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CLOInterest Summary - December 2014 Edition

Core Content Overview

This document provides a comprehensive outlook on the performance and credit quality of Collateralized Loan Obligations (CLOs) across the US, Europe, and Asia (ex-Japan) for the year 2015. It also discusses key market developments, including the role of regulatory changes, economic conditions, and the impact of interest rate trends on CLO structures and performance.

Main Views and Key Information

Global Outlook for 2015

• Improving Economic Conditions: Economic growth and ample liquidity are expected to keep leveraged loan default rates low in 2015.
• Credit Quality: Despite weakening loan underwriting, CLO transaction terms and credit enhancement have not deteriorated, allowing tranches to absorb moderate increases in defaults.
• New Issuance: CLO issuance in 2015 will be lower than in 2014 but will remain substantial due to strong historical performance and investor demand.

US CLOs

US BSL CLOs

• Default Rates: Speculative-grade default rates will rise slightly but remain low by historical standards.
• Leverage Trends: Corporate leverage remains high, but defaults are not expected to increase significantly.
• CLO Structures: CLOs will continue to follow the CLO 2.0 template, which provides strong structural protections.
• Subordination: Aaa (sf) classes will maintain high subordination levels (around 37–40%), above pre-crisis levels.
• Collateral Composition: Senior-secured first-lien loans will make up at least 90% of portfolios.
• Warehouse Facilities: Generally available for larger managers, though less so for smaller ones.
• Refinancing and Redemptions: Redemptions and amortization of older deals will free up collateral and investible funds, supporting new issuance.
• Interest Rates: Expected to rise in 2015, which may negatively impact CLOs, especially CLO 2.0s due to lower interest coverage.

US SME CLOs

• Performance: Expected to mirror BSL CLOs, with strong credit quality and similar issuance volumes to 2014.
• Default Rates: Low for SME loan borrowers, supported by economic growth and limited refinancing needs.
• Structural Features: CLO 2.0 structures provide sufficient credit enhancement for SME loans.
• Collateral Diversification: SME CLO portfolios are well diversified across countries, industries, and obligors.

European CLOs

• Default Rates: Expected to remain low, around 2%, due to adequate liquidity and manageable refinancing risk.
• Leverage: Increased for European issuers, particularly B-rated ones, reflecting easy access to credit.
• CLO Structures: CLO 2.0 structures will continue to support strong credit quality, with subordination levels (40–45%) higher than CLO 1.0s (35%).
• Amortization: Will drive performance improvements through increased over-collateralization (OC).
• New Issuance: Expected to rise modestly, with limited structural innovations, as the market adapts to regulatory rules and collateral availability.

Asia (ex-Japan) CLOs

• Credit Quality: Will improve slightly due to declining corporate default rates in the region.
• Performance: Strong portfolio diversification across countries, industries, and obligors supports stability.
• Regulatory Role: Banks may issue CLOs to meet regulatory capital requirements under Basel III, especially for refinancing maturing deals.

Key Highlights

• Regulatory Impact: The Dodd-Frank risk retention rules and the Volcker Rule are unlikely to significantly affect new CLO issuance, though they may influence future market dynamics.
• Economic Recovery: The US economy is expected to grow modestly, with low inflation, which may delay rate hikes and support CLO performance.
• Interest Rate Trends: Rising rates in 2015 may reduce excess spreads, impacting CLO 2.0s more than CLO 1.0s due to their reliance on LIBOR floors.
• CLO Manager Corner: Black Diamond Capital Management issued the first US CLO compliant with the European Capital Requirements Regulation.

Document Structure

• Contacts: Includes managing editor and editors.
• Key Links: Directs to CLO & Structured Credit Quick Check, CLO Global Methodology, and 2015 Outlook.
• News & Analysis: Focuses on the 2015 Outlook, Ultra-low Treasury Yields, and CLO Manager Corner.
• Performance & Surveillance: Covers market performance, OC ratios, and refinancing trends.
• Moody’s Bulletin Board: Lists recent events, publications, and announcements.
• Moody’s, Served to Your Liking: Highlights the availability of Moody's content across multiple platforms.
• Analysts and Contact Information: Includes key contacts for further inquiries.

Conclusion

The 2015 outlook for CLOs is cautiously optimistic, with continued strong performance driven by improving economic conditions, structural protections, and limited defaults. While regulatory pressures and rising interest rates may affect issuance volumes and spreads, the overall credit quality of CLOs is expected to remain robust.