Listen to the latest episode of Credit Exchange with Lisa Lee
Published in London & New York
10 Queen Street Place, London
1345 Avenue of the Americas, New York
Creditflux is an
company
© Creditflux Ltd 2026. All rights reserved. Available by subscription only.
Opinion CLOs
Fitch is acknowledging what loan investors have learned the hard way
by Dagmara Michalczuk
Dagmara Michalczuk
Co-chief investment officer
Tetragon Credit Partners
By updating its CLO rating framework, Fitch may force managers to reprice documentation risk
To many CLO market participants, rating agency methodologies are a kind of invisible financial engineering. They are complex and largely taken for granted, much like an internal combustion engine or airplane aerodynamics. Few of us consider the underlying mechanics any more than we think about what powers a car or keeps a plane in the air. CLO rating frameworks also tend to evolve incrementally, and their details are often the domain of CLO bankers and researchers. Yet despite their behind-the-scenes profile, rating agencies play a central role in shaping credit markets, providing both loan-level and CLO debt tranche ratings.
As the credit cycle grows long in the tooth, mounting evidence of shifts in loan recoveries and the increasing prevalence of liability management exercises (LMEs) have recently prompted Fitch to revisit its CLO rating methodology. In late April, the agency published an exposure draft outlining proposed changes to its CLO criteria, alongside commentary on how ‘senior secured’ definitions will factor into its recovery assumptions. The implications could be meaningful, not just for CLO ratings, but for behaviour across the USD 2tn global loan market, as it may incentivise CLO managers to push for stronger loan documentation.
Senior secured has become a spectrum
For years, the phrase ‘senior secured’ functioned as a broad stamp of approval in CLO models, supporting relatively favourable recovery assumptions. That era may be ending. Fitch’s latest guidance underscores a reality the market has increasingly confronted: not all senior secured loans are created equal. A series of restructurings have shown that priority and collateral protection can be engineered away before a bankruptcy court weighs in. While some ongoing litigation may challenge these practices, the wide dispersion in recovery outcomes, sometimes among first-lien pari passu lenders, suggests that senior secured has become a spectrum rather than a cohesive category.
By connecting recovery assumptions to the strength of senior secured status, Fitch is acknowledging what loan investors have learned the hard way. In modern leveraged finance, priority isn’t just granted, it must be negotiated upfront and then defended.
Against that backdrop, Fitch’s emphasis on a robust definition of senior secured reflects a meaningful recalibration. For CLO modelling purposes, a loan will earn strong recovery treatment only if it (1) has a first-priority claim on clearly pledged collateral adequate to support debt repayment; (2) is protected against material layering of equal or senior debt; and (3) cannot be meaningfully subordinated in right of payment.
Fitch has also indicated that if subsequent ‘priming’ debt exceeds 20%, the original loan may no longer warrant senior secured treatment. More broadly, the agency reserves the right to factor in vulnerability to up-tiers, drop-downs and double-dips when assessing recoveries.
Quality of documentation is key
To be sure, determining what constitutes robust documentation is not straightforward, and translating legal nuance into model inputs inevitably introduces judgment. But the alternative of continuing to assign uniform, generous recoveries to anything labelled ‘first lien’ is increasingly difficult to justify. The past decade has made it clear that documentation quality is a key driver of recovery outcomes. Ignoring it in CLO models risks misrepresenting reality rather than simplifying it.
For CLO managers, this should reinforce the importance of document underwriting in credit selection. If a deal’s recovery and structural treatment hinges on definitions, baskets and covenants, then those details deserve the same scrutiny as leverage and EBITDA add-backs. Fitch’s framework firmly pushes the market in that direction. Negotiation leverage, where CLO managers have it, should increasingly focus on closing the loopholes that will be penalised.
This won’t change the loan market overnight. Demand for loans remains strong, and PE sponsors are unlikely to surrender flexibility without a fight. But by challenging the assumption that the ‘senior secured’ moniker guarantees strong recoveries, Fitch may be forcing an overdue repricing of documentation risk. Over time, that pressure may reshape how loans are structured, negotiated and priced. In CLOs, where small recovery variations can compound into large performance differences, that shift will matter not just for ratings, but also for CLO security performance, particularly at the bottom of the capital stack.
