Pools of risky loans with larger exposures to energy are on “negative” watch, as shocks from the coronavirus pandemic continue to ripple through financial markets, according to S&P Global.
Fifteen U.S. collateralized loan obligations are on watch due to their bigger energy exposures, including CLOs managed by Oaktree Capital Management, Marathon Asset Management, and Bardin Hill Investment Partners, according to a March 20 report from S&P. CLOs are the biggest buyers of high-yield corporate loans, packaging the debt into slices of varying risk and return.
The credit ratings firm said it will also review CLOs with larger exposures to other industries hurt by the pandemic, while monitoring the impact of potential downgrades of the loans they hold. When assessing credit ratings, S&P said it is assuming the coronavirus pandemic will peak in June or August, as estimated by some government authorities.
“Measures to contain Covid-19 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers,” S&P warned in the report. Debt ratings in the hotel and leisure sectors will be among those scrutinized due to pandemic-related concerns, S&P analyst K.P. Rajan said Monday in a phone interview.
The Federal Reserve has taken a series of emergency steps to quell panic in markets since Covid-19, the illness caused by the novel coronavirus, has prompted a broad sell-off in stocks and corporate debt. As part of its latest action, the Fed announced Monday that it will begin buying investment-grade corporate bonds.
Loans held by CLO managers are riskier. They typically invest in corporate debt that’s rated below investment grade, with a limit to the amount of low-rated CCC loans they may hold. Exceeding the threshold could lead to losses for investors in CLOs, with those in the riskiest slices of the loan pools being first to take the hit.
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In placing CLOs on watch because of their larger energy exposure, S&P explained that the “performance factors examined include some combination of higher-than-average exposure to loans from ‘CCC’ rated obligors, reduction in overcollateralization ratios, decline in portfolio credit quality, and compression of portfolio weighted average spread.”
The credit ratings provider said “these factors typically have a greater impact on the subordinated and lower mezzanine CLO notes, leaving them more vulnerable to distressed market conditions.”
While the safest portions of CLOs, particularly the notes rated AAA and AA, should not see any losses, the below-investment-grade portions might as the market turmoil continues, Jimmy Kobylinski, an analyst with S&P, said Monday by phone. “We don’t know how this will play out in three to six months,” he said, adding that CLO investors generally could see losses in the slices rated BB or B.
Marathon CLO VII is among the collateralized loan obligations on S&P’s watch list. Andrew Rabinowitz, Marathon’s president and chief operating officer, said Monday by phone that the CLO is past its reinvestment period, meaning its portfolio is now static as it is winding down.
Oaktree CLO 2014-1, Oaktree CLO 2015-1, and Oaktree CLO 2019-1 are also on S&P’s negative watch list. A spokesperson for Oaktree, the alternative investment firm co-founded by Howard Marks, didn’t immediately provide comment.
Halcyon Loan Advisors Funding 2012-1 and Halcyon Loan Advisors Funding 2013-1, which are managed by Bardin Hill, are also on “watch negative.” A spokesperson for Bardin Hill, formerly known as Halycon Capital Management, declined to comment.
The energy sector has been pummeled in the coronavirus pandemic, with plunging oil prices raising concern over borrowers’ ability to meet their debt obligations. Crude is now trading below $30 a barrel, compared with more than $60 at the beginning of this year.
