Prices of loans held by CLOs recovered again in April, giving managers some more breathing room.
But funding costs, rising interest rates and credit deterioration remain a challenge.
Citigroup reports that the median portfolio price of collateralized loan obligations issued post crisis rose by 1.4 basis points, extending a rally began in March.
According to Citi’s quarterly CLO scorecard report, the portfolio prices for vintage CLO 2.0 issues via trading finished the month at $95.5 per $100. Citi research now shows 16.75% of CLOs portfolios trade above par in the bank’s CLO tracking index, compared with only 5.7% in March and 0.4% at year-end 2015. (More than 25% of leveraged loans that make up CLO pools are trading above $100, in the Loan Syndications & Trading Association index).
The Citi report also notes that the recovery in prices in March and April “significantly” boosted the net asset values of the most subordinated tranches of securities issued by CLOs, known as the equity, by 15%. CLO equity prices in the secondary market went up to $48 per $100 to $50, as well.
The median portfolio price for new-issue CLOs in the first quarter was $98.80 per $100, and the weighted average ratings factor improved to show fewer risky leveraged loans contained in the portfolio. The percentage of loans trading below $90 was only 2, showing that managers are concentrating on a “cleaner portfolio,” the Citigroup report noted.
“Still, managers paid for the tough primary market environment,” the Citi report notes, with the funding costs of new issue CLOs reaching 225 basis points to exceed other 2.0 vintages that have averaged 203 bps costs in ramping up. Leverage also boosted to 14.4x, above the 2.0 vintage average of 11.5x.
The deterioration of credit quality of portfolio loans continues to be a drag, though, as the triple-C rated buckets reached a record high level of 3.3% as tracked by Standard & Poor’s. Worried over downgrades and avoiding exposure to distressed energy sector debt, managers have issued CLOs in the last two quarters with drastically reduced levels of C-rated assets in the initial pool. The inclusion of between 8-9% of Caa1-or-below rated loans in CLOs in the latter half of 2014, for example, has shrunk to just 2.6% in the first quarter of this year, according to Citi’s figures.
Eight defaults in March and April (Midstates Petroleum, Core Entertainment, Peabody Energy, Vertellus Specialties, Southcross Holdings, Templar Energy, Foresight Energy and Aspect Software) increased the defaulted loan balance on CLO 2.0s to 0.6% from 0.4%, and CLO’s overcollateralization cushion decreased by 0.1% across the capital stack, Citi reported.
With the a three-month Libor rate hovering around 0.63%, April was the first month CLOs saw the impact of last fall’s Federal Reserve’s interest-rate hike, with CLOs paying around 30 basis points extra to debt tranches and earning only 3 basis points more on average from collateral “due to the prevalent existence of Libor Floor benefit,” the report noted.
The report noted that cash flow to the most subordinate equity tranches of CLOs decreased by 0.6% to 4.4% in April, one of the months in which quarterly CLO equity payments (as done by 80% of CLO 2.0s) are distributed. The average for equity cash flow over the last four years is 4.8%.
Another speed bump for CLO managers has been the slowdown in the ability to build par in a portfolio. The annualized notional figure growing par after issuance dropped to 22.8 basis points, the lowest level in the CLO 2.0 era, Citi report. Their CLO portfolios grew by only 1.2 basis points in April, as managers instead used returns to build the cash levels to 1.3% (close to the record high of 1.4% at the end of January).
