'Taiyang-ui Seokeoseu' Also Faces Financial Drought Due to COVID-19... Red Light for Low-Credit Companies

Credit Rating Downgrades for Collateralized Loan Obligations by Moody's and Other Rating Agencies

[Asia Economy Reporter Jeong Hyunjin] The COVID-19 pandemic is tightening its grip on companies with low credit ratings. This is because the possibility of default on collateralized loan obligations (CLOs), which serve as almost the only source of funding for these companies, is being raised. As central banks and governments around the world focus their economic stimulus measures on companies with high credit ratings, the risk of funding shortages for relatively low-credit companies has increased.

Bloomberg reported on the 2nd (local time), citing the example of Cirque du Soleil, that "the unprecedented decline in the value of leveraged loans is causing significant turmoil in CLOs." CLOs are asset-backed securities (ABS) secured by loans banks have made to companies, mainly used as a financing tool by low-credit companies with credit ratings of BBB- or lower.

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Canadian performance company Cirque du Soleil was hit hard as its tours, including those in Las Vegas, were canceled one after another due to the COVID-19 pandemic. Recently, Moody's and S&P downgraded the credit ratings of a significant portion of the company's $1 billion (approximately 1.23 trillion KRW) loans, which are CLOs utilizing leveraged loans. Moody's downgraded the rating four notches from B3 to Ca, and S&P lowered it three notches from B to CCC-. Bloomberg noted, "A downgrade of a single loan does not necessarily impair the repayment ability of CLOs, but if such downgrades occur simultaneously, it could impact CLO defaults and related issues."

The problem is that as low-credit companies face declining performance, the quality of CLOs is also deteriorating. According to Bloomberg, distressed companies have secured funding through CLOs amid prolonged low interest rates since the global financial crisis. However, recently, as the risk of default has increased, these risk factors have begun to be more reflected in CLOs. The COVID-19 pandemic has broadly impacted the real economy, increasing the risk of revenue decline and loan defaults for individual companies.

Moreover, the CLO market alone amounts to $670 billion (approximately 823.5 trillion KRW). Against this backdrop, the Wall Street Journal (WSJ) recently evaluated that "high-risk loans that appeared safe due to financial engineering are facing a massive test," referring to CLOs that pooled bonds of low-credit companies to reduce default risk.

Credit rating agencies have recently been paying attention to the business conditions of vulnerable sectors included in CLOs. Moody's, in a recent report, stated that the extent of exposure to vulnerable sectors due to COVID-19 and the refinancing needs of low-credit companies will affect the scale of CLO damage.

Moody's analyzed about 900 CLOs and found that, on average, 14.5% of the loans included in CLOs were exposed to "highly vulnerable sectors" negatively affected by COVID-19 and the drop in oil prices. Highly vulnerable sectors include hotels, gaming, leisure, retail (excluding food services), and automobile manufacturing. Moody's also reported that some CLOs have risk exposure levels as high as 34.1%. Exposure to "moderately vulnerable" sectors such as business and customer services, high-tech industries, capital equipment, and healthcare averaged 53.2%. Considering this, the exposure of CLOs to vulnerable sectors hit by COVID-19 approaches 70%.

Concerns about CLOs are arising across the United States and Europe. According to S&P, in a recent survey of European CLO managers conducted by JP Morgan, 45% of respondents were most worried about downgrades of loan ratings, while 26% were most concerned about CLO defaults. S&P stated, "Although widespread downgrades have not yet occurred in Europe, market participants know it is only a matter of time before downgrades happen."