In CLO Market, Debt Goes From Bad to Worse

 | Feb 26, 2016 | 3:44 PM EST
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The CLO market -- or the business of warehousing tranches of loans that are often below investment grade -- is not in good shape. (Collateralized loan obligations, or CLOs, are a common financial vehicle.)

Tranches of CLOs that Standard & Poor's rates as BB, or two notches below investment grade, have slipped on average by 17-18 cents to roughly $0.60 on the dollar in secondary markets this year, according to an investment manager familiar with the private trading. Meanwhile, B-rated tranches are collectively trading down about 25% on the year.

This does not bode well for the companies' troubled underlying debt, which reflects mounting concerns over firms' ability to meet their debt obligations. Another problem is that event-driven hedge funds -- usually the ones on tap to pick up loans they view at a discount in the event of a selloff -- are increasingly leading the bearish charge in the market, the investment manager said on the condition of anonymity because much of the trading is private.

Seadrill (SDRL) is among those topping the list with struggling leveraged loans held in CLOs, with roughly $918 million in loans on CLO books, trading down at $39.25 as of Wednesday, the manager said. The Bermudan offshore drilling contractor's stock is also down 84% over the last 12 months as Seadrill is one of many distressed energy companies tanking alongside crude prices.

British tech giant Avaya came in second with $817 million of its $2.1 billion leveraged loans in such investment warehouses, he said, with the paper trading down at just $0.58 on the dollar Wednesday as shares have declined 35% since early December.

Next up is Cumulus Media (CMLS), the AM/FM radio giant that Real Money reported Friday has deep debt troubles, sending shareholders, lenders and even employees fleeing in droves. The manager said $814 million of its $2 billion in loans is held by CLOs, with the debt trading at $0.64 on the dollar as of Wednesday.

On Wednesday, Meredith Coffey, executive vice president of the Loan Syndications and Trading Association (LSTA), argued that much of the weakness in the CLO market can be attributed to Dodd-Frank regulation.

"The LSTA is an association that represents the interests of all participants in the nearly $4 trillion corporate loan market," she said. "Importantly, the LSTA does not represent the securitization market or the market for collateralized loan obligations, or CLOs. Instead, the LSTA represents the corporate loan market – and our concern is how certain regulations could severely diminish securitization (particularly CLOs) and how this could markedly reduce U.S. companies' access to the loans they need to expand, build factories, build cellular networks and engage in M&A as they grow and create jobs."

Coffey argued that financial regulation is hurting U.S. firms' ability to issue levered loans, or those deemed sub-investment-grade, amid the government's effort to curb another asset bubble akin to 2008's subprime mortgage mess with new leverage and capital requirements.

 "And there is nothing wrong with being 'non-investment-grade,'" she said. "Indeed, many of these companies are very familiar and reliable names. For instance, non-investment-grade borrowers include communications companies like Cablevision (CVC), Charter Communications (CHTR) and Univision."

Pullback in leveraged loan investments has also been seen in mutual funds which typically have an appetite for such risky debt, so long as it comes with a substantial interest rate. But investors have lately been pulling out cash at a record clip.

Last week, $645 million exited leveraged loan mutual funds and ETFs, bringing the outflow over the last 30 weeks to nearly $17 billion, according to Lipper, a data service owned by Thomson Reuters.

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