Portfolio managers are trying to assess the damage the repricing tidal wave has inflicted on their funds, with most dreading what their returns will look like once the water recedes, while other say the damage will be light.
“Repricings will absolutely hurt the performance of closed-end funds and CLOs, as well as the formation of new CLOs,” said a New York-based investor, representing those with the former outlook. “Sadly, the underwriters are once again going to try and squeeze as much out of investors as they can. It’s almost as if they cannot help themselves. They can’t actually. History has shown that.”
For the month ending March 8, closed-end loan funds — funds that invest primarily in collateralized senior corporate floating-rate loans — returned 0.77%, according to the Closed-End Fund Association, a national trade association representing the closed-end fund industry. Between March 8, 2010 and March 8, 2011, the same funds returned 11.56%.
“[Repricings] certainly are not having a positive impact,” said another New York-based investor. “Not only are you getting a lower coupon and yield, but break prices on the new loans are lower than where they were, so it can only be a negative impact.”
Indeed, the average loan issued in February sold at 100.66% of its face value at the start of trading — the highest level since 2007, according to the Wall Street Journal. Last year’s loans listed on KDP Investment Advisor’s completed loan calendar were sold with an average discount of 98.57 from March through December, and most of those loans subsequently rose past par. For investors used to seeing discounted loans that rise on the secondary after breaking for trading, the par-plus break prices can be a tough pill to swallow.
Repricings are also having a negative impact on CLOs, sources said. “The biggest risk to CLO issuance,” analysts at JPMorgan Securities said in a recent report, “is loan repricing.” Tighter spreads, declining Libor floors, or floors disappearing altogether are problematic for CLO new issuance, even if the CLO structure itself has improved, the analysts added. Repricings are particularly troublesome for a CLO’s arbitrage between the senior financing and the yield on other assets. And the situation could worsen if spreads contract even more, a scenario the JPMorgan analysts are expecting.
“Lower yields will affect returns in funds and equity payouts in CLOs,” said a Boston-based fund manager. “[Equity] notes in CLOs are getting hurt by low Libor.”
A Canadian-based investor added, “Yields are being reduced fairly aggressively across the whole market. Most funds are forced to just [accept the repricings] in hopes of staying invested. In some cases, the bank deals are being replaced with high yield bonds or are being shifted to a larger pro-rata and smaller term loan B structure. Either way, this just makes it harder for funds because they have to replace that paper with lower yielding primary or secondary paper.”
Sources said that almost two-thirds of new loans are going to reprice existing debt. And repricings will continue to make up the majority of the primary calendar, sources say, because banks and issuers are being egged on by the amount of money coming into the loan market. According to Lipper, investors have poured more than $11 billion into loan funds so far this year.
So when one looks at the number of deals syndicated last year that could still be repriced (see chart below), the source of all this loan market tension becomes clear.
Some, however, aren’t buying into the panic.
“[Repricings] are not helping, but they’re not hurting too much,” said a New York-based banker. “There’s a ton of existing paper in the hands of CLOs, maybe $300 billion worth, that even the recent spate of refinancings hasn’t made a significant impact on. It’s like turning a battleship; it’ll take an extended period of lower coupons to hurt returns.”
Those with a positive outlook on the trend point out that even after repricing, today’s loan coupons remain reasonably high.
“Spreads on [loans syndicated last year] were artificially high,” said a Boston-based portfolio manager. “Today, after repricing, spreads are much closer to what you’d expect. The average spread is still higher than historical averages.”
This portfolio manager said repricings haven’t made much of an impact on his fund, which is 60% older loans. “Those loans are not refinancing at lower rates. We’re actually seeing those loans extend their maturities and pay to do that, [so] coupons go up on that side.” He added that many new funds that have started up have a larger percentage of newer loans. So the magnitude of the damage from the repricing wave may be more severe for those managers.
