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Opinion CLOs
We expect to see global banks as the leading buyers of CLO triple As in 2025
by Thomas Majewski
Thomas Majewski
Founder & managing partner
Eagle Point Credit Management
The market hasn’t quite reverted to its pre-pandemic state — but banks are back in CLOs
As the market finds steady footing in an elevated rate environment, a big shift is happening at banks: after a brief period of restraint, they’re getting back into the business of lending and underwriting. They are re-entering the market with renewed vigour and competitive offerings against their private credit counterparts, signalling a potential return to pre-pandemic dynamics, albeit with important distinctions. This shift signals a number of promising developments for CLOs in the coming months.
But first, it’s worth considering what caused banks to back away from CLOs over the past two years. On one hand, floating rate investments delivered returns significantly better than expected, creating attractive net interest margins (NIM). On the other hand, rising rates heightened vulnerabilities in banks’ fixed-rate portfolios, prompting many institutions to reassess their risk appetites and lending criteria. As banks recalibrated, private credit stepped in to fill the void.
In the past year, however, the landscape has changed. Renewed bank appreciation for floating rate assets is also a positive development for the CLO market, as the rate volatility of 2023 highlighted the strength of CLO triple As. In fact, we expect to see global banks as the leading buyers of CLO triple As into 2025, and CLO primary desks willing to backstop or purchase CLO triple As as a part of their mandates.
Tightening spreads helped banks engage
Another factor that beckoned banks back into CLOs was the spread tightening cycle in 2024. It provided an easy impetus for banks to re-engage with clients and take back market share. With the expectation that rates will remain elevated for some time, floating rate loans remain attractive, even with the expectation of tighter spreads in the future.
How far will the banks’ newfound appetite for CLOs go? Will they support loans for more credit-sensitive paper? It remains to be seen. The market hasn’t quite reverted to its pre-pandemic state for CLOs. Some historical benchmarks that were common before COVID are now impossible to meet due to an overabundance of caution. These include the 85-87.5% advance rates in loan accumulation facilities and more flexible buying rights.
The memory of recent market dislocations has led to a focus on higher-quality credits and enhanced structural protections. Though spreads on assets continue to be supportive, it becomes more incumbent on banks to adjust the leverage available to reflect this new paradigm.
Finally, the difference between top and middling performance for a CLO collateral manager in this environment lies in finding the optimal balance between prudent risk management and competitive market positioning. Banks that can offer more supportive advance rates, low funding costs and flexible trading rights — reminiscent of pre-COVID terms — while maintaining appropriate risk controls, will emerge as market leaders.
Looking ahead, the return of bank lending and investing capacity should help stabilise CLO formation rates and provide much needed liquidity to the broader leveraged loan market.