OREANDA-NEWS. How the equity portion of a recovery distribution will be accounted for is becoming more important to bondholders as additional defaults are expected this year, Fitch Ratings says. Equity receives no credit in the calculation of a CLO's aggregate principal balance, or overcollateralization (OC) ratios, until the manager monetizes the equity position. Equity may be increasingly seen in restructurings in the near term due to the distress in commodity sectors and noncommodity issuers with high prepetition leverage, struggling business models and declining enterprise valuations.

Typically, CLOs account for defaulted issuers either at the lower end of market value or a rating agency assumed recovery amount for the purposes of OC test ratios. Some CLOs' definitions provide that a rating agency's recovery rate is applied in the first 30 days of a default even if the market value rate is lower, and the "lower of" rule applies after the first 30 days. This rule can lead to a drop in the recovery rate applied to a defaulted obligation from one reporting period to another.

In our report, Equity in US Leveraged Loan Restructuring Dents US CLO Metrics we provide details on the restructurings of Verso Corporation (NewPage), RCS Capital Corp, Arch Coal, Millennium Health and what the likely impact of equity on those restructurings will be.