Fed aid could revive the CLO market by June
The emergency corporate debt safety nets announced by the U.S. Federal Reserve could revive the sale of new securities that underpin the lower-grade loan market by June, according to one of the largest managers of investments eligible for the program.
“The announcement was incredible in every way,” said Angie Long, chief investment officer of Palmer Square Capital Management, a manager of secured loan obligations, or CLOS. Nevertheless, it will take several months to finalize the logistics of the new program and launch the new CLO program. “I think people were hoping for mid-May, but maybe it’s more mid-June,” she said.
The Fed has earmarked up to $100 billion from a $2.3 trillion lending program to help investors buy asset-backed debt, including the highest quality bonds of certain types of CLO, according to a Citigroup study Inc.
CLOs are crucial for companies rated below investment grade, as they buy around 65% of the “leveraged loans” that these companies use to finance their operations. Investment vehicles have become very popular over the past decade among institutional investors looking for high returns.
New federal loans and a program available for bonds issued by companies that recently lost their investment-grade credit ratings sparked a rally in credit markets on Thursday, boosting the riskiest assets the most. A CLO bond index managed by Palmer Square jumped about 2.71% on Thursday, its biggest one-day rise since the recent selloff began in late February.
CLO managers borrow money by issuing bonds to buy pools of leveraged loans, using interest and loan repayments to repay their bond investors. Bonds are divided into tranches ranked by credit rating. Holders of the highest-rated debt are paid off first, exposing owners of the lowest-rated debt to potential losses if defaults increase.
The Government Term Asset-Backed Securities Lending Facility, or TALF, will only be applicable to AAA bond purchases of so-called static CLOs created on or after March 23, according to research by Citigroup.
The Fed’s approach to corporate debt markets reflects the line the central bank must cross – priming the liquidity pump without supporting overleveraged companies that would likely have defaulted regardless of the coronavirus pandemic. said Jim Caron, who helps manage a roughly $5 billion debt portfolio at Morgan Stanley Investment Management.
“It’s a very narrow goal; it’s not supporting the whole high yield bond index,” he said.
It is easier to measure risk in static CLOs because their managers buy and hold a single set of shorter-term bond-backed loans. Most CLO managers trade loans and loans, constantly changing the mix of loans backing their medium-term obligations. A few new short-term or static CLOs have hit the market in recent months, but overall supply has been anemic and TALF should help revive activity.
Palmer Square is the nation’s largest static CLO manager, having closed deals worth about $6 billion, Ms. Long said. “We have the infrastructure and the pipes in place to take advantage of that.”
Static CLOs accounted for about 5% of new transactions initiated in 2019, up from about 2% in 2017, according to research from Citigroup.
“We expect more static/short-term CLOs to be valued,” Citigroup analyst Maggie Wang said in a research report after the new TALF metrics were announced.
The WSJ Dollar Index, which measures the US currency against a basket of 16 others, fell about 0.11% on Friday morning to 93.45 from 93.56 on Thursday, extending a multi-day slide.
Write to Matt Wirz at [email protected]
Corrections & Amplifications
Palmer Square Capital Management operates a CLO index which rose 2.71% on April 9 and is the largest manager of static CLOs in the country. An earlier version of this article incorrectly stated that Pennant Park operated the index and was the largest manager of static CLOs. (April 10, 2020)
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