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News in brief

November 2022 | Issue 250
Flat Rock eyes double Bs for CLO interval fund launch
Flat Rock Global is expanding its CLO fund roster and eyeing double B-rated tranches of US middle market CLOs as part of a new interval fund, according to market sources.
The vehicle, Flat Rock Enhanced Income Fund, will focus on double B-rated CLO investments but can, to a lesser extent, invest in other CLO junior debt tranches and CLO equity.
Flat Rock will conduct quarterly repurchase offers at net asset value of no less than 5% of outstanding shares, to satisfy interval liquidity requirements.
Robert Grunewald and Shiloh Bates, both based in New York, will be portfolio managers on the fund.
Flat Rock is well known as a middle market CLO investor and the firm has at least one other CLO interval fund — Flat Rock Opportunity Fund — which launched in July 2018 and invests primarily in CLO equity.
As of 30 June, that fund had $276 million assets. It was a finalist in Creditflux’s best CLO fund award category in 2022 and 2021, having picked up the award in 2020.
Flat Rock also manages another credit interval fund, Flat Rock Core Income Fund. Creditflux reported that fund was previously a private business development company named Flat Rock Capital Corporation, which the firm chose to convert to an interval fund.
It invests in the first lien debt of US middle market companies with ebitda between $5 million and $75 million, as well as CLOs and other BDCs.
Flat Rock is not the only CLO investor to have an interval fund focusing on double B rated tranches. Eagle Point registered Eagle Point Income Company in 2018. That fund, however, focuses on broadly syndicated loan CLOs.
US CLO managers face SEC marketing rules compliance
The 4 November deadline for compliance with the SEC’s marketing rule is fast-approaching, with sources describing the rule as “creating an adversarial situation for managers and arrangers”.
As previously reported, US CLO arrangers may need to provide clear and prominent disclosures when soliciting investors, depending on the type of communication.
There has been limited guidance from the SEC over what constitutes solicitation, and managers and arrangers need to take a view on what communication this could be.
CLO offering memorandums are typically not considered an endorsement “to the extent the content includes a description of the material terms, objectives, and risks of the notes,” whereas pitchbooks would most likely come under the scope of the SEC regulation.
“I’m sympathetic to the arrangers out there because they are being asked to take on additional burdens from a compliance perspective,” says one source.
“But on the other hand, the way the rule is drafted, managers have no choice but to get some sort of comfort on this because they need a reasonable basis to believe that there is compliance.”
Nochu turns tables after experiencing CLO walkouts
Norinchukin Bank’s retreat from global CLO investing — having agreed to take down the senior notes of several upcoming CLOs — has disappointed market participants. However, although they don’t condone such actions, sources say there were mitigating circumstances.
They say Norinchukin was anchor triple A investor on two US CLOs over the course of the third quarter. On both occasions, CLO equity investors backed out at the 11th hour after sharp loan rallies made deal economics unpalatable. This led to a scramble to find replacement equity investors.
Having been burned on those occasions, the bank presumably felt that walking away from deals did not fall foul of CLO etiquette.
Creditflux first reported that Norinchukin had backed out of the market on 13 October, with a CVC Credit European CLO among the deals it walked away from.
Norinchukin had only returned to US CLO investing a year ago and to European CLOs earlier this year, having sat on the sidelines since 2019.
European real estate available with pruned inflation hedges
Throughout the upheaval in European credit this year, one segment of the market that has shown itself to be resilient against the pressures of inflation is real estate debt. In fact, such has been the allure that sources say some issuers are looking to tap the European CMBS and nascent CRE CLO markets for the first time.
DWS’s head of European real estate debt, Alexander Oswatitsch, says there has been an element of repricing in the real estate debt space. But there is an inflation hedge of sorts to protect investors, as rental growth has boosted income, while cost of debt also increases.
“The two sides are balancing, with rental growth to some extent mitigating the impact of increased property yields,” he says.
DWS held a first close on a European junior real estate debt fund in March at €150 million, with the goal of growing that to €500 million, according to an announcement at the time. Oswatitsch says opportunities are opening in the capital structure as a knock-on of how senior lending is changing.
“Transaction volumes are down, but there will be refinancing opportunities in the coming months,” says Oswatitsch.
“However, with less senior capital available as banks retrench, senior loan amounts will be smaller and not everyone will have the equity to fill the void. That opens up a junior debt market at about 50-65% loan-to-value.”
Real estate debt loans tend to have stronger covenant packages than corporate credit agreements, and they are backed by physical assets, making them enticing for investors.
Nuveen raises $150 million to invest further in CLOs
Nuveen is expanding its CLO product suite with the launch of a new CLO opportunities fund, according to recent regulatory filings.
The vehicle, Nuveen CLO Opportunities Fund, has raised at least $150.2 million, filings reveal. It is unclear which part of the CLO capital stack the fund will invest in.
The manager closed its inaugural CLO captive equity fund at over $375 million in April. At closing, that fund had invested in “equity stakes of multiple new issue Nuveen CLOs, CLO warehouses, as well as debt and equity tranches of legacy Nuveen CLOs through the secondary market”, the firm said at the time of announcement.
Creditflux first reported on the fund in August 2020.
The latest CLO fund launch is likely geared towards third-party CLO tranches, as Nuveen’s Symphony Asset Management unit is one of the most experienced investors in this space.
Aside from the CLO opportunities fund, Nuveen is one of several managers looking to launch a European CLO platform. At the time of press, the firm has yet to hire a European CLO portfolio manager, sources say.
A spokesperson for the firm did not respond to a request for comment.
Mid-market endurance test prompts funding overhaul
For even the biggest borrowers, access to funding is not what it was. But low to middle market companies in particular are struggling as they face a slowing economy and a banking sector that is increasingly restrictive in extending credit. This creates an opportunity for private investors, says Bobby Barrett, partner at Z2.
“Most private, non-sponsored companies don’t know where to go, and it’s a greater challenge if they don’t have a long track record of historical performance,” says Barrett.
Z2 is a new manager focusing on debt and equity investments of $10-100 million mostly in private North American companies.
“There’s a huge opportunity for this kind of capital,” adds Barrett, who works alongside Z2 managing partner Scott Gold and partner Jake Sussman.
“Today, we see limited competition from other alternative credit providers, as most non-sponsor financing is for large, well-diversified companies.”
Z2 can invest across the capital structure, from senior secured loans to common equity, and the firm examines each situation, sector by sector, company by company. Bar real estate, which it avoids, Z2 styles itself as industry agnostic.
“Use of our capital is varied,” says Barrett. “Some companies are trying to take advantage of the declining economic environment to acquire companies or accelerate organic growth; others are trying to replace existing credit lines or just get by.”
US CLO equity payments drop to lowest since covid
US CLO equity payments have taken a hit in October due to a mismatch between one-month and three-month Libor and Sofr. 65% of loans in US CLOs reference one-month Libor, whereas all liabilities pay from three-month Libor or Sofr.
According to Bank of America research, CLO payments in October were referencing three-month Libor at around 274 basis points, which was 170bp higher than where July payments referenced. On the other hand, payments from the assets in CLOs only increased by around 140bp, according to BofA, as most loans referenced one-month Libor.
Equity investors therefore had to deal with around 30bp of lower income on an annualised basis which, when converted to a quarterly payout and levered by roughly 10 turns, comes to a 70bp decrease compared to July payments.
Creditflux data for 259 US CLOs that closed pre-2022 and have made October payments shows that the average equity payment in October yielded 10.61% annualised, compared with 14.48% in July and 17.49% in April.
This is the worst payment period since the coronavirus caused chaos in financial markets in March 2020, according to BofA research.
The mismatch between one-month and three-month Sofr was less pronounced, sources say, meaning that 2022 CLOs were less affected than those still referencing Libor. The basis between one-month and three-month Sofr in mid-July was around 40bp.
The issue is not going away. US CLO equity payments in January will reference a mid-October rate where the basis between one-and three-month Libor is around 75bp.
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Global credit funds & CLO's
November 2022 | Issue 250
Published in London & New York.
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