Middle market collateralized loan obligations (MM CLOs) have been a part of the U.S. CLO market for a long time, but in recent years, they have become an increasing topic of discussion as new investors look at the space and asset managers seek to raise additional funding for their direct lending businesses. As a proportion of U.S. CLOs outstanding, MM CLOs currently represent about 12% of the total (both by par and transaction count), but since 2023, they have represented an increasing proportion of CLO new issuance (see table 1), a trend that appears will continue.

As such, S&P Global Ratings is publishing this MM CLO primer to provide a high-level overview of the collateral and structural features we see when we review a typical MM CLO transaction, and the themes that come up during our discussions with market participants. We'll start with a brief overview of MM CLO issuance and spreads in recent years, then compare key attributes of broadly syndicated loan (BSL) CLOs and MM CLOs, and then discuss market themes. Finally, we'll highlight some of the differences we see between BSL CLO and MM CLO indenture provisions.

Table 1

Middle-market CLOs have primarily been a U.S. phenomenon so far, but the European CLO market saw its first publicly rated MM CLO in fourth-quarter 2024, and there has been ongoing discussion around further transactions (see "Private Markets Monthly (EMEA Edition), February 2025: What Barings' Middle-Market CLO Means For The European Market," published Feb. 28, 2025). This primer will focus on the much larger and more established U.S. MM CLO market. For more information on the nascent European market for MM CLOs, see "Is There A Middle Ground For European Middle Market CLOs?" published Nov. 16, 2023.

Furthermore, although some market participants use other terms for MM CLOs (e.g., private credit CLOs, direct lending CLOs, etc.), for purposes of this primer, we'll refer to them as MM CLOs for simplicity, even while noting that CLOs from some managers have companies in their portfolios larger than what has traditionally been considered middle-market based on EBITDA size and the amount of debt outstanding.

The Investor Base Has Grown

Middle market CLOs are part of a larger private credit ecosystem that has seen rapid growth in recent years, and the investor base for MM CLOs has grown as well. As MM CLOs continue to move into the mainstream, life insurance companies, money managers, and pension funds have been joined by U.S. banks, Japanese banks and insurance companies, and sovereign wealth funds and investors in the Middle East, Korea, and elsewhere.

Investor allocations to MM CLOs have been driven by relative value and the spreads on offer, but also by a desire for asset diversification and a need for asset-liability matching by insurance companies and pension funds who have a need for yield on longer maturity assets. With a large number of Americans and others retiring every day, we expect these institutions to continue to allocate money to MM CLOs and fuel growth in the space. Managers and others have spent time in recent years educating the investor base on MM CLOs, and the strong rating performance shown during the pandemic in 2020 and since has also helped.

Middle-market CLO 'AAA' tranche credit spreads (i.e., SOFR + XXX) have historically been considerably wider than comparably rated BSL CLO 'AAA' tranches (see table 2). Spreads compressed significantly in 2024, but even with new issue MM CLO 'AAA' tranches pricing at the tight end of their historical range, they still offer a material spread pickup over BSL CLO 'AAA' notes. The additional spread is in part due to investor perceptions of MM CLO liquidity and transparency relative to the much larger BSL CLO market, although MM CLO 'AAA' tranches have gained in liquidity in recent years.

Table 2

Key Differences Between BSL CLOs And MM CLOs

While BSL and MM CLOs have far more in common than differences, there are some relevant attributes that vary between the two types. The notable differences start with the respective sizes of the two CLO markets and the motivations for CLO managers to issue BSL and MM CLO transactions in the first place. Other differing attributes include the source of the loans in the collateral pool, some of the attributes of the loans, the composition of the CLO collateral pools, and the structure of the CLO transactions.

The table below summarizes some of the key differences between BSL CLO and MM CLO transactions.

Table 3

We discuss some of these key distinctions between BSL and MM CLOs in further detail below.

Issuer motivation:   For BSL CLOs, the typical incentives for a manager to issue a new CLO include building assets under management (AUM), generating fee income, and producing a target rate of return for the CLO equity. In contrast, many MM CLO managers use CLOs primarily as a means of financing their direct lending funds, which include both private funds and SEC registered Business Development Companies (BDCs). In this application, CLOs for MM managers are one piece of a fund complex's capital sources and may be used in tandem with other forms of financing such as corporate revolvers, traditional bank asset-based lending (ABL) facilities, unsecured bonds and other forms of bank financing arrangements.

For direct lenders that issue CLOs, it's worth noting that they typically don't silo their CLO strategy and will allocate loans they make across their CLOs, funds, and separately managed accounts (SMAs). Incorporating CLOs as part of their strategy helps them increase scale and fundraising opportunities as investors continue to allocate money to the space.

Source of loans:  In most MM CLOs, many of the loans are originated by the manager (or an affiliate) in their role as a direct lender, either on their own or through a club deal between the manager and a handful of other direct lenders. This contrasts with the BSL CLOs, where loans come from the $1.4 trillion U.S. BSL market and can be held across dozens, or even scores, of CLO managers and other investors.

As a result, companies in most MM CLO collateral pools tend to be smaller than those in BSL CLOs, with EBITDA sizes of $100 million or less (and often a lot less). As of fourth-quarter 2024, the median EBITDA for companies in our universe of about 3,000 credit-estimated companies (nearly all of which are held in MM CLOs) is around $30 million. This compares with a few hundred million or more for the typical rated loan issuers found in BSL CLO transactions. It's worth noting that while the median-sized company in MM CLOs is still quite small, the direct lending market has been trending towards larger companies in recent years.

Credit estimates versus ratings:  More than 95% of the companies in BSL CLOs are publicly rated, but at least 80% of the companies issuing the loans in MM CLOs aren't rated. Our CLO analysis and credit model (CDO Evaluator) rely on ratings (or implied ratings) for each asset in the collateral pool, and as a result, many of the companies in MM CLOs are credit estimated for purposes of the CLO analysis. A corporate credit estimate is a point-in-time, confidential indication of our likely rating on an unrated entity and is primarily used in our analysis of MM CLOs (for more information, see "Anatomy Of A Credit Estimate: What It Means And How We Do It," published Jan. 14, 2021).

Collateral attributes:  Compared to BSL CLOs, MM CLOs have more exposure to loans from lower-rated (or credit estimated) obligors. As of fourth-quarter 2024, the average U.S. BSL CLO exposure to loans from 'B-' companies and companies with ratings in the 'CCC' range (including 'B-' on CreditWatch negative) was about 26.0% and 5.3% of total assets, respectively; the proportion for MM CLOs with corresponding level credit-estimated ratings was higher at about 73.4% and 13.9%.

In addition to having a lower-rated companies in their portfolios, most MM CLO also tend to have lower diversity, with fewer obligors, larger positions, and greater industry concentration. To compensate, MM CLO tranches tend to have significantly more credit enhancement in the form of par subordination than do tranches from BSL CLO transactions (see Transaction structures section below), and MM CLOs as an asset type have historically shown strong rating performance in part because of this.

MM CLOs also tend to have shorter average tenor of the loan collateral and higher loan spreads relative to BSL CLO portfolios, both of which are beneficial from a credit perspective when we do our CLO analysis. Shorter-maturity collateral pools should experience fewer defaults than longer-maturity collateral pools, all else being equal, and excess spread (which the average MM CLO has more of than the average BSL CLO) can serve as a form of credit enhancement if coverage tests fail and cash is diverted to pay down the senior notes.

Both BSL and MM CLO portfolio weighted average spread (WAS) metrics tightened in 2024. The average BSL CLO collateral WAS tightened by about 18 basis points as many companies in the BSL market refinanced or repriced their loans to take advantage of more accommodating market conditions, and by the end of 2024 the average BSL CLO WAS sat at SOFR+348. Less refinancing and repricing of loans took place in the direct lending market, but the WAS tightened here as well during the year, by just over 10 basis points, ending the year with a WAS of SOFR + 559 for the loans in our MM CLOs. Loans to smaller EBITDA borrowers saw less of a decline than loans to larger companies.

Chart 1

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Transaction structures:  In contrast with the BSL CLOs, where something of a standard capital structure has evolved, MM CLOs have a greater variety of transaction structures. Many MM CLOs used for funding purposes issue only investment-grade classes of notes, and some have just a senior rated note (usually 'AAA' rated) and equity. Other MM CLOs look more like a standard BSL CLO structure, with notes issued from 'AAA' down through 'BB-' (and sometimes 'B-'). Given that the main motivation behind the issuance of many (although not all) MM CLOs is to facilitate the direct lending business of the CLO manager or their affiliates, MM CLO capital structures often aren't economically optimized (i.e., leveraged) in the same way typically seen in BSL CLOs.

Themes From The Market

In our conversations with MM CLO investors, managers, and other market participants, the following themes tend to come up frequently.

Underwrite the manager, not the CLO:  Because most MM CLO managers (or their affiliates) originate and underwrite a meaningful proportion of the loans in their CLO collateral pools, MM CLO performance in a downturn may be more correlated by manager than it would be for a BSL CLO, where the manager is acquiring assets from a large, relatively liquid loan market and more assets are held across CLOs from different managers.

Manager specialization:  Direct lenders often specialize in lending to specific segments of the market and may have portfolios with companies that differ by EBITDA size (i.e., lower, core, and upper middle market). Additionally, they may also focus on specific industry categories (i.e., software, healthcare providers and services, etc.), focus on PE-sponsored versus non-sponsored companies or specific underwriting or loan types (i.e., recurring revenue loans). In some sense, the middle market is a collection of smaller market segments rather than a single market with all MM CLO managers directly competing against one another.

Chart 5

Buy and hold vs. buy and sell:  Most BSL CLO managers seek to add value by managing their CLO portfolios to adapt to shifting credit conditions (for example, trading out of an industry sector they think might come under stress) or to take advantage of loans in the market they think may be undervalued or overvalued. Assets in MM CLOs, by contrast, are traded in and out of CLO portfolios relatively less frequently, putting more weight on the original asset selection for the CLO portfolio, and the underwriting of the loans.

Different ways of looking at asset diversity:  BSL CLO collateral pools have always been diverse by obligor count and have become even more so in recent years. The typical MM CLO collateral pool has fewer obligors than the typical BSL CLO collateral pool, and the impairment of any one asset can have a greater impact. However, MM CLOs have much greater asset diversification across different managers, as MM CLO loans may be unique to a single collateral manager or small number of managers. As such, they can add diversity to a portfolio of CLO tranches. The typical MM CLO has only a single-digit percent asset overlap with CLOs from other MM CLOs managers (see slides 34-35 in "Private Credit And Middle-Market CLO Quarterly: Waiting For The Sun," published Jan. 24, 2025).

Transparency:  Nearly all of the loans in the BSL market come from publicly rated companies, and when rating changes occur, they're typically published along with a rationale for the change. Most loans in the BSL market also have readily available prices, which can be used by investors in their analysis of new issue and secondary market CLOs. In contrast, most loans in MM CLOs don't come from publicly rated companies and aren't actively traded, limiting price discovery.

However, some investors contend that MM CLOs offer a different kind of transparency, with managers providing them with company financials and/or credit metrics (EBITDA, leverage, interest coverage, etc.) when loans are added to the MM CLO portfolio, as well as (sometimes) on an ongoing periodic basis. Managers may also elect to display credit estimates in monthly CLO trustee reports or otherwise provide them to investors.

Relationship with borrowers:  MM CLO managers or direct lenders may have more direct communication with borrower companies (and other lenders to those companies) than is possible in the BSL market. When needed, this can allow lenders to "get to the table" more quickly and modify loan agreements. For example, during the pandemic-driven downturn in 2020, many direct lenders amended loan terms to avoid missed interest payments and defaults, enabling companies to ride out the impact of the shutdowns. Note that S&P Global Ratings may treat these loan modification as Selective Defaults (see "U.S. Corporate Defaults: Variations, Forecasts, And The Implications For CLOs," published April 29, 2021).

Financial maintenance covenants (covenant-lite):  Loans in the direct lending market are much more likely to have financial maintenance covenants (that is, to not be covenant-lite) than loans in the institutional (BSL) loan market. This is especially true for companies at the lower end of the EBITDA scale (see slides 20-21 in "Private Credit And Middle-Market CLO Quarterly: Waiting For The Sun," published Jan. 24, 2025).

Loan document provisions:  In addition to financial maintenance covenants, loans in the direct lending market tend to have stronger protections elsewhere in the document as well. Flexibility is often specifically tailored to meet borrower needs, including things like delayed-draw term loans (DDTLs), payment-in-kind features, recurring revenue structures, and other items; and otherwise, lender protections are much stronger. For example, EBITDA definitions in the direct lending market tend to be much tighter than in the BSL market, with fewer permitted addbacks or adjustments to EBITDA. This is a function of the significant negotiating leverage afforded to small groups of like-minded lenders who often have long-term relationships with one another.

Liability management transactions:  The flexibility (and weakness) present in BSL market loan documents that enables non-pro-rata liability management transactions (LMTs)--where lenders get impaired and the equityholders remain unchanged (see "Demystifying Loan Liability Management Transactions And Their Impact On First-Lien Lenders," published Oct. 30, 2024)--has not yet been a significant issue in the direct lending market, despite a few high profile instances that have generated headlines.

Payment-in-kind (PIK) toggles:  PIK features have increased in direct lending in recent years, especially for larger EBITDA companies that have the ability to choose between issuing debt into the BSL market or direct lending market. PIK features are a key flexibility distinguishing the direct lending space from the BSL market. The structure we have seen most often is for a loan to be able to defer 50% of the credit spread, with the rest (SOFR plus the other 50% of the credit spread) required to be paid in cash, although this may be evolving. Loans with PIK toggle features are less common among smaller EBITDA borrowers (see slide 21 in "Private Credit And Middle-Market CLO Quarterly: Waiting For The Sun," published Jan. 24, 2025).

Recurring revenue loans:  Recurring revenue loans are a type of financing sometimes used by growth-stage companies in the software and technology industries and are underwritten based on a company's revenue (from things like subscription services) rather than EBITDA. It's usually contemplated that these companies will "graduate" to EBITDA underwriting by a specified point. These types of loans are seen to varying degrees across MM CLOs from different managers based upon the mix of companies in their portfolios.

CLO tranche liquidity:  There is a relatively active secondary market for BSL CLO tranches, especially for 'AAA' notes from the largest BSL CLO managers (in market parlance, "tier one" managers). Tranches from MM CLOs don't trade with the same volumes, but anecdotally, we've heard that a 'AAA' note from a large MM CLO manager may trade with comparable liquidity to a 'AAA' note from a smaller BSL CLO manager.

BSL Vs. MM CLO Document Provisions

A large majority of document provisions are similar between BSL and MM CLO indentures, but there are a few areas where there are differences between the two. This isn't an exhaustive list, but common examples include the below. For some of these items, there can be differences based on which segment of the direct lending market an MM CLO manager focuses on. MM CLOs backed by loans from larger EBITDA borrowers may have indenture provisions that are closer to those in BSL CLO indentures for some of the items below.

Trading flexibility:  MM CLOs have limited post-reinvestment trading flexibility compared to BSL CLOs. BSL CLOs typically allow the manager to reinvest unscheduled principal proceeds and sales proceeds from credit risk assets after the CLO reinvestment period has concluded, subject to conditions. In contrast, most MM CLO indentures don't permit the manager to reinvest any proceeds after the CLO reinvestment period has concluded.

Interest diversion tests and subordinate manager fees:  MM CLOs have overcollateralization (O/C) and interest coverage (I/C) tests, but most MM CLOs don't have an interest diversion test (IDT) or subordinate (i.e., incentive) manager fees at the bottom of the CLO payment waterfalls the way that BSL CLOs do.

CLO 'CCC' asset basket size:   Nearly all BSL CLOs have a 'CCC' basket size of 7.5%, meaning that if 'CCC' assets as a proportion of collateral exceeds that amount on a CLO determination date, the excess 'CCC' assets will be carried at market value rather than at par for purposes of calculating the par coverage tests. MM CLOs have the same concept, but the 'CCC' threshold is larger to account for the greater proportion of 'CCC' assets in MM CLOs. Historically, the most common bucket size has been 17.5%, but it is larger in some MM CLO transactions. It's worth noting here that CLOs (both BSL and MM) are not forced sellers of excess 'CCC' rated assets, or other assets.

Valuing distressed or defaulted assets:  Unlike BSL loans, most loans in MM CLOs aren't rated or actively traded and don't have a market price readily available. CLOs aren't fundamentally market value vehicles, but loan prices can impact O/C ratios when there is an excess 'CCC' amount. In a BSL CLO transaction, these assets are typically carried at market value, but given the absence of market value for most loans in MM CLOs, other mechanisms may be used. These include using an external pricing service, using the manager's estimate, or other means to determine the assumed value to carry the asset at in the coverage tests.

Other basket sizes:  In addition to the 'CCC' basket size outlined above, other concentration limitations may also differ between typical BSL CLOs and MM CLOs. Compared with BSL CLOs, MM CLOs will often have larger allowable buckets for deferrable or partially deferrable assets, but smaller buckets for loans without maintenance covenants (i.e., covenant-lite loans) and non-senior secured loans. However, for covenant-lite loan basket sizes, there has been some convergence between BSL CLOs and MM CLOs, especially at the upper end of the middle market where issuers can sometimes choose between issuing a loan into the BSL market or through direct lending. Finally, MM CLOs typically have a zero percent bucket for corporate bonds, while BSL CLOs may have a small basket for them.

Asset swaps/collateral substitutions:  If a company in a MM CLO comes under stress, some managers may remove these loans from the collateral pool and replace them with other loans, typically ones that the manager (or an affiliate) has already made to other companies. Managers may do this because they find it easier to work out a distressed loan outside the confines of CLO document provisions. Also, if the manager or an affiliate holds the MM CLO equity, the economic impact of holding the loan inside or outside the CLO may be similar. However, it's important to note that managers aren't required to do this, and it may occur (or not occur) based on the situation. Generally, MM CLO document provisions will require the asset to be removed from the collateral pool at fair market value or greater, with any excess amount being treated as a contribution.

BSL CLOs also have the ability to do asset swaps (credit risk for non-credit risk swaps, bankruptcy exchanges, etc.), where the manager can replace an asset outside the reinvestment criteria to minimize losses, but these are typically third-party sales rather than internal transfers. This can also be true for MM CLOs with loans to companies in the upper end of the middle market.

Workout loan language:  LMTs have become more common in the BSL loan market (see "Demystifying Loan Liability Management Transactions And Their Impact On First-Lien Lenders," published Oct. 30, 2024), and BSL CLO indentures often have extensive language to allow CLOs to participate in LMT situations, subject to certain guardrails, with a goal of maximizing asset recoveries. Because of the relationship-based nature of the direct lending market, and stronger loan documents (especially for smaller EBITDA companies), the direct lending market has historically seen far fewer LTMs. As a result, many (although not all) MM CLO indentures have limited or no workout loan language allowing for participation in LMTs. This may be correlated to the size of the companies in the portfolio.

Transfer of assets at CLO origination:  Because many of the assets in a MM CLO are originated by CLO manager (or an affiliate) rather than acquired in the open market as they would be for a BSL CLO, there may be differences in the way the loans are transferred to the CLO at the time of issuance. For example, the initial acquisition of MM CLO collateral may be done through loan participations or bespoke loan sale agreements, and our analysis may be supported with things like true sale and non-consolidation opinions that are not typically seen in BSL CLOs.

Up-to-date MM CLO information

For up-to-date information on S&P Global Ratings-rated MM CLOs, including credit metrics for our universe of 3,000 credit estimated companies, performance statistics for our rated MM CLOs, and manager information, our MM CLO slide deck is an excellent resource. The slide deck is updated and published quarterly. To be added to the distribution list, please reach out to any of the authors of this article. For the latest version, see "Private Credit And Middle-Market CLO Quarterly: Waiting For The Sun," published Jan. 24, 2025.

Related Research

• Private Markets Monthly (EMEA Edition), February 2025: What Barings' Middle-Market CLO Means For The European Market, Feb. 28, 2025
• Systemic Risk: Private Credit's Characteristics Can Both Exacerbate And Mitigate Challenges Amid Market Evolution, Feb. 18, 2025
• Private Credit And Middle-Market CLO Quarterly: Waiting For The Sun, Jan. 24, 2025
• Demystifying Loan Liability Management Transactions And Their Impact On First-Lien Lenders, Oct. 30, 2024
• Is There A Middle Ground For European Middle Market CLOs? Nov. 16, 2023
• U.S. Corporate Defaults: Variations, Forecasts, And The Implications For CLOs, April 29, 2021
• Anatomy Of A Credit Estimate: What It Means And How We Do It, Jan. 14, 2021