Since markets re-opened late in April, the number of newly syndicated CLO transactions is very close to 2019, although year-on-year the pandemic led to a 39% decline, or roughly EUR 7.5bn. More transactions closed in Q2 2020 than January and February combined, although associated volumes are around 50% lower. But the trend observed in Q3 points towards a return to normal, with some managers slowly starting to increase deal size.

The positive trend is also illustrated by the recovery of leveraged loan prices since the sell-off in March. Such a recovery alongside improved liquidity should provide managers with more options to deal with asset covenants.

“CLO managers have successfully adapted to the current context, adjusting both the terms and size of transactions to facilitate access to post-Covid markets,” said Benoit Vasseur, an executive director in the structured finance team of Scope Ratings and co-author of a report out today. “The average ticket has significantly decreased compared to the levels observed since 2014, allowing managers to target a narrower investor base and maintain higher credit quality.”

Given the pressure on the rating of the underlying loans and general market sentiment, the first transactions to emerge showed increased credit enhancement for senior investors and thicker equity tranches, resulting in lower deal leverage. Reinvestment periods are also getting shorter, and the first European transaction with a static pool was issued recently, as already observed in the US market. Rated tranches have benefited from an extra 2% to 4% subordination on average since May 2020.

“As expected, high-yield corporate downgrades have reduced junior over-collateralisation cushions and the reported proportion of CCC rated loans in European CLOs pools has almost tripled on average, reaching levels as high as 12% for some transactions,” said Cyrus Mohadjer, senior analyst in Scope’s structured finance team and co-author of today’s report.

Leveraged loan issuance has been fragile, particularly in the BB space where bonds have been the preferred instrument. Compared to Q1, volumes of sub-investment-grade loans have decreased by around 30%. While corporate borrower risks have increased in most industries, forbearance measures implemented by various governing bodies are delaying the conversion of those risks into defaults. CLO tranches have thus been relatively resilient; and the relatively high level of industry diversification in CLOs could prove to be a natural hedge against potential waves of sectoral insolvencies.

Download the full report here