March 23, 2017 - On Wednesday, Bloomberg, WSJ and LCD – and nearly every other news outlet – warned that Sears had added “going concern” language to its latest filing with the SEC. On the news, Sears’ stock fell 12%.

While high profile, Sears is just the latest retailer to see troubling headlines. As has been widely discussed, e-commerce is biting at many retailers’ margins, and the proposed border adjustment tax has the potential to be particularly painful for the sector. But despite the headlines, retail hasn’t contributed much to default rates in recent years. In a report released yesterday, Fitch calculates that the sector’s average default rate over the past 10 years was 1.8%, below the overall loan market’s 2.7% default rate. But this may be changing; retail is the third most stressed sector, with more than $6.5 billion of loans on Fitch’s watchlist. All told, Fitch sees $6 billion in retail defaults in 2017 (a 9% default rate), very close to the $6.4 billion of energy defaults tallied in 2016.

How are pressures in the retail sector appearing in the secondary market – and in CLO portfolios? On Wednesday, the LSTA posted secondary trading trends, and noted that – while the retail sector is bifurcated – it is generally trading actively (and downwardly). Meanwhile, last week, Morgan Stanley and Nomura delved into the impact of retail exposure in CLOs. Retail accounts for roughly 8% of CLO portfolios – and for a fair amount of stress. While just 6.4% of loans in the S&P/LSTA Leveraged Loan Index are priced below 90, 20% of retail loans in CLOs are, Nomura noted. However, not all retail sectors are created equal. On the high end, no pet stores (though the sector is sliding) or restaurants are priced below 90, and just 1% of grocery chains in CLOs are below that demarcation. But sadly, 52% of apparel, which is the largest retail subsector, is priced below 90. Department stores also are hard hit, with 73% of the segment priced below 90. Now, to be fair, department stores account for only 6% of CLO retail exposures – and Sears doesn’t even crack the top 50, Morgan Stanley reports. However, there’s $920 billion of Neiman Marcus exposure in CLOs and, unfortunately for those CLOs, it’s priced near 80, according to TR-LPC.

And if one takes a broader definition of “distressed”, the news is worse. Rather than focusing solely on price, Morgan Stanley defined distressed CLO collateral as loans rated CCC+/Caa1 or lower or rated B-/B3 or higher but trading at CCC+/Caa1 levels. Based on this broader classification, MS sees 30% (by balance) of loans in Textile & Apparel Manufacturing and 24% of loans in Retailing (excluding food & drug) as distressed. By these calculations, retail-related credits account for more than 20% of the distressed collateral in U.S. 2.0 CLOs. This is the largest single distressed sector in CLOs, including oil & gas. So, while the retail lagged the overall default rate in the last decade, it may lead in the next decade.

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