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News in brief

March 2022 | Issue 243
CLOs outperform yet again despite tough month for credit
CLOs can do no wrong it seems, and funds that invest in them topped Creditflux’s credit hedge fund rankings once again in January.
The beginning of 2022 marked a turning point for the CLO industry as new transactions had to move on from Libor to Sofr.
On top of that, inflation has been rising and central banks have intervened to increase interest rates.
Regardless, the Creditflux CLO hedge fund index rose 1.44% in January. Flat Rock’s CLO strategy led the way, with Prospect, Fair Oaks, CIFC and Lupus Alpha also generating strong returns.
The next highest category was credit fund of funds. These gained 0.8% in the month.
European loans stumble after bright start to 2022
Jitters around inflation, interest rate hike expectations and escalating geopolitical tensions in Russia/Ukraine have created softness in the European leveraged loan market.
CLO managers say new issue loans are being talked wider. As Creditflux goes to press, Carlyle-backed Spanish ceramic coating business Altadia’s €1.2 billion term loan, for instance, revised margins 25 basis points wider to Euribor plus 475bp, with a 0% floor to entice investors. However the deal includes 25bp ratchets that step down twice — at 0.75x and 1x inside opening leverage.
Meanwhile, French laboratory service company Cerba Healthcare increased the discount on its Euribor plus 400bp term loan from 99.5 to 99.
This marks a turn from January, when loan demand was running high.
“There was a strong focus on loan products in January, with some primary deals even switching from fixed-rate senior secured debt towards loans or FRNs because investors felt more comfortable with floating rate products in a rising rate environment,” says Deborah Cohen Malka, partner at AlbaCore Capital Group.
“That was good for CLOs, but nervousness around Russia/Ukraine has created more softness in the loan market and dispersion within credit.”
Cohen Malka believes some companies have been able to offset inflation and mitigate cost pressure. But some with good earnings haven’t been able to pass through cost inflation, which could put pressure on margins and cash-flow, as well as potentially causing downgrades.
Nevertheless, she is constructive on the relatively benign forecasted default rates.
AB targets software companies after niche securitisation
Deutsche Bank priced an unusual securitisation for AB last month. The deal accommodates the manager’s expertise in the software and technology sector.
ABPCI Direct Lending Fund ABS II is a $450 million deal targeting private credit instruments, including recurring revenue loans and hybrid asset-based loans, along with regular middle market loans.
Revenue recurring loans are based on a borrower’s revenue stream, rather than on positive ebitda. Typically, they are extended to companies in their formative years that are developing fast but have a high rate of cash burn. Young software companies are one sector that tends to obtain financing by this means.
Revenue recurring loans in the AB deal must have a maximum loan to value ratio of 45%, according to documents seen by Creditflux.
AB’s securitisation priced senior-most notes at Sofr plus 210 basis points, with Kroll Bond Rating Agency assigning these an A rating.
Three other debt tranches feature in the capital structure of the 4.3-times levered deal, and these all pay fixed-rate coupons (despite the underlying portfolio consisting entirely of floating rate collateral).
The market for revenue recurring loan securitisations is small. Golub Capital is one of the few firms to issue a similar deal.
All rise: investor fights inflation with litigation financing
With the US consumer price index rising to 7.5% in February, investors are looking to niche investment strategies to hedge against inflationary pressure.
Raphi Schorr, partner and deputy chief investment officer at HighVista Strategies, says his firm is helping investors hedge against inflation risk by turning to the courtroom.
“Inflation concern is more easily allayed in short-to-medium term credits where exposure to rising interest rates is less significant,” Schorr says.
One of the strategies HighVista uses is litigation financing, where it lends against delays in the awarding of court settlements.
Schorr says his strategy can help a plaintiff reduce their risk and fund appeals while also delivering an attractive return.
CLOs go island hopping as EU rules bar Cayman Islands
Swathes of CLO special purpose vehicles are set to be relocated this month following the introduction of European Union regulations designating the Cayman Islands as a money laundering location.
The rules, which come into effect on 13 March, prohibit European investors from participating in deals domiciled in the Caribbean islands.
The legislation impacts any US CLO structured to comply with European risk retention rules that is marketed to investors in the EU, meaning non-risk retention compliant transactions are expected to keep their Cayman-domiciled SPV. The final draft of the legislation was published on 21 February.
A portion of the CLO market has chosen the island of Jersey, a British crown dependency, to domicile new deals — this includes Neuberger Berman Loan Advisers CLO 48, which priced on 22 February.
Another, likely larger portion of the market, will domicile deals in Bermuda, which is more conveniently located from a time-zone perspective to deal parties in the US.
“The Cayman Islands have a notion of a ‘continuation of a legal entity’ with Bermuda and Jersey, so a filing can dissolve in Cayman and continue its existence in the other jurisdiction,” says Larry Berkovich, partner at Allen and Overy.
“This involves an additional layer of regulatory filings and costs, but it doesn’t seem to be prohibitive.”
The US state of Delaware has also emerged as a destination for the SPVs, though setting up an onshore CLO could risk adverse tax implications for equity investors based outside the US.
Packaging company Schur is painful for European CLOs
The dramatic fall in loans taken out by Austrian flexible plastic packaging manufacturer Schur Flexibles has shocked CLO managers. The firm is hiring PJT Partners and Allen & Overy ahead of a potential restructuring.
The firm’s loans plunged 20 points in February after it discovered errors in its accounts, which may have resulted in inflated ebitda numbers. Moody’s Investors Service has placed the B2-rated firm on review for downgrade.
The Schur €475 million term loan due 2028 and paying Euribor plus 425bp collapsed from 101.17 to 75.4 on 16 February.
Nearly half of European CLO managers (27/56) hold a total of around €165 million of Schur’s term loan, according to the latest trustee reports from CLO-i.
Apollo Global Management (Redding Ridge) has the largest volume at €31 million across 10 deals. It is followed by Investcorp Credit Management (€12.1 million in nine deals) and Carlyle Group (€10 million in five).
“We have placed Schur’s ratings on review for downgrade because of the sudden changes in the management team, including the chief executive and chief financial officer, which may have a negative impact on the company’s credit profile,” wrote Donatella Maso, vice president at Moody’s.
Russian power play causes Europe to break away from US
Russian intervention in Ukraine has become a central issue for credit market investors, who had been slow to acknowledge the mounting threat due to a prior fixation on high inflation and central bank hikes.
While some credit investors went into 2022 hoping to play high yield versus investment grade compression, European underperformance versus the US has become the most prominent feature.
The iTraxx Europe investment grade index gapped out from 47.75bp at the start of the year to beyond 71bp — outstripping US counterpart CDX IG by about 4bp. Similarly iTraxx Crossover has converged on CDX HY, with constituents such as Novafives and Saipem moving into the ranks of the most risky for a near-term default.
Russia’s amassing of troops on the Ukrainian border went almost ignored by mainstream credit markets for several weeks, despite ballooning Russian and Ukrainian sovereign spreads. But president Vladimir Putin’s decision on 22 February to recognise the Donestk and Luhansk regions of Ukraine as independent states left western leaders in no doubt a full-scale invasion could soon follow.
Russian Federation five-year CDS was 344bp at time of press on a monthly move of 137bp, according to IHS Markit. But Ukraine is even further into distressed territory, with five-year CDS at 26 points up front. Its three-month CDS has spiralled out to 4,138bp, signalling a high probability of default.
The response of Nato countries to Russia’s actions looks set to heap pressure on Europe’s challenged economies. In particular, Russia is warning of doubled gas prices if Germany freezes approval of the Nordstream 2 gas pipeline.
Investors brace for rare iTraxx versus CDX IG roll dynamics
Credit traders are gearing up for a highly volatile index roll in March that could bring rare relative value dynamics between CDX and iTraxx.
The investment grade arena has produced an unusual situation in which iTraxx Europe trades on top of CDX IG and faces a steeper roll into its new series.
Recent turmoil in eastern Europe has pushed Europe 1-2bp outside its US counterpart, whereas previously it had been upwards of 2bp inside.
Moreover, the expected constituent changes and extra duration at the roll could place the new Europe series 37 index 8bp wider than outgoing S36 on fair value. There has been only a 6bp lift into CDX IG 38.
“There has been only one other roll since 2010 — the March 2021 roll — when the prior Main and CDX IG series had similar intrinsic values and the Main roll was steeper than the CDX IG roll,” says a Barclays credit strategist.
“During that roll, long-risk positions in Main did roll early, with investor positioning in the prior on-the-run series (S34) going from $17 billion of net protection sold to nearly $6 billion of net protection bought after just the first week.”
IHS Markit is yet to publish provisional changes, but Crossover and CDX HY could lose three to four ‘rising stars’ apiece to upgrades.
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Global credit funds & CLO's
March 2022 | Issue 243
Published in London & New York.
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