CLOs should realise gains from reorg equity positions: Pearl Diver

Reorg equity sitting within CLOs has risen in value over the last year and Pearl Diver Capital says it may be a good time to exit these positions “and realise value for CLOs”.

The CLO investment firm has posted its views on social media through a research paper where it finds that the ability of US CLOs to hold reorg equity has benefited investors: there has been a 20% growth in the value of reorg equity in CLO portfolios in 2021.

However, there may be little upside left for CLO managers that hold on to these positions. “The mixture of interest rate rises, persisting inflation and supply chain issues, combined with geopolitical risks all point to a more volatile period ahead,” writes Pearl Diver. “We think that given the value appreciation, now is a good time to exit reorg equity and realise the value for CLOs.”

By selling equity that has recovered, CLO equity tranche NAVs could rise by up to nine points in some cases, Pearl Diver finds.

US CLOs have been afforded greater flexibility to hold non-loan assets since the Volcker rule was amended in October 2020. This meant, among other things, that CLO managers could participate in corporate restructurings.

Pearl Diver says although CLO portfolios have made good use of this provision, managers have to be selective. “For every reorg equity that doubles in value, there is another one that halves,” it writes.

The firm points to Cirque Du Soleil as a strong performer with its equity tripling in value over 2021. On the flipside, 24 Hour Fitness’s membership numbers have struggled to grow and its common equity has halved. McDermott’s equity has also halved.