Impact of Fed Hikes on Lower-Rated CLO Collateral

Apollo Chief Economist

Fed hikes are having a more and more negative impact on companies with higher leverage, lower coverage ratios, and weaker cash flows. Specifically, the latest data for the third quarter shows that downgrades by S&P of CLO collateral have surpassed upgrades by a ratio of 4:1, see the first chart below.

The bottom line is that Fed policy is working exactly as the textbook would have predicted. Higher rates are biting harder and harder on middle-market corporates with poor credit metrics.

With total employment in high yield-issuing companies at 11 million and total employment in loan-issuing companies at 8 million, higher rates will ultimately have a negative impact on employment, see the second chart.

Source: S&P Global Ratings, Apollo Chief Economist
Total employment in the US high yield index: 11 million; total employment in the leveraged loans index: 8 million
Source: Bloomberg, ICE BofA H0A0 Index, Morningstar LSTA Index, Apollo Chief Economist. Note: Data includes 842 companies in the HY index with employment data available for 584 companies and median employment assumed for the rest. Similarly, there are 1,073 companies in the leveraged loans index with employment data available for 450 companies and median employment assumed for the rest.

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