NEW YORK (S&P Global Ratings) April 9, 2020--S&P Global Ratings continues to assess the rapidly shifting credit dynamics within collateralized loan obligation (CLO) portfolios due to the recent, and continuing, rating actions (downgrades, CreditWatch placements, and outlook changes) on the speculative-grade corporate loan issuers that back them. In light of this rapid shift, and consistent with our criteria for analyzing CLOs (see "Global Methodology And Assumptions For CLOs And Corporate CDOs," published June 21, 2019), we may make qualitative adjustments to our analysis when rating CLO tranches to reflect the likelihood that changes to the credit profile of the underlying assets may affect a portfolio's credit quality in the near term. Deterioration in credit quality between pricing and closing might increase the possibility of a transaction being assigned preliminary ratings in connection with its pricing date that would later fail to pass our analysis at close.
In ordinary circumstances, to rate a tranche at a given level, we look for the break-even default rate (BDR) generated from our Cash Flow Evaluator model for a CLO tranche to exceed the scenario default rate (SDR) generated by our CDO Evaluator model at the applicable rating level.
However, given the uncertainty and pace of corporate rating actions in the current market environment, and to address concerns regarding the potential sensitivity of a particular portfolio's credit profile to these changes in the near term, we may now look for a cushion by which the BDR must exceed the SDR for each class we rate within a CLO transaction on a case-by-case basis as well. When reviewing CLO portfolios in the current credit environment, we intend to review the likelihood of near-term changes to the credit profile by evaluating transaction-specific risk factors that may include, among others, the percentage of the underlying portfolio that comes from obligors that:
- Have ratings in the 'CCC' range;
- Are rated 'B-';
- Have ratings currently on CreditWatch with negative implications;
- Have ratings currently with a negative outlook;
- Operate in what we view as a higher-risk corporate sector (see Related Research section below); and/or
- Sit within a static portfolio CLO transaction.
Our analysis will consider the relative size of such percentages compared to the portfolios of other similar CLO transactions. We will assess the above factors when analyzing new issue CLO transactions, as well as when conducting surveillance of existing transactions for purposes of considering which tranches might not have the credit support commensurate with their current ratings any longer.
For those CLO transactions where we perceive a lower risk due to a material change in credit profile compared to peers, the minimum cushion between the CLO tranche BDRs and SDRs would generally be limited to 1%. For transactions where we perceive the risk of a near-term change in credit quality to be greater, we would generally expect a minimum BDR-to-SDR cushions of up to 5% across the rated notes. Our expectation is that most analysis will result in cushions around the mid-point of this range. We will continue to assess this cushion range and its applicability in light of market conditions.
S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak around midyear, and we are using this assumption in assessing the economic and credit implications. In our view, the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Related Criteria
- Global Methodology And Assumptions For CLOs And Corporate CDOs, June 21, 2019
Related Research
- Credit Conditions Europe: Europe Goes Into Lockdown, April 1, 2020
- Credit Conditions North America: Unprecedented Uncertainty Slams Credit, March 31, 2020
This report does not constitute a rating action.
The report is available to subscribers of RatingsDirect at www.capitaliq.com. If you are not a RatingsDirect subscriber, you may purchase a copy of the report by calling (1) 212-438-7280 or sending an e-mail to research_request@spglobal.com. Ratings information can also be found on S&P Global Ratings' public website by using the Ratings search box located in the left column at www.standardandpoors.com. Members of the media may request a copy of this report by contacting the media representative provided.
| Analytical Managers, U.S. CLO Team: | Brian O'Keefe, New York + 1 (212) 438-1513; brian.okeefe@spglobal.com |
| Jimmy N Kobylinski, New York (1) 212-438-6314; jimmy.kobylinski@spglobal.com | |
| Analytical Manager, European Structured Credit Team: | Emanuele Tamburrano, London (44) 20-7176-3825; emanuele.tamburrano@spglobal.com |
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