European collateral loan obligations (CLOs) typically benefit from portfolio diversification, both from an issuer and a sector perspective. CLO managers maintain portfolios of leveraged loans that have an average exposure to 161 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 704 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 on March 31, 2023. 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 Quality Deteriorates Amid High Inflation: Key Changes To Credit Metrics

Based on our review of first-quarter (Q1) 2023 data and comparing against Q3 and Q4 2022, 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 2,897 in Q4 2022 compared with 2,870 in Q3 2022, and then remained flat at 2,900 in Q1 2023. At the same time, underlying CLO loan prices reversed some of the recent decline, increasing to 93.13 in Q1 2023 compared with 91.13 in Q4 2022 (see chart 1).
• Cash flow pressures at asset level have started mounting across sectors, affecting consumer goods, commodity chemicals, capital goods, and energy-heavy sectors, among others. Median EBITDA interest coverage for European CLO obligors is 3.0x, which is 0.3 times lower than the previous quarter as persistently high input inflation, slower price rises, and rising interest costs have begun affecting free cash flows. The average unstressed recovery rating is predominantly '3' (50%-70%), constituting 84% of CLO portfolio assets held.
• Obligors on negative outlook or 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

European CLO Exposure To Corporate Rating Actions

Chart 2

So far this year, CLOs have been more exposed to downgrades than upgrades with only four of the eight corporate upgrades in January found in European CLO portfolios compared with all three of the downgrades. In April, nine of the 10 corporate upgrades were found in CLO portfolios (90%). However, across the remaining months the percentage was consistent with January at about 50%. Conversely, in February, only four of the six corporate downgrades were found in CLO portfolios (67%). However, across the remaining months, the percentage was similar to January at about 90%. Over the same period, no CLO tranches have been downgraded as structures withstand the negative rating impact of the corporate actions.

How Well Have CLOs Managed Their WAL Tests?

Earlier vintage CLOs are showing tighter constraints on weighted-average life (WAL) tests as they approach the end of their reinvestment periods compared with more recent vintages. This is partially driven by the earlier vintages maintaining a constant WAL over their reinvestment periods through continued reinvestments, while the maximum WAL test continues to decrease over the same period. The WAL constraint is also driven by the starting point WAL cushion, which tends to be lower in earlier vintages. For example, the average WAL for CLOs issued in 2017 with 4.5 years left of the reinvestment period was six years, while the average maximum WAL covenant was 8.6 years, giving those transactions a starting point WAL cushion of 2.60 years. Compared with 2018 (2.76 years), 2019 (3.00 years), 2020 (3.00 years), 2021 (3.40 years), and 2022 (3.80 years) vintages, WAL cushions increased driven by lower portfolio WALs at issuance and increasing maximum WAL covenants.

Earlier vintages may therefore have less flexibility to accept loan/bond refinancing proposals and maturity/credit amendments in the near term, notwithstanding any amendment to their WAL tests.

Chart 3

Chart 4

Chart 5

Chart 6

Chart 7

Chart 8

The average maximum weighted-average life does not step down linearly as CLOs with shorter reinvestment periods, but issued in the same year, are included along the x-axis by the number of years they have left in their reinvestment period. For example, the maximum weighted-average life of a CLO with a 4.5 year reinvestment period will be included in the average at the starting point of 4.5, whereas a CLO issued in the same year with a reinvestment period of 3 years will be included at 3.0 on the x axis. The apparent step-up in the maximum WAL and the subsequent increase in WAL cushions when these CLOs are considered is explored further in charts 11 and 12 below.

Examining CLOs with reinvestment periods between three and five years, the later-vintage CLOs have more headroom on their WAL test covenants, as they approach the end of their reinvestment period, because they benefit from shorter starting WALS.

Chart 9

As a result, the WAL cushions for later vintages tend to be higher.

Chart 10

Typically, reinvesting CLOs are structured with 4.5 year reinvestment periods, which are associated with 8.5 year maximum WAL tests. As a result, the starting point WAL cushion is typically around four years.

Chart 11

While these measurements are typically structured in linear formation (i.e., lower reinvestment periods combined with lower maximum WALs), more recent vintage CLOs--especially those issued as early as 2022 with three-year reinvestment periods--have been structured with progressively longer maximum WAL tests, a theme that originated in 2020 vintage CLOs.

Chart 12

Although a number of the CLOs issued in 2020 have now been reset, the CLOs issued in 2022 with three-year reinvestment periods and maximum WAL covenants of more than seven years will benefit from larger WAL test cushions when managing refinancing and amend and extend proposals.

Average European CLO 'CCC' exposure shows upward trend

Average European CLO 'CCC' exposure increased in Q4 2022 to 5.38% by December 2022 compared with 3.37% in October of the same year. European CLOs continued to work through their existing 'CCC' exposures in Q1 2023, with 'CCC' exposure falling to 4.75% in April 2023 but rebounding to 5.20% in June 2023 as CLOs simultaneously navigate instances of downward rating pressures on underlying credits. Just over 20% of all European CLOs now comprise on aggregate more than 7.5% exposure in 'CCC' rated obligors (see chart 12).

Chart 13

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 13).

Chart 14

Sector Averages Of Reinvesting European CLO Assets

Before diving deeper into the results, 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 euro CLO portfolio at the end of each quarter exposure include 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; and
• 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 704 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 of 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 Q1 2023, 10.13% 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 the 10.65% at the end of 2022. We also examined the breakdown between negative bias, positive bias, and stable for 26 GICS sectors, each weighted by euro notional exposure (see chart 15). 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.

Chart 15

European CLOs' key metrics

In response to investors' growing interest following the COVID-19 pandemic and ongoing credit effects on companies and European CLOs, S&P Global Ratings is publishing a regularly updated list of rating actions we have taken globally on nonfinancial corporations that have had an effect on European CLOs, and a summary of how European CLOs have been affected with key benchmarks.

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

To compare European CLO data each week, S&P Global Ratings provides you with an EMEA CLO Collateral Managers Dashboard. This 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 first-quarter 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 of 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 S&P Global Ratings' structured finance group uses in its rating process for CLOs.

We aggregate CLO exposures reported in trustee reports available as of the end of the first quarter of 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 S&P Global Ratings-rated CLO assets were issued by 704 corporate issuers operating across various GICS industries and represent over 95% of the total par of the CLOs aggregated in this first-quarter 2023 update. The credit rating, recovery rating, spread, price, and leverage ratio values of these floating S&P Global Ratings-rated CLO assets were used 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 overall credit rating distribution of the portfolio, 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 non-performing rating: 'CC', 'SD' and 'D', 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 CreditWatch negative rating, the CreditWatch negative percentage is a proportion of the total CLO par amount considered in this analysis. This is also broken down per GICS sector (see table 2) as a total sum of the par of CLO GICS sector assets.

With 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 broken down 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 the assumptions we make around debt and EBITDA, as 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. We have credit ratings, recovery ratings, and spread information for all loans issued by the 709 issuers as of June 30, 2023, and each end of quarter in table 1.

Due to limitations within the various data sources, we did not have complete coverage regarding 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 94% of the loans.