Global credit funds & CLO's
March 2020
| Issue 221
Published in London & New York.
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News in brief
March 2020 | Issue 221
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CLO refinancing auction draws plaudits despite failure to clear
A novel approach to refinancing a CLO failed to clear, despite optimism behind the concept. Creditflux reported that Mitsubishi UFJ Financial Group was refinancing Credit Suisse Asset Management’s Madison Park Funding 19 via an auction on 20 February, rather than a syndication process. Sources say the senior notes failed to clear the reserve level, so the refi was scrapped, even though the reserves on the double As and the single As were hit. Despite the failed refi, CLO investors say the concept behind a refi auction is sound, because it dramatically reduces costs.
Covid-19 outbreak rattles carry traders
The coronavirus panic hitting financials markets at the end of February has been a strong driver of relative value trades, with CDS underperforming both cash bonds and equity, while financial names felt the heat more than corporate borrowers as geographical risk came into play. Instant recovery had been the common theme of 2020, with any catalyst for widening quickly overwhelmed by the weight of long positioning to continue grinding tighter. This is one reason why investors were caught offside by the late February sell-off through successive sessions, as an Italian outbreak took the coronavirus closer to home for European traders. But another problem for CDS was timing. “Last week people began focusing on the roll,” says one portfolio manager, referring to the 20 March transition from iTraxx series 32 and CDX series 33 indices into new, updated portfolios. “The current series should tighten once it goes off-the-run — by about 15bp in iTraxx Crossover — so everyone was positioned for that and now they’ve been forced to unwind their trades.” According to IHS Markit, Crossover soared from 211bp on 19 February (just 8bp wide of its post-crisis record tight print) to 253bp on 25 February, its widest level since October. CDX HY added 49bp in the same time, to 335bp. The ratio hit to investment grade CDS was more pronounced. iTraxx Europe added 9bp, to 50.5bp, while CDX IG gapped 10bp, to 54.5bp. Financial sector CDS, led by Italian names, were worst hit of all. At time of press, bonds had not moved nearly as much. This could be the cash market’s typical delayed reaction, says a second PM. Or it could be symptomatic of expectations for another V-shaped recovery.
BDCs tap bond market to improve funding mix
A plethora of business development companies have turned to the institutional bond market to refinance their debt. Goldman Sachs BDC, for example, announced in its quarterly earnings call last month that it was issuing its first institutional bond. The $360 million offering, due 2025, came with a coupon of 3.75%. Goldman says proceeds will repay borrowings under its secured credit facility. Moody’s assigned Goldman’s BDC a Baa3 rating in January (Fitch rates the BDC BBB-). As part of the bond issue, the BDC entered an amendment with its lenders, cutting the secured facility’s spread from 200 basis points to 187.5bp and extending the maturity to 2025. “The offering diversified our funding mix toward more unsecured debt, which improved our financial flexibility without increasing our overall cost of borrowing,” said Brendan McGovern, chief executive officer of the BDC on the earnings call. “We were able to price our unsecured debt at nearly the same level as our secured revolving credit facility.” Golub BDC is also looking at bond issuance, according to chief executive officer David Golub in its fourth quarter earnings call. The BDC merged with Goldman Sachs Middle Market Lending Corp in December.
Real assets are now the top picks in private credit
Direct lending is no longer the darling of the private credit market, with pension funds increasingly making space for credit strategies backed by real assets. Investment consultant Bfinance has found that 2019 was the first ever year in which there were more searches for real asset debt, in dollar terms, compared to corporate private debt, according to a recently published report. It finds some insurers are gravitating towards infrastructure debt as regulatory changes make unrated assets more attractive for these firms, while pensions are looking to move from infrastructure equity to debt. Others still are allocating at the expense of corporate direct lending owing to spread compression. A recent example of a real asset allocation is the pension fund of BNL/BNP Paribas Italia. Creditflux reported last month that the fund was looking to deploy capital in infrastructure debt, real estate debt and corporate debt, among other asset classes. The pension scheme is set to commit €20 million to private closed-end euro denominated debt funds, as part of its private debt mandate. According to the Bfinance report, infrastructure debt fundraising reached $14 billion in 2019, up from $9 billion the year before. Real estate debt fundraising totalled $27 billion last year, down slightly on $29 billion in 2018. Creditflux data shows that European corporate direct lending outweighs these two markets with €38 billion ($41 billion) raised last year. Many US-based pension funds have also opted for real assets exposure.
ESG pervades US CLOs but screening approach divided
Environmental, social and governance (ESG) investing is reshaping the US CLO market, with February bringing the first CLOs marketed that have explicit ESG-related investment criteria. “I’ve been in 10 meetings before this panel and all but one brought ESG up,” said Amir Vardi, managing director at Credit Suisse Asset Management, on a panel at the Structured Finance Association’s SFVegas event last month. But market participants remain split on whether positive or negative screening remains the correct approach to ESG compliance. Negative screening prohibits managers from investing in certain industries, such as tobacco manufacturing. Positive screening, meanwhile, sees investors rate each credit internally, typically from one to five. Creditors then work with businesses and can apply pressure to see improvement on established ESG metrics. Announcing her firm’s implementation of an internal rating system for ESG risk, as well as a ban on plastic bottles from its offices, Pretium Partners’ senior managing director Roberta Goss said ESG is not yet impacting pricing. “I don’t think right now it is impacting our cost of liabilities,” Goss said. “I don’t know when that inflection point will happen.”
No hedges, but no problem for optimistic CLO investors
CLOs are prone to idiosyncratic risks, but investors have told Creditflux that they are confident about performance in 2020, despite the lack of hedging options. The general consensus is that some deals will suffer, but the vast majority will deliver after a disappointing end to 2019 for junior debt. “We see more idiosyncratic risks in credit this year, but we’re optimistic about CLO performance across the capital structure based on relative value,” says Alex Navin, portfolio manager at BlueBay Asset Management.
“We see more idiosyncratic risks in credit this year”
Alex Navin,
Portfolio manager | BlueBay Asset Management
Navin adds that as yet there are no perfect hedges for CLOs, but investors can mitigate macro risks effectively by using credit indices and options. According to another investor, if a CLO holder is feeling bearish it’s better to sell the position entirely. “There is a secondary market, but investors should look at CLOs as buy and hold. If you’re not prepared to do that, then you probably shouldn’t be buying at all,” he says. Over the past two years there have been talks about launching a tradeable index that would provide CLO investors with a efficient tool to go long and short CLO risk, but this has yet to materialise.
Wide double Bs leave CLO refis trapped in catch 22
$12.5 billion of US CLOs have refinanced this year on the back of steep CLO term curves — but wide junior CLO spreads have made some equity investors and managers think twice about repricing. The popular trade has been to refinance 2017 CLOs; 28 such transactions have taken place in 2020. CLOs with two years left on their reinvestment are refinancing their triple As at about 103.2 basis points this year. This is helping CLO managers lower their cost of debt by 32bp on average, according to Creditflux data. CLO double Bs are refinancing at 683bp and this is posing a dilemma, given this is wide of 2017 levels. Among the 10 largest CLO managers, Credit Suisse Asset Management is the only one that has not yet refinanced a 2017 deal (it has three: Madison Park Funding XXV, XXIII and XLII). These three deals priced with triple A spreads of 118bp, 121bp and 118bp, respectively — which is roughly 15.8bp wider than the market average for two-year refis. But their double Bs are paying 610bp, 625bp and 605bp, respectively. This is roughly 69bp inside current market averages. Some CLO equity investors have taken the plunge, refinancing their 2017 deals and accepting wider junior debt pricing, given the overall savings made as part of a refi. For example, Neuberger Berman 14 refinanced its double Bs at 675bp from 645bp originally, but it did reduce funding costs by 20bp. CLOs managed by GSO, Rockford Tower and TCW have taken similar paths to refinancing this year. Among the larger CLO issuers, none have refinanced all of their 2017 deals.
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