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News in brief
May 2021 | Issue 234
CLO fund comes top by distance in middling month for credit
A CIS Asset Management fund, which invests mainly in US CLO equity, was the star performer in March after gaining 7.36% in the month.
CLO Alpha Compartment Taunus comfortably beat its peers, with the Creditflux index for CLO funds hitting just 0.6% as primary CLO spreads gapped out.
A range of credit funds made it into our top 10 for the second successive month and yet again fund of funds have outperformed, gaining 1.5% when most other strategies returned -0.71 to 0.6%.
The median return in March across our database of 141 funds was 0.33%. Emerging markets were the weak link as covid deaths escalated in several emerging countries, including Brazil and India.
China Huarong’s late annual report unsettles market
China Huarong Asset Manager, the state-owned bad debt manager, has been a big driver of credit volatility in an otherwise placid market, after its delayed annual report sent shockwaves through the region and beyond.
China Huarong International Holdings’ five-year CDS gapped from 134.5 basis points at the start of the month to 1,404bp by mid-April, according to IHS Markit, after it missed the 31 March deadline. It shot back to 520bp soon after, but had careened again to 775bp at time of press.
The iTraxx Asia ex-Japan index, of which Huarong is a constituent, suffered on the back of this against a much flatter overall global credit picture. The index surged from 63.5bp to 91.25bp, before bounding between 75bp and 84bp. It was 81.25bp at time of press.
Financial regulators belatedly tried to project a message of reassurance, with the China Banking & Insurance Regulatory Commission saying the firm has normal operations and sufficient liquidity. Some media reports speculated that China’s central bank could assume some of Huarong’s assets, while others suggested it could file its 2020 results by May.
This did not deter Fitch from cutting its rating of Huarong on 26 April by three notches, from A to BBB, citing the “limited transparency of Huarong’s disclosure”. It added that the “government sponsor’s indication of timely support may dampen the company’s ability to refinance offshore at a reasonable cost”.
“As the sixth-biggest issuer represented in the CEMBI Broad index, Huarong is a big deal and should continue to cast a cloud and create ripples in the whole region,” wrote JP Morgan credit analysts.
ESG factors show up in leveraged loan pricing in US
Environmental, social, and corporate governance factors are filtering through to the US CLO market and influencing loan prices.
“You can already see ESG’s impact in the trading prices for specific loans,” says King Street’s Young Choi. “Companies that have ESG issues trade at different prices and the market is starting to notice.”
Sources say the driving force behind ESG integration in US CLOs is large asset managers that buy triple A debt. Some of these investors are believed to use ESG as a factor in staff bonus payments.
BlackRock, PGIM, Pimco and State Street all have ESG investment strategies.
Not all US investors are happy with the latest developments. Sources say that a hedge fund-style single B investor unsuccessfully attempted to push back on all the ESG language in a CLO last month, on the grounds that the ESG movement would eventually lead to gun control regulation.
A Citi research paper released recently estimated that 11% of US CLOs issued in 2020 included at least one ESG consideration, up from 3% in 2019.
The bank’s analysts believe between 20 and 40% of CLOs will have ESG considerations baked into the documentation in the next two years.
Nochu stays on sidelines but hope lingers for return
Reports in the mainstream media last month suggested Japanese heavyweight CLO investor Norinchukin Bank was looking at deals in the market ahead of a return to CLO investments.
But several sources, including CLO managers on the bank’s approved list, tell Creditflux that Nochu is unlikely to come back until much later this year.
Tokyo-based Nochu was an anchor CLO triple A investor in the US and Europe. But heightened scrutiny by Japanese regulators led it to step back in 2019. Since then, the bank has let its book run down.
However, other Japanese investors including Sumitomo Life are in the market, with sources indicating the insurer was buying CLO paper throughout 2020.
The Nochu bid gave CLO managers certainty of execution and typically provided a floor for CLO spreads, but the bank did require strict covenants in deal documentation.
WhiteStar finally makes it to Europe
US CLO manager WhiteStar Asset Management opened an office in London last month in what officials describe as the culmination of a plan that has been many years in the making.
“We think there are a great number of synergies with US and European CLO manager platforms,” says Gibran Mahmud, WhiteStar chief executive officer, who is based in the company’s Dallas headquarters.
“When we started WhiteStar we always planned to expand into Europe, but we didn’t want to build two businesses from scratch at the same time and wanted to build each the right way,” he says.
“We’ve been risk retention compliant on our US CLOs since 2015 and have been fortunate to be able to partner with a lot of investors in Europe, so we wanted to have a footprint to better service our European-based partners.”
WhiteStar has hired Gordon Neilly to lead the firm’s expansion in Europe.
This will be the WhiteStar team’s second time entering the European CLO management space, having negotiated the purchase of contracts from ING Capital Management in 2005, and later selling them to Carlyle Group in 2012. These transactions were completed when WhiteStar officials worked at Highland Capital Management.
WhiteStar aims to build its CLO team over the coming months, either through building from scratch or acquisitions.
“We wouldn’t be opposed to acquiring a CLO manager again for the right platform and the right people — one that has done right by its investors to date, had a conservative credit culture, and good performance,” Mahmud says.
WhiteStar is believed to have recently been a bidder on European CLO platforms.
BofA and State Street divided over CLO convertibles
A split has emerged in the approach between the two big buyers of triple A-rated CLO tranches that are structured as loans.
Bank of America has started buying these in convertible form, where it has the option to convert the loan into a note at any time, as previously reported by Creditflux. But State Street is not following suit.
One of the reasons these firms are buying CLOs in loan form is that they can account for their holdings as such, which typically means less mark to market volatility than if the CLOs were in note form.
International Financial Reporting Standards dictate that, for an investor, an instrument has to be accounted for as a whole, taking into account the cash-flow characteristics over the entire life of the instrument, according to IFRS 9.
BofA appears to have followed this guidance, given cash flows are not affected if the loan CLO tranche were to convert to a note.
Accounting treatment for convertible assets becomes more complicated if, for instance, a bond transforms into stock as the payment profile changes.
European CLOs issued by Cairn Capital and Permira Credit are the only ones to embed convertible tranches into their capital structures.
BofA is understood to be committed to holding CLOs for the long-term, but including the note option gives the bank flexibility, as notes have better liquidity than loans.
Non-mandated CDS clearing leaps ahead of margin deadline
The regulatory drive to increase clearing of derivatives is making big strides in the credit market. But a standout feature of 2021 is the acceleration in central counterparty clearing of products not subject to a regulatory mandate, such as CDS index options and single names.
The general uptrend took the notional volume of client-cleared CDS at LCH to €193 billion in 2020, versus €43 billion in 2019. Last year, clearing reached over €30 billion in a single day during the weeks of the iTraxx and CDX index rolls.
CDSClear clients cleared €5.3 billion of single name CDS notional in the first quarter. This is 2.5 times more than the same period last year, despite trading volumes having fallen.
Uncleared margin rules (UMR) are a factor in the acceleration, with phase five due to begin in September. Asset managers, banks, hedge funds, corporations and pensions may be in scope if they have an average aggregate notional amount in excess of $50 billion between March and May.
“The next phase of uncleared margin rules will capture the broadest array of counterparties yet,” says Laura Misher, managing director for pricing, valuations and reference data at IHS Markit.
The firm expects those close to the threshold to ramp up use of clearing to avoid having to exchange initial margin.
“Phase five clients are making their final push to comply,” adds Misher. “This includes renegotiation of credit support annexes, setting up of tri-party or third-party relationships for segregation of collateral, ensuring accurate calculation of initial margin due, and ensuring collateral management systems can cope with the changes.”
US Libor falls to record low of 17.3 basis points on 21 April
Three-month US Libor plunged to historic lows last month, posting at just 17.3 basis points on 21 April.
Following the global financial crisis of 2008, Libor reached a low of 23.6bp in October 2013.
Around a third of leveraged loans issued pre-covid pay a spread over Libor floored at 1%. 60% of loans have a 0% floor, while another 4.9% are floored somewhere in between. A tiny 1.1% of the market is unfloored.
On the liability side, 70% of CLO tranches have 0% floors and 18% are unfloored, sources say.
CLO equity investors have been accruing an excess spread since summer 2020 as a result of Libor’s decline. While CLOs are protected from short-term volatility in Libor, a lower base rate means a greater spread basis paid to equity while Libor remains between zero and 1%.
Since the pandemic began, a greater share of newly issued loans feature Libor floors as creditors seek protection from rate risk.
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Global credit funds & CLO's
May 2021 | Issue 234
Published in London & New York.
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