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News in brief

May 2022 | Issue 245
Dispersion begets dispersion in mixed bag of fund returns
Idiosyncratic risks are set to rise in credit, with fund managers becoming occupied with tail risks, and that has been seen in a scattered set of March hedge fund returns.
Almost half of funds in our database produced positive returns (a step up from the 17% that did so in February), but the range of results was wide. A structured finance fund brought up the rear, losing 17.73%, while the table topper is a fund of funds managed by Ayaltis (up an estimated 4.5%). Somewhat counterintuitively, the fund of funds has starred by spreading risk across managers.
Elsewhere, funds that invest in CLOs and credit derivatives bounced back well. These types of funds suffered in February.
Managers look at rating agency combos as weighted average life drops
CLO managers are looking closely at rating agency pairings as investors opt for shorter risk horizons, according to market participants.
At IMN’s European CLO and leveraged loans conference last month, Bank of America CLO structurer Tomasz Gruszka said that, prior to the recent volatility, rating agency pairing structures did not matter much but, now, differences between the agencies can be “quite substantial”.
Since Russia’s invasion of Ukraine, European CLOs have typically featured a seven-year weighted average life (in terms of asset pools), while deals pre-pandemic featured an eight-and-a-half or nine-year WAL. There has also been a wide variation in structures.
London-based Brendan Condon, vice president in CLO origination and structuring at Deutsche Bank, agreed with Gruszka.
“Managers ramping in primary now have deals with around seven years in maturity. That means an indicative portfolio which has more primary than secondary will be similar if not longer to the weighted average life,” he said. “This can have an impact on rating agency combinations, as some rating agencies are more sensitive to the WAL of the asset pool, whereas others just look at the model WAL.”
Sources say S&P is sensitive to short WAL. It models the actual weighted average life of a deal, whereas Moody’s and Fitch model the covenanted weighted average life in general, minus one year.
“The cost of debt makes everything more constrained,” says one source. “You must optimise for a structure that works in a particular situation.”
Investable universe for Euro CLOs shrinks amid inflation
The number of loans suitable for European CLOs is getting smaller at a time when new CLO issuers are looking to enter the market.
Direct exposure in European CLOs to Russia-Ukraine has been minimal. But CLO managers are keeping a close eye on second order impacts within portfolio companies of rolling lockdowns in China, inflation, interest rate rises, wage increases and staff shortages, and energy prices. Sectors impacted include airlines, building materials, building products, gaming, leisure and auto.
“CLO managers are looking at the input costs and seeing which obligors can pass these on to their customers and which ones can’t,” says one investor.
“Add to that all the covid-impacted sectors, plus sectors such as retail, which were struggling pre-pandemic, and going forward, the investable universe is shrinking and diversity across the board will decline because more companies are being added to the do-not-invest list.”
Meanwhile, the number of European CLO managers looks set to increase, with Creditflux reporting that firms such as Nuveen, Pemberton, Signal, Muzinich, Fortress and Pimco are all setting up platforms.
The good news is that European CLO portfolio metrics remain healthy. Triple Cs are elevated at 5%, but they are still lower than last year’s 8%.
In addition, the demand for fixed rate assets has increased, meaning managers can use the bond universe to build diversity.
Top macro credit PM will fly solo with fund launch
A new credit investment firm could soon be in the offing, following the departure of Alberto Gallo from Algebris Investments in April, suggest market sources.
Gallo’s plans are not known. But sources say his departure paves the way for a first run at leading his own fund management business, having led teams within firms for the past 15 years. He has also built a high profile through macroeconomic commentary, including financial television interviews and his ‘Silver Bullet’ blog for Algebris.
Gallo has nearly 20 years’ experience, as a portfolio manager and a bank credit strategist.
He worked at Algebris for six years, becoming head of global credit strategies and overseeing the firm’s €670 million Global Credit Opportunities fund. That predominantly invests through CDS indices and options, convertible and high yield corporate credit, as well as additional tier one instruments.
It is understood Algebris’s other portfolio managers will maintain oversight of the credit opportunities fund, with James Friedman leading.
Gallo joined Algebris in 2016 after leaving RBS, where he was head of global credit macro research during a five-year spell at the bank. He previously worked in credit strategy positions at Goldman Sachs, Bear Stearns and Merrill Lynch.
CLO triple As lag recovery as IG relative value opens up
The CLO market rebounded in late April after a volatile two months following Russia’s invasion of Ukraine, but triple A notes have lagged the recovery even as mezzanine debt tranches tightened.
Triple A spreads in the secondary market are stuck around the 133.5 basis point area, according to Prytania Solutions’ CLO index. Index spreads blew out from below 120bp over Sofr to over 140bp in the final week of February and, while they have regained some lost ground, levels have trended slowly wider since the middle of April.
Fixed-rate ABS products have widened further and faster relative to CLOs. This technical factor is partly responsible for widening CLO triple As, which in turn is caused in part by investors that buy across structured credit products who think they can get cheaper paper in other asset classes.
“Triple As remain somewhat wide, and part of the reason is investors selling in the secondary market because CLO triple As have retained value relative to investment grade credit,” says Wynne Comer, chief operating officer at AGL Credit Management. “You can sell CLO triple As and buy investment grade, which would be a nice relative value play.”
Another factor in wider triple A pricing is the Libor to Sofr transition, which has left US banks unable to make Libor-denominated investments. Comer says that US-based asset managers and Japanese banks have filled the gap and kept levels in check, after major investors absented themselves from the primary market for a prolonged period.
“We’re seeing the return of the Japanese buyers since their year end,” Comer says.
CRE CLO episode shines light on CLO get-out clauses
Market disruption clauses are rare in CLO warehouse agreements, but litigation surrounding a cancelled 2020 CRE CLO underlines how these can give CLO issuers added flexibility in a doomsday scenario.
A New York Supreme Court judge last month ordered Bancorp Bank to repay Cascade Funding’s $12.5 million deposit after the latter terminated an asset purchase agreement for a CRE CLO in March 2020. The Waterfall Asset Management affiliate did so on the grounds of market disruption, which stipulated it could pull the plug on the deal if credit spreads widened, as they did vigorously during the pandemic.
Although CLOs tend to be ramped in the open market (the CRE CLO hinged on an $825 million portfolio purchase), market disruption clauses have appeared in warehouse agreements.
“Such provisions exist in some CLO warehouse deals, but are not standard, and when they exist, are more often than not bespoke to the transaction at issue,” says a New York-based structured credit lawyer.
In periods of dislocation, CLO issuers are likely to want to add assets. Meanwhile, warehouse providers are incentivised to de-risk.
In March 2020, US CLO warehouses were largely spared from being unwound, although stop-draw triggers were hit, forcing managers to put deals on ice. Sources say there were a couple of banks at the time which refused to settle trades that had been agreed during this period due to internal risk measures.
Phase 6 of uncleared margin rules drives CDS clearing volumes
2022 is shaping up to be a bumper year for CDS clearing activity, not only due to increased trading of the asset class, but a confluence of other factors, such as regulations, product expansion and wider geographical reach.
One seldom discussed driver of derivatives clearing volume this year is the September roll-out of phase six of uncleared margin rules. This brings margin posting requirements into scope for market participants with an aggregate average notional amount of $8 billion, largely affecting buy-side firms such as hedge funds, asset managers, pensions, insurers, and energy companies. 
“Phase six is huge and an operational challenge that many clients are still getting up to speed on,” says Michael Amakye, head of CDSClear Sales at LCH. “With CDS, this is particularly seen in clearing of index options, even though there is not a mandate to clear those. Partly this is because the trades tend to be a bigger size than, say, single name CDS. And they also get placed for shorter durations — one to three months — rather than being held.”
LCH cleared a record €927 billion worth of CDS notional in the first quarter, through index, single names and options — up 48% from the same period in 2021. Of that amount, index options made up €62 billion, a 71% jump, and the firm launched client clearing of options, with BNP Paribas and JP Morgan its first clearing brokers.
“Market volatility was elevated in Q1, but still some way below the covid-19 related spike of March/April 2020,” says Amakye. “Conditions were better for CDS activity, which was much higher in this period compared to 2020.”
Natwest buys triple As in bid to win future CLO business
NatWest Markets is understood to be buying European CLO triple A paper on its balance sheet in the hopes of picking up future mandates for its arranging business, according to market sources.
Creditflux reported on NatWest’s ambitions to strengthen its CLO arranging business last year. The bank has a track record of co-arranging European CLOs with GreensLedge. In 2021, the pair worked on three deals: a reset of Blackstone’s Crosthwaite Park in February, a reset of Napier Park’s Henley CLO III and a refi of KKR’s Avoca CLO XX, giving the bank 0.61% market share.
Barclays, Jefferies and BofA dominated overall European CLO issuance last year, with 13.25%, 12.87% and 10.31%, respectively.
Banks buying triple As to win mandates is not an uncommon strategy — Bank of America, Deutsche Bank, Citi and JP Morgan also invest in European CLO triple As, according to sources. But these banks do not closely link their CLO buying and CLO arranging functions.
NatWest is not the only bank attempting to strengthen its CLO arranging business. Mizuho is serving as co-bookrunner on Spire Partners’ upcoming European CLO with Jefferies. The bank outlined its European CLO plans to Creditflux last year.
NatWest arranged 24 European CLO new issues between 2010 and 2015, according to CLO-i. In recent years it has sought to revive this franchise, but suffered a blow in June when head of CLO structuring Luca Giancola left. Vivek Sadhwani now leads that team.
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Global credit funds & CLO's
May 2022 | Issue 245
Published in London & New York.
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