The Wall Street Journal - 21.03.2020 - 22.03.2020

THE WALL STREET JOURNAL. *** Saturday/Sunday, March 21 - 22, 2020 |B11

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tion in credit quality”

triggered by the coronavirus

pandemic.

A Cirque du Soleil spokes-

woman said the company was

“working day and night to

manage this difficult situa-

tion” and declined to comment

further.

While not as large as the

subprime-mortgage market

that felled the U.S. economy a

dozen years ago, the CLO

trade has become a big busi-

ness. Financial engineers have

manufactured more than $700

billion of CLO debt in the U.S.

and Europe in recent years.

Well-known managers include

Blackstone’s GSO Capital Part-

ners, Neuberger Berman and

Eaton Vance Corp.

According to the Interna-

tional Monetary Fund, in re-

cent years, these funds have

bought more than half of all

leveraged loans, a risky type

of debt used by private-equity

firms to make buyouts. For ex-

ample, private-equity firm TPG

bought Cirque du Soleil in a

2015 deal that saddled the cir-

cus with nearly $900 million

of debt that was later bought

by dozens of CLOs.

TPG declined to comment.

A CLO works like this: The

fund manager collects hun-

dreds of risky loans from dif-

ferent borrowers. It then re-

packages them into triple-A

rated paper, supported by

smaller, riskier slices of lower-

rated paper and equity, which

are sold to investors. Banks in

the U.S. and Japan, insurance

firms, hedge funds and money

managers have piled in as CLO

investors.

Cash flow collected from all

the loans goes to pay the high-

est-rated paper first. If there

is a problem with the underly-

ing loans, the riskier bonds,

which are lower rated, don’t

get paid. No triple-A rated

CLO bond has ever defaulted,

according to ratings firm S&P

Global Inc.

CLOs existed before the fi-

nancial crisis, but have blos-

somed in popularity in the

past few years. That created a

well of credit for risky compa-

nies to tap. As CLOs competed

for loans to invest in, borrow-

ers were able to take on more

debt per dollar of earnings at

lower rates, and to demand

looser terms, known as cove-

nants.

The industry now faces

looming problems. Lots of

funds invested in the same

loans, so a big default will

cause losses for many. The top

20 loans that saw the biggest

price declines from Feb. 27 to

March 11 were distributed

across nearly 500 funds, Trepp

data show. Trepp tracks 1,250

CLOs, which is about 85% of

the market.

Geoffrey Horton, CLO ana-

lyst at Barclays, says that lack

of concentration in any one in-

dustry should protect inves-

tors. The biggest industry con-

centrations in U.S. CLOs are

health care and pharmaceuti-

cals at 12.5% for the median

fund, followed by high-tech-

nology at more than 10%.

These are industries that

might partly benefit from the

coronavirus pandemic. Indus-

tries in the front line, like ho-

tels, gaming and leisure, retail,

energy and consumer goods

and transport, make up a com-

bined 14.8%.

Another problem is that the

industry may have underesti-

mated the likelihood that dif-

ferent industries can hit diffi-

culties simultaneously when

an unexpected event like the

coronavirus strikes.

Change in the strength of each currency against the dollar

Source: Tullett Prebon

10

–15

–10

–5

0

5

%

March

Euro

Yen

Pound

March 19

U.S. Fed boosts

dollar supplies

–15.6

CDS U.S. Intermediate

Holdings (Cirque du Soleil)

117 CLOs

–20.2

GIP III Stetson I

127 CLOs

>21

Fieldwood Energy

90 CLOsown two loans

Lots of collateralized loan obligations invest in the same loans and industries, so a big default will

cause losses for many.

Biggest industry

concentrations in U.S. CLOs*

Some loans

popular among

CLOs saw big

price falls

Sources: Barclays (concentration); Trepp CLO (loans)

*Other industries, not shown, total 39.9% †CLO count based on deals in Trepp’s database, which covers about 85% of the market.

‡Price drop reflects change from Feb. 27 to March 11.

Healthcareandpharma

Hightech

Banking,financeandrealestate

Businessservices

Hotels,gamingandleisure

Media

Telecom

Beverage,foodandtobacco

Chemicals,plasticsandrubber

12.5%

10.2

7.4

6.7

5.8

5.3

4.5

4.0

3.9

EXPOSURE

$450 million

$273M

$386M

BCP Renaissance

Parent

Owned by

203 CLOs†

Price drop‡

–16.0 cents

on the dollar

$208M

$164M

–17.5

McDermott

International

155 CLOs

The Federal Reserve on Fri-
day expanded a lending opera-
tion that will accept municipal
debt as collateral amid funding
strains that could intensify as
cities and states combat the
coronavirus pandemic.
The changes apply to a lend-
ing facility to backstop the $3.8
trillion money-market mutual-
fund industry unveiled on
Wednesday. The Fed originally
limited the program to the
$800 billion in
prime money-mar-
ket funds, which in-
vest in very short-
term corporate debt, but on
Friday extended it to certain
municipal money-market mu-
tual funds. Municipal bond
money-market funds contain
$134 billion, according to the
Fed.
The Fed said it would also
accept highly rated municipal
debt of less than 12 months as
collateral for the facility. While
that might help alleviate some
strains in muni-debt markets,
the bulk of stresses have been
in longer-dated securities that
aren’t eligible for the facility.
The central bank said the fa-
cility for the time being
wouldn’t accept more complex
securities such as variable-rate
demand notes or tender option
bonds, but that they would
consider adding them in the fu-
ture. The program’s main aim
is to maintain strong function-
ing of the financial system, and
especially short-term funding
markets that have faced pres-

Cirque du Soleilcanceled
itsfamedshowsinLasVegas
and around the world a week
ago, leaving fans disappointed.
Over 100 investment funds
suffered too, as the value of
the circus’s loans tumbled.
The company is among
thousands of businesses
whose loans have been pack-
aged with similarly risky, junk-
rated debts into funds, which
were then sold to investors
globally.
The idea behind these
funds, known as collateralized
loan obligations, or CLOs, is
that different businesses are
extremely unlikely to all hit
problems simultaneously. By
pooling and diversifying their
holdings, these funds could
transform risky loans into
highly rated, safe investments
that pay better yields than
Treasurys.
CLOs boomed in recent
years as investors hunted for
income in a world of ultralow
interest rates. That boom, in
turn, fed demand for risky lev-
eraged loans. The fast growth
led global regulators to warn
of potential instabilities build-
ing in the financial system.
The Bank of England even
compared the industry to the
subprime mortgage boom be-
fore the 2008 financial crisis.
Then came the coronavirus.
Its broad impact across indus-
tries—canceling flights, emp-
tying conferences, scrambling
vacations, closing restaurants,
emptying cruise lines and
shuttering schools and of-
fices—threatens to undermine
the key assumption that al-
lows CLOs to turn risky loans
into triple-A-rated invest-
ments: that diversifying loan
holdings will protect investors.
“These things were struc-
tured for perfection, for eco-
nomic good times,” said John
Griffin, a finance professor at
the University of Texas at Aus-
tin who has studied the CLO
market. He thinks that many
CLOs are likely to see losses,
though other people in the in-
dustry say it is too early to
tell.
Cirque du Soleil’s show can-
cellation made its already-
risky debt harder to repay. The
price of its senior term loan
tumbled to 69.5 cents on the
dollar after the shows were
called off, down from 92.5
cents as of Feb. 27, according
to Trepp CLO, which tracks the
industry.
On Wednesday, credit rat-
ings firm Moody’s Corp.
slashed Cirque du Soleil’s rat-
ing deep into speculative terri-
tory, citing a “broad deteriora-

BYCEZARYPODKUL
ANDPAULJ.DAVIES

Risky Loans Face a Huge Test From Crisis

Cirque du Soleil’s show cancellation made its debt harder to repay. An advertisement for the Beatles ‘Love’ by Cirque du Soleil.

ETHAN MILLER/GETTY IMAGES

tries, following an earlier round

of such “swap” lines announced

Sunday for central banks in Eu-

rope and Japan. On Friday, the

Fed said it would increase the

frequency of dollar funding op-

erations with five of the foreign

central banks. The announce-

ments came after investors and

companies scrambled for dol-

lars earlier this week, storing

up cash to weather a prolonged

coronavirus economic crunch.

“We are definitely seeing a

bit of easing” said Viraj Patel, a

foreign exchange and global

rates strategist at research firm

Arkera.

The scramble for dollars in

recent days was sparked by the

broader selloff as investors

moved to sell stocks, commodi-

ties and bonds, and rushed to

the safety of short-term dollar-

denominated debt and cash.

Other Fed moves have also

eased tensions. Yields on 10-

year Treasurys fell Friday to

0.932% from 1.121% Thursday,

according to Tradeweb. Yields

on European bonds also fell.

The clamor for dollars eased

and Treasury yields declined

Friday, signs that the Federal

Reserve’s moves to increase

dollar access are calming mar-

kets at the heart of the global

financial system.

The ICE Dollar Index, which

tracks the green-

back against a

basket of curren-

cies, fell 0.68% on Friday, to

102.05, following three days of

gaining more than 1%. Curren-

cies that have suffered against

a strong dollar gained, with the

British pound climbing 1.34%

after hitting its lowest level in

35 years earlier this week. The

Australian dollar fell 0.73% on

Friday and has lost 17% of its

value against the dollar this

year and is near its lowest

since 2002.

The Fed said Thursday it

would lend billions of dollars at

near-zero interest rates to cen-

tral banks in Australia, South

Korea and seven other coun-

BYCAITLINOSTROFF

Moves Show Signs

Of Calming Investors

rarily provide billions of dol-

lars at near-zero rates to other

central banks grappling with

greenback shortages in many

parts of the world. Earlier in

the week, the Fed said it

would launch a new lending

facility to backstop

money-market mu-

tual funds—an op-

eration that it ex-

panded Friday to include

municipal debt.

Some analysts said the moves

by the Fed and other central

banks had a stabilizing effect.

The measures, coupled with

efforts by governments to sup-

port businesses and people

facing months of disruption,

have given investors hope that

“the economic fallout, which is

going to be big, will at least be

minimized,” said Paul Jackson,

global head of asset allocation

at Invesco.

Still, the mood among mar-

ket participants remained sub-

dued.

“Any day that you see a lit-

tle bit of a rally, it tends to

last a day at most, because the

underlying problem of the vi-

rus is still there,” said Robert

Carnell, head of research and

chief economist, Asia-Pacific,

at ING Bank NV in Singapore.

Despite Friday’s losses, some

beaten-down stocks found re-

lief, at least temporarily. MGM

Resorts International gained

$1.41, or 18%, to $9.11. Cruise-

line operator Carnival added

$2, or 20%, to $12. United Air-

lines Holdings rose $3.22, or

15%, to $24.50. All three stocks

have still lost more than 70% of

their value so far this year.

Zoom Video Communica-

tions, whose teleconferencing

software has gotten heavy use

as lockdowns have forced mil-

lions of Americans to work

from home, climbed $6.78, or

5.5%, to $130.55.

“You can see investors

starting to turn to opportuni-

ties in the midst of the sell-

ing,” said Mike Loewengart,

managing director of invest-

ment strategy at E*Trade.

Adding to the many swirl-

ing dynamics in the markets,

Friday was a “quadruple

witching” day, meaning op-

tions and futures on both in-

dexes and stocks were set to

expire simultaneously.

Some traders said the large

chunk of options expiring may

have put a lid on market vola-

tility, compared with the even

wilder swings seen earlier in

the week.

Continued from page B1

Stocks End

Worst Week

Since 2008

that, in turn, extend credit. The

Treasury Department has

kicked in $10 billion to cover

credit losses the Fed sustains

in the money-market facility.

The money-market facility

required the approval of Trea-

sury Secretary Steven Mnuchin

because the Fed invoked its

emergency-lending authorities

to authorize it. Mr. Mnuchin

said Friday he had also ap-

proved the latest expansion.

“This will create additional li-

quidity to support the states

and municipalities!” he said on

Twitter.

State and local governments

have canceled long-term bond

sales and watched their short-

term costs double or triple this

week as investors dumped

bonds. On Wednesday, rates

shot up to 5.2% from 1.3% last

week on variable rate munici-

pal bonds that reset their rates

every week according to what

bondholders are willing to pay,

according to the Sifma Munici-

pal Swap Index.

Separately, the central bank

said Friday it would ramp up a

program with five other for-

eign central banks to increase

the frequency of operations

that are designed to make U.S.

dollars available overseas at

near-zero interest rates.

The Fed initially unveiled

these “swap” lines with five

central banks in Canada, Eu-

rope and Japan on Sunday. The

central banks said Friday they

would conduct seven-day ma-

turity operations daily rather

than weekly, and that they

would continue to offer an 84-

day maturity operation weekly.

alongside equities. Mutual and

exchange-traded municipal

bond funds held $882 billion as

of Dec. 31, according to the Fed,

after record inflows last year.

The Fed’s move to shore up

money funds on Wednesday

came after it created another

lending facility that accepted

short-term commercial debt.

Many funds holding such debt

were unable to easily sell their

holdings to meet large volumes

of shareholder redemption re-

quests, according to industry

lawyers. Illiquidity in the com-

mercial-paper market made it

difficult for the funds to com-

ply with post-financial crisis

rules requiring them to hold

set quantities of liquid assets.

The Fed has currently com-

mitted to purchase $700 billion

in Treasury and mortgage se-

curities, but some Democratic

lawmakers have suggested in

the past that the central bank

should expand those purchases

to include municipal debt. By

law, the Fed can only buy mu-

nicipal debt with maturities of

up to six months.

While the Fed can’t buy cor-

porate debt or lend directly to

households and businesses, it

can invoke emergency powers

to establish lending facilities

sure this week. Even during the

2008 financial crisis, the cen-

tral bank never took as drastic

a step as it did Friday with mu-

nicipal bonds.

The money-market facility

extends risk-free loans to banks

that, in turn, can purchase the

assets of money funds and de-

posit them as collateral at the

Federal Reserve Bank of Bos-

ton, which is running the pro-

gram.

Municipal bond prices cra-

tered Thursday after a week of

tumult as investors fled the as-

set class, pulling a record $12.2

billion from mutual and ex-

change-traded funds in the

week ended Wednesday, ac-

cording to Refinitiv.

“It sucks,” said Hazim Taib,

chief financial officer of the

Connecticut Housing Finance

Authority, which is now paying

between 5% and 7.5% on its

about $825 million in AAA-

rated tax-exempt variable-rate

debt. “A market that is sup-

posed to be liquid and func-

tioning is no longer liquid and

functioning so if you want

somebody to buy your bonds

you have to pay through the

nose.”

Yields on 10-year triple-A

rated munis climbed to 2.34%

from 1.84% in 24 hours Thurs-

day—higher than the rate 30-

year bonds paid out as recently

as Monday, according to Refini-

tiv. Fund managers seeking

bids on long lists of bonds

struggled to find offers they

were willing to take and inves-

tors were shocked to see muni

portfolios built as a hedge

against stock volatility drop

BYNICKTIMIRAOS
ANDHEATHERGILLERS

Fed Takes Steps to Address

Strains in Muni-Debt Market

Municipal bond

prices cratered as

investors fled the

asset class.

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