Trico windshield wiper blades, manufactured by the auto parts maker First Brands, are displayed for sale in Medford, Mass.Brian Snyder/Reuters
Some Canadian fund managers are reducing risk in their credit portfolios after the recent collapse of two U.S. companies raised questions about the health of the sector.
The concerns stem from the bankruptcies of auto parts company First Brands Group and subprime auto lender Tricolor Holdings, both privately held companies that accessed the public credit market.
First Brands borrowed from the broadly syndicated loan market, in which the loans were arranged by and traded through investment banks. Tricolor issued asset-backed securitizations on its pool of “junk” auto loans.
After JPMorgan Chase & Co. recorded a US$170-million charge in its third quarter connected to Tricolor, chief executive officer Jamie Dimon vowed to “scour all process, all procedures, all underwriting, all everything.”
“We think we’re okay in other stuff,” he told analysts in an Oct. 14 conference call, but said “my antenna goes up when things like that happen. And I probably shouldn’t say this, but when you see one cockroach, there are probably more … everyone should be forewarned on this one.”
Mr. Dimon said JPMorgan wasn’t exposed to First Brands, but firms such as U.S. investment bank Jefferies Financial Group Inc. and Swiss lender UBS Group AG also reportedly lost millions in that company’s bankruptcy.
First Brands’ debts are held widely among collateralized loan obligation (CLO) portfolios, including some in Canada’s nascent CLO exchange-traded fund (ETF) sector.
Minimal Canadian exposure
Tiffany Zhang, National Bank Capital Markets’ director of ETFs and financial products research, says the exposure to First Brands among Canadian CLO ETFs was “pretty minimal,” ranging roughly from zero to under 50 basis points.
“There was little to no impact on the AAA tranches owned by the Canadian CLO ETFs from the First Brands’ default,” she says.
Still, she cautions investors about the opacity of the CLOs in the ETF market, which is touted for its transparency.
“As we get into more complex strategies and structures, some of the benefits of ETFs will be lost,” she says.
Konstantin Boehmer, head of fixed income at Mackenzie Investments, which offers Mackenzie AAA CLO ETF MAAA-T, says some of the CLOs held by the fund “inevitably” have small exposure to First Brands.
“As we only own the AAA tranche and are well-diversified among managers, there has been no impact on performance,” he says.
Mr. Boehmer says his funds didn’t have any direct exposure to First Brands, adding that the AAA CLO ETF doesn’t make “active credit calls” but instead focuses on picking better managers.
Still, he’s also concerned about the “cockroach” effect and, as a result, his team has reduced overall risk across most of its active mandates.
“It’s not that we are running away from credit risk here or saying that it’s the start of another credit crisis … but our concerns on our side are that underwriting standards and maybe a fear of liquidity exiting the market could lead to some more pressure on the credit markets, overall,” he says.
If that does happen, he says it could also be a buying opportunity.
CIBC Income Advantage Fund ETF CCLO-NE had about 0.23 per cent exposure to First Brands, in line with the broader CLO industry average, according to Aaron Young, executive director and head, client portfolio management at CIBC Asset Management.
Mr. Young says his team isn’t worried about systemic risk in the credit space, but is being “more judicious” in what it’s adding.
RBC Global Asset Management, which offers RBC AAA CLO (CAD Hedged) ETF RCLO-NE, said in a statement sent by e-mail that it has “a de minimus exposure” to First Brands and that the impact on its fund “if any, will be minimal.”
BMO Global Asset Management says exposure to First Brands and Tricolor in its BMO AAA CLO ETF ZAAA-NE is “immaterial,” adding in a statement sent by e-mail that the fund is “highly diversified and backed by a portfolio of more than 35,000 senior secured loans to businesses.”
Corton Enhanced Income Fund RAAA-T, subadvised by alternative credit manager Astra Asset Management UK Ltd., is focused on the European CLO market and not exposed to First Brands, says Corton Capital Inc. consultant Keith Pangretitsch.
The odd bankruptcy is a fact of life in the credit space, he says, but he sees the fallout from First Brands as manageable.
Mr. Pangretitsch adds that the exact exposure of First Brands’ debt within the CLO industry is still being determined, but the approximate value is US$2.1-billion, or roughly 0.2 per cent of the total US$1.2-trillion CLO market.
Jeff Sujitno, portfolio manager at Wellington Square Advisors, which subadvises Brompton Funds’ Brompton Wellington Square AAA CLO ETF (CDN-hedged) BAAA-T, says the fund has minimal exposure to First Brands that’s within the industry average.
He believes the CLO structure has proven resilient, given that the ETFs have held their value in the weeks after the First Brands bankruptcy came to light.
The market impact
Anxieties around the sector have led to outflows in the U.S.-listed CLO ETF space and in the broader U.S.-listed senior loan ETF category, but less so in Canada, according to National Bank Financial’s ETF research team. (Senior loan ETFs hold the senior loans directly, while CLO ETFs invest in slices of CLOs that are backed by hundreds of loans.)
U.S.-listed CLO ETFs saw about US$188-million in outflows from Oct. 1 to Oct. 24, led by Janus Henderson AAA CLO ETF JAAA-A, the first and largest CLO ETF, and the Janus Henderson B-BBB CLO ETF JBBB-A. Overall, three products saw outflows and 11 products saw inflows.
Meanwhile, U.S.-listed senior loan ETFs saw about US$2.7-billion in redemptions during the Oct. 1 to 24 period. National Bank Financial’s ETF research team says nine ETFs had outflows while only three ETFs had small inflows in this category.
Canada’s CLO ETF market, valued at about $660-million across 14 products from six providers, remained in inflow territory during the Oct. 1 to 24 period. National Bank Financial says the sector attracted approximately $51-million in inflows during the period, on par with the same period in September.
Ms. Zhang says Canada doesn’t have a large presence of senior loan ETFs, noting that ETF flows in this category aren’t as representative of investor sentiment compared with the U.S.-listed ETFs.
Still, she says flows were flat from Sept. 1 to 24, and there were outflows of roughly $30-million from Oct. 1 to 24.