High Quality
Open the downloaded document, and select print from the file menu (PDF reader required).
August 2009
In this issue
Following a Stressful Period, CLO Performance Shows Some Signs ofStabilization
I
ndicators suggest a near-term bottoming out in the cycle, but refinancing poses alonger term risk
.
CLO Market Pulse
Key indices for July were nearly flat in this mostly quiet month.
CLOs May Fill a Gap in DIP Financing
Corporate bankruptcies rise while bank lenders remain cautious.
No Mystery in the Repackaging of Downgraded CLO Notes
Some critics may not fully understand the analysis of this securitization technique.What is it that they are missing?
Observations on Weighted Average Life Contraction in CLO Portfolios
Weighted average life in CLO portfolios has declined relatively steadily over thelast year. We discuss some empirical data and observations.
Loan Price Rally Boosts Market Confidence, but CLO Managers AreCautious
Trading decisions must take account of the impact on collateral par values.
Name Overlap in Cash-Flow CLOs Suggests Limits to DiversificationAcross CLOs
Collateral pools within broad regions hold many common assets.
2
Note Cancellation within CLO Transactions and Its Rating Impact
Moody’s believes the likelihood of such changes in CLO capital structures is low
CLO Surveillance Update: The Sweep Continues
T
he sweep continues with further downgrades and a few upgrades.
Market Value CLO Ratings Revised Following an Update to Methodology
New assumptions reflect extreme volatility since Lehman failure.
Announcements and Publications
We list recent events, announcements, and publications.
Contributors
Eun Choi
Managing Director +1 (212) 553-4962
Katherine Frey
Group Managing Director +44 (20) 7772-5521
Yvonne Fu
Group Managing Director +1 (212) 553-7732
Paul Kerlogue
VP-Sr Credit Officer +44 (20) 7772-8603
Christina Padgett
Sr Vice President +1 (212) 553-4164
Ramon Torres
VP-Sr Credit Officer +1 (212) 553-3738
Yuri Yoshizawa
Senior Managing Director +1 (212) 553-1939
Contact Us
EDITORS:
Jerry Gluck, Algis Remeza
Moody’s Views on the Global CLO Market
2
August 2009
Moody’s CLO Interest
Moody’s CLO Interest
The Fundamental ViewFollowing a Stressful Period, CLO Performance ShowsSome Signs of Stabilization
Moody’s observed considerable deterioration in CLO portfolio metrics during the first half of this year.Nonetheless, against the backdrop of a likely ‘hook-shaped’ economic recovery
characterized by very slowgrowth and continued stressful credit conditions, the corporate sector is showing signs of stabilization. Here,we discuss the implications of firming corporate conditions for the future credit performance of CLOs.
The Deterioration to Date Has Been Sharp…
Corporate default rates continue to edge toward historical highs and have recently surpassed the peakobserved during the last recession. During the first seven months of this year, Moody’s trailing globalspeculative-grade default rate rose from 4.2% to 10.7%. The rate is expected to grow further, topping out at12.2% globally in Q4 2009.
Consistent with this picture, rating transitions for leveraged loans have beensharply negative. For example, over the last year, 15.7% of single-B rated loans have migrated to Caa1 orbelow, more than double the average one-year transition rate for the preceding five years.Direct measures of CLO collateral performance have mirrored this deterioration. The weighted average ratingfactors (“WARFs”) of Moody’s-rated CLOs have climbed significantly since late 2008, indicating a substantialdecline in the average credit ratings of the loans backing these transactions. Moreover, portfolio par amountshave fallen significantly, as measured by overcollateralization (“OC”) levels.In light of these factors, CLO ratings have undergone significant rating migration during the first seven monthsof this year. Through July 31st, Moody’s downgraded 2,650 CLO tranches globally, totaling the equivalent ofroughly US$118 billion from more than 650 CLO transactions. Of the downgraded tranches, 310 were initiallyrated Aaa and downgraded by an average of 3.3 notches.
…But Some Encouraging Signs have Emerged
After leveraged loan prices bottomed near 60 in the months following the Lehman bankruptcy, they haverecently risen above 80. Still, current prices are low compared to levels historically near par, indicative ofcontinued caution among lenders.In the last two to three months, we have observed signs of stabilization in some CLO portfolio metrics.Portfolio WARFs, Caa-rated asset and defaulted asset exposures, as well as OC levels have weakened at aslower pace. In some cases, such measures have improved slightly, following significant deterioration startingin late 2008. (In the “CLO Market Pulse” section, we provide more details on CLO portfolio index performanceover time.)Despite the expectation of still higher (trailing) speculative-grade default rates by year’s end, Moody’s projectsa significant improvement by mid-2010, with the global rate falling substantially to 4.4% by next July.Nonetheless, a significant risk for the leveraged loan market remains in that most loans will not mature until2013-2014, at which time default rates could rise if credit market conditions remain stressful and refinancingproves difficult.
CLO Spreads Remain Wide and Issuance Remains Spotty
Any optimism about corporate performance is, at best, filtering slowly to attitudes toward CLO liabilities. CLOliability spreads have fallen. Since reaching their high in the spring, the spreads of Aaa-rated CLO trancheshave declined by more than 200 bps. Still, they are substantially higher than the spread levels seen last yearprior to the Lehman bankruptcy. In part, the exceptionally wide spreads for Aaa-rated CLO tranches reflectconcerns about further downgrades of CLO liabilities.
1
, May 2009.
2
3
August 2009
Moody’s CLO Interest
Moody’s CLO Interest
With liabilities spreads still wide, new CLO issuance remains very weak. The limited new issuance has beendominated by the repackaging of existing notes or motivated by balance-sheet considerations. We do notanticipate a significant change in this pattern until the signs of market stabilization are unambiguous and arecovery is well under way.
Jian Hu Managing Director +1 (212) 553-7855 Jian.Hu@Moodys.com Danielle Nazarian Senior Vice President +1 (212) 553-4054 Danielle.Nazarian@Moodys.com Fei Fern Wang Assistant Vice President – Analyst +1 (212) 553-4621Fei.Wang@Moodys.com
Add a Comment