CLO market: Corporate distress? Bring it on
It is an almost unchallenged truth that the next crisis will be triggered by over-leveraged corporate borrowers crumbling under the weight of cheap debt that they have taken on over the last decade. Right in the middle of this are the CLO buyers that have made much of that lending possible. But rather than taking fright at the prospect of a slew of triple-C credits in their pools, CLO managers are running straight towards it.
A lot of people are worried about collateralized loan obligations (CLOs). These are the levered buyers that have fuelled extraordinary growth in sub-investment grade lending to $1.4 trillion worldwide, while at the same time facilitating the evaporation of loan covenants and the extension of cheap debt to highly risky credits.
Ask any market participant where they think that the next crisis is coming from and their answer will almost always be corporate credit. “We have been watching the market very closely and have seen degradation in investment grade. BBB is the new A,” says Aoiffe McGarry, director in ABS syndicate at Citi in New York. “It is very competitive and corporates have been able to take advantage of structurally strong capital markets.”
This is most definitely also the case in the sub-investment grade markets, where firms have been funding at unprecedentedly cheap levels. “But if the cycle turns you want to be in the secured space because there are protections there. Investors are beginning to worry about their exposure to US corporates and I think the US consumer will fare better,” McGarry warns.
That concern has prompted a lot of people to take a very hard look at the pools of corporate loans within the more than $750 billion CLOs that are now outstanding globally.