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October 2022 | Issue 249
Loan trading

What matters is what you do with it

Charlie Dinning
Data journalist
Sam Robinson
Head of research
CLO managers yearn for flexibility so they can take advantage when credit sells off. But it isn’t enough on its own: triple C-flex CLOs saw portfolios erode this year, while CBOs outperformed
This year, for the second time in three calendar years, CLO managers were presented with a prolonged bout of volatility and an opportunity to take advantage of cheap loans and bonds. It was an opportunity they did not squander, with managers trading $129 billion of assets between March and July.
On average, US CLO managers traded 18.72% of their CLO portfolios and built 12.5 basis points of par on their junior over-collateralisation (OC) test cushions.
“2022 has been one of the better par building environments for CLOs, as 99% of loans traded at a discount to par, with the whole market selling off rather than one sector, leaving opportunities to make good relative value swaps,” says Dan Ko, portfolio manager at Eagle Point Credit Management, a CLO equity investing firm.
Another US CLO equity investor tells Creditflux that their portfolio of CLOs saw 30bp of par build in the second quarter alone — one of the best quarters on record.
US CLO portfolio trading (%) vs change in par (bp)
analysis 1.svg
Not everyone’s a winner
However, par building wasn’t universal. 28 managers lost at least 1bp of cushion on their junior-most OC tests on average.
Z Capital Credit Partners lost the most par on average among US CLO managers, at 84.3bp. ZCCP 2018-1 and 2019-1 each lost over 100bp of cushion between March and July, while Z Capital’s latest transaction, ZCCP 2021-1, gained 6bp of OC cushion. The manager runs triple C-flex CLOs and these deals may find it difficult to stop par erosion, depending on how they are positioned before a sell off.
HPS Investment Partners also runs high triple C CLOs. Two of them — Strata I and II — lost 112bp of par on average. These losses made HPS the manager with the second highest loss of par in its portfolio on average. It lost 60.8bp across 12 CLOs. Z Capital traded on average 18% of its CLO portfolios. HPS traded 21.3%.
At the other end of the spectrum, Park Avenue, Hayfin and Seix were the three managers that built the most par on average; 68.3bp, 63.7bp and 55.5bp, respectively. But all three had different tactics.
Park Avenue was a low portfolio turnover manager between March and July, trading 13.1% of its CLO portfolio on average. Hayfin was above average at 24% and Seix was almost bang-on average, trading 17.4%.
Bond-flexed on them
While CLOs that allow a higher percentage of their portfolio to be invested in triple C credits lost par on average, bond-flex CLOs did the opposite. Our analysis includes 29 bond-flex CLOs. On average they gained 26.4bp of cushion between March and July while trading accelerated, and turned over 75.2% of their portfolios.
All three of Diameter Capital’s CBOs traded assets worth over 160% of their portfolio sizes, and on average the manager built over 100bp of par across those three deals. Scott Goodwin, co-founder and managing partner of Diameter, said this was an explicit strategy for the firm.
“As interest rates increased and bond prices fell, we found opportunities to sell single-B rated loans and buy higher rated bonds at lower prices,” he says. “In addition to building par, we believed this rotation would help the portfolios withstand a potential recession and a deterioration in credit markets.” In part, Diameter bought investment grade bonds, which Creditflux reported on in August.
“We found opportunities to sell single-B rated loans and buy higher rated bonds at lower prices”
Scott Goodwin, Co-founder and managing partner | Diameter
Goodwin points out that, in normal bear markets, the Federal Reserve cuts interest rates to support the economy but this was not the case in 2022. “This year’s volatility has come with concerns about inflation and rising interest rates. Owning fixed rate bonds and being long interest rate duration therefore would have detracted from performance this year, when historically it would have mitigated losses. This underperformance of fixed rate bonds creates opportunities in the market going forward.”
It was not just in its bond-flex CLO portfolios where Diameter was far and away the most active manager. It averaged a portfolio turnover of 79% through its regular CLO portfolios, almost double that of Rockford Tower Capital Management, which was the second most active at 43.9%.
However, while Diameter rode an active trading strategy in its bond-flex CLOs to a higher cushion on its junior OC test, it had the opposite effect on its CLO portfolio. Diameter CLO II lost 48bp of par and Diameter I gained only 4bp of par.
Rockford Tower, meanwhile, gained 16.4bp of OC cushion on average. Napier Park Global Capital and Bardin Hill investment Partners were the other two managers to average over 40% portfolio turnover in their CLOs. Napier Park lost 15.3bp of par in its portfolio, but Bardin Hill gained 15.8bp.
Managers that had the lowest average turnover in their portfolios were AIG (5.3%), PPM (5.7%) and Guggenheim (5.9%). These three also had differing par gains and losses. PPM gained 18.6bp of par in its portfolio but AIG lost 12.8bp, while Guggenheim lost 20.8bp.
You’ve got to be in it to win it
Still, the general rule seems to be that the more vigorously a portfolio is traded, the greater the chance of par build. The 10 US CLO managers that traded the lowest percentage of their portfolios averaged 4.8bp of par build, while the 10 most active managers gained 12.9bp of OC cushion.
CLOs were generally well positioned to take advantage of the drop in loan prices, says Ko. Triple C levels had fallen back to pre-covid levels of 3-3.5%, and the addition of anti-priming language in 2020 allowed CLOs to be involved in distressed credits.
Percentage of CLO portfolio traded by Carlyle in March to July
The largest US CLO manager, Carlyle Group, was the most active between March and July. It traded $11.2 billion of assets across 52 CLOs, which equated to 33.8% of its portfolio. Carlyle was also the highest net purchaser of four of the top 10 issuers and the highest net seller on five of those 10.
Credit Suisse Asset Management was the largest net purchaser of Central Parent, which was the issuer with the largest amount of debt bought in absolute and net terms. CLO managers bought $1.49 billion of Central Parent between March and July, and sold just $83.5 million. CSAM made net purchases of $107.1 million, Carlyle bought $107 million and Ares picked up $74.5 million net. CDK Global, which owns Central Parent, was bought by Brookfield (the majority owner of Oaktree Capital Management) in July. $750 million of new first lien loan notes were issued as part of the sale.
Endo Pharmaceuticals was the issuer that sold off the most. It filed for chapter 11 in August, a bankruptcy S&P described as primarily driven by “ongoing uncertainty around opioid-related and other lawsuits, as well as the company’s high debt burden”.
The weighted sale price of Endo was only 82.2 cents. Redding Ridge Asset Management was the largest net seller.
  • Manager portfolio trade %: amount bought and sold between March and July across all deals in data divided by total size of portfolios. Transactions include principal purchases and sales. Prepayments and distressed exchanges are excluded.
  • Manager change in OC: average change in junior-most OC test cushion in deals from March trustee reporting date to July.
  • Data includes US CLOs and bond-flex CLOs which were within reinvestment period as of July 2022 and went effective prior to March 2022.
  • For individual issuers the average purchase and sale prices were calculated on a weighted average of the size of the trades.
  • Where no trustee report was published for a month, the nearest available report has been taken. If trustee reports were unavailable deals have been excluded.
  • Middle market, European and US CLOs that were reset or reissued within the period considered are excluded.
  • Data sourced from CLO-i and Moody’s Analytics.
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Global credit funds & CLO's
October 2022 | Issue 249
Published in London & New York.
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