(Bloomberg) -- The increase of special-purpose acquisition companies is yet another positive factor working in favor of the red-hot collateralized loan obligation market -- which is very close to achieving an annual sales record, according to CLO equity investor Flat Rock Global.
That’s because having SPACs hunt for acquisition targets in the riskiest borrowers within CLO loan pools may mean credits that currently trade somewhat below par can trade back up to that price as a result of the SPAC merger process, Shiloh Bates, managing director at Flat Rock, said in a telephone interview.
“There’s not a ton of these distressed issuers in the CLOs anyway, but if you have 600 active SPACs hunting around -- and they’re hunting on a short fuse, as they need to either deploy money and start making their fees, or give it back in two years -- some of these distressed loans can repay at par through a SPAC process, and that’s great for CLO equity – it’s very accretive,” Bates noted.
This is just one more factor improving CLO equity returns, which are already on a tear this year due to a healthy so-called arbitrage, or the degree of profitability of bundling leveraged loans into such products. That’s measured by the gap between the interest earned from the underlying leveraged loans and the cost of borrowing for a CLO manager to purchase the assets. Equity holders in a collateralized loan obligation get paid last, and hold the riskiest slice of the deal.
Read more: CLO Credit Lines Grow Fast as Record Looms
Blank-check companies raise capital from investors and typically need to deploy this capital through a merger with a target company within two years, as to not risk having to return the money to investors.
Many of these SPACs are targeting distressed businesses, Bates said. If a company wants to go public or have mainstream funds buy shares in an IPO, it can’t be that levered. The single-B rated type of credit, for example, isn’t the profile of what trades well on a stock exchange, he added.
But to list via a SPAC does work, he said. Going through a SPAC means that “people rolled up their sleeves and did a lot of work on it; it’s a story the SPAC investors understand and they don’t mind the leverage,” Bates said. “As part of the SPAC process, new money comes in that can be used to delever and that can result in a better valuation on an exchange.”
Trading at Par
Some SPACs may bid to acquire some of the riskiest companies within CLO leveraged loan portfolios. When a publicly traded SPAC enters into a merger agreement with one of these companies, it may result in repayment of the company’s debt, lifting ratings and price.
In a Thursday client note, Bates cited a May research article from S&P Market Intelligence where the authors identified 12 SPACs that may emerge as bidders for companies that have term loans with higher risk of default.
One example came to fruition: Syniverse Holdings entered into a definitive merger agreement with a publicly traded SPAC called M3-Brigade Acquisition II Corp. According to an Aug. 19 note from Moody’s Investors Service, the rating firm placed the company’s Caa1 rating on review for an upgrade because of the merger, saying that it “will result in Syniverse becoming a public company and the repayment of a significant portion of the existing debt.”
The first-lien loan to Syniverse Holdings was trading at 80% of par in November 2020. Today, given its SPAC merger, it trades at par, Bates said.
Another such example is spyware technology company NSO Group, which is reportedly considering going public via a SPAC, according to Flat Rock’s note. While a transaction has not yet been announced, NSO Group’s term loan currently trades at 86% of par, Bates said.
“While the trading level would not put the loan in the distressed category, we believe many CLO managers are likely rooting for the SPAC process to unfold,” Bates said.
To be sure, the rise of distress-seeking SPACs is not a fundamental driver of the CLO market, but more of a “cherry on top”, Bates said. The main drivers of record issuance are the current excellent arbitrage, the strong demand from investors seeking yield, the asset class’ ability to successfully weather last year’s pandemic downturn, and the acceptance of CLOs as a mainstream asset class, he noted.
Sales of new-issue CLOs stand at $124.3 billion so far this year, just shy of the sector’s all-time annual record in 2018 of $130.4 billion, according to data compiled by Bloomberg.
Relative Value: Auto ABS
- The new issue market for subprime auto ABS continues to see tiering between platforms, according to Bank of America research analysts. They selectively favor lower-tier subprime auto-loan ABS platforms due to the ability to pick up spread and the outlook that credit performance will be stable to modestly weaker
- The same rationale led the analysts to selectively prefer subprime auto loan ABS over prime auto loan ABS. The spread differences between top and lower-tier subprime auto-loan ABS and top-prime auto-loan ABS are 11bps and 3bps, respectively
Re: CLOs and loans switching to Secured Overnight Financing Rates in the fourth quarter: “You’ve got all the paper issued in the last two years having some meaningful provision for what happens when Libor disappears,” Christopher Jackson, a partner at Allen & Overy, said in an interview. “It doesn’t pose a host of legal issues in the short term. Various forms of documentation contemplate SOFR, and the topic is pretty well vetted. The issue is, what do we do with new issue deals dominated in SOFR on day one?”
ABS deals in the queue include Aqua Finance (home-improvement loan ABS) and Driven brands (whole business). ABS-15Gs were also filed by LendingPoint, GreatAmerica, and J.G. Wentworth.
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