NEW YORK, March 6(LPC) - Collateralized Loan Obligation (CLO) managers are preparing to warn investors that the fast-spreading coronavirus could impact the performance of the loans they own as production slowdowns weigh on earnings.
Investment firms have discussed adding the virus, which has swiftly spread around the globe, as a risk factor in US CLO documents, according to sources familiar with the conversations.
Concerns about a pandemic sent markets into a freefall last week, with the Dow Jones Industrial Average falling more than 12% and the LPC 100, a cohort of the 100 most liquid US loans, dropping almost 2%. This week the Dow was up 4.5% Wednesday and then fell 3.6% Thursday.
In late January, the World Health Organization (WHO) declared the outbreak of the respiratory disease a ‘public health emergency of international concern.’ More than 100,000 people globally have been infected with over 3,400 deaths as of March 6, according to data compiled by the Johns Hopkins Center for Systems Science and Engineering.
Language under consideration warns that a widespread health crisis could impact the ability of the fund to pay its investors.
Because the long-term impact of the virus is unknown, it is causing significant uncertainty in both domestic and global financial markets, a source said the language would indicate.
The virus “could have a material adverse effect on certain obligors of collateral obligations, including disruptions to obligors’ supply chains, closures of their facilities or decreases in demand for their products and services,” a potential clause states according to a source.
Any additional widespread health crisis in the future could have a similar adverse effect and negatively impact the fund’s ability to make payments to its CLO tranches, the clause explains.
“CLO managers are monitoring their exposure” to the virus, according to Jason Merrill, an investment specialist at Penn Mutual Asset Management. “When you look at deal documents, I wouldn’t be surprised if there is not a direct reference to the coronavirus or at least a mention to a potential future communicable disease and the risk that might pose to portfolios.”
CLOs are the biggest buyers in the US$1.2trn US leveraged loan market, which companies including American Airlines and Callaway Golf rely on for financing for daily operations and to back mergers and acquisitions.
The funds, which sell slices of varying seniority, from Triple A to B, to investors including insurance companies and banks, may feel pressured as the companies whose loans they purchase warn a slowdown in operations due to the virus could hurt their earnings.
Callaway, which tapped the loan market for debt to back its acquisition of apparel and equipment producer Jack Wolfskin, is among borrowers that have warned investors that the virus could disrupt business. Callaway’s US$446m term loan is owned by several US CLOs, according to LPC Collateral data.
The golf equipment manufacturer said this week that its suppliers are beginning to resume operations but are not at full capacity, and demand for consumer products has not recovered in affected areas in Asia, according to a regulatory filing.
Additional spreading could affect Callaway’s ability to manufacture its products, which could have a “significant negative impact” on its 2020 financial results, the company said in the filing.
Callaway spokespeople did not return an email requesting comment.
A mitigating factor for CLOs is the diversification of their collateral, which should help insulate portfolios from downgrades of a single issuer or a number of borrowers in one sector that result from a virus-related issue, according to a February 28 report from Fitch Ratings.
But “the effect of the slowdown on corporate issuers and subsequently CLOs will ultimately depend on the operational flexibility these companies have and CLO managers’ active management of portfolios,” Fitch analysts wrote in the report. (Reporting by Kristen Haunss; Editing by Michelle Sierra)