CLOs and CLO Closed-End Funds
CLO Closed-End Funds such as Eagle Point Credit or Oxford Lane Capital Corp. have gained popularity over the past few years in the present low-interest-rate environment. However, what exactly is a CLO. To begin with, CLO stands for collateralized loan obligation. It is essentially a "structured security". Using Eagle Point Credit as an example, the largest holdings of this CLO fund are CIFC Funding 2015-II, Ltd. 15.16%, and Barings Income Nt Ltd 2018-I FRN. Unlike a traditional fixed income product such a bond fund, which owns the debt of a municipality or corporation, A CLO fund owns collateralized loan obligations. More specifically, it holds the securities issued by a CLO.
CIFC Funding 2015-II, Ltd. is not a company in a traditional sense. It is manufactured to hold non-investment grade, or "junk" (typically B to BBB rated), 1st lien senior loans that are secured. To a lesser extent CLOs also invest in other investments such as 2nd lien loans and debt that is unsecured. In other words, the CLO purchases a variety of bank loans that separately are risky, but bundled are theoretically safer, depending on the specific tranche. Using a municipal bond issuance as an example, funding for toll road construction can be raised via a bond offering. That bond offering will issue various tranches of debt. When an investor purchases that toll road bond, it could be from a lesser risk tranche or a subordinated tranche which carries high risk but also attendant returns. The same thing occurs with the CLO. CIFC Funding 2015-II, Ltd. raised proceeds from its issuance of both secured (debt tranche) and unsecured securities (equity tranche) to raise capital. After the requisite capital is raised, the CLO would go out and purchase a portfolio of loans that are from banks to business. Again, these loans are generally riskier types of loans.
It should be noted, until recently, most CLO issuances were not rated junk, though their holdings were junk. To make things theoretically safer for the retail investor, CLO funds spread the risk further by owning a variety of CLOs. Eagle Point, for example, is a Fund, however, it usually invests in equity tranches. That would make it a riskier CLO fund. Institutional investors generally purchase CLOs. The average, everyday investor should not own individual CLOs. They are too risky. If such an investor owns CLO funds, such an investment should only be for a fraction of his or her portfolio. In short, even CLO funds are too risky to comprise a large portion of anyone's portfolio. If you were a retail investor invested in any CLO or concentrated in a CLO fund please contact us. If you were an administrator at a municipality, school district, pension fund, credit union, or community bank, or were "ratings constrained" in any way please see below.CLO Downgrades
There has been a barrage of loan downgrades that will, in turn, prompt ratings agencies to downgrade the debt and equity issued by the CLOs. Moody's has downgraded about $22 billion worth of CLOs which is about 1/5 of the CLOs that are rated by them. These CLOs are on a list earmarked for potential further downgrades. Losses on CLOs have increased dramatically. It is believed that about 40% of those CLOs had an investment-grade rating or non-junk rating. That is changing as many of these CLOs are now or will shortly become non-investment grade. The biggest issue may be with municipalities, school districts, pension funds, community banks, and credit unions. These entities are often constrained by agreements or charters that forbid investing in junk securities. When these securities fall below the threshold, they must be liquidated. This creates two issues. The first is a run on the market which depresses prices further. Second is these entities will have to take principal losses that were not supposed to occur in the first place. That is a huge deal for a local administer at a municipality or a trustee on a board that was assured they were investing something safe. If your entity is in such a situation please contact Shepherd Smith Edwards & Kantas. We have represented school districts, municipalities, credit unions, and retirement plans in the last financial crisis. The consultation is free and we will put on a presentation to your board, if applicable, of what we uncovered and highlight all options available.
Examples of CLO Funds:
- Blackstone/GSO Senior Floating Rate Term (BSL)
- Eaglepoint Credit Company (ECC)
- Highland Floating Rate Opportunities (HFRO)
- Oxford Lane Capital Corp (OXLC)
- Aberdeen Income Strategies Fund (ACP)
- OFS Credit Company Inc (OCCI)
- XAI Octagon FR & Alt Income Term Trust (XFLT)
Examples of CLOs:
- FREMF 2019-KF60 C
- Barings Income Nt Ltd 2018-I FRN
- BRISTOL PARK CLO LTD 6.37%
- Battalion Clo 2015-9r FRN
- Octagon Investment Partners 40, Ltd.
- Madison Park Fund Xli, Ltd