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 136 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, our inaugural edition of sector average metrics for European CLO assets focuses on loans issued by over 480 corporate issuers, which represents over 90% of the assets under management (AUM) held in reinvesting European CLOs rated by S&P Global Ratings as reported at March 31. 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.
COVID-19 Caused Credit Deterioration In Q1 2020: Key Changes To Credit Metrics
Based on our review of first-quarter 2020 data, the average reinvesting European CLO portfolio rated by S&P Global Ratings exhibited the following changes:
- Credit quality deteriorated across several sectors as downgrades and negative CreditWatch placements due to the economic effects of COVID-19 increased toward the end of the first quarter of 2020. In particular, we draw on the inverse correlation between movements in the SPWARF and the WAP over the same time horizon (see chart 1).
- That said, entities held by European CLOs carry on average 0.25x less leverage than the overall European S&P Global Ratings-rated speculative-grade universe.
- Interest coverage ratios for European CLO obligors also imply, on average, at least 10% more headroom than the overall European speculative-grade universe.
- The average unstressed recovery implied by our corporate recovery ratings has continued to be at about 60% since 2019. Rating actions during the first quarter did not materially affect expected recoveries. However, as corporates resort to new debt raises to shore up liquidity, we expect to see lower recovery rates in subsequent quarters.
- The WAP of the loans in the CLO portfolios plummeted to 88 by the end of first-quarter 2020, although some prices rebounded at the beginning of Q2 (see chart 2).
Credit Quality Deterioration Offset by Robust Credit Metrics and Recoveries… For Now
Credit quality deteriorated in the first quarter of 2020, though less than a quarter of our overall negative rating actions during the period filtered through to CLOs and their holdings. This is a result of the type of industries most visibly and severely affected during March, such as transportation, oil, travel, and retail, which are less prevalent in European CLOs. We suspect the second quarter may lead to a further deterioration of the overall credit quality of CLO holdings, partially mitigated by active portfolio management.
Furthermore, the first quarter 2020 average debt-to-EBITDA and interest coverage ratios of issuers present in European CLOs were surprisingly robust at 6.0x and 3.1, respectively, which is in line with year-end 2019. Moreover, entities held by European CLOs carry on average 0.25x less leverage than the overall European S&P Global Ratings-rated speculative-grade universe. Interest coverage ratios for European CLO obligors also imply, on average, at least 10% more headroom than the overall European speculative-grade universe.
Before diving deeper into the results, it is worth highlighting the following caveats:
- 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.
- Our analysis of reinvesting euro CLO portfolio exposures include average values over time for key credit metrics (see table 1, as well as the Appendix for calculation specifics). Those metrics are:
- Issuer count: the obligor count across all European CLO transactions;
- SPWARF: the S&P Global Ratings' weighted average rating factor for the CLO collateral, with a higher value indicating a lower average rating across transactions;
- WARR: the weighted average recovery rate for the loans in the portfolios, as implied by the corporate recovery rating we have assigned to each loan;
- WAS: the weighted average spread over LIBOR of the loans in each CLO portfolio; and
- WAP: the weighted average price of the loans in each CLO portfolio based on market sources.
|European CLO Assets With Derived S&P Global Ratings' Credit Rating And Recovery Rating(i)|
|CLO (no.)||Obligor count (no.)||Asset count (no.)||Debt count (no.)||Asset amount (mil. €)||SPWARF||WARR (%)||WAS (%)||WAP||On CreditWatch Negative (%)||With negative outlook (%)|
|(i)See the appendix for detailed explanations of these metrics. SPWARF--S&P weighted average rating factor. WARR--Weighted average recovery ratio. WAS--Weighted average spread. WAP--Weighted average price.|
CLO Assets Weighted By Exposure
Weighted average metrics
Our analysis focuses on a pool of loans issued by over 480 corporate issuers, representing over 90% of the AUM currently held in reinvesting European CLOs that we rate. For each sector, we calculated the average metrics for all of the assets that we rate, weighted by the euro notional exposure to each asset. These metrics include the SPWARF, WARR, WAS, and WAP (see table 1 and the Appendix).
Average metrics per industry
The corporate issuers operating within various industries have different credit profiles, and the loans they issue also have different characteristics. Using CLO exposures for these CLO assets, we calculated the average metrics described in the Appendix, weighted by par, across the various Global Industry Classification Standard (GICS) sectors.
|Floating-Rate European CLO Assets With Derived S&P Global Ratings' Credit And Recovery Ratings|
|Global Industry Classification Standard sector||Obligor count (no.)||Asset amount (mil. €)||Exposure (%)||SPWARF||WARR (%)||WAS (%)||WAP||On CreditWatch negative (%)||With negative outlook (%)||Debt-to-EBITDA ratio||EBITDA interest coverage|
|Health care providers and services||37||3,933||8.80||2,774||68.41||3.36||91.68||-||1.88||7.67||2.86|
|Commercial services and supplies||32||2,433||5.45||2,741||63.27||3.91||86.33||-||2.11||6.66||3.03|
|Hotels, restaurants, and leisure||27||2,274||5.09||3,164||57.75||4.06||86.31||0.99||0.79||6.05||4.23|
|Diversified telecommunication services||14||2,159||4.83||2,596||59.84||3.17||91.63||-||1.58||6.14||3.35|
|Diversified consumer services||14||1,888||4.23||3,059||61.14||3.45||88.51||-||0.11||6.71||3.28|
|Trading companies and distributors||10||1,610||3.60||2,851||63.97||4.24||86.85||-||0.74||6.57||3.11|
|Health care equipment and supplies||11||862||1.93||2,950||66.82||3.80||88.97||-||1.01||7.98||2.88|
|Containers and packaging||17||765||1.71||2,825||68.12||4.06||88.46||0.00||0.49||6.83||3.56|
|Technology hardware, storage, and peripherals||4||677||1.51||3,296||62.45||3.96||89.84||-||0.88||7.39||2.43|
|Internet And catalog retail||9||593||1.33||3,323||65.79||4.08||88.32||0.23||0.22||5.76||4.07|
|Real estate management and development||5||566||1.27||2,980||64.88||4.68||89.17||-||0.28||6.53||3.40|
|Aerospace and defense||9||548||1.23||2,456||64.52||3.52||88.27||-||0.32||6.25||4.88|
|Life sciences tools and services||6||522||1.17||1,838||53.97||3.22||95.20||-||0.32||6.46||3.98|
|Electronic equipment, instruments, and components||6||491||1.10||2,723||60.66||3.44||89.32||-||0.34||7.12||3.36|
|Construction and engineering||9||470||1.05||2,809||67.82||3.98||92.61||-||0.41||5.81||7.35|
|Food and staples retailing||5||361||0.81||2,568||56.58||3.95||92.10||-||0.20||5.76||3.56|
|Interactive media and services||5||281||0.63||3,371||57.08||4.32||91.68||0.19||-||7.72||2.27|
|Paper and forest products||4||226||0.51||2,506||69.23||4.51||89.48||-||-||4.73||5.38|
|Textiles, apparel, and luxury goods||2||175||0.39||3,039||66.20||3.93||81.44||-||-||7.10||3.53|
|Metals and mining||2||138||0.31||2,860||67.24||3.83||89.33||-||-||5.46||2.94|
|Wireless telecommunication services||1||103||0.23||1,982||65.00||3.50||93.44||-||-||4.63||4.64|
|Semiconductors and semiconductor equipment||2||98||0.22||1,009||50.73||3.34||95.12||-||-||1.01||15.06|
|Air freight and logistics||1||30||0.07||2,860||71.50||6.25||N/A||-||0.07||5.24||2.95|
|Oil, gas, and consumable fuels||2||9||0.02||5,749||44.39||5.41||100.29||-||-||4.32||5.82|
|Road and rail||1||0||0.00||3,610||50.00||5.25||N/A||-||-||5.46||3.33|
Ratings bias per GICS sector
At the end of the first quarter, 26.0% of the S&P Global Ratings-rated CLO assets had a negative rating bias (i.e., ratings from issuers with a negative outlook, or on CreditWatch negative), up from the 21.21% at the start of 2020. We also examined the breakdown between negative bias, positive bias, and stable for 21 GICS sectors, each weighted by euro notional exposure (see chart 3). The bias breakdown per GICS sector can be sensitive to the rating bias of the issuers with higher CLO exposure, particularly the GICS sectors with less obligors.
The scope: S&P Global Ratings-rated CLO assets, representing 90% of AUM in reinvesting European CLOs
The information is based on the aggregation of CLO exposures to corporate issuers as reported in first-quarter 2020 trustee reports of reinvesting European CLOs.
S&P Global Ratings' corporate group issues and maintains credit ratings for the vast majority of companies that issue the loans held in CLOs. As part of our credit rating process, we capture various ratios of the issuer at the time of the rating. We also issue and maintain recovery ratings for most loans held in CLOs.
Almost all of the companies that issue loans held in European CLOs are classified within the GICS. These industry classifications are utilized within the CDO Evaluator credit model, which S&P Global Ratings' structured finance group uses in its rating process for CLOs.
We aggregate CLO exposures reported in trustee reports available as of the end of first-quarter 2020 and calculate various metrics, weighted by the outstanding par amount of exposures and stratified by the GICS classification of the issuer of the loans. Our analysis focuses on those assets with an S&P Global Ratings' credit rating and an S&P Global Ratings' recovery rating. These S&P Global Ratings-rated CLO assets were issued by over 480 corporate issuers operating across various GICS industries and represent over 90% of the total par of the CLOs aggregated in this first-quarter 2020 update. The credit rating, recovery rating, spread, price, and leverage ratio values of these floating S&P Global Ratings-rated CLO assets were used to calculate the averages outlined in tables 1 and 2.
The six metrics we use in our analysis are listed below.
S&P Global Ratings' weighted average rating factor (SPWARF)
The SPWARF of a CLO portfolio provides an indication of the overall credit rating distribution of the portfolio, weighted by each asset's par balance. The rating factor for each of the portfolio assets is determined by S&P Global Ratings' credit rating (or implied rating) and the rating factor. (An individual asset's S&P Global Ratings rating factor is the five-year default rate, given the asset's S&P Global Ratings credit rating and the default table in the corporate CDO criteria, multiplied by 10,000.) The SPWARF is calculated by multiplying the par balance of each collateral obligation by the S&P Global Ratings rating factor (including exposures to issuers with a non-performing rating: 'CC', 'SD' and 'D', each with a rating factor of 10,000), then summing the total for the portfolio and dividing this result by the aggregate principal balance of the collateral obligations included in the calculation.
Weighted average recovery rate (WARR)
For a subset of assets with an S&P Global Ratings recovery rating, the WARR is the sum product of each asset's recovery rate (the number within parenthesis to the right of the recovery rating) and the asset's par exposure as a percentage of the sum of the par of the subset of assets. For more details on S&P Global Ratings' recovery ratings, see "Recovery Rating Criteria For Speculative-Grade Corporate Issuers," published Dec. 7, 2016.
Weighted average spread (WAS)
For a subset of floating-rate assets, the WAS is the sum product of each asset's nominal spread above the base rate and the asset's par exposure as a percentage of the sum of the par of the subset of assets.
Weighted average price (WAP)
For a subset of assets with loan prices, the WAP is the sum product of each asset's price at the end of the quarter and the asset's par exposure as a percentage of the sum of the par of the subset of assets.
On CreditWatch negative
For those assets with a CreditWatch negative rating, the CreditWatch negative percentage is a proportion of the total CLO par amount considered in this analysis. This is also broken down per GICS sector (see table 2) as a total sum of the par of CLO GICS sector assets.
With negative outlook
For those assets with a negative outlook, the outlook percentage is a proportion of the total CLO par amount considered in this analysis. This is also broken down per GICS sector (see table 2) as a total sum of the par of CLO GICS sector assets.
The leverage is based on the assumptions we make around debt and EBITDA, as used in our rating analysis:
- Debt: For the purpose of debt, we include items such as leases (both capital and operating), preferred shares (if deemed as debt-like), and accrued dividends.
- EBITDA: Our analysis generally adheres to what EBITDA stands for (earnings before interest, taxes, depreciation, and amortization). That is, revenue minus operating expenses plus depreciation and amortization, including noncurrent asset impairment and asset reversal.
Beyond that definition, our decision to include or exclude an activity from EBITDA depends on whether we consider that activity to be operating (e.g. acquisition-related or restructuring costs) or nonoperating (e.g. asset impairment or non-recurring items).
We generally calculate a company's credit ratios based on a three-year weighted average: the previous one year's results, our current-year forecast (incorporating any reported year-to-date results and our estimates for the remainder of the fiscal year), and our forecast for the next fiscal year. We apply weights to the core and supplemental ratios for the respective years to get to one final ratio for each metric. The length of the time series applied is dependent on the relative credit risk of the company and other qualitative factors, and the weighting of the time series varies according to transformational events.
Interest coverage ratio
For entities with weaker leverage assessments, interest coverage ratios can also shed light into the issuer's ability to service its debt.
We use the EBITDA value, as described above, divided by the carrying cost, or interest burden of the issuer's debt.
Data coverage of the floating S&P Global Ratings-rated CLO assets listed in table 1 and 2
Because we focus only on S&P Global Ratings-rated CLO assets (which represent over 90% of the overall AUM in the sample), by definition, we have full coverage of the data used to calculate the SPWARF, WARR, and WAS in tables 1 and 2. We have credit ratings, recovery ratings, and spread information for all loans issued by the approximately 480 issuers.
Due to limitations within the various data sources, we did not have complete coverage regarding the price and leverage ratios for all the loans issued from all issuers. We were able to source pricing information for 89% of the loans and corporate leverage ratio information for 86% of the loans.
This report does not constitute a rating action.
|Primary Credit Analysts:||Sandeep Chana, London (44) 20-7176-3923;|
|Marta Stojanova, London + 44 20 7176 0476;|
|Shane Ryan, London + 44 20 7176 3461;|
|Analytical Manager:||Emanuele Tamburrano, London (44) 20-7176-3825;|
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