Moody's: Global CLOs to perform well in 2015 despite weaker leveraged loan underwriting

The performance of collateralized loan obligations (CLOs) in the US, Europe and Asia (excluding Japan) will remain strong as a result of the improving global economy, according to Moody's Investors Service's "2015 Outlook -- Global CLOs."

The report discusses the outlook for US broadly syndicated loan (BSL) CLOs, US small- and medium-enterprise (SME) CLOs, European BSL CLOs and Asian (excluding Japan) CLOs.

The strengthening global economy will be the main driver of CLO credit performance in 2015. US BSL and US SME CLOs will benefit from historically low leveraged loan default rates. European CLO performance will be similarly strong even though economic growth in the region will be weaker than in the US.

 

The absence of refinancing pressure will further help CLO performance. "Debt maturities have been pushed to 2018 and beyond for European CLOs, which will keep default rates low," says Ian Perrin, a Moody's Senior Vice President.

However, risks persist in the sector. Loan covenant quality will continue to erode in 2015 in the US and Europe and corporate leverage will remain high. Covenant-lite subordination will also continue to shrink as the amount of debt subordinate to first-lien loans declines.

"Loan underwriting will continue to weaken in 2015, but CLO structures and transaction terms will support performance," says Yvonne Fu, a Manager Director of Structured Finance at Moody's. US and European CLOs will continue to adhere to the strong structural features and protections inherent in the CLO 2.0 template.

Rising interest rates will pressure excess spread for US CLOs. However, the risk of excess spread compression in Europe is minimal because the European Central Bank is unlikely to tighten monetary policy given the weak economic outlook.

CLOs will seek ways to comply with regulations, such as the Volcker Rule and Dodd-Frank and European risk retention rules, to appeal to investors globally.

For US BSL CLOs, the pending implementation of the new risk retention rules, along with rising interest rates, will cause a decline in new issuance in 2015, though levels will remain high, bolstered by amortization and redemptions of older deals. Issuance for US SME CLOs will remain at a similar level to 2014.

Even though European CLOs will need to comply with risk retention rules and contend with a scarcity of collateral, Moody's expects a modest increase in European CLO issuance in 2015.

For Asian (excluding Japan) CLOs, the continued decline in corporate defaults in the region and the need to refinance existing deals will lead to an improvement in credit quality from already strong levels.

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