Vanishing CLO Profits Are Sparking Infighting: Credit Weekly

Skip to Content News Archives Economy Energy Oil & Gas Renewables Electric Vehicles Mining Commodities Agriculture Real Estate Mortgages Mortgage Rates Finance Banking Insurance Fintech Cryptocurrency Work Wealth Smart Money Wealth Management Investor Personal Finance Family Finance Retirement Taxes High Net Worth FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials More Innovation Information Technology FP500 Podcasts Small Business Lives Told Tails Told Shopping Financial Post Store Obituaries Place a Notice Advertising Advertising With Us Advertising Solutions Postmedia Ad Manager Sponsorship Requests Classifieds Place a Classifieds ad Working Profile Settings My Subscriptions Saved Articles My Offers Newsletters Customer Service FAQ News Economy Energy Mining Real Estate Finance Work Wealth Investor FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials This advertisement has not loaded yet, but your article continues below.HomePMN BusinessVanishing CLO Profits Are Sparking Infighting: Credit WeeklyA type of investment that once generated some of Wall Street’s juiciest fixed-income returns has deteriorated so badly that investors are heading for the exits and arguing about who’s to blame.Author of the article: You can save this article by registering for free here. Or sign-in if you have an account.b[675kba9k326fsvkk7lbb19_media_dl_2.png Goldman Sachs(Bloomberg) — A type of investment that once generated some of Wall Street’s juiciest fixed-income returns has deteriorated so badly that investors are heading for the exits and arguing about who’s to blame.THIS CONTENT IS RESERVED FOR SUBSCRIBERS ONLYSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.SUBSCRIBE TO UNLOCK MORE ARTICLESSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.REGISTER / SIGN IN TO UNLOCK MORE ARTICLESCreate an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.THIS ARTICLE IS FREE TO READ REGISTER TO UNLOCK.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountThe tussle concerns collateralized loan obligations, investment vehicles that package corporate loans into pieces of varying size and risk. The $1.3 trillion market is a perennial favorite with institutional buyers like pensions and hedge funds.Lately, though, the returns on the riskiest portions of CLOs have plunged well below zero, and the damage to the so-called equity tranches is spilling over into some investment firms that court individual investors. At one $580 million fund based in Chicago with significant CLO equity investments, a bitter feud has erupted between its two managers over who or what caused a 50% decline over the past two years. A slew of other funds with high CLO exposure have slashed their dividends and warned shareholders of more trouble ahead.Get the latest headlines, breaking news and columns.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Top Stories will soon be in your inbox.We encountered an issue signing you up. Please try againOther long-term buyers of CLOs are looking for a way out. Greenwich-based Eagle Point, which made its name as a sophisticated picker of CLO equity, has been shifting exposure to assets that seem a world away: infrastructure loans and equipment financing. Eagle Point told Bloomberg this week the market could well be poised for a second straight year of losses.CLOs make money by buying and bundling bank loans and then issuing debt in the bond market at a lower interest rate, reaping the difference, or arbitrage, as a profit. The managers split the CLO into tranches with varying levels of reward and risk; investors who buy the safer senior tranches get paid a promised rate of return.Anything left goes to the holders of the riskiest securities, known as the equity but in reality essentially a form of highly subordinated debt. Returns for those investors can be quite lucrative — but if nothing is left over, they can be stuck with losses. “CLO equity for years was a glorious place for investors who understood the market,” said Michael Hislop, an analyst at Curasset Capital Management. “But recently, underlying loan performance hasn’t been good enough to compensate equity buyers for the risk, and they’ve really gotten hammered.”The shakeup may be just getting started. A dearth of corporate mergers has all but halted new supply into the CLO market, and a selloff of software debt earlier this year dented CLO holdings. Yet asset managers and exchange traded funds keep demanding even more of these bonds, which drives down the rate of return and thus narrows the gap between what the CLO can earn on its holdings and what it has to pay to bondholders.The result: A diminishing pile of opportunities to generate leftovers for the equity investors. While holders of the more senior tranches are still getting paid as promised, CLO equity returned negative 15% in the first quarter. This advertisement has not loaded yet.This advertisement has not loaded yet, but your article continues below.More pressure may be ahead, according to strategists at Goldman Sachs Group Inc., who estimated last month that profits are likely even worse than widely thought. Crunching the CLO data deal-by-deal rather than in aggregate, which they argue is less precise, shows a slimmer arbitrage than traditional metrics suggest.One factor pushing profits lower are money managers who raise special funds known as captive equity. These are pools of capital they control that can buy any and all CLO equity that their own firm might sell. This positions them to quickly take advantage of sudden downdrafts like the one that hit software loans this year, but there’s concern in some quarters about weakened discipline, since there are no external equity buyers pressuring CLO managers to scrutinize loan documents.In May, the drama at a publicly listed fund called XFLT began unfolding. XFLT is overseen by Chicago-based XA Investments. The fund’s board voted to oust its day-to-day manager, Octagon Credit Investors, and bring in a new manager, an affiliate of King Street called Rockford Tower. The board pointed to the fund’s steep decline in net asset value over the last two years. But the fund’s shareholders are required to approve efforts to appoint Rockford Tower, and as a July 30 vote approaches, the clash has escalated. Octagon, which has argued that it actually outperformed CLO fund peers, this week called for the board’s replacement, accusing it of trying to “evade accountability for its own poor stewardship and inattention to shareholder interests.” Octagon didn’t respond to messages seeking comment for this article.XA in turn accused Octagon of making its own attempts to sidestep responsibility for choosing investments that underperformed, dismissing the idea that the fund’s stumbles are largely a function of poor market conditions. Around half the fund’s holdings are senior loans rather than CLO equity, XA President Kim Flynn told Bloomberg in a Friday email, so the result “is not directly comparable” to CLO equity funds.Click for a podcast with Eagle Point Credit on CLOs facing a second straight year of equity losses as borrowers slash funding costs.Morgan Stanley and JPMorgan Chase joined Goldman Sachs in the high-grade debt market this week, bringing the latest fundraising push by Wall Street’s biggest banks to nearly $34 billion. The banks tested investor appetite after posting second-quarter earnings that largely beat analysts’ projections, as they benefited from buoyant markets, ongoing volatility and a resurgence in dealmaking. All six major US banks that posted results this week said they set aside less money to cover bad loans, a sign of growing optimism about the outlook for borrower defaults.Bonds sold by hyperscalers have become a drag on investor portfolios. From falling prices and wider spreads to negative total returns, the debt is underperforming on almost every metric. The bonds are in the red on average, according to data compiled by Bloomberg, and rank among the worst performers in indexes this year. Data-center operator Prime Data Centers postponed a planned bond sale, in a sign of the limits of investor demand for AI exposure. Read more: Pure Data Centres Scraps Bond Sale in Favor of Bank LoansWall Street banks, scouring every corner of the capital markets to finance the AI buildout, are turning to leveraged loans, with QTS Realty Trust more than tripling the size of a proposed loan to $3.25 billion. It also nixed plans for a $1 billion bond offering. CoreWeave is seeking to raise $2.6 billion in debt in the leveraged loan market.A steady flow of second-half debt issuance from the biggest US technology companies — including Microsoft’s expected return to the bond market — is likely to keep valuations under pressure for the remainder of 2026, Barclays said.Read more: Data Center Troubles Stoke Industry’s Fear of Coming DistressGMI Cloud, another US-based data center operator, is seeking a NT$20.45 billion ($635 million) multi-tranche loan deal supported by customer contracts for GPUs, one of the first such financings in Asia.Royal Bank of Canada is expanding its credit derivatives trading business in the US and Europe, betting that multibillion-dollar fundraising for AI will fuel demand for hedging products.Sculptor Capital flagged several “warning signs” in markets that have led it to take profits and reduce exposure across most strategies after posting a net year-to-date return of 7.9%. Those signals include heavy issuance across credit, equity, and convertible markets, and spiking volatility and high inflation.CoreLogic amended the terms of its roughly $5.3 billion debt offering and shifted part of the funding to loans from bonds after struggling with lukewarm investor demand.Robinhood Markets is gauging investor interest in a bond backed by bills for its branded consumer credit cards, in what would be the firm’s first offering of its kind.The New York Yankees are in advanced talks to raise nearly $3 billion of financing from Apollo, as more institutional capital flows into professional sports. Read more: Apollo Likens Risky Private Credit to Mere ‘Sprinkle’ on CupcakeKlarna is seeking to offload credit risk tied to a portfolio of ‘buy now, pay later loans’, in a deal aimed at freeing up capital as it looks to accelerate its international expansion plans. KKR started marketing a debt deal tied to PayPal’s buy now, pay later business in Germany, the first of its kind in Europe.Luxury-car maker Aston Martin is in talks with funds including BlackRock-owned HPS to raise additional finances to shore up its available cash.A group of secured creditors of Altice International Sarl sent a default notice to the telecom firm, alleging it violated the terms of its debt by shifting money and assets out of their reach.Troubled business services giant Foundever Group reached an agreement with a group of creditors to reduce its multi-billion dollar debt load, with the company’s controlling shareholder injecting fresh funds and installing new management.Thames Water is working to raise more debt in case it runs out of cash while talks for a rescue deal drag on.Elliott Investment Management and Veritas Capital Fund Management-backed Cubic Corp. is negotiating with some of its lenders for an injection of fresh capital, a year after it inked a similar deal to redo its debt stack.Apollo hired James Keller from Goldman Sachs as a managing director in charge of investment-grade syndication, as part of its Apollo Capital Solutions team.Singaporean asset manager CapitaLand Investment disbanded its special opportunities team, bringing an end to a dedicated unit that was set up to pursue investment strategies that typically came with higher risks.UBS hired former Goldman Sachs managing director Takehiro Sakuramoto as head of debt capital markets for Japan, as the Swiss lender seeks to rebuild its presence in the Asian nation’s corporate bond market.Notice for the Postmedia NetworkThis website uses cookies to personalize your content (including ads), and allows us to analyze our traffic. 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