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 162 different corporate issuers operating across 41 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, this edition of sector average metrics for European CLO assets focuses on loans issued by 700 corporate issuers, which represents over 95% of the assets under management (AUM) held in reinvesting European CLOs rated by S&P Global Ratings as reported at June 30, 2022. 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.

European CLO Credit Quality Remains Unchanged While Increasing WAS On Lowering WAP: Key Changes To Credit Metrics

Based on our review of 2022 data and looking into the second quarter, the average reinvesting European CLO portfolio rated by S&P Global Ratings exhibited the following changes:

• S&P Global Ratings' weighted-average rating factor (SPWARF) remained broadly unchanged compared with the previous quarter falling to 2,870 from 2,876. At the same time, however, underlying CLO loan prices exhibited significant declines, driven by macroeconomic headwinds and deterioration in the general market sentiment, in our view (see chart 1).
• Data as of October 2022, shows that the decline in loan prices has not been uniform across rating categories, with loans issued by corporates rated in the 'BB' category falling by 8.16% since January compared with an 11% decrease in the 'B' category. Unsurprisingly, the decline is even more pronounced in the 'CCC' category (20.20% decrease) and nonperforming category (31.45% decrease). As a result, the price differential between rating categories is expanding, with the average loan issued by a 'BB' rated corporate pricing 3.03 percentage points higher than a 'B' rated corporate in October. The price difference was only 0.19 percentage points in January. Similarly, the difference in pricing between a loan issued by a 'B' rated corporate and 'CCC' rated corporate is 14.71 percentage points as of October compared with only 7.00 percentage points in January (see chart 2).
• Average adjusted leverage for obligors held by European CLOs is 0.2x higher than the previous quarter, at 6.7x. The key driver has been lower growth expectations for next 12-18 months, predominantly rated in the 'B' category, as inflationary pressures start weighing on corporate outlook and credit metrics, particularly in the consumer goods, industrial/cap goods, commodity chemicals, and labor-and-energy exposed healthcare issuers in Europe. CLOs have 96 obligors domiciled in the U.K., of which nearly half are 'B+' and 'BB' category rated issuers and only nine are in the vulnerable 'CCC' category.
• Average EBITDA interest coverage for European CLO obligors is 0.6 times higher than for the previous quarter, at 3.8x. The average unstressed recovery rating is predominantly '3' (50%-70%), constituting 85% of CLO portfolio assets held.
• Average key credit ratios improved (including significantly reduced proportion of CLO obligors on CreditWatch negative) following continued net upgrade rating actions. Obligors on negative outlook or CreditWatch negative formed 12% of the overall portfolio holdings, a touch higher than the previous quarter. More than half of these were rated 'B-' and below.

Chart 1

Chart 2

Market Value Overcollateralization

Analyzing daily data since January 2022, we can observe how the weighted-average price movements of portfolios would affect the average overcollateralization ratios if they were calculated based on loan market values.

Chart 3

Based on loan market values, the average 'AAA' overcollateralization ratio is 146% as of October 2022, which represents a 17 percentage point decline from the 163% level in January. This figure does not tell the whole story as the average 'AAA' overcollateralization ratio remained at or near the 160% level until May, before falling to 147% in July and rebounding to 155% in August. This trend that can also be seen in the loan-level weighted-average price movements in charts 1 and 2. Since September, the average 'AAA' overcollateralization ratio has continued to fall with the October level of 146% the lowest observed for this year. Unsurprisingly, the average overcollateralization ratios at lower rating levels followed a similar path and it is worth noting that in June the average 'B' ratio fell to as low as 96%, signifying that they were then undercollateralized based on this calculation. While the average 'B' overcollateralization ratio rebounded in August, largely mirroring 'AAA' notes, the ratio as of October is back at 96%. The 'BB' average overcollateralization ratio fell to as low as 100% in July and as of October are 1% lower at 99%. The average investment-grade overcollateralization ratios did not breach 100% during the year, maintaining a minimum 5% cushion.

Macroeconomic Headwinds Dampen CLO Issuance

In the second quarter of 2022, median debt-to-EBITDA and interest coverage ratios of issuers present in European CLOs remained broadly similar to the previous quarter, at 6.2x and 3.4x, respectively. Only 14 obligors had interest cover ratios at or below 1.0x, the same as previous quarter. Of these, eight were rated 'CCC+' or below, six of which have less than adequate or weak liquidity. Joye Media SLU's senior secured debt was the only defaulted asset in the portfolios, which we subsequently upgraded twice, to 'CCC-' in July and to 'B-' in October, after it completed its debt repayment and refinancing. Of the S&P Global Ratings rated universe in CLO portfolios (700 parents in total), 48 obligors (or 7% of the total) have weak or less than adequate liquidity, 71% of which (34 obligors) were rated 'CCC+' or below.

The data point to increased diversification in CLO portfolios (700 parent obligors compared with 600), focus on higher-rated obligors in jurisdictions where the macroeconomic outlook is bleakest (such as U.K.) and reduction in exposure to obligors with liquidity pressures.

European CLOs continue to work through their existing 'CCC' exposures while simultaneously navigating instances of downward rating pressures on underlying credits, with now just below 4% of CLOs comprising on aggregate more than 7.5% exposure in 'CCC' rated obligors (see chart 4).

Chart 4

This goes hand-in-hand with a small rise in CLO portfolio exposure to obligors on CreditWatch negative. To put this into context, however, average exposure levels to obligors on CreditWatch negative remain below 1%.

Chart 5

Sector Averages Of Reinvesting European CLO Assets

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 at the end of each quarter exposure 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.

Table 1

CLO Assets Weighted By Exposure

Weighted-average metrics

Our analysis focuses on a pool of loans issued by 700 corporate issuers, representing over 95% 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.

Table 2

Ratings bias per GICS sector

At the end of the second quarter of 2022, 11.72% of 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), down from the 21.70% at the start of 2020 and down from 12.37% at the start of the first quarter of 2022. We also examined the breakdown between negative bias, positive bias, and stable for 24 GICS sectors, each weighted by euro notional exposure (see chart 6). 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 fewer obligors.

Chart 6

European CLOs' key metrics

In response to investors' growing interest following the COVID-19 pandemic and ongoing credit effects on companies and European CLOs, S&P Global Ratings is publishing a regularly updated list of rating actions we have taken globally on nonfinancial corporations that have had an effect on European CLOs, and a summary of how European CLOs have been affected with key benchmarks.

The report, titled "Weekly European CLO Update," covers all currently S&P Global Ratings' rated European CLOs, including those that are in their reinvestment period. The rating actions and benchmarks will be refreshed weekly to provide an update of the European CLO market.

To compare European CLO data each week, S&P Global Ratings provides you with an EMEA CLO Collateral Managers Dashboard. This dashboard is a single snapshot view of CLO-critical credit risk factors where you can examine, compare, and benchmark individual S&P Global Ratings' rated European CLOs.

https://www.spglobal.com/ratings/en/research-insights/topics/powerbinew

Appendix

The scope: S&P Global Ratings-rated CLO assets, representing 95% of AUM in reinvesting European CLOs

The information is based on the aggregation of CLO exposures to corporate issuers as reported in the second-quarter 2022 trustee reports of reinvesting European CLOs.

S&P Global Ratings' corporate group issues and maintains credit ratings for most 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 the second quarter of 2022 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 700 corporate issuers operating across various GICS industries and represent over 95% of the total par of the CLOs aggregated in this second-quarter 2022 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, where we have no loan price we assumed par at 100.

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 4) 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 4) as a total sum of the par of CLO GICS sector assets.

Debt-to-EBITDA ratio

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.

For a subset of floating-rate assets, the debt-to-EBITDA ratio is the sum product of each asset's obligor nominal debt-to-EBITDA ratio and the asset's par exposure as a percentage of the sum of the par of the subset of assets.

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.

For a subset of floating-rate assets, the EBITDA interest coverage ratio is the sum product of each asset's obligor nominal EBITDA interest coverage and the asset's par exposure as a percentage of the sum of the par of the subset of assets.

Data coverage of the floating S&P Global Ratings-rated CLO assets listed in tables 1 and 2

Because we focus only on S&P Global Ratings-rated CLO assets (which represent over 95% 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 700 issuers as of June 30, 2022, and each end of quarter in table 1.

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 99% of the loans and corporate leverage ratio information for 94% of the loans.