ARC publishes updated Collateralised Loan Obligation (‘CLO’) Rating Criteria

London, 26 February 2018 - ARC Ratings has published its updated Collateralised Loan Obligation (‘CLO’) Rating Criteria. This is an update to the methodology previously published on 23 February 2017. There are no material changes and as such no rating impact. This methodology can be accessed at

ARC’s Collateralised Loan Obligation (‘CLO’) Rating Criteria (the “Criteria”) applies to managed transactions comprising granular and diverse pools of assets, typically loan obligations, from small and medium sized enterprises (‘SMEs’). The definition of SMEs may vary per jurisdiction but in line with the European Union definition, an SME may also include self-employed individuals, including artisans, sole traders and entrepreneurs, as well as small, medium sized enterprises and micro business. ARC will consider all these types of entities as SMEs within its rating analysis.

CLOs typically have three distinct tranches of liability: senior, mezzanine and the subordinated / equity. The senior tranche has priority of payment before the mezzanine and the equity tranche is the ‘first loss piece”. The size of the senior, mezzanine and equity tranches plays an important role in the ratings determination given the significance of subordination in a CLO transaction. Under a CLO structure that has super senior, senior, mezzanine and subordinated bonds, collateral principal is first paid to the super senior bonds, followed by the senior, mezzanine and subordinated bonds. Collateral losses of interest or principal are typically absorbed by excess spread, then by the lowest rated tranches and then by more highly rated tranches, in reverse order of payment priority. Overcollateralisation (OC) and interest coverage (IC) tests must be passed in order for interest to be paid to the individual tranches. If the tests are failed, interest and principal that would have been paid to the junior tranches will be diverted. Cash diverted under the interest waterfall may be used to acquire additional assets or senior tranches may be paid down until the OC and IC tests are passed.

The majority of CLO transactions are managed by a Collateral Manager, therefore an assessment of the Collateral Manager is crucial, as the Collateral Manager may buy and sell assets in / out of the transaction subject to documented covenants.

This report provides an overview of how CLO transactions are analysed. The Criteria applies globally, although every individual country and specific transaction may give cause to additional observations or deviations, which will be disclosed in the transaction specific reports. This criteria addresses timely payment of interest, as well as ultimate repayment of principal.

This should be read in conjunction with ARC’s Global Structured Finance Criteria.

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