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October 23, 2015  

Short-Term CLO Buyers Resigned to Losses

Some short-term collateralized loan obligation investors are cutting losses on positions they took a few months ago, when values were higher.

Hedge fund managers and other “fast-money” buyers largely resisted selling into a falling market in late September and early October, even as they circulated an ample supply of bid lists. But many of those shops now are showing a willingness to accept lowball offers.

Sources said the shift started on Oct 16, and continued into this week.

On Oct. 20, for example, a mere 10.7% of the CLO paper offered on the secondary market failed to trade. That’s down from 19.5% on Oct. 15, 33.3% on Oct. 14 and 28.6% on Oct. 13, according to Empirasign. “People were finally willing to let bonds go at levels they were unwilling to sell at the week before,” one investor said.

With the sales, losses crystallized for many bondholders who expected to hold their positions for short periods before selling at profits. The effects were worst for triple-B-rated notes, which saw some $150 million of trading volume late last week and early this week at discount margins of 450-650 bp. Had the investors sold in late September, the same bonds might have fetched 425 bp — still wider than the original purchase prices for many.

Among this week’s trades was a piece of a March 2015 deal from HIG Capital unit HIG Whitehorse, at a discount margin of 590 bp. Sources said the seller likely picked up the bonds at issuance at a spread of about 450 bp over three-month Libor. The apparent goal was to carry out a flip trade in which it would collect the deal’s first coupon payment and then exit the position at a slight gain. With values falling, however, the investor took an estimated loss of 7%.

Discount margins express a floating-rate security’s absolute return by combining its spread with its benchmark, in this case three-month Libor. Despite the recent deterioration of those levels, traders said they were encouraged by signs that the market may have hit bottom with this week’s selling. “At least it’s not plummeting,” one said. “It’s bad, but it feels like things are going more sideways than down this week.”

Another trader said it’s possible that if the added trading continues, values actually could climb. He noted that leveraged-loan prices appear to be rising after a long period of decline, suggesting friendlier market conditions.

According to the S&P/LSTA Leveraged Loan Index, large leveraged loans in the U.S. were trading at an average of 90.9 cents on the dollar on Oct. 19, continuing a climb that started when the index hit a yearly low of 90.48 cents on Oct. 5. They had been falling since late April, from a high of 96.74 cents.

Those declines, along with concerns about weakness among energy companies and other broad economic factors were the main drivers of the CLO market’s recent plunge. That deterioration, in turn, marked the second time this year the bets of short-term investors backfired — the first having taken place during the first quarter.

Sources said the effects were more severe this time. With that in mind, one investor said he was gathering capital in preparation for opportunities that might arise if prices keep falling. “I don’t see a near-term turnaround,” he said. “It’s really a function of there being more sellers than buyers, and I think there remain a number of motivated sellers who may become forced sellers as yearend approaches.”