Recent market headlines have been dominated by volatility in the software sector as rapid AI advances are perceived as threatening certain companies’ business models. The risk-off sentiment has spilled over into the CLO market, where massive selling pressure on software credits is testing the largest exposed industry across CLO portfolios.
According to Octus’ CLO data, 12.1% of U.S. broadly syndicated loan CLO collateral is classified under the software and services industry on the basis of the Global Industry Classification Standard, and the sector accounts for 9.11% of European BSL CLO collateral.
Since mid-January, the Morningstar LSTA U.S. Leveraged Loan Index has declined 1.85%, largely weighed down by its software and services component. The sector, which accounts for 15.89% of the index, has fallen 7.76% over the same period. Notably, roughly 14% of loans in the software component are now trading below 80, and the sector now trades at an average price of about 89. Loans from issuers with AI disintermediation risk trade even lower, at $86.4 on average, according to Bank of America’s research.
Morningstar LSTA US Leveraged Loan Index Performance
Morningstar LSTA US Leveraged Software Loan Index Performance
Against this backdrop, CLO portfolios have suffered mark-to-market price drops, with 13% of the portfolio loans trading below 90 and 5.6% trading below 80, up 3.6 points and 0.8 points from January, respectively.CLO junior tranches have come under immense pressure. As shown in the February data table below, the junior overcollateralization cushion has narrowed by 82 bps year over year to 3.49%, and 7.1% of U.S. BSL CLOs have failed their most junior overcollateralization test, up 0.5 points from January and 2.1 points from a year earlier.
Pressure on junior debt tranches has further weighed on CLO equity performance. In addition to lower interest income from portfolio assets, with the weighted average spread tightening by 27.4 bps year over year, the erosion in junior overcollateralization cushions has diverted cash flows away from the equity tranche to repay debt tranches.The median quarterly equity distribution for the first quarter of 2026 across all U.S. BSL CLOs stands at 2.4%, down 0.3% from the fourth quarter of 2025 and 1% below the historical average, according to Deutsche Bank Research. Trailing-four-quarter equity distribution is at 10.3%, 3 points below the historical average and the lowest payout since 2018. The bank’s analyst, however, noted that the number of managers failing to make distributions declined by three from the previous quarter, while the number of CLO transactions failing to pay distributions fell by 42 to 194.
Source: Deutsche Bank Research
Among reinvesting U.S. BSL CLOs, 2020-vintage deals have the highest software and services exposure, at 12.5%, followed by 2019-vintage deals, at 12.4%, and 2025-vintage deals, at 12.2%, according to Octus’
Structured Finance Insights.
In Europe, 2025-vintage deals show the highest exposure at 10.2%, followed by 2024-vintage and 2021-vintage at 9.9%.
Although BSL CLO portfolios are constrained by diversity score and industry concentration limits, industry exposure can still diverge meaningfully across managers. Among U.S. managers with more than $1 billion of BSL CLO assets under management, software and services exposure ranges from 3.13% to 24.46%, a dispersion of 21.33%.Black Diamond, Fort Washington and PGIM rank among the least exposed managers to the sector in their reinvesting CLOs, with Black Diamond’s allocation notably low at 3.13%, about 1.08% lower than Fort Washington, the second-lowest.
Golub, Silver Point and New Mountain are the most exposed managers to the software and services sector, with Golub leading at 24.46%, about 3.81% higher than Silver Point’s 20.65%.
In Europe, the dispersion in allocations among reinvesting CLOs is slightly narrower. Hayfin, Alcentra and Sona rank among the least exposed managers, with Hayfin at just 1.89%.
Napier Park, Canyon Capital and Bridgepoint have the highest exposure, with Napier Park leading at 17.8%, 15.91% higher than the lowest allocation.
Andrew Ward, a portfolio manager at Eldridge Capital Management, told Octus that the firm’s relatively low exposure to the software and services sector was partly due to the timing of its CLO platform launch last year, which allowed the team to construct portfolios with potential AI disruption risks in mind.“Beyond displacement risks for software companies, there are significant technical risks and valuation pressures that the market is processing,” Ward said. “For credits in decline, the asset-light nature of software makes it difficult to finance without amortization and strong structural protections.”Octus’ Fundamentals data shows that across all the software loans in both the U.S. and Europe, roughly a third mature in or before 2028, most of which were printed during the Covid-19 period. These loans were financed with high leverage in a low rate environment and become current in 2027. Notably, about one-third of the 2028 maturity cohort is trading at about 80 or below, increasing near-term refinancing risks.
Source: Fundamentals by Octus
Ludovic Walter, co-head of European CLOs at Sona Asset Management, told Octus that the firm’s 3.74% allocation to the sector partly reflects concerns about inflated valuations.“A lot of these businesses were purchased in 2021 at high valuations – in some cases up to 15x to 20x EBITDA multiples – and capital structures were put in place based on those valuations,” Walter said.These high EBITDA multiples were mainly underpinned by software companies’ perceived high growth rates and recurring contracted nature of their revenues, supported by the low rate environment at that time.
However, adjusted EBITDA often includes addback adjustments to incorporate projected cost savings, synergies or other forward-looking assumptions, Therefore, “the reported leverage might be 6x to 7x, but if you look at it on a pure cash basis, in some cases it’s closer to 8x to 9x,” Walter noted. “Now with the higher rates, what you see on the equity side, the multiples are lower, so mechanically, the loan to value has gone up materially.”
Source: Fundamentals by Octus
A research note published by S&P Global Ratings in late February highlighted that the technology sector has seen the highest EBITDA adjustments, with addbacks averaging about 35% of marketing EBITDA at deal inception over the past 10 years, versus about 25% for other sectors.These adjusted addback figures, S&P noted, may not accurately reflect borrowers’ sustainable earnings power and have historically proven to be overly optimistic in some cases.By inflating EBITDA, such addbacks can make leverage metrics appear lower than they actually are, effectively increasing the debt capacity embedded in capital structures. S&P noted that this dynamic can also introduce additional event risk by providing borrowers with greater head room under negative covenants and restricted payment baskets.
Commenting on the cautious sentiment surrounding the sector, Jacob Walton, co-head of European CLOs at Sona Asset Management, said, “I don’t think anyone’s expecting software numbers to be terrible in the near term, and we don’t really anticipate rating actions either. We are in the mark-to market phase of this journey. After the First Brands fallout, investors have a different tolerance to risk.”
“The vast majority of the market trading above par doesn’t leave you so much upside elsewhere to compensate for anything that comes down,“ Walton added. “I think it’s part of how we feel about initial portfolio construction. We like to be nimble and maintain liquidity depths in our underlying assets.”
To better assess CLO collateral issuers’ financial health, the tables below present several portfolio metrics from Octus’ Structured Finance Insights for the least and most exposed managers to the software and service industry.
Among these, cash EBITDA margin, cash EBITDA growth and free cash flow margin are directly associated with issuers’ cash-based profitability and cash generation, while interest coverage ratio and net leverage remain partly dependent on pro forma adjusted EBITDA figures that may incorporate addbacks.
In the U.S., capital expenditures-adjusted interest coverage ratios appear increasingly sensitive in portfolios with higher software and services exposure, with higher allocations associated with progressively lower coverage in general.Cash EBITDA margin and cash EBITDA growth show the opposite trend, with higher concentrations correlating with stronger profitability and growth metrics.By contrast, net leverage and free cash flow margin exhibit only weak correlations with software and services exposure.
In Europe, software and services exposure shows little correlation with interest coverage ratios, cash EBITDA margins, net leverage or free cash flow margins. However, cash EBITDA growth exhibits a relatively stronger relationship with sector exposure, with higher concentrations generally associated with higher growth rates.Among liquid software and services leveraged loans tracked by IHS Markit, Octus identified 59 U.S. loans and 12 European loans that declined by more than 10% over the past four weeks, based on pricing data as of March 1. These top decliners were listed in tables below:
CLOs hold a significant amount of the listed decliners. Across all reinvesting and non-reinvesting transactions, approximately 46.21% of the tracked U.S. loans, weighted by original loan amounts, were held in CLOs, compared with 64.56% of the top-declining European loans.Among 165 managers with positions of the 71 listed tracked loans, Blackstone, UBS Asset Management and Carlyle report the largest exposures by balance value.
On the loan supply side, information technology leveraged loan issuance has dropped sharply. Of the total loans issued in February, Octus data shows only 3.8% of deals were in the information technology sector, 8.2 points down from January.Octus’ CLO data has identified 273 loans from 136 issuers in the software industry under Moody’s Ratings’ classification, totaling $67.27 billion, of which 89.1% are U.S. loans. Please reach out to
[email protected] for more loan details.
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