Upgrades will boost CLO-heavy CLOs, says Citi

An expected wave of CLO upgrades could prove a particular boost to those CLOs which have large holdings of other CLOs, points out Citi in its recent Global Structured Credit Strategy report. Four CLOs stand out as having particularly high holdings of mezzanine CLOs: Babson Capital’s Osprey CDO 2006-1 and Sapphire Valley CDO (with 39% and 26% exposure to CLOs respectively) and Highland Capital’s Rockwall CDO II (36%) and Rockwall CDO (31%).

Citi says that Moody’s announcement that it is putting more than 200 tranches from 103 CLOs on review for upgrade will have a big impact on other CLOs, since, unlike Standard & Poor’s similar action, it focuses on CLOs from the bottom of the capital structure.

In most cases these CLO-heavy CLOs are failing tests, shutting off distributions to the equity. Upgrades of collateral out of the triple C range could result in these deals coming back into compliance with their tests, says Citi.

The bank notes that there are hundreds of CLO tranches that are similar to the CLOs that have been put on review for upgrade by Moody's and S&P. As a result, it concludes, 2011 is likely to be a poster year for CLO upgrades.