CLO market dulled by software spillover

Blame the downbeat software sector. Fear of disruption from artificial intelligence has gripped investors and sent leveraged loan prices for software firms tumbling.

That AI worry is having ripple effects. The sell-off in software loans that began earlier in the year, with some pointing to an inflection point on 9 January, has begun to seep through the broader market.

“The software risk isn’t spilling over, but the sentiment is. CLO managers are getting more conservative, spurred by what’s going on in the software space,” said Robert Zable, global head of CLOs and liquid bank loans at Guggenheim.

Overall leveraged loans, even those without AI exposure, have fallen about an eighth to a quarter of a point, according to market participants. Those that have been pummelled by AI worries have seen their secondary prices slide two to four points lower.

“Loan prices have sold off across every rating spectrum. It seems to me there is real concern about what might happen if artificial intelligence disruptions are really significant,” said Michael Kurinets, CLO investor at Capra Ibex. “It’s been discussed for a long time but the singular focus is very recent... Almost every piece of research from every dealer seems to be about AI disruption to software development.”

Bank of America, Barclays, Deutsche Bank, Goldman Sachs, JPMorgan Chase and Barclays are just a few of the investment banks whose research outfits have penned concerns about artificial intelligence and software risk in recent days.

Perhaps nowhere has the impact been felt more strongly than in the repricing of leveraged loans, typically a barometer of the robustness of investor demand. Both the US and European markets saw a frenzy of repricing activity in January, with Europe recording the biggest amount of repricing ever in its history, according to Bank of America Research.

“The loan market opened the year at full throttle, but a sudden AI-risk roadblock has ground momentum to a halt,” said Scott Macklin, head of US leveraged finance for Obra Capital.

After a multi-month peak in repricing volume, signs of investor fatigue have emerged, said Macklin. This week’s calendar is notably leaner on repricings, and has filled with refinancings and M&A-led acquisition financing.

“If you look at the secondary price of recently repriced loans, they aren’t trading up that much and that gives managers more conviction to say no,” said Zable.

European software company Team.blue’s dollar loan repricing was reportedly shelved due to the volatility, according to BofA Global Research. German healthcare software firm Dedalus also halted a leveraged loan repricing, according to sources.

“There’s a level the market will accept. And then the market just goes, actually, I’d rather run cash,” said Daire Wheeler, head of European liquid credit at Benefit Street Partners, speaking about repricings. “It takes a bit of time — that will come in through February, March, April.”

The problem could be particularly acute for private credit CLOs. Software concentration risk is highest in private credit, which has 20% of its AUM in tech, according to Barclays. This is far more than the exposure of broadly syndicated loans.

So far, for both BSL and private credit CLOs, the issuance calendar hasn’t felt an impact from the leveraged loan softness. As Creditflux went to press, Oak Hill Advisors priced a BSL CLO reissue with its senior triple As at SOFR plus 114bps, a fresh recent low, with GoldenTree pricing a reset with its triple As one basis point wider. Bankers are prepping more deals, according to market participants.