U.S. collateralized loan obligations performed well in 2005, with Standard & Poor's raising the ratings on 22 CLOs and lowering two. The consistent performance is expected to continue, S&P says in the research report, "U.S. CDO Rating Performance Robust But Mixed in 2005; Outlook for 2006 Stable For Most Deal Types." The ratings agency anticipates that this year, overall CLO rating performance will remain stable, but that subordinate tranche ratings of some CLO transactions could be at risk for negative rating action as speculative-grade default rates increase.
Specifically, CLO transactions that were originated with higher spreads are challenged by the lower spreads found on loans available now. "CLO transactions originated in higher spread environments saw declines in their weighted average collateral spreads as the higher spread loans in the pools paid down and managers were unable to source new loans at comparable spreads," the report says.
Stephen Anderberg, the primary credit analyst who worked on the report, offered a variety of tips for managers going forward. "The best possible thing for those deals is to lower the minimum weighted spread at the same time they reprice senior liabilities if they can get senior note holders to agree," he said. He also explained that loan deals have a couple of natural advantages that should benefit them, including the high recovery rating they have had in the past relative to assumptions when they closed. Through whatever means possible, he said, managers should maintain their ability to manage the portfolio and avoid dipping into asset classes they are not familiar with. "They should be sticking with assets with which they are comfortable, not picking up an asset they might not like just to pick up spread," he said.