CLO spreads pressured from coronavirus, heavy secondary supply; Fed program to purchase AAAs

By Cristal Cody

Tupelo, Miss., March 23 – The CLO market remains in the cross-hairs from fallout due to the coronavirus but may receive some help from the Federal Reserve, according to market sources on Monday.

“Bonds most vulnerable to coronavirus are in CLO, CMBS, floorplan ABS and rental car ABS sectors,” Moody’s Investors Service Corp. said in a report released Monday.

“The negative effects of a slowdown in economic activity stemming from the global spread of coronavirus will vary across structured finance transactions asset classes in the U.S. and the rest of the Americas,” Moody’s said. “The ability of securitizations to withstand the fallout of the pandemic will depend on its duration.”

Numerous U.S. states and cities are on lockdowns with residents ordered to stay at home and only essential services to remain open to try to stem the virus’ spread.

U.S. CRE deals with large retail and hotel exposures are “highly vulnerable,” according to Moody’s. “Some junior CLO notes are especially vulnerable to holdings in highly exposed industries,” Moody’s said. “Although U.S. CLOs are well diversified across many industries, a meaningful share of collateral in certain deals consists of loans to highly exposed companies, putting the credit quality of more junior CLO tranches at risk.”

Companies presenting higher risks include hotel, gaming and leisure, automotive, consumer-durables and oil and gas sectors, according to the report.

CLO yields have soared over the past week, while spreads have moved out, BofA Securities, Inc. analysts said in a research note released on Monday.

CLO AAA paper is now at an average 6.2% yield compared to 2.7% a week ago, according to the report.

AAA spreads have widened to 500 basis points from Libor plus 200 bps on average a week ago.

CLO BB spreads have softened about 100 bps on the week to Libor plus 1,200 bps average area.

Heavy secondary supply has pressured levels across fixed income markets, and the rush for liquidity has particularly affected higher quality assets, including CLO AAA’s, Wells Fargo Securities LLC analysts said in research notes on Monday.

“We track roughly $5 billion in U.S. secondary supply via Bids Wanted in Competition over the past two weeks,” the analysts said. “We estimate over 80% of BWIC supply has been AAA/AA tranches, with a heavy concentration in AAA bonds. In contrast, we estimate less than 5% of BWIC supply has been non-investment grade.”

The secondary market has seen $1 billion-plus back-to-back trading sessions in high-grade CBO/CDO/CLO securities over the past two weeks, Trace data shows.

CLO investors have switched to focusing on dollar prices rather than spreads, with AAA bonds now traded in the mid 80’s to low 90’s, or a discount margin of 425 bps to 475 bps, the Wells Fargo analysts said.

The Federal Reserve announced several new programs and measures on Monday to shore up the U.S. economy, including the Primary Market Corporate Credit Facility for new bond and loan issuance.

The only Fed program that will impact the CLO market is the Primary Dealer Credit Facility, which lends to primary dealers to purchase AAA-rated CLO tranches, among other assets, a Wells Fargo report said Monday.

Eligible collateral to pledge under the PDCF includes AAA-rated CLOs, CDOs, and CMBS, as well as other securities such as high-grade corporate bonds and commercial paper.

“While excessive secondary supply is still a concern for AAA CLOs, we think the PDCF may lead to a slowdown in CLO AAA spread widening, although dealers may still face additional frictions around CLO purchases,” Wells Fargo analysts said.

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