CLO managers consider Moody's rating across capital structure; CLO spreads remain wider

By Cristal Cody

Tupelo, Miss., Aug. 6 - More CLOs are expected to be rated across the capital structure by Moody's Investors Service instead of Standard & Poor's, according to an informed source.

"In the last two months or so, we have seen three new CLOs choose to be rated by Moody's from the tops to the bottoms of their structures, instead of S&P - including Sound Point III, Halcyon Loan Advisors Funding 2013-2 and Anchorage Capital CLO 2013-1," Credit Suisse Securities AG analysts said in a note. "In contrast, very few CLO 2.0 deals had chosen to do so previously, except some middle market deals."

The reason for the shift "seems to lie in the uncertainty regarding S&P's recovery rate assumptions, especially related to cov-lite loans, which have proliferated in the past 18 months," the analysts said.

"As a result, some CLO managers and other market participants are concerned that it might become more challenging to satisfy S&P's minimum weighted average rating test and CDO monitor test, if cov-lite loans are to receive lower recovery ratings/rates," the Credit Suisse analysts said. "To avoid this risk, some new CLOs - such as the three mentioned earlier - chose to obtain Moody's ratings across the capital structure. And other CLO managers are considering a similar move."

Moody's default rate assumptions are higher and "seem to be a little tougher than S&P's," the analysts said.

New CLO managers

Moody's said in a report that new CLO managers continue to enter the new issue market this year and "some of the managers who have entered the business even more recently do not have investment professionals with substantial CLO or leveraged loan experience, which raises risks because manager decisions can substantially affect a CLO's performance, especially in a market downturn."

The CLO market has become "more receptive to these new managers, evident in the ability of some to issue multiple CLO 2.0 transactions, as well as the relaxation of reinvestment restrictions in their deals," Moody's said.

Liability spreads often are higher in many of the recently priced CLOs by new managers than in deals from more experienced CLO managers, market sources note.

New CLO issue spreads remain at relative wide levels, with AAA tranches pricing around the area of Libor plus 130 basis points to 135 bps, a market source said.

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