Fitch explores possible junior-note downgrades for two U.S. CLOs

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Fitch Ratings has placed subordinate notes on two U.S. collateralized loan obligations on notice for potential downgrades, contemplating a ratings action that has not previously occurred for a post-crisis CLO.

According to a release from the ratings agency, Fitch has placed three classes of notes for a middle-market CLO managed by Ivy Hill Asset Management, and a Class C tranche in a 2018 deal managed by Palmer Square Capital Management on a negative rating watch.

Fitch cited the junior notes sensitivity “to increased negative credit migration in their portfolios, as a result of expected disruptions caused by the coronavirus pandemic in select sectors.”

The $334.4 million Ivy Hill Middle Market Credit Fund IX portfolio has a 14% exposure to industries with high exposure to coronavirus-related risks, as well as a 1.2% exposure to defaulted assets. Palmer Square faces 15.6% exposure to high-risk industries, as well as higher exposure to long-dated assets (4%) and 0.3% exposure to defaulted assets.

The negative watch does not impact either deal’s senior-note tranches, the Class A notes that constitute the highest proportion of the combined note balances (as is standard for most CLOs).

Fitch instituted the ratings watch after completing a review of all outstanding CLOs (both broadly syndicated deals of major corporate loans and middle-market CLOs of direct loans to small/medium enterprises).

No note class for any post-crisis “CLO 2.0” has been downgraded to date, according to Fitch. CLOs are structured for payments from obligor loan payments to pay full principal and interest to senior Class A notes first, before payments are made to the subordinate notes. The junior notes in CLOs pay higher coupons, but bring added risk in their “first-loss” position.

The portfolio also saw a slight degradation in overall average ratings for loans in the portfolio, as well as a small decline in average recovery rates below the minimum threshold in the deal documents. The deal is currently failing Fitch’s minimum weighted-average recovery and WA ratings factor tests, according to the release.

The three tranches under rating watch for the Ivy Hill IX portfolio are the C-R notes (rated A- with an original balance of $30.1 million), D-R notes (BBB-. $16.1 million) and E-R notes (BB-, $17.3 million); all were reissues of notes from a 2014-vintage CLO sponsored by Ivy Hill that was refinanced and extended in December 2017.

The Class C notes for Palmer Square Loan Funding 2018-4, a rare static-issue CLO when launched in October 2018, are rated BBB by Fitch. The Class C notes had an original balance of $18.6 million.

Fitch is the only agency carrying ratings on the notes for either deal. (S&P Global Ratings, like Fitch, has an AAA rating for the $175.3 million Class A notes in Ivy Hill’s transaction, but S&P did not rate any of the four subordinate tranches for the refinanced transaction in December 2017.)

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