Credit ratings for SME CLOs forecast to remain stable despite rising insolvencies

European small- and medium-sized enterprise (SME) collateralised loan obligations (CLOs) are expected to have mostly stable credit ratings this year, despite a deterioration in the SME environment.

Research from Morningstar DBRS said that higher borrowing costs, higher input prices, higher labour costs and subdued consumer spending are likely to lead to a rise in SME insolvencies this year, particularly in cyclical sectors such as consumer discretionary.

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The ratings agency said that access to finance will continue to be another challenge for European SMEs in 2024.

However, it said it is more positive on SME CLO performance, adding that the asset class will benefit from credit enhancement levels and structural deleveraging that should provide protection against portfolio deterioration, at least for the most senior notes.

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“Despite the expected macroeconomic and structural headwinds affecting SME borrowers, we do not anticipate that the expected deterioration in arrears and rise in borrower defaults will affect credit ratings stability in 2024,” Morningstar DBRS said. “The upgrade to downgrade ratio will likely decline, but stay positive.

“Rated SME CLOs will continue to benefit from transaction deleveraging, healthy credit enhancement levels, and a time lag for defaults to materialise. If the stance of the central banks changes for the worse on interest rates – where they may increase rates to tame the resurgence of inflation –  then we anticipate a further rise in credit deterioration. In this case, we might expect some rating downgrades in junior and mezzanine classes of existing transactions.”

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