CLO mezz tranches are now attractive, says Morgan Stanley

In structured credit research published today, Morgan Stanley says that it has changed its view on mezzanine CLO tranches from that held earlier in the year. Strategists now think that current market prices provide an attractive entry point for mezzanine tranches, particularly single-A. They see loss-adjusted returns for A-rated tranches in the 9-10% range across different scenarios and for triple B minus-rated tranches in the low to mid teens in all but the most pessimistic scenarios.

Based on Morgan Stanley’s analysis, strategists remain constructive about the prospects for senior triple-A and double-A tranches. They continue to think that these tranches offer attractive value relative to other comparably risk-remote asset classes from a principal loss perspective.

In much of the CLO capital structure, prices are down relative to their April highs. This weakening has occurred in the face of growing evidence of increasing collateral quality metrics in CLO portfolios reflected in improving coverage tests, declining triple-C buckets and the tide turning in the ratings performance of CLO tranches towards upgrades in US CLOs.  

Though volatility due to the macro concerns is not going away any time soon, say strategists, a secular credit healing is underway as long as the US economy remains on track for at least moderate, sustainable growth. In this context, high yield credit stands out as a sweet spot and CLO tranches, particularly at their current prices, offer an attractive way of expressing this thesis.