Portfolio quality upgraded amid European CLO resets in H1 24

The portfolio credit quality of European CLOs that were reset in the first half of 2024 were improved compared with the original transactions, according to Fitch Ratings’ latest Monthly European CLO Index report.

“Before the resets, the portfolio average triple-C exposure was 2.8%, consistent with other Fitch-rated reinvesting EMEA CLOs, and with defaulted assets accounting for no more than 1%,” Fitch stated.

More broadly, Fitch notes that recent European CLOs have been structured with smaller cushions on the tests and less excess spread available, reducing the default rate cushion on the identified portfolio.

Based on a stressed portfolio shaped in line with the portfolio profile and collateral quality tests, most EMEA CLO tranches benefit from a cushion against downgrades in the underlying portfolio. 

For instance, Fitch notes that all notes have cushions except the class E notes based on the stressed portfolio for Invesco Euro CLO VIII.

The report notes: “The increased cushion on the identified portfolio is mainly due to the decrease in the PCM hurdle rate between the stress and identified portfolios. This is due to the cushions that CLO managers incorporate in the collateral quality and portfolio profile tests when structuring a transaction.”

Fitch points out that the average triple-C exposure of these deals at the reset closing date declined to 1.7%, and nearly no defaults were observed in portfolios. 

These transactions have normally been reset by – or in proximity to – the end of their reinvestment periods and are part of the 2022-2023 vintages launched amid unfavourable spread market conditions.

In the first half of the year, up to mid July, 17 CLOs (amounting to €7bn) were reset. Eight of these upsized their target par balances from €25m to €200m. 

Fitch highlights that only Carlyle Euro CLO 2022-5 reduced its target par balance. This is due to the outstanding CLO trading below par.

“When a CLO is upsized, the transaction typically includes an effective date determination requirement condition including the satisfaction of portfolio profile tests, collateral quality tests, coverage tests and the collateral principal amount with defaults carried at the collateral value being above par,” Fitch said.

The majority of these resets showed rising levels at closing, in line with new deal levels, reaching 90% or above. 

However, Fitch said two outliers – Rockford Tower 2018-1 and Grosvenor Place 2022-1 – showed ramp levels of between 80% and 90% due to deleveraging and substantial cash balances, respectively. The portfolios of non-upsized deals were closer to par.

Camilla Vitanza