From Reuters.com

Loan buyback-related rating actions stir debate

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A wave of downgrades tied to loan buybacks is igniting debate in the leveraged loan and CLO markets, highlighting the growing tension between CLO managers and rating agencies.

CLO managers are already facing mark-to-market losses resulting from the growing number of loans rated below triple-C in their portfolios. The proportion of CLO portfolios with 15-20% of assets rated CCC+ or below went from about 13% last month to about 37% this month, according to a May 8 research report from Morgan Stanley, which based its calculations on a sample of 527 transactions (Fig. 1).

CLO managers are now dealing with an additional problem arising from rating actions that place issuers that buy back their loans below par in technical default. These technical defaults, managers say, artificially inflate the number of distressed loans in their portfolio, increasing the likelihood that many CLOs will go static.

Loan buybacks – which occur when an issuer buys back its loans in the secondary market – have gained in popularity as issuers look to retire debt in a sub-par market and reduce interest costs.

The buybacks, typically completed via an amendment process, are not coercive in nature, giving investors the flexibility to decide whether or not they would like to tender their paper at the price being offered by the issuer. In some cases, companies use cash on hand or increased equity contributions from private equity sponsors to de-lever.