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Fitch: "Late Cycle" Behaviors Worth Watch for U.S. CLOs.

New York: Supply and demand imbalances in the leveraged loan market are leading to some late cycle credit behaviors that U.S. CLO investors should keep a close eye on, according to Fitch Ratings in its 2018 Virtual Investor Video Series for structured finance.

Among the aforementioned late cycle behaviors that have emerged, according to Structured Credit group head Kevin Kendra, include a lack of new credit creation in the leveraged loan market and the fact that most CLO issuance is coming in the form of refinancings and re-pricings of older transactions. Additionally, the strong appetite for leveraged loans is leading to a more issuer-friendly environment for borrowers with first lien leverage metrics and looser documentation becoming more prevalent.

Kendra said that credit quality for CLO underlying portfolios is likely to be impacted over time if first lien leverage continues to increase along with 'CCC' baskets. The CLO tranches likely to be most affected are the lower rated ones that Fitch does not assign ratings to. Conversely, the 'AAA' tranches that Fitch rates on all of its CLOs are well insulated from underlying market pressures.

Structurally, CLOs have performed quite well in the face of difficult market conditions for sectors like retail, oil and gas and media and entertainment. This is leading some investors to question how long performance be sustained this deep in the credit cycle. Not surprisingly, retail and energy leveraged loans are most susceptible to default over the next 12 months. Longer term, however, leveraged loans tied to business services and technology could come in for some adverse movement.

Another development worthy of note is the rollback of the risk retention rules that Kendra said fundamentally changed the market. With CLO issuance very likely to surpass the $100 billion high water mark of 2017 and the risk retention rules no longer in play, smaller CLO managers that jettisoned the market some years back are likely to re-emerge, which will only quicken the pace of new CLO issuance.

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Publication:Daily the Pak Banker (Lahore, Pakistan)
Date:Sep 25, 2018
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