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Good Intentions, Limited Impact: ESG-Excluded Sectors Proliferate In U.S. CLO Indentures

With environmental, social, and governance (ESG) factors increasingly becoming a discussion topic amongst collateralized loan obligation (CLO) market participants in recent years, they have correspondingly influenced the language in CLO transaction documents. While a small number of European CLOs have added "positive" screening for ESG factors in recent years, where the manager scores individual companies and commits to maintaining a minimum threshold level for the transaction portfolio, U.S. CLOs have to date been more focused on "negative" screening, where the CLO indenture includes a list of sectors the manager is restricted from investing in for ESG or values purposes. Although the concept of negative screening in corporate loan and bond securitizations isn't entirely new (e.g., in 1999, we rated a U.S. collateralized bond obligation [CBO] with indenture provisions that disallowed the manager from investing in tobacco and firearms companies), ESG-excluded category provisions have become far more common in U.S. CLO documents over the past five years.

To examine the addition of the ESG-excluded category provisions to U.S. CLO documents and the proliferation of ESG-excluded sectors itself during that time, we reviewed more than 1,500 executed indentures from U.S. CLOs since 2014, including both new issue CLO transactions and CLO resets, which sometimes added ESG-excluded categories to the documents being amended in connection with the reset process. Our sample included both broadly syndicated loan (BSL) CLOs and middle market CLOs. We discuss our observations from our study in this article.

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The Influence Of Corporate ESG Factors In Our Credit Rating Analysis Of European CLOs

European collateralized loan obligations (CLOs) typically benefit from portfolio diversification in the form of obligors across many countries and industries. The credit rating of each obligor is one of the key inputs used in our CDO Evaluator model to generate a probability distribution of potential default rates for the given portfolio of assets in aggregate (see our CLO criteria in "Related Criteria And Research"). Therefore, if the influence of ESG factors in our credit rating analysis of the underlying obligors is material enough for our credit ratings to be affected, they can also, albeit indirectly, influence our credit rating analysis of CLOs. For each obligor, where assigned, we will use its ESG credit indicators and euro notional exposure to analyze the influence of ESG factors in European CLOs asset pools. To the extent a specific obligor has not been assigned an ESG credit indicator, for the purposes of this analysis, we have used ESG credit indicators for the parent or super parent under the hierarchy of the obligor as a proxy, where available. ESG credit indicators relate to an obligor's stand-alone analysis or, in the case of a parent company, the group credit profile. An obligor's ESG credit indicator does not reflect the influence of ESG factors on the related parent. As such, the ESG credit indicator could diverge from that of its related parent where assigned (see "ESG Credit Indicator Definitions And Application," published Oct 13, 2021"). Where no ESG credit indicator is available we do not include this obligor in our analysis of the underlying obligor in European CLOs.

Example of interactive charts within the full article;

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Everything you ever wanted to know about CLOs, Corporate Credits, Leveraged Finance and what they are. With the aim of providing market participants with further advanced analytical insight into Corporate Credits, CLOs and Leveraged Finance deals, S&P Global Ratings is holding regular podcast episodes every fortnight, based on key features we’re seeing in corporate credits and sectors that CLOs are exposed to.

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Quarterly Reports North America

U.S. CLO And Leveraged Finance Quarterly Key Themes: An Early Spring Chill In The Credit Markets

Our GDP growth forecast at 3.2% for 2022 remains favorable, but growth is slowing (down from 5.7% in 2021 and our prior 2022 forecast of 3.9%). Healthy consumer savings, low unemployment levels, and good corporate liquidity remain bright spots. Business headwinds will likely stall, or reverse, the net positive rating momentum seen over the last 16 months. Risks, including persistently high inflation, tightening financial conditions, ongoing supply chain disruptions and staffing challenges, and escalating geopolitical conflicts and tensions, have contributed to the increase in our 12- month recession estimate to the 20%-30% range.

Our ratings are skewed to the low speculative-grade categories, with about one-third of issuers rated 'B-'or lower. We are concerned that slowing growth, rising interest rates, and other cost pressures will impair this group's free cash flow generation, which is modest. Low near-term refinancing needs and good liquidity balances give some 'B-' issuers time to proactively adjust their operational and financial plans. Our corporate ratings (and consequently CLO ratings) have remained stable in spite of growing macroeconomic headwinds and increased volatility in the credit markets since the escalation of the Russia-Ukrainian conflict in late February. U.S. broadly syndicated loan (BSL) CLOs finished the first quarter with reasonably stable credit metrics, and our outlook is for stable CLO rating performance.

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Quarterly Reports EMEA

CLO Pulse Q2 2020: Sector Averages Of Reinvesting European CLO Assets

European collateral loan obligations (CLOs) typically benefit from portfolio diversification, both from an issuer and sector perspective, with CLO managers maintaining portfolios of leveraged loans that have an average exposure to 137 different corporate issuers operating across 38 different industry categories.

In this publication, we examine the aggregate asset quality held by European CLOs, observed through key credit metrics and consolidated by S&P Global Ratings' CLO industry sectors. Specifically, this edition of sector average metrics for European CLO assets focuses on loans issued by 477 corporate issuers, which represents over 95% of the assets under management (AUM) held in reinvesting European CLOs rated by S&P Global Ratings as reported at June 30. We calculated the average metrics for all floating-rate assets with both an S&P Global Ratings' credit rating and an S&P Global Ratings' recovery rating (the S&P Global Ratings-rated CLO assets), weighted by the euro notional exposure to each asset.

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Global Ratings And Default Trends

Quarter-On-Quarter Default Totals Inch Up

The 2022 global corporate default tally increased to 14 after Ukraine-based leading poultry meat producer and exporter of consumer goods MHP SE missed an interest payment. So far in 2022, the global corporate default tally is at its lowest year-to-date level since 2014; however, the pace of defaults has increased compared with the previous two quarters, which had 13 and 12 defaults, respectively (see chart 1). By region, emerging markets now leads the global corporate default tally along with the U.S., with seven defaults each. This is the highest year-to-date default tally for emerging markets since 2015 and comes at a time when global financing conditions are tightening, inflation is rising, and the Russia-Ukraine conflict is generating significant market volatility--all of which could lead to additional credit stress for lower rated issuers (see "Credit Conditions Emerging Markets Q2 2022: Conflict Exacerbates Risks," March 29, 2022).


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