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In gauging oil and gas exposure, focus on price

| March 13, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The recent sharp down trade in energy prices has sent CLO investors scrambling to gauge exposure. It is lower than the oil bust of 2014 to 2016 but still meaningful. Exposure varies significantly across CLO deals and managers. Although par exposure to oil and gas loans looks similar across annual vintages, exposure to price looks different. And that could matter if ratings drift lower across industries in coming months and more deals approach their limits on exposure to ‘CCC’ loans.

Energy exposure across leveraged loans lower than 2014-2016

Current oil and gas exposure across the broad leveraged loan market is running lower than its prior peak. Oil and gas loans in February 2014 constituted 4.58% of the S&P/LSTA leveraged loan index but in February stood at 3.20% (Exhibit 1). The average since 2008 is 3.13%. CLOs usually hold a more narrow range of oil and gas names than the broader market.

Exhibit 1: Market index exposure to oil and gas is around the average since 2008

Source: LCD, Amherst Pierpont Securities

Exposure in CLOs runs around 2.5%

CLO oil and gas exposure depends on industry definition—S&P, Moody’s or Markit—but centers around a median of 2.50% with a long tail of higher exposure (Exhibit 2). S&P classification includes energy equipment; Moody’s classification includes utilities from oil and gas; Markit classification is purely oil and gas, which could explain why Markit consistently stands out as showing generally lower concentrations.

Exhibit 2: Energy exposure across CLOs centers around 2.5% with a long tail

Source: S&P, Moody’s, Markit, Amherst Pierpont Securities

Energy exposure in CLO managers’ aggregate portfolio of managed loans also centers around 2.50% with a long tail of higher exposure, suggesting some managers intentionally have above-market exposure to the sector (Exhibit 3). Many but not all of the most highly concentrated managers are small. But some of the CLO market’s largest managers also currently are overweight.

Exhibit 3: Manager exposure also centers around 2.5% with a tail of overweights

Source: S&P, Moody’s, Markit, Amherst Pierpont Securities

Looking across CLO vintages

CLO exposure to oil and gas as a share of portfolio par balance looks similar for now across different annual vintages. The median CLO portfolio holds around 2.50%, the 10th percentile holds 0.6% and the 90th percentile holds 4.6% (Exhibit 4). The differences across vintages are small.

Exhibit 4: Current par exposure to oil and gas loans looks similar across CLO vintages

Note: Loan industry categorized based on Moody’s criteria. Source: Intex, Amherst Pierpont Securities

But using price as a measure of loan quality, vintages start to look different. The 2019 vintage looks the strongest, and the 2014 vintage the weakest. The difference between these vintages in weighted average loan price for the median portfolio is $14—$84.98 for 2019 and $70.90 for 2014.

Exhibit 5: Weighted average price for oil and gas loans across vintage looks more distinct

Note: Loans industry categorized based on Moody’s criteria. Source: Intex, Amherst Pierpont Securities

A recent 44% plunge in oil prices

Oil prices continue to trend lower, partly reflecting an expected drop in travel, transportation and general economic activity. The drop also reflects a presumed price war of some duration among oil producers. Depending on the duration of these influences, highly leveraged oil and gas producers could face downgrade or default.

Exhibit 6: Oil prices have dropped 44% since mid-January

Note: data as of 3/10/2020. Source: Bloomberg, Amherst Pierpont Securities

The risk of triggering limits on ‘CCC’ loan holdings

Most CLO managers have a limit of 7.5% of portfolio par balance on loans rated ‘CCC’ or lower. If a manager exceeds the limit because of downgrades in oil and gas or any industry, the price discount from par on the excess ‘CCC’ loans counts against the par balance of the deal, potentially triggering diversion of cash flow from the most junior classes to more senior classes.  The reduction in deal par balance usually starts with the lowest priced ‘CCC’ loans first, making the price of ‘CCC’ loans important.

The older vintages of CLO with low oil and gas loan prices could see the sharpest impact if downgrades of any sort fill up the ‘CCC’ bucket. In a leveraged loan market likely to see ratings drift over the next few months, loan price matters as much as par exposure. More recent vintages look the strongest.

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