just over 2.25% six months ago. JP Morgan strategists have moved from neutral to overweight on IG corporate hybrids. “Extension risk remains low even at wider senior spreads,” they wrote in a note, positing a 4.2-year average duration.
Because asset managers have cut their allocations, corporate hybrids are no longer a crowded trade.
According to Viktor Hjort, global head of credit strategy at BNP Paribas, hybrids are a balancing act between tending to underperform when central banks are hawkish and outperforming on weak growth.
Russia sanctions cause non-payment concerns for Europe
The European CLO market is having to continuously wrestle with an evolving sanctions regime following Russia’s invasion of Ukraine, with concerns that non-payment by or to sanctioned entities could disrupt cashflows.
Understanding Russia exposure has become a key part of the due diligence process for both managers and arrangers, who are concerned that an obligor could breach eligibility criteria and cause non-payment.
With the sanctions targeted at high-ranking officials and associates of the Russian government, rather than the Russian state broadly, the impact of the regulations is limited with regards to CLOs and loans.
However, there are a number of known regular investors in European CLOs that are sanctioned entities, according to several sources.
The identity of CLO noteholders is often unknown, but issues arise when the sanctioned entity is a known deal partner, such as an equity investor.
Legal experts say that, since the investment is made with the issuer rather than directly with the manager, the question of payment legality is dealt with by paying agents and clearing systems, such as Clearstream or Euronext, rather than the CLO collateral manager.
Earlier in the year, some CLO managers had discussed setting up side accounts to deposit equity payments for the duration that sanctions are in place, Creditflux understands.
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Global credit funds & CLO's
June 2022 | Issue 246
Published in London & New York.
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