(Bloomberg) -- Investors in the riskiest slice of bonds backed by corporate loans are now getting their lowest payouts in five years, while some get none at all, according to Deutsche Bank AG.
With borrowing costs near multi-year lows, median equity distributions for the securities, known as collateralized loan obligations, reached an annualized rate of 12.1%, the lowest since 2020, bank strategists Conor O'Toole and Jamie Flannick wrote in a Monday note.
This year's wave of refinancings by junk-rated companies has eaten into the potential profits from bundling into bonds. Those dwindling profits come at a time when concerns over credit quality have been percolating. Flannick expects loan repricings to continue to weigh on CLO payouts into 2026, barring a selloff.
"If you believe that the market is still heading toward a soft landing and the labor market holds in and we have tight pricing in loans and CLOs, it feels like it can continue like this over the next year," he said in an interview. "But if you're thinking that the macro setup is going to change a bit and things get softer and we have a repricing in loans, then I think CLO equity looks really attractive again."
There's also a large swath of deals that hasn't paid anything to equity investors this quarter, according to the report. Within that group, more than 20% of the underlying loans are trading below 80 cents on the dollar on average.
These are mostly older vintages of CLOs that have lost their chance to reset and are past the phase of actively reinvesting loan proceeds. The estimated average value of their CLO equity is negative.
"Another relatively niche but interesting piece has been this cohort of deals that are a little bit left adrift," Flannick said. "Basically their liquidation value is underwater."
Average net asset value for CLO equity broadly is around 45% of par, down from 48% a year ago, according to the report.
Leveraged loans briefly sold off in April when President Trump laid out his tariff policy before recovering. The recent high-profile implosions of First Brands and Tricolor hit the debt harder, with the Bloomberg Global Leveraged Loan Index posting its first negative return in two years in October.
"Lower NAVs have meant that a deal which is liquidated in the current environment will yield, on average, less than at most points over the last year beside the April selloff and weeks-long recovery following into June," the analysts wrote.
With the vast majority of CLO managers having reported performance metrics for the fourth quarter, it's shaping up to be the sixth-straight quarterly decline in equity payments, the analysts said. The median CLO equity payment for this quarter is 2.6%, down slightly from 2.7% in the third quarter.
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