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Staying Ahead Of The CLO Market Breakfast Briefing (Part II of III)

No one knows exactly when the Federal Reserve will decide to increase its benchmark lending rate, but we do know that it will inevitably happen.

Participants in a recent panel discussion on Collateralized Market Obligation (CLO) trends and investment opportunities shared their perspectives on how a rise in the Federal Reserve Rate may affect the asset class as a whole. Here are some highlights:

The Impact Of Fed Rate Increases

  • The Debate Continues: Panelists indicated that we will likely see the beginning of rate increases in 2015; however they disagreed on the direct impact to the CLO markets.
  • Hedging As The Linchpin: If investors are hedging against the implications of a rising Fed Rate, panelists described the ability to avoid potential fallout. Employing LIBOR floor hedges, for example, could help investors in managing exposures.
  • Unleveraged Loan Portfolios May Become More Attractive Than CLOs: With an expected increase in interest rates, panelists anticipate that investors may buy unleveraged loans via separately managed accounts rather than CLOs, which may see some arbitrage erosion as a result of LIBOR floors. If and when this occurs, panelists anticipate an increase in the perceived attractiveness of unleveraged loan investments (as opposed to CLOs).
  • More Risks & Challenges: Panelists cite the fact that higher interest rates will pose a number of challenges for equity investors as arbitrage opportunities are squeezed, and collateral yields remain the same. Moreover, the potential tightening of AAA spreads will also threaten re-pricing as an option, and could run into risk retention rules, posing even more challenges for CLO issues.

To learn about S&P Capital IQ’s portfolio capabilities for structured finance assets and to prepare for some of the challenges discussed, please visit our microsite.

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