Global credit funds & CLO's
March 2020 | Issue 221
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March 2020 | Issue 221
News derivatives
Tranche traders aim to navigate default risk while staying clear of coronavirus contagion
Dan Alderson
Deputy editor
The CDS market is navigating between two sources of risk for equity and mezzanine high yield index tranches. The default of US media company McClatchy has focused idiosyncratic concerns, while the spread of the coronavirus has stoked fears of a systemic sell-off.
McClatchy is the second bankruptcy credit event to hit the on-the-run series 33 of US high yield index CDX HY, following Dean Foods in November. The McClatchy credit event auction is scheduled for 10 March, with CDS at time of press indicating a pay-out of around 40 cents to protection buyers, according to IHS Markit. Another media sector constituent of the index, Frontier Communications, was tipped by three market sources as an imminent trigger risk. It was quoted at 49.5 points up front by IHS Markit. In total, 19 constituents of HY were trading at up-front levels, with most heading further into distressed territory. “0-15s [equity tranches of CDX HY] have underperformed by about three points year-to-date due to the aforementioned names, along with Whiting Petroleum [47.5 PUF] and Noble Corp [56 PUF],” says one portfolio manager in New York. This is a turnabout from December, when wide-end constituents outperformed the index during its end of year rally. Another reversal took hold up the capital structure in CDX HY 15-25% junior mezzanine tranches as Creditflux went to press. This resulted from the index widening 52bp, to 332.5bp, in the space of 10 days as novel coronavirus cases mounted in Europe, the Middle East and Central Asia. This took CDX HY beyond the 331bp it traded at going into December.
“The 15-25s outperformed since the start of 2020, thanks to investors chasing yield in January,” says the New York PM. “They have underperformed in the last few days.” Although this distorts the capital structure it also creates opportunities, adds the PM. Investors could wait to buy back into the junior mezz risk at signs of stability, or real money buyers could use their firepower to load up risk unconcerned about whether it looks rich or cheap. The extent to which tranche investors give either factor their attention will be determined by the length of time they plan to stay in a trade, says a European portfolio manager. “My investment horizon is much longer and I don’t care about temporary market moves,” he says, adding that, in the medium term, correlation will rise as systemic risks related to the US election, coronavirus or a trade-war increase.
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Coronavirus: rises in infections of covid-19 led to CDX HY 15-25% widening 52bp in 10 days