As reinvestment ends, the 2021 and 2022 vintages are testing CLO managers

In 2026, we are at a crucial juncture for European CLO managers. The 2021 and 2022 vintages are reaching the end of their reinvestment period. Understanding why this is significant is vital to grasping the current state of the CLO markets.

Single-B CLOs are one of the more specialist corners of the European credit market, and the yields reflect that.  They currently offer a premium over BBs, at around Euribor + 8% to 9.5%, while BBs tranches trade around Euribor + 5% to 5.5%. That premium is there for good reason. BBs are far better protected and significantly more liquid.  While single-Bs sit close to the bottom of the structure and behave more like equity if not managed correctly.

It is not a part of the market for everyone. Like CLO equity, single-B tranches are better suited for funds with limited liquidity needs. Defaults are more likely at this level than further up the structure – that is simply the nature of the risk. However, in practice, realised default rates here have historically been very low, and certainly lower than in single-B corporate high yield. Investors are being paid, and paid well, to take that risk, and have been for a long time.

Why the 2021 and 2022 vintages matter

We have always talked about manager tiering in CLOs, but for much of the cycle, it has been a matter of spread differentials and reputation rather than realised outcomes. European CLOs have not seen a tranche default in deals issued since the Global Financial Crisis, but with this vintage, that picture is beginning to be tested in a small number of weaker deals. The 2021 and 2022 vintage deals are reaching, or have already reached, the end of their reinvestment periods, which can last up to five years.

This means the portfolio is broadly set and there is less scope for the managers to actively improve it. Most deals are in a perfectly decent state and are increasingly being refinanced. But there are some where CLO managers loaded up on too many concentrated positions, or are exposed to expensive 2021 IPOs, purchased at peak valuations, leaving single-B tranches vulnerable to principal losses if the deals were liquidated today.

What matters now

This matters because with less room to adjust portfolios, some unpredictable and more esoteric credit events – Altice being the obvious one – have materially impacted CLO equity valuations. In a subset of deals, there is a genuine risk that this will spill over into the single-Bs. These bonds are typically bid with a cash price in the 50s to 70s, which indicates spreads around 1,200bp to 1,500bp, making the bonds clearly speculative at that point. Having said that, we have seen limited actual trading as holders are not willing to give up the upside, as the structures have ultimately been designed to protect bondholders.

What separates the weaker deals now is less about asset selection and more about how managers choose to manage the liability structure. Some have proactively diverted equity cash flows and junior management fees in favour of the rated note holders. Others have not, and it is precisely those deals that are struggling.

Juggling a weaker asset mix within a complicated liability structure is never easy, and it becomes more difficult when the equity investor is not the CLO manager. Where the manager owns the equity, the incentive is clearer. Protecting the single-Bs protects the value of the wider CLO franchise, which is worth far more than any one deal.

This is well-trodden ground in the US. Crystallising losses in high yield CLOs is treated much as it is in corporate high yield, where it is known that defaults will occasionally happen. Europe has not really experienced this before, and our sense is that European investors are rather less forgiving than their American counterparts.

So far, we have seen only one example. Bain agreed with single-B holders that the class would not be repaid in full and the manager would liquidate the remaining assets. That was a 2018 deal, with little else that could realistically be done.

Encouragingly, we have also seen managers do it the right way: cleaning up portfolios and refinancing older transactions after injecting fresh equity, on the basis that a clean next deal will make the money back over time.

Investor implications

While the Bain example is interesting and a few more CLOs could follow, this only represents a very small part of the market, and we continue to have high conviction in the asset class.  Our belief in CLOs underscores a couple of points we have made for a long time and that have rarely been as well evidenced.

First, manager due diligence is everything. The 2021 vintage has passed its reinvestment period and leaves managers with little room to manoeuvre. This allows investors to determine if active managers have earned their fees and may deserve a larger allocation.

Second, active management matters enormously – the ability to rotate out of weakening credits and build a cushion is precisely what separates the stronger deals from the weaker ones.

And third, it is worth paying attention to who controls the equity, as it can shape the incentives on how CLOs are managed. This determines where we prefer to take the risk.

There are still some very good opportunities with selected managers in single-B tranches. Generally speaking, however, within high yield CLOs, we think the BBs offer the best risk-adjusted returns: they are well protected relative to the single-Bs while still paying a healthy spread. In the newer vintages, we would prefer to own a blend of BBs and long-dated CLO equity over the single-B tranche outright. That combination gives us better-protected carry alongside genuine upside, without sitting in the part of the structure that, as the 2021 vintage is now showing, has the least room for manoeuvre when things go wrong.