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CLOs: Leaving Las Vegas

Rating downgrades threaten CLO structures.

The loan default rate in the US hit a five year high of 3.59% in October as $8 billion worth of loans to gaming and resort company Las Vegas Sands teetered on the brink of breaching their covenants. A covenant breach was only avoided when chief executive Sheldon Adelson injected $525 million of his own money into the struggling company. But it was not just Las Vegas Sands that had a narrow escape: its loans are referenced in a full 293 US CLOs – in some cases accounting for more than 3% of the entire portfolio.

But it is not just defaults that CLO managers are concerned about – they also need to be extremely wary of rating downgrades. A loan might have to be sold from a CLO structure if it or the issuer’s rating falls below a certain level, regardless of how the loan itself is performing. Buckets for triple-C credits are on average 7.5% of the portfolio – but some structures can have a limit as high as 15%. Some transactions use the rating of the issuer while others use the rating of the loan facility, which is generally higher. According to Citi, the average triple-C basket in US CLOs rose to 6.4%

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