The leveraged loan is a $1.2 tn dollar market.
What is a leveraged loan?
A leveraged loan is a type of loan that is extended to companies or individuals that already carry a high debt burden or poor credit history.
CLOs (Collateralized Loan Obligations) are the largest buyer of leveraged loans. The CLO market itself is $700 bn market which means they make up about 58% of total leveraged loan market.
What risks are CLOs exposed to?
CLOs are exposed to risks related to credit downgrades. The issue going on today is that there are there are record number of loans rated B-/B3. This level is one notch above the lowest junk rated bonds.
Credit downgrades could have an effect of reducing value of a CLO portfolio. If the portfolio loses too much, asset-coverage tests will get set off.
What scenarios could play out if there are credit downgrades?
The first scenario that could play out is CLO managers are forced to sell debt at firesale prices. In the second scenario, they are forced to suspend cash payments to the riskier level, lowest equity tranche
What are CLOs worth now (April 20th, 2020)?
Presently, CLOs on a whole are receiving about 70 cents of every $1 in par value. The AAA tranche is still valued at $1 for every $1 par, due to its safer, lower returns. The lesser rated tranches, such as BB are only fetching 60 on every $1 in par value
How have CLO credit ratings been affected?
Moody’s was recently forced to cut rating on 859 CLO securities. These are ratings for the CLO securities and not the underlying leveraged loans themselves, which have undergone their own downgrades. This comprises of 20% of all bonds Moody’s grades