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CLO Spotlight: How COVID-19 Affected U.S. Middle-Market And BSL CLO Performance In 2020

(Editor's Note: On April 13, 2021, due to popular demand, we added an excel file listing underlying tranches that have had their ratings lowered in the second half of 2020 due to the pandemic [beneath table 3 in the Recap Of 2020 Rating Actions section].)

The advent of the COVID-19 pandemic and the resulting shutdowns in early 2020 presented significant performance challenges to many of the companies whose loans were held in U.S. collateralized loan obligation (CLO) transactions. With some companies in consumer-facing sectors facing the prospect of a second quarter with severely impacted business and earnings, negative actions on corporate ratings came swiftly amongst rated broadly syndicated loan (BSL) issuers. Many of the same pressures faced the credit-estimated companies within S&P Global Ratings-rated middle-market (MM) CLO transactions as well (see "Credit Estimates For Entities Backing U.S. Middle-Market CLOs Took A Hit From COVID-19," published Dec. 1, 2020). It wasn't long before the effects of lowered credit estimates were felt within MM CLO portfolios, followed by a reduction in cushion amongst their overcollateralization (O/C) tests.

This change in portfolio credit and CLO metrics resulted in a modest number of downgrades on U.S. CLO ratings. However, in spite of the fact that companies held in MM and BSL CLOs both experienced stresses due to the pandemic, the outcomes of how the two CLO types fared in 2020 ended up being somewhat different. To examine those differences in performances, we took samples of each type of CLO and studied their 2020 performance for some interesting findings, which we discuss below.

Before COVID-19: The Rise Of MM CLOs

According to S&P's Leverage Commentary Data (LCD), there was a steady increase in the number of MM CLOs issued between 2015 (12 issued for the year) and 2019 (32 issued for the year). In 2020, 27 MM CLOs were issued, despite a first half with light CLO issuance due to uncertainty about the direction of the credit markets because of the pandemic. As a result of the increased number of MM CLOs outstanding, in the three years preceding the onset of the pandemic, there was also an increase in the number of outstanding credit estimates on issuers with loans held in MM CLOs, to about 1,300 in 2020 from 650 in 2017. For this purpose, we define an outstanding credit estimate as one that has a performing score (credit estimate score of 'ccc-' and higher), and which was assigned less than one year ago (for more details, see "Anatomy Of A Credit Estimate: What It Means And How We Do It," published Jan. 14, 2021).

At the start of 2021, there were 111 MM CLOs that were rated by S&P Global Ratings for which we have received trustee reports (there are a handful of deals rated at the end of 2020 that have not yet issued their first trustee report, and these have been excluded). As seen in the chart below, the MM CLOs are not all the same: individual MM CLOs have significantly different proportions of loans in their portfolios from issuers that are credit estimated. The remaining, non-credit estimated loans come from issuers that are either publicly or privately rated, or for which we derive ratings from methods in our criteria other than credit estimates. If we're not able to derive any rating or implied rating for a performing issuer, we treat it as 'CCC-' under our criteria and within the tables and S&P Global Ratings' weighted average rating factor [SPWARF] calculations below.

Chart 1

image

U.S. BSL CLO And MM CLO 2020 Comparison

For this study, we focused on two samples of CLOs: a cohort of 61 MM CLOs issued across 20 managers and a cohort of 404 BSL CLOs issued across 75 managers. The BSL CLO cohort is the same cohort referenced within our 2020 recap of U.S. BSL CLOs in "U.S. CLO Insights Index 2020 Review: Coping With COVID-19," published Jan. 14, 2021. Both cohorts consist of CLOs that already began issuing trustee reports as of the start of 2020, and are scheduled to reinvest for all of 2020. To maintain comparability in the metrics over time, we excluded deals where during 2020 there were significant structural changes due to upsize resets or senior note paydowns from principal cash, and CLOs with variable-funding notes.

Obligors in MM CLOs are mostly held by a single manager, while BSL obligors are held by many

At the start of 2020, the 61 MM CLOs in our sample together had exposure to 1,543 parent issuers, while the 404 BSL CLOs together had exposure to 1,476 parent issuers. Many of the exposures held within the MM CLO portfolios are unique to one MM CLO manager: 1,065 issuers out of 1543, or 51%, on a dollar weighted basis. For our BSL CLO sample, issuers held by only one manager were rare, as only 91 issuers out of 1476 are held only within the BSL CLOs issued by one BSL manager. In fact, several of the most widely held issuers are held across 60-plus managers (see table 1 and "The Most Widely Referenced Corporate Obligors In Rated U.S. BSL CLOs: Fourth-Quarter 2020," published Jan. 7, 2021, for the list of top 250 issuers in our U.S. BSL CLOs).

Table 1

Uniqueness Of MM And BSL CLO Portfolios
MM sample (61 U.S. MM CLOs) BSL sample (404 U.S. BSL CLOs)
Exposures Count of issuers (no.) % AUM across MM CLO sample Count of issuers (no.) % AUM across BSL CLO sample
Total count of parent issuers within sample 1,543 100.00 1,476 100.00
Exposure across one manager only 1,065 50.99 91 0.18
Exposure across two managers 302 24.41 54 0.28
Exposure across three managers 111 12.83 48 0.35
Exposure across four managers 43 6.88 43 0.50
Exposure across five managers 15 2.96 59 0.91
Exposure across six managers 4 0.92 59 0.91
Exposure across seven managers 2 0.55 62 1.45
Exposure across eight or more managers 1 0.47 1,060 95.42
MM--Middle manager. BSL--Broadly syndicated loan. CLO--Collateralized loan obligation. AUM--Assets under management.

Start And End Points Of Both Cohorts' 2020 Performances Differ Somewhat

Most U.S. BSL and MM CLO portfolios experienced credit deterioration in 2020 due to the pandemic. We summarized the average change in U.S. MM and BSL CLO portfolio performance in 2020 across various parameters in table 2 below.

Table 2

Average Change In U.S. MM And BSL CLO Portfolio Credit Metrics During 2020
Par (%) Jr. O/C cushion (%) SPWARF 'B-' (%) 'CCC' bucket (%) No derived S&P Global Ratings' credit rating (%)(i) Non-performing (%) WAS (%) WAL
MM
Start 5.24 3,813 66.97 9.63 7.67 0.74 5.27 3.88
End 4.16 3,980 63.74 17.70 7.33 1.42 5.27 3.48
Change 0.08 (1.08) 167 (3.23) 8.07 (0.33) 0.68 0.00 (0.41)
BSL
Start 3.88 2,644 19.97 3.99 0.10 0.54 3.56 5.01
End 2.16 2,837 25.00 8.69 0.03 1.02 3.55 4.69
Change (0.99) (1.72) 194 5.03 4.70 (0.07) 0.48 (0.01) (0.32)
(i)Treated as 'CCC-' for SPWARF. MM--Middle market. BSL--Broadly syndicated loan. CLO--Collateralized loan obligation. O/C--Overcollateralization. WAS--Weighted average spread. WAL--Weighted average life. SPWARF--S&P Global Ratings' weighted average rating factor.

Most of these credit-related metrics ended the year in worse shape than where they started (see the Appendix for a month-by-month breakdown). We review some of them below.

SPWARF

Despite starting in 2020 with significant differences in credit quality, both BSL and MM CLOs experienced credit distribution due to the pandemic, resulting in increases to SPWARF values for both cohorts (see chart 2).

Chart 2

image

Non-performing assets

Interestingly, the proportion of portfolio exposure to non-performing issuers across the two samples were fairly similar during 2020 (see chart 3; the spike in the BSL line is partially due to the distressed exchange of widely held BSL CLO obligor Envision in late April through early May).

Chart 3

image

'CCC' buckets

'CCC' buckets increased for both BSL and MM CLOs in 2020. 'CCC' buckets for BSL CLOs more than doubled in March (to 10% from 4%), and increased further in April, before gradually declining after May. 'CCC' buckets for MM CLOs started the year at a much higher level, but experienced more of gradual increase between March and July (see chart 4).

Chart 4

image

Jr. overcollateralization (O/C) cushion

Defaults along with increases in the 'CCC' buckets for both samples resulted in a decline in O/C test cushions. Within CLO transaction documents, defaults are generally haircut by the lower of the market price or rating agency recovery values, while excess 'CCCs' above a defined threshold proportion are generally haircut by the market price. Haircuts on the BSL CLOs came quickly given the volatility in the BSL loan prices and the pace of corporate downgrades into the 'CCC' buckets as O/C cushions of BSL CLOs dropped sharply in the second quarter.

Given that the market prices of MM loans are less transparent than prices for BSL loans (many loans in MM CLOs are only held by a single manager and not actively traded), and the changes for credit estimates during the pandemic occurred over months rather than weeks, the O/C decline for MM CLOs was more gradual than for BSL CLOs (see chart 5).

Chart 5

image

Other Findings

Some of the notable trends in 2020 we discovered include the following:

  • Similar to the BSL CLOs, MM CLOs portfolios experienced turnover into different issuers, while some loans to the same issuer saw terms negotiated (change in spread, maturity, etc.).
  • On average, MM CLOs ended the year with more par preservation relative to BSL CLOs.
  • MM CLOs experienced a reduced and a more measured decline in O/C cushion as most of the deals did not lose par and had a higher 'CCC' trigger (typically set at 17.5%, as opposed to 7.5% for typical BSL CLOs). About 5% of the MM CLO sample failed their tranche OC tests at some point during 2020, whereas just under a quarter of the sample of BSL CLOs experienced a junior O/C failure at some point in 2020.

Recap Of 2020 Rating Actions

As corporate rating actions and lowered credit estimates accumulated within BSL and MM CLO portfolios, by the start of the second half of 2020, we had placed several hundred CLO ratings on CreditWatch with negative implications. During the third quarter, we resolved these CreditWatch negative placements and lowered our ratings on hundreds of CLO tranches.

However, as discussed, given the higher overcollateralization of MM CLOs tranches, most of which was preserved during the downturn (the MM portfolios on average, did not lose par by the end of 2020), a smaller proportion of the MM CLO tranche ratings wound up experiencing a downgrade in 2020.

Table 3

U.S. BSL And MM CLO CreditWatch Resolutions And Non-CreditWatch Downgrades In Second-Half 2020
Rating as of July 12, 2020 Rating actions in second-half 2020
Rating category as of July 12 O/S rating as of July 12 Watch Neg as of July 12 Affiormation (off Watch Neg) or no downgrade One-notch downgrade Two-notch downgrade Three-notch downgrade Four-notch downgrade Five-notch downgrade
BSL
'AAA' 904 904
'AA' 780 777 3
'A' 675 15 660 10 1 3 1
'BBB' 655 94 572 62 13 5 3
'BB' 577 289 324 145 46 40 14 8
'B' 181 174 72 78 22 9
'CCC' 13 11 5 4 4
'CC' 1 1
Grand total 3,786 583 3,315 302 86 57 18 8
MM
'AAA' 190 190
'AA' 120 120
'A' 99 1 98 1
'BBB' 91 91
'BB' 49 7 44 3 2
'B' 4 2 3 1
'CCC' 0
'CC' 0
Grand total 553 10 546 4 3 0 0 0
BSL--Broadly syndicated loan. MM--Middle market. CLO--Collateralizd loan obligation.

The following excel file is a list of U.S. CLO ratings downgraded in the second half of 2020:

https://www.spglobal.com/ratings/_division-assets/excel/covid19affectedusmiddlemarketandbslcloperformancein2020.xlsx

2020 MM CLO Performance Fared Better Than BSL CLOs Overall

While BSL CLOs have a high level of industry and obligor diversity, and higher average portfolio credit quality (as indicated by a lower SPWARF), MM CLO portfolios on the other hand, offer higher tranche subordination, coverage test triggers, and loan spread combined with shorter loan maturity. During the downturn in 2020, we find that both BSL and MM CLOs experienced credit deterioration and portfolio turnover; by the end of 2020, however, MM CLO portfolios emerged with better par preservation. The higher tranche subordination, par preservation, and the low exposure to non-performing issuers of MM CLOs contributed to the relatively stable ratings performance of MM CLO notes in 2020.

Related Research

Appendix

Table 4

Average Middle-Market CLO Portfolio Metrics In 2020
Jr. O/C cushion (%) SPWARF 'B-' (%) 'CCC' bucket (%) No derived S&P Global Ratings credit rating(i) (%) Non-performing (%)
1/1/2020 5.24 3813 66.97 9.63 7.67 0.74
2/1/2020 5.27 3841 65.80 9.82 8.76 0.76
3/1/2020 5.28 3852 65.28 9.86 9.16 0.80
4/1/2020 5.31 3925 63.14 12.34 10.01 0.91
5/1/2020 4.92 3957 63.83 13.75 9.80 1.05
6/1/2020 4.59 4041 59.36 16.78 11.28 1.26
7/1/2020 4.43 4065 59.18 16.93 11.36 1.54
8/1/2020 4.16 4046 60.88 17.47 9.71 1.64
9/1/2020 4.00 4011 62.17 17.91 8.35 1.47
10/1/2020 3.98 4003 62.81 18.22 7.55 1.53
11/1/2020 3.91 3997 62.42 18.42 7.53 1.49
12/1/2020 4.01 3974 63.75 18.20 6.97 1.31
1/1/2021 4.16 3980 63.74 17.70 7.33 1.42
(i)No derived S&P Global Ratings credit rating treated as 'CCC-' for SPWARF calculations. MM--Middle market. CLO--Collaterlaized loan obligation. O/C--Overcollateralization. SPWARF--S&P Global Ratings' weighted average rating factor.

Table 5

Average BSL CLO Portfolio Metrics In 2020
Jr. O/C cushion (%) SPWARF 'B-' (%) 'CCC' bucket (%) Non-performing (%)
1/1/2020 3.86 2644 19.97 4.11 0.54
2/1/2020 3.80 2645 20.20 4.07 0.56
3/1/2020 3.76 2639 20.16 4.13 0.63
4/1/2020 3.73 2857 23.47 10.06 0.81
5/1/2020 2.38 2986 25.40 12.31 1.61
6/1/2020 1.13 2960 25.71 11.86 1.35
7/1/2020 1.39 2951 24.82 11.41 1.53
8/1/2020 1.48 2925 24.35 10.66 1.57
9/1/2020 1.56 2900 24.36 10.10 1.39
10/1/2020 1.76 2883 24.84 9.35 1.35
11/1/2020 1.90 2865 24.52 9.03 1.35
12/1/2020 2.04 2854 24.79 8.86 1.28
1/1/2021 2.13 2839 25.02 8.73 1.03
BSL--Broadly syndicated loan. CLO--Collaterlaized loan obligation. O/C--Overcollateralization. SPWARF--S&P Global Ratings' weighted average rating factor.

This report does not constitute a rating action.

Primary Credit Analysts:Daniel Hu, FRM, New York + 1 (212) 438 2206;
daniel.hu@spglobal.com
Stephen A Anderberg, New York + (212) 438-8991;
stephen.anderberg@spglobal.com
Ramki Muthukrishnan, New York + 1 (212) 438 1384;
ramki.muthukrishnan@spglobal.com
Analytical Manager:Jimmy N Kobylinski, New York + 1 (212) 438 6314;
jimmy.kobylinski@spglobal.com

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