Pools of risky loans under “negative” watch on the coronavirus and energy problems

Subprime loan pools with higher energy exposures are on “negative” watch as shocks from the coronavirus pandemic continue to trickle down to financial markets, according to S&P Global.

Fifteen US secured loan bonds are on watch due to their greater exposure to energy, including CLOs managed by Oaktree Capital Management, Marathon Asset Management and Bardin Hill Investment Partners, according to a March 20 report by S&P. CLOs are the largest buyers of high yield business loans, dividing debt into tranches of variable risk and return.

The credit rating firm said it would also review CLOs with larger exposures to other sectors affected by the pandemic, while monitoring the impact of potential downgrades of loans they hold. When assessing credit ratings, S&P said it assumed the coronavirus pandemic would peak in June or August, as some government officials estimated.

“Measures to contain Covid-19 have pushed the global economy into recession and could cause an increase in defaults among borrowers of non-financial businesses,” S&P warned in the report. Debt ratings in the hospitality and leisure sectors will be among those to be considered due to concerns over the pandemic, S&P analyst KP Rajan said in a telephone interview on Monday.

The Federal Reserve has taken a series of emergency measures to quell panic in the markets since Covid-19, the disease caused by the novel coronavirus, caused a large sell-off in stocks and corporate debt. As part of its latest move, the Fed said on Monday it would start buying investment grade corporate bonds.

Loans held by CLO managers are riskier. They typically invest in corporate debt rated below investment grade, with a limit on the amount of low-rated CCC loans they may hold. Exceeding the threshold could result in losses for investors in CLOs, with those in the riskier tranches of loan pools being the first to suffer.

[II Deep Dive: The High-Octane, In-Demand, and Worrying World of Risky Loans]

By placing CLOs on watch due to their greater exposure to energy, S&P explained that the “performance factors examined include a combination of above-average exposure to loans from ‘CCC’ rated obligors, a reduction in overcollateralisation ratios, a decline in the portfolio’s credit quality, and compression of the portfolio’s weighted average spread.

The credit rating provider said that “these factors generally have a greater impact on subordinated and lower mezzanine CLO bonds, making them more vulnerable to troubled market conditions.”

While the safer portions of CLOs, especially AAA and AA rated ratings, are not expected to suffer any losses, portions below investment grade could do so as market turmoil continues, Jimmy Kobylinski said Monday, analyst at S&P, by phone. “We don’t know how it will play out in three to six months,” he said, adding that investors in CLOs could generally see losses in tranches rated BB or B.

Marathon CLO VII is one of the secured loan obligations on S&P’s watch list. Andrew Rabinowitz, president and chief operating officer of Marathon, said by phone Monday that the CLO has passed its reinvestment period, which means its portfolio is now static as it comes to an end.

Oaktree CLO 2014-1, Oaktree CLO 2015-1 and Oaktree CLO 2019-1 are also on S & P’s negative watch list. A spokesperson for Oaktree, the alternative investment firm co-founded by Howard Marks, did not immediately comment.

Halcyon Loan Advisors Funding 2012-1 and Halcyon Loan Advisors Funding 2013-1, which are managed by Bardin Hill, are also on negative watch. A spokesperson for Bardin Hill, formerly known as Halycon Capital Management, declined to comment.

The energy sector has been hit by the coronavirus pandemic, with falling oil prices raising concerns about the ability of borrowers to honor their debts. Crude is now trading at less than $ 30 a barrel, up from over $ 60 earlier this year.

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