CLO Managers Fret Altice Downgrade to Trigger Selloff of Riskiest Bonds

(Bloomberg) — The fallout from Altice France’s decision to threaten a haircut for creditors is just beginning. 

The ratings downgrade to CCC that followed means some managers of collateralized loan obligations, which bundle up slices of loans from the likes of Altice and sell them as bonds, are in jeopardy of breaching the maximum amount of risky debt that they are typically allowed to hold. 

“With Altice’s loans declining in value, CLO managers are going to need to sell other CCC debt that’s priced higher,” Pratik Gupta, a strategist at Bank of America Corp, said ahead of the downgrade. About 13% of US CLOs may have breached thresholds as a result of the cut, assuming managers don’t react, he said.

To get back under the threshold, some may opt to sell at deep discounts, particularly if similar debt owned by most CLO managers also sees a ratings cut. If the saga were to spread and trigger a prolonged shutdown of the CLO market, it would hit the real economy by making it more difficult for riskier businesses to refinance after interest rates surged in recent years. 

Investors should “remain cautious” when it comes to other large exposures that are rated B3, a step away from the riskiest C category, Citigroup Inc. strategists led by Maggie Wang wrote in a note this week. 

Debt issued by ION Trading and Stada, an entity linked to Nidda Healthcare Holding GmbH, are other B3-rated exposures widely held by CLO investors, they wrote. A spokesperson for Stada declined to comment. 

The headache marks something of a turnaround in risk sentiment. Sales of CLOs started the year at a historically fast pace as the “everything rally” sent demand for credit soaring, with investors moving up the risk curve in search of returns before the Federal Reserve begins to cut interest rates.

The spike in demand came even as credit metrics among junk borrowers were worsening, with Apollo Global Management Inc. pointing to companies having less income to service their debt. A rising percentage of B or CCC-rated issuers have negative cash flows, Oaktree Capital Management’s Chief Investment Officer Bruce Karsh wrote in a note last week, citing a BofA study.

While an individual loan downgrade usually wouldn’t damage a CLO’s ability to pay returns to investors, the sheer size of Altice’s debt stack – Altice France alone has a debt load of about €24 billion – means it has ripple effects in the market. The downgrade to CCC means it’s classed as having a high risk of default.

“Many of the larger players are going to have size and very large positions in a number of these names,” Gunther Stein, head of US performing credit at Sound Point Capital Management, said on the Bloomberg Credit Edge podcast.

“It’s something we all have to be thoughtful around in terms of how we’re managing our portfolios and, candidly, hopefully we’re early in terms of exiting these positions.”

Week in Review

• US high-grade corporate bond sales totaled around $530 billion as of Wednesday, the busiest first quarter on record, as investors clamored for relatively high yields before the Federal Reserve starts cutting rates.
• Thames Water Utilities Ltd.’s parent company said it won’t be able to refinance or pay off a £190 million loan that matures on April 30, unless lenders give it an extension. That could potentially push the parent into administration.
• As European and British banks race to repay giant Covid-era loans, they’re having to lean ever more heavily on selling covered debt to meet their funding needs. Some market participants wonder if the market is reaching a saturation point.
• Home Depot told investors it expects to take on $12.5 billion of debt to help fund its planned purchase of building-products distributor SRS Distribution Inc.
• Paramount Global’s debt rating was cut to junk by S&P Global Ratings, which cited pressure on cash flow because of the continued decline in the company’s broadcast and cable TV business.
• A key creditor group of defaulted Chinese developer Shimao Group Holdings Ltd. has urged all bondholders to reject the company’s proposed restructuring plan, as the standoff between the two sides escalates.
• Exuberant credit markets have spurred banks to shift estimates. JPMorgan Chase & Co. lowered its year-end forecast for US investment-grade bond spreads, citing “overwhelming” demand for the asset class while supply starts to ease off. The bank now expects spreads on the JPMorgan JULI index to end 2024 at 95 basis points, from a forecast of 125 basis points in November
• Deutsche Bank said it now expects US high-grade bond spreads to tighten to 75 basis points in the next three to six months, compared with a forecast of 90 basis points in February.
• German bank sees euro-denominated high-grade spreads hitting 95 basis points, 19 basis points tighter than current levels, and euro high-yield spreads to tighten 50 basis points to 300 basis points in the next three to six months

On the Move

• John Aylward’s hedge fund Sona Asset Management has hired Lee Hope as a managing director in its European leveraged finance team as the firm continues to expand.
• Bank of Nova Scotia hired JPMorgan Chase & Co. managing director Andreas Pierroutsakos to oversee leveraged-finance origination, according to people with knowledge of the matter.
• UBS Group AG is hiring Jake Webster as the Swiss bank looks to rebuild its sovereign, supranational and agency debt capital markets business, according to people with knowledge of the matter.
• David Trahan, who headed Citigroup Inc.’s investment-grade debt syndicate for North America, has exited the Wall Street giant.
• Steve Monahan, head of Bank of America Corp.’s US debt private placement business, is retiring after nearly 40 years at the Wall Street bank. Mark Williams, who has been with the bank for 27 years, will replace him, according to an internal memo reviewed by Bloomberg.

 

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