Credit quality of U.S. broadly syndicated CLOs improved during the first quarter, aided by a default rate on underlying loan issuers at its lowest level in two years, according to Fitch Ratings.
In a report issued Tuesday, Fitch also noted that exposure to issuers with negative outlooks – or on watch for potential downgrades – was “proportionally less” for collateralized loan obligations, in its initial 2021 surveillance report on outstanding deals.
Fitch said it identified only 13 issuers with loans held in CLOs that were in default at the end of March 2021, down from 28 at the end of December 2020. “Default exposure in U.S. broadly syndicated loan CLOs under Fitch’s surveillance at the end of 1Q2021 is at the lowest quarter-end level seen since 2Q2019,” the report stated.
Those loans on credit watch by the ratings agency – those rated triple-C or below or among its “Top Market Concern Loans” list – also declined to 9.6% from 11.7% in the prior quarter.
The report stated exposure to issuers with negative outlook or credit-watch ratings status was 28.1% at the end of March, down from 34% at the end of 2020.
Fitch noted the market had its third consecutive quarter of net upgrade activity for portfolio-held loan issuers, with 59 net upgrade actions, which helped improve the weighted-average ratings factor figures for CLOs.
Improving credit quality also supported better average overcollateralization test cushions for deals, with the junior OC test cushion improving to 3% in the first quarter for CLOs within their reinvestment period – up approximately 40 basis points from year-end 2020, Fitch’s report stated. Senior OC tests also were about 40 basis points higher quarter-over-quarter to 8.1%.
The weighted average spread (WAS) for CLOs in the Fitch index was 3.73% in March, down slightly from 3.78% in December 2020. Fitch stated spread metrics have been supported by loans with Libor floors. Only 2% of CLOs in Fitch’s index were failing their WAS covenant level.
