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Tetragon Financial Group
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=== Increasing interest rates support CLOs’ cash generation in the near term === In the near term, the rising interest rates should have a positive impact on collateralised loan obligation (CLO) cash flow generation, especially by increasing the residual cash flow to CLO equity tranches. Since the beginning of 2022, three-month Libor increased from 0.21% to the current 2.20% (27 June) and given the record-high inflation (the US CPI hit a 40-year high of 8.5% in March 2022) the consensus expectation is for the Federal Reserve to continue raising rates throughout 2022. In the long run, however, the increasing cost of debt may translate into higher default rates and collateral quality deterioration. In this scenario, cash flow would be redirected from equity (and potentially also junior debt) tranches due to internal test breaches. So far, the default rate in the United States has increased only slightly (0.6% on a last 12 months (LTM) basis) and is expected to reach 1.5% in 2022 and be in the 1.25–1.75% range in 2023 according to Fitch. This compares to c 4% recorded at the pandemic peak (September 2020) and over 10% in late 2009 as a result of the global financial crisis (Fitch). Tetragon is currently invested only in US-based CLOs, predominantly in equity tranches. Tetragon is exposed to the CLO market in several ways. It owns a 100% stake in CLO manager LCM and CLO-investing asset manager Tetragon Credit Partners (TCIP). Tetragon also invests in TCIP-managed funds, as well as directly into CLOs managed predominantly by LCM but also third-party managers. The combined exposure amounts to 19% of Tetragon’s NAV.
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