Article/Intelligence
Riskiest Credits Lead Tariff Selloff; Transportation, Home Furnishings, Automotive Worst Hit; Managers and Investors See Volatility a Buying Opportunity
CLO liabilities also sold off sharply in recent weeks but regained some lost ground following Trump’s 90-day pause of the lion’s share of the tariffs on April 9. Investors were seeking spreads in the primary market in the 140 bps-150 bps range at the triple-A level earlier this week, up from 110 bps-120 bps in early February. Following the policy reversal, triple-A spreads have tightened by about 10 bps in the secondary market, according to sources.
Offsetting the turmoil was the start of the new Japanese fiscal year this month. This means that the investor base in the country, in particular regional Japanese banks, have renewed budgets ready to deploy into senior CLO tranches, creating a ceiling for spreads. Sources in the United States say that domestic investors are sitting on the sidelines, poised to redeploy back into the liability market.
Unlike during the Covid-19 crisis in 2020 and liability-driven investment selloff sparked by then British Prime Minister Liz Truss in 2022, CLO managers and investors alike see the current bout of volatility as a buying opportunity. One equity investor told Octus, formerly Reorg, that volatility without defaults is the ideal scenario for CLO equity returns and expressed confidence in the fundamentals of underlying collateral pools.
Nevertheless, the pain endures. The worst-hit sectors within the U.S. loan index have been transportation, home furnishing and automotive. These were followed by airlines, chemicals, metals and mining, transportation and entertainment.
Debt prices across a few industries remained unscathed, however, with credits getting hit either directly or through second- or third-order impacts. Attributing price action solely to a particular industry works in some cases where cost structures and end markets are consistent across players, but tariff exposure and dynamics have had an idiosyncratic element to them, especially driven by credit quality, as discussed shortly.
We have previously discussed the trends from across leveraged loan borrower investor calls concerning tariffs HERE.
The European market has also traded off, with most of the worst performers being already weak credits. “For about 20% of our portfolio in Europe, there could be an impact of some sort, but the rest is fine,” said a loan investor in London, while another said that the exposure to tariffs is “modest.”
“There is not going to be a systemic default context. It’s going to be idiosyncratic. And CLOs are designed to withstand idiosyncratic defaults,” said another, highlighting that most investors would have done their due diligence on tariff exposure well before April 2.
The wide dispersion among specific industries can be seen below, where the gap between the median and the worst performer, or even the 25th percentile, is wide:
Worst rated, highest beta credits have seen the biggest price declines. Spreads for the companies with the lowest credit quality widened the most, with the majority of the instruments among the double-digit decliners being Caa1 rated or lower by Moody’s. However, we note that bid-ask spreads for some of these instruments are wide, also affecting the daily moves shown below:
When looking across the U.S. CLO managers, the following had the largest exposure to the sectors that have seen the greatest price declines, as highlighted earlier including household durables or auto. However, exposure to the outsized underperformers or companies that have seen little change will truly drive performance.
