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Moody's recovers some CLO rating market share after change in methodology

The share of new-issue CLOs rated by Moody's rose in the first seven months of 2021 as the rating agency clawed back some of the ground it lost in 2020. The recovery comes amid a decline in market share from Fitch, which is now proposing amendments to its CLO rating criteria.

The Moody's share of CLO ratings in 2020 had fallen to multiyear lows in both the U.S. and Europe, according to LCD, prior to a change in methodology by Moody's in December 2020 that resulted in significant improvements in the weighted average rating factor, or WARF, which indicates the default probability of a CLO's collateral assets.

For the most part, managers in the U.S. hire one rating agency to rate their CLOs, although some opt for up to three. As of July 31, 67% of new-issue CLOs were rated by one rating agency, while 31% were rated by two and 2% were rated by three (based on new-issue CLO count as tracked by LCD). For European deals, two is commonplace, with 94% of new-issue deals this year rated by two agencies and the remainder opting for three.

As of July 31, Moody's had rated 41% of new-issue U.S. CLOs in 2021, versus 22% for full year 2020. The increase was more pronounced in Europe, where Moody's rated 92% of new-issue deals, by count, from January to July, after rating 52% of transactions in 2020, according to LCD data.

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In December 2020, Moody's published its updated methodology for rating CLOs, in which the key change related to the treatment of assets in a CLO that have a negative outlook or whose ratings are on review for downgrade.

As part of the updated methodology, for the purpose of assessing an obligor's Moody's Default Probability Rating, assets on review for downgrade are now adjusted down by one notch, versus two previously. In addition, there are now no adjustments for assets that have been assigned a negative outlook, whereas previously they were adjusted down by one notch.

Anecdotally, managers contacted by LCD said that the extra points of WARF gained as a result of adopting the amended language on existing CLOs were significant and made Moody's a more attractive prospect for new issues.

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S&P Global Ratings, which rated 89% of the new-issue U.S. CLOs that priced in 2020, according to data compiled by LCD, still remains the rating agency of choice in the U.S. despite an observed decline, featuring on 67% of U.S. deals this year. However, in Europe, S&P Global Ratings has featured on slightly fewer deals than Moody's, rating 88% of new-issue CLOs, versus 95% in all of 2020, LCD data shows. LCD is a unit of S&P Global Market Intelligence and not S&P Global Ratings, which is a separately managed division of S&P Global.

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Should these trends hold, the share of rated deals by Fitch Ratings will fall to multiyear lows. Indeed, Fitch has featured on 19% and 20% of new-issue U.S. and European deals, respectively. In 2020, Fitch rated 35% and 53% of U.S. and European deals, while in 2019, it featured on 66% and 85%, respectively.

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Fitch changes

On Aug. 9, Fitch Ratings published proposed updated assumptions to its global criteria for rating CLO notes, which is expected to result in a "modestly positive impact on ratings," with approximately 4% of U.S. CLO ratings and 30% of Europe, the Middle East and Africa CLO ratings affected, Fitch Ratings wrote in an accompanying press release.

"CLO notes currently rated in the 'AAsf' category may be upgraded by one notch, while 'Asf' and lower rating categories may be upgraded by one to two notches as a result of the proposed criteria changes. There are no downgrades expected from the criteria update," Fitch wrote.

The key changes being proposed include an update to Fitch's base case probability of default assumptions to reflect — among other things — the continued decline in default rates, a shorter risk horizon by up to one year than the maximum permitted weighted average life that reflects observed performance, and an update to its default timing and distribution assumptions.

Among other changes are updated industry categories and specific scenarios for CLO notes backed by static portfolios.

"Fitch's updated assumptions reflect the durable performance of CLO notes through multiple cycles including the most recent coronavirus recession and the continued development of the global leveraged loan market," Fitch wrote.

Feedback on the exposure draft is requested by Sept. 10.

Spokespeople for S&P Global Ratings, Moody's and Fitch declined to comment on this story when contacted by LCD.