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News in brief

October 2022 | Issue 249
Creditors look to block asset stripping in loan docs
Loan managers are using their increased negotiating leverage amid tighter credit conditions to push back on private equity sponsors’ ability to asset strip portfolio companies.
Creditors are writing stips into loan documentation that would protect them against the so-called “J Crew trapdoor”, which allowed the US retailer to move collateral into unrestricted subsidiaries following a credit event in 2017.
Specifically, lenders are including “material IP blockers” that prevent a company from transferring intellectual property to subordinates. They are also trying to ban asset transfers to unrestricted subs without agreed carve-outs.
Lenders made attempts to avoid trapdoors in the years following J Crew’s 2017 default. But amid the financing boom in 2021, sponsors were able to secure favourable documentation terms, with some creditors concerned the strategy became institutionalised.
Derek Gluckman, vice president and senior covenant officer at Moody’s in New York, says one of the most aggressive features to emerge in documentation allows sponsors to take some or all of their restricted payment basket, double it in size, and incur debt or make unrestricted investments with the proceeds. Sponsors can then move their restricted basket to an unrestricted subordinate, taking it out of the scope of litigation, or to pay itself dividends.
From there, Gluckman says, the collateral is no longer securing the secured lenders.
“Whereas carve-outs were previously narrowly tailored and negotiated amounts, I think lenders have lost control,” he says. “That could surprise lenders in certain stressed credits.”
CLO managers find safety and return potential in IG
An investment grade bond might not seem the most suitable candidate for a CLO portfolio, but managers are increasingly going up the capital structure as they brace for a recession.
“We have been buying IG bonds in both our CBO and CLO portfolios,” says Scott Goodwin, co-founder of Diameter Capital Partners.
“Given the deep dollar price discounts and the potential for these bonds to outperform and hopefully even perform well in a recession, we believe there is a place in both CBOs and CLOs for IG bonds.”
As reported by Creditflux in August, Diameter was among the CLO managers to be holding IG bonds in a group consisting of Allstate, Ares, Brigade, HPS, PGIM and Sound Point.
CLO investors cite just how quickly IG bonds can recover versus other asset classes, and the current market certainly seems to be a good entry point, with the iShares iBoxx $ Investment Grade Corporate Bond ETF reaching a low of 104.91 as Creditflux goes to press.
Other investors point out the positive impact IG bonds have on CLO weighted average rating factor scores.
Among the most purchased IG bonds in CLOs are Apple, Boeing and Centene, along with financials such as BofA, Goldman Sachs and JP Morgan.
Apple bonds have been purchased at 90.55 to 85.25 cents this year.
Patchy primary market slows European take-outs
European CLO issuance is reaching a crossroads, with several warehouses ramped while the path to the primary market is hazardous.
“Managers are generally ramped somewhere between €40 million and €200 million, and most have hit the stop draw trigger,” says one equity investor. “They need to figure out what to do — triple A availability isn’t great, particularly in Europe, and the economics don’t work.”
Another London-based investor agrees that while CLO managers are pitching to open warehouses given the sell-off in loans, the opportunity set is not attractive for warehouses that ramped at higher weighted-average prices.
In Europe, after Hayfin Emerald X priced on 19 August, there wasn’t another deal until 16 September, when four CLOs priced.
Warehouses usually run for two years, and some are starting to offer longer maturities, so sources say most managers are not under pressure to liquidate.
In the short-term, warehouse pricing has increased, while leverage has dropped as investment banks look to minimise risks.
US CLO syndication returns after long layoff as triple As settle tighter
After months where CLO liability pricing lagged the loan market, September saw a reversal as a vibrant investor base helped CLOs outperform.
US CLO triple As averaged 219 basis points in September as Creditflux goes to press, 14.7bp tighter than the average for August. Meanwhile, loans saw an average bid of 92.7 cents on 26 September, down more than two cents since the end of the previous month.
CLO managers say the relatively illiquid market for senior CLO debt is due to technicals.
The first half of 2022 saw a drying up of the CLO syndication process as big money investors in triple A tranches, particularly the large US banks, sat on the sidelines. But more recently issuers have been able to syndicate their senior notes again, says Megan Messina, head of CLO capital markets at Oaktree Capital Management.
“I’ve always been a fan of syndication, because it widens the net of investors in the market,” says Messina.
Anchor triple A investors such as Norinchukin Bank are buying again and this can move spreads tighter, but sources say other smaller investors have also re-entered to make syndication a viable alternative.
Some investors, including Hildene Capital Management co-chief investment officer Dushyant Mehra, say there are better opportunities in the secondary market.
“Since the global financial crisis, we have not seen a market where triggers are generally not in danger of failing while pricing in 3-5% cumulative losses on a forward-looking basis, with certain equity profiles still yielding 20% plus,” says Mehra.
Blackstone scores record with century of US CLOs
Blackstone Credit has become the first manager to price 100 US CLOs, following the printing of Storm King Park CLO in August.
The firm has CLO roots stretching back to 1998, with the team that would become GSO Capital Partners pricing their first CLO, Smoky River CDO, while at Royal Bank of Canada.
GSO, which was formed in 2005, would later be taken over by the Blackstone Group, and ultimately renamed Blackstone Credit in 2020.
Outside of those 100 deals, the manager has also acquired a number of CLOs over the years, including taking over as sub-advisor on Friedberg Milstein’s three US CLOs back in 2007, taking over Essex Park CDO from Katonah Debt Advisors in the same year, and acquiring Callidus Capital and its nine CLOs in January 2010.
Carlyle Group has now also managed more than 100 US deals, after the acquisition of CBAM earlier this year made the firm the largest manager globally by assets under management.
Despite losing first first place to Carlyle, Blackstone Credit is still the second-largest manager globally, with $42.29 billion across 79 CLOs as of the end of quarter two.
Investors urged to look at CLO funds amid PE slowdown
Institutional investors are said to be eyeing CLOs and structured credit as they seek to calibrate duration risk and prepare for recession. In addition, year-to-date performance in private equity portfolios isn’t meeting pension funds’ tough returns targets.
One of the biggest factors preventing greater allocation to credit is the resurfacing of the ‘denominator effect’, whereby public market portfolios have declined dramatically in proportion to private market volatility, constraining allocation increases to private markets.
Nevertheless, CLO risk retention and CLO equity funds may be more attractive than PE funds at present, because PE funds cannot exit deals and give money back to investors, whereas the first payment date from CLO funds is typically earlier and cash-flows occur more quickly. The strategies are short duration and can complement the J curve embedded into private equity strategies.
“By the time you’ve finished deploying capital in a PE fund, you’ve got most of your money back on a CLO equity strategy,” says Jack Yang, co-founder and president at Sycamore Tree Capital. “And because it’s a levered income play, it’s a real diversifier compared to a lot of alternative investment strategies that are more capital appreciation focused.”
Large institutional investors are also looking for increased duration through custom mandates, argues Satya Kumar, managing director at Sycamore, responsible for custom mandates. “Sophisticated investors have generally been low on duration, and with rates rising, you’ll see some start to bring duration back to their books with increased allocation to treasuries,” he says.
Dispersion picks up as candidates for distress emerge
Dispersion will be a concern for all parts of the global credit market in the fourth quarter, say traders who are focused on relative value.
Correlation trading holds the spotlight, following the roll of iTraxx (series 36 to 38) and CDX (S37 to S39) index tranches in September. Portfolio changes coincided with falling correlation due to dramatic widening in some constituents, such as Kohl’s (a CDX IG name) gapping out from 390bp to 710bp in recent weeks.
Default candidates are increasing in European and US high yield, with Ceconomy’s rapid deterioration adding it to those trading above 1,000bp. The company was previously a stable performer.
Emerging market distress is prominent. Turkey and Ghana (which have had the two worst performing currencies against the dollar in 2022) are joining the likes of Tunisia in rapid deterioration.
A global concern is China’s escalating problems (CDS at 107bp from 39bp in January). But the UK’s blow out to covid crash levels at 46bp shows even developed world sovereigns are in the frame, with Italy and Germany also closely watched.
The strength of the dollar, slowing global growth, as well as rising rates and commodity prices are all driving dispersion.
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Global credit funds & CLO's
October 2022 | Issue 249
Published in London & New York.
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