Traders Will Soon Be Able To Buy CLOs & Other Risky Debt Products On RobinhoodTyler DurdenMon, 08/03/2020 — 05:30
Esoteric credit products like CDOs and CLOs gained mainstream notoriety ten years ago as politicians, pundits and a deeply humbled Wall Street accused them of helping to nearly destroy the global economy. But a few years ago, banks started looking for new ways to package and sell “safe” high-rated CLOs and other products based on the newly ascendant leveraged loans.
Now, it seems, lenders are facing a perfect storm: With the Fed making a foray into the corporate credit market, part of the central bank’s quest to make investing losses a thing of the past (at least for now — or for as long as it can) and Robinhood-enabled retail traders buy up tech stocks, bitcoin, gold (or at least the precious metals ETFs that offer ‘easy exposure’ to gold and silver), ETF sponsors are quickly dreaming up new products to hawk to this newly invigorated generation of retail bagholders traders who understand only one thing about market dynamics: Prices simply don’t go down.
And with brokerages now relying on bundling retail trades and selling ‘order flow’ to the big HFT firms — all of Robinhood’s established competitors have now adopted this business model as commissions have gone out of fashion — there’s a new perverse incentive to create products that will encourage mom-and-pop traders to play in markets previously reserved for institutional traders. And the latest example of this comes via Janus Henderson, the $337 billion asset manager that just filed to launch a new ETF that will allow Robinhood traders to buy into the highest-quality AAA-rated CLOs.
At a time of mounting corporate defaults and deepening economic gloom, a new fund may be about to bring collateralized loan obligations to the masses.
Janus Henderson is planning a U.S. exchange-traded fund that will seek floating-rate exposure to the highest-quality CLOs, according to a filing with the Securities and Exchange Commission this week. While many loan ETFs exist, there are currently none dedicated to CLOs.
CLOs, which package and sell leveraged loans into chunks of varying risk and return, have drawn scrutiny in recent months as the coronavirus pandemic spurs a wave of corporate distress. They typically don’t attract retail investors, though an ETF would in theory make them far more accessible.
Wary day traders can rest assured: because the loans comprising these CLOs are among the safest and most highly rated on the market.
The riskiest corners of the $700 billion CLO market may be signaling trouble, but the highest-rated tier tends to be a safe space, he said.
“In the case of AAA CLOs, it’s a safe and low-risk asset class,” said the chief investment officer. “Yields are fairly low on AAA CLOs in the first place, but if investors can earn 150 to 175 basis points of spread on a short duration asset, it can be attractive.”
And with the Fed bent on keeping rates low until things get “back to normal”, this might be only the beginning.
The central bank’s intent to keep them low for the foreseeable future could mean the more-than $4 trillion U.S. ETF market sees a spate of launches like the fund planned by Janus Henderson, according to Ken Monahan at Greenwich Associates.
“Given that yield suppression is here to stay it would seem, you’ll probably see a lot more of this,“said the senior analyst covering market structure and technology. “RMBS and CMBS are probably not far off.”
CLOs are a cousin of collateralized debt obligations, which became notorious for their starring role in the 2008 financial crisis.
There are several major differences, however, not least that CDOs bundle loans to consumers rather than businesses.
But once the Fed backstop is removed — if that ever happens — the only real beneficiaries of this product will be the fund sponsors who collect the management fees, and the HFT firms who front-run the order flow in the underlying CLOs.
Pre-COVID, the bull case for shipping rates was all about plunging newbuild orders. A drop in orders in 2019 pointed to rising freight rates in 2021, given the lag between contract signing and delivery. Mid-COVID, the bull case for rates is even more about plunging newbuild orders than before. There will be a lot fewer vessels on the water in 2021, 2022 and beyond than previously thought.
New data provided to FreightWaves by U.K.-based VesselsValue confirms that 2020 is shaping up to be an exceptionally weak year for tanker, bulker and container-ship orders.
New data from Alphaliner shows that container-ship newbuild capacity is down to just 9.4% of capacity on the water. “For the first time in more than 20 years, the global newbuilding pipeline fell below the 10% threshold,”reported Alphaliner on Wednesday, calling it a “historic low.”
Tanker and bulker orderbooks
According to VesselsValue, the tanker orderbook has fallen to 9% of the operating fleet in terms of capacity (measured in deadweight tons or DWT) as of July. This is down sharply from a high of 23% in January 2016.
The dry bulk orderbook is only 7% of the on-the-water fleet. This is down from 24% in January 2015 and an even higher peak — 27% — in January 2010.
The number of ship orders year-to-date is extremely low. VesselsValue data shows just 134 tanker orders through July, 28% below last year’s pace, despite historically high spot rates. Only 88 bulkers are on order, 31% below last year’s pace.
Clarksons Platou Securities has released data for specific tanker and bulker segments. For very large crude carriers (VLCCs, 200,000-plus DWT), the orderbook is only 7.4% of the on-the-water fleet. For Suezmaxes (120,000 – 199,999DWT), it’s 11.3%.
In the products sector, the ratio is just 6.5% for medium-range (MR) tankers (30,000 – 59,999DWT). It is 0.8% for long-range 1 (LR1) tankers (60,000 – 79,999DWT) and 9.6% for LR2s (80,000 – 119,999DWT).
In the dry bulk sector, Clarksons puts the orderbook-to-fleet ratio at 10% for Capesizes (120,000-plus DWT). It is 8% for Post-Panamaxes (85,000 – 119,999DWT) and 6.8% for Panamaxes/Kamsarmaxes (65,000 – 84,999DWT).
According to Alphaliner, the container-ship orderbook is down to just 2.21 million twenty-foot equivalent units (TEUs). This contrasts to a high of around 7 million TEUs in 2008. In that year, orderbook capacity was more than 60% of on-the-water capacity.
Of ships on order, virtually all are in the 10,000-plus TEU category or the 3,999-TEU-or-less category. There are effectively no orders in the midsized 4,000 – 9,999TEU category.
As Star Bulk (NASDAQ: SBLK) President Hamish Norton explained during a Marine Money virtual forum in June, “What may be legal today may not be legal in five years. In the old days, ships were grandfathered in until the end of their useful life. Given the political situation, people are afraid — I think with good reason — that a ship they order today will not be grandfathered in, and will become obsolete.”
The second reason for the orderbook shortfall is COVID-19. Travel restrictions in the first half of the year made newbuild contracting extremely impractical. Furthermore, current and future economic fallout make it much tougher to pull the trigger on orders and get financing. “If economic uncertainty can be measured by ship-ordering activity, then shipowners must be feeling completely lost at the moment,” wrote Stifel analyst Ben Nolan in a recent research note.
The pricing of secondhand ships is also undercutting the case for newbuilds. Newbuild prices are at too high a premium to secondhand prices for most orders to make sense.
Stamatis Tsantanis, CEO of Seanergy (NASDAQ: SHIP), explained during a Capital Link webinar last week that a secondhand 5-year-old Capesize costs around $30 million, whereas a newbuild costs $50 million. “The price differential is not justified by the incremental earnings [of the newbuild],” he pointed out.
Risks to rate upside
The IMO2050-coronavirus one-two punch sounds like a guaranteed recipe for future freight-rate strength. But there are no guarantees in ocean shipping. Following is a devil’s advocate list of things that could go wrong:
Cargo demand could slump —A multiyear virus-induced recession or depression could cut cargo demand as much or more than vessel capacity. This would erase owners’ future rate-negotiation advantage.
Another demand risk relates to GHG emissions. If the world’s governments are serious about forcing GHG cuts by shipowners, wouldn’t they also force cuts of fossil-fuel consumption? And if so, wouldn’t this reduce future demand for tankers, bulkers and gas carriers?
The coronavirus changes the equation. One theory is that the cleaner post-lockdown skies and waters will drive momentum for environmentalism and GHG regulation. In this scenario, shipping decarbonization is more likely.
Another theory is that the outbreak will spur an extended period of economic pain and geopolitical unrest. In this scenario, countries would focus on rescuing economies and keeping transport costs cheap, making shipping decarbonization less likely.
If owners believe GHG regulations face significant delays, or may not happen at all, they could lose their fear of ordering.
Orders may go forward regardless of IMO2050 and COVID headwinds—If rates jump in 2021 – 22 due to lower vessel supply, owners could decide to order regardless of the premature-obsolescence risk, on the belief that they’ll earn sufficient returns before obsolescence strikes. This would limit the duration of the upcycle.
Alternatively, if there is a deep economic slump due to the coronavirus and owners do not order ships, there could still be newbuilds — a lot of newbuilds.
Commercial shipbuilding is almost entirely based in China, South Korea and Japan. Asian governments could fill yard slots with orders by state-controlled shipowners tapping state-backed financing.
This would not only preserve Asian shipbuilding jobs, it would also depress freight rates — a plus for economies that benefit from cheap transport of raw-material imports and finished-goods exports. Economies like China’s.
Talk to a shipping veteran who has been around since the 1980s and the conversation will often turn to the infamous Sanko orders. In 1983, Japan’s Sanko Steamship Co. placed a $1.25 billion order at Japanese yards for 103 dry bulk newbuilds totaling 4 million DWT. The order helped Japanese yards but crippled rates for years.
The fear, if orders don’t pick up, is that an Asian shipbuilding nation will “pull a Sanko.” Most likely, China.
Judging by recent statements out of Russian media, the Kremlin has been closely monitoring just where the Pentagon intends to send the some 12,000 troops ordered to permanently depart Germany, after the Trump administration slammed Berlin for not shouldering its fair share of NATO defense spending.
While its believed the majority will be returning home, with a little less than half to return be redeployed around Europe, on Friday Poland indicated some will be deployed right near Russia’s doorstep. As the Defense Postreported:
Washington will deploy at least 1,000 soldiers in Poland and oversee forces on NATO’s eastern flank, Defense Minister Mariusz Blaszczak said Friday after the US announced a massive troop pullout from Germany.
Blaszczak told a Polish public radio broadcaster, “At least 1,000 new soldiers will be deployed in our country,”
“We will have an American command in Poland. This command will manage the troops deployed along NATO’s eastern flank,” he said.
“It will be the most important center for ground forces in our region,” he said. “We will soon sign the final pact with the Americans.” The Trump administration has long been in negotiations as part of an ongoing deal with Warsaw which cements closer defense ties, something which has riled Moscow.
Further angering the Kremlin is that Secretary of Defense Mark Esper last week said the Germany withdrawal will reinforce NATO’s south-eastern flank near the Black Sea, due to the redistribution of American forces. It’s expected that many could go to Baltic countries as well as Italy.
Meanwhile, last month it was reported that the Polish proposal to rename a base “Fort Trump” — which would host US troops in the East European country - has crumbled over disagreements over funding and precisely where the soldiers would be garrisoned.