Downgrades across obligors in U.S. broadly syndicated loan (BSL) collateralized loan obligation (CLO) collateral pools again outnumbered upgrades in January 2023, see "U.S. BSL CLO Obligors: Corporate Rating Actions Tracker 2023 (As Of Feb. 10)," published Feb. 14, 2023), although the amount of actions have declined over the past few months. Most of the credit metrics across the CLO Insights 2023 U.S. BSL Index remained stable during the first month of the year, with CLO 'CCC' buckets inching up to 5.48% and average junior overcollateralization (O/C) cushions declining slightly to 4.39%. Despite BSL CLOs having gained some par during 2022, some transactions are still seeing haircuts in their O/C tests due to exposure to defaulted assets and excess 'CCC' assets (typically greater than 7.5%), with most of these being seen in CLOs originated in 2019 and earlier. Exposure to assets from 'B-' rated companies now sits at just under 31%, a record. A potential mitigating factor is that less than 4% of BSL CLO collateral comes from obligors rated 'B-' have a negative outlook.

Table 1

The Benefits Of Active Management In 2022

In comparing what could've happened in 2022 versus how the average CLO transaction actually fared, we find the trades done by managers did significantly alter the course of the average transaction.

In last month's update, we summarized our rating actions across U.S. BSL CLO obligors in 2022 (see "CLO Insights U.S. BSL Index 2022 Wrap Up: Credit Metrics Deteriorated Slightly, But Par Gains And Healthy O/C Test Cushions Should Help In 2023," published Jan. 12, 2023. During the full year, companies in U.S. BSL CLO collateral pools saw over 270 downgrades, including 78 obligors lowered to 'B-', 72 obligors lowered into the 'CCC' category, and 29 obligors lowered to a non-performing (below 'CCC-') rating. As noted in table 1 above, several of the credit metrics only deteriorated slightly between the start and end of 2022, despite having moved around considerably during the year. For example, BSL CLO exposure to 'CCC' assets (including obligors rated 'B-' on CreditWatch negative) started 2022 at 4.94%, then dropped to a low of 4.01% on July 1st, before reversing course and ending up at 5.23% at the end of 2022.

Meanwhile, we note average portfolio turnover in full-year 2022 across the reinvesting BSL CLOs in the index was about 30% in 2022, compared to over 49% in 2021. The higher level of portfolio turnover in 2021 is mostly due to higher refinancing and new issuance volumes in the loan market in 2021 compared to 2022. However, in comparing what could've happened had the CLO managers done nothing in 2022, we find the trades done in 2022 did significantly alter the course of the average transaction (see tables below).

Comparing what happened to what could have happened

Borrowing from the framework we utilized in our 2016 and 2020 studies on manager value, we assessed the value of active portfolio management by comparing two sets of metrics:

• The actual change in BSL CLO credit metrics during 2022, including portfolio turnover (left);
• Metrics from the same BSL CLO collateral pools, but assuming they were static CLOs with no trading or asset turnover during 2022 (middle); and,
• The difference between the two sets of metrics (right).

Looking at our hypothetical static portfolios metrics in the middle table, we see that CLO 'CCC' buckets could have increased to 7.33% versus the actual year-end value of 5.23%, while non-performing exposures could've increased to 0.81% versus the actual 0.50%. Also, junior O/C test cushions would have been 0.30% lower (4.15% versus the actual 4.45%). In fact, the only metric that would have been better without active management was BSL CLO exposure to obligors rated 'B-'. Managers during the year saw their 'B-' exposures increase as they traded out of 'CCC' rated issuers (or issuers that wound up with a 'CCC' category rating at the end of 2022), and often times, traded into 'B-' exposures (or issuers that wound up with a 'B-' rating at the of 2022).

When reviewing the impact of trades made by CLO managers in 2022, we find across the 30% turnover: the 'CCC' bucket exposure was reduced by 2.1%, non-performing exposure was reduced by 0.31%, and 'B-' exposure increased by 1.9%. 2022 also saw periods of loan price volatility, especially around the middle of the year, which gave CLO managers an opportunity to de-risk their portfolios and build par, a rare combination and a time for several managers to prove their ability to add value. Some managers built par by purchasing bonds that were trading at a discount in 2022.

Differences in performance amongst the Index

The vintage effect on performance was noticeable during the year, as we see clear differences across the credit metrics CLOs originated pre-pandemic and post-pandemic.

Relative to post-pandemic CLOs, pre-pandemic CLOs:

• Started 2022 with a higher' CCC' bucket (6.08% vs. 3.48%);
• Experienced slightly more turnover (30.93% vs. 30.06%);
• Saw a reduction in 'CCCs' during the year (-0.15% vs. +0.87%); and
• Saw a smaller increase in par (+0.13% vs. 0.28%).

The pre-pandemic transactions had weaker credit metrics at the start of 2022; relative to post-pandemic CLOs, they were closer to exceeding the 7.5% 'CCC' thresholds, and they also had less average junior O/C test cushion. During the year, managers made slightly more trades across these pre-pandemic CLOs, resulting in slightly higher average portfolio turnover. CLO managers were effective in managing the size of the 'CCC' buckets despite the fact that about 70 CLO obligors were experiencing downgrades into the 'CCC' category during the year. However, the de-risking efforts limited CLO managers' ability to build par and build O/C cushion; the par gain across pre-pandemic CLOs (+0.13%) was lower than the par gain across post-pandemic CLOs (+0.28%), and it was also reflected in the average increase in junior O/C cushions (+0.01% compared with +0.20%).

On the flip side, post-pandemic transactions had cleaner portfolios, and thus had more cushion within their 'CCC' thresholds and junior O/C cushions at the start of the year. They saw a larger increase in 'CCC' exposure (+87 basis points (bps) as opposed to a reduction of 15 bps for pre-pandemic CLOs). Meanwhile, across the trades made in 2022, post-pandemic CLOs were able to build more par (+28 bps) and O/C cushion.