CLOs reprice as software and geopolitics test sentiment

Collateralised Loan Obligation (CLO) markets have repriced meaningfully over the past few weeks. Spreads on AAA notes have widened by around 10bp from the tights of early February, while BB spreads have moved 150-200bp wider in both European and US CLOs. The widening has been more pronounced in European B notes and, importantly, dispersion across managers has increased again. This quality “tiering” between managers has been building for some time, especially since summer 2025, but it is now much more visible as investors differentiate between managers with lower exposure to stressed sectors and those carrying more tail risk.

The immediate catalyst has been the repricing of software risk. Since late January, the market has been reassessing the durability of some software business models as AI tools improve rapidly, with Anthropic’s release of industry-specific plug-ins for its Claude Cowork tool in particular triggering a sell-off in software leveraged loans. Software exposure (using S&P’s industry classification for software and services) averages 8% in European CLOs and 10% in US CLOs, according to Intex data, compared to around 20% in US private credit according to data from Morgan Stanley. Software exposure varies greatly between managers, however, with the range roughly 1% to 17% in European and 2% to 20% in US CLOs, according to Deutsche Bank data. Software is clearly not the only sector facing some form of disruption from AI tools,  with media, business services and cybersecurity for example facing disintermediation and the risk of compressed margins. In addition, not all software firms are equally exposed; mission-critical platforms with proprietary data, or those with regulatory barriers or high switching costs should prove more resilient, while generic point solutions and simpler application software faces greater disruption risk.

Fundamentally, we do expect downgrades and defaults in leveraged loans to rise, particularly among the more leveraged 2021 vintage issuers. Around half of the assets maturing in 2028 in European CLOs were originated in 2021, at peak multiples, tighter spreads and more aggressive leverage. Software is one of the main sectors represented in that cohort, alongside chemicals, where issuers could face more challenging conditions to refinance. At the same time, the broader maturity wall remains manageable in Europe, with very limited maturities in 2026 and less than 10% of CLO portfolios maturing in 2027. Similarly, in the US, there is a large proportion of software loans coming to maturity in 2028 where the borrowers could face challenges in refinancing and are at risk of potential downgrades, but the maturity wall is also limited across 2026 and 2027. Exposure to loans rated CCC remains elevated, but broadly stable in both European and US CLOs. The share of loans trading below a cash price of 90 has risen materially in both markets, reflecting higher tail risk being priced in; in European CLOs the share increased from 6.3% to 14.4% between June 2025 and February 2026, while in US CLOs it rose from 8.6% to 13.5% (see Exhibit 1).

This increase in the share of loans trading down shows investors pricing in greater default and downgrade risk, though again the tiering between managers perceived as weaker or stronger is resulting in wider spread dispersion. European BB CLO spreads currently range from 575bp to 850bp over three-month Euribor, for example, while US BB spreads range from 600bp to 900bp over SOFR.

CLO resets and refinancings are likely on pause at current spread levels, though selective new issuance should continue especially for managers who can ramp portfolios at a discount. We are also seeing investors step in at wider levels, while selling has been relatively contained. We note secondary supply was higher in US CLOs last week resulting in spreads widening more rapidly than in Europe. The escalation in Iran has clearly added a macro risk premium, mainly through the possibility of higher energy prices and weaker risk appetite, but so far spread widening has remained orderly.

CLOs are diversified portfolios of senior secured, broadly syndicated loans, with limits on single name, industry and CCC exposure. These portfolios are actively managed, with the managers able to rotate away from weakening credits and build cushion in the CLO to absorb higher expected losses. Those structural protections remain important in an environment where idiosyncratic risk is rising. That is a key distinction versus parts of private credit, where fund exposures can be more concentrated to certain sectors and borrowers and loans are not publicly syndicated, meaning investors have less transparency on the underlying loans and on valuations (compared to senior secured loans trading with regular pricing).

So where does that leave investors? In our view, wider CLO spreads are justified. Higher downgrade risk, greater dispersion across managers and the uncertainty created by the conflict in Iran all argue for caution. Our CLO modelling always considers underperforming loans; we also conservatively project a higher default rate on performing loans in software and other cyclical sectors such as chemicals and automotive. CLOs are designed to absorb stress, with a typical BB CLO tranche able to withstand around 30% cumulative loan defaults over the life of a deal, assuming a 60% recovery rate, before taking any impairment.

We think CLO spreads are becoming more attractive again, and we see relative value at the current levels for certain managers and at certain rating levels. However, patience is key as the opportunity now lies in backing the right managers at spread levels that properly compensate for the risk.