CLOs seek to link assets to loan index after missing Covid sale

NEW YORK, June 26 (LPC) – Secured Loan Bond (CLO) managers in the United States are pushing to buy loans at increasingly discounted prices after being excluded from troubled opportunities amid the pandemic coronavirus was taking hold.

Onex Credit and Oak Hill Advisors are among the companies that have sought to include a provision linking the price at which loans can be added to their portfolios to a leveraged loan index, according to the deal documents. Tying the ability to buy discounted loans without penalty to an index sensitive to market volatility would have allowed CLOs to better profit from the fall in prices in March. Some CLOs have also pushed to lower the minimum price at which investments can be purchased.

CLO managers want more flexibility to buy distressed loans as defaults mount and the health crisis continues. The funds, the biggest investors in the US $ 1.2 billion leveraged loan market, are forced to buy assets that trade below a certain threshold. Such a restriction may put the $ 688 billion US CLO asset class at a disadvantage over hedge funds and distressed lenders. Filling up on discounted loans could help funds meet internal tests and increase returns for more junior investors when overall market performance improves.

The LPC 100, a cohort of America’s 100 most liquid loans, has fallen more than 21% year-to-date to 77.87 cents to the dollar on March 23, a nearly 11-year low. Prices have since rebounded and the LPC 100 held steady at 93.79 on Thursday.

“When you look at manager performance during times of volatility, do you see better results when documents are too restrictive or when they have little leeway,” said Dan Wohlberg, principal at Eagle Point Credit Management, which invests in CLOs. “Investors in debt and stocks have determined that a slightly larger toolbox could be beneficial. “

FLEXIBILITY IN DISTRESS

Many CLOs are allowed to buy loans, typically 80 or 85 cents and up, and mark debt at par. If purchased below this level, a loan would be calculated in the CLO tests at the purchase price.

CLO managers are now looking to tie the price at which a loan can be bought to an index to account for market volatility rather than a fixed price. If a discount obligation were defined as a percentage lower than a loan index, it would have allowed managers to take advantage of loans that traded significantly in March.

The provision arose in the aftermath of the 2008 financial crisis, but disappeared as markets improved. Now some market players want to bring it back.

“You want the CLO managers to buy cheap loans; it benefits both debt and equity, ”said Dagmara Michalczuk, portfolio manager at Tetragon Credit Partners, which invests in CLO equity.

In the offer documents for the OCP CLO 2020-18 of Onex Credit, there is an option for the surrender obligation to be linked to an “adjusted price of the leveraged loan index”, defined as the price of the S & P / LSTA US Leveraged Loan 100 index multiplied by 90%.

Oak Hill is seeking to include similar language in OHA Credit Funding 6, a new fund it is raising, offering a variety of eligible loan indices, including the S & P / LSTA US Leveraged Loan 100 Index, Credit Suisse Leveraged Loan Indices. , Deutsche Bank Leveraged Loan Index, Goldman Sachs / Loan Pricing Corporation Liquid Leveraged Loan Index or Merrill Lynch Leveraged Loan Index, according to a transaction document.

An Onex spokesperson could not comment. An Oak Hill spokesperson could not be reached.

Some senior debt investors objected to this provision, fearing that it would allow a manager to buy too many risky credits.

There has also been pressure to lower the minimum price at which debt can be bought to 50 cents. According to Sean Solis, partner of the Milbank law firm, many CLOs have a minimum price at which loans can be purchased, often 60 to 65 cents.

“There were real opportunities to buy discounted loans in March that were trading in the 1950s, but the CLOs couldn’t buy,” he said.

Some investors have even allowed managers to buy up to 5% more loans below this 50-60 cent threshold because the manager takes a large discount to buy the credit.

“You want tests that protect noteholders, but you also want to give managers enough flexibility to mitigate risk and generate value,” said Laila Kollmorgen, portfolio manager at PineBridge Investments, a CLO investor. “It’s a fine line.”

CLO managers have previously sought the possibility of swapping distressed or defaulting assets with other similar loans that may offer better paybacks as well as permission to provide bailout funding to struggling businesses, previously reported. Refinitiv LPC.

As markets continue to grapple with the pandemic, demands for additional flexibility will persist.

“In the CLO market, managers, equity and debt investors come together around shared experiences and in some cases say, ‘Managers need the right tools to operate in this market,’ he said. Wohlberg said. “We will continue to see some development around these capabilities. (Reporting by Kristen Haunss; Editing by Michelle Sierra)

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