Fed impact on CLOs to be minimal; programs eyed to boost spreads; downgrades rise

By Cristal Cody

Tupelo, Miss., April 13 – Market participants are keeping an eye on possible help for the CLO market amidst the coronavirus economic shutdown.

Ahead of the Good Friday holiday, the Federal Reserve announced additional and expanded stimulus measures. Its Term Asset Backed Securities Loan Facility will now include AAA-rated tranches of newly issued static CLOs.

Static CLOs made up about $6 billion, or roughly 1.5%, of U.S. broadly syndicated CLO issuance from 2016 through 2019, according to a Wells Fargo Securities LLC report on Monday.

The Fed programs are “unlikely to provide direct relief” to broadly syndicated CLOs, middle-market CLOs or the underlying loans, the Wells Fargo analysts said.

“Therefore, we expect these programs to boost CLO spreads indirectly, through better relative value comparisons, as the Fed directly supports other markets,” the analysts said.

The Fed is taking limited steps to unclog CLOs, BofA Securities, Inc. analysts said in a research note released Monday.

The TALF facility size is $100 billion and will be split among several sectors, including asset-backed securities, CMBS issues and CLOs.

The inclusion of outstanding CMBS and newly issued CLO AAAs “is a move in the right direction but, in order to be as effective as the 2008 TALF program, the 2020 program needs to be expended to include secondary position of CLOs,” the BofA note said. “In addition, the limitations on CLOs – static and newly originated loans – likely means the impact on CLOs will be limited.”

Fitch Ratings said in a report on Friday that exposure in U.S. broadly syndicated CLOs to loans on its lists of top loans of concern and tier 2 loans of concern has increased.

“The average exposure in U.S. BSL CLO portfolios to issuers named on our loans of concern lists in Fitch’s most recent U.S. Leveraged Loan Default Insight report is 10%, up from a 6% average at the end of fourth-quarter,” Fitch said.

Fitch said it will apply an updated stress scenario to all CLO portfolios globally and will apply a one-notch rating adjustment to corporate issuer ratings and recovery rates for companies in industries considered most vulnerable to the coronavirus disruption and to all companies with a negative outlook.

“Any CLO note rating that has an erosion of cushion compared with rating levels under the stress scenario will be placed on Rating Watch negative,” Fitch said.

In its updated sensitivity tests, Fitch expands the list of affected industries to include issuers with loans in CLOs from the automobile industry.

U.S. CLO portfolios have seen significant downgrade activity.

“Nearly 16% of par notional in U.S. BSL CLOs is attributable to an issuer with a surveillance rating downgrade between the end of February and April 8,” Fitch said.

Moody’s Investors Service said in a report on Friday that the stimulus measures will lessen the economic pain but the credit climate will remain difficult.

“For financial institutions and structured finance transactions, support to the economy will help to reduce asset quality deterioration,” Moody’s said. “Collateralized loan obligations backed by broadly syndicated loans may only benefit modestly from measures that support distressed sectors. That is because the stimulus package prioritizes aid to companies that face temporary revenue and liquidity stress but have solid longer-term business prospects. This focus will benefit investment-grade companies more than the speculative-grade companies whose loans back CLO transactions.”

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