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May 2023 | Issue 254

News in brief

CLOs go topsy-turvy as debt stacks yield more than equity tranches
Just under $4 billion US CLOs have priced in April as Creditflux goes to press, down around 50% from the total figure for March as the market rebounded following the banking sector-induced volatility. But some investors eyeing the primary market say that the equity tranche has a lower return profile than most of the debt stack.
Speaking on The Last Tranche podcast, Dan Ko, principal and portfolio manager at Eagle Point Credit Management, said his firm has not made a primary market equity investment in around nine months due to the challenged arbitrage that means certain new CLOs have modelled equity returns as low as 6%.
“With Sofr at 5%, that’s equivalent to a yield on a triple A investment,” Ko says. “If I had to buy new issue, I would rather buy new issue double Bs that have low to mid-teens yield to maturity or mid-to-high teens on a yield to call basis, which is nearly double some of the returns of lower tier collateral managers’ equities.”
CVC Credit has a captive equity fund that allows investors to control the timing of its CLOs. CVC has printed five new CLOs globally this year, the most of any manager, and the firm’s global head of performing credit, Gretchen Bergstresser, says the longer-term outlook for the deals’ equity remains higher than lower mezz tranches.
“There are two components to CLO equity returns, one of which — the cash on cash — is tight right now,” says Bergstresser. “The other component is how much pick-up you can get in a 10-times levered vehicle by buying assets in the mid-90s and for those assets rallying to par over time.”
Managers raise rated-note feeders despite scrutiny from US insurance association
Alongside its investigation into CLOs, the National Association of Insurance Commissioners is weighing up its treatment of collateralised fund obligations (CFOs) and rated-note feeders. But this has not dampened appetite much, with Creditflux reporting on large managers, such as Blackstone, raising rated-note feeders for private credit strategies.
But sources say that, amid the NAIC’s investigation into CFOs and rated-note feeders, some sponsors are treading carefully.
A New York-based lawyer says some sponsors are looking at raising structures which are not backed by any equity investments, while others are looking at rated-note feeders that hold assets directly, rather than through a feeder fund.
“These end up looking like a private CLO with various tests, such as those on portfolio diversification,” he says.
He also argues that rated-note feeders are used by insurers for bona fide investment purposes.
“Smaller insurance companies are unable to initiate separately managed accounts because it’s inefficient for $5 million ticket sizes,” he says. “So they have to invest in a commingled fund structure, which can attract a 30% higher capital charge versus a larger insurer, which can invest in the same pool of assets in SMA format.”
Loan prepayments open up CLO liquidation option
There could be fresh impetus for European CLOs being liquidated amid a pick-up in M&A, which could cause loan prepayment rates to rise. With CLO triple A spreads still close to historic wides, equity investors might view a liquidation as the best exit strategy.
But market participants are not immediately concerned. The European Leveraged Loan Index is pricing in the 94/95 context, and with equity NAVs low, and cash payments still flowing, there’s little incentive for equity to call the deals, sources say.
“A couple of months ago, equity NAVs were negative,” says one investor. “If we do see loan prices rally, that could be a catalyst for some of these deals being called, but given prepayments are lower, the arbitrage will probably keep working.”
One CLO manager says the increasing amount of European CLOs that have exited their reinvestment period isn’t a concern. 25-30% of European CLOs are out of reinvestment, but there should be enough demand from new CLOs to replace legacy ones.
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Global credit funds & CLO's
May 2023 | Issue 254
Published in London & New York.
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