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Third Ave: Morgan Stanley found 348 US CLO 2.0 deals’ equity tranches currently having NAV below zero

Third Ave: Morgan Stanley found 348 US CLO 2.0 deals’ equity tranches currently having NAV below zero H/T streetEye

As of January 2016, Morgan Stanley found 348 US CLO 2.0 deals’ equity tranches currently having NAV below zero. CLO 2.0 are deals that took place after the 2008 credit crisis and that typically feature higher levels of subordination, tighter collateral eligibility requirements, and shorter non-call and reinvestment periods than the pre-2008, or CLO 1.0, deals.

As we move into 2016-17, it will be very important to watch CLO new issuance, as this has supported the high yield and bank loan market, allowing private equity to finance M&A activity. The trends in the credit markets—higher yields, higher default rate expectations, contagion from oil into other sectors with healthier fundamentals, and a disconnect between lower and higher quality bonds—have been exacerbated over the last few months. Credit markets seem to be pricing in a recession in the US. While we are not in the business of forecasting the macroeconomy, it is also important to note that several other relevant variables point in a different direction, for example, cheap oil will likely boost the US economy. It may well be the case that the turmoil in credit markets is merely reflecting heightened uncertainty over Central Banks and interest rates, a longer than expected commodity slump, and concerns over China’s modest 6-7% GDP growth projections instead of a recession in the US economy. Should this be the case, credit markets are offering a wealth of opportunities. As usual, we thank you for your interest and look forward to writing to you next quarter. Until then, we look forward to sharing our views on current events and the Fund.

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Dear Fellow Shareholders:

We would like to reiterate our commitment to maximizing the value of the remaining positions in the Third Avenue Focused Credit Fund (the “Fund”) and returning capital to you in as timely a manner as practical in relation to realizing the value of the portfolio. We believe that there is significant value embedded in the portfolio, and that time and management effort will allow this value to be surfaced. We have conviction in the companies in which we are invested. Volatility over the last year has not impaired our thesis on most of these investments. Eight of the top ten holdings in the Fund have reorganized and/or exited bankruptcy within the past six to 24 months. The Fund now owns post reorganization equity and debt in companies that have reduced their debt burden and are on better footing to grow their businesses. Most of these companies were previously owned by private equity firms and are now owned by funds that, like ourselves, have experience in working out distressed positions. This change in ownership usually comes with a renewed focus from management and new board members, as well as an emphasis on maximizing value for the new shareholders. We believe that the value in the portfolio can better be realized as market conditions normalize and/or certain corporate events occur. We believe the best course of action from a total return perspective is to take the time needed to obtain prices we believe represent this value. We intend to complete this process in a timely manner. We, the Third Avenue Credit team, are committed to seeing this through, and we have the support of Third Avenue to do so. As we move forward, we will provide as much transparency as we can, without impairing our ability to optimize realizations in the portfolio. We will publish factsheets monthly and Portfolio Management commentary every quarter to keep you abreast of developments in the Fund. This information will be available on our website (http://thirdave.com/fund/thirdavenue-focused-credit-fund/). This letter starts with an update on the Fund and then discusses the developments in the high yield and distressed debt markets.

Full PDF below

Q1-2016-Credit