CLOs Rally as Investors Savor Liquidity Revealed by UK Selloff


Global prices for bonds backed by leveraged loans are rallying from a short-lived, UK-centered selloff that’s changing investor perceptions about the $1.2 trillion collateralized loan obligation market.

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(Bloomberg) — Global prices for bonds backed by leveraged loans are rallying from a short-lived, UK-centered selloff that’s changing investor perceptions about the $1.2 trillion collateralized loan obligation market.

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In Europe, Ares Capital Corp. and OakTree Capital Group sold new CLOs this month, even as other debt markets, including junk bonds, have been largely moribund. New CLO sales since mid-September have topped €5 billion ($5.2 billion).

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When UK pension funds dumped assets in September to raise money to meet margin calls, they focused on the esoteric instruments tied to leveraged loans, effectively affirming the market’s huge liquidity. That’s now becoming a boon as credit broadly rallies. The drop in CLO prices due to liability-driven investing (LDI) — the use of derivatives to match assets and liabilities — is fueling demand and an uptick in deals.

“The LDI selling has confirmed that there’s liquidity in the CLO market. They could have sold other holdings, but they chose CLOs,” said Cyrille Javaux, portfolio manager at Fidelity International. “The spread widening that resulted from LDI selling has attracted buying interest,” especially from US asset managers. 

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Bargain Hunters

Prices reflect the relative liquidity of these instruments: top rated US CLOs fell a little more than a cent on the dollar between mid-September and late October. Meanwhile, high-grade European corporate bonds, which many investors would have historically viewed as more liquid, fell about four cents on the euro.   

Bargain hunters including Apollo Global Management and Blackstone Inc. made quick gains from buying CLOs in the secondary market. European banks resumed looking at the market again. And investors have kept buying, signaling that whatever concerns they may have about the economy in 2023, they have faith that the safest CLOs will perform well.

CLO managers are getting inquiries from new cohorts of buyers, according to market participants. Continental European banks, natural holders of the highest-rated bonds, are kicking the tires though they have yet to make any sizable purchases, they said. 

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The speed with which UK pension funds sold CLOs, as well as the large number of investors that started turning more attention to these securities, has helped trigger new sales. The demand underscores how liquidity emerged in unexpected places during the sell off stoked by the UK pension fund exodus.  

“A record amount of CLO bonds were sold into the secondary market,” said Jane Lee, head of CLO investing at Blackstone. “Expectations to the contrary, the market was able to digest all of this and other than a brief pause, CLO issuance continued to tick along.”

Prices in the market have also been resilient, rebounding in both the US and Europe. In the US, both AAA- and AA-rated tranches have also retraced most of the losses, according to the Palmer Square CLO index. European prices have already retraced their losses for the highest-rated CLOs.

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The quick rally stands in contrast to 2020, when money managers were broadly selling assets as prices plunged and panic spread in the early stages of the coronavirus pandemic. But this time, with only the UK rattled, CLOs broadly performed better.

“The recent forced selling of UK pension funds was much more orderly than the early days of Covid,” said Lauren Basmadjian, co-head of liquid credit and head of US loans & structured credit at Carlyle Investment Management. “Supply found demand quickly, which indicates that the CLO secondary market is functioning well.”

Apollo was one of the biggest buyers of CLOs when UK pension funds were selling. The firm said it bought $1.1 billion of CLOs over a three-week period in October. Blackstone, Ares, Oak Hill also stepped in but not all investors have returned to the market. 

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Norinchukin Bank, once nicknamed a CLO whale, as of October stopped buying new deals in the US and Europe because of steep price movements, Bloomberg reported last month. The Japanese firm had previously bought mainly newly issued CLOs.

“Forced selling started in some of the highest quality assets, among them senior CLO tranches,” said Bret Leas, head of global corporate structured credit and ABS at Apollo. “There was nothing inherently wrong with these CLO tranches and in fact it was the opposite, these were some of the best-quality, most-liquid holdings.”

Elsewhere in credit markets: 

EMEA 

There were eight issuers raising at least €3.3 billion-equivalent in Europe’s primary market on Monday, including three sterling-denominated transactions.

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  • Credit sentiment and activity in Europe’s primary market may be mixed as a comparatively benign few weeks risks being unsettled by recent Covid protests in China
  • Superdry Plc is in talks with a specialist lender backed by US activist Elliott Capital Management to refinance a loan that’s due in a few weeks and is key to the retailer’s survival
  • While much of Europe Inc. is shrinking state-backed loans from the pandemic, Italian companies are still sitting on mountains of such borrowings, complicating government efforts to help them surmount the latest crisis: soaring energy costs
  • Adler Group SA shares jumped as much as 64% after the landlord agreed an expensive deal with creditors to extend debt maturities and postpone publication of audited accounts

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Asia 

The cost to insure Asia ex-Japan’s investment-grade dollar bonds against default is headed for its first increase in five days, as the protests in China over Covid restrictions weighed on risk sentiment. 

  • A sense of uncertainty swept through Chinese markets on Monday as growing protests against Covid curbs and a record number of infections complicated the nation’s path to reopening
  • China Evergrande Group sold land once reserved to build its Shenzhen headquarters in a 7.5 billion yuan ($1 billion) deal that marks the latest disposal by the defaulted property giant
  • South Korea is continuing with efforts to ease strains in its credit market, with local financial firms making a second round of contribution to a key bond stabilization fund redeployed in October
  • Warren Buffett’s Berkshire Hathaway Inc. has kicked off its marketing of a potential multi-part yen bond that may price as early as Dec. 1

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Americas 

Corporate borrowers will consider tapping bond and loan markets in the coming week as lending costs drop and investors snap up debt ahead of 2022’s close. 

  • Activity could follow after a week of subdued primary issuance coincided with US Thanksgiving holiday
  • Private credit firms, flush with money to invest in an economy that may be on the brink of a recession, are increasingly looking at lending based on companies’ assets to limit potential losses
  • US junk bond funds saw investors add cash for a fifth straight week while the high-grade asset class suffered a 14th consecutive withdrawal
  • For deal updates, click here for the New Issue Monitor
  • For more, click here for the Credit Daybook Americas

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