Global credit funds & CLO's
October 2020
| Issue 228
Published in London & New York.
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October 2020 | Issue 228
Libor floors and Volcker tweak bode well for future of CLOs
Sayed Kadiri headshot
Sayed Kadiri
It’s been a truly miserable year, but amid all the despair covered so tirelessly by the mainstream media has been an omission; namely, that CLOs have withstood the damage caused by the pandemic.
In fact, the volatility in credit over the past few months has provided an opportunity for CLO managers to add long-term value for their investors to the extent that annualised equity distributions could increase by up to 20%, say market participants. A couple of factors are weighing in favour of CLO managers. First, the sharp drop in US interest rates has meant that Libor floors are relevant again. Three-month Libor has dropped from 190 basis points in January to 23bp in September and the average Libor floor on a US loan is 80-90bp. Lauren Basmadjian, senior portfolio manager at Carlyle Group, says that because rates are set to stay low for longer, this could have long-term benefits for CLO returns. “In March, there was a lot of fear that CLO equity payments would be shut-off for multiple quarters due to OC [over-collateralisation] breaches. Not only is that not the case, equity distributions are set to be higher because of the 75bp pick-up on many loans due to Libor floors,” she says.
Another advantage for managers is the relaxation of the Volcker rule. From this month, CLOs will be permitted to purchase bonds and will be able to have a greater influence on loan workouts.
“Investment grade bonds with low coupons could be par-building opportunities. If rates ever rise, many of these new issue bonds with low coupons will trade at a discount because of duration risk, as opposed to credit risk,” says New York-based Basmadjian.
With more tools at their disposal, CLO managers will need to trade dynamically to get the best out of these circumstances. “The world has changed in the past few months and managers must trade accordingly. You cannot afford to stick to your original underwriting thesis for many loans as it will no longer hold up,” Basmadjian says.
This approach does not necessarily mean cutting out loans from portfolios entirely. Instead, Carlyle has been trimming investments in loans and rotating into defensive sectors.
Basmadjian claims that Carlyle has traded about $4 billion of its $18.5 billion CLO portfolios since June, a 21.6% turnover in three months.
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“The world has changed and managers must trade accordingly”
Lauren Basmadjian,
Senior portfolio manager | Carlyle Group
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