OREANDA-NEWS. S&P Global Ratings today raised its credit ratings on Avoca CLO IV PLC's class C1, C2, and N Combo notes. At the same time, we have affirmed our ratings on the class D Def and E Def notes (see list below).

Today's rating actions follow our review of the transaction's performance and the application of our current counterparty criteria (see "Counterparty Risk Framework Methodology And Assumptions," published on June 25, 2013). Since February 2012, when the transaction entered its amortization period, the class A and B notes have fully amortized. This has resulted in increased available credit enhancement for all classes of notes, except for the class E Def notes.

Since our previous review in November 2015, the transaction has deleveraged, leading to a reduction in the outstanding notes' balance of approximately €32.7 million (see "Various Rating Actions Taken In CLO Transaction Avoca CLO IV Following Performance Review," published on Nov. 6, 2015). The current principal balance in the transaction is €47.2 million, which we consider to have led to a general increase in credit enhancement for all tranches of notes.

Obligor concentration has also increased, with the portfolio down to 10 obligors from 20 at our previous review. The largest single obligor makes up 25% of the portfolio and the top five assets contribute 75% of the balance. In addition, we have observed a general improvement in ratings in the underlying portfolio, in particular, a decrease in the assets rated in the 'CCC' category (rated 'CCC+', 'CCC', or 'CCC-') to 4.89% from 9.70%.

Despite the improved portfolio performance, we note that the class E Def notes' overcollateralization and interest coverage tests continue to fail. This performance was exacerbated by a one-off legal expense incurred on the February payment date, which led to interest shortfalls at the class D Def and class E Def level. However, we note that the deferred interest balance on the class D notes was paid at the August 2016 payment date.

We have considered counterparty risk in the transaction by applying our current counterparty criteria. Under these criteria, the maximum potential rating on the notes in this transaction remains at 'A+', based on the downgrade provisions documented for the account bank and custodian.

We have subjected the transaction's capital structure to a cash flow analysis to determine the break-even default rate for each rated class of notes at each rating level. We used the portfolio balance that we consider to be performing, the reported weighted-average spread, and the weighted-average recovery rates that we consider to be appropriate. We incorporated various cash flow stress scenarios using our standard default patterns, levels, and timings for each rating category assumed for each class of notes, in conjunction with different interest rate stress scenarios.

With increased available credit enhancement for the class C1 to D Def notes, our credit and cash flow analysis results suggest higher ratings than those previously assigned.

However, today's upgrades of the class C1 and C2 notes are capped by the downgrade provisions documented for the account bank and custodian. The maximum potential rating on any class of notes in Avoca CLO IV is 'A+ (sf)'. We have therefore raised to 'A+ (sf)' from 'BBB+ (sf)' our ratings on the class C1 and C2 notes.

As well as the maximum rating of 'A+ (sf)' due to counterparty risk, our ratings on the class D Def notes are constrained by the application of the largest obligor default test, a supplemental stress test that we outline in our corporate collateralized debt obligation (CDO) criteria (see "Global Methodologies And Assumptions For Corporate Cash Flow And Synthetic CDOs," published on Sept. 17, 2015). This assesses whether a CDO tranche has sufficient credit enhancement to withstand specified combinations of underlying asset defaults, based on the ratings on the underlying assets. The test assumes a flat recovery of 5%.

Our cash flow analysis indicates that the class D Def notes can support a higher rating than that currently assigned (due to the increased available credit enhancement). However, the largest obligor default test is failing at the current rating level, albeit by, in our view, a non-material amount. Taking into account the non-material size of this failure of the supplemental tests, and the improvement in cash flow results, we have affirmed our 'B+ (sf)' rating on the class D Def notes.

Based on our cash flow results, we have affirmed our 'CCC - (sf)' rating on the class E Def notes.

Due to reductions in the rated principal balance and improved credit enhancement for the class D Def notes, our cash flow analysis shows that the class N Combo notes can support ratings that are significantly higher than the currently assigned rating. However, the application of our supplemental tests implies a rating of 'CCC+ (sf)', even after giving benefit to excess spread in the transaction. Following the application of our criteria for assigning 'CCC+', 'CCC', 'CCC-', and 'CC' ratings, we have raised to 'B - (sf)' from 'CCC - (sf)' our rating on the class N Combo notes (see "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published on Oct. 1, 2012).

Avoca CLO IV is a cash flow collateralized loan obligation (CLO) transaction, backed primarily by leveraged loans to speculative-grade corporate firms. Avoca CLO IV closed in January 2006 and is managed by KKR Credit Advisors (Ireland).