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S&P: CLOs show strong historic performance with few defaults

The CLO asset class has performed strongly, according to a recent report from S&P (“Twenty Years Strong: A Look Back At U.S. CLO Ratings Performance From 1994 Through 2013”), with few negative rating actions on senior notes due to underlying collateral deterioration, few defaults, and minimal loss rates since the agency started rating the asset class in the mid-1990s.

The data show that very few rated CLO 1.0 tranches have defaulted despite these CLOs weathering at least one recession (and in some cases two). The agency believes the data show that CLOs are a robust platform that has been able to withstand significant levels of economic stress, and one that should continue to demonstrate a positive performance, provided that the leveraged loan default rate remains low.

Looking at the default statistics, of the over 6,100 ratings issued by S&P on over 1,100 U.S. CLO transactions, only 25 tranches have defaulted and had their rating lowered to D as a result. Based on this, S&P calculated a 0.41% default rate, or just over four tranches for every 1,000 it has rated.

In addition to the tranches that have already defaulted and had their ratings lowered to D, there are still another seven CLO tranches currently carrying a CC rating (used when the agency expects default to be a virtual certainty, regardless of the anticipated time to default).

Assuming that all seven of the CLO tranches rated CC ultimately will default, the default rate would be 0.52%, or just over five tranches for every 1,000 rated.

Most of the CLO tranche defaults occurred in the wake of the 2008 financial crisis.

The 25 defaulting CLO tranches can be grouped into one of these general categories:

  • Collateral deterioration (12 tranches)
  • Market-value provisions (six tranches)
  • Missed interest on non-deferrable notes (five tranches)
  • Investor actions (two tranches)

Analysis of the full universe of rated CLOs shows that at year-end 2013 only eight investment-grade CLO tranches (or 0.15% of the notes originally rated BBB- or higher) have defaulted, while 17 speculative-grade CLO tranches (or 1.78% of the notes originally rated BB+ or lower) have defaulted. This compares very favorably with the percentage of rated speculative corporate loans that have defaulted.

Notably, no tranches originally rated AAA or AA experienced a loss. For the limited number of tranches that experienced a default, S&P observed losses averaging in the mid-40% area for tranches originally rated investment-grade, and the mid-50% area for tranches originally rated below investment-grade.

2013 CLO performance remains strong

Since the mid-1990s, Standard & Poor’s Ratings Services has rated more than 1,100 U.S. cash-flow CLOs with an aggregate note balance of more than $645 billion (including equity). At year-end 2013, 705 of these CLOs were still outstanding, with an aggregate note balance of approximately $293 billion, versus 654 CLOs and $279 billion at the start of the year.

As of year-end 2013, S&P had 402 CLO 1.0 transactions remaining (or $151 billion in volume terms), versus 303 CLO 2.0 transactions (or $143 billion).

The same positive rating performance trends of the past several years continued in 2013, primarily due to the generally positive performance of the underlying corporate loan collateral.

Performance indicators benefiting CLO transactions include:

  • Stable rating performance of non-financial U.S. speculative-grade companies
  • A continuation of low leveraged loan default rates through 2013
  • Elevated loan repayment rates

This stable collateral performance has translated to stable rating performance among CLO 2.0 transactions, and, combined with the amortization of senior tranche balances, upgrades on many CLO 1.0 transactions on the back of large paydowns to senior notes.

Those downgrades to CLO 1.0 ratings that did take place in 2013 mostly occurred in CLOs that had paid down significantly, but which are now left with small, relatively concentrated portfolios with significant exposure to loans from CCC companies.

CLO 2.0 transactions continued to show stable rating performance in 2013, with a few upgrades and no downgrades. – Staff reports