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How The European CLO Market Has Developed Over 180 Days Of COVID-19


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How The European CLO Market Has Developed Over 180 Days Of COVID-19


In May, we published "How COVID-19 Changed The European CLO Market In 60 Days," which discussed how the first two months of COVID-19 had altered the market for European collateralized loan obligations (CLOs). Following six months of heightened rating actions on nonfinancial corporates spurred by the economic fallout from the pandemic, data for CLOs show how the market has continued to evolve.

New CLOs have priced during this period, but at a slower pace and at lower levels compared from those in 2019. The focus is on monitoring the performance of loans underlying existing transactions, as well as challenges that existed before and persisted during COVID-19, including high leverage ratios, EBITDA add-backs, and covenant-lite loans.

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

Second Quarter Brought Some Signs Of Recovery

Table 1

Default Summary By Original Rating For European CLOs
As of June 30, 2020
CLO 1.0 CLO 2.0
Rating No. of original ratings No. of defaults Currently rated No. of original ratings No. of defaults Currently rated
AAA 472 0 0 349 0 211
AA 225 0 0 358 0 240
A 239 0 0 249 0 168
BBB 291 4 0 225 0 149
BB 205 17 1 209 0 143
B 11 1 0 179 0 133
Total 1,443 22 1 1,569 0 1,044
Source: S&P Global Ratings Research.

Chart 1


By the end of second quarter, decisive monetary action, reversal of high yield flows, abatement of coronavirus cases in key economies, and hopes of vaccine trials had restored the technical background seen in speculative-grade primary demand in the corporate loan market (see "European Leveraged Finance And Recovery Second-Quarter 2020 Update: Finding Equilibrium," published July 20, 2020).

At the same time, European CLOs rated by S&P Global Ratings and issued before 2013, or CLOs 1.0, had almost fully terminated, with a 1.5% default rate in 20 years. European CLOs we rated that were issued from 2013 onward, or CLOs 2.0, had displayed very stable performance until second quarter, with only one tranche downgraded in their history before the COVID-19 outbreak.

However, the 12-month trailing speculative-grade default rate for corporates in Europe rose to 3.4% in June, and we expect it to reach 8.5% by March 2021 (see "The European Speculative-Grade Corporate Default Rate Could Reach 8.5% By March 2021," published June 8, 2020).

The Impact Of The Last Six Months

In February, we took 19 negative rating actions globally on corporates and sovereigns that we deemed to be related to COVID-19 (negative rating actions include outlook revision to negative, CreditWatch negative placement, or downgrade). The concurrent collapse in global oil prices caused 1,931 negative rating actions globally between March and July 2020 (see "COVID-19: Coronavirus- And Oil Price-Related Public Rating Actions On Corporations, Sovereigns, And Project Finance To Date").

As of July 27, 2020, 341 European speculative-grade companies experienced negative rating actions. The wave of negative rating actions has affected several sectors, geographies, and products.

Since February, we have placed 34 tranches of European CLOs on CreditWatch negative. Out of this, we have affirmed our ratings on seven tranches, have downgraded 18, and nine tranches remain on CreditWatch negative. For these transactions, reduced credit quality and lower excess spread combined with increases in haircut adjustments have put pressure on the junior tranches (see "Ratings Recap Of July 2020 European CLO CreditWatch Resolutions," published July 14, 2020, and "Ratings Recap Of August 2020 European CLO CreditWatch Resolutions," published Aug. 18, 2020).

From March to August, the rating breakdown for corporate loans contained in European CLO portfolios evolved in this way:

Chart 2

Charts 3 and 4 show how the rating transitions for corporates in European CLO portfolios have affected the portfolio exposures. According to our CLO criteria, a corporate rating on CreditWatch negative would be notched down by one rating in our CLO analysis. For example, we would treat a corporate rating of 'B/WatchNeg' as a 'B-' rating in our CLO analysis (see "Global Methodology And Assumptions For CLOs And Corporate CDOs," published June 21, 2019).

Chart 3


Chart 4


These are average figures and display a large dispersion. They are also based on the latest trustee report available as of the rating action. We are now beginning to see the effect of actions that each portfolio manager took to counterbalance the wave of negative rating actions. There have been reductions in the 'CCC' buckets, though nonperforming buckets have increased.

Chart 5 shows the rating category evolution in the European CLOs we rate. Each box plot represents the distribution by percentage of notional amount in European CLOs exposed to the 'B-', 'CCC', and 'D' rating categories for each day.

Chart 5

At the same time, not all CLOs are structured the same. For example, higher credit enhancement, higher overcollateralization triggers, or even better economic arbitrage may allow some CLOs to perform better.

Other Metrics To Watch Out For

As CLO 1.0 credit performance was solid even during the last recession, and considering that the current CLO structure benefits from greater credit enhancement per rating level, shorter reinvestment periods, pools backed by corporate debt only, and regulations requiring "skin in the game," it is possible to assume continued stable performance for post-2012 CLOs.

However, challenges remain, including higher leverage ratios, EBITDA add-backs, and cov-lite loans. Even considering these, our recovery expectation is still slightly lower than 55% in European CLOs, which is much lower than the historical recovery average of 73%, but typically much higher than what transaction documents have in their covenants for 'AAA' rated CLO tranches.

Generally, recovery ratings for CLOs have remained largely unchanged.

Chart 6

The chart below shows rating actions on corporates in Europe, Middle East, and Africa (EMEA) and if they affected European CLOs during the past 180 days.

Chart 7


When we look at the breakdown by industry and geography, we can see how corporate rating actions have been affecting the EMEA region. The charts below show the number of corporate downgrades and/or negative CreditWatch placements, and of those, how many are in CLOs.

Chart 8


Chart 9


At the same time, we note that European CLOs are also affected by corporate rating actions in the U.S. However, given the lower exposure, only 66 of over 1,022 corporate rating actions in the U.S. affected European CLOs.

Nevertheless, to grasp the full picture, we look at the same breakdown for our subset of CLOs. The charts below show the facility asset notional amounts affected in CLOs by corporate rating actions and the average notch change we would apply in CLOs.

Chart 10

Chart 11

The effect has left all CLO facilities exposed at different levels. The split by CLOs and their current facility exposure by total facility amount ranges from 10%-40% of par amount (see table 3).

Table 2

European CLO Facility Exposure
Facility exposure amount (mil. €) No. of CLOs Average facility exposure amount (mil. € ) Average facility exposure Average facility amount (mil. €) Average max. facility amount (mil. €) Average min. facility amount (mil. €)
>150 6 168.570 84 2.074 8.138 0.086
>125 29 133.594 76 1.945 7.035 0.061
>100 56 110.576 67 1.861 6.167 0.126
>75 38 89.997 65 1.641 5.519 0.058
<75 10 54.458 34 1.792 4.944 0.169
Total 139 108.219 67 1.823 6.168 0.095
CLO--Collateralized loan obligation.

The Next Six Months

We anticipate that rating actions on corporate issuers will continue to affect CLOs through the end of 2020 and into 2021. Currently our ratings on 46 corporate obligors remain on CreditWatch negative.

When comparing the limited number of CLO downgrades to the significant number of negative corporate rating actions that affect them, we believe CLOs have shown resilience in the last 180 days.

Of the European CLOs we rate, 27% by current balance have been affected to date, with €15 billion subject to negative corporate rating actions. Of this, we downgraded 24% and 3% remains on CreditWatch negative. By comparison, as of April, 17% of the balance (€8 billion) had been affected. In some instances, multi-notch downgrades occurred, though the amount is not prominent.

The S&P Global Ratings weighted-average rating factor (SPWARF) has increased close to 200; however, we have seen signs of recovery with the level dipping in recent months. Assets rated in the 'CCC' category had increased above 7.5% in most CLOs, though these levels have also been declining to below 7.5% on average since then. At the same time, while the ratings on 103 corporate obligors are now considered nonperforming ('CC', selective default ['SD'], or 'D'), the average level of nonperforming ratings on obligors in European CLO portfolios is now 14, or 0.49%, up from 0.07% in early March. The total amount by balance is just above €25 million, across 19 CLOs.

Table 3

European CLO Benchmarks
Benchmark SPWARF 'BB-' and ratings above (%) 'B-' ratings (%) 'CCC' category Nonperforming category (%) CreditWatch negative (%) Negative outlook (%) WARR
March 1, 2020 2691.04 11.05 19.51 1.81 0.07 0.88 18.44 53.72
April 1, 2020 2785.66 10.82 18.83 5.74 0.09 5.02 23.86 54.11
May 1, 2020 2913.73 9.85 22.73 9.64 0.13 6.75 37.20 54.36
June 1, 2020 2897.74 10.61 24.97 8.82 0.23 6.82 39.37 52.02
July 1, 2020 2916.32 10.24 25.35 9.22 0.25 7.35 40.51 54.13
Aug. 1, 2020 2887.23 10.04 25.66 7.79 0.58 7.33 40.29 54.13
Sep. 1, 2020 2885.69 9.87 25.66 7.45 0.49 7.11 40.17 53.95
SPWARF--S&P Global Ratings weighted-average rating factor. WARR--Weighted-average recovery rating.

Overall, European CLOs have performed well compared to the amount of negative corporate rating actions that have occurred over the past 180 days. However, we acknowledge that the pandemic is not over, negative corporate rating actions are still likely, and the impact of these actions on CLOs will continue to evolve.

Related Research

The primary authors would like to thank Philippe Blois for his contributions to this report.

This report does not constitute a rating action.

Primary Credit Analyst: Shane Ryan, London + 44 20 7176 3461;
Secondary Contact: Emanuele Tamburrano, London (44) 20-7176-3825;

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