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CLO Spotlight: Twenty-Five Years Strong: European CLOs' Lifetime Default Rate Is Only 1.5%

(Editor's Note: We intend to update this article periodically as the tally of European CLO tranches rated 'D' changes due to additional defaults. Table 3 contains a list of S&P Global Ratings-rated CLO tranches that have defaulted.)

European collateralized loan obligations (CLOs) have proved remarkably stable since S&P Global Ratings rated its first transaction in 2000. During this time, European CLOs have resisted several upheavals, including the global financial crisis, the dotcom bubble, and the COVID-19 pandemic, and have seen very few defaults.

In Europe, we refer to CLOs issued since 2013 as CLO 2.0 and those issued before the global financial crisis as CLO 1.0. We include transactions backed by loans to large corporates, but exclude those backed by loans to small and midsize enterprises, those backed by collateral in a single jurisdiction, and the collateralized debt obligations of asset-backed securities.

CLO 1.0: 25 Years Of Solid Credit Performance

From 2000 to the end of 2009, S&P Global Ratings rated almost 1,500 CLO tranches issued by over 220 European CLOs. We have since withdrawn all of these ratings as the tranches were mostly redeemed in full, with only a small number defaulting. Of the almost 1,500 CLO tranches, a mere 22 defaulted, 20 of which were term notes and two combination notes. Four were from tranches that we initially rated investment grade (in the 'BBB' category), and two of these were pari passu tranches in the same transaction. Overall, 13 CLOs, across seven collateral managers, had at least one tranche suffering a default.

Will CLO 2.0 Outperform CLO 1.0?

After 11 years, European CLO 2.0 transactions' credit performance is arguably stronger than that of their earlier counterparts, with no tranche defaulting or having a rating in the 'CCC' category. This is thanks to CLO 2.0 transactions' better structural protections, namely:

  • They have greater credit enhancement, especially at the senior level. 'AAA' credit enhancement has increased to 38% from 30% in European CLO 1.0 transactions, while 'AA' credit enhancement has risen to 29% from 23%. At the more junior 'BB'/'B' level, the credit enhancement is lower than in CLO 1.0 transactions.
  • Their eligibility criteria focus on corporate debt and exclude structured finance and synthetic assets.
  • A large portion of the issuers now have ratings, whether public, private, or confidential, whereas in CLO 1.0 transactions, credit estimates were more prevalent.
  • The structures tend to have less leverage, shorter reinvestment periods, and fewer derivatives such as currency options and basis swaps.
  • The structures now include a risk-retention rule to align the interests of different stakeholders. This is otherwise known as "skin in the game".

For the time being, we do not rate any European CLO 2.0 tranches in the 'CCC' category. CLO 2.0 transactions have typically undergone a reset or refinancing, meaning that most of the original notes do not follow the typical amortization pattern.

Table 1

European CLO transactions -- default summary by original rating
--CLO 1.0-- --CLO 2.0--
No. of original ratings No. of defaults Currently rated No. of original ratings No. of defaults Currently rated
AAA 481 0 0 846 0 495
AA 227 0 0 917 0 648
A 249 0 0 594 0 406
BBB 296 4 0 567 0 391
BB 211 17 0 528 0 381
B 11 1 0 474 0 366
Total 1,475 22 0 3,926 0 2,687
Trustee report data to Jan. 31, 2024. CLO--Collateralized loan obligation. European CLO 2.0--European CLOs closed between Jan. 1, 2013, and March 31, 2024.

Table 2

European CLO 2.0 issuers -- default summary by original rating
No. of CLOs No. of defaults No. of outstanding CLOs
AAA 418 0 373
AA 422 0 380
A 423 0 380
BBB 423 0 381
BB 421 0 381
B 393 0 364
Total 2,500 0 2,259
CLO--Collateralized loan obligation.

European CLO 2.0 Transactions Continue To Perform Well In Challenging Conditions

Challenges include the conflicts in Ukraine and Israel and higher interest rates than in the past five years. While the number of corporate defaults is increasing, it remains low compared to historical levels.

In our view, the structural protections that CLO 2.0 transactions have introduced will help sustain their performance. However, concerns persist about the flexibility that the leveraged loan and CLO 2.0 documentation gives portfolio managers. For example, we have seen instances of CLOs exiting the reinvestment period but remaining fully reinvested for several years. The longer the CLO is reinvested, the longer the 'AAA' noteholder will have to wait to receive the principal repayment.

Another challenge that CLOs 2.0 transactions are likely to face concerns the recovery amount when obligors default. The underlying loans' covenant-lite nature and weaker documentation will lead to lower recovery rates than historical levels.

Table 3

CLO defaults in Europe*
CLO name Class name DOA initial rating Reinvestment Initial rating Initial credit enhancement Rating before default Date of default Reason for default
Avoca CLO II B.V. C-1 Nov-04 5.2 BBB 9.1 CCC- Aug-16 Principal loss
Avoca CLO II B.V. C-2 Nov-04 5.2 BBB 9.1 CCC- Aug-16 Principal loss
Avoca CLO II B.V. D Nov-04 5.2 BB 7.7 CC Aug-16 Principal loss
Avoca CLO III PLC E Aug-05 6.1 BB 7.4 CCC- Mar-17 Principal loss
Avoca CLO IV PLC E Def Jan-06 6.1 BB 6.9 CCC- Aug-16 Principal loss
Avoca CLO V PLC F Aug-06 6.0 B 5.6 CCC- Apr-18 principal loss
BACCHUS 2007-1 PLC E Sep-07 5.6 BB- 8.5 CCC- Feb-18 Missed interest payment
Leopard CLO I B.V. E-1 Jan-03 5.1 BB 7.7 CCC- Nov-15 Principal loss
Leopard CLO I B.V. E-2 Jan-03 5.1 BB 7.7 CCC- Nov-15 Principal loss
Leopard CLO II B.V. D Apr-04 5.0 BB 9.4 CC Oct-16 Missed interest payment
Leopard CLO III B.V. E1 Apr-05 5.0 BB- 7.1 CCC- May-17 Principal loss
Leopard CLO III B.V. E2 Apr-05 5.0 BB- 7.1 CCC- May-17 Principal loss
Leveraged Finance Europe Capital III B.V. D Oct-04 5.0 BBB- 9.6 CCC- Feb-17 Missed interest payment
Leveraged Finance Europe Capital III B.V. E Oct-04 5.0 BB- 7.1 CC Nov-18 Principal loss
Munda CLO I B.V. E Dec-07 6.0 BB- 8.65 CCC Oct-19 Principal loss
North Westerly CLO I B.V. IV-A Jun-03 5.0 BB- 7.4 CC Aug-16 Principal loss
North Westerly CLO I B.V. IV-B Jun-03 5.0 BB- 7.4 CC Aug-16 Principal loss
North Westerly CLO II B.V. D-1 Sep-04 6.0 BB- 7.8 CC Sep-17 Principal loss
North Westerly CLO II B.V. D-2 Sep-04 6.0 BB- 7.8 CC Sep-17 Principal loss
Strawinsky I PLC D Aug-07 6.0 BBB 10.9 B- Mar-20 Missed interest payment
*The table excludes combination notes. CLO--Collateralized loan obligation. DOA--Date of assigning.

Our EMEA CLO Collateral Managers Dashboard compares weekly European CLO data. This 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

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Abhijit A Pawar, London + 44 20 7176 3774;
abhijit.pawar@spglobal.com
Secondary Contacts:Emanuele Tamburrano, London + 44 20 7176 3825;
emanuele.tamburrano@spglobal.com
Shane Ryan, London + 44 20 7176 3461;
shane.ryan@spglobal.com

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