Fitch Ratings assigns the following ratings and Rating Outlooks to NewStar Clarendon Fund CLO LLC:
--$166,662,500 class A-1 notes 'AAAsf'; Outlook Stable;
--$66,587,500 class A-2 notes 'AAAsf'; Outlook Stable.
Fitch does not rate the class B, C, D, or E notes, or the subordinated A or B notes.
TRANSACTION SUMMARY
NewStar Clarendon Fund CLO LLC (the issuer) is a collateralized loan obligation (CLO) that will initially be collateralized by a $400 million portfolio of primarily broadly syndicated loans (BSLs) along with a portion of middle market (MM) loans, with the portfolio composition expected to transition over time to be primarily comprised of MM loans. The CLO will be managed by NewStar Financial, Inc. (NewStar). Fitch's Funds and Asset Manager Ratings team has evaluated NewStar and determined its capabilities to be acceptable for purposes of managing this transaction. The CLO will have a four-year reinvestment period and a two-year noncall period.
RATING RATIONALE
Fitch's analysis focuses primarily on a series of Fitch stressed portfolios constructed in accordance with the composition of the Fitch test matrix. The stressed portfolio at each matrix point accounts for many of the worst-case portfolio concentrations permitted by the indenture. Cash flow modeling of the Fitch stressed portfolios indicates performance in-line with the assigned ratings for each class in Fitch's standard cash flow scenarios.
KEY RATING DRIVERS
Sufficient Credit Enhancement: Credit enhancement (CE) of 41.7% for class A-1 and class A-2 notes (collectively, class A notes), in addition to excess spread, is sufficient to protect against portfolio default and recovery rate projections in an 'AAAsf' stress scenario. CE is significantly higher than the levels typically seen on broadly syndicated CLOs.
'B/B-' Asset Quality: Fitch expects the credit quality of the underlying obligors to primarily fall in the 'B/B-' range. Fitch's base case analysis centered on a portfolio with a weighted average rating factor (WARF) of 39, in accordance with the initial expected matrix point. The analysis on such portfolio, in addition to analysis on the other permitted matrix points, indicated the class A notes demonstrate cash flow performance in line with other 'AAAsf' CLO notes. In the base case analysis class A notes are projected to be able to withstand default rates of up to 71.1%.
Strong Recovery Expectations: The transaction requires a minimum of 90% of the portfolio to consist of senior secured loans, cash and eligible investments, while portfolio management is governed in part by a Fitch weighted average recovery rate (WARR) test. In its base case analysis of the class A note ratings, Fitch modified the WARR of the portfolio to reach the base case minimum trigger of 66.8%, and further reduced recovery assumptions for higher rating stress scenarios. The base case analysis of class A notes assumed a 35.1% recovery rate in Fitch's 'AAAsf' scenario.
FITCH ANALYSIS
Each Fitch-stressed portfolio was assumed to consist of $400 million par amount of loans, 90% of which represented senior secured loans and 10% second-lien loans. Notable portfolio concentrations specified by the transaction documents include:
--Minimum 90% senior secured loans, cash and eligible investments;
--Maximum 10% second lien loans and first-lien last-out loans;
--Maximum 3% concentration for the top five obligors; no others greater than 2.5%, subject to a maximum 1.5% second lien loans issued by a single obligor;
--Maximum 17.5% assets rated 'CCC+' and below (by Fitch);
--Maximum 5% fixed-rate obligations;
--Maximum industry concentrations: 20% for one industry, 17.5% for one industry, 15% for one industry, and no others greater than 12.5%.
Portfolio management will be governed in part by a Fitch test matrix, which includes various combinations of permitted weighted average spread (WAS), WARF, and WARR covenants from which the manager may choose; the manager may also linearly interpolate between any two adjacent points. Fitch constructed a series of Fitch stressed portfolios based on various permitted WARF, WAS, and WARR combinations to ensure the projected cash flow performance of the class A notes at these matrix points remained consistent with the 'AAAsf' rating level.
The initial expected matrix point features WARF, WAS and WARR triggers of 39, 4.65% and 66.8%, respectively; analysis of this portfolio is herein referred to as the base case analysis.
The portfolio presented to Fitch consists of primarily BSLs with a portion of MM loans. Given the expected transition to MM loans over time, Fitch constructed each Fitch stressed portfolio based on characteristics typically seen in MM loan portfolios. Compared with BSL portfolios, MM loan portfolios generally contain fewer obligors; therefore each Fitch stressed portfolio consisted of 80 unique obligors to account for relatively greater obligor concentration in MM CLOs.
To further account for potentially greater obligor concentration Fitch stressed the maximum permitted sizes of the largest 10 obligors, as opposed to its standard stress of maximizing the largest five obligors in its analysis of CLOs comprised of BSLs. Fitch also maximized the permitted industry concentrations for the three largest industries and assumed the maximum permitted portfolio weighted average life of eight years when creating each Fitch-stressed portfolio.
Each Fitch-stressed portfolio is composed of 95% floating-rate assets and 5% fixed assets. Fitch assumed that all floating-rate assets earn 4.65% over LIBOR, while the fixed-rate assets earn 6%, as represented to Fitch by the arranger as the base case WAS and minimum weighted average coupon of the portfolio, respectively.
The Fitch Portfolio Credit Model (PCM) was used to determine hurdle default rates (rating default rates, or RDRs) and expected portfolio recovery rates (rating recovery rates, or RRRs) for each Fitch stressed portfolio at the 'AAAsf' rating level. The base case Fitch stressed portfolio PCM default rate and recovery rate outputs were 71.7% and 35.1%, respectively, at the 'AAAsf' rating level.
Fitch used a customized proprietary cash flow model to replicate the principal and interest waterfalls, as well as the various structural features of the transaction and to assess their effectiveness, including the structural protection provided by excess spread diverted through the overcollateralization (OC) tests and interest coverage (IC) tests. The cash flow model was run using the PCM outputs for each of the Fitch stressed portfolios.
Fitch's cash flow modeling of each stressed portfolio considered 12 stress scenarios to account for different combinations of four default timings and three interest rate stresses. The class A notes passed the 'AAAsf' PCM hurdle rate in 10 of the 12 stress scenarios when analyzing the base case Fitch stressed portfolio, with two marginal model failures of 0.6% and 0.5% below the threshold.
Additionally, Fitch tested the projected cash flow performance of the class A notes at a total of 180 possible matrix combinations. There were at most three model failures at any given matrix combination, with the largest degree of model failure not exceeding 1.5% below the 'AAAsf' threshold.
Fitch was comfortable assigning 'AAAsf' ratings to class A notes because it believes the notes can sustain a robust level of defaults, combined with low recoveries, as well as other factors, such as the strong performance of class A notes in the various matrix points tested, the strong performance of the class A notes in the sensitivity scenarios, and Fitch's assessment of NewStar and its capabilities as a CLO asset manager.
COUNTERPARTY CRITERIA APPLICATION
Provisions for the eligible investments to be purchased with intra-period interest and principal collections, as well as the rating requirements of the institutions at which the issuer's various bank accounts will be established, conform to Fitch's counterparty criteria for supporting note ratings of up to 'AAAsf'. Eligible investments are required to mature or be putable at par prior to the next payment date.
The provisions for the concentration account, which will hold proceeds from underlying obligors for no more than two business days before being swept into the issuer's bank accounts, include rating triggers and remedial provisions that do not fully meet Fitch counterparty criteria expectations. Fitch criteria expect the institution maintaining such account to preserve ratings of at least 'A' and 'F1' and, upon downgrade below these levels, to be replaced with an institution meeting such ratings within 30 days. The concentration account documents feature replacement provisions that are triggered after a downgrade below 'F1', with no long-term rating provisions, and require replacement with another party rated at least 'F1' but not necessarily within a 30 day timeframe.
Fitch views the risk presented by the concentration account provisions as remote, and believes sufficient mitigants exist. The account is held at Wells Fargo Bank, N.A. (rated 'AA-/F1+'; Outlook Stable by Fitch) and replacement provisions upon rating downgrade are present, albeit not strictly in conformance with criteria expectations. Fitch notes that the account is expected to be swept daily and believes that the maximum exposure period of two business days is not likely to result in material risk to the class A notes. Class A notes would benefit from other structural mechanisms in the event of the loss of funds held in this account (e.g. principal for interest and/or the availability of excess spread).
RATING SENSITIVITIES
Fitch evaluated the structure's sensitivity to the potential variability of key model assumptions, including decreases in recovery rates and increases in default rates or correlation. Fitch expects the class A notes to remain investment grade even under the most extreme sensitivity scenarios. Results under these sensitivity scenarios ranged between 'Asf' and 'AAAsf' for the class A notes. The results of the sensitivity analysis also contributed to Fitch's assignment of Stable Outlook to the class A notes.
PERFORMANCE ANALYTICS
Fitch will monitor the transaction regularly and as warranted by events with a review. Events that may trigger a review include, but are not limited to, the following:
--Asset defaults;
--Portfolio migration;
--OC or IC test breach;
--Breach of concentration limitations or portfolio quality covenants;
--Future changes to Fitch's rating criteria.
Surveillance analysis is conducted on the basis of the then-current portfolio. Fitch's goal is to ensure that the assigned ratings remain an appropriate reflection of the issued notes' credit risk.
An assessment of the transaction's representations and warranties was also completed and found to be consistent with the ratings assigned to the notes. For further information, see 'NewStar Clarendon Fund CLO LLC -- Appendix', dated Jan. 15, 2015.
Details of the transaction's performance are available to subscribers on Fitch's Web site at www.fitchratings.com.
Additional information is available at 'www.fitchratings.com'.
The ratings are based on information provided to Fitch as of Jan. 15, 2015. Sources of information used to assess these ratings were provided by the arranger, Citigroup Global Markets Inc., NewStar, and the public domain.
Applicable Criteria & Related Research:
--'Global Structured Finance Rating Criteria' (Aug. 4, 2014);
--'Global Rating Criteria for Corporate CDOs' (July 25, 2014);
--'Criteria for Interest Rate Stresses in Structured Finance Transactions and Covered Bonds' (Dec. 19, 2014);
--'Counterparty Criteria for Structured Finance and Covered Bonds' (May 14, 2014).
Applicable Criteria and Related Research: NewStar Clarendon Fund CLO LLC -- Appendix
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=854208
Global Structured Finance Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=754389
Global Rating Criteria for Corporate CDOs
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=753057
Criteria for Interest Rate Stresses in Structured Finance Transactions and Covered Bonds
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=838868
Counterparty Criteria for Structured Finance and Covered Bonds
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=744158
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=971255
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