Loans from 'B-' obligors in U.S. broadly syndicated loan (BSL) collateralized loan obligations (CLOs) have been on a steady decline since peaking at just over 30% in mid-2023. After reaching a recent low in October 2024, at just under 25% of total BSL CLO assets, a handful of widely held issuers in different industries saw their ratings lowered to 'B-' in December 2024 (see table 2), resulting in a small uptick to back above 25%. However, overall credit quality continues to improve, as the average S&P Global Ratings' weighted average rating factor (SPWARF) remains well below 2700 and the proportion of assets with ratings on a negative outlook has declined to below 13% of assets. This is due, in part, to improving credit conditions and fewer companies having ratings with a negative outlook, but it's also due to CLO managers rotating into higher quality assets (see last month's CLO Insights update, "CLO Insights U.S. BSL Index: 2024 Year In Review; Value In Manager Trades," published Jan. 17, 2025, where we review the impact of active management in 2024).

There has been a notable decline in CLO weighted average spread (WAS), which isn't surprising given the high level of refinancing and repricing activity in the BSL loan market in 2024. As a result of CLO manager derisking efforts, BSL CLO par balance and junior overcollateralization (O/C) cushions have both declined by about 60 basis points over the past year, with the tradeoff being cleaner CLO portfolios. Anecdotally, we're hearing that investors in both new issue and existing CLOs are pushing managers to maintain cleaner, lower-spread portfolios, and that if investors are interested in picking up additional spread, they can look to the private credit market and middle-market CLOs.

Table 1

Table 2

Comparing Junior 'BB' CLO Tranches From New Issue Vs. Refinancing

In tables 3 and 4 below, we compare the rating performance of junior CLO notes originally rated within the 'BB' category for new issue CLOs and CLO refinancings (refis; including resets) issued in the same year. The refi notes will be from transactions issued in an earlier vintage (typically at least two years prior due to the two-year non-call period of most new issue CLOs). For ratings that have been withdrawn, we compare the latest outstanding rating prior to withdrawal.

We find that despite being issued and rated within the same year, the rating performance between new issue and refinanced junior CLO notes can differ across certain vintages.

Table 3

2014 vintage: the problem child

We find a larger subset of junior notes of the original 2014 vintage transactions experienced notable negative rating changes to 'CCC+' and below (over 13% of the original 'BB' notes issued in 2014 were downgraded into the 'CCC' category or lower). A higher proportion of 2014 vintage CLOs had outsized positions in energy and retail related issuers, which wound up seeing deterioration in 2016 and 2017, which then made these CLOs unlikely candidates for reset. Several were well into their amortizing period during the pandemic, which made liquidations harder, resulting in several downgrades and some defaults (over 8% of these 2014 vintage tranches were lowered to a nonperforming rating).

2017-2018: the calm before the storm

We see the original 2017 and 2018 vintage junior CLO notes also experienced a high proportion of downgrades during their life relative to other CLO vintages, with 54% and 36%, respectively, being downgraded below their original rating, even higher than the 2014 vintage of 22% (though the magnitude of downgrade was much less severe). Almost all of the downgrades were just into the 'B' category. These two vintages were closed right after the energy and retail slowdown in 2016-2017, and relative to the 2014 vintage, they had cleaner portfolios before entering the pandemic.

Table 4

Comparison with resets

Looking at tables 3 and 4, we see 2014-2015 vintage refi notes had no downgrades. This was the very first wave of resets, so the sample size much smaller and positive selection bias may have been a factor. As we review the 2017-2019 vintage refis (2019 was a lower refi volume year), we see a majority of each of these three vintages experienced downgrades, higher than each of the respective vintages of the original 'BB' notes. A majority of these refinanced transactions were originally closed in 2015 and prior and had experienced some deterioration during the energy and retail slowdown in 2016 and 2017. As these deals were reset in 2017-2019, they experienced even more deterioration during the pandemic (especially since the original new issue transactions typically close with cleaner portfolios).

For now, none of the junior notes since 2022, original nor refi, have yet experienced a downgrade. Since the pandemic, many of the reset transactions since have seen a portfolio cleanup, with removal of weaker credits and/or cash injection prior to the close of the reset, making their portfolios closer to the starting point of a new issue transaction. Given the recent dearth of loan supply from new BSL issuers nowadays, much of new issue BSL CLO portfolios are made up of loans from existing issuers, thus making the new issue and reset portfolios more similar. Perhaps the difference in ratings performance between the 2024 vintage new issue and reset/refis may be less pronounced if we were to enter a stressed period.