S&P Global Ratings maintains ongoing surveillance on the collateralized loan obligations (CLOs) it rates during their lifecycle, so that it can take appropriate and timely rating actions on each transaction. We actively monitor the changes in each CLO's portfolio and performance through multiple review processes each year. During these reviews, we assess whether the ratings assigned are consistent with the credit quality of the securitized assets and the level of credit enhancement the CLO structure provides. Our rating actions reflect quantitative and qualitative analysis of the transactions according to our criteria.

Below we outline our surveillance process for monitoring cash flow CLOs, which represent most of the CLO transactions we rate.

Overview: CLO Lifecycle, Reviews, And Rating Actions

The timelines for newly issued CLOs vary by transaction, but nearly all CLOs include a specified series of stages in their lifecycle (see chart 1 and "S&P Global Ratings' CLO Primer," published Sept. 21, 2018). We actively monitor the lifecycle stages and performance of each CLO we rate through multiple review processes to determine if the ratings assigned are still appropriate. Our reviews commence soon after the CLO is issued, and they continue until the CLO matures and the ratings on the notes are discontinued.

Chart 1

During the review, if our analysts decide there is a reasonable possibility that the ratings on a CLO could be revised, then the CLO is selected for further analysis. Once completed, an analyst presents the analysis, rationale, and rating recommendation for the CLO to a ratings committee. The committee then reviews the analysis and presentation and decides on the appropriate rating actions (the committee review). Rating actions are taken only by a committee and not by individual analysts.

Chart 2 outlines the information typically required to run our models for in-depth reviews.

Chart 2

We use these data to assess credit and cash flows (two key analytical areas for CLOs), as well other rating factors when determining the rating action (see chart 3).

Chart 3

Effective Date Process

CLO transaction documents require CLO managers to purchase all the assets in the portfolio--up to at least the target par amount--by a certain date, which is known as the "effective date." The documents also contain provisions directing the trustee to take certain actions upon the effective date. These typically include a requirement that the trustee:

• Requests rating agency confirmation of the ratings issued as of the closing date; or
• Conducts the "effective date process" for most transactions rated by S&P Global Ratings by running the formula version of CDO Monitor (see "S&P Adds Transparency To Its Effective Date Process For CLOs," published April 20, 2015).

When a transaction's effective date occurs, we may, where required, affirm the ratings issued on the closing date, based on our review of the effective date portfolio. This process is typically applied for reinvesting CLOs and static CLOs where the portfolio may not be 100% ramped-up on the issue date.

Ongoing Surveillance Analysis Versus Initial Rating Analysis

When assigning initial ratings to a CLO transaction, we analyze the portfolio based on our criteria and the assumptions the portfolio manager provides. At this stage, the portfolio is typically not fully identified or purchased by the portfolio manager--unless it is a static CLO or a refinancing of an existing CLO.

Conversely, in our surveillance analysis, as of the effective date and thereafter, we generally have access to the actual portfolio and the transaction's performance and use this for our analysis. We may, however, consider additional stresses, based on minimum portfolio standards or macroeconomic stresses we deem appropriate as provided in our criteria (see "Global Methodology And Assumptions For CLOs And Corporate CDOs," published June 21, 2019).

CLO Reporting Obligations

Transaction documents typically require the trustee for each CLO to prepare and make available periodic reports, such as monthly and payment date reports, to various third parties, including rating agencies. We use this information to evaluate transaction performance that may affect the ratings.

These periodic reports usually provide key details on some or all of the following:

• The portfolio assets (cash, seniority, par, maturity, coupon, rating, etc.);
• The tranches or notes (balance, margins, any deferred interest, etc.);
• The coverage tests thresholds and their results;
• The collateral quality tests and their results;
• The assets purchased or sold since the last report;
• The transaction counterparties; and
• Other information required in the CLO indenture, such as the defaulted and deferring assets (including the market value, if available) and assets in the 'CCC' rating category.

The trustee payment date reports typically provide most of the information contained in the periodic trustee reports. They also include crucial information on the upcoming payment date, the calculation period, and the interest and principal proceeds available for distribution, as well as how these funds are expected to be distributed on the payment date and the changes in the CLO's note balances after paydowns.

We may discuss any questions we have about these reports with the trustee or the collateral manager.

Surveillance

We review each CLO multiple times each year because regular monitoring is critical in identifying ratings that have a reasonable possibility of change and in taking appropriate and timely rating actions. Our review processes rely on a systematic screening of information in the periodic trustee reports to identify transactions that have meaningful changes in the collateral credit quality ('CCC' rated assets, defaults, recovery rates, etc.) and/or the structural support (coverage tests, trading gains and losses, credit enhancement, etc.).

During these reviews, a CLO may be referred for a committee review if the reviewing analysts conclude that there is a reasonable possibility for a rating change on certain tranches or notes. We disclose each rated CLO's last review date, which is the date of either the last rating action or another formal review that occurred within the past 12 months, on our S&P Global Ratings website.

The timing and method of these surveillance processes follow our policies and procedures. Our assessments include:

• The frequency and availability of transaction- or entity-specific performance and other relevant information;
• Specific risk considerations and expectation relevant to a transaction;
• Any material changes, including changes to criteria and ratings models, that could affect a credit rating;
• The impact of macroeconomic changes or financial market considerations; and
• The availability of new information (derived from a variety of sources) that is relevant to a transaction's creditworthiness.

It is important to note that while most transactions involve cash flow analysis, some do not. These include:

• Transactions with ratings that are dependent on other ratings or are guaranteed by a third party,
• Transactions that are not effective, and
• Amortizing CLOs that have very few remaining obligors and are no longer well diversified due to the increased concentration.

Although we do not run cash flows for these transactions, which represent a small portion of the CLOs we rate, we still review the key credit factors that drive the ratings and ensure that the ratings are still appropriate for the transactions' current metrics.

Reviews and metrics

We periodically conduct a cash flow analysis for transactions that have gone effective and have available trustee reports using our two proprietary models: CDO Evaluator and Cash Flow Evaluator. We review and screen the results, along with other CLO performance data extracted from trustee reports, to identify transactions that are experiencing changes in the collateral credit quality and/or have structural performance elements that may trigger a more comprehensive review.

The key metrics we typically examine to assess changes in collateral credit quality include:

• Increases or decreases in defaulted assets,
• Loans from companies with ratings in the 'CCC' category,
• Loans from industry sectors that are experiencing stress,
• Loans trading at deep discounts (less than 80% of par),
• Loans from companies with ratings on CreditWatch, and
• Currency mismatches for multicurrency deals.

For structural elements, we typically examine the following metrics, among others:

• Changes in the overcollateralization and interest coverage tests,
• Paydowns in liabilities, and
• Interest deferrals on rated notes

We also examine the following factors (which are generally captured in our automated cash flow analysis):

• Significant changes in the S&P Global Ratings' weighted average spread (WAS), weighted average recovery rate (WARR), weighted average rating factor (SPWARF), or weighted average life (WAL).

Comprehensive review

When CLOs are identified for a more thorough review, they are assigned to qualified analysts to perform the review and present their analysis, rationale, and rating recommendation to a committee. After receiving an assignment, the analyst gathers the most recent available trustee report and attempts to contact either the trustee or the manager if there are any questions. If a rating on a CLO is on CreditWatch negative (which indicates that the rating has a one-in-two likelihood of a downgrade), the analyst may contact the manager for details of any trades or other significant events that have occurred since the as-of date of the last available trustee report.

The analyst will then perform an in-depth review of the transaction, which typically involves:

• Examining the changes since the last rating action;
• Assessing if any material structural changes have occurred;
• Evaluating the current state of the portfolio, including the credit support to the notes; and
• Generating cash flow analysis and additional scenario analysis.

Models 

The analyst typically also runs two key models during the comprehensive review:

• The CDO Evaluator model, which is used to assess and analyze the credit quality of the CLO's portfolio; and
• The Cash Flow Evaluator model, which is used to project the CLO's cash flows based on its portfolio, capital structure, and payment priorities, as well as the existing interest rates at the time of analysis.

For a brief overview of these models, see "S&P Global Ratings' CLO Primer," published Sept. 21, 2018.

To maintain its assigned rating, a tranche's break-even default rate (BDR) will generally need to be greater than its scenario default rate (SDR) at the current rating level. However, we may assess this on a case-by-case basis, based on other quantitative and qualitative factors we deem relevant. (For more information on BDRs, SDRs, and our criteria, see "Global Methodology And Assumptions For CLOs And Corporate CDOs," published June 21, 2019.)

The analyst uses the cash flow results, along with the credit analysis of the assets in the CLO portfolio, to assess the transaction's current performance and the potential impact on the assigned ratings.

Supplemental tests 

We also typically apply certain supplemental tests during this review: the largest obligor default test and the largest industry default test (for more details, see our criteria "Global Methodology And Assumptions For CLOs And Corporate CDOs," published June 21, 2019). These tests are usually not rating drivers during the reinvestment period when the portfolio is well diversified. However, as the CLO enters its amortization phase and the portfolio begins to show signs of concentration, these supplemental tests may cap the ratings on the notes to address obligor or industry concentration. They may also limit upgrades on amortizing transactions.

Committee review

Once the comprehensive analysis is completed, the analyst will present the analysis, rationale, and rating recommendation to a rating committee, which ultimately decides the rating action.

The rating committee may consider qualitative factors in its assessment, in addition to quantitative results from our CDO Evaluator and Cash Flow Evaluator models, based on its view of the relationship between the various risks and mitigating factors. These qualitative factors typically include but are not limited to the transaction's exposure to 'CCC' rated assets, stressed industries, long-dated assets, and any assets trading at a low market value. If needed, the committee may request additional hypothetical analyses, based on factors not previously covered to gauge their impact on the cash flows and the rating cushion.

CreditWatch Actions

A CreditWatch placement indicates our view that a rating could change in the next three to six months. It focuses on identifiable events and short-term trends that could cause a rating to change. We may place ratings on CreditWatch when a committee concludes that there is at least a one-in-two likelihood of a rating change.

A positive or negative CreditWatch indicates the potential direction of a rating. We typically resolve a CreditWatch placement within 90 days, but we may extend the placement for another 90 days if necessary. CreditWatch placements and their resolutions are decided by a rating committee in a committee review.

A CreditWatch placement does not mean a rating change is inevitable, however. Although many rating actions are preceded by a CreditWatch placement, rating changes can and do occur even when the ratings are not on CreditWatch.

Notices And Rating Agency Confirmations (RACs)

Our ratings surveillance process includes a review of notices and requests from the trustee and issuers, such as information on key person changes, requests of annual certifications, request for a RAC, proposals for optional redemption, supplemental indentures, and notification of event of defaults. The notices may also include the proposed refinancing of all or a portion of the existing notes, issuance of additional notes, amendment of the current payment structure, or extension of the reinvesting period.

If a notice contains a proposal that we believe could affect the ratings on the notes, we would typically review the five key areas of our analytical framework:

• Credit quality of the securitized assets,
• Legal and regulatory risks,
• Payment structure and cash flow mechanics,
• Operational and administrative risks, and
• Counterparty risks

We use this framework to evaluate the potential impact the proposal could have and conduct a committee review to determine if executing the proposal would lead to a change in ratings. We may contact the trustees, issuers, or managers to clarify any questions we have.

RAC requests seek our confirmation that a proposed change would not, in and of itself, result in a rating action. The transaction parties may include RAC requests in a transaction's documents, though this is not something we require. Since we are not a party to the documents for the transactions we rate, the presence of a RAC requirement in a transaction does not obligate us to provide a RAC. It also does not imply that we would agree to review it. We retain sole discretion in deciding whether to review a RAC request or provide a RAC on the proposed change to the transaction (for more details, see "Standard & Poor's Clarifies Its Approach To Requests For Rating Agency Confirmation On Structured Finance Transaction," published May 18, 2012).

If a RAC is not requested or if we do not provide RAC, a committee may take rating actions if implementing the proposed changes affect the credit ratings. We also typically flag notices of proposed optional redemptions for follow-up after the proposed dates to verify if the redemptions occurred on those dates, and we communicate directly with the trustee regarding any questions or clarifications. For these notices, we typically rely on the trustee's note payment report to determine whether the ratings should be discontinued following full repayment or presented to a committee for a rating action.

Discontinuance

We regularly review rated CLO notes with outstanding balances that have been reduced to zero according to the periodic reports provided by the trustees. These paydowns usually occur because the note balance was repaid in full due to amortization or following a redemption event. We review these notes under our rating methodology for the full repayment of the original balance, accrued interest, and any deferred interest, as applicable (unless our ratings address principal repayments only).

During the review, an analyst will determine if the ratings on the applicable notes can be discontinued. A rating committee is typically not needed for a discontinuance review because there generally is sufficient evidence from the trustee reports to determine that the note balances have been repaid in full (along with accrued interest and any applicable deferred interest).

If a full repayment does not occur, a rating committee will review the affected notes. Failure to repay the notes in full typically occurs when there are either insufficient redemption proceeds or if the noteholders have agreed to receive less than the outstanding balance on the notes. We typically view the failure to repay outstanding principal when due (by legal final maturity or sooner in case of a redemption event) as a breach of the promise under our ratings definitions (see "S&P Global Ratings Definitions," published Nov. 10, 2021). When an instrument breaches this promise, we typically revise the issue credit rating to 'D (sf)', and the rating will generally remain outstanding for at least 30 days before it is withdrawn.

Noteholders' voluntary agreement to receive less than the outstanding amount due on their issuance does not affect how we apply our ratings definitions. Most CLOs provide noteholders with the ability, when voting unanimously, to accept less than the outstanding amount due to them in an optional redemption, and this may not trigger an event of default as defined in the transaction's indenture. However, exercising this option would generally constitute a default under our ratings definitions.

As a CLO nears its stated maturity, we expect that the portfolio's remaining collateral will be liquidated on or before the stated maturity date and any remaining rated notes will be repaid with those proceeds, along with all the senior expenses in accordance with the priority of payments. If there is a risk that the rated notes will not be repaid in full, we may take rating action(s) commensurate with the risk of nonpayment before any outstanding rating is discontinued.

Related Criteria

• Global Methodology And Assumptions For CLOs And Corporate CDOs, June 21, 2019
• Principles Of Credit Ratings, Feb. 16, 2011

Related Research

• S&P Global Ratings Definitions, Nov. 10, 2021
• S&P Global Ratings May Add Additional Qualitative Factors When Rating CLO Tranches Due To Changing Credit Dynamics, April 9, 2020
• S&P Global Ratings' CLO Primer, Sept. 21, 2018
• S&P Adds Transparency To Its Effective Date Process For CLOs, April 20, 2015
• Standard & Poor's Clarifies Its Approach To Requests For Rating Agency Confirmation On Structured Finance Transaction, May 18, 2012