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Technology sector risk levels in CLOs continue to mount

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CLO managers face numerous challenges in 2018, such as more covenant-lite features and tighter coupons affixed to newly issued (or refinanced) leveraged-loan assets.

But managers are still keen to keep an eye on a longtime harbinger of portfolio risk: sector exposure.

In recent years, oil and gas loans have been the bane of some portfolios that saw weighted average spreads and cash flows weaken as highly leveraged energy producers, exploration companies and petroleum-related fields were sunk by falling fuel prices.

That sector remains under some scrutiny now as the industry has stabilized, but new ones have taken the spotlight as areas to watch, including media, retail and technology.

John Fraser, head of U.S. credit management for Investcorp Credit Management, said at an industry gathering Thursday that one of the firm’s greatest concerns today in its CLO holdings is in the technology sector.

“Technology is at the very top of the list,” Fraser said at the 7th annual conference on CLOs and leveraged loans, hosted by Information Management Network. “It’s a pretty broad industry basket; it covers about 12% to 13% of the [loan] market. It seems like most of the new issuance this year ... [and] it’s one where valuations are starting to look a little bit like 2000-2001.

“We are seeing [loan] structures that provide extremely generous add-backs to the EBITDA definition, and even then the headline leverage can be as high as" eight times, Fraser said. “That suggests to me that sector in particular is going to be a source of significant issues at some point.”

So might health care, where pressures are growing on the uncertain direction of government reimbursements, or on potential regulation of drug prices, said Fraser, who was on a morning panel discussing broadly syndicated CLO market forecasts and trends.

Retail is considered a risk, with problems surrounding high leverage and the transformation of online shopping cutting away at brick-and-mortar store sales.

Worries about retail also abound in the middle-market CLO space, where a sponsor is likely to have also directly originated a loan being held in its portfolio of small/medium enterprise loans.

In another panel discussion at the IMN conference, Churchill Asset Management senior managing director David Heilbrunn said his firm was focused away from sectors with exposure to cyclical volatility like stores and restaurants, categories that Churchill has “never been fans of.”

“CLOs are meant to have predictable patchwork patterns,” he said.

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