Egan-Jones CLO* Summary Report (November 8, 2023)

Egan-Jones CLO* Summary Report (November 8, 2023)

*Egan-Jones' ratings in this report are not issued under an NRSRO license

For every fixed-income instrument, there is a tension between estimated losses and earnings. Will Rogers might emphasize a return “of” assets versus a return “on” assets. What continues to be comforting is the relatively low level of defaults reported to date. According to Figure III-D, as of October 2023, for CLOs covered in our report (which includes over 1,500 domestic CLOs), the default rate was only 1% per annum for the traditional market and 2.8% for the middle market. In comparison, based on Figure II-B, the AAA tranche coupon rose from 2% as of May 2022 to 7% as of October 2023. Meanwhile, according to Figure II-A, the subordination of the AAA tranche remained relatively stable, decreasing from 30% to 29%. All of this is supported by the asset coupon, which increased from 4.5% as of May 2022 to 9% as of October 2023. Our key takeaway is that, on a risk-adjusted basis, the returns for this asset class have improved dramatically while only modest risk has manifested, as shown by the modest level of defaults. The primary drivers of these changes are the significant 500+ point rise in Fed funds rates and rise in treasury yields, rather than any dramatic rise in default risk. Per Joshua Easterly, co-founder of Sixth Street Partners, speaking on the low issuance levels at a recent Bloomberg Global Credit Forum, “A lot of that AAA demand came out of US banks who had a lot of excess liquidity. They're no longer buyers at the moment given their balance-sheet issues.”¹

Currently, Egan-Jones tends to have a more positive view of CLO credit quality as compared to other credit rating agencies, as demonstrated in the table below.

I. Deal Key Metrics Summary

As of October 2023, Egan-Jones rated 1543 CLO deals. We collected and calculated available deal level, tranche level, and asset level key metrics such as deal weighted average rating factor and tranche subordinations, compared with prior period(s) analysis results and summarized highlights below.

I-A. Weighted Average Rating Score

Egan-Jones collected the weighted average rating score (WARS)³ of covered CLO deals. The 25th, 50th, and 75th percentiles of the WARS value were 3705, 3803, and 3895, respectively. Egan-Jones calculated and compared the monthly average value of WARS data from May 2022 to this month. The mean value of WARS has increased over the observed period, which indicates the overall default risk might be increasing.

I-B. Diversity Score

Egan-Jones collected the Diversity Score (DS)⁴ of covered CLO deals. The 25th, 50th, and 75th percentiles of the DS value were 58, 64, and 69, respectively. Egan-Jones calculated and compared the monthly average value of DS data from May 2022 to this month. The mean value of DS has decreased over the observed period, which indicates the diversity level of the portfolios might be decreasing.

I-C. Super Senior Tranches Subordination

Egan-Jones collected the senior tranches subordination⁵ (%) (STS) of covered CLO deals. The 25th, 50th, and 75th percentiles of the STS value were 33.2, 35.0, and 36.9, respectively.

I-D. CCC+ or Lower Rating Percentage

Egan-Jones collected the CCC+ and Lower Rated Asset Percentage (%) (CLRA) of covered CLO deals. The 25th, 50th, and 75th percentiles of the CLRA value were 5.2, 6.8, and 8.2, respectively. Egan-Jones calculated and compared the monthly average value of CLRA data from May 2022 to this month. The mean value of CLRA has increased over the observed period, which indicates the percentage of lower-rated assets might be increasing.

I-E. CLO Leverage Summary

Note: Deal balance is the sum of current balance of all deal tranches; Debt balance is the sum of current balance of all debt tranches.

Egan-Jones reviewed various liability/asset metrics. The 25th, 50th, and 75th percentiles of the total deal balance to collateral balance (total current tranches balance / current collateral balance) were 96.0%, 98.0%, and 100.0%, respectively. The 25th, 50th, and 75th percentiles of the debt balance to collateral balance (current non-equity tranches balance / current collateral balance) were 107.0%, 108.0%, and 110.0%, respectively.

II. Tranche Key Metrics Summary

II-A. Tranche Subordination Analysis

The average subordination levels (defaulted assets are valued at market value) of senior tranches and mezzanine tranches were 36.1% and 14.1%, respectively. The 25th, 50th, and 75th percentiles of senior tranche subordination levels (defaulted assets are valued at market value) were 33.3%, 35.1%, and 36.9%, respectively. The 25th, 50th, and 75th percentiles of mezzanine tranche subordination levels (defaulted assets are valued at market value) were 6.9%, 13.5%, and 20.4%, respectively.

The mean, 25th, 50th, and 75th percentiles of the available subordination of each rating category (includes +/-) can be found in the table above.

II-B. Tranche Coupon Analysis

The average coupon of senior tranches and mezzanine tranches are 6.6% and 8.9%, respectively. The 25th, 50th,and 75th percentiles of senior tranche coupon are 6.7%, 6.8%, and 6.9%, respectively. The 25th, 50th, and 75th percentiles of mezzanine tranche coupon are 7.4%, 8.3%, and 10.9%, respectively.

The mean, 25th, 50th, and 75th percentiles of the available coupon of each rating category (includes +/-) can be found in the table above.

II-C. Tranche Spread Analysis

The average spread (over 3 months LIBOR) of senior tranches and mezzanine tranches are 1.5% and 3.9%, respectively. The 25th, 50th, and 75th percentiles of senior tranche spread (over 3 months LIBOR) are 1.3%, 1.4%, and 1.6%, respectively. The 25th, 50th, and 75th percentiles of mezzanine tranche spread (over 3 months LIBOR) are 2.1%, 3.1%, and 5.8%, respectively.

The mean, 25th, 50th, and 75th percentiles of the available spread (over 3 months LIBOR) of each rating category (includes +/-) can be found in the table above.

II-D. Egan-Jones Ratings vs Other Agencies

Below is a summary of Egan-Jones ratings compared with other agencies. For the detailed full listing and sorting of Egan-Jones’s CLO ratings, please visit our website at https://portal.egan-jones.com/client/fast/clo.aspx.

Egan-Jones's Key Rating Features & Differences Compared With Others

Below is a summary of Egan-Jones's approach (see our Methodology for a more complete description):

1. Our rating is derived from estimated losses.

2. The probabilities of default utilized are generally more conservative than industry standards.

3. Generally, our ratings are more heavily model driven and take into account fewer subjective assumptions.

4. Generally, we updates the cashflow and ratings monthly based on the availability of the trustee reports.

5. Our analysis is conducted using information and cash flow engines supplied by a recognized industry provider.

III. Pool Asset Key Metrics Summary

This section summarizes the characteristics of the underlying loans in the CLO deals.

III-A. Asset Distribution

III-B. Asset Coupon Analysis

III-C. Asset Rating Analysis

III-D. Asset Default Analysis

Notes

1. Bloomberg - A Shrinking $1.3 Trillion Securities Market Is Bad News for the Economy
2. Adj asset coupon means gross asset coupon minus the asset estimated losses which is assumed 50% of loss given default.
3. The Weighted Average Rating Score is derived from the 10-year default rate and used to calculate the weighted average default probability of the portfolio.
4. Diversity Score represents the number of independent, identical assets that we can use to mimic the default distribution of the actual portfolio.
5. Tranches Subordination is calculated as (Collateral Value - (Pari-Passu Balance + Senior Balance)) / Collateral Value. Defaulted assets are valued at market value.

For more details, please refer to Egan-Jones's CLO methodology.

Appendix

Links to Egan-Jones CLO reports: https://portal.egan-jones.com/non-nrsro-ratings/clo

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