KBRA Assigns Preliminary Ratings to Refinancing Notes of Carlyle Euro CLO 2019-2 DAC

LONDON--(BUSINESS WIRE)--Kroll Bond Rating Agency UK Limited (KBRA) assigns preliminary ratings to four classes of refinancing notes to be issued by Carlyle Euro CLO 2019-2 DAC, a cash flow collateralised loan obligation (CLO) backed primarily by a diversified portfolio of Euro-denominated corporate loans and bonds.

Refinancing Notes
Class	KBRA Preliminary Rating	Initial Amount (€mm)	Interest Rate^(2)	O/C (%)^(3)
Class A-1-R	NR	246.00	3mE+ 0.89%	137.87%
Class A-2B-R	AA (sf)	20.00	2.20%	137.87%
Class B-1-R^(1)	A (sf)	13.50	3mE+ 2.20%	124.86%
Class B-2-R^(1)	A (sf)	16.50	2.40%	124.86%
Class C-R^(1)	BBB (sf)	26.00	3mE+ 3.50%	115.42%
^(1) Each class of notes can defer interest without triggering an Event of Default
^(2) 3mE = Three-month EURIBOR. At the occurrence of a Frequency Switch Event, the floating rate notes will change to semi-annual pay and the index will switch to Six-month EURIBOR
^(3) O/C = Overcollateralisation as per June 2021 trustee report

Transaction overview

Carlyle Euro CLO 2019-2 DAC is a €408.7 million European cash flow collateralised loan obligation (CLO) managed by CELF Advisors LLP (CELF Advisors or the collateral manager), a wholly owned subsidiary of Carlyle Investment Management L.L.C., an affiliate of The Carlyle Group L.P. The CLO closed in August 2019 and has a remaining reinvestment period of 2.6 years.

On the refinancing date the outstanding Class A-1A, A-1B, A-2B, B and C (the original notes) are expected to be fully redeemed using the proceeds from the issuance of the Class A-1-R, A-2B-R, B-1-R, B-2-R and C-R (the refinancing notes). The outstanding Class A-1A and A-1B are expected to be redeemed in full through the issuance of a single Class A-1-R, effectively consolidating the two original classes. The original Class B is expected to be redeemed in full through the issuance of a floating and fixed paying note respectively Class B-1-R and B-2-R. The newly issued refinancing notes are expected to have the same terms of the original notes including notional balances, stated maturity and reinvestment period but are expected to pay a lower interest rate. Additionally, the refinancing notes are expected to extend the non-call period by 18 months for optional redemption in whole, while no further partial refinance is expected to be permitted.

The collateral in Carlyle Euro CLO 2019-2 DAC mainly consists of broadly syndicated leveraged loans issued by corporate obligors diversified across sectors. As of the June 2021 trustee report, the aggregate principal balance of collateral obligations plus the principal proceeds equals €398.40 million. This is a decline of €1.60 million since the transaction first closed. The transaction currently has €2 million of assets reported as defaulted and the resulting adjusted collateral principal amount is €397.1 million which is a decline of 0.73% since the transaction closed. The current portfolio K-WARF excluding defaults is 2735 compared to 2965 of September 2020, which represents a weighted average portfolio assessment of around B.

The rating on the A-2B-R Notes consider the timely payment of interest and ultimate payment of principal by the applicable stated maturity date, while the ratings on the Class B-1-R, B-2-R and C-R Notes consider the ultimate payment of interest and principal by the applicable stated maturity date. Upon the successful execution of the refinancing, KBRA expects to affirm the ratings on the Class A-2A, D and E notes and withdraw the ratings of the original notes that are being refinanced provided they are paid in full as expected.

The ratings for the Class A-2A, D and the Class E notes were first issued by Kroll Bond Rating Agency Europe Limited (KBRA Europe) which is registered by ESMA as a Credit Rating Agency in the EU and a credit rating affiliate of KBRA UK. Following the assignment of the expected ratings on the refinancing notes, the ratings on Class A-2A, D and E are expected to be transferred to KBRA UK.

In performing the rating review, KBRA utilized its Structured Credit Global Rating Methodology, as well as its Global Structured Finance Counterparty Methodology and ESG Global Rating Methodology.

Key Credit Considerations

Experienced collateral manager: CELF Advisors, affiliated with the Carlyle Group, is an experienced European CLO manager with a long track record and as of June 2021, CEFL Advisors manages approximately €8.1 billion across 20 active CLOs.

CLO structure: The rated notes benefit from internal credit enhancement through subordination, overcollateralisation, and excess spread.

Credit quality: The portfolio has a K-WARF of 2735, which is in line with an average credit quality of B.

Allowance for bonds, cov-lite loans, and non-Euro obligations: The portfolio is required to hold a minimum of 90% secured senior obligations and allows for a maximum of 30% covenant-lite loans, 10% unsecured senior, second lien, high yield, or mezzanine bond obligations, and up to 20% non-Euro obligations. Non-Euro exposure will require a currency hedge and the portfolio is expected to only hold Euro denominated assets at close.

Interest rate risk: The transaction is exposed to both interest rate risk and basis risk. The portfolio allows for up to 12.5% fixed rate assets and will issue two fixed rate tranches for under 9% of the capital structure. The floating rate liabilities reference 3mE and the portfolio may have exposure to 1mE, 3mE, 6mE or a separate reference rate. The transaction may also be exposed to a timing mis-match based on asset/liability payment frequency.

Key Document Provisions

Par flush: The transaction allows trading gains and excess par to be reclassified as interest with restriction on certain dates including on close.

Prohibition on acquisition of long-dated assets: The document prohibits long-dated purchases, but maturity amendments and restructurings may result in a limited concentration of assets with maturities later than the maturity of the notes.

Post reinvestment period trading: Trading after the reinvestment period is limited by the reinvestment criteria, although this can extend the life of the transaction.

Cov-lite loan definition: The amount of cov-lite loans may be understated due to the loose definition in the Indenture.

For a full view of the Key Credit Considerations and Key Document Provisions please visit Structured Credit: Carlyle Euro CLO 2019-2 DAC New Issue Report.

Sensitivity Analysis

Several hypothetical scenarios were created to evaluate the sensitivity of the transaction to different input parameters for K-PAT and the cash flow analysis. Credit migrations in the portfolio are represented by increase in the portfolio K-WARF. The revised portfolio is run through K-PAT to arrive at the new expected default and recovery amounts which is then run through the cash flow analysis. The scenarios evaluated include:

1. Increasing the K-WARF by 10% to 3008
2. One notch downgrade of the current portfolio
3. Reduction in weighted average portfolio recovery rate by 10%

Sensitivity Testing
Class	Target Rating	Par Sub %	Actual Portfolio Net Loss %	Sensitivity 1		Sensitivity 2		Sensitivity 3
				Portfolio Net Loss	Notch Change	Portfolio Net Loss	Notch Change	Portfolio Net Loss	Notch Change
Class A-2B-R	AA	27.7	26.9	28.2	0	30.7	0	32.9	-1
Class B-1-R & B-2-R	A	20.2	20.8	22.0	0	24.5	0	26.2	-1
Class C-R	BBB	13.7	15.7	16.7	0	19.0	-1	20.5	-1

Surveillance

Events that may result in a rating change to the Notes include, but are not limited to the following:

• Deterioration in the transaction’s asset performance that exceeds historical experience or projections
• Modifications of the transaction structure
• Actions by the collateral manager if any collateral obligations are sold as credit risk obligations or defaulted obligations

After the initial rating is assigned, KBRA will continue to monitor the transaction until the rated notes are fully repaid.

KBRA’s surveillance process involves a periodic review of the following:

• Trustee reports to determine if all payment obligations are met and the transaction is in compliance with all triggers
• Trends in collateral performance relative to historical experience

ESG Considerations

KBRA ratings incorporate relevant credit factors, including those that relate to Environmental, Social and Governance (ESG). The following section highlights ESG considerations that are generally associated with corporate credit securitizations such as the subject transaction.

Environmental Factors

Climate Change and Natural Disasters

Climate change, natural disasters, and the outbreak of epidemic disease can pose long-term economic risk that can put meaningful and, at times, sudden, pressure on the cash flows of corporate borrowers. Portfolio diversity at the individual obligor or corporate sector level can help mitigate this risk relative to more concentrated pools. KBRA’s analytical process incorporates positive adjustments for portfolio diversification by obligor, industry, and credit quality.

Social Factors

Demographic and Economic Trends

Demographic trends drive the overall direction in which an economy is moving, which in turn influences the underlying growth rate of the economy, consumption, and the demand for and performance of corporate credit. These trends are mainly affected by population growth, demographic change, the employment rate, changes in regulation, consumer behavior, and other secular trends. For example, shifting consumption patterns of the general population has had a negative influence on demand within the traditional consumer retail sector. This has led to downgrades and defaults, which has stressed corporate credit portfolios and CLO transactions from a cash flow and diversity perspective.

KBRA monitors these trends which can impact portfolio diversification, default projections, and overall transaction performance.

Governance Factors

Collateral Manager or Servicer

KBRA’s Global Structured Credit Methodology incorporates an evaluation of the collateral manager or servicer. KBRA typically considers what impact, if any, the relative strengths and weaknesses of such party’s business may have on the performance of the managed or service collateral pool. Considerations for collateral managers or servicers include industry experience of key personnel, operational risk, historical performance and track record of the firm and its strategies, management style and investment philosophy. KBRA may make a quantitative adjustment (positive or negative) when identifying a model portfolio or in determining recovery assumptions if, for example, a manager reveals a particular strategy with respect to portfolio construction or trading of distressed assets. KBRA’s collateral manager review can be found in the Global Structured Credit Methodology.

Transaction Structure and Parties

The offering documents and/or collateral management agreement generally outline the responsibilities of the collateral manager or servicer. Additionally, the governing documents detail the transaction’s overall structure, payment mechanics, covenants, representations and warranties of transaction parties, enforcement mechanisms, events of default, or roles of third-party service providers. For CLOs and other types of structured credit that allow for reinvestment and asset substitution, the governing documents also set forth the provisions for ramp-up, reinvestment, par maintenance, and sale. KBRA considers transaction provisions, including the roles and capabilities of and risks associated with key transaction parties during the course of our credit analysis. Transaction provisions are considered in the context of prevailing market standards. Meaningful omissions or departures from such standards could influence our rating analysis.

To access ratings and relevant documents, click here.

Disclosures

Further information on key credit considerations, sensitivity analyses that consider what factors can affect these credit ratings and how they could lead to an upgrade or a downgrade, and ESG factors (where they are a key driver behind the change to the credit rating or rating outlook) can be found in the full rating report referenced above.

A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.

Information on the meaning of each rating category can be located here.

This credit rating is endorsed by Kroll Bond Rating Agency Europe Limited for use in the European Union. Information on a credit rating’s endorsement status is available on its rating page at KBRA.com.

Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.

About KBRA UK

Kroll Bond Rating Agency, LLC (KBRA) is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority pursuant to the Temporary Registration Regime. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider. Kroll Bond Rating Agency UK is located at Augustine House, Austin Friars, London, EC2N 2HA, United Kingdom.