Spreads on triple-A rated European CLO notes have sat stubbornly around the 130bp mark for much of the past year.
Partners Group estimates that the weighted average triple-A spread was 129bp in the last two quarters of 2024. It tightened to 121bp in the first quarter of this year, but then went back to 133bp and 131bp in the second and third quarters.
Spreads have, of course, tightened over a longer period, from highs of around 190bp in the second quarter of 2023, Partners' data shows. But over the last year, triple-As have hit a pricing floor.
Pricing is unlikely to become less sticky in the near future. Moody’s forecast “stable Aaa CLO note spreads of around 130bp” in its outlook for 2026.
One reason is the high volume of new CLO issuance, which has been called a record. Moody’s research shows new issuance reaching €46.5bn this year by October, already surpassing the €44bn of new issue deals in the whole of 2024.
High demand from CLO managers for investor capital limits how much they can tighten triple-A spreads.
Nevertheless, European triple-As trade as much as 10bp wider than US notes, so there is clearly room for spreads to tighten. The fact that they refuse to budge makes it clear that the investor market is not very deep.
Banks made up over 40% of the investor base for European CLO triple-A notes in 2024, according to TwentyFour Asset Management. So reliant is the market on banks that it is not uncommon for about half the triple-A tranche of a CLO to be placed with the arranging bank.
That is likely to be another sign of a shallow market. If the same anchor investors are regularly needed to take large chunks, it is not surprising spreads do not get beaten down.
Comfort zone
The presence of arranging banks as major investors probably distorts triple-A pricing, holding it at unnaturally steady levels. But there are some advantages to both managers and banks.
Managers gain certainty: they do not have to worry about finding enough triple-A investors. The triple-A tranche often makes up least half the capital, so being able to place it is a big weight off their minds.
Banks can also structure triple-A tranches as loans rather than bonds. That means the drawdown of the debt can be delayed, often for about three months, giving the manager flexibility.
When the CLO begins to generate cashflow from its loans, no interest has to be paid on the undrawn portion, which raises returns for managers or third party equity investors.
Arranging banks also tend to have less complex requirements for CLO documentation than other anchor investors.
Nice work
For banks, investing in triple-A CLO tranches is likely quite attractive. In other asset classes like corporate bonds, they do not tend to buy large chunks of new issues, even to win business.
When banks do underwrite unsecured bonds or equities, they are usually confident they can sell down the debt to other investors fairly quickly.
But triple-A CLO tranches typically offer much higher spreads than investment grade corporate debt. According to Janus Henderson, on average, in the decade to the end of 2024, “AAA CLOs paid an additional 130bp over the risk-free rate, compared to 78bp for IG credit.” And that is for paper with much higher credit ratings.
If and when changes to the EU’s Solvency II regulatory regime come into force in 2027, it will become more attractive for insurance companies to invest in triple-A tranches of European CLOs. But that does not mean a flood of insurance money will pour into them — nor does it improve the asset class's attractiveness to other groups of investor.
As things stand, the present safe but staid investor base, anchored by arranging banks, is likely to continue to offer consistent pricing, with spreads not moving much in either direction.
That's fine for CLO managers, as they can get their deals done. But the price is a stodgy market, with little prospect of real price tension appearing.
