Sonal Patel, Managing Director, Head of Sales – Americas, Bermuda and Caribbean, and Richard Gordon, Managing Director – Cayman Islands, explain why suggestions of distress in the CLO market have been overstated, and how the resilience of the asset class is now winning through, despite some significant challenges ahead.
If financial and economic markets have been defined by one word in 2020, it is 'uncertainty'. The full impact of Covid-19 on credit markets in general and CLOs in particular is still playing out. And the longer-term effects of current and future stimulus packages are yet to be fully realised.
Add in prospects for inflation, which have been difficult to predict since the longest low-interest rate/low-inflation period in history began in the wake of the financial crisis, and there are clearly some considerable uncertainties at play.
As Covid lockdowns took hold across the globe in early 2020, there was a lot of talk about whether or not there might be widespread credit defaults. But the credit markets have proved to be quite robust. Part of that is due to the significant amount of stimulus and support that government agencies have been offering to both individuals and corporations.
That doesn't mean that it hasn't been challenging for CLOs. In November 2020, Bloomberg found that year-to-date issuances were 30 per cent down compared to the same period in 2019.
Yet it appears that markets were rallying towards the end of the year, and Bloomberg was upbeat when it reported on 3rd November 2020 that issuance had rebounded. According to its own data: 'CLO volume reached $13.8bn last month, a 20% increase over September and the most since $15.7bn was issued in April 2019."1
One of the possible explanations is that while during the pandemic some sectors have been under strain, others have done well, and CLO products are as diverse as the global economy itself.
As a global fiduciary and administration service provider with 16 offices around the world, Ocorian has serviced US CLOs for 10 years and represented around 50 managers in well over 500 structures. This provides us with a useful overview of the market and enables us to offer some reflections of how it may play out as we move through 2021.
Despite a challenging landscape, we are seeing new structures being formed and existing warehousing-type structures moving from a stalled environment through to issuance.
We shouldn't, however, understate the gravity of the shocks that have beset the CLO market in 2020. These will necessitate significant operational adjustments to the way the market works.
First, structures. Reviewing our data across CLO management structures, we have noted that approximately 30% of managers have had some form of consolidation event over the last decade. This has often been caused by the need for capital for managers to grow their businesses, and consolidation among market participants is a way for them to grow and scale up their operations.
Second, investors are seeking yield and will continue to do so in 2021, but they will also be seeking quality. The quality of credit assets under management looks set to be a key theme throughout the year and as Bloomberg points out in its report, spreads are already tightening. The balance between risk and reward will, as ever, pose a challenge.
Third, politics and economics. Post the US election, the likelihood is that the prospective dichotomy between a Democratic House of Representatives and a Republican Senate will enable the country to avoid dramatic changes to US policy at home and abroad. At the same time, the effects of stimulus and inflation will likely come into force, but exactly how the economy and business sectors are going to respond is unclear until we see how swift any recovery is. We cite the US economy here as the US is the largest CLO market in the world and is therefore typically indicative of the broader CLO landscape.
As an independent fiduciary and administrator, we feel our role is even more pertinent than it was pre-Covid. The CLO market needs dedicated support – an agent of competence for investors and managers – and this is our core business. This value-add and the technology-driven data that we can produce is going to be crucial in 2021 and thereafter.
This is especially the case as investors' information needs are likely to be different and more detailed than in the past. Having a fiduciary and partner can help both them and managers in terms of differentiating information and producing bespoke-type reporting.
For example, if a CLO product is coming to the end of its useful life, it may end up with residual illiquid assets. We have seen mechanisms in the course of our work that offer solutions as to how to deal with these types of situations and can offer support and guidance to investors and managers.
This points, for example, to new, or at least evolved, documentation, particularly in the context of restructurings. Much CLO documentation was prepared in an environment that could not have predicted the kind of market impacts that have been experienced in 2020. Evolution of documentation is something that we see and can provide some support with going forward.
Technology will also play a crucial role. Ocorian's systems have proved remarkably resilient during 2020. We were able to transition to a remote working environment seamlessly and, importantly, continue to be able to interact effectively and securely with our key government partners across, for example, functions involving registrars and regulators.
In summary, it's our view that the CLO market represents an asset class that has weathered a lot over the last 12 months. That said, we also believe it will sustain its resilience and retain its appeal for investors and managers for a long time to come.
For more information about Ocorian's CLO services, get in touch with our team below.
1 Bloomberg Quint " CLO Sales Reach USD14 billion in Busiest Month Since Early 2019" Adam Tempkin 3rd November 2020
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