Investor concerns over CLOs exposure to ailing retailers appears to be considerably overblown, according to Wells Fargo.
In a report published Tuesday, Wells said that retailer loans held by collateralized loan obligations are performing as well, if not better, than most of other loans in CLO portfolios, outside of the oil and gas industries.
While retailers such as JC Penney and The Gap have reported weak earnings, the vast majority (86%) of retail loans held in collateralized loan obligation portfolios are trading at near or above par. Only 8% of those retail loans are priced below $80, with nearly all the pain in retail industry loans isolated to the shoe/apparel and discount store sectors.
Other sectors, including pet supplies, have been among the highest-demand assets in the loan market targeted by “nimble” CLO managers who have built par through savvy early-year trading during a volatile market period, the report stated.
“Within retail, we see a large divergence in performance by subsector, and CLO managers are acting on this divergence,” analyst David Preston wrote in the report.
Only 34 CLOs issued since the financial crisis have an “outsized” exposure to retail loans trading below $80, which Wells considers to be wide of 200 basis points from the CLO’s purchase price. Those loans are mostly confined to large holdings in lower-priced apparel/shoe or discount store loans like J. Crew, Rue 21 and 99 Cents Only Stores, the report stated (all three stores are the most held retail loans trading below $80). Apparel/shoes make up 18% of CLO retail holdings.
Retail exposure was a hot topic at a CLOs conference last week. In an informal poll conducted in one session by conference host Information Management Network, 57% of attendees saw credit deterioration in retail as the highest risk for CLO and leveraged loan investors in 2016.
Wells’ report also cites investor concerns about U.S. CLO exposure to loans in the retail sector, but the firm sees only a limited exposure risk of 7% to CLO portfolios in the aggregate. Moreover, 86% of the exposure is to loans trading at $90 of par or above, and 79% to those trading above $95 like PetSmart and Bass Pro. There are fewer retail loans trading below $80 than in the broad market, as well as when compared to the loan market outside of commodities.
The the 8% of retail loans that are priced below $80 equate to just 0.43% of all CLO assets. Only 2% of CLO retail exposure is trading at distressed levels below $60, according to Wells.
More evidence of the exaggerated risk of retail loans is the sector’s comparable price distribution to the broad loan market excluding oil & gas and mining/minerals. According to Wells, only 6.7% of retail loans trade below $80, compared to the general loan market average of 8.1. Retail has a strong segment of loans priced above $95 (81.4%), nearly equal to the broad market average (ex-commodities) of 82.2%. A greater percentage of retail loans trade above par (43.7%) than in the overall loan market sans energy and mining (41.1%).
“Even during the stress period of February 2016, retail loans actually outperformed the broad loan market, when looking at price distribution,” according to the report.
Oil and gas loans, meanwhile have nearly 60% of loans trading at distressed levels below $80, 19.7% trading above $95 and only 2.6% trading above par.
CLO managers have been adding loans in pet food & supplies and department stores, but reducing exposure to apparel/shoes. Most of the active trading this year has been confined to a few brands – Petco, PetSmart, Men’s Wearhouse, Neiman Marcus, Dollar Tree and J. Crew.
PetSmart’s loan, issued in June 2015 for $4.3 billion (rated ‘Ba3’ by Moody’s and ‘BB-’ by S&P) ended trading Monday at $99.89, for instance. PetSmart has the most widely held loan among CLO portfolios, as an estimated $1.2 billion-$1.4 billion.