CLOs face ratings downgrades; A-rated and higher tranches ‘spared’; AAA notes tighten

By Cristal Cody

Tupelo, Miss., April 20 – The CLO market is poised for a heavy impact from the coronavirus-related economic fallout with a chunk of the market facing potential ratings downgrades.

On Monday, Moody’s Investors Service announced it placed on review for downgrade ratings on 117 securities issued by 39 European broadly syndicated CLOs, following its announcement on Friday that it has placed on review for downgrade ratings to 859 securities issued by 358 U.S. broadly syndicated CLOs, plus 25 linked CLO combination securities, secured notes and repackaged securities.

The euro notes represent 14% of Moody’s European-rated CLOs, while the dollar portion represents 19% of Moody’s U.S.-rated CLO securities.

“No Aaa (sf)- or Aa (sf)-rated tranches have been placed on review as of this time due to the adequacy of their structural protections relative to the increase in collateral risk we have thus far observed,” Moody’s said in a report on Monday. “Given the relatively large sizes of typical Aaa (sf)-rated tranches, this means that approximately 95% of CLO debt by balance we rate has not been placed on review for downgrade.”

The rating actions on the CLO securities are mostly due to credit quality deterioration from the coronavirus outbreak, Moody’s said.

So far, tranches rated single A and above “have largely been spared,” Wells Fargo Securities LLC analysts said in a note on Monday. “While we continue to think BBB prices may not reflect downgrade risk, we believe that fears of forced selling – particularly by insurance companies – due to downgrades are overblown.”

Nearly 30% of BBB rated bonds, or $11 billion in current face, are estimated on review for downgrade by the three rating agencies, according to a BofA Securities, Inc. report on Monday.

“As most BBB's are rated Baa3, a downgrade action would cause them to be Non-IG, and might result in some forced selling by ratings sensitive investors including insurance companies and mutual funds,” the BofA analysts said.

CLO BBB spreads are now around Libor plus 700 basis points with wide dispersion due to manager tiering and portfolio quality, the BofA analysts said.

“Although current spread levels incorporate the increased tail risk and are pricing, we expect them to gap wider due to forced sales and a reduced investor base,” the analysts said.

Meanwhile, new deals are pricing in April, while in the secondary market, CLO AAA-BB spreads tightened over the past week by about 25 bps to 40 bps, according to the BofA analysts.

CLO AAA notes came in 40 bps to head out on Friday at Libor plus 210 bps.

“However, liquidity remains challenged for lower-tier managers and/or higher-beta portfolios and most of the spread tightening occurred for top-tier managed and cleaner quality portfolios,” the analysts said.

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