European CLO Performance: An Interactive Look At ‘CCC’ Exposure And The SPWARF

On March. 24, 2020, S&P Global Ratings published its quarterly European CLO index publication covering fourth-quarter 2019 performance, in which we took a look at some of the key metrics behind our ratings on the CLO notes (see "European CLO Performance Index Report Q4 2019").

Recent concerns include the underlying assets' credit quality, particularly in relation to the potential rating migration of 'B-' rated issuers to the 'CCC' rating category. In fourth-quarter 2019, exposure to assets rated in the 'CCC' category increased quarter-on-quarter. However, European CLO exposure to 'CCC' category rated assets remains low, with the average transaction having a 2.9% exposure and with more than 75% of CLOs having an exposure of 4.0% and below.

Managers' Exposure To Assets Rated In 'CCC' Category, Q4 2019

^{Source: S&P Global Ratings.
Copyright © 2020 by Standard & Poor's Financial Services LLC. All rights reserved.}

All European CLO transactions except one remain below the typical 7.5% limit in transaction documentation. Exposure over this limit is carried at a haircut for the purpose of the overcollateralization test so that it breaches quicker and, in times of stress, diverts interest to deleverage the most-senior tranche. To understand how increasing 'CCC' exposure impacts coverage tests generally and how variations in CLO documentation can impact noteholders differently, see this video.

Managers' Exposure To Assets Rated 'B-' And In 'CCC' Category, Q4 2019

^{SPWARF--S&P Global Ratings' weighted average rating factor. Source: S&P Global Ratings.
Copyright © 2020 by Standard & Poor's Financial Services LLC. All rights reserved.}

A higher concentration of assets in the 'B-' and 'CCC' rating category generally implies a riskier portfolio. This is reflected in a higher S&P Global Ratings' weighted-average rating factor (SPWARF), which in turn, increases the scenario default rate, our measure of portfolio credit risk. The chart above shows the relationship between the SPWARF and the proportion of assets rated 'B-' and below. While there is a generally a positive relationship between the two factors, differences can occur due to the barbelling of portfolios.