Who is buying and what is changing
Carlyle Group Inc., KKR & Co. and Oaktree Capital Management are weighing purchases of beaten-down US leveraged loans with the aim of packaging them into CLOs, according to people familiar with the plans. Other managers are lining up as well, opening a near-record number of warehouse facilities to gather collateral before bringing deals to market. Barclays strategists put the count at about 286 active lines.
"The opportunity is getting a little more exciting," said Dagmara Michalczuk, Tetragon Credit Partners' co-chief investment officer and an investor in CLO equity. "A lot of folks are deciding to pull the trigger at the moment."
The selloff has broadened. What began in October among the most stressed, lower-rated borrowers has spilled into stronger credits, said Ian Gilbertson, co-head of US CLOs at Invesco.
Prices, payouts and the CLO math
Loan prices are marked down. JPMorgan strategists said earlier this week more than nine in ten names traded below face value, a share that later moved closer to about 85%, with spreads sitting near their widest levels of the past year.
CLO demand matters because these vehicles own roughly two thirds of the leveraged loan universe. But the hinge is equity - the riskiest slice of a CLO, which gets paid last. Deutsche Bank analysts estimate CLO equity distributions are averaging 2.8% this quarter and are on track for the first quarterly rise since 2024, though payouts remain muted versus long-run norms.
Lower loan prices can lift equity in two ways: higher coupon income today and potential gains if loans bought below par are ultimately repaid at 100 cents on the dollar. Buy at 97, get paid back at 100, and equity benefits disproportionately because of leverage.
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Another tailwind: the economic spread for CLOs - the difference between the yield on their loan assets and the cost of their issued debt - has been drifting wider. According to JPMorgan strategists, the gap reached 1.41 percentage point during the past week, a 0.07-point increase from the prior week, topping the 1.16-point average over the past year.
"In the long run, we always view bouts of volatility like this to be beneficial for CLO equity," said Dan Ko, a portfolio manager with Eagle Point Credit Management, which purchases CLO equity.
Risks and where cracks could show
The worry hanging over a $1.5 trillion market is simple: higher interest costs and inflation could squeeze the most fragile borrowers and spark more defaults. The task for buyers is to sift for discounted loans that still have solid fundamentals. Some sectors face structural headwinds from technology shifts. Cable TV operators, for instance, are under strain as audiences move to internet streaming.
"There's a real separation between companies that can live with today's cost of capital, and some companies whose capital structures were built in different environments," said Michael Levitin, a portfolio manager at MidOcean Partners.
Even so, new CLO formation would add loan demand, which could help some companies line up financing as the Federal Reserve is expected to keep tightening and capital is harder to source.
The bottom line for investors
Managers are moving because the setup is rare: widespread loan discounts, slightly better equity cash flows, and a marginally fatter arbitrage. It has not unleashed a flood of issuance - new US CLOs sold this year total about $139.2 billion through Thursday's close, running more than 16% below the same point last year - but it is enough to restart deal talk. If you own credit or CLO exposure, the trade-off is clear in plain English: cheaper entry points and higher carry versus the risk that tighter financial conditions tip weaker issuers into default.
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