European credit just had a streak end.
The most junior tranche of a Bain Capital-managed European CLO failed to pay investors back in full. Fitch downgraded it to default this week, marking the first time a European CLO tranche has skipped a full repayment since the asset class was overhauled after the 2008 financial crisis.
It's a small dollar amount in a EUR 200-billion-plus market, but a meaningful signal.
A CLO - short for collateralized loan obligation - is a giant bundle of higher-risk corporate loans, sliced into tranches that get paid in order of seniority. Senior tranches get paid first, and junior CLO tranches absorb losses first.
For more than a decade, Europe's revamped CLOs have had a remarkable record: not a single tranche missed a full repayment. That ended with Bain Capital Euro CLO 2018-1 DAC, a EUR 361 million transaction priced in 2018.
The class F notes - the riskiest slice - returned EUR 7.4 million to investors when they were supposed to return EUR 11.2 million.
Bain Capital Credit, the asset's manager, is one of the larger European CLO managers and has been actively running the strategy since 2018.
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The CLO exited its reinvestment period in April 2022, meaning the manager could no longer swap new loans into the pool to replace dud assets.
Fitch had already cut the class F notes to "CCCsf" late last year as the par value test - a measure of whether the collateral covers the bonds - failed and defaulted loans piled up.
Fitch reckons what the underlying loans are worth right now sits below what the rated tranches are owed. In plain English: even a fire sale wouldn't cover what's owed at the junior level, and holders of those notes are looking at real principal losses.
Other 2018-era European CLOs have similar profiles: end of reinvestment, par value tests under pressure, and stretched portfolios.
One default doesn't break a market, but it does break a narrative.
The "post-2008 European CLO has never defaulted" line was a selling point for the asset class. Now there's a footnote, and risk-pricing on the junior tranches is likely to widen.
Fitch has hinted this might not stay isolated, with the Bain default potentially the first of a small cluster rather than a one-off. Whether that's true depends on how many other 2018 vintages are riding on similarly stretched portfolios.
European credit spreads have already been compressed to multi-decade lows on the senior end - a default at the bottom of the stack tends to ripple upward.
The streak is over.
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