Stress in the $1.1 trillion leveraged loan market this year has pulled down the prices of the debt of weaker companies, but not by enough yet to generate bargains for sector’s largest investors.
And while some see a pile of tinder in the U.S. corporate debt boom that could amplify pain in a recession, Hart said CLOs are unlikely to provide the spark. Although CLOs are designed to provide a hedge against plummeting loan prices, their managers aren’t yet increasing support for the sector’s weakest performers, which could leave riskier loans vulnerable to going even lower in price.
Market participants worry that it only takes one-to-three downgrades before a leveraged loan in the Single B-rated category slumps into the Triple C-rated bracket. With CLOs eager to avoid surpassing their Triple C-rated loan limits, managers already have begun to triage their portfolios in case a cascade of downgrades from Single B to Triple C hits the market.
Michael Terwilliger, portfolio manager at Resource Alts, said liquidity risk is going to be the biggest concern, particularly if CLOs not only pull back on buying, but dump loans into a stressed market.
In case you missed it... the picture is a reference to trying to 'catch a falling knife' when a market is falling... no-one knows the bottom!