BlueMountain to Saba Searching for Yield in Bond Exotica
BlueMountain Capital Management LLC and Saba Capital Management LP are leading investors into the debt market’s darker corners to boost returns, buying securities from collateralized loan obligations to bonds that seldom trade.
BlueMountain, the $11 billion hedge fund firm in New York, raised twice the amount it anticipated this month from pension managers for a credit fund that buys CLOs, asset-backed securities and less liquid corporate bonds. Saba, founded by Boaz Weinstein, says CLOs are cheap compared with the underlying loans, while Citigroup Inc. sees banks “getting increasingly involved” in the securities for higher returns on capital.
Investors are casting a wider net as they face a fifth year of near-zero interest rates and bond yields at record lows amid Federal Reserve efforts to lift the economy and lower unemployment. Even the lowest-rated portions of CLOs, which were shunned after the financial crisis, are making a comeback.
“The corporate market has compressed so much, people are looking everywhere,” said Ashish Shah, head of global credit investments at New York-based AllianceBernstein LP, which oversees $230 billion in fixed-income assets. Investors such as him have “become more open” to assets like CLOs because they “haven’t compressed as much as comparable credit,” he said. “They represent remaining parts of value in the market.”
CLO issuance has more than tripled this year to a more than five-year high of $36 billion, data compiled by Bloomberg and Morgan Stanley show. The instruments, which peaked at $91.1 billion of sales in 2007, are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return.
JPMorgan Chase & Co. expects $45 billion of CLOs will be sold in 2012, and as much as $70 billion next year, analysts led by Rishad Ahluwalia said in a report dated Oct. 19.
“During hot markets, bankers will typically slowly start pushing the envelope little by little, introducing either lower credit quality or increasingly esoteric structures to get a sense of the market’s acceptance,” Adrian Miller, director of global market strategy at GMP Securities LLC in New York, said in a telephone interview. “There’s still room to go with structured credit.”
Elsewhere in credit markets, Clear Channel Communications Inc. issued $2 billion of bonds after the radio and billboard company said its offer to exchange term loans for the new notes was oversubscribed. The U.S. Securities and Exchange Commission approved rules intended to increase transparency in a corner of the market for mortgage- and asset-backed bonds.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, increased 1.06 basis point to 10.78 basis points. The gauge, which narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities, touched 8 basis points on Oct. 17, the lowest level in Bloomberg data back to 1988.
The cost of protecting corporate bonds from default in the U.S. and Europe was little changed.
The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, rose 0.1 basis point to a mid-price of 98.7 basis points as of 12:15 p.m. in New York, according to prices compiled by Bloomberg. The measure has climbed from 89.7 on Oct. 17, the lowest level since contracts on the latest version of the index started trading Sept. 20.
In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 0.3 to 128.2.
The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds of Caracas-based Petroleos de Venezuela SA, or PDVSA, are the most actively traded dollar-denominated corporate securities by dealers today, with 93 trades of $1 million or more as of 12:14 p.m. in New York, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority.
Clear Channel’s 9 percent securities due in December 2019 yield 780 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg. More than $8.6 billion of loans were submitted for the exchange, the San Antonio-based company said in a statement today.
The so-called priority guarantee notes will be “fully and unconditionally” backed by the parent company and all “existing and future domestic wholly-owned restricted subsidiaries,” the company said in an Oct. 12 statement. The notes also will be secured by certain Clear Channel assets.
The SEC agreed to a plan by the Financial Industry Regulatory Authority to create public reporting for trades of so-called specified government-backed mortgage bonds and securities tied to Small Business Administration loans, according to an Oct. 23 notice posted on its website.
The protocols for disclosures through Finra’s Trace system will allow for the unique identifiers of bonds called CUSIPs to be hidden, in favor of generic information about the securities.
JPMorgan predicts that relative yields on top-rated portions of CLOs will drop to 125 basis points more than the London interbank offered rate by the end of the year, compared with coupons on new deals last week of as much as 143 basis points over the benchmark, analysts Ahluwalia and Maggie Wang wrote in the Oct. 19 report. Spreads will continue to narrow to 100 by the middle of 2013, they said.
“Some CLOs issued before 2008 are still undervalued comparing to the underlying assets,” James Wang, a money manager at Saba in New York, said in a telephone interview. Wang said he likes debt from older CLOs, which “are more stable because they are short-dated” and “have relatively low volatility compared to the average CLO.”
BlueMountain raised $1.5 billion, double its target, for its Credit Opportunities Master Fund I that invests in structured corporate credit including CLOs, asset-backed securities and less liquid corporate credit. Investors were primarily pension funds in the U.S., Canada, Japan, and Europe, Stephen Siderow, the fund’s president and co-founder, said in an interview last week with Deirdre Bolton on Bloomberg Television’s “Money Moves.”
“We actually don’t think you have to take on that much more risk to enhance your return,” Bryce Markus, a money manager at BlueMountain, said in a telephone interview yesterday. “You need to forego liquidity and possibly accept complexity but not necessarily greater market risk. For longer- duration capital we think these types of assets make a ton of sense.”
Pension managers were particularly attracted to the fund because they traditionally have had long-dated liabilities and shorter-dated, more liquid portfolios, said Markus, a managing principal at the firm.
“We are seeing more and more pension funds embrace that type of investing, where they see significant returns from moving into longer-dated, less liquid investments,” he said.
BlueMountain also bought a portfolio of assets from synthetic collateralized debt obligations, backed by derivatives bets on the creditworthiness of borrowers, from Credit Agricole SA (ACA), Siderow said last week in the Bloomberg Television interview.
“There will be more of those types of transactions” as U.S. and European banks cut risk and raise capital to comply with more stringent global capital requirements and the Dodd- Frank Act in the U.S., he said.
The Fed’s resolve to hold interest rates at about zero for another three years has pushed yields on corporate debt to the lowest ever. Bonds with maturities from one to three years have returned 4.1 percent this year, compared with 11.7 percent for debt with seven- to 10-year maturities, according to Bank of America Merrill Lynch index data.
The move back into structured credit is likely to be tempered by the outsized losses they left investors with during the crisis four years ago, said Noel Hebert, chief investment officer at Bethlehem, Pennsylvania-based Concannon Wealth Management LLC, which oversees about $250 million.
Institutional investors “won’t soon wade back into that pool regardless of yield -- too much career risk,” he said. “The one unforgivable sin is to get pinged by them again,” so it’s more hedge funds or more aggressive fund managers that are investing now, he said.
As opportunities in older CLOs diminish amid spread- tightening and maturities of existing bonds, investors are migrating toward new deals, said Robert Cohen, a senior credit analyst at Los Angeles-based DoubleLine Capital LP, which oversees $45 billion in assets.
“The CLO structures have worked and they’ve survived a terrible credit cycle,” he said. “As those prices tighten up with the rest of the market, it makes people think about investing in new deals, plus a new deal has the benefit of new collateral and fresh portfolio quality and coverage tests as well,” Cohen said.
Yields on the top-rated tranches widened to as much as 725 basis points seven months after the September 2008 collapse of Lehman Brothers Holdings Inc., Morgan Stanley data show. Spreads on benchmark U.S. CLO portions rated AAA trade at 130 basis points, JPMorgan said in the Oct. 19 note.
“CLO AAAs are one of the cheapest highly-rated assets” with “negligible credit risk,” the JPMorgan strategists wrote last week.
Some funds that buy speculative-grade debt are allocating money to lower-ranking investment-grade portions of CLOs “because they’re getting similar or higher yield and they’re getting the fact that CLO A has subordination below it to protect them from some default losses,” which explains some of the rally in that slice, Citigroup analyst Ratul Roy said in a telephone interview.
In the past, “there was limited equity capital available so managers needed to bring most or all of the equity do get a deal done,” DoubleLine’s Cohen said. “Now managers are able to get deals done with substantially less, with third party capital, so that’s helping to drive new issuance.”
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