Thomas Cook: A Warning to CLO Managers

The globally operating travel group Thomas Cook entered liquidation this week, after it was unable to reach an agreement between its shareholders, financiers and numerous creditors, leaving hundreds of thousands of travellers stranded. A potential restructuring would likely have resulted in a significant loss for bondholders, but now it looks like the senior unsecured bonds are virtually worthless – Debtwire expects a recovery of 0-10% and the bonds are now trading at around 6 cents.

Thomas Cook makes an interesting case study. High yield defaults have been on the rise, and though some people argue that most of these are individual cases, there does seem to be a clear trend. Some CLO managers have been keen to add senior secured bonds to CLO portfolios; it adds diversification and, as bonds tend to be a lot more volatile than loans, it allows the manager to try to add some value by switching between them, though clearly this doesn’t come without risk.

Unsecured bonds are a different story; only a handful of managers have traded these in CLOs. Most CLOs will have a limit of 10% to mezzanine loans and senior unsecured bonds, but in general European CLOs are mainly invested in senior loans and the senior secured allocation is 98% on average. We’re generally not a fan of managers investing in junior debt as there is virtually no upside from a CLO debt point of view, and in our view it’s a trade that’s only done to boost equity yields.

Thomas Cook was not a widely held name in the CLO market; its bonds were unsecured and fixed rate so not a great fit. From what we can see, only four CLO managers have traded Thomas Cook in the last two years. Two managers held it for a brief period and sold the bonds at a premium, and only two managers still owned small sizes in the bonds when prices dropped below 90, after buying in the low-to-mid 90s, clearly convinced on the credit. Managers Accunia and Barings have sold their final holdings at prices between 28 and 33.50 in recent months. As the bonds are now trading at 6, those look like good sales, but the losses on these positions were still over 70%.

In 2018 some managers (and by extension CLO equity investors) took large losses on Galapagos and CMC Ravenna. Investing is not without risk, no one can be right on every investment and we wouldn’t expect CLO managers to avoid all defaults. However, this does further cement our view that unsecured debt has no place in CLOs, and that debt investors might want to be cautious with managers that are overly focused on high equity returns, as this can come at the expense of collateral quality.