Audience for the document: Share Class: Language of the document:


Share Class: Language of the document:

Change Details

If you need to change your email address please contact us.
You are ready to start subscribing.
Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. T. Rowe Price has been independently verified for the twenty four-year period ended June 30, 2020, by KPMG LLP. The verification report is available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request

Other Literature

You have successfully subscribed.

Notify me by email when
regular data and commentary is available
exceptional commentary is available
new articles become available

Thank you for your continued interest

Please enter valid search characters

U.S. Fixed Income

Attractive Yields, Slowing Bank Loan Downgrades Support CLOs

Jean-Marc Breaux, CFA, Credit Analyst
Stephen M. Finamore, CFA, Portfolio Manager

Analysis can uncover value in collateralized loan obligations.

Key Insights

  • Total collateralized loan obligation (CLO) issuance in 2020 is likely to be meaningfully below the 2019 level, providing technical support for the market.
  • The pace of credit rating downgrades in the bank loan market has moderated over the last few months, and capital markets have reopened to loan issuers.
  • These supportive factors, combined with the attractive yields and solid structures of some CLOs, have allowed us to find value in certain CLOs.

Total CLO issuance in 2020 is likely to be meaningfully below the level from 2019, with new CLO deals continuing to lag last year’s pace in 2021. While the bank loan market experienced heavy credit rating downgrades in March and April, the pace has moderated over the last few months, and capital markets have reopened to loan issuers. Combined with the attractive yields and solid structures of some CLOs that enhance their credit, these factors have allowed us to find attractive value in certain segments of the market.

Portfolios of Bank Loans

CLOs are portfolios of bank loans,1 corporate debt that typically has high yield credit ratings, that are structured into slices, or tranches. Unlike other types of securitized credit, a third-party collateral manager actively manages the underlying loan portfolio. Most of the CLO debt tranches have credit ratings that range from AAA to BB, depending on the amount of credit enhancement—support from the cash flow structure of the CLO. The equity tranche sits at the bottom of the capital structure, has no credit enhancement, and does not pay a coupon, instead receiving all remaining cash after debtholders have received their expected principal and interest payments.

Slowing New CLO Issuance

After issuance stalled at the peak of the market volatility earlier in the year, new CLO issuance increased month over month beginning in April. We believe that new deals will roll out at a rate of about USD 6 billion per month over the remainder of the year. This pace would bring the total new 2020 issuance to about USD 70 billion, which would be a decrease of about 35% from last year. However, an increase in loan issuance or higher outflows from loan funds, which would boost available supply, could cause the 2020 new CLO total to be modestly higher. Compared with 2019, we also anticipate lower CLO issuance in 2021 unless there is a meaningful pickup in mergers and acquisitions or private equity activity that boosts loan issuance.

This muted outlook for new CLO supply should be a supportive technical factor for the market, with all else being equal. However, because CLOs are a major source of demand for bank loans, a slower pace of new CLO issuance is a negative technical factor for the underlying loans that make up CLOs. Overall, we expect the positive technical support from a lower level of CLO issuance to outweigh the technical headwinds for the loan market.

Less than 10%

As of July 31, less than 10% of the bank loan market was at distressed levels.

Rapid Credit Rating Downgrades of Underlying Loans

The economic recession triggered by the coronavirus pandemic has obviously impacted the businesses of many bank loan issuers. Moreover, in our view, underwriting standards had deteriorated throughout 2018 and 2019. This shift was reflected in higher leverage and looser protective covenants.2 The lower underwriting standards also negatively affected the ratings mix of the loan market, which becomes increasingly important in a downturn or recession when there is more downgrade activity.

Since March, the credit rating agencies have downgraded about 40% of the loan market, with most of the actions coming in March and April after the initial onset of the pandemic. The pace of downgrades has moderated since then. In July, both the number and total volume of loans upgraded outpaced the number and volume of downgrades.

However, the rating agencies have been slower to downgrade CLOs, especially those rated higher than BBB. As a result, we could see some near-term rating actions on A and AA rated CLOs, particularly on those with weaker structures and collateral. However, we think that AAA rated CLOs are unlikely to see downgrades unless the agencies change their methodologies.

Anticipated Loan Default Rate Lower Than Originally Expected

During the depths of the economic shutdown in late March and early April, we anticipated a prolonged recessionary environment that would trigger a large spike in the default rate on bank loans over the next year. However, since then we have witnessed the effects of massive monetary and fiscal stimulus as well as the progress made toward containment and treatment of the virus. While defaults increased to 3.9% in July, the highest level in five years,3 we now anticipate a lower peak default rate than we originally feared.

Furthermore, the number of bank loans trading at distressed levels of less than USD 80 has notably decreased, indicating that the loan market now also anticipates fewer defaults. At the end of March, 28% of the bank loan market was trading below USD 80, but as of July 31, less than 10% of the market was at distressed levels.4

Finally, in a positive sign for loan credit quality, second-quarter corporate earnings, while undeniably poor, have not been as devastating as originally anticipated. Also, the combination of lower rates, large inflows into high yield funds, and new CLO formations has provided loan issuers with liquidity. With loan market issuance limited in the immediate aftermath of the crisis, many loan issuers accessed the secured or unsecured high yield bond markets to meet their near-term debt obligations and generate cash buffers for use until revenue returns closer to historical levels. Since then, the loan new issue market has reopened, although it remains at lower issuance levels than in the high yield bond market.

Loan Defaults Slowly Working Into CLOs

As CLOs are actively managed, we expect loan default rates within CLOs to be lower. But the range of outcomes should be wide, with stronger deals as low as 1% and weaker structures over 10%. It will take time for the loan defaults to work into the CLO market, but we believe that the market is already pricing in this default scenario to a large degree. We anticipate that BB rated CLOs, as well as some BBB rated tranches with weaker structures, will ultimately experience losses from defaults.

Credit Analysis More Important Than Ever

The modestly better-than-expected economic backdrop and lighter new CLO issuance support our selective positions in higher-quality CLOs, which we have been adding to some of our diversified fixed income portfolios. These tranches offer higher yields than similarly rated corporate bonds. Also, the structural features of CLOs divert interest payments from the equity and lower-tier debt tranches to the higher-rated senior notes if overall credit quality deteriorates beyond a certain threshold, providing additional credit support.

The obvious risk to these positions is that a second wave of the virus prompts another broad shutdown of economic activity. However, we believe that our deep analysis of the credit quality and cash flow structures of our CLO holdings, paired with a strong high yield research platform, will allow us to select the deals and tranches that are well positioned to weather the ongoing uncertainty and volatility.

What We're Watching Next

A relatively small percentage of outstanding CLOs have recently been diverting interest payments away from their equity tranches, and some equity slices may be indefinitely separated from payments. It could be difficult for the managers of these poorly performing CLOs to issue new deals, illustrating the importance of evaluating and monitoring CLO collateral managers.

1 Also referred to as leveraged loans.
2 Covenants provide legal protection for debt holders against a deterioration in the borrower’s fundamental credit metrics.
3 Data source: Standard & Poor’s (see Additional Disclosures).
4 Data source: J.P. Morgan (see Additional Disclosures).

Key Risks—The following risks are materially relevant to the strategy highlighted in this material: Debt securities could suffer an adverse change in financial condition due to ratings downgrade or default which may affect the value of an investment. Fixed income securities are subject to credit risk, liquidity risk, call risk, and interest rate risk. As interest rates rise, bond prices generally fall. Investments in high yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk, such as nonpayment of principal or interest, and risks of bankruptcy and insolvency.

Additional Disclosures

Copyright © 2020, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.

Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2020, J.P. Morgan Chase & Co. All rights reserved.

Important Information

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.

Morningstar Awards 2020©. Morningstar, Inc. All Rights Reserved. Awarded to T. Rowe Price for 2020 U.S. Morningstar Exemplary Stewardship and to Jerome Clark for 2020 U.S. Morningstar Outstanding Portfolio Manager, U.S.A.

© 2020 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.