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SF Credit Brief: CLO Insights: The Average U.S. BSL CLO 'CCC' Bucket Tops 5% For The First Time Since January 2022

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U.S. BSL CLO Obligors: Corporate Rating Actions Tracker 2024 (As Of April 26)

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SF Credit Brief: CLO Insights: The Average U.S. BSL CLO 'CCC' Bucket Tops 5% For The First Time Since January 2022

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The stable to negative trend in U.S. broadly syndicated loan (BSL) collateralized loan obligation (CLO) collateral credit metrics continued in October, with most metrics remaining unchanged while two important ones continued to see modest deterioration. The proportion of assets with ratings that have a negative outlook--a forward-looking indicator of corporate credit quality--increased to 14.46% of total assets from 13.36% in September and a low of 9.83% in May (see table 1).

The average BSL CLO 'CCC' basket also topped 5% in November--the first time since January 2022. However, the 5.02% average can be misleading because there is a significant vintage effect, with pre-pandemic CLOs having an average 'CCC' exposure of 5.80% while post-pandemic CLOs averaged just 4.00%. Since some CLOs (mostly pre-pandemic ones) have already exceeded their 7.5% 'CCC' thresholds, we believe their overcollateralization (O/C) ratios may experience market value haircuts within upcoming trustee reports. Further, the average O/C ratios across our BSL index dipped very slightly for the first time in November, mostly due to transactions with larger exposures to issuers that defaulted in the third quarter, though average par balance across all CLO portfolios continue to hold steady.

Table 1

CLO BSL Index Metrics (CLO Insights 2022 U.S. BSL Index)(i)
Issuer credit rating
As of date 'B-' (%) 'CCC' category (%) Nonperforming category (%) SPWARF WARR (%) CreditWatch negative (%) Negative outlook (%) Weighted avg. price of portfolio ($) Junior O/C cushion (%) % of target par Turnover (%)
January 2022 26.41 4.94 0.17 2700 60.44 0.88 12.33 98.79 4.37 99.68 0.00
February 2022 27.16 4.27 0.37 2708 60.43 0.28 11.94 98.83 4.41 99.68 5.68
March 2022 27.09 4.26 0.39 2708 60.41 0.11 11.35 98.02 4.40 99.68 8.15
April 2022 27.44 4.17 0.13 2690 60.45 1.06 10.86 97.88 4.31 99.69 11.35
May 2022 27.76 4.26 0.14 2700 60.45 1.20 9.83 97.57 4.30 99.70 14.46
June 2022 27.70 4.14 0.20 2706 60.48 1.27 10.46 94.60 4.39 99.71 16.66
July 2022 28.59 4.01 0.35 2720 60.27 1.35 11.08 92.19 4.45 99.74 19.55
August 2022 28.70 4.00 0.34 2726 60.32 1.46 11.53 93.81 4.47 99.78 21.86
September 2022 29.00 4.21 0.59 2754 60.24 1.03 12.20 94.85 4.50 99.81 23.61
October 2022 28.85 4.40 0.50 2751 60.16 1.16 13.36 92.12 4.50 99.82 25.58
November 2022 28.85 5.02 0.40 2754 60.13 0.59 14.46 92.40 4.47 99.84 27.05
(i)Based on trustee reports that are dated within one month of the date they are available to us (the start of each month). This index includes only 2021 vintage and prior transactions that have closed with CLO liabilities indexed to LIBOR (excludes 2022 vintage CLOs that would be indexed to SOFR). BSL CLO--Broadly syndicated loan collateralized loan obligation. SPWARF--S&P Global Ratings' weighted average rating factor. WARR--Weighted average recovery rate. O/C--Overcollateralization. SOFR--Secured overnight financing rate.

Downgrades outnumbered upgrades across U.S. BSL CLO obligors by about 2:1 during the three months ended October (see "U.S. BSL CLO Obligors: Corporate Rating Actions Tracker 2022," published Nov. 8, 2022). Table 2 lists some of the widely held issuers that were downgraded in October, including three that transitioned to the 'CCC' rating category.

Table 2

Widely Held U.S. BSL CLO Issuers That Were Downgraded In October 2022
Rating
Downgrade date Issuer GIC sector Current Previous
Oct. 1, 2022 Bausch Health Cos. Inc. Pharmaceuticals SD CC/Negative
Oct. 5, 2022 Level 3 Communications Inc. Diversified telecommunication services BB-/Negative BB/Watch Neg
Oct. 6, 2022 Rackspace Technology Global Inc. IT services B-/Stable B/Stable/
Oct. 14, 2022 Turaz Global S.a.r.l. Software CCC+/Negative B-/Stable
Oct. 20, 2022 PECF USS Intermediate Holding III Corp. Commercial services and supplies CCC+/Stable B-/Stable
Oct. 29, 2022 Team Health Holdings Inc. Health care providers and services CCC+/Negative B-/Stable
BSL CLO--Broadly syndicated loan collateralized loan obligation. SD--Selective default.

Over 50 CLO Obligors Were Downgraded To 'CCC' This Year

More than 50 issuers have been downgraded to the 'CCC' rating category so far in 2022, while 27 issuers were upgraded out of the 'CCC' range (see table 3). Most of the upgrades occurred in the first half of the year, while most of the downgrades occurred in the third quarter. As a result of these actions, the 'CCC' buckets gradually declined across the index during the first half of the year, reaching a low of 4% in August, before rising to just over 5% by the start of November (see table 1).

Table 3

Rating Actions In And Out Of The 'CCC' Rating Category Across U.S. BSL CLO Obligors In 2022
Q1 2022 Q2 2022 Q3 2022 Q4 2022(i) Total(i)
Upgrades from the 'CCC' rating category (no.) 6 12 9 0 27
Downgrades to the 'CCC' rating category (no.) 8 12 22 10 52
(i)Through Nov. 4, 2022. BSL CLO--Broadly syndicated loan collateralized loan obligation.

Where Will The 'CCC' And Default Buckets Go?

Across reinvesting U.S. BSL CLOs, the average 'CCC' and default buckets approached 11% and 7%, respectively, in 2009 during the GFC (BSL CLO 1.0 transactions), and was 12% and under 2% in 2020 during COVID-19 pandemic (BSL CLO 2.0s). The increasing levels of 'B-' exposure across U.S. BSL CLOs has been a hot topic because of what it could mean for future CLO 'CCC' baskets. Although infrequent, we do occasionally see multi-notch issuer downgrades into the 'CCC' rating category from 'B' or higher, especially during periods of stress.

In our recent leveraged finance update, we included some historical context of rating transitions into the 'CCC','CC', and 'C' or 'D' (default) buckets during the most recent recessions: the 2001 dot-com, 2009 global financial crisis (GFC), and 2020 COVID-19 pandemic recessions (see "U.S. Leveraged Finance Q3 Update: 'CCC' Buckets Pick Up In CLOs As Cash Flow Generation Falls," published Oct. 27, 2022). We also included various financial ratios going back to 2019, segmented by rating and industry.

As part of our scenario analysis on U.S. BSL CLO ratings in 2022, we included two additional scenarios that reflect the corporate transitions experienced during the GFC and the COVID-19 pandemic. Table 4 shows an excerpt of the full transition tables, focusing on the 'B' rating category.

Table 4

Proportion Of U.S. BSL CLOs That Transitioned To 'CCC+' And Below
Transition period
Rating at start of transition period GFC (December 2007 to November 2009) (%) COVID-19 pandemic (February 2020 to January 2021) (%)
B+ 15.18 7.08
B 35.37 9.62
B- 38.81 32.65
Note: The transition periods are not annual transition rates. The data are from tables 3 and 4 in "Scenario Analysis: How The Next Downturn Could Affect U.S. BSL CLO Ratings (2022 Update)," published Aug. 4, 2022. GFC--Global financial crisis.

As we consider hypothetical 'CCC' and default buckets over the next potential downturn, the most imminent risk for the 'CCC' buckets is the overhang of 'B-' rated assets, which currently comprise about 29% of U.S. CLO portfolios. However, unlike prior recessionary periods, there is a difference in the composition of the 'B-' exposures. Historically, many 'B-' rated assets were from issuers that had been downgraded to 'B-'. However, more than two thirds of the current 'B-' rated assets are from issuers that were initially rated 'B-'. Since most of the current 'B-' exposures have not experienced a downgrade to date, the future transition rates of current 'B-' rated issuers may look different this time around.

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
Secondary Contact:Deegant R Pandya, New York + 1 (212) 438 1289;
deegant.pandya@spglobal.com

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