Fitch: CLOs and CEFs Offer Structural Trade-Offs as Investment Vehicles for Leveraged Loans

NEW YORK--(BUSINESS WIRE)--Link to Fitch Ratings' Report: CLOs and CEFs: A Comparison of Leveraged Loan Investment Vehicles

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=622909

Collateralized loan obligations (CLOs) and leveraged loan closed-end funds (CEFs) offer structural trade-offs for senior and junior investors, as well as leveraged loan managers, according to Fitch Ratings in a special report published today. While both structures are intended to offer leveraged exposure to a diversified pool of leveraged loans, they vary in terms of their regulatory and operating frameworks, investment flexibility, leverage levels, and structural triggers, among other features. Regardless of their differences, however, the recent improved performance of the leveraged loan market has spurred new issuance activity in both types of investment vehicles.

According to Fitch's analysis, the senior classes of both CLOs and loan CEFs weathered the recent financial stress well from a ratings perspective, with limited downgrades of senior CLO tranches and no downgrades for CEF debt or preferred stock. In the case of CLOs, asset cash flows were diverted to pay down senior notes once overcollateralization tests were breached. In the case of loan CEFs, market value asset coverage declines obligated fund managers to deleverage through asset sales.

In contrast, there was greater performance variability in the junior and equity classes for CLOs and loan CEFs during the recent financial crisis, primarily due to differences in the deleveraging triggers incorporated into the transactions' operating documents. While CEFs' deleveraging crystallized market value losses for the equity class, CLO junior classes suffered temporary cash flow interruptions and downgrades, but many have since recovered lost income. As outlined further in the report, the relative performance of different classes of CLOs and loan CEFs is expected to vary depending on the nature, timing and magnitude of any given stress scenario.

In the wake of the financial crisis, issuance activity for both investment vehicles has increased, though CLO issuance is still at a fraction of pre-crisis levels. Interestingly, several of the new leveraged loan CEFs were launched by investment advisors that traditionally have managed CLOs or private equity funds but are now entering the CEF market to diversify funding sources and management-fee income streams. For loan managers, much of the trade-off between CLOs and loan CEFs will come down to weighing the attractiveness of the permanency of capital associated with loan CEFs against a lower leverage/return profile and the potential ramifications of forced asset sales in scenarios such as the recent financial crisis.

Fitch has published rating criteria for both transaction types in order to evaluate the credit quality and liquidity of the underlying loans, the transaction's structure, and the capabilities of the manager. The criteria, along with issuer-specific research for both structures, are available at 'www.fitchratings.com'.

The full report, 'CLOs and CEFs: A Comparison of Leveraged Loan Investment Vehicles', is also available at 'www.fitchratings.com' or by clicking on the link above.

Additional information is available at 'www.fitchratings.com'.

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