Monday, 26 February 2018

Corporate savings and credit spreads

The corporate savings rate rose in Q3 as per the Z1 survey and looks like it has probably risen more since. 

It's a bit weird as capital formation ie capex, was rising into year end. 

As per the chart below business loans picked up a little in Jan and are flat in the first week of Feb so far having gone negative for a few weeks in Q4. 

Good job Yellen didnt hike rates to a neutral level before leaving the Fed as I think that would probably be enough to trigger a recession. 

Instead we have continuing very loose rates trying to underwrite, in my view, a transition between economic cycles without a recession in the middle.

The new cycle will involve lower corporate margins and more defaults. So how do you play credit spreads widening over time? 

One simple solution is CLO equity. If during the two year reinvestment period leveraged loan spreads widen, then as the CLO reinvests excess cashflows and early repayments the spread between the collateral pool yield and the CLO note funding costs widens, increasing the return to the CLO equity. 

Obviously the CLO manager has to avoid defaults or stopping out of deteriorating credits at marked down prices to generate an overall benefit. 

This credit spread widening benefitting CLO equity is exactly what happened in the 2 year period into March 2016, and in my view this cycle could potentially happen several times over the next 10 years or so.

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