Portfolio Analytics Wrap: Beyond Fundamentals – What’s Really Driving CLO Pricing

CLO instrument prices, measured as the weighted average price of the portfolio assets, have long reflected the credit fundamentals of underlying borrowers, with metrics such as interest coverage and leverage serving as key anchors for valuation.

Octus’ Portfolio Analytics data shows a clear positive correlation between the CLO instrument price and interest coverage ratios across both U.S. and European portfolios. In the United States, this correlation is stronger among higher-rated credits, although price sensitivity is lower. In contrast, Europe shows the opposite trend, with lower-rated credits exhibiting both a stronger correlation and greater price sensitivity to interest coverage than higher-rated loans.
 

 

On the leverage side, instrument prices show a negative correlation with portfolio net leverage in both regions. This relationship is especially pronounced in the United States among lower-rated assets. In Europe, while leverage remains a meaningful factor at the portfolio level, its influence on pricing diminishes in the riskier credit tiers.
 

 

How lower-rated asset exposure, interest coverage ratio and net leverage vary by sectors in U.S. and European CLO portfolios is broken down in the charts below:
 

 

 

The relationship between interest coverage, leverage and CLO instrument pricing is well understood. But the data also points to a more complex reality.

As the CLO market and the broader loan sector contend with rising macro uncertainties, tighter loan supply and shifting demand dynamics, CLO instrument prices are no longer driven by credit metrics alone. They are increasingly shaped by a mix of liquidity dynamics, structural pressures and manager positioning, turning instrument pricing into a reflection not just of borrower strength but of how managers navigate the market’s shifting technical terrain.

Jay Huang, head of structured credit investment at CIFC Asset Management, noted that the biggest risk when investing in CLO debt is actually not the credit risk but rather the short-term mark-to-market volatility that is often misinterpreted as credit risk to a wider audience.

“It’s the CLO paradox. CLOs have historically had less than one-tenth the default rate of corporate bonds. At the same time, CLOs have historically exhibited greater price volatility,” Huang said. “The wider audience often misinterprets the greater price volatility in CLOs as greater credit risk. Very few are aware that it’s quite the opposite.”

Huang believes that the greater price volatility in CLOs is actually the reflection of the thinner investor base of CLOs.

“The CLO market is supported by just 200 to 300 institutional investors globally. When even a few step back during times of macro volatility, prices of CLOs can swing sharply as a result,” Huang added. “While many misread this as a sign of credit distress within CLOs, those who understand the technical dynamics of a thinner buyer base often recognize the opportunity behind the noise.”

As a result of the thinner investor base, CLO tranche price movements do not always align with changes in underlying loan prices.

“When the market prices of the underlying loans trade up or down materially, you will generally see some correlation in market prices of CLO tranches, but that is not always the case,” Huang noted. “For instance, there are many instances of times when loans trade up but CLO liabilities widen because of a different technical, such as an uptick in supply in the CLO new issue market.”

Amid headline-driven volatility, Pratik Gupta, head of CLO research for Bank of America Securities, told Octus that there has been a shift in how managers are considering portfolio composition. “Their focus is no longer to optimize the spread of the portfolio but to minimize the potential loss on portfolios.”

Gupta noted a distinct shift away from single-B and triple-C rated names, with the triple-C bucket across CLO portfolios reduced by 0.4% through managers’ active tradings over the past three months.

However, this shift comes with a cost. According to S&P Global Ratings, the BSL CLO portfolio weighted average notional par has declined by 0.56% year over year, with April 2025 portfolio par standing at 99.18%, down from 99.73% in April 2024.

“Consistent par build is not easy; instead, CLOs tend to lose par slowly through time,” said Daniel Hu, director at S&P Global Structured Finance Ratings. “Par loss can come from CLO managers selling risky collateral at a discount.”

CLO collateral managers have taken different approaches to mitigating these risks. Some managers might choose to sell off weaker credits with a discount to maintain a low triple-C exposure at the cost of par loss, while others might choose to carry a higher triple-C exposure but maintain their par.

Investor sentiment also varies across different parts of the capital structure.

“Breaching the 7.5% triple-C bucket limit sometimes could be good for CLO noteholders, because if [overcollateralization] tests are tripped as a result, the cash that would have gone to equity now could be used to deleverage the deal,” said Al Remeza, associate managing director of CLOs and structured credit at Moody’s Ratings. “This has certainly helped CLOs historically, but equity obviously suffers in these circumstances.”

The approach to managing triple-C assets has also evolved in response to the wave of refinancings and resets in recent years.

“Before the pandemic, if CLO spreads have tightened after the non-call period, CLO managers could reset a transaction with minimal portfolio clean up,” S&P’s Hu said. “During the pandemic, many of these reset transactions experienced above-average credit deterioration as ‘CCC’ buckets increased significantly. Nowadays, managers typically clean up the portfolios and/or inject cash before a reset.”

As a result, managers are increasingly incentivized to present a cleaner pool of assets to investors ahead of a refinancing or reset, often through more frequent cleanup trades and small losses on positions that have drifted out of favor or fallen below portfolio quality thresholds.

As managers assess credit risk, the growing prevalence of liability management exercises, or LMEs, has introduced new layers of complexity to CLO portfolio management.

According to Bank of America, roughly $23 billion of the $29 billion in loan defaults across U.S. CLOs in 2024 was restructurings. In 2025, about 66% of the $12 billion in defaults has also taken the form of restructurings.

“What’s been difficult about evaluating defaults going forward has been the high proportion of distressed exchanges as they tend to be more idiosyncratic, more opportunistic, and very much oriented towards private equity LBOs. Over 70% of our defaults are LBOs,” said Christina Padgett, head of leveraged finance research and analytics at Moody’s.

Because of structural and regulatory constraints embedded within CLO documentation, managers are often unable to participate actively in LMEs, leaving them at a relative disadvantage when terms are negotiated.

Gavin Zhu, head of U.S. CLO research at Barclays, noted the prevalence of uptiering in LMEs, which can result in creditor-on-creditor violence. “CLOs, or loan investors more broadly, might have more of a bimodal distributed view that either they get full recovery or nothing,” Zhu said.

Still, when LMEs are successfully executed, they can result in stronger recovery outcomes.

According to Bank of America, the recovery rate on defaulted credits has increased 15% year over year, with the current year-to-date recovery standing at 60%. Gupta attributed this improvement in part to the widespread use of 100% pro rata treatment in current LME structures. “The rationale is to avoid litigation issues,” he said.

Recent cases such as Mitel’s nearly zero recovery and Ascend Performance’s term loan, which recovered just around 10 cents on the dollar, have underscored the idiosyncratic risks posed by LMEs, prompting many CLO managers to reduce exposure to overly exposed names.

“In the past, you could see portfolios with more than 75 basis points of exposures in, for example, 15 names with good spreads. Now you rarely see deals with lots of names with more than 35 basis points of exposure,” said BofA’s Gupta. “There’s been a conscious effort to basically normalize weights across all names, because managers don’t want to overly take that unforeseeable idiosyncratic risk where the loan price can fall by more than 30 points in a single day.”

Hu at S&P observed that B3/B- rated credits had been rising as a percentage of CLO portfolios for years but have recently declined. “Besides managers rotating out of risky B- names, the private credit market has played a big role in absorbing these companies,” he added.

“We’re seeing fewer B3s accessing the market – it’s now more B2s,” added Padgett from Moody’s. “There’s also a bifurcation where investors are avoiding cyclical or tariff-sensitive issuers and concentrating in safer names. Tariffs, in particular, have constrained new LBO formation by making it harder to forecast and agree on value.”

With the current loan pipeline quite muted, leveraged loan spreads have tightened faster than CLO liabilities, which has made the equity arbitrage quite challenging and brought attention to the metric of CLO asset depth, measuring how easily a loan can be traded without materially affecting its price.

When investors evaluate CLO tranches, they look beyond the arbitrage that is heavily influenced by market timing and issuance dynamics that managers cannot control. Increasingly, they are conducting deep dives into individual portfolio holdings and the managers behind them.

“The first layer is always who the manager is, what their style is, and how much support they have in the market,” said Zhu from Barclays. “Asset pricing and portfolio composition are especially critical for mezzanine tranches, which are more exposed to defaults and vulnerable to issues from interest coverage or overcollateralization tests.”

One key metric investors focus on, Zhu added, is the market value overcollateralization, or MVOC, which reflects not only the asset mix but also whether the manager holds names that the broader market still values.

Looking ahead, the chance of a Federal Reserve cutting cycle is slim in the near term but is likely to arrive within the next 12 months.

“I don’t think the Fed will be cutting rates this year, but in all likelihood, there are increased expectations that the Fed will be on a cutting cycle next year,” said BofA’s Gupta.

A lower-rate environment could create headwinds for floating-rate assets such as CLOs, potentially softening investor demand. Lower rates, however, would likely support an uptick in LBO and M&A activity, boosting loan supply and reshaping the current demand-supply dynamics in the CLO market.

“Most investors at the top of the capital stack will be relatively insulated from this shift,” said Zhu of Barclays. “But further down the stack, returns could be hurt.”

In a more extreme rate-cutting scenario, Zhu added, retail investors may begin pulling capital from AAA CLO ETFs as yields lose appeal, and insurance buyers may scale back mezzanine tranche purchases if they struggle to sell fixed-rate annuities, though this scenario is not currently in our base case. “In contrast, CLO equity could start to look more attractive to BB buyers, since equity behaves more like a quasi-fixed-rate instrument.”