The Shoe Keeps Dropping: CLOs With Negative Equity Soar By 30% In February To Record 453

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One month ago, we noticed the latest “shoe to drop” in the global credit rout, when as a result of soaring downgrades to energy companies’ credit ratings, the Collateralized Loan Obligations (CLO) market went into a state of frozen animation, leading to a standstill in new CLO issuance.
As we previously wrote citing S&P, the credit quality of CLO assets is deteriorating, the result of 45 energy borrower downgrades in February. S&P said that the credit ratings of around 1.4% of assets held by US CLOs have been downgraded or placed on credit watch with negative implications this year. Worse, the sudden repricing means that the negative total returns of US CLO BBs and single-Bs in January have already been more severe than those realized in the entire year of 2015.
As Chris Flanagan, head of US mortgage and structured finance research at Bank of America Merrill Lynch in New York, said “people are definitely trying to get their heads around what [increased CCC holdings] says about the credit cycle. The market has changed dramatically in just six weeks.’
We noted that the biggest implication from the ongoing rout to the CLO 2.0 product is that the lower issuance of CLOs, the main buyers of leveraged loans, will make it harder for companies to issue new debt in the already-challenged US$870bn US leveraged loan market which provides junk loans to companies including retailer Dollar Tree and countless near-distress shale companies.
Indeed, we have already seen the flipside of this when as reported previously, the vast majority of “use of proceeds” from energy equity offerings has been to repay secured debt and energy revolvers.
As a way of keeping tabs on the not so quiet selling in the CLO space, we noted that as of the end of January, the median CLO 2.0 equity NAVs tumbled by 9 percentage points, or by 85%, and according to Morgan Stanley calculations, a whopping 348 US CLO 2.0 deals’ equity tranches had NAV below zero as shown in the chart below.

This post was published at Zero Hedge on 03/14/2016.