November 2017KEY LINKS»CLO Global Methodology»SME & Mid-Cap FocusAbout usMoody’s CLO/Structured Credit Groupis the leading source for credit ratingsand research on collateralized loanobligations (CLOs) and the entirestructured credit market. The CLO/Structured Credit Group leveragesMoody’s decades of experience inbank loans and high yield as well asour market-leading default studiesto produce the most accurate ratingmethodologies for this asset class.FEATURE ARTICLESShrinking first-lien cov-lite debt cushions drive modest USCLO portfolio recovery rate decline2Lower debt cushions for the cov-lite loans that dominate the leveraged market, particularly loanswithout subordination, imply lower CLO collateral recovery rates ahead.US CLO Sector Update – Q3 2017: CLO new issuance marcheson amidst mixed asset credit metrics6An update of issuance and performance trends in the sector.European CLO Sector Update – Q3 2017: CLO issuance strongas CLO metrics deteriorate slightly7An update on issuance and performance trends in the sector.Leveraged Loan Covenants - North America: Creditagreements provide extraordinary dividend capacity at loaninvestors' expense8Weaker restricted payment protections are giving borrowers greater leeway to pay dividends andmake other payouts to equity holders at a time when dividend recaps are making a comeback.PERFORMANCE & SURVEILLANCEAugust 2017 Market Pulse: Defaults drop while Caa exposuresup9October 2017 Surveillance Update: Deleveraging drivesupgrades15MOODYS.COM FEATURE ARTICLESShrinking first-lien cov-lite debt cushions drive modest US CLOportfolio recovery rate declineOriginally published on 17 November 2017Shrinking leveraged loan debt cushions, exemplified by the increased prevalence of covenant-lite (cov-lite) loans without subordinateddebt, have contributed to a modest decline in our portfolio weighted average recovery rate (WARR)1 assumptions for collateralized loanobligations (CLOs).2 Since the emergence of CLO 2.0s, CLOs’ cov-lite loan exposures have grown, along with an increase in cov-lites'share of the leverage loan market, which comprised 75% of new institutional loan issuance in 2016. 3 The decline in portfolio WARR iscredit negative for CLOs because (1) lower future recovery rates on underlying loan defaults imply greater portfolio par losses, makingCLO tranches more likely to lose credit enhancement, and (2) the loss of WARR cushion at a time when portfolios' weighted averagespread (WAS) is shrinking reduces trading flexibility for CLO managers.»CLO portfolio recovery rates have declined as first-lien cov-lite structures weakened. With the deterioration in structuralsupport for first-lien cov-lite loans, our median portfolio WARR among CLOs we rate has also fallen, to 49.2% in June 2017 from50.9% in January 2012.»First-lien Cov-lite debt cushions are either disappearing or shrinking. As cov-lite loans have grown in popularity since the crisis,the share of cov-lite loans without subordinated debt cushion has increased, while the average debt cushion for other cov-lite loanshas shrunk. Most of the CLOs we now rate hold roughly 10%-15% of cov-lite loans without subordinated debt, compared with 2012when all deals held less than 5%.CLO portfolio recovery rates have declined as first-lien cov-lite structures weakenedWeakened structural support for first-lien, cov-lite loans has contributed to a decline in the median portfolio WARR among CLO 2.0swe rate, to 49.2% in June 2017 from 50.9% in January 2012, as Exhibit 1 shows.After years of record issuance, cov-lite loans now account for a much larger proportion of the leveraged loan market than they didbefore the credit crisis. In 2016, cov-lite loans comprised 75% of new institutional loan issuance. However, when it comes to investors’protection and loan recovery rates, the relative position of debt instruments in a company's capital structure and the amount of debtsubordinated to the loan matter more than its cov-lite moniker. Post-crisis cov-lite loans have considerably less debt cushion to protectthem in case of default. The average debt cushion below first-lien cov-lites was 22% in 2016, compared with approximately 28% in2012 and 33% pre-crisis, as Exhibit 2 shows. Historically, debt cushion has been positively correlated with loan recovery rates and itsdeterioration will have a negative impact on recoveries, come the next credit downturn.4This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.2 27 November 2017CLO Interest: November 2017 Exhibit 1US BSL CLO 2.0 portfolio median WARR has declined since 2012*4848.54949.55050.55151.5Median CLO W ARR (%)*Limited number of CLO 2.0 transactions prior to 2012.Source: Moody's Investors ServiceExhibit 2The share of first-lien cov-lite loans without subordinate debt is on the