Portfolio Analytics Wrap: CLO Managers Sharpen Focus on Credit Fundamentals to Safeguard Par Amid Tight Loan Spreads

The U.S. CLO market entered September with an unusual pause, as no new issue deals priced in the first week of the month, and sources indicate that the forward-looking pipeline for CLO issuance is beginning to thin out. The lull follows a slower August, when total U.S. new issuance fell by $5.2 billion, or 27.7%, from July, although volumes were $0.5 billion higher than in August 2024.

The slowdown reflects a technical imbalance in the loan market, with repricings limiting net supply and loan prices hovering near historic highs. CLO managers are waiting for an attractive entry point – not only with more eligible collateral but also with improved asset-liability dynamics.

The asset-liability dynamic is typically measured by arbitrage, or the excess spread between the yield on the asset and the cost of CLO liabilities. It is an important metric in both CLO issuance and ongoing management. While the calculation is straightforward, it provides a useful proxy for assessing the income for a CLO portfolio.

Because the arbitrage is a point-in-time measure, it is highly sensitive to prevailing market conditions. Daily moves in loan or liability spreads can shift the excess spread, resulting in a wide dispersion of arbitrage profiles across vintages and throughout the life of a CLO transaction.

The loan market has recently posed a tough backdrop for CLO arbitrage. According to Morningstar LSTA Leverage Loan Index analysis, the weighted average nominal spread on U.S. leveraged loans was 323 bps as of Aug. 31, which is the tightest level since 2010. Spread compression has been mainly fueled by the massive wave of loan repricings since June, with $159 billion repricing in July alone.

Roughly half of repricings have shaved 50 bps off loan coupons, while 16% were cut by 75 bps, which is equivalent to three Federal Reserve rate cuts, according to Bank of America. These savings lower the yield on CLO assets and therefore squeeze the arbitrage.

Limited primary loan supply has further tilted market technicals in favor of borrowers. Of the $314 billion of loan issuance this year, only 53% has gone toward dividend recaps, M&A or leveraged buyouts and actually added to the overall supply, according to BofA. At the same time, the year-to-date $144.61 billion of CLO issuance has been constantly fueling strong demand, while about 266 outstanding CLO warehouses represent substantial dry powder still waiting to be deployed. The imbalance has pushed loan prices higher, with 39% of the repriced loans now trading above par, including 13% above 100.25, BofA noted.

In this unbalanced environment that squeezes the CLO arbitrage, Mehdi Kashani, head of structured credit at Arini, told Octus that the market needs to look beyond this point-in-time measure and to “think about the CLO vehicle as a manager’s median to really demonstrate how they can drive alpha to a loan portfolio over time.”

The lifecycle of a new issue CLO typically lasts for seven to nine years, with five years in its reinvestment period and additional two to four years to get redeemed or amortized. Market conditions can shift meaningfully over this horizon, but CLOs offer considerable optionality through their structural features, including the ability to refinance or reset liabilities to reduce the cost of capital. As a result, a manager’s ability to build and maintain a strong credit fundamental portfolio that can perform through cycles and remain eligible for reset or refinancing opportunities is extremely crucial.

Among the CLO collateral-level metrics, revenue growth, interest coverage and weighted average rating factor, or WARF, are key quantitative indicators of portfolio credit health and risk level.

Revenue Growth

Revenue growth provides insight into the business momentum of underlying issuers and their capacity to generate cash flow to service debt. According to Octus’ Portfolio Analytics data, the top-performing managers on this measure as of the second quarter of 2025 include Hayfin, Oak Hill and RBC BlueBay in the United States, and Bridgepoint, Guggenheim and Napier Park in Europe.
 

Hayfin ranks first in portfolio revenue growth among U.S. CLO managers, posting a 10.1% increase as of the second quarter. The manager has six U.S. CLOs with $1.5 billion in total assets under management and 14 European CLOs with €5.5 billion in collateral.

Peter Swanson, senior portfolio manager and head of U.S. high yield and syndicated loans at Hayfin, said that his firm’s strong revenue growth figure is a reflection of “a defensively positioned portfolio that can perform through cycles.” For cyclical sectors, he noted, Hayfin is more selective, favoring companies with some mix of flexible business models, healthy asset coverage and moderate leverage.

“Industrial distributors are an example of a flexible business model,” Swanson added. “They carry inventory, so even though they might be selling products to more cyclical end markets, they can free up cash through selling down stock, which will support their cash flow on a through-cycle basis regardless of a potentially less consistent top line.”

Diameter, which ranks sixth among U.S. CLO managers with 7.87% portfolio revenue growth in the same period, takes a more active stance toward cyclical credits. The firm manages eight U.S. CLOs, totaling $3.9 billion in assets.

“Typically, we try to avoid secular decliners and instead focus on being a proactive seller of more cyclical credits when the sector macro is changing for the negative,” said Scott Goodwin, managing partner and co-founder at Diameter. “We think about where the earnings are going to be in the future rather than reacting to what’s already happened, like waiting for negative earnings, negative events, or rating actions. If you could spot these signs of deterioration in the loan market, the cost of changing your mind will be very low, given the breadth of options.”

Goodwin added that Diameter’s sub-$10 billion CLO AUM allows them to stay nimble while having a big enough team to do bottom-up credit research. “Some managers at a $30-40 billion sized CLO business basically have to own the index and don’t have the luxury of selling fast.”

Josh Green, portfolio manager at Diameter, highlighted the importance of evaluating the “interest forward coverage” through cash flow.

“The market view is that if a company has sufficient liquidity but is burning cash, it’s not going to be a problem,” Green said. “However, we see cash burn as a leading indicator of portfolio deterioration, so we tend to sell that loan well before it could turn into a more severe issue, like an LME.”

Across the Atlantic, Napier Park ranks third in portfolio revenue growth among European CLO managers, with a 6.77% increase as of the second quarter. The firm reissued its second U.S. CLO transaction of 2025 in mid-August, and manages 26 U.S. CLOs with $10.5 billion in assets and 10 European CLOs with €3.7 billion.

Julia He, senior managing director and head of European CLO business development and European credit research at Napier Park, attributes the growth to the firm’s stringent credit selection and active management.

“We believe revenue growth is more driven by getting idiosyncratic credit right, like which one to buy or sell and when, through bottom-up analysis, rather than simplistic sector allocation,” she said. “We owned some of the names currently trading at a lower price at a certain point in the past, but we sold them at the right time at a higher price close to par. A fundamental thesis that recognizes changes in credit profile is very important in this ever-changing environment.”

Deepak Natarajan, managing director, trading and co-head of the London office at King Street Capital Management, echoed the sentiment. “Within sectors you can have businesses with very different risk profiles. So top down allocation only gives you so much information,” he said. In portfolio construction, Natarajan added, his team focuses on identifying businesses with pricing power and durable top-line drivers, such as recurring revenue models and nondiscretionary demand, while stressing the issuer’s cash flow resilience and operating leverage.

King Street ranks ninth in revenue growth among European CLO managers, with a 5.43% increase as of the second quarter. The manager has 18 U.S. CLO with $6.9 billion assets and seven European CLOs with €2.8 billion.

Interest Coverage

The portfolio interest coverage ratio measures the cushion borrowers have between earnings and interest expenses. It reflects the portfolio’s issuer-level debt servicing capacity as well as its sensitivity to changes in interest rates and issuer operating performance. Octus’ Portfolio Analytics shows that the top-performing managers on this measure as of the second quarter of 2025 were Muzinich, Fort Washington and Whitebox in the United States and BlackRock, Serone and Palmer Square in Europe.
 

Fort Washington, with 3.52x weighted average interest coverage in its two CLOs as of the second quarter, ranks second in the United States. Breen Murphy, the vice president and portfolio manager at Fort Washington, attributed such coverage to the firm’s overweighting to asset-heavy and cash flow-heavy sectors that are less cyclical. “We have more names in telecom and media relative to other managers, which own more in tech and healthcare,” he said.

Whitebox has a weighted average portfolio interest coverage of 3.42x, which ranks 3rd in the United States. The firm manages five CLOs with around $2 billion assets and recently priced its fifth one in late June.

Paul Roos, head of structured credit at Whitebox, told Octus that “paranoia is the key.” Roos noted that Whitebox’s investment thesis is built on a “three-legged stool”: debt subordination, issuer real free cash flow and management credibility.

“Lacking any one of these three, the whole trade will fall apart,” Roos said. By closely monitoring these factors and maintaining a more defensive portfolio, Roos noted, the firm has greater flexibility to adjust the portfolio as market dynamics shift. “This, along with events like a refi or a reset, helps us create value over the longer term,” he added.

Palmer Square ranked third among European CLO managers, with a weighted average interest coverage ratio of 3.11x across its 16 European CLOs totaling €5.7 billion. The firm also manages 35 U.S. CLOs with $16.9 billion in assets.

Jon Brager, managing director and portfolio manager at Palmer Square, emphasized the importance of a long-term vision in credit underwriting. “Most people tend to look at a borrowers’ current state and the projections on cash flows and EBITDA over the next couple of years,” Brager said. “But these really don’t answer the question of what these companies will look like five to seven years from now.” He noted that most borrowers will need to refinance their loans a year or two prior to maturity, making it critical to assess a company’s business durability, capital structure resilience and refinancing capacity over a longer horizon.

Arini, with 3.04x interest coverage ratio, ranks seventh among European CLO managers. The firm has six European CLOs with €2.37 billion in assets.

“We are managing to maintain clean portfolios throughout cycles. This is a deliberate choice and a thesis around what generates the best equity returns,” Kashani at Arini told Octus. He noted that issuers relying on favorable rate environments to support debt repayment do not seem sustainable for him.

Weighted Average Rating Factor

Weighted average rating factor, or WARF, is a numerical representation of the credit risk of a portfolio. For each rating notch, there is a numerical rating factor that corresponds to the 10-year probability of default. The WARF is calculated by taking the weighted average of all these numerical factors for each of the individual issuers in the portfolio.

WARF is typically established at the time of portfolio construction and reflects where a manager’s credit assumptions fall on the spectrum, from conservative to aggressive, with a lower number reflecting a more conservative approach. WARF changes as issuer ratings within the portfolio change, but this metric, as Napier Park’s He cautioned, can “lag the change of industry and market conditions where companies operate because rating agencies react to the financial results of these changes.”

As of the second quarter, Empower Capital, Nassau and Onex posted the lowest WARF among U.S. CLO managers, while Pemberton, M&G and Arini top the European rankings, according to Octus’ Portfolio Analytics.
 

Nassau Global Credit ranks second among U.S. CLO managers with a WARF of 2546. The firm manages 10 U.S. CLOs totaling $2.1 billion in assets and five European CLOs with €1.8 billion.

Jonathan Insull, chief investment officer at Nassau Global Credit, said the firm’s low WARF reflects a deliberate effort to maintain clean portfolios. He emphasized that such discipline is especially important in today’s challenging arbitrage environment, as it gives managers the flexibility to reset or refinance when opportunities arise and helps lower funding costs.

“This is how you can improve the arbitrage math,” Insull said. “If you try to time the market and wait until the arbitrage looks just right, it can be a difficult exercise, especially given how long it takes to ramp up a vehicle nowadays.”

Oaktree, with 2575 in its WARF across its 17 U.S. CLOs with $7.4 billion assets, ranks sixth. The firm also manages 13 European CLOs worth a combined €5 billion.

Megan Messina, managing director and assistant portfolio manager within Oaktree’s U.S. senior loans strategy, told Octus that the firm’s U.S. CLOs are designed with an average WARF in the mid-to-high 2500s.

“The tail wags the dog,” Messina said. “This is especially true in CLOs, as a deal can have a low WARF and still be a loser due to a fat tail.” Consistently finding ways to build par through deep credit research to offset inevitable losses in a sub-investment-grade portfolio is critical to managing tail risk, Messina noted.

“We see bull markets as riskier than bear markets and tend to be more active in periods of increased volatility when risk is priced appropriately,” Messina said. “We have not seen an issuance opportunity in the past 2 months in US BSL CLOs primarily due to a mismatch in bank loan spreads versus CLO spreads. Post-Labor Day, CLO spreads have compressed and are entering a potentially interesting overall cost of financing. This, coupled with a pickup in primary loan issuance, could result in a CLO market opportunity.”

King Street, with a WARF of 2819, takes a more aggressive stance, and, as Natarajan put, “I’d say we probably rank better than average on WARF, but slightly higher than average on triple-Cs.” He noted that the firm is constantly seeking undervalued triple-C-rated names whose recovery far exceeds what the market prices in. “Where we see value, we would much rather stay the course versus swapping into the growing B3 bucket just to optically bring down triple-Cs.”

“You’ll often find where we have positions in the riskier credits within the CLO, we have significantly larger positions across our funds in those names.” Natarajan said that he believes that alpha can be realized through managing the tail of the portfolios. “Everything is tradable at a price. On that riskier part of the market, if you’re not prepared to be big and follow your money, then you probably shouldn’t be in the trade.” Natarajan added that King Street’s 30 years of practice in the distressed credit market grants it the ability to have a meaningful role in shaping outcomes.

CIFC manages 62 U.S. CLOs with $28 billion assets and eight European CLOs with €3 billion. The firm’s U.S. CLO portfolio revenue growth ranks eleventh, with 7.48% as of the second quarter. Ira Ginsburg, senior managing director, senior portfolio manager and head of CLOs at CIFC, told Octus that as a credit investor, his firm’s focus is on managing downside risk.

“It is reassuring to see that capital and liquidity remain available and the loan market has a healthy level of support and resilience,” Ginsburg said. He added that many issuers that became overleveraged during the low-rate era have been contending with tighter cash flow in today’s higher-rate environment, so the anticipated base rate cuts would offer an improved cushion to many issuers in the market.

Ginsburg acknowledged that these strong technicals may temper CLO equity returns in the short term. Diameter’s Goodwin echoed the view, noting that with loans currently trading at a short duration of 1.5 to two years, the loan spread compression and recouponing, coupled with a series of base rate cuts, would essentially extend the loan duration. As a result, if CLO managers need to sell loans in a wider-spread environment, the added convexity from longer duration could lead to sharper mark-to-market losses.

“We might see a couple quarters of lower CLO equity payments, but eventually CLOs will reset at the same lower spreads as well,” Palmer Square’s Brager noted.

So far this year, $30 billion in CLO redemptions have fed loan supply into the new issue market. Bank of America noted that among post-reinvestment CLOs with $122 billion in collateral, roughly $50 billion, or 41%, is currently callable as their overcollateralization cushions have fallen below 3.5%. The bank’s analysts added that with the broader loan index trending higher, the equity net asset value of these callable deals is expected to improve, making it more attractive for equity tranche investors to exercise calls.

“The CLO market needs more deals to be liquidated to help restore better equilibrium,” said Logan Lowe, the portfolio manager at Diameter. “That’s really the antidote it needs right now.”