The question was fairly blunt: has the CLO market hit rock bottom?
Collateralized loan obligations have had a stuttering start to the year, but new issuance has picked up over the past couple of months, at a pace some believe could put the market within earshot of original full-year 2016 forecasts of $55 billion to $60 billion.
But in the opinion of CLO managers and other participants at this week’s 5th annual IMN CLO and Leveraged Loan conference, the answer to whether the worst is over seems to be “not yet.”
In an informal straw poll conducted during the conference’s first session Monday, 87% of respondents said that the problem subsectors of debt held by CLOs – in oil and gas, minerals & mines, retail and publishing – will only worsen this year. Those 87% said exposure to those industries will be either have a marginally or significantly negative impact on CLOs. Only 13% of respondents said the impact would be the same as in 2015.
In fact, many believe the main threat for credit deterioration of CLOs will come from speculative-grade borrowers in the retail sector – with 57% of those polled saying that retail posed to highest risk to CLO and leveraged loan investors for 2016.
“The first four months has been quite slow compared to what we’ve seen in 2015,” said Jian Hu, a managing director in structured finance at Moody’s Investors Service, speaking at a late afternoon panel on the CLO market outlook for 2016. Despite encouraging pickup of loans in the new issue pipeline to feed the demand for constructing CLOs, credit deterioration remains a problem for these investment vehicles.
Even the pickup of new CLO issuance has inspired much confidence in the market. Amit Roy, the head of new CLO issues at major CLO arranger Goldman Sachs, said the newly issued deals – particularly those seen early in the year – were either driven by sponsors that held on to a substantial levels of assets, or were deals that were already in the works before market turmoil hit, making it difficult to get warehouse financing.
And the “arb” – or the difference in the interest rate spreads paid on CLO debt and the spreads on loans used as collateral – has been “less than fully compelling,” said Roy.
Energy loans remain a source of risk for CLOs, of course, but there are other areas of concern. . Minerals and wells, at 23.1%, remain high on the list due to the troubled coal industry. Healthcare is set at 15.4%, but there is growing concern about the risk of retail-based loans will have on CLO portfolios. The survey showed 57% of the audience believed retail is a trouble spot.
As for which sectors may boost leveraged loan performance in 2016, many of the panelists were surprised to see technology (at 43.5%) as the top vote-getter. Healthcare came in second, at 27.5, and unsurprisingly, oil and gas at 21%. Many of the panelists on Monday thought oil and gas had to potential to be a performer as distressed debt begins to trade at higher par prices.
There’s certainly room for improvement in that sector. Within the exploration and production segment alone, $38 billion, or 43% of all non-defaulted junk-grade E&P debt – trades at distressed levels, according to BCA Research strategist Matthew Conlan. Conlan, the keynote speaker, delivered the sobering news that gas prices would have to reach, and sustain, levels of $45-$60 a barrel in order to give companies in this sector enough cash flow just to break even. And these companies need to do more than just breakeven; they need to cut their indebtedness.
One bright spot is that these companies do not have too much debt that needs to be refinanced: only 15% of the $100 billion in high-yield debt is due by 2020; 75% is maturing between 2020 and 2023.
The influence of energy loans has been a factor in the increasingly steeper discounts loans must apply to sell. According to panelists on the panel on the outlook for leveraged loans, only 20% of loans were trading at or above par. A plurality of audience members polled – 45.1% – believe that number will drop by the end of the year to between 10-20%.
In addition, nearly half of respondents put loan volume at only between $400-500 billion in new issuance this year, compared to $783 billion in 2015.
The energy sector will remain in focus Tuesday, when several panels will discuss strategies for CLOs with distressed assets, including trading in a distressed environment and the impact on the secondary market for CLO paper.