DBRS Morningstar Finalizes Its Global Methodology for Rating CLOs and Corporate CDOs and DBRS Morningstar CLO Insight Model

DBRS Morningstar finalized its “Global Methodology for Rating CLOs and Corporate CDOs” (the CLO Methodology) and “DBRS Morningstar CLO Insight Model (v.1.0.0.0)” (the CLO Insight Model; collectively, the CLO Methodology, including the CLO Insight Model).

The CLO Methodology, including the CLO Insight Model, presents the criteria that DBRS Morningstar uses to assign new credit ratings and monitor outstanding credit ratings in the collateralized loan obligation (CLO) asset class globally.

Changes and Rating Impact in CLOs

The CLO Methodology, including the CLO Insight Model, supersedes two existing DBRS Morningstar methodologies: “Rating CLOs and CDOs of Large Corporate Credit” (published October 6, 2023) and “Cash Flow Assumptions for Corporate Credit Securitizations” (published on February 7, 2023), and the related public predictive model “DBRS Morningstar CLO Asset Model” (collectively, the Superseded CLO Methodologies, including the CLO Asset Model).

Accordingly, DBRS Morningstar subsequently has withdrawn and archived the Superseded CLO Methodologies, including the CLO Asset Model.

The finalization of the CLO Methodology, including the CLO Insight Model, follows the conclusion of the Request for Comments (RFC) period that began on September 22, 2023. DBRS Morningstar received no comments during the RFC period. The CLO Methodology, including the CLO Insight Model, is effective as of October 22, 2023.

The reason for the changes is to update certain assumptions (listed below) based upon updated datasets and expand our analytical approaches to address broadly syndicated loan (BSL) CLOs.

The reason for these changes is unchanged from the press release “DBRS Morningstar Requests Comments on the Proposed Global Methodology for Rating CLOs and Corporate CDOs and DBRS Morningstar CLO Insight Model,” published on September 22, 2023.

The changes include:
(1) The introduction of two new primary analytical approaches: the Current Profile Approach and Trading Scenarios Approach. Each analytical approach represents collateral compositions and other assumptions used in the application of the methodology. The Trading Scenarios Approach is further subdivided into active management stresses related to (A) BSL and Market-Sourced CLOs and (B) Middle Market and Private Credit CLOs. Trading Scenarios for BSL and Market-Sourced CLOs introduce scenarios to analyze the risk/return profile of actively managed leveraged loan portfolios in structures such as BSL CLOs.
(2) Updates to the calculation of default probabilities for publicly rated borrowers.
(3) Updates to recovery rate assumptions, including additional stresses for covenant-lite loans.
(4) Updates to country tiering.
(5) Updates to industry classifications.
(6) Introduction of credit dispersion into stressed portfolio assumptions.
(7) Updates to amortization and prepayment rate assumptions.
(8) Updates to surveillance for existing credit ratings, including performing a Current Profile analysis.

DBRS Morningstar also updated the CLO Asset Model and renamed it as the “DBRS Morningstar CLO Insight Model.”

Other updates to the model include:
-- An update of the core model code to a new programming language, Python.
-- Implementation of amortization and prepayment rate assumptions.

The CLO Insight Model produces stressed default rate assumptions used in a cash flow engine that tests the ability of specific tranches or notes to withstand each credit rating-level stress assumption, similar to the CLO Asset Model. DBRS Morningstar uses a Monte Carlo simulation technique to determine a ratings-based lifetime pool default rate that can be equated with a certain credit rating. The changes also include user workflow improvements as well as changes to the model deployment infrastructure.

For further information on the CLO Insight Model, please refer to the Source Code White Paper available at https://clo-whitepaper.crcc2f9.eas.morningstar.com/.

DBRS Morningstar deems changes described above to be material.

Based on DBRS Morningstar’s preliminary impact analysis, DBRS Morningstar expects a limited impact on outstanding DBRS Morningstar public and private credit ratings under the Superseded CLO Methodologies. All credit ratings in all CLO transactions rated using the Superseded CLO Methodologies are expected to be affected. Most of the affected outstanding credit ratings under these methodologies are expected to be confirmed, with a limited number of expected upgrades or downgrades with a magnitude of one to two notches.

Changes and Rating Impact in Related Asset Classes

Other DBRS Morningstar credit rating methodologies previously referenced the Superseded CLO Methodologies, including the CLO Asset Model, as applicable, and will continue to reference the CLO Methodology, including the CLO Insight Model, as applicable (“Related Methodologies”, listed below). No outstanding credit ratings under such Related Methodologies will be impacted as a result of the material updates related to the CLO Methodology, including the CLO Insight Model.

In addition, DBRS Morningstar conducted a review of the Related Methodologies (listed below) in conjunction with the finalization of the CLO Methodology, including the CLO Insight Model, published on October 22, 2023. DBRS Morningstar updated the Related Methodologies to reflect the new naming conventions for the CLO Methodology and CLO Insight Model, where relevant. DBRS Morningstar also updated relevant Scope & Limitations and Related Research sections of the Related Methodologies. The updates to the Related Methodologies are also effective as of October 22, 2023.

DBRS Morningstar deems the updates to the Related Methodologies not to be material.

No credit ratings under the Related Methodologies are expected to change as a result of this update.

Related Methodologies (and previous version date):
(1) Global Methodology for Rating Debt Issued by Investment Funds (October 2023).
(2) Rating CLOs Backed by Loans to European SMEs (October 2023).
(3) Rating U.S. Equipment Lease and Loan Securitizations (June 2023).
(4) Rating Structured Finance CDO Restructurings (November 2020).
(5) Rating Structured Aircraft Transactions (March 2023).
(6) Rating U.S. Structured Settlements Asset-Backed Securitizations (October 2022).
(7) Rating U.S. Structured Finance Transactions (September 2023).
(a) Rating U.S. Structured Finance Transactions—Appendix II: U.S. Health-Care Receivables ABS (September 2023).
(b) Rating U.S. Structured Finance Transactions—Appendix V: Obligations Backed by Insurance Policy (Financial Guarantee) (September 2023).
(c) Rating U.S. Structured Finance Transactions—Appendix VII: Insurance Commission ABS (September 2023).
(d) Rating U.S. Structured Finance Transactions—Appendix XI: U.S. Consumer Litigation Finance (September 2023).
(e) Rating U.S. Structured Finance Transactions—Appendix XII: U.S. Paired Policies (September 2023).
(f) Rating U.S. Structured Finance Transactions—Appendix XIII: U.S. Agricultural Production Lending (September 2023).
(g) Rating U.S. Structured Finance Transactions—Appendix XIV: U.S. Venture Debt (September 2023).
(h) Rating U.S. Structured Finance Transactions—Appendix XVI: Obligations Backed by Market-Value Collateral (September 2023).
(8) Rating European Consumer and Commercial Asset-Backed Securitisations (October 2022).
(9) Rating Canadian Equipment Finance Securitization Transactions (September 2023).
(10) Master U.S. ABS Surveillance (July 2023).
(11) Master European Structured Finance Surveillance Methodology (October 2023).
(12) General Corporate Methodology—Appendix 2—Canadian Government Pooled Lending Vehicles (March 2023).

Updates to the Related Methodologies supersede the previous versions.

In addition, no impact will occur on outstanding credit ratings under the “Global Methodology for Rating and Monitoring Covered Bonds” (which references the “Rating CLOs Backed by Loans to European SMEs,” which currently references the CLO Methodologies and will continue to reference the CLO Methodology). No changes were made to the “Global Methodology for Rating and Monitoring Covered Bonds” at this time.

Notes:
DBRS Morningstar methodologies are publicly available on its website www.dbrsmorningstar.com under Methodologies & Criteria.

For more information on this methodology or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.