During 2019, U.S. speculative-grade nonfinancial corporate downgrades outpaced upgrades 418 to 116--a downgrade-to-upgrade ratio of over 3 to 1 (compared with a ratio of less than 2 to 1 in 2018, which saw 277 downgrades and 189 upgrades). Of the issuers with loans held in collateralized loan obligations (CLOs), many of the downgrades were within the energy-, healthcare-, and retail-related sectors.

U.S. Speculative-Grade Corporate Downgrades Add Up In 2019

Table 1

The increase in exposure to 'CCC' and nonperforming together is less than 1% in 2019, evidence of manager attempts to de-risk amid the high volume of downgrades (60 to 'CCC' and 50 to nonperforming, as noted above). De-risking has come at a price, as the deals within this index have lost about 29 basis points (bps) of par (non-haircut) on average. Accounting for market value haircuts on the defaulted and 'CCC's (if applicable), the cushion of junior overcollateralization (O/C) tests have dropped 62 bps on average, to 3.7% at the end of the year from 4.3% at the start of the year.

Some Notable Downgrades In 2019

Table 2

Market Prices For Weaker Loans Have Seen Better Days

The drop in junior O/C tests was driven by par loss, as well as lower market values for defaulted assets and 'CCC' rated assets (if applicable). The average market price of loans with a nonperforming rating held within our CLO index has dropped to 48 at the end of the year from 69 at the start of 2019. The average price of 69 at the start of the year represented a volatile period for prices for most of the leveraged loan market (including performing loans). The average price of nonperforming loans at the end of third-quarter 2018 (representing a period of stable prices) was 81. Meanwhile, the average price of 'CCC' rated loans held within our CLO index has declined to 78 at the end of the year from 83 at the start of 2019. Interestingly, the average price of 'CCC' loans at the end of 2019 is lower than the average price of nonperforming loans five quarters ago (third-quarter 2018)!

Managers Took Different Approaches In 2019

The largest five global industry classification (GIC) exposures of the index continues to be software, health care providers and services (P&S), hotels/restaurants/leisure, media, and IT services, though the exposures to these five GIC sectors has declined in 2019 (all have declined except health care P&S). Some of the lesser held sectors saw a slight increase in 2019 to make up the difference (like diversified telecom services, capital markets, and insurance). Software was the largest GIC exposure for 167 transactions from our index at the start of 2019, of which 30 transactions have had their largest GIC exposure transition to another sector (like media or health care P&S) by the end of 2019.

Chart 1

We have updated our list of top 250 issuers held in U.S. broadly syndicated loan (BSL) CLOs (see "The Most Widely Referenced Corporate Obligors In Rated U.S. BSL CLOs: Fourth-Quarter 2019," published Jan. 10, 2020. Together, loans from these 250 issuers represent about 52% of overall U.S. BSL CLO exposure rated by S&P Global Ratings. The portfolio exposures to these 250 issuers can vary widely across the CLOs within our index, evidence of the difference in CLO manager preference to the loans from larger widely held issuers (the top 250 issuers tend to have higher credit ratings, but offer lower spreads). One hundred deals from our CLO index had less than half of their portfolio exposures to 250 large issuers (three deals have less than 30% exposure to the top 250, meaning over 70% of these three portfolios are exposed to lesser held issuers, many of which offer higher spreads). Meanwhile, 227 deals from our sample have a majority (>50%) of their portfolios exposed to these 250 widely held names (five deals have over 70% exposure to the top 250 issuers, which tend to have higher ratings).

Chart 2

Some CLOs have maintained or gained par while their 'CCC' and below buckets have increased notably, while other CLOs have experienced an above average decline in par as their 'CCC' and below buckets have declined. Still, some CLOs have experienced a decline in exposures to 'CCC' and below, while seeing above average increases in 'B-' exposures, and vice versa. We find that the differences in sector exposures and top 250 exposures have had an impact on performance in 2019.

Some of the transactions within our 2019 CLO index will exit their reinvestment periods in 2020 (given where spreads are, it is unlikely many of these deals will get reset this year). Time will tell how these deals perform, as their 'CCC' buckets will likely grow as the CLOs amortize, leading to potential O/C failures if market prices remain low. Most of our downgrades to CLO 2.0 notes are to the junior notes during the amortization phase. We recently placed 11 tranches from eight CLOs on CreditWatch negative (see "Ratings On 11 Classes From Eight CLOs Placed On CreditWatch Negative," published Jan. 22, 2020).

Starting next month, we will provide updates on a new CLO index for 2020 with rated U.S. BSL CLOs that will reinvest for all of 2020.

Table 3