Single Bs return to US CLOs as issuers avoid par sub sting

Charlie Dinning

Data journalist

Single B tranches have returned to US CLO structures, but with a new purpose. They have appeared in deals rated by Fitch and Moody’s in an arrangement that sees Moody’s rate the triple A and single B tranches, while Fitch rates all tranches in between.

The new single B notes are typically sized at just $1 million. They are a consequence of the volatility in the CLO market, which has seen US CLO double B discount margins shift wide of 800bp from an average of 720 basis points in April, according to CLO-i.

This drastic widening of double Bs has made it harder to get Moody’s to rate the notes out to an 8% par subordination, sources say. As a result, issuers have brought in Fitch to rate them and achieve the 8% attachment point.

However, this creates another problem. If Fitch rates the junior-most tranche in a CLO, the deal must adhere to both Fitch and Moody’s matrices, according to sources. To avoid having to use both, sources say that US CLOs have started pricing with an extra tiny single-B rated tranche. This is rated by Moody’s and is held by the equity investor.

“The market is trying to get creative”

Dan Ko, Portfolio manager | Eagle Point Credit Management

Some investors have attempted to work around the requirement for Fitch and Moody’s matrices by issuing an unfunded single B tranche rated by Moody’s, but have found Fitch requires two matrices under this circumstance.

Equity investors may not want to be in a deal with a single B tranche, sources say. Dan Ko, portfolio manager at Eagle Point Credit Management, points out that, “the market is trying to get creative as ultimately CLO equity with a single B in the structure will trade worse in the secondary market. Some equity investors won’t bid for it if there is a single B in the deal.”

Fitch’s participation in US CLOs has increased. For regular US CLOs in 2022, the rating agency has been involved in 43 out of 106 deals (40.6%), as opposed to 72 out of 331 CLOs (21.8%) last year. It is showing no signs of slowing down, with numerous CLOs in the pipeline adopting thin single Bs.

Having Fitch rate the belly of the CLO, but not the junior-most tranche, is not a new phenomenon. But until this year Moody’s would usually rate the triple As and double Bs, with Fitch rating the double As down to the triple Bs.

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Global credit funds & CLO's

June 2022 | Issue 246

Published in London & New York.