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New wave of negative actions hit junior CLO notes in May

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By Paola Aurisicchio
06 May 2020

May opened up with another round of negative ratings actions for CLOs, with junior tranches coming under pressure as the number of leveraged loan downgrades climbs.

S&P Global Ratings put an additional 48 tranches from 27 US CLOs under negative watch on May 1, for a total of 406 negative actions on CLOs since March 20. Of the nearly 4,200 US CLO tranches rated by S&P, the rating agency has taken negative action on 9% of all tranches since March, while Moody’s has put 859 CLO tranches on review for downgrades.  

The outlook for double-B and single-B rated bonds in particular has dimmed. S&P reported that 210 out of 604 double-B tranches (34.8%) have been moved to watch negative, and 172 out of 184 single-B, almost 94% of the total rated by the agency, could be downgraded.

Despite the small percentage of triple-Bs under review, it is the part of the capital stack that most concerns investors, who expect a domino effect that could lead to important changes in CLO buyer base in the event of widespread downgrades.

“Most of the triple-Bs, we think they are going to be downgraded to double-B, because the current rating...is just one notch from being double-B. This is going to change the investor base dramatically, from the insurance companies to alternative investors,” said Ujjaval Desai, head of structured products at Sound Point Capital, speaking in a virtual panel held by IMN at the end of April.

Insurance companies' exposure to CLOs has been on the rise in the recent years, with insurers holding approximately $122bn at the end of 2019, according to the Loan Syndications and Trading Association (LSTA).

Insurers have primarily invested in senior or higher mezzanine bonds, as well as some CLO combo notes referencing various senior and junior CLO notes and equity. If the pace of CLO downgrades accelerates, market players say that it might impact the holdings of certain investors with rating restrictions with regards to what they can invest in, in particular insurance companies and mutual funds.

“Downgrades cause a lot of issues for investors,” said a CLO investor. “If we see more downgrades from triple-B to double-B, suddenly you need a very different capital requirement.”  

By Paola Aurisicchio
06 May 2020