CLO Buyers Prepare New Funds to Scoop Up Beaten Down Bonds
CLO Buyers Prepare New Funds to Scoop Up Beaten Down Bonds
(Bloomberg) -- Collateralized loan obligation investors including Napier Park Global Capital and Neuberger Berman are preparing new funds specifically designed to buy struggling CLO securities, according to people with knowledge of the matter.
The so-called credit opportunity funds will target beaten down BBB and BB rated slices, said the people, who asked not to be identified because the details are private. Both will focus on tranches with high-quality loans that while likely to be volatile in the near-to-medium term, have the potential to never suffer principal losses.
CLOs -- which package and sell leveraged loans into chunks of varying risk and return -- are grappling with an avalanche of downgrades both to their underlying holdings and the structures themselves as the coronavirus pandemic shuts down entire swaths of the U.S. economy. The new funds are said to be among a handful targeting similar strategies, betting they’ll be able to profit by distinguishing downgraded portfolios with performing credits from ones likely to see more defaults.
Representatives for Napier Park and Neuberger Berman declined to comment.
Hidden Gems
CLOs tranches in the BB tier are trading at less than 70 cents on the dollar on average, down from near par as recently as February, according to Palmer Square index data. BBB prices, after falling to as low as 71 cents on the dollar late last month, have bounced back into the mid 80-cent rage.
CLOs are built so that buyers of riskier -- and higher paying -- slices absorb losses before investors higher up the capital stack.
But significant loan-by-loan credit work is still needed to sift through tranches and find those that won’t saddle mezzanine investors with haircuts, observers cautioned.
The Napier Park Strategic CLO Fund II is in the early stages of fundraising and no investors have committed so far, according to one of the people familiar with the matter. Marketing materials reflect a macro assumption behind the strategy that the economic downturn caused by the Covid-19 outbreak will, at worst, not exceed 1.5 times that of the Great Depression, the person said.
The Neuberger Berman CLO Opportunity Offshore Fund is further along, and will have a maximum size of $500 million, according to a recent SEC filing.
“We have selectively started adding into some portfolios opportunistic capacity, building a base in BBB and BB rated debt on the argument that if you can buy CLO BBs today in the low 60s dollar price and remain confident, as we are, about full ultimate payment of principal and interest on that bond, you’re clearly locking in a potential significant price-appreciation upside,” Neuberger Berman portfolio manager Pim van Schie said in an early-April video posted on the company’s website.
Still, many market watchers expect some losses to reach BB and potentially even BBB investors in the coming quarters -- pain the asset class was largely able to avoid in the aftermath of the 2008 financial crisis.
Moody’s put 859 CLO bonds, worth $22 billion, on review for downgrade Friday, including 355 in the BBB equivalent tier and 369 in the BB equivalent bucket. S&P also on Friday placed 155 CLO tranches on negative watch.
“Given where pricing is at this point in time, I’m not surprised to see these opportunity funds pop up, as many of these managers are taking a bullish long-term view on leveraged loans and mezzanine CLO tranches,” said Nick Robinson, a partner at Allen & Overy. “We’ll be seeing more of them.”
©2020 Bloomberg L.P.