CLOs prove resilient amid First Brands loan rout
The sharp sell-off in loans tied to First Brands Group, a US auto-parts supplier, has rippled through credit markets in recent weeks — but for investors' outstanding senior secured loans held in Collateralised Loan Obligations (CLOs), the damage appears modest and distinct from reported off balance sheet financings. Here is our current take.
First Brands, best known for producing aftermarket car parts, ran into refinancing trouble this summer. The company scrapped a planned refinancing of its 2027 senior secured term loans in early August, prompting some lenders to demand a “quality of earnings” review. Soon after, reports surfaced that Apollo had built a short position against the company’s debt over concerns about its financial reporting, namely the use of “factoring”, a form of separate invoice financing— and investor confidence unravelled.
Within days, the price of First Brands’ first-lien loans plunged from the high 90s to the mid-40s, one of the steepest drops seen in the US loan market this year. Rating agencies responded swiftly: both S&P and Moody’s downgraded the company several notches, from B+/B1 to CCC+/Caa1, citing refinancing risks, high leverage, and strains in its supply chain financing.
Last week, First Brands Group, LLC and its affiliates filed for Chapter 11 protection in the US Bankruptcy Court for the Southern District of Texas. The company’s debt rout sent a chill through the leveraged loan space, particularly in the auto sector, which underperformed all other industries in September.
Despite the headline moves, CLOs’ exposure is modest and diversified. Out of roughly $4.7 billion in first-lien senior secured debt, US CLOs hold $2.1 billion (54% of the USD tranche), while European CLOs hold €520 million of the euro tranche. That equates to roughly 0.21% of total US CLO collateral and 0.19% in Europe — a small fraction of overall portfolios.
Importantly, most of the CLOs holding these loans are still within their reinvestment periods, giving managers flexibility to trade or adjust their portfolios. While exposure varies — from as little as 0.1 basis points (bps) to as high as 180bps across US managers, and up to 130bps in Europe (the highest exposure being in only three deals out of 470) — few have concentrations large enough to threaten the CLO debt tranches.
CLO pools contain on average between 150 and 400 individual names from fifteen sectors and similar geographic jurisdictions. Their structural built-in protection, active management, and diversified collateral pools mitigate single-name volatility and make CLOs one of the more resilient credit vehicles in a late-cycle environment. A single-B rated CLO tranche has on average 6.5% protection from losses, whilst for investment grade BBB tranches that grows to over 14%. In simple terms, if you assume a 50% recovery on the loan, European BBB CLOs with the maximum exposure would have loss coverage of 21.5x and single-B 10x, a clear example of how CLO structures dilute the risk of idiosyncratic events.
We have been in a low default cycle for quite some time now, and we don’t necessarily view the First Brands event as a sign of broader market weakness, but more of a contained, idiosyncratic shock, as loan market fundamentals remain broadly intact, supported by stabilising corporate earnings and lower leverage levels. However, dispersion — particularly in lower-rated CCC assets — is likely to persist as individual stories like this one emerge. What the CLO market offers, and which we consider an added value for investors is data transparency. Investors can see exactly what names have been added or sold in a CLO transaction at any point in time and at what price. In relation to the First Brands issue, for us it represents a powerful tool to evaluate managers and assess their skills and their best practices in managing CLOs.
CLOs appear well-positioned to navigate the next phase of the credit cycle. Nevertheless, as we expect divergence in performance within the space, due diligence and deal selection should remain a key focus for investors.
