Global credit funds & CLO's
October 2020
| Issue 228Published in London & New York.
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October 2020 | Issue 228
Analysis
CLOs
Relative value plays swell secondary
Charlie Dinning
Data journalist
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The secondary CLO market has been revived this year as volumes shatter 2019 totals. Investors have found greater value in secondary than in primary — and they gain full portfolio disclosure
Credit volatility this year has triggered a new appreciation of the secondary CLO market, where record volumes have been traded. According to CLO-i data, US b-wic volumes have hit $36.7 billion year to date, which is 68.2% of US CLO new issue volumes ($53.8 billion).
The importance of a vibrant secondary market was underlined at Creditflux’s CLO Symposium last month when we sought to sell fictitious CLO tranches to a panel of investors. Often, they weren’t swayed by the primary offering and instead highlighted better value in the secondary market.
Specifically, the panel highlighted how secondary trading can include complete portfolios, so it eliminates the guesswork involved in evaluating a primary CLO with a bucket of unramped, unidentified assets.
Senior investors prefer short deals
This year, senior CLO investors have turned risk averse and are reluctant to invest in five-year reinvestment deals. But junior debt and equity investors prefer longer-dated deals because they afford CLO managers more time to navigate loan markets and build par.
The sell-off in mid-March, when secondary US and European CLO triple A spreads widened roughly 200-400 basis points to land at 500bp in the US and 300bp in Europe, led to CLOs being traded on a price basis rather a spread basis.
This created enticing opportunities for investors. The CLO secondary space became a buyers’ market, says one CLO trader, and CLO lower mezzanine investors were able to get high-quality paper in the 60s. This, according to another CLO trader, made the asset class more compelling than equity bonds, which were selling in the high teens and 20s of par.
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500bp
US CLO triple A secondary spreads hit post-crisis highs
European CLO double B secondary covers 2020
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Higher up the capital structure, US CLO triple A covers fell from an average of par in February to 95.7 in April. European CLO triple A paper was trading above par on average in January and February, but through March and April was clearing at 95.
With the CLO market in distress, senior tranche investors sought comfort in short duration CLO bonds. The average cover on a US CLO triple A bond that had left its reinvestment period in April was 98.4, almost three points higher than the market average. In Europe, post-reinvestment triple A bonds were clearing at an average of 97.5 in April, almost 2.5 points above the market average.
Junior mezzanine investors, on the other hand, saw opportunity in US CLO double B bonds that had at least four years of reinvestment left. These cleared with an average cover that was 2.5 points higher (68.1) than the market in April (65.5) as spreads had widened out to around 1,200bp, according to market sources.
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European CLO equity covers 2020
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US CLO equity covers 2020
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US CLO triple A secondary covers 2020
All data from CLO-i
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US CLO double B secondary covers 2020
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Pricing became opaque in March
The pricing information available on secondary CLO items was scarce to begin with. In the week beginning 9 March, over $2.5 billion of US CLO bonds were listed in the secondary market but $2.3 billion had no colour attached. $1.8 billion of that week’s US CLO b-wic lists was made up of US CLO triple As, as investors sold their most liquid paper into the volatile market.
The European secondary CLO market had its peak the following week as €717 million of European CLOs were listed, including €535 million of European CLO triple A paper. Again, pricing information was scarce: €650 million of the total market was settled with no colour attached as investors searched for a price level.
One European CLO trader says that the market did itself no favours with the lack of colour, as whole lists of ‘did not trades’ (DNTs) make CLO investors less willing to participate. The only upside of this period is that the swathes of DNTs suggest there was no forced selling.
CLO equity was scarcely available on b-wics during the height of pandemic-induced volatility: there was no European CLO equity that traded with colour for two months and no US CLO equity that traded with a cover attached for three months. Trace data suggests there were some CLO equity trades during this time, but a large amount of CLO trading shifted from b-wics to bilateral business.
Even without equity appearing in many b-wic lists, year-to-date secondary CLO trading volumes have far outpaced 2019. There were €6 billion of European CLOs and $33.1 billion of US CLO bonds listed in 2019. Up to 24 September, €10.1 billion of European CLOs and $36.7 billion of US CLO paper has been listed in 2020.
$2.5bn
US CLO bonds listed in secondary market in one week
US CLO triple B secondary covers 2020
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European CLO triple B secondary covers 2020
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Central banks kick-off rally
Market sources say the starting point for the CLO rally was the intervention of central banks. The CLO market rose in incredibly quick time and investors have since grown confident enough to rotate down the capital structure and take longer duration. By the end of August, the highest average cover for every rating band was on bonds with at least four years of reinvestment left to run, showing investors’ willingness to take on duration risk.
The primary CLO market returned to the standard pre-covid five-year reinvestment and two-year non-call transaction in September as First Eagle priced Wind River 2020-1 — proving CLOs can withstand anything thrown at them.
€717m
Peak weekly value of secondary market for European CLOs
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