By the Numbers
The curious case of lower-rated CLO bonds on BWIC
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Many CLO investors may assume that bonds with lower ratings have worse liquidity than their higher-rated counterparts. This may be true if investors measure liquidity by the outstanding size of the market or absolute trading volume. But trading volume as a share of outstanding amount and price disclosure in the secondary market paint a different picture. In that landscape, ‘BBB’ and ‘BB’ classes look surprisingly good.
‘BBB’ and ‘BB’ bonds make up a surprising share of BWIC volume
CLO investors typically sell bonds through dealers in the secondary market by listing bonds for “bids wanted in competition” (BWIC). ‘AAA’ bonds account for an average of 65% of new issue CLO par value, but over the last five years they only represent an average of 46% of annual BWIC par supply (Exhibit 1). The par share of ‘AA’ and ‘A’ bonds on BWIC over the last five years is more in line with their share in the primary market.
The ‘BBB’ and ‘BB’ bonds typically represent 10% of the newly issued broadly syndicated loan (“BSL”) CLOs. They have, however, both taken a much larger par share of BWICs. While BWIC volume varies from year to year, the ‘BBB’ bonds have an average of 11% of annual par BWIC volume, nearly double their share in the primary market. The share of ‘BB’ bonds in BWIC has fallen to 11% in 2022 from a 5-year average of 17%, but it remains high compared to the typical small share of ‘BB’ new issuance in the primary market.
Exhibit 1: ‘BBB’ and ‘BB’ bonds were an average of 28% annual BWIC volume
Note: BWIC data only reflects the BSL CLOs. ‘BB’ CLO includes CLO tranches rated ‘BB’ and below. The share of each rating stack is calculated based on the bid list par value. 2023 YTD BWIC data is as of February 10, 2023.
Source: KopenTech, Santander US Capital Markets LLC.
These results obviously point to much more active trading in ‘BBB’ and ‘BB’ classes of CLOs as a share of outstanding par balances, and underwhelming trading in ‘AAA’. Of course, ‘AAA’ trading still dominates the CLO market in terms of absolute par volume because of the large par amount of ‘AAA’ CLO debt.
Some plausible reasons for the disproportionately high turnover in ‘BBB’ and ‘BB’ positions:
- More frequent differences in relative value over time
- More portfolios with active trading strategies
- Fewer portfolios able to hold positions indefinitely
As for the disproportionately low turnover in ‘AAA’, the opposite may apply:
- ‘AAA’ classes are more remote from the changes in MVOC and credit that often drive swings in relative value
- Insurers and banks hold roughly half of outstanding ‘AAA’ CLO debt, based on work by the Federal Reserve, and those portfolios usually avoid active trading, and
- Accounting rules at insurers and banks usually protect quarterly income from swings in market value and allow those portfolios to hold positions through market volatility
‘BBB’ and “BB’ bonds have more complete BWIC pricing color
Bonds on BWIC end up getting reported as traded, did not trade (“DNT”) or unclassified. Surprisingly, the proportion of unclassified trades on BWIC for ‘BBB’ and ‘BB’ bonds has been lower than for senior bonds (Exhibit 2). While the final outcomes of those trades are unknown, investors can at least infer that availability of price information in trading lower-rated CLO bonds has not been worse than that of bonds at the top of the capital structure and arguably has been better.
Exhibit 2: The proportion of unclassified trades is smaller for lower-rated bonds
Note: BWIC data only reflects the BSL CLOs. ‘BB’ CLO includes CLO tranches rated ‘BB’ and below. The share of each rating stack is calculated based on the bid list par value. 2023 YTD BWIC data is as of February 10, 2023.
Source: KopenTech, Santander US Capital Markets LLC.
The CLO BWIC market paints an interesting picture of turnover and price information across rating classes. Portfolios that want to trade actively may have more company lower in the capital structure.
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