articles Ratings /ratings/en/research/articles/201201-covid-19-tests-the-resilience-of-european-clos-in-2020-11757952 content esgSubNav
Log in to other products

Login to Market Intelligence Platform


Looking for more?

In This List

COVID-19 Tests The Resilience Of European CLOs In 2020


U.S. Residential Mortgage And Housing Outlook: Positive Momentum Carries Into 2021


Servicer Evaluation: Brean Real Estate Solutions LLC


Quote Book: Gleaning Sector Trends From Rating Actions For BSL CLO Market Participants (As Of Jan. 15, 2021)


SF Credit Brief: Review Of 2020 U.S. CLO Insights Index Published

COVID-19 Tests The Resilience Of European CLOs In 2020

2020 has been an extraordinary year for collateralized loan obligations (CLOs), and certainly one to remember. The leveraged loan market, which fuels the CLO market, was hit hard by the pandemic. Defaults and 'CCC' holdings in CLO portfolios are up, loan supply is down, and while CLO managers have been navigating the new environment by trading out of weaker corporate sectors, this strategy has in some instances come at the price of par losses. All combined, these factors have negatively affected European CLO ratings, largely in the form of CreditWatch negative placements and downgrades of junior tranches.

In this publication, we dig deeper into our rating actions on European CLOs this year, focusing on the impact of corporate rating actions on the underlying portfolios, as well as how CLO transactions' structural mitigants have limited the rating pressure on speculative-grade tranches.

Setting The Scene: European CLO Rating Actions To Date

Since March 2020, we have placed 39 European CLO ratings on CreditWatch negative, with around 65% of those actions subsequently being resolved with a downgrade, averaging one rating notch. As of the date of this publication, there are no European CLO ratings on CreditWatch negative.

Table 1

European CLO CreditWatch Negative Resolutions
Through Nov. 30, 2020
Rating category Affirmed One-notch downgrade Two-notch downgrade Total no. of actions
AAA - - - -
AA - - - -
A - - - -
BBB 4 3 - 7
BB 8 17 2 27
B 2 3 - 5
Total 14 23 2 39

A Recap Of Corporate Credit And CLO Developments

We consider that the wave of COVID-19-related rating actions on nonfinancial corporates started around April (see "How The European CLO Market Has Developed Over 180 Days Of COVID-19," published Sept. 2, 2020). By the following month, the 12-month trailing European speculative-grade default rate had already risen to 2.7% from 2.3% a month earlier. In parallel with rising defaults, 'CCC' buckets in European CLO portfolios started to breach their limits in an increasing number of transactions. These limits are typically set at 7.5% and are designed to calculate lower par value test ratios by carrying 'CCC' balances exceeding the limit at market value.

Chart 1


At this point, European CLO ratings began facing downward pressure as a result of corporate downgrades, and CLO rating cushions--the difference between the tranche break-even default rate (BDR) and its respective scenario default rate (SDR)--began to erode. This resulted in our first and largest set of CreditWatch negative placements on European CLO ratings to date (see "Ratings On 18 Classes From 14 European CLOs Placed On Watch Negative," published April 27, 2020).

Corporate rating actions affecting CLO portfolios peaked during May and June. The average S&P Global Ratings weighted-average rating factor (SPWARF) across European CLOs passed the 2900 mark (compared with an average of 2700 in March), with average 'CCC' exposure increasing to just below 10%.

Chart 2

Since peaking in the second quarter, the rate of negative corporate rating actions has abated, and so has pressure on CLOs and subsequently CLO rating actions (see "Ratings On Seven Classes From Six European CLOs Placed On Watch Negative," published June 9, 2020, and "Ratings On Nine Classes From Seven European CLOs Placed On Watch Negative," published July 24, 2020).

Negative CLO Rating Actions Have Largely Affected 'BB' And 'B' Categories

Our approach to analyzing new and existing CLOs is consistent with our CLO rating framework (see "Global Methodology And Assumptions For CLOs And Corporate CDOs," published June 21, 2019). Our ratings framework considers--among other factors--multivariate stress runs and assumptions on the underlying collateral pool, at each rating level.

CLOs typically issue different tranches of liabilities and use the net proceeds to purchase a pool of assets. The cash flows generated by the assets are then used to pay back investors generally sequentially from the senior investors that hold the highest-rated (typically 'AAA') securities, to the lowest rated (for example, 'B-' rated). Any residual payments are made to equity investors, who bear the first-loss risk and hold unrated securities. Lower-rated classes of notes are typically associated with more credit risk than the higher-rated classes. Therefore, investors in these classes are compensated with a higher rate of return.

Normally, any credit-negative impact on the assets in a CLO's underlying portfolio would have some knock-on effect on the rated liabilities issued by the CLO. However, the extent of the impact differs across the rated securities, and typically the biggest impact may be on lower rated securities. This is partly because they rank lower in a CLO's priority of payments, they have lower credit enhancement levels, and they are relatively more dependent on the performance of other supporting factors, such as excess spread. Credit enhancement levels for European CLO tranches rated 'BB' and 'B' are generally in the range of 9%-11% and 6.5%-8.5%, respectively.

European CLO ratings performance this year has mostly matched the intention of their structures, in our view. The credit events over the year have almost exclusively affected speculative-grade CLO ratings so far, largely in the 'BB' and 'B' rating categories.

In addition to facing more pressure from deteriorating credit quality and their lower levels of credit enhancement, 'BB' and 'B' rated tranches depend more on the performance of other types of credit support, such as excess spread generation over the underlying portfolio's weighted-average life, all else equal, and depending on their cost of funding. In our view, excess spread plays an important role in CLOs because it provides another form of credit support at times when the CLO may be in distress. In particular, when any CLO coverage tests are breached, interest proceeds outstanding are redirected to help cure the breach by repaying noteholders sequentially. This essentially implies that all CLO noteholders have at their disposal a second resource to help repay their original principal investment in addition to principal proceeds. In other words, they have excess interest proceeds in times of potential distress.

Even so, we acknowledge that a breach of coverage tests has other knock-on effects on CLO performance. Depending on where the CLO is in its payment waterfall when the coverage test breaches, a redirection of interest proceeds to help cure a coverage test breach may conversely result in a deferral of interest due on deferrable classes of notes, which as a result may pay-in-kind (PIK). Although there are nuances in the multivariate paths of the cash flows, junior ratings that PIK--especially those which pay higher coupons--are likely to be more dependent on excess spread.

When excess spread or the weighted-average life of the underlying pool declines, this may lower the tranche's BDR at lower rating levels more than at higher rating levels, and thereby negatively affect its rating cushion (we note that a reduction in the weighted-average life may at the same time improve the SDRs, which may offset some of the reduction in rating cushion). Overall, these factors combined have pressured 'BB' and 'B' rated classes and explain why our rating actions have largely been limited to speculative-grade ratings. (For CLO tranches rated 'B-', we consider additional factors in accordance with our "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, 2012.)

Chart 3


European CLO Rating Actions So Far Have Been Relatively Limited

Several other reasons, in our view, explain why rating action on European CLOs have been relatively limited. Limited CLO exposure to affected corporate names, structural mitigants, and portfolio managers' strategies may be considered contributing factors.

Not all corporate rating actions have affected CLOs

Let's start with corporate rating actions. Although the downgrades that affected corporate issuers of leveraged loans were significant, this does not mean that every negative corporate rating action caused CLO credit quality to deteriorate.

Our analysis shows that just over half of the corporate rating actions from March 1 to Sept. 1 have filtered through to CLOs (330 out of 638 over the period based on the types of actions shown in chart 4). As the results show, European CLOs are not invested in every corporate on which we have lowered our rating. Based on our analysis, just over 53% of downgrades in the speculative-grade corporate universe affected European CLOs.

Chart 4


Higher credit enhancement provides more protection against headwinds

In contrast to lower-rated notes ('BB' and 'B'), higher-rated notes benefit from more credit enhancement. This means that they are also relatively less sensitive to deterioration in other performance metrics, such as a decline in excess spread over the weighted-average life of the portfolio. Overall, they are able to withstand greater levels of credit deterioration, all else being equal.

Chart 5


CLO managers have adjusted portfolios to protect credit quality

As we have discussed in recent publications and webcasts, since the start of the downturn, CLO managers have been proactively trading out of potentially weaker corporate credits and sectors (or those considered more sensitive to social distancing, such as the travel industry). They have redeployed proceeds into relatively more defensive sectors, such as health care, chemicals, and education, thereby improving the overall credit quality of their CLO portfolios. Although in some instances the trading of underlying assets has resulted in some par losses, it has limited further increases in 'CCC' rated exposures and stymied the deterioration in credit quality (see "European CLOs: The True Impact Of 'CCC' Assets On Overcollateralization Ratios," published July 9, 2020). In our view, one of the most important considerations for CLO managers was to ensure that par value and interest diversion tests remained compliant as CLOs headed toward determining the priority of payments on their payment dates. To date, very few of the European CLOs we rate have failed these tests, and no CLO so far has deferred payments on any of their deferrable classes.

Chart 6

Chart 7

Overall, we believe European CLOs have demonstrated resilience since the start of the pandemic. We acknowledge that the pandemic is not over--even with advancements in potentially available vaccines -- and therefore the impact of rating actions on CLOs will continue to evolve.

S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic. Reports that at least one experimental vaccine is highly effective and might gain initial approval by the end of the year are promising, but this is merely the first step toward a return to social and economic normality; equally critical is the widespread availability of effective immunization, which could come by the middle of next year. We use 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.

Related Criteria

Related Research

This report does not constitute a rating action.

Primary Credit Analyst: Sandeep Chana, London + 44 20 7176 3923;
Secondary Contact: Emanuele Tamburrano, London + 44 20 7176 3825;

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at

Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: