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Loan Note: How the Fed may deflate low-risk CLOs; non-bank lenders needed for CRE retrofit

How changing bank policy may affect the collateralised loan obligation market. Plus: a retrofitting role for non-bank lenders, and S&P's take on the default rate. Here's today's brief for our valued subscribers only.

They said it

“We like emerging market local debt within an overall bond underweight. Much monetary tightening has been done, and valuations are compelling”

Taken from the BlackRock Investment Institute’s Weekly Market Commentary.

First look

Downward trend: CLO activity slowing (Source: Getty)

Less demand for low-risk CLOs as Fed policy shifts
Could the lower-risk end of the collateralised loan obligation market become a victim of the Federal Reserve’s tightening monetary policy? It’s not an obvious relationship, but one that has been picked up on by Oaktree Capital Management in its latest Performing Credit Quarterly market commentary for the first quarter of this year.The commentary points out that the Fed added more than $4.6 trillion to its balance sheet in 2020-21, accruing an equal amount of liabilities and flooding the banks with excess reserves. These reserves, which earned almost no interest, were used to invest in safe assets with higher interest rates such as AAA-rated CLO tranches. It was a development that helped spur record-breaking levels of activity in the market.But in March, the Fed brought its quantitative easing programme to a halt, meaning it was no longer seeking to be a net buyer of assets. Thus, the flow of fresh bank reserves has dried up and, with it, the need to keep buying AAA CLO tranches. Furthermore, the Fed is now paying a higher interest rate on reserves and treasuries are offering higher yields, making CLOs less attractive by comparison.The effects of this are already being seen in a CLO market where low-risk tranches make up 65 percent of each CLO. Market activity slowed in the first quarter of this year and CLO managers have been forced to offer wider yield spreads on AAA tranches to complete deals, even though the underlying credit fundamentals of CLOs remain strong.

Funders needed for real estate’s retrofit revolution
Non-bank lenders are being asked to step up to the plate to help address the environmental, social and governance standards expected to be met by European commercial real estate.A new report from CBRE Investment Management finds that 60 percent to 75 percent of Europe’s real estate stock is in need of refurbishment to meet required Energy Performance Certificate standards, representing a debt requirement of between €720 billion and €900 billion. Around half of this is accounted for by the office sector.The report says that banks alone cannot provide the required financing, partly because of slotting and Basel IV regulations encouraging a move away from value-add lending. This means non-bank lenders are being called upon to support the funding need.“The need for an alternative source of funding is clear – as is the size of the opportunity,” says Dominic Smith, senior director, credit research at CBRE Investment Management. “Non-bank lenders who have built capability to meet one of real estate’s most pressing challenges will be able to deliver strong returns and improved ESG performance to investors.”However, Smith cautions that such lenders will “pick and choose the schemes that offer the best margins and strongest location fundamentals”, and that retrofitting concentrated in the most desirable areas will leave other areas with a shortage of lettable stock. Note to readers: Loan Note will be taking a break next Monday 2 May, returning Thursday 4 May 

Essentials

Mixed news on defaults
S&P Global Ratings reports that the global corporate default tally reached a total for the year so far of 26 after Switzerland-headquartered mineral fertiliser producer EuroChem Group missed a coupon payment, making it the fourth European default in April.Europe saw no defaults at all in the first quarter as the region’s 12-month trailing speculative-grade default rate dropped to just 0.7 percent at the end of March – its lowest level since October 2008. Despite the increase in defaults in the second quarter, the current total of 26 is lower than the 32 recorded at the same time last year.However, S&P Global Ratings is predicting that the default rate could rise to 2.5 percent by the end of this year.

Italian manager launches UTP trading
Prelios Group’s BlinkS digital marketplace for loan portfolio trading has been given the green light to trade Unlikely to Pay loans, having previously only been open to non-performing loans. Prelios, the Milan-based asset manager, said it was now able to finalise the sale of some loans on behalf of Italian banks belonging to the Cassa Centrale – Credito Cooperativo Italiano Group.The platform was set up to assist in the deleveraging of Italy’s NPLs. The UTP sector is expected to increase in scale due to the continuing effects of the global pandemic. Unlike bad loans, UTP loans are not yet in default and could potentially be returned to health.

New hires for Sycamore Sycamore Tree Capital Partners, the Dallas-based credit manager, has hired Amanda Montgomery and Marc Gonyea into marketing roles.

Montgomery joins from Allianz Global Investors as a managing director. At Allianz, she spent eight years in relationship management and sales roles, including as the senior relationship manager responsible for the south-west region. Prior to Allianz, Montgomery was an institutional allocator at San Diego City Employees’ Retirement System, where she was head of public markets for both fixed income and equities.Gonyea joins from Alcentra as a managing director with a start date of July 1. At Alcentra, he was a managing director responsible for institutional clients across channels and regions in the US. He was also a senior marketer at Benefit Street Partners and held similar positions at Och-Ziff Capital, The Blackstone Group, Goldman Sachs and Bankers Trust.

LP Watch

Institution: San Jose Federated City Employees’ Retirement System Headquarters: San Jose, USAUM: $2.84 billionAllocation to alternatives: 28.62%

San Jose Federated City Employees’ Retirement System has outlined its private markets pacing plan for fiscal year 2022-23, according to materials set to be confirmed in its upcoming investment committee meeting.

The California public pension has outlined $149 million for investment into private markets for FY 2022-23 – down from the $162 million pacing projection for FY 2021-22. The actual investment into private markets for FY 2021-22 will reach $167 million by 30 June.

Of this $149 million, $30 million is slated for private debt investment. San Jose FCERS has appetite for private debt investment in the corporate sector across North America.

Furthermore, San Jose FCERS has confirmed three commitments to private debt vehicles made across FY 2021-22: $9 million each to Angelo Gordon Credit Solutions Fund IIArbour Lane Credit Opportunity Fund III and Octagon CLO Opportunity Fund IV.

Angelo Gordon, an investment and advisory firm focused on the alternatives market, launched CSF II in September 2021. Since launch, it has raised nearly $1.4 billion for the fund.

Arbour Lane Capital Management launched its third private debt vehicle in June 2021 and has attracted investment from a number of public pensions such as Texas County and District Retirement System and Teachers’ Retirement System of the State of Illinois. Arbour Lane specialises in opportunistic credit and special situation investments across the US.

Octagon Credit Investors’ fourth CLO vehicle was launched with a $500 million target size in December 2021. It is a New York-based independent firm focused on providing credit solutions in North America.

San Jose Federated City Employees’ Retirement System currently allocates 2.7 percent of its investment portfolio to private debt, comprising $76.7 million in capital.

The $2.84 billion public pension’s recent private debt commitments have tended to target vehicles with value-add or opportunistic strategies that invest in North America.


Today’s letter was prepared by Andy Thomson with John Bakie and Robin Blumenthal