Conditions might, at first glance, seem ripe for European CLO managers to launch ‘print and sprint’ deals.
Managers sometimes use print and sprint tactics to take advantage of weaker leveraged loan prices, printing CLOs quickly and racing to fill their portfolios with cheap loans during the ramp-up phase.
Most managers complete around 50% of the ramp-up by the time they price their deals, at which point liability spreads are fixed. They then purchase most of the remaining loans between pricing and closing.
Loan prices have certainly fallen since the start of the year. Approximately 29% of European leveraged loans are now trading at or above par, down from two thirds of the market at the start of the year, according to Bank of America figures.
Cheaper loans can boost returns for CLO equity investors. Managers can buy these loans at low prices and then build par by selling them if they appreciate in value, handing wadges of cash to their equity investors.
Enticing as bargains on leveraged loans might be, managers should be wary of the print and sprint approach.
Part of the softness in loan prices stems from the Iran war. The war has caused energy prices to spike, hampering borrowers with higher costs and making defaults more likely.
Loans have traded down as CLO managers and other loan investors have priced in the impact of the war.
But loan prices might not stay down for long, as the war’s duration is strongly correlated with the US president’s erratic decision making.
Should the war end suddenly, loan prices will rally. Managers that have priced deals that are still being ramped will have to buy loans at higher prices, without benefitting from tighter liability spreads.
This will squash the arbitrage between the asset and liability spreads on the affected deals, eating into equity returns.
Printing deals opportunistically to scoop up some inexpensive loans leaves managers exposed to loan price volatility.
CLOs are long-term investment vehicles and managers should print deals carefully, buying loans that will deliver returns over time.
Rather than printing and sprinting, managers should perhaps wait and see.