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COMMENTS

CLO Spotlight: Coronavirus Will Put U.S. CLO Diversity And Managers To The Test


CLO Spotlight: Coronavirus Will Put U.S. CLO Diversity And Managers To The Test

(Editor's Note: This is the first article in which we list companies with loans held in U.S. CLO collateral pools that have experienced coronavirus-related rating actions. We will update and republish the list of affected CLO obligors on a periodic basis as warranted.)

With market sentiment (heralding real and perceived economic impact) fluctuating as the Covid-19 issue evolves, the investor community has raised many questions on what the impact on credit quality and on S&P Global Ratings' credit ratings might be. To address some of these questions, we are highlighting and discussing the U.S. sectors that are more vulnerable to the still-developing economic fallout (with many sectors already experiencing significant price declines), entities that have already experienced rating actions, and our preliminary view of the potential consequences for U.S. BSL CLOs.

Our U.S. Macro View

While the coronavirus' rate of spread and the timing of its peak continues to be highly uncertain, modeling by academics with expertise in epidemiology indicates a likely range for the peak to be June 2020. For the purpose of assessing the economic and credit implications, we assume the global outbreak will subside during the second quarter of 2020, consistent with our recent report, "Global Credit Conditions: COVID-19's Darkening Shadow," published March 3, 2020. As the situation evolves, we will update our assumptions and estimates accordingly.

On March 3, 2020, our economists noted that the global macro impact from the coronavirus--then present in more than 70 countries, now more than 100--had doubled since the previous update on Feb. 11. S&P Global Ratings is now predicting that the U.S. economy will be severely weakened by the coronavirus in the first half of the year (see "Economic Research: Coronavirus Update: A Bigger Hit To First-Half U.S. Growth," published March 3, 2020). We now believe that the coronavirus will be a material headwind to growth in the near term, with a potential corresponding effect on the ratings on speculative-grade corporate loan issuers. For our most recent published research on the impact of the coronavirus, visit our hot topics page at https://www.spglobal.com/en/research-insights/topics/coronavirus.

CLO Diversification May Provide Protection

CLO exposure to sectors and issuers is broad…

U.S. BSL CLOs benefit from issuer and sector diversification. Most BSL CLO managers maintain highly diversified portfolios of leveraged loans, with exposure to many different corporate issuers across multiple sectors. Based on our review of the fourth-quarter 2019 data (see "CLO Spotlight: Fourth-Quarter 2019 CDO Monitor Benchmarks Reveal Relative Credit Quality And Diversity Of CLO Portfolios," published Jan. 24, 2020), the average reinvesting U.S. BSL CLO portfolio rated by S&P Global Ratings had an average obligor diversity metric (or effective obligor count) of 202; and an average industry diversity metric (or effective industry count) of 25.

Collectively, U.S. BSL CLOs have exposure to about 1,500 issuers across more than 60 Global Industry Classification Standard (GICS) industries.

But it's not business as usual with the coronavirus affecting several industries

There have been several industries clearly affected by the coronavirus so far. As of March 11, 2020, we note that three of the entities with the top 250 most widely held loans in U.S. BSL CLOs have experienced a negative rating action in part because of coronavirus concerns. Nine other entities that are not as widely held in CLOs have also experienced negative rating actions with coronavirus cited as a reason. Specifically, the concerns for these issuers were over declining volume of leisure and business travel, corporate events cancellations, and supply chain and production disruption. (We note that the impact from the coronavirus was not the sole determinant of all the negative ratings actions listed in table 1).

Table 1

U.S. BSL CLO Obligors with Coronavirus-Related Rating Actions(i)
Rating
Action date Issuer Rank No. of S&P-rated U.S. BSL CLOs with exposure GIC Current Previous Coronavirus-related concerns noted
2/3/2020

Wynn Resorts Ltd.

1,251-1,500 1 Hotels, restaurants, and leisure BB/Watch Neg BB Decline in Macau visitation
2/12/2020

GBT III B.V.

1,001-1,250 37 Hotels, restaurants, and leisure B+/Stable BB/Stable Impact on business travel
2/14/2020

Boardriders Inc.

1,001-1,250 34 Textiles, apparel, and luxury goods B-/Negative B-/Stable Supply chain disruption
2/26/2020

Sabre Corp.

Top 250 164 Software BB/Watch Neg BB/Stable Impact on travel bookings
2/26/2020

Tenneco Inc.

Top 250 190 Auto components B+/Stable BB/Negative Production concern
2/27/2020

Cooper-Standard Holdings, Inc.

1,001-1,250 42 Auto components B/Negative B+/Negative Production concern
3/3/2020

Samsonite International S.A.

1,001-1,250 53 Textiles, Apparel and Luxury Goods BB+/Watch Neg BB+/Negative Impact on business travel
3/9/2020

Ryman Hospitality Properties Inc.

1,001-1,250 58 Equity real estate investment trusts (REITs) B+/Watch Neg B+/Negative Room cancellations
3/10/2020

EG Group Ltd.

Top 250 268 Specialty retail B/Negative B/Stable Impact on sales expansion and margin stability
3/10/2020

National Amusements Inc.

751-1,000 58 Entertainment B+/Watch Neg B+/Stable Impact on theatre attendance
3/10/2020

Aimbridge Acquisition Co Inc

251-500 141 Hotels, restaurants, and leisure B/Watch Neg B/Negative Business and leisure travel cancellations
3/10/2020

Sabre Corp.

Top 250 164 Software BB-/Negative BB/Watch Neg Expected decline in travel volume
3/11/2020

GPS Hospitality Holding Co. LLC

751-1,000 45 Hotels, restaurants, and leisure CCC+/Negative B-/Stable Limited improvement in operating performance
(i)As of March 11, 2020. BSL CLO--Broadly syndicated loan collateralized loan obligation. GIC--Global industry classification.

As of March 11, 2020, U.S. BSL CLOs rated by S&P Global Ratings have, on average, a 0.79% exposure to the names listed in table 1, with the highest exposure of any single U.S. CLO at 3.4%. As new developments unfold, we expect there will be further rating actions across the 1,500-plus issuers operating across the 60-plus GIC industries with loans held in U.S. BSL CLOs. Our rating and view on a company's credit standing will depend on specific factors such as the rating cushion it has relative to its downgrade leverage threshold and the amount of liquidity it has to meet upcoming obligations (interest and refinancing maturities).

In table 2, we list the GIC exposures across U.S. BSL CLOs as of the start of the year.

Table 2

GIC Exposure Across Reinvesting U.S. BSL CLOs(i)
GIC industry % exposure GIC industry % exposure
Software 8.74 Metals and mining 0.84
Healthcare providers and services 6.47 Electrical equipment 0.81
Hotels, restaurants, and leisure 5.93 Food and staples retailing 0.79
Media 5.45 Independent power and renewable electricity producers 0.78
IT services 4.31 Communications equipment 0.77
Diversified telecommunication services 4.19 Technology hardware, storage, and peripherals 0.76
Capital markets 3.86 Wireless telecommunication services 0.75
Commercial services and supplies 3.77 Household durables 0.74
Chemicals 3.58 Electric utilities 0.64
Insurance 3.22 Interactive media and services 0.63
Trading companies and distributors 2.91 Semiconductors and semiconductor equipment 0.61
Specialty retail 2.82 Energy equipment and services 0.54
Machinery 2.63 Air freight and logistics 0.41
Entertainment 2.57 Construction materials 0.41
Containers and packaging 2.18 Distributors 0.39
Oil, gas, and consumable Fuels 2.08 Leisure products 0.38
Pharmaceuticals 1.98 Biotechnology 0.32
Aerospace and defense 1.68 Internet and direct marketing retail 0.29
Diversified consumer services 1.67 Textiles, apparel, and luxury goods 0.29
Food products 1.67 Gas utilities 0.25
Health care technology 1.55 Equity real estate investment trusts (REITs) 0.22
Electronic equipment, instruments, and components 1.54 Thrifts and mortgage finance 0.22
Professional services 1.40 Mortgage REITs 0.20
Building products 1.39 Household products 0.19
Auto components 1.33 Automobiles 0.14
Project finance: power 1.14 Transportation infrastructure 0.14
Life sciences tools and services 1.13 Project finance: oil and gas 0.12
Real estate management and development 1.02 Multiline retail 0.11
Healthcare equipment and supplies 1.01 Water utilities 0.11
Road and rail 0.95 Beverages 0.10
Airlines 0.95 Marine 0.06
Construction and engineering 0.89 Paper and forest products 0.06
Personal products 0.88 Consumer finance 0.04
(i)As of March 2020. BSL CLO--Broadly syndicated loan collateralized loan obligation. GIC--Global industry classification.

Unsurprisingly, industries reliant on business travel/consumer discretionary spending (e.g., airlines, specialty retail, hotels, restaurants, and leisure, and entertainment) and cross-border supply chains (e.g., electronic equipment, instruments and components, auto components, and chemicals) are particularly exposed from a credit perspective, with increased pressure on revenues and earnings (see "Global Credit Conditions: COVID-19's Darkening Shadow," March 3, 2020). For example, we have placed our investment grade ratings on both Royal Caribbean Cruises Ltd. and Carnival Corp. on CreditWatch with negative implications because of potential lower cruise demand (neither are currently held in U.S. BSL CLOs).

Over the next several weeks, S&P Global Ratings will conduct reviews on global airline companies to reflect our updated views on the industry and this highly uncertain and fast-moving situation (see "Coronavirus' Global Spread Poses More Serious Challenges For Airlines," March 12, 2020). Amongst U.S. BSL CLOs, exposure to airline issuers is less than 1% across six airline issuers. American Airlines is the largest airline exposure by far, and is the fifth-largest issuer held in U.S. BSL CLOs.

We also view the already beleaguered high-yield energy space as vulnerable in light of the sharp drop in oil and gas prices recently. On March 9, we revised our oil and gas price assumptions down, with our West Texas Intermediate oil price assumption lowered 36% to $35 per barrel. All investment-grade and high-yield exploration and production and oilfield services companies will be reviewed in the next several weeks. For the high-yield segment, in particular, issuers without hedges that face upcoming maturities and are somewhat squeezed on borrowing-base revolving credit facilities will most likely face multiple-notch downgrades (see "Unrestrained Supply Swamps Oil Outlook: S&P Global Ratings Revises Oil & Gas Assumptions," March 9, 2020). The good news here is that U.S. BSL CLOs nowadays have reduced their exposure to oil and gas companies to about 2% from about 4% during the last energy downturn in 2014-2016.

Already susceptible to missteps, 'B-' issuers could face more negative rating actions

The well-established rise of 'B-' loans (about 20% of U.S. BSL CLO assets) has created a large pool of leveraged credits that were already susceptible to missteps (operational or economic). As of late January, about 22% of all 'B-' U.S. issuers had negative outlooks or CreditWatch statuses. Meanwhile, the S&P/LSTA Leveraged Loan Index bid price dropped to about 88 (as of March 12) from almost 97 in early January.

As we have previously written, the 'B-' universe is not evenly distributed across sectors (see "As The 'B-' Universe Expands, Timing Is Everything," published Dec. 6, 2019), and neither are the negative outlooks. Still, as of now, low-rated issuers with maturities this year certainly face grim prospects for refinancing. Negative rating actions are likely to occur as the change in the fundamentals for the economic landscape and capital markets are digested. That said, default potential is also not evenly distributed across sectors. In 2019, four sectors (consumer products; metals, mining, and steel; oil and gas; and retail and restaurant sectors) accounted for 60% of defaults, and, more recently, four sectors (energy, retail, business and consumer services, and branded non-durables) accounted for just over 51% of the 'CCC' category.

While loans maturing in 2020 present refinance risks, CLO exposure is minimal

The flurry of corporate loan refinancing activity in recent years has pushed back the loan maturity wall substantially. Consequently, the exposure to loans held in U.S. CLOs maturing this year is immaterial. At the start of March, about 0.4% of collective U.S. CLOs exposure across 41 issuers have loans maturing the rest of 2020 (2.2% are set to mature in 2021, while 5.0% in 2022). Also, about half of the entities with loans maturing this year are rated 'CCC+' and below, while about one-fourth are rated 'B-' and the remaining rated 'B' and above. If current credit conditions continue, it will pose a severe challenge for the weaker issuers to refinance this year. Just a small handful of CLO managers have around 2% of loans in their CLO portfolios set to mature in the year 2020.

Reinvesting U.S. BSL CLOs Have Some Room To Absorb Additional Rating Downgrades On Entities In Their Portfolios

Loan prices, in concert with equity prices, have exhibited widespread volatility since the latter half of February due to the coronavirus, which may have O/C test implications (due to market value haircuts). Amortizing CLOs, which typically have higher concentration in 'CCC' category issuers, may see junior O/C test volatility due to the decline in line prices (in addition, clean-up calls may become difficult given low market values). The lower prices and corporate rating volatility may also expose the junior CLO notes of amortizing CLOs to a potential risk of downgrade as well.

Reinvesting U.S. BSL CLOs have some room to absorb additional rating downgrades on the companies that issue the loans in their collateral pools. As of early March 2020, the average reinvesting transaction has 4.8% exposure to corporate issuers rated 'CCC+' and below and 3.8% of cushion in their junior O/C tests. Because reinvesting U.S. BSL CLOs are entering this period with higher exposure to 'B-' issuers (at about 20%, up from about 15% at the start of 2019), this cushion can evaporate fairly quickly given a few downgrades of issuers into the 'CCC' category and low loan prices. If the pace of negative corporate rating actions increases, we see downgrade risk for some CLO subordinate tranche ratings and, potentially, some 'BBB' tranche ratings.

The coronavirus situation remains fluid. We will update this commentary in light of new corporate rating actions, to provide insights into affected CLOs.

This report does not constitute a rating action.

Primary Credit Analysts:Daniel Hu, FRM, New York (1) 212-438-2206;
daniel.hu@spglobal.com
Robert E Schulz, CFA, New York (1) 212-438-7808;
robert.schulz@spglobal.com
Ramki Muthukrishnan, New York (1) 212-438-1384;
ramki.muthukrishnan@spglobal.com
Stephen A Anderberg, New York (1) 212-438-8991;
stephen.anderberg@spglobal.com

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