May 2018KEY 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 ARTICLESCLOs – Global: Falling WARR is latest hit to trading flexibility,ability to absorb further collateral weakening2Lower WARR levels reduce cushions with respect to CLOs' WARR triggers, thus reducing CLOs'ability to hold assets with lower WARF.CLOs – Europe: Sector Update – Q1 2018: CLO performancemetrics deteriorated but remained healthy enough to supportCLO issuance6European BSL CLO issuance remained strong in Q1 2018 while CLO credit quality slightlydeteriorated.HEARD FROM THE MARKETCLOs – Europe: Heard from the Market: Recent Moody's andIMN conferences10PERFORMANCE & SURVEILLANCECLOs – Global: February 2018 Market Pulse: Credit-risk salespush European CLO 2.0 metric movements12CLOs – US: April 2018 Rating Surveillance Update:Refinancings fuel more paydowns17MOODYS.COM FEATURE ARTICLESCLOs – Global: Falling WARR is latest hit to trading flexibility, ability toabsorb further collateral weakeningOriginally published on 23 April 2018The weighted average recovery rate (WARR) among US and European CLO 2.0s we rate has declined significantly in recent years,eroding CLOs' trading flexibility and ability to absorb further collateral credit quality deterioration.»Declining WARR is credit negative. Lower WARR levels reduce cushions with respect to CLOs' WARR triggers, thus reducing theflexibility allowed by collateral quality test modifiers to put excess WARR toward holding assets of lower credit quality, as measuredby weighted average rating factor (WARF).»The shift reflects trends in the leveraged loan universe. Over the last two years, leveraged loan credit quality has weakened viahigher first-lien leverage and the growing prevalence of covenant-lite (cov-lite) structures.»CLOs globally are facing reduced trading flexibility. CLO managers' ability to trade-off collateral quality metrics while sourcingeligible collateral has declined, not only as the result of the WARR erosion, but as a consequence of the deterioration in creditquality in CLO portfolios measured by the WARF and the decline in collateral weighted average spread (WAS).Declining WARR is credit negativeRecent declines in WARR among CLOs we rate have shrunk the excess with respect to their WARR triggers, thus reducing CLOs' tradingflexibility and increasing their susceptibility to trigger breaches. As Exhibits 1 and 2 show, since January 2016, the median WARR forboth US and European CLOs' has declined by roughly 80 bps. As a result, WARR cushions have declined by 50 bps among US CLOs andby 253 bps among European CLOs.Exhibit 1Reported WARR and WARR cushion have declined for EuropeanCLOsMedian WARR and WARR cushion for European CLO 2.0s we rate*Exhibit 2Reported WARR and WARR cushions have also shrunk for US CLO2.0sMedian WARR and WARR cushion for US CLO 2.0s we rate*3.03.54.04.55.05.56.06.545.545.846.046.346.546.847.0Jan-16Jul-16Jan-17Jul-17Jan-18WARR cushion (%)Reported WARR (%)Reported WARRWARR cushion*We use the WARR cushion as a proxy of the excess WARR in a CLO transaction. TheWARR cushion is difference between the actual reported WARR and reported WARRcovenant for each CLO transaction. The reported WARR covenant might have beenadjusted as a result of the collateral quality test modifiers.The excess WARR is the difference between reported WARR and the base case matrixWARR trigger which it is used in the collateral quality test modifiers.Source: Monthly reports and Moody's Investors Service 4.6 4.8 5.0 5.2 5.4 5.6 5.8 6.048.448.648.849.049.249.449.649.850.0Jan-16Jul-16Jan-17Jul-17Jan-18WARR cushion (%)Reported WARR (%)Reported WARRWARR cushionSource: Monthly reports and Moody's Investors Service2 18 May 2018CLO Interest: May 2018 Lower CLO collateral quality test metrics reduce deals' ability to use the excess of one metric, such as WARR, to put toward anothermetric, such as WARF, when buying and selling assets. More bluntly, when a deal's excess WARR shrinks, its ability to buy weaker qualityassets declines.Furthermore, given that many deals are already putting at least some excess WARR toward buying assets with higher WARF,1 furthererosion of excess WARR will result in many CLOs breaching both their WARF and WARR tests. For example, all else being equal, if wedowngrade the instrument ratings on around 50% of a typical CLO portfolio without any change in corporate family ratings (CFR),2the WARR cushion would largely disappear, tripping the WARR trigger and the WARF trigger on those deals which are using the excessWARR to pass their WARF tests.Exhibit 3 shows the extent to which a sa