Creditflux Newsletter

Wells Fargo recommends buying triple A and double A tranches of middle market CLOs, arguing that these deals should outperform other CLOs in an environment of rising defaults. Although the secondary market for these deals is thin, mid-market triple As trade around 100 basis points wider than the 150-200bp currently seen on broadly syndicated triple As.

In a recent report, Wells Fargo’s structured credit analyst Dave Preston notes that middle market CLOs are a diverse sector, with some managers specialising in second-lien or distressed loans, while other managers put together deals with a mix of mid-market and broadly syndicated assets.

According to Wells Fargo’s calculations, mid market CLOs are currently performing worse than mainstream CLOs in default terms, with an average 6.8% defaulted bucket in mid-market deals – down from 7.5% in November. However, these deals typically have higher cash balances.

Mid market deals are less likely to be failing overcollateralisation tests than mainstream deals, with 13 of the 80 deals tracked by Wells Fargo currently failing at least one test, compared to 143 out of 565 for all CLOs.

Although higher defaults can be expected among mid-market loans, CLOs backed by these assets should outperform broadly syndicated loans in a rising default scenario because they are less levered.