CLO Managers in Europe Root Out Risky Loans on ‘Cockroach’ Fears
(Bloomberg) — After Jamie Dimon’s cockroach warning, Europe’s CLO managers have been furiously cleaning house.
October saw the investment vehicles’ highest monthly volume of deeply discounted asset sales since records began, capping the most active quarter yet, as managers sought to offload riskier loans amid the credit market jitters triggered by the rapid unraveling of First Brands and Tricolor.
Managers of collateralized loan obligations, which repackage mostly leveraged loans into bonds of varying risk and reward, typically sell weaker holdings toward year-end to crystallize losses and lock in returns. But the scale of this year’s activity is unprecedented.
Sales of euro- and sterling-denominated term loan Bs priced below 75 cents on the euro jumped to €357 million ($414 million) last month, well above the Covid-era peak of €226 million in July 2020.
The wave of disposals is eroding the cushion between assets and liabilities, particularly for investors in the most junior tranches of the capital stack. That risks leaving some managers with less flexibility to trade or reinvest as they may have to divert cash flows if they breach their coverage requirements. Variations in credit quality, portfolio strategy and structural headroom are increasingly exposing performance gaps across the market.
“After some high-profile idiosyncratic defaults, a clear difference has emerged between CLO managers who avoided problems and those who did not,” Aza Teeuwen, a partner at TwentyFour Asset Management wrote in a note published on Tuesday.
Loan Selloff
Toward the end of the summer, triple-C rated loans started to underperform against their higher-rated counterparts as buyers demanded a higher premium to hold the most vulnerable credits. Between early August and the end of September, triple-Cs lost around ten points, falling to 73.2 cents on Sept. 26, just below the level reached in the initial phases of the Covid pandemic.
The sharp fall was exacerbated by the lack of distressed buyers, who were waiting for prices to fall further before stepping in. Triple-C loans finally appeared to find a floor in October, stabilizing at around 76 cents. They’re were priced at about 75 cents as of Nov. 13.
Although panic over a few names likely skewed prices, a broader shift is also evident: bad news on a credit now prompts much more aggressive unwindings, Russell Holliday, head of Europe and portfolio manager at Sound Point Capital, said.
“Some underperformance that in the past would have caused positions to drop 3, 4, or 5 points, now drop 10, 15, or even 20 points,” he said.
The paucity of buyers interested in the 75-95 price range in Europe is fueling this trend. The US market, by contrast, has larger and deeper pockets of capital to deploy in this space. US CLOs also benefit from more diversified collateral pools, whereas their European counterparts have a more limited range of investment opportunities.
Moreover, European managers are less likely to put up new capital to support their position in the event of a First Brands-style meltdown. US managers, meanwhile, can hold the position and put more money into a debtor-in-possession financing, fresh funding that allows distressed firms to keep operating while they restructure.
“As credits become stressed, there’s going to be a more natural inclination in Europe to sell more so than in the US,” Steven Oh, global head of credit and fixed income at PineBridge Investments, said.
Manager Performance
The drop in prices means that European CLO managers have seen the safety cushion between their assets and debts shrink for the riskiest parts of their structures. The so-called Market Value Over-Collateralisation — or MVOC — for BB and B-rated tranches dropped by around one percentage point in the last two months, echoing a similar decline earlier in the year.
To reduce future risk, many European managers have chosen to sell weaker positions and accept losses now, so they can finish the year with a more stable, lower-risk portfolio.
The stakes are even higher for smaller managers with limited track records. They are under particular pressure to demonstrate prudence and resilience in order to reassure investors and preserve their ability to issue new vehicles in 2026.
“Those that took the opportunity to move up in credit quality and towards top performing managers will now be seeing the benefits,” TwentyFour AM’s Teeuwen wrote.
–With assistance from Rachel Graf.
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