The toy retailer is the 132nd most prominent exposure in the US CLO market and the ninth largest specialty retailer, according to S&P.
The ratings agency downgraded the company’s credit rating last week, which had little direct on effect on CLOs. Nonetheless, the continuing cloud over specialist retail should be prompting CLO managers to change their exposures.
CLOs, unlike most other ABS asset classes are active management vehicles, rather than static pools, and investors are making as much a bet on a manager when they buy into a deal as they are in a pool of loans.
Given this differentiation, sources have told GlobalCapital that a number of firms in the US and Europe are beginning to advertise a lack of any retail exposure as part of their broader appeal.
The market was caught cold in the first quarter of 2016, when oil and gas volatility killed deal liquidity for some sellers and led to one of the quietest new issuance quarters in years.
While specialist retail volatility is not likely to present the same systemic sector risk as energy, there are a number of names widely held in CLOs which should cause concern.
Firms such as Sears and J.Crew face similar overarching pressures to Toys‘R’Us, such as competition from Amazon and high overhead costs, and both have been on the tip of the tongues of investors, as they talk about the stresses facing retail.
Other firms such as PetCo have fared better.
But active trading out of problem retail names and into other credits would increase investor confidence in manager’s ability to read market trends and react proactively to macro ebbs and flows.
It would also suggest that CLO issuers are ready to accept what investors have said for some time — the consumer-driven seasonal swings which determine success in specialist retail make the sector too volatilile to be an long-term attractive proposition in the senior secured loan market.
Given increased leveraged loan supply over the past few months, now looks like the perfect time for CLO managers to pick up some new assets, and leave specialist retail behind.