A slowing economy is likely to weigh on US corporates, leading to rating downgrades that could induce CLO managers to sell loans on the basis of failed overcollateralization or weighted average ratings tests. A small but growing handful of new issue deals are already taking active bets on such downgrades and incorporating a bigger bucket for downgraded debt or accommodating a hybrid pool of bonds and loans.
“The big concern among investors these days is the risk B3 loans getting downgraded to C and potentially triggering a sale from the CLO portfolio,” said one CLO issuer. “Equity investors are especially worried about a downgrade risk diverting cash straight to debt holders.”
Rating agencies also expect