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News in brief
March 2021 | Issue 232
High yield fund sets pace with 22% return in January
Wasserstein Debt Opportunities Fund has set the early pace for credit hedge funds in 2021 after registering a 21.7% gain in January. This builds on the high yield fund’s success last year and takes 12-month returns to 40.44%.
Wasserstein’s fund was the exception to the rule (it gained from a credit restructuring) as CLO funds were the outperformers in January as spreads reached some of their tightest levels since the 2008 financial crisis.
CLO funds managed by Alcentra, Crystal, Lupus Alpha, Flat Rock and Orchard each added more than 5.5% in January.
European desk staffing could limit CLO repricings
The sheer volume of European CLO resets and refinancings has left market participants questioning the market’s ability to handle the business.
JP Morgan’s European CLO new issue head Steve Baker claimed on Creditflux’s CLO webinar last month that managers have strong motivation to refinance and reset deals, given liability spreads and the opportunity they are afforded to re-comply with weighted average life and triple C tests.
One factor that could affect the pace of repricing, he said, was the ability of market participants — including lawyers, rating agencies, arrangers, trustees and investors — to process deals quickly.
“When I talk to my US colleagues and look at the volumes there, you question if Europe can get to that stage,” London-based Baker said. “At the moment, given how European desks are staffed, it will be slower.”
As Creditflux goes to press, new issue CLO volumes in 2020 total €4.15 billion. Refinancings and resets have topped that, with €4.34 billion and €3.23 billion issuance, respectively.
CLO managers have also issued around 50 cleansing notices on Euronext to explore potential refinancing opportunities, and if spreads continue to tighten this number could surge. Such notices do not guarantee a refinancing (they provide the chance for arrangers and managers to talk about deals), but market conditions provide strong incentives.
Deals that were due to be refinanced and reset last year, along with those pricing in 2020 with one-year non calls, are also obvious reset and refi candidates for 2021.
Nomura to grow new issue CLOs after warehouse boost
Nomura is emerging as a force in US CLO arranging with sources indicating it has secured multiple big mandates — including a new CLO for Credit Suisse Asset Management.
It is understood the bank’s growth plans were scuppered by covid, but rather than retreat, senior management decided to plough resources into new issue CLOs by increasing warehouse capacity.
That has meant Nomura’s pipeline is blossoming, sources say, with other top 20 issuers signing up with the bank.
The change could be reminiscent of Barclays, which had for most of the last decade been on the fringes of the US CLO primary market, but has established itself as a top-five firm since hiring CLO head John Clements in May 2018.
Nomura’s US CLO arranging business is headed by Florian Bita, a former CLO trader who has led the reinvention of the firm’s CLO business since joining in late 2018. Before his arrival, Nomura had tended to work on CLO refinancings.
In February, Nomura issued its first CLO of the year — Regatta XVIII Funding for Napier Park Global Capital — in a deal that priced in line with market tights.
Bita: leading Nomura’s move into the US primary market
European CLO leverage hits double-figures
European CLO leverage has increased this year, from an average of 9.4 debt-to-equity in 2020 to 10.3 times in 2021, according to Creditflux data.
In February, Spire Partners priced the highest levered reinvesting European CLO in recent years. Aurium V has 13.17 leverage embedded in its capital structure, topping CBAM’s Bastille Euro 2020-3 at 13.05 times and Blackstone’s Marino Park CLO at 12.48 times.
Sources say the combination of tightening spreads, discounts shrinking on double B and single B notes and rating methodology changes are all encouraging increased leverage.
Double B discounts were stuck at 97 cents, sources say, but that discount has slowly decreased. CVC Credit Partners, for example, reset double Bs on Cordatus Loan Fund IV at 99.01 cents, PGIM’s Dryden 44 double Bs priced at a 98 discount and Redding Ridge Asset Management’s RRE 6 double Bs were issued at par.
Managers are also adding leverage as the cost of debt has fallen from highs of 284bp in April 2020.
Redhedge squeezes relative value out of tight IG bonds
Going outright long investment grade credit is a tough position to be locked into given today’s ultra-tight spreads. But London-based Redhedge has developed a relative value approach to this market in the past four years that aims to be beta-neutral and uses quantitative models to come up with long/short European bond combinations.
The strategy delivered last year, says founder Andrea Seminara, gaining 5.03%, with its biggest weekly fall being just 12.9 basis points. He says Redhedge has focused on anomalies in IG corporate credit curves.
“We try to find bonds that move erratically from their fair value versus our curve models,” he says. The model runs a regression analysis on all points of a bond’s credit curve using Redhedge’s own issuer-based adjustments to identify what shape it thinks the curve should take.
If a bond has deviated from its fair value at the three-year point in the curve, for example, Redhedge will either go long or short the issuer depending on whether it is trading too tight or wide. It then hedges this with a counter position in either a bond from a similar issuer, or a different bond in the same company’s capital structure.
iTraxx Europe has reached 49.25bp as Creditflux goes to press. Seminara says that massive central bank support has driven spreads tighter, as have passive funds such as ETFs that tend to buy the same bonds whenever they receive inflows.
This dynamic means corporate bond spreads can move very slowly away fair value, during which time Redhedge adds to its position.
Tale of two leaders as Brazil and Italy go separate ways
The intervention of governments has been a prominent factor in financial market performance during the coronavirus pandemic. But Italy and Brazil have provided stark examples of how individual leaders can drive credit performance sharply in opposite directions.
Italy’s installation of former European Central Bank president Mario Draghi as prime minister on 13 February, in a bid to re-establish stability, sent the country’s spreads on a rally so strong its five-year CDS ended up not only at pre-covid levels but some 25bp inside at just 70.5bp. That was a 190bp improvement from the covid sell-off last year.
Italy succeeded three days later in raising €14 billion through 10-year government bonds at a near-record low yield of just 0.568%. Italian banks also went on a bull run around this time, with UniCredit senior CDS surging in from 134.5bp at the start of the month to 108.5bp by mid-February.
Brazil’s credit performance in February was an entirely different story. Its five-year sovereign CDS gapped out from 150bp to 183.5bp. Much of that widening came after 22 February, when president Jair Bolsonaro sent markets into a spin by sacking Roberto Castello, the chief executive of Petrobras.
The state-run oil company also blew out nearly 30bp on the day in five-year CDS, or 44bp from where it traded near the start of February.
So far reaching was the impact that index CDX EM, of which Brazil is a constituent, also added 7bp on the day to 175bp.
Differences emerge in shape of new CLO bond buckets
The future of bonds in CLO portfolios is beginning to take shape after amendments to the Volcker rule came into effect in October last year. Sources say bond buckets of up to 5% of portfolios are beginning to feature in deals, and are mixed into the allowance for other assets such as second lien and subordinated loans.
Allen & Overy partner Lawrence Berkovich says that while some CLOs define bonds relatively broadly to include a variety of debt securities, others are more restrictive — but the trend is toward flexibility for managers to hold high yield bonds on their books.
“Some deals permit bonds broadly, but others draw a distinction between senior secured and high yield bonds, for example,” Berkovich says. “It comes down to what investors are willing to accept, but broad bond buckets are more common than when Volcker amendments first became effective.”
Some CLO managers have pushed for a higher proportion of non-loan assets, which would be Volcker-compliant for the lion’s share of CLOs that no longer rely on the loan securitisation exemption under the Volcker rule. But the 5% threshold that predated the amendments appears to have stuck.
Some investors are cautious amid the slim possibility that the new US Congress could still invalidate the amendments to the Volcker rule during a 50-day legislative period under the Congressional Review Act.
“There’s a small group of investors in a small number of deals who agree to a bond bucket in theory, but make the bond bucket conditional on the review period under the Congressional Review Act being over,” says New York-based Berkovich.
US credit specialists prepare for partial return to office
Positive covid-19 data coming out of the US is turning market participants’ attention to a potential return to the office.
With positive cases declining to under 60,000 a day from the early January peak of over 300,000, and a seven-day rolling average number of vaccinations at 1.37 million, getting back to the old routine has become a real possibility.
However, many market participants have told Creditflux that their workplace will look different post-pandemic.
One official who works at a new CLO manager says the plan is to downsize their New York City footprint and have more staff working from home either full or part-time.
Others plan to open satellite offices in new locations. Speaking on The Last Tranche podcast in February, Sound Point Capital Management’s founder Steven Ketchum said his firm was close to leasing new office space in Florida.
“Being in the same room and bumping into each other at the water cooler is something that creates value for our investors and we don’t want to lose that, but creating a work-life balance for people and making sure they are as productive as they possibly can be is the way of the future,” said Ketchum.
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Global credit funds & CLO's
March 2021
| Issue 232
Published in London & New York.
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