Double B CLO turbos offer value, says Barclays Capital

In a credit strategy report entitled "Turbo BB CLO tranches: don't miss the trees for the forest", Barclays Capital researchers warn investors not to ignore the value of double B turbo tranches. Many CLOs include a feature that diverts cashflow to pay down the double B tranche ahead of more senior tranches in some circumstances. Typically, principal repayments are accelerated for the double B notes when the double B overcollateralisation test is failing but when the triple B OC test is not.

As the report points out, during this narrow window (of around 1% on average), the double Bs could receive a sizeable repayment, especially at a time when covenant waivers are increasing the spread on the portfolio.

Barclays Capital estimates that the turbo feature should add between 10 and 20 points to the value of a typical CLO double B tranche. However, the value of the turbo is highly dependent on the level of defaults and downgrades in the portfolio. "The risk is that a systemic increase in defaults and downgrades could cause the OC tests on both the double B and triple B tranches to fail simultaneously, rendering the turbo feature worthless," notes the report.

It recommends buying a diversified portfolio of these tranches.