Contents

CLOs

Flexible allocation

Bond buckets on the rise

High yield bond (HYB) holdings across US CLOs continue to rise, following their reintroduction in October 2020. A new Fitch study indicates that HYB exposure is found mostly in recent vintage transactions, while exposure within CLOs tends to be much lower than indenture-mandated limits.

Indenture provisions related to HYB exposure vary from outright prohibition to limitations linked to non-senior secured loan exposure limits. More recently, specific limitations for non-senior secured bonds separate from second-lien and unsecured loans have emerged, according to Fitch.

The up-tick in CLO bond allocations started to show up with more regularity in mid-2021, but managers are still using bond buckets on an occasional basis and remain well within the 5% limit for non-loan allocations. As of last month, the average bond exposure in broadly syndicated loan CLOs under Fitch’s surveillance was 1.8%, with the highest exposure in one CLO standing at 4.3%.

“Prior to 2021, we would see most managers avoid bonds and some that would be more prevalent, but still in very small positions. You see the same thing today – where managers want to park cash or be a little bit more liquid. With that, we would expect continued small positions or a small percentage of bonds held in CLO portfolios,” says Derek Miller, md, North America structured credit at Fitch.

Russ Thomas, director, US structured credit at Fitch, adds: “We went through and noted some managers that were using it more than others. It tends to be the multi-asset firms with established high yield desks that will use the strategy.”

Bond buckets provide CLO managers with flexibility and enables them to build par in deals during times when the high yield market presents attractive pricing opportunities. Thomas observes: “We would expect to see continued use of the bond buckets under favourable conditions, but mostly on a limited, opportunistic basis - as we have seen so far.”

Average HYB allocations among asset managers included in Fitch’s CLO Asset Manager Handbook increased slightly to 19% of total firm AUM in the 2022 edition (based on full-year 2021 figures) from 18% in the prior year’s edition. Of the 34 US broadly syndicated loan (BSL) firms reporting HYB allocations within total AUM, 32 had bond buckets included in 2021 and 2022 deals. Twenty-five of the 34 managers have been utilising the buckets, with the overall range at 0.4% of par notional exposure.

Overall, BlackRock (with HYBs accounting for 64% of total platform AUM), Shenkman (60%), Nuveen Asset Management (36%), Brigade (35%) and GoldenTree (20%) represent the top five managers in terms of HYB representation in total firm AUM, as of year-end 2021.

Typically, at least 90% of a CLO’s collateral must be senior secured loans, and there are up to 10% limits on other types of assets, including second lien loans, unsecured loans and - in certain transactions - bonds. Where non-senior secured loan allocations are allowed, they are usually limited to 5% and can have sub-limits for assets such as unsecured bonds.

However, bonds tend to be fixed rate and, therefore, open CLOs up to some basis risk against primarily variable-rate note liabilities. Furthermore, bonds are usually subordinate to other debt in the capital structure or are unsecured - both of which increase potential losses, should the issuer default.

More broadly, Deborah Ogawa, senior director of US structured credit at Fitch, reports that CLO performance metrics remain robust, while average net portfolio losses are shrinking.  Nevertheless, in terms of credit quality, some weakening is apparent for CLOs with exposure to issuers with ratings on negative outlook.

Angela Sharda

Structured Finance

SCI Start the Week - 22 August

A review of SCI's latest content

Don’t miss out on your chance to be recognised in this year’s SCI CRT Awards! The submissions deadline is 25 August. For more information, click here.

Last week's news and analysis
BMO busy
Canadian lender in SRT market with third Algonquin of 2022
CDS volumes soar
CDS notional volumes break half year record
L-Street open?
Prior buyers hopeful L-Street will go live again, others sceptical
Proportional representation
Scaling factor suggested for capital charges
Tangible benefits
Are aircraft the inflation-beating asset that investors are missing?
Unexpected update
Recognition of EU STS securitisations to be extended
US CRT return?
US impasse raises corporate and leveraged loan CRT prospects

For all of last week’s stories including ‘Market moves’ and ‘Risk transfer round-up’ click here.

SCI CLO Markets
CLO Markets provides deal-focused information on the global primary and secondary CLO markets. It offers intra-day updates and searchable deal databases alongside BWIC pricing and commentary. Please email David McGuinness at SCI for more information or to set up a free trial here.

Recent premium research to download
Japanese SRT prospects - July 2022
Japanese banks have historically been well-capitalised, but implementation of the Basel output floors could change this. Against this backdrop, this Premium Content article investigates the prospects for capital relief trade issuance in the jurisdiction.
Australian securitisation dynamics - July 2022
In contrast to Europe and the UK, the Australian securitisation market is continuing to see healthy issuance activity, despite the country dealing with the same inflation and rates pressures as the rest of the world. This Premium Content article investigates why it’s always sunny Down Under.
Container and Railcar ABS - June 2022
Global supply chain issues could continue to support US container and railcar ABS. However, as this Premium Content article shows, both markets are facing challenges on other fronts.
CLO Migration - June 2022
The switch from the Cayman Islands to alternative domiciles, following the European Commission’s listing of the jurisdiction on the EU AML list, appears to have been painless for most CLOs. This Premium Content article investigates.

SCI events calendar: 2022
SCI’s 8th Annual Capital Relief Trades Seminar
20 October 2022, London
SCI’s 3rd Annual Middle Market CLO Seminar
15 November 2022, New York

Call for SCI CRT Awards 2022 submissions
The submissions period has opened for the 2022 SCI CRT Awards – covering the global capital relief trades market and the US credit risk transfer market. Nominations should be received by 25 August. Winners will be announced at the London SCI Capital Relief Trades Seminar on 20 October. Qualifying period: deals issued in the 12 months to 30 September 2022. For more information on the awards, click here.

Call for MM CLO Awards Submissions
The submissions period has opened for the 2022 SCI Middle Market CLO Awards – covering US Middle Market CLOs issued in the 12 months to 30 September 2022. Nominations should be received by 20 September. Winners will be announced at the SCI Middle Market CLO Seminar on 15 November in New York.
For more information on the awards, click here.

Capital Relief Trades

BMO CRT launched

BMO completes capital relief trade

Bank of Montreal has finalized a US$286m financial guarantee that references a revolving US$4.4bn portfolio of North American senior secured and senior unsecured corporate loans (SCI 17 August). Dubbed Algonquin 2022-3, the transaction is BMO’s third issuance from the program this year.

The last transaction from the programme was called Algonquin 2022-1 and was executed in April along with another Algonquin trade (see SCI’s capital relief trades database). The US$487.5m financial guarantee was priced at SOFR plus 8.5%. The latest deal was priced 100bps wider compared to Algonquin 2022-1.

The SPV is called Manitoulin USD with the Algonquin platform used to securitize North American senior secured and senior unsecured corporate loans.

The widening of the transaction coheres with the pricing that investors have been seeing elsewhere in the CRT market, but the extent of the widening across the space remains unclear (SCI 1 August).

Banks and investors have been limiting widening in transactions by carrying out a loan-by-loan analysis of portfolios with the aim of limiting exposures to sectors which are more at risk from rising inflation.  

Stelios Papadopoulos 

Structured Finance

Reciprocal relationship

Increased market volatility has raised asset allocator demand for private credit strategies, particularly structured credit. Hildene Capital Management explains how structured credit asset managers and insurers can work together in today’s volatile market.

Insurance companies are among the investors leading the way in understanding how this unique asset class – known for its enhanced yields and credit protections – can help them diversify away from traditional corporate bond-based insurance portfolios as well as increase returns without meaningfully sacrificing credit risk. And yet, the insurance companies are not the only beneficiaries of such investments. The relationship between structured credit asset managers and life insurance companies is hardly one-sided; rather it is a reciprocal relationship. Structured credit managers benefit from the insurers’ persistent capital base by deploying that capital in assets complementary to existing core strategies, and insurers benefit from the capabilities and expertise of seasoned structured credit investors who meet their unique regulatory and operational needs.

Such a reciprocal relationship can exist, given that structured credit assets – namely collateralised loan obligations (CLOs), asset-backed securities (ABS), mortgage-backed securities (MBS), and trust-preferred collateralized debt obligations (TruPS CDOs) – offer insurers favourable risk-reward profiles stemming from material structural protections like overcollateralisation and credit enhancement, layers of portfolio diversification, and cashflow profiles aligned with their liabilities.

For example, many structured credit securities have embedded triggers that force the rapid return of principal during times of distress, a feature that ‘vanilla’ corporate bonds typically do not offer. Additionally, in many cases, structured credit assets represent diversified pools of underlying debt obligations, providing additional diversification into a single tradable security. Finally, the cashflow profile of typical structured credit assets is well-suited to match longer duration life insurance liabilities, allowing insurance companies to obtain stable and consistent cashflows over an extended time period, which is difficult to achieve with similarly-rated corporate bonds.

Among structured credit assets, TruPS CDOs stand out for life insurance managers due to their fundamental credit security, long duration nature and potential for enhanced yields. TruPS CDOs are particularly attractive, given that senior and mezzanine TruPS CDO tranches remain discounted relative to other structured credit assets. Backed by the debt of highly-regulated entities like regional and community banks, TruPS CDOs have benefitted from the decade-plus economic recovery, which has de-levered and de-risked the legacy securities. As credit enhancement has built in these deals, it has fostered credit ratings upgrades, in turn making a significant portion of TruPS CDO bonds attractive for insurance investment mandates.       

With this in mind, insurers can leverage asset managers to source alternative credit assets that maintain or improve capital efficiency and increase returns through structural enhancements. In particular, experienced structured credit managers can provide insurers access to complex and differentiated assets like TruPS CDOs via bespoke investment solutions tailored to their clients’ unique regulatory constraints and liquidity hurdles. Furthermore, an asset manager with an active management strategy can also generate book gains through active trading and event-driven opportunities, further enhancing total returns.

It is clear, particularly in today’s unpredictable market environment, that traditional ‘vanilla’ insurance portfolios concentrated in investment grade corporate bonds are ripe for disruption. In such a market, structured credit can offer excess returns, as well as meaningful diversification and structural protections not found in similarly-rated investment grade corporate bonds.

The end result: insurers are equipped with an optimised portfolio that is well-suited for their long- and short-term needs, while structured credit managers receive a stable, persistent capital base ready for deployment into an addressable market.

CDO

Insurance assurance

Christopher Freeze, senior md and head of investor relations at Churchill Asset Management, answers SCI's questions

Q: Churchill closed its inaugural collateralised fund obligation (CFO) last month. The US$700m transaction will invest across the firm’s flagship private capital fund strategies. What were the drivers behind the launch of the deal?
A: At Churchill, we are a solutions-oriented firm solving for investor needs. We asked ourselves: how can we introduce insurance company investors to the full array of our flagship investment strategies in a way that truly works for them?

In the US, insurance companies are heavily regulated and have regulatory capital challenges related to investing in certain types of private funds. We sought to find a way for them to access our core private capital strategies, where the capital charges were otherwise prohibitive.

The CFO structure we created essentially combined the best of Churchill. It has a meaningful private credit allocation that is paying a cash yield immediately, as well as a substantial allocation to private equity assets that generate longer-term returns. The blend was a unique offering that fortunately happens to benefit from the nature of our platform.

Ultimately, we had a lot of great conversations with insurance companies who found it interesting. Investors also appreciated that we are indirectly owned by a Fortune 100 insurance company, TIAA, which showed a lot of alignment as well.

Many of the approximately 25 investors we spoke to were already invested in or were looking at similar structures. I believe the asset class will continue to grow, as top asset managers - like Churchill - try to find ways to better engage with insurance companies and help meet their needs.

Q: Could you provide more details on the collateral backing the CFO?
A: Churchill’s CFO is comprised of a pool of existing private equity assets, as well as commitments to the four flagship strategies we offer. We allocated a portion to our senior lending strategy, which is a more conservative mandate with a low loss rate over our 16-year history. Another portion was allocated to our junior capital strategy, which has a slightly higher return profile. The remainder was invested in our two private equity strategies – US middle market private equity fund commitments and US middle market co-investments.

Q: What are the innovative aspects of the deal’s structure?
A: CFOs are relatively new, and people still have a lot of questions about them. We expected that more risk-adverse insurance companies would gravitate to a more conservative offering, so we tried to appeal directly to that group of investors with a healthy mix of two different kinds of asset classes.

We did not ask investors to invest in any untested strategies. Each of the asset classes that the CFO invests in are core strategies of Churchill. Additionally, as many CFOs have very long investment periods, we committed all the capital to those core strategies as soon as possible following closing, so that investors know exactly what exposure they are getting.

We also tried to deliver something that was highly diverse. We hope that our CFO will ultimately have exposure to 750 or more underlying investments – if that is achieved, it will be one of the most diversified investment structures out there.

We believe this offers comfort to insurance companies, who are debtholders in the structure and should allow them to feel good about things working out well. Of course, it’s operationally intensive, given the number of investment positions – but we have the right infrastructure in place and believe it’s well worth the benefit.

Q: Does this deal open the door for CFOs to be increasingly backed by private credit exposures rather than predominantly private equity commitments?
A: I think you could see more private credit CFO structures come to market because of the underlying nature of credit instruments. The biggest initial challenge for CFO issuers is figuring out how you pay the coupon and mitigate effects of the j-curve, and private credit investments have strong, consistent cashflows that can do just that.

While investors likely have to give up a little of total return in such a transaction, it’s ultimately very attractive to have these types of cashflow assets paying the coupon early on in the life of the transaction. This is what made Churchill’s CFO innovative and different, and could lead the way for other managers who previously may not have thought about using credit in this way. However, it does require having a senior lending or junior capital strategy that insurance companies are comfortable having exposure to, because ultimately they have to believe in your capability to deliver.

Q: What are the prospects for the CFO market going forward and what do you hope Churchill’s role will be in it?
A: I think the market will continue to grow, but the barriers to entry are still very high. That’s why the successful managers in this space are predominantly large-scale managers, with strong track records and diversified strategies that investors want to access.

Put yourself in an investor’s shoes. You can invest in a single-name fixed income asset and receive a certain yield.

Alternatively, you can invest in a CLO and get that same yield, plus an additional premium, but with a more highly diversified credit exposure. Or, you can invest in a CFO and get a substantially higher yield enhancement, with many of the same protections as found in a CLO structure. Now, more than ever, investors are looking for ways to create additional returns - and if a CFO structure can help meet their objectives, it’s a very attractive option.

Churchill continues to think about opportunities to offer transactions in this space, with different structural options based on investor feedback we’ve received. Certain insurance companies, for instance, are interested in long-dated structures, as they have long-dated obligations (e.g. life insurance). Others, however, want the opposite, and are looking for a credit-oriented structure as a result. Ultimately, we are contemplating different approaches that can address these goals – and it’s pretty exciting.

Claudia Lewis

Structured Finance

UCITS cat bond index touted

Sector developments and company hires

Plenum Investments has released a catastrophe bond market study and index family, with the aim of providing investors with what the firm describes as an “investment compass”. Plenum believes that the index will enable a fund offering to be matched with the individual risk appetite of an investor, while allowing the performance and risks of funds to be compared with each other.

“The index is intended to set a benchmark standard in the cat bond fund industry. The study also shows how fund managers deal with the challenges of the cat bond market and includes all cat bond funds that comply with the UCITS guidelines and invest directly and exclusively in cat bonds,” the firm states.

The index family comprises 12 indices reflecting the returns of all 14 cat bond funds available in UCITS format, representing US$8.8bn in AUM (or a 23% market share of the collateralised natural catastrophe business). The indices are calculated on an average and capital-weighted basis and are further divided into two risk categories for the average-weighted calculation.

They are investable total return fund indices, which are calculated and published on a weekly basis. The reference currencies of the indices are US dollar, Euro and Swiss franc.

Meanwhile, according to Plenum, the market study creates comparability between cat bond funds for the first time by calculating their risks using a uniform risk ratio model. “This market survey makes cat bond funds comparable for the first time by using the same risk model for all funds. We show that there are significant differences between the funds, in terms of risk diversification as well as exposures, and that certain funds carry (tail) risks above average compared to their expected returns,” comments Dirk Schmelzer, managing partner and fund manager at the firm.

Since 2010, UCITS cat bond funds have become a major pillar of the capital markets-based transfer of reinsurance risk. The strong growth and rising numbers of cat bond funds, the increasing heterogeneity of funds, the different risk models and the lack of a risk presentation standard remain challenging for investors.

In other news…

EMEA

Propel Finance has announced the completion of its first private securitisation as a part of its latest £500m financing round. The UK-based asset manager was supported by strategic advisers Blake Morgan (legal) and EY (corporate finance) in its inaugural transaction. The latest funding round follows several initial funding rounds with the British Business Bank and marks the latest stage in Propel’s strategy to expand and diversify its funding base to boost continued development and support for UK SMEs. The partial refinancing of Propel’s existing British Business Bank ENABLE Funding facility was supported by Citi, which structured a £275m private securitisation facility, and Quilam Capital, which provided a further £35m mezzanine and working capital facility. British Business Bank will continue to support Propel as a funding partner, with the ENABLE Funding facility allowing the firm to offer £165m of finance to SMEs across the UK.

Structured Finance

Leadership shake-up at Intrum

Sector developments and company hires

Intrum says it has reached an agreement with Anders Engdahl, who will step down from his position as president and ceo of the firm and leave with immediate effect. The Intrum board has appointed current board member Andrés Rubio as acting president and ceo, with the recruitment of a permanent solution expected to commence during the autumn.

Engdahl was internally recruited from the cfo role to the ceo position, with the intention of driving the ONE Intrum transformation. While the firm acknowledges that he has managed to grow and transform the business over the last couple of years, the board believes that Intrum has not delivered on its market-leading position and full potential - mainly due to “insufficient commercial development”. Consequently, the board has concluded that a more transformation-oriented and commercial leadership – with a proven track record of similar transformation – is needed to realise the firm’s full value.

Rubio has extensive experience from several management positions - including at Cerberus, Apollo Management International and Altamira Asset Management - and was appointed a board member of Intrum in 2019. One area that he is expected to improve in his new role is Intrum’s organisational structure, by making it clearer, with shorter decision-making paths and improved ways of working.

Rubio will remain a member of the Intrum board.