CLO Ratings - Recent Methodology Changes: European CLO Strategy | Europe

Research evidence excerpt

CLO Ratings - Recent Methodology Changes: European CLO Strategy | Europe

IdeaMmezz, we believe this means the vast majority of the ratings are likely to stay

within their current broad rating category. In the BBB segment for example, most

Fitch ratings are BBB- and most Moody's ratings are Baa3, and thus even a two-

notch pickup will take these to BBB+/Baa1 respectively i.e., staying within the broad

triple-B range. However, in the AA tranche for instance, most Fitch ratings are AA

and Moody's are Aa1/Aa2 and if the agencies do implement two-notch uplifts here,

we could see some migrations into AAA/Aaa ( Exhibit 3 ). More delevered CLOs may

likely be better positioned to benefit here, in our view.

In Exhibit 3 to Exhibit 7 we show the current ratings split across the mezz stack.

For now, there is little certainty on which tranches will be ultimately impacted but

taking a look at the current universe can help provide a rough estimate. It remains to

be seen whether recently downgraded tranches (mainly single-Bs) ( Exhibit 8 ) will

see some positive actions on the back of these changes. It also remains to be seen

whether CLO documents for new deals will see some shifts in tests as they

incorporate the changes to rating agency recovery assumptions.

Exhibit 3: Current ratings for the AA Exhibit 4: Current ratings for the A

tranche tranche

Current rating composition of originally broadly rated AAs Current rating compositon of originally broadly rated As

AA/Aa2 AA+/Aa1 AAA/Aaa 18 A-/A3 A/A2 A+/A1 AA-/Aa3 and above 35

16 Billions 30 Billions

25 12

20 10

15 8

5 2

0 0

S&P Moody's Fitch S&P Moody's Fitch

Source: Intex, Bloomberg, Morgan Stanley Research Source: Intex, Bloomberg, Morgan Stanley Research

Exhibit 5: Current ratings for the BBB Exhibit 6: Current ratings for the BB