By the Numbers
The rise of technology raises CLO risk and reward
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.
CLO exposure to technology companies has drifted higher for nearly a decade, but that has accelerated recently. Technology issuers this year make up 25% of new loans. But technology loans tend to carry lower ratings and trade with more volatility than other sectors. As the Fed begins to cool the economy, technology could carry more risk than reward. And so could CLO managers that seem to be persistently overweight.
Issuance of leveraged loans tied to buyouts in technology has boomed recently, driven by record volume of M&A. The share of new-issue loans to software and data companies reached 25% of the institutional loan market this year, according to LCD, well above the historical 10% to 20% range (Exhibit 1). Remote working trends, online business service needs, infrastructure, and business intelligence investment may be contributing to the growth.
Exhibit 1: Tech leveraged loan share soars in 2022
Data source: LCD
Corresponding to the tech issuance boom in the loan market, the tech share of loans in outstanding CLOs has also been trending up since 2018 (Exhibit 2). From pre-pandemic levels around 10%, it has increased to 11.5%, a shallower ramp than the loan market overall.
Exhibit 2: Average tech loan share in outstanding CLO deals by issuance year
Note: Data show Moody’s industry code = high tech. Data only include outstanding CLO deals with Intex performance updates as of January or February 2022. Data shows tech share for remaining outstanding deals in each vintage.
Source: Intex, Amherst Pierpont Securities.
Not all managers have the same tech exposure. Across CLO deals issued from 2018 to 2021, the average deal tech exposure peaked in 2021 at 11.5% but with wide dispersion. A handful of CLO managers have consistently overweighted the sector in the past four years. For example, Eaton Vance, Blackrock and Neuberger Berman were on the Top 10 managers in tech exposure four years in a row (Exhibit 3).
Exhibit 3. Top U.S. CLO managers by tech exposure
Data source: INTEX, Moody’s industry code = high tech
Despite the tech sell-off in the equity market, the credit risk of the sector has been relatively stable. In February, S&P released its latest forecast on US speculative-grade corporate defaults and doubled its baseline forecast from 1.5% in December 2021 to 3% by end of 2022. Tech companies represent 9.3% of the total speculative-grade population S&P studied, and the agency has painted an overall less gloomy picture for the sector. Specifically, the rating upgrades in the tech sector exceeded rating downgrades by 11.3%, measured by issuer on a 12-month trailing basis (net rating actions). Looking forward, S&P’s positive rating outlook in the tech sector outpaces credit watch by 5.2% (net rating bias). In contrast, the agency expects the credit watch in all speculative-grade sectors to exceed rating positive outlook by 2.2% (Exhibit 4).
Exhibit 4. S&P rating actions and outlook for speculative-grade companies by industries
It is worth noting that tech is among the most leveraged sectors in the loan market and trades with relatively high volatility compared to the overall index. Tech, health care and business equipment and services are the top three industry sectors in the leveraged loan index, representing 35% of index current market value. Forty-five percent of leveraged loans in the tech sector are ‘B-‘, much higher than the 26% in healthcare and 16% in retailers. It is also 24% higher than the leveraged loan index (Exhibit 5). In the past years, benign credit risk coupled with low interest rates has rewarded investors who assumed risk. Both ‘B’ and ‘CCC’ loans in the index have outperformed ‘BB’ rated loans in recent years, a possible explanation for some CLO managers’ favorable tech allocations.
Exhibit 5: Rating distribution of selective industries in S&P LSTA leveraged loan index.
Data source: S&P LCD, rating distribution data as of March 2022.
Investors entered 2022 with a persistent inflation and heightened geopolitical risk, a very different macro-economic picture from past years. Tech loans will remain a large sector in CLOs given the issuance boom in leveraged loan space, but it is less certain whether the lower-rated, risky assets will outperform their counterparts the next time.
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