I'm not to sure how debt funds work, but I do know there has been a massive increase in debt funds over the past half decade or so.
Are these funds at any risk of major losses in their existing portfolios with rising interest rates and use of leverage?
Would be curious to know the nitty gritty!
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It's going to depend on the collateral, which have varying degrees of credit risk. Debt funds make a profit on the spread between the coupon and their financing costs.
I'm not an expert in the slightest, but will try my best. Every debt fund is structured a little bit differently, so hard to say how many debt funds are exposed to rising interest costs. As @Terran said, debt funds are really playing a spread game. You've got balance sheet debt funds and CLO debt funds. The latter I'm guessing has completely dried up, so they are at risk from the standpoint of "can they do any deals". The former is a little different, but debt funds cost of capital is approaching 8-10% so they just aren't that attractive in the market.
Does the value of the existing portfolio of loans for debt funds go down? They are "locked in" to a return (even with leverage), but the existing rates in the market are much higher.
Any concerns these debts funds get "marked to market" and they have a margin call on the leverage they are using?
Yes, but they should be hedged. That'll offset the mark downs.
Depends on the structure... and the short answer is leverage is what kills.
CLO Debt Funds - they hold very little on their books, aim to sell off their loans every couple months so there's nothing to collapse back on them. Their only risk is through poor portfolio management, originating a bunch of loans held in their warehouse, the CLO market collapsing, and then the warehouse lenders margin calling them. So it could happen, but it would be due to poor management (overleveraging the warehouse line, not hedging balance sheet before selling off in CLO, and not having solid plan to sell loans), not systematic risks. A well managed CLO debt fund shouldn't face many problems.
A/B Debt Funds - They originate a whole loan, sell the A note & keep the B note. They may line up the A note concurrently with close or post-close. These guys might take a hit, they probably have warehouse lines & maybe put whole loans on lines if they don't have an A note at close... but overall, there isn't much to come back and bite them.
"True" Debt Funds - they raise a fund from institutional investors & originate loans. Maybe they sell off an A note here or there or use a line here or there, but overall they originate loans to hold on the balance sheet and distribute interest to investors. They're probably the safest unless they get a huge redemption queue and have to sell off their loans at a loss, but usually their LP docs protect them from this.
Line Debt Funds - Not really a main strategy of a debt fund, mostly a tool they use, but some debt funds aggressively warehouse their loans with floating rate lines. These warehouse lenders can assess the value of the loans over time and create a mark-to-market that may result in a margin call. They would need to either post collateral or remove loans from the line, either take equity. So they could get hurt big time
REIT Debt Funds - they are just like equity REITs, mostly financed through bonds and stock. They have a stock price that can move up and down and likely there are triggers within their bond issuances that make a dropping stock price very dangerous. Additionally they have to pay interest on their bonds so if they take back any properties that means they won't be collecting that interest and can face a lot of trouble in paying back their bonds.
Kind of tapped out on explaining at the end there but you get the idea. gotta go back to work
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