CLO market observes SVB collapse with trepidation

News Analysis 13 March

CLO market observes SVB collapse with trepidation

CLO market participants observed the fallout from the collapse of Silicon Valley Bank with trepidation on Monday (13 March) as fears over contagion in other parts of the financial landscape remained heightened, according to market sources. The US government took over SVB on Friday, and fellow tech-focused institution Signature Bank on Sunday.

While SVB was a lender in a select number of leveraged loans, generally the asset class is well protected from the direct fallout of SVB's collapse, with the bank focused on high growth companies in an earlier stage of the business cycle than a typical leveraged loan issuer.

Erik Miller, partner at Canyon Partners based in Dallas, said he would be surprised if the CLO market had much exposure on the asset side.

"The kinds of companies that occupy the CLO market, and certainly the companies that we invest with, tend not to be SVB's profile of clients," Miller said. "CLOs either buy more established tech that has made its way to the balance sheet of a bigger bank, or they buy more traditional businesses - such as industrials, hospitality or real estate - which never had big books with SVB to begin with".

On the CLO liability side, SVB was not a major holder of CLO paper on its own books, sources said. However, some of the smaller or regional US banks that saw their stock prices fall on Monday do invest frequently in CLO triple-As, meaning the asset class could see continued selling pressure as banks focus on their liquidity issues.

"Regional bank stocks are down pretty hard today," said Dan Ko, principal and portfolio manager at Eagle Point Credit Management. "Some of them are triple-A buyers who have more pressing matters on their hands than CLO primary activity right now".

US CLO triple-As were trading 20 to 30 basis points wider on Monday than the end of last week, sources said, while the loan market saw an equivalent move wider in spreads.

The CLO formation engine continued apace on Monday with two US new issues, amounting to USD 900m for new issuance. Sources said they expect the creation of new CLOs is likely to pause or slow in the short term, as investors wait for increased clarity on the fallout from SVB's collapse.

Some commenters, including research strategists at Bank of America have argued that CLOs, which are floating-rate and have mark-to-market price stability, could have helped SVB and other banks with their solvency issues amid the rising interest rate environment of the last year.

"The story here is not a credit story and the broad banking system remains exceptionally well-capitalised," wrote BofA analysts Pratik Gupta, Chris Flanagan and Victoria Xu in a research paper on Monday. "Cracks in the system will no doubt continue to emerge as individual banks and other sectors adjust to the Fed's higher-rate world and economic fundamentals deteriorate".

In the longer term, the impact of the collapse of SVB on the Federal Reserve's interest rate hiking is likely to be felt across risk assets, including loans and CLOs. Analysts at Goldman Sachs said that they no longer expect the Fed to hike rates again later this month, which would have profound impacts on CLO market forecasts for 2023.

"In light of recent stress in the banking system, we no longer expect the FOMC to deliver a rate hike at its 22 March meeting with considerable uncertainty about the path beyond March," wrote Goldman's analysts on Monday.