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S&P: Corporate downgrade trends continue credit deterioration in CLOs

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The percentage of defaulted loans in U.S. CLOs has fallen, but a spike in corporate downgrades has sharply increased the amount of ‘CCC’-rated obligors in the second quarter, according to S&P Global Ratings.

Default buckets of speculative-grade loans held by CLOs declined “marginally” across post-crisis CLOs, including 1.15% for 2012-vintage deals, compared with 1.55% in the first quarter. That despite a ratio of 82 U.S. corporate speculative-grade downgrades to 49 during the second quarter that increased the non-investment-grade default rate to 3%.

But seven of 12 speculative-grade default issuers in the second quarter are “represented widely across CLO portfolios,” including three obligors (Murray Energy Corp., Community Health Systems Inc. and Del Monte Foods) that held distressed exchanges in June. Community Health’s default action affected 178 U.S. CLOs.

And the level of exposure to assets with underlying ratings of CCC (two rungs above a default in S&P’s ratings ladder) increased across each vintage issuance of deals from 2012 to 2016. The largest increase was in 2016-vintage deals, which had a 111-basis-point swing to 4.73% from 3.62% in the first quarter.

For 2013 and 2014 vintages, the percentage of CCC-rated assets are at near-peak levels (6.27% and 6.73%, respectively) compared to 2016, as deals with higher concentrations of energy-related loans were stressed by the fallout in oil & gas production and exploration.

In addition to the additional pressure of growing buckets of lower-rated assets, the share of CLO note tranches on watch for a possible downgrade has returned to its 2016 peak levels, according to S&P.

In the report issued Monday, S&P stated that subordinate tranches on nine U.S. collateralized loan obligations in the second quarter were placed on credit watch negative – a signal that S&P is considering a downgrade based on the potential for default on certain lower tranches of notes. (Four were since downgraded in July and a fifth was affirmed; the four others remained under review as of late August, according to S&P report data.)

Three CLOs had note tranches downgraded by S&P in the first quarter of the year.

Moody's Investors Service has downgraded 15 tranches among four outstanding CLO transactions in 2018.

Due to the high volume of refinancing activity in the leveraged loan sector ($221.9 billion in repricings YTD in 2018), the report noted weighted average spreads declined again in the quarter across CLOs issued between 2012-2016. Weighted average spreads have trended tighter dating to mid-2016, according to S&P, with 2012-vintage CLOs the tightest at 3.42% (down from 3.45% in the first quarter).

Deals from 2015 and 2016 each had average spreads of 3.58%, narrowed from 3.66% in the first three months of 2018.

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