Moody’s review cast doubts on market for CLO
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Proposals from Moody’s Investors Service, the rating agency, to review assumptions about likely loan recovery rates for non-investment grade borrowers could slow down growth in the market for US collateralised loan obligations, according to analysts at JPMorgan.
The review relates particularly to such borrowers’ leveraged loans, typically used in buy-out deals, and could result in an upgrading of the loans.
Investors in CLOs - pools of loans that are split into tranches with varying risk profiles - are concerned that a review by Moody’s will lead to tightening spreads on loans, which could make it more difficult to find enough high-yielding assets to construct CLOs and so lead to a slowdown in growth in the market.
JPMorgan analysts said they believed that the amount of spread tightening would be limited, but that future CLOs could move towards buying riskier assets or using greater leverage to make such deals attractive.
“It is conceivable that asset composition may shift towards riskier collateral, or that capital structures may tighten at some rating levels,” they said.
Moody’s said in January that it was looking at non-investment grade loans and bonds in the US and reviewing its data on recovery rates in the event of default.
It has found that its assumptions about loan recoveries were too low compared with similarly rated bonds and is proposing a review, which could see loan ratings lifted by 1 to 1½ notches on average, Mike Rowan, group managing director at Moody’s, said on Monday.
JPMorgan analysts said that a series of upgrades for leveraged loans could see spreads - a proxy for yield - tightening, particularly for those that could move into investment grade territory.
However, some in the market believe that higher assumed recovery rates are already built into market pricing.
JPMorgan analysts also said that the huge role that CLOs play in the US leveraged loan market, where they account for more than 60 per cent of demand according to the bank, would mean that spreads could not tighten for long.
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