A year ago, a common topic of discussion was so-called "zombie CLOs," or transactions in their amortization phase with little chance of being reset (too large an equity contribution required) or optionally redeemed (liquidation proceeds insufficient to cover the rated notes). There were a fair number of these transactions: about 31% of rated U.S. CLOs were outside their reinvestment periods at the end of 2023, and 44% were expected to be outside their reinvestment period by the end of 2024.

Instead, 2024 turned out to be an extremely active year for CLO issuance. The market roared back to life and broke records with $201.95 billion of new issuance and $306.94 billion of CLO resets and refinancings during the year, per Pitchbook/LCD. An increase in loan prices fueled some of this, with optional redemptions (i.e., liquidations) of existing transactions picking up sharply. As a result, currently only about 21% of rated U.S. CLOs are outside their reinvestment periods, 10% lower than a year ago.

Looking at corporate ratings, downgrades across U.S. broadly syndicated loan (BSL) CLO obligors outpaced upgrades 299 to 231 in 2024 (see chart 1 below). The downgrades across U.S. BSL CLO obligors were mostly concentrated within the issuers with lower credit ratings to begin with ('B-' and lower); CLO obligors rated 'B' and higher actually saw more upgrades than downgrades in the second half of the year. Most BSL CLO metrics finished the year with notable improvement. Average 'CCC' buckets have come off their highs over a year ago, and average default exposure remained well under 1% for most of the year. Additionally, the proportion of BSL CLO obligor ratings on Outlook Negative, an important indicator of future corporate ratings trends, ended the year below 14%, significantly below where they started the year.

Table 1

Chart 1

Active Management Continues To Benefit CLO Portfolios

We used the framework from our prior articles on manager value to assess the metrics from our CLO Insights Index of 376 reinvesting transactions over the past year. As noted in table 1 above, the sample started 2024 with slightly weaker credit metrics (average 'CCC' bucket of 6.93% and average SPWARF of 2713) while the portfolio par was close to target par (average of 99.99%). In our prior study on manager value ("Managers Matter: Active Management Of U.S. BSL CLOs During Uncertain Times Shows Its Value," published Nov. 30, 2023), we found that BSL CLO managers were able to maintain par (some even built par) in 2022 by reinvesting into fixed rate bonds from higher rated issuers at a discount to par. That trade was no longer available in 2024 in a declining rate environment and thus we see a notable decline in par balances in 2024 (declining 68 basis points [bps] on average to 99.30% during the year) though we see there has been a notable improvement in other CLO metrics by the end of the year.

Across our index of 376 reinvesting U.S. BSL CLOs in 2024:

• The average portfolio turnover reached 60% at the loan level; at the issuer level, average turnover was 28%. The difference in loan turnover and issuer turnover highlights the volume of refinancing activity across the CLO obligors in 2024 (i.e., refinancing an existing loan will count as a new loan, though the issuer is the same).
• The average portfolio par balance declined 68 bps to 99.30% of target par from 99.99%.
• The average 'CCC' exposure declined 96 bps to 5.98% from 6.93%.
• The average SPWARF values declined by 45 to 2668 from 2713.
• The average junior overcollateralization (O/C) cushion declined by 60 bps to 3.94%.

Table 2

What Could Have Happened Without Active CLO Management In 2024

Assuming a hypothetical static CLO scenario where CLO managers made no trades after the start of 2024, across our index we see:

• No turnover and thus, no par loss.
• Average 'CCC' exposure increased 226 bps to 9.19% from 6.93%.
• Average SPWARF values increased by 78 to 2790 from 2713.
• Average junior O/C cushion declined by 100 bps despite no par loss; instead, the hypothetical decline is due to haircuts from higher 'CCC' and default exposures (declined to 3.54% from 4.54%).

Table 3

The Value Of Active Management

In 2024, by turning over their portfolios by 60% at the loan level (28% at the issuer level), CLO managers have:

• Reduced portfolio par balance by 68 bps.
• Reduced SPWARF by 123 (actual reduction of 45 in 2024 compared to a hypothetical increase of 78).
• Reduced 'CCC' exposure by 321 bps (actual reduction of 0.96% compared to a hypothetical increase of 2.26%).
• Preserved a junior O/C cushion of 0.40% despite the par loss of 0.68% (actual reduction of 0.60% in 2024 compared to a hypothetical reduction of 1.00%).

Through reinvestment in 2024, CLO managers have improved the credit profile of their CLOs by trading out of several issuers that would have been downgraded into the 'CCC' category and trading into issuers rated 'B-' and higher. These de-risking trades come at a price of par as these loans are typically sold at a discount. By the end of 2024, most of the index had 'CCC' concentrations below the 7.50% trigger, and fewer deals experienced excess 'CCC' haircuts to their O/C numerators. Had the managers not reduced the 'CCC' buckets, the expected haircuts from the elevated 'CCC' and default buckets would have been greater than the impact of the par loss, resulting in hypothetical year-end O/C cushions that are 0.40% lower than the actual year-end cushions.

Table 4