(Via The Wall Street Journal) -- U.K. Crisis Spills Into U.S. Junk Debt
Once a niche product, CLOs are now widely held by investors around the world, including the British pensions, insurers and funds that got caught by the recent crash in U.K. currency and government-bond markets. Many of them sold CLO bonds to meet margin calls, sending prices of the securities tumbling well below their intrinsic value, analysts and fund managers said.
Some U.S. investment funds rushed to snap up the bonds at what they considered incredible bargains.
“It was the heaviest selling pressure we’ve ever seen,” said Tom Majewski, a managing partner at Eagle Point Credit Management, a Greenwich, Conn.-based investment firm specializing in CLOs. Eagle Point purchased about $80 million of CLO securities in the seven trading days ended Oct. 5, double the amount it would normally buy in a seven-day period, he said.
In recent weeks, trading of the CLO bonds most commonly held by pensions and insurers hit its highest level since March and April of 2020, according to analysis by The Wall Street Journal of trading data reported to a U.S. regulator. CLO prices stabilized last week after falling to their lowest level since mid-2020, but the selling continued unabated. Average daily trading in the first week of October was around $1 billion, twice the daily average over the past 12 months, according to analysis by the Journal.
The surge of activity took place while global markets—with the exception of the U.K.—were far calmer than at the outbreak of the Covid-19 pandemic. The S&P 500 lost 7% in the past three weeks, compared with 16% in March 2020.
Rising turmoil in CLOs shows how fluctuations of normally placid interest rates in developed economies are rattling financial markets in unexpected ways. Forced selling by U.K. investors has also hit corporate bonds, stocks, mortgage-backed securities and asset-backed securities, investors and analysts said.
CLOs are a sliver of assets held by U.K. pension funds that try to guard against changes in interest rates through so-called liability-driven investment strategies. Con Keating, head of research at Brighton Rock Group, said he estimated them to be a maximum of 5% of assets under management.
Pensions and others had invested £1.6 trillion ($1.8 trillion) in LDIs by 2021, data from trade group The Investment Association show. In the relatively small market for CLOs, sales a percentage of that size have the ability to shift prices, unlike in larger markets for government bonds and stocks.
Weakness in the CLO market may also have a knock-on effect on leveraged buyouts—a lucrative business for Wall Street—because the investment vehicles purchase about 60% of the loans backing the deals.
CLOs are investment vehicles primarily run by alternative-asset managers like Blackstone Inc. and Carlyle Group Inc. The firms sell bonds and stocks to outside investors, then use the money to buy junk-rated corporate loans, which pay interest that is redistributed to holders of the CLO bonds and shares. Investors piled into CLOs over the past decade, sparking worry of excessive risk taking, but they held up in the 2020 market panic, making them even more popular.
Most CLOs issue bonds of different rank: Those with triple-A credit ratings get paid first, while junior bonds rated as low as double-B wait in line to receive payment. Insurers and pensions favor the higher-ranked CLO bonds because their credit ratings satisfy regulatory guidelines and because they pay higher yields than corporate and mortgage bonds with comparable investment-grade ratings.
Heavy selling of CLOs started the week ended Sept. 23, when the pound hit a 37-year low, forcing U.K. investors that use derivatives to hedge foreign-exchange risk to sell assets to cover losses, said Wayne Dahl, a managing director at Los Angeles-based Oaktree Capital. The deluge intensified the following week, when prices of U.K. government bonds tumbled, triggering margin calls on LDIs, held by pension funds.
“That generated a ton of emails internally,” Mr. Dahl said. “We’ve definitely been buyers.”
About $13 billion of investment-grade CLO bond trades were reported in the U.S. during the past three weeks, according to analysis by the Journal of a database maintained by Interactive Data Corp. and the Financial Industry Regulatory Authority. That is the highest volume since a three-week stretch in March and April 2020 when about $15 billion changed hands.
CLO prices have dropped to their lowest levels since May of 2020, according to an index of the securities operated by Palmer Square Capital Management. The firm’s investment-grade CLO bond index traded at 88.7 last week, down 4% since the start of September.
Some bond prices slipped even further, particularly those of European CLOs that were heavily owned by U.K. investors. The double-A-rated bond of a euro-denominated CLO managed by Investcorp Credit Management dropped about 5% in late September to roughly 90 cents on the dollar, according to data from KopenTech LLC. A spokeswoman for Investcorp declined to comment.
Falling CLO bond prices make it more expensive for CLO managers to borrow money to launch investment pools, reducing new issuance. Fewer new CLOs means fewer buyers for the “leveraged loans” investment banks sell to help private-equity firms fund their takeovers at a time when debt investors are already worried about a potential recession.
Banks that financed Vista Equity Partners and Elliott Management Corp.’s $16.5 billion buyout of Citrix Systems took a roughly $500 million loss on related loans sold in September amid weak investor demand. The market will face an even bigger test when banks try to place $6.5 billion of loans for Elon Musk’s planned $44 billion purchase of Twitter Inc.
“From a CLO manager’s perspective, the selloff isn’t helpful,” said Lauren Basmadjian, a partner at the Carlyle Group, one of the world’s largest CLO operators. “What our market needs is stability to issue CLOs.”
But Carlyle also invests in CLO bonds and from that standpoint, the forced selling by U.K. institutions is a windfall, Ms. Basmadjian said: “We’ve definitely been adding exposure over the last month.”
- Collateralized loan obligation prices have been hit hard by a slump in the British pound and the unwinding of U.K. pension investments
- Weakness in the CLO market may also have a knock-on effect on leveraged buyouts, including the financing for Elon Musk’s planned purchase of Twitter.
Once a niche product, CLOs are now widely held by investors around the world, including the British pensions, insurers and funds that got caught by the recent crash in U.K. currency and government-bond markets. Many of them sold CLO bonds to meet margin calls, sending prices of the securities tumbling well below their intrinsic value, analysts and fund managers said.
Some U.S. investment funds rushed to snap up the bonds at what they considered incredible bargains.
“It was the heaviest selling pressure we’ve ever seen,” said Tom Majewski, a managing partner at Eagle Point Credit Management, a Greenwich, Conn.-based investment firm specializing in CLOs. Eagle Point purchased about $80 million of CLO securities in the seven trading days ended Oct. 5, double the amount it would normally buy in a seven-day period, he said.
In recent weeks, trading of the CLO bonds most commonly held by pensions and insurers hit its highest level since March and April of 2020, according to analysis by The Wall Street Journal of trading data reported to a U.S. regulator. CLO prices stabilized last week after falling to their lowest level since mid-2020, but the selling continued unabated. Average daily trading in the first week of October was around $1 billion, twice the daily average over the past 12 months, according to analysis by the Journal.
The surge of activity took place while global markets—with the exception of the U.K.—were far calmer than at the outbreak of the Covid-19 pandemic. The S&P 500 lost 7% in the past three weeks, compared with 16% in March 2020.
Rising turmoil in CLOs shows how fluctuations of normally placid interest rates in developed economies are rattling financial markets in unexpected ways. Forced selling by U.K. investors has also hit corporate bonds, stocks, mortgage-backed securities and asset-backed securities, investors and analysts said.
CLOs are a sliver of assets held by U.K. pension funds that try to guard against changes in interest rates through so-called liability-driven investment strategies. Con Keating, head of research at Brighton Rock Group, said he estimated them to be a maximum of 5% of assets under management.
Pensions and others had invested £1.6 trillion ($1.8 trillion) in LDIs by 2021, data from trade group The Investment Association show. In the relatively small market for CLOs, sales a percentage of that size have the ability to shift prices, unlike in larger markets for government bonds and stocks.
Weakness in the CLO market may also have a knock-on effect on leveraged buyouts—a lucrative business for Wall Street—because the investment vehicles purchase about 60% of the loans backing the deals.
CLOs are investment vehicles primarily run by alternative-asset managers like Blackstone Inc. and Carlyle Group Inc. The firms sell bonds and stocks to outside investors, then use the money to buy junk-rated corporate loans, which pay interest that is redistributed to holders of the CLO bonds and shares. Investors piled into CLOs over the past decade, sparking worry of excessive risk taking, but they held up in the 2020 market panic, making them even more popular.
Most CLOs issue bonds of different rank: Those with triple-A credit ratings get paid first, while junior bonds rated as low as double-B wait in line to receive payment. Insurers and pensions favor the higher-ranked CLO bonds because their credit ratings satisfy regulatory guidelines and because they pay higher yields than corporate and mortgage bonds with comparable investment-grade ratings.
Heavy selling of CLOs started the week ended Sept. 23, when the pound hit a 37-year low, forcing U.K. investors that use derivatives to hedge foreign-exchange risk to sell assets to cover losses, said Wayne Dahl, a managing director at Los Angeles-based Oaktree Capital. The deluge intensified the following week, when prices of U.K. government bonds tumbled, triggering margin calls on LDIs, held by pension funds.
“That generated a ton of emails internally,” Mr. Dahl said. “We’ve definitely been buyers.”
About $13 billion of investment-grade CLO bond trades were reported in the U.S. during the past three weeks, according to analysis by the Journal of a database maintained by Interactive Data Corp. and the Financial Industry Regulatory Authority. That is the highest volume since a three-week stretch in March and April 2020 when about $15 billion changed hands.
CLO prices have dropped to their lowest levels since May of 2020, according to an index of the securities operated by Palmer Square Capital Management. The firm’s investment-grade CLO bond index traded at 88.7 last week, down 4% since the start of September.
Some bond prices slipped even further, particularly those of European CLOs that were heavily owned by U.K. investors. The double-A-rated bond of a euro-denominated CLO managed by Investcorp Credit Management dropped about 5% in late September to roughly 90 cents on the dollar, according to data from KopenTech LLC. A spokeswoman for Investcorp declined to comment.
Falling CLO bond prices make it more expensive for CLO managers to borrow money to launch investment pools, reducing new issuance. Fewer new CLOs means fewer buyers for the “leveraged loans” investment banks sell to help private-equity firms fund their takeovers at a time when debt investors are already worried about a potential recession.
Banks that financed Vista Equity Partners and Elliott Management Corp.’s $16.5 billion buyout of Citrix Systems took a roughly $500 million loss on related loans sold in September amid weak investor demand. The market will face an even bigger test when banks try to place $6.5 billion of loans for Elon Musk’s planned $44 billion purchase of Twitter Inc.
“From a CLO manager’s perspective, the selloff isn’t helpful,” said Lauren Basmadjian, a partner at the Carlyle Group, one of the world’s largest CLO operators. “What our market needs is stability to issue CLOs.”
But Carlyle also invests in CLO bonds and from that standpoint, the forced selling by U.K. institutions is a windfall, Ms. Basmadjian said: “We’ve definitely been adding exposure over the last month.”