European collateral loan obligations (CLOs) typically benefit from portfolio diversification, from both an issuer and a sector perspective. CLO managers maintain portfolios of leveraged loans that have an average exposure to 163 different corporate issuers operating across 39 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 633 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 up to Dec. 31, 2023, in the first quarter of 2024. 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 Stabilizes: Key Changes To Credit Metrics

Based on our review of fourth-quarter (Q4) 2023 data and comparing against Q3 2023, 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) increased marginally to 2,903 in Q4 2023 compared with 2,902 in Q3 2023. At the same time, underlying CLO loan prices continue to be stable, decreasing just slightly to 95.85 in Q4 2023 compared with 95.89 in Q3 2023 (see chart 1).
• Cash flow pressures at the asset level have started mounting across sectors, combining weaker operating results in certain sectors (such as chemicals, health care services, and consumer goods) and higher cost of financing. Median EBITDA interest coverage for European CLO obligors has continued to decline to 2.7x. The average unstressed recovery rating is predominantly '3' (50%-70%), constituting 84% of CLO portfolio assets held.
• Obligors on negative outlook, or on CreditWatch negative, continue to comprise 10% of the overall portfolio holdings, as downside risks on cash flow generation increased in Europe, driven by a combination of inflation-driven margin compression, softening demand in certain sectors, and rising interest rates.

Chart 1

Delayed Deleveraging And Worsening Coverage Metrics

Highly leveraged issuers, needing to refinance their approaching maturities, face mounting uncertainties compared with those obligors in the same position over the past couple of years.

Median debt-to-EBITDA ratios for European obligors have remained broadly unchanged since the end of the pandemic at around 6x. However, interest coverage ratios have worsened significantly in the past 18 months to 2.7x from 3.6x in the first half of 2022. This is due to a number of factors, including continued high leverage, unwinding of pre-2022 hedges put in place due to expiry or refinancing, and persistent higher cost of financing due to higher underlying rates.

Non-financial Q1 2024 results point to resilience and a tentative recovery. However, certain sectors still remain operationally challenged, such as chemicals, telecoms, health care services, labor-intensive business services and industrials (see "Corporate Results Roundup Q1 2024: Recovery continues excluding commodity sectors but remains fragile and fragmented," published May 8, 2024).

Obligors struggling with higher leverage and fairly low interest coverage ratios of below 1.5x include TK Elevator Topco GmbH, Polaris Parent, LLC, and EG Group Ltd. Of these, TK Elevator has addressed its maturity wall through an amend and extend (A&E) this year. However, a downgrade from 'B' may ensue if operating under-performance and EBITDA margin weakness continues. Polaris Newco's liquidity curtailed as higher cost of debt weighs on cash flows and recovery remains uncertain. EG Group, though rated 'B-', is making attempts to kick-start deleveraging using debt repayment from asset sales.

Though asset sales can be a valid tool issuers use to deliver on deleveraging in a lackluster operating performance environment, there have been two instances involving high-profile issuers where that came part and parcel with priming risk.

Altice France S.A. has used its substantial basket of investments to remove valuable assets outside of the restricted group. As it pursues sales of these, it has signaled its reluctance to apply all proceeds to deleveraging. Though value arguably exists in the secured creditor restricted group for sufficient coverage of senior lenders, this may not be the case for the subordinated debt. No imminent triggers exist to precipitate an action by the owner, as creditors have pre-emptively engaged advisors as they realize they are beholden to the owner's benevolence.

Ardagh Holdco payment in kind (PIK) noteholders have been similarly primed as the company raised new financing, double-dipping into two separate collateral pools, particularly that of the 75% ownership in Ardagh Metals, from which the holding company lenders do not benefit.

Both situations are an illustration of the lack of creditor protection in loan documents, highlighting owner behavior as potentially a factor in recovery prospects. Perhaps these, in particular Altice France, would trigger a greater focus on enhancing protection against asset transfers by reducing investment capacity, minimizing or eliminating issuer ability to reclassify subsidiaries into unrestricted, tightening asset sale cash sweep application, and others. Patches to CLO terms in preventing "snooze-loose" terms, loan market association (LMA) loan agreement language, etc., have perhaps reached their limit and it is now time to turn to the real culprit, which is the boundless issuer-friendly flexibility in underlying loan documentation terms.

Chart 2

The effect on European CLOs was similar with the weighted-average debt-to-EBITDA ratios relatively unchanged over the past 12 months, while the weighted-average interest coverage ratios have reduced to 2.6x from 3.6x in European CLO portfolios.

Chart 3

With refinancing and rating changes over the past couple of years, CLOs have been resilient with the affected notional amount per CLO low given the nature of the (as designed) well-diversified portfolios. The SPWARF has remained stable throughout, ranging only between 2879 and 2953 from the start of 2023 until the end of April 2024. The 'B' ratings moved to 43.27% of the average rating of assets in European CLO portfolios from 47.63%, 'B-' ratings moved to 26.28% from 23.87%, and nonperforming assets to 0.51% from 0.15%, which was offset by increases in 'B+' ratings and 'BBB-' ratings along with a steady decline in the 'CCC' category.

Average European CLO 'CCC' Exposure Increases

Average European CLO 'CCC' exposure decreased in Q4 2023 to 4.45% compared with 4.51% in Q3 2023. Over 22% of all European CLOs comprised on aggregate more than 7.5% exposure to 'CCC' rated obligors at the end of 2023 (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% (see chart 5).

Chart 5

Sector Averages Of Reinvesting European CLO Assets

Before diving deeper into the results of our analysis, 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 European CLO portfolios at the end of each quarter exposure includes 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 Euro Interbank Offered Rate (EURIBOR) of the loans in each CLO portfolio.
• 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 633 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 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 Q4 2023, 9.93% 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 11.04% at the end of Q3 2023. We also examined the breakdown between negative bias, positive bias, and stable for 24 GICS sectors, each weighted by euro notional exposure (see chart 4). 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.

European CLO key metrics

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

Our EMEA CLO Collateral Managers 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 Q4 2023 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 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 we use as part of our rating process for CLOs.

We aggregate CLO exposures reported in trustee reports available as of the end of Q4 2023 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 CLO assets were issued by 633 corporate issuers operating across various GICS industries and represent over 95% of the total par of the CLOs aggregated in this Q4 2023 update. We used the credit rating, recovery rating, spread, price, and leverage ratio values of these floating-rate CLO assets to calculate the averages outlined in tables 1 and 2.

The seven metrics we use in our analysis are listed below.

Weighted-average life (WAL)

For a subset of assets, the WAL is the sum product of each asset's term to maturity and the asset's par exposure as a percentage of the sum of the par of the subset of assets.

S&P Global Ratings' weighted-average rating factor (SPWARF)

The SPWARF of a CLO portfolio provides an indication of the portfolio's overall credit rating distribution, 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 'CC', 'SD', or 'D' rating, 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 rating on CreditWatch negative, the CreditWatch negative percentage of assets is a proportion of the total CLO par amount considered in this analysis. This is also split per GICS sector (see table 2) as a total sum of the par of CLO GICS sector assets.

With a 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 split per GICS sector (see table 2) as a total sum of the par of CLO GICS sector assets.

Debt-to-EBITDA ratio

The leverage is based on our debt and EBITDA assumptions 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. Credit ratings, recovery ratings, and spread information for all loans issued by the 633 issuers are as of Dec. 31, 2023, and each quarter-end in table 1.

Due to various data source limitations, we had inadequate coverage of 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 93% of the loans.