CLO Market Puzzle: Soft Issuance Persists Amid Favorable Conditions

NEW YORK, NY – March 06, 2026 – The collateralized loan obligation (CLO) market is presenting investors with a perplexing paradox. Despite credit market conditions that appear broadly favorable, new issuance has remained stubbornly soft, raising questions about underlying economic health and shifting structural dynamics. A new report from Egan-Jones Ratings Company has cast a spotlight on this trend, revealing a market that is more complex than surface-level indicators might suggest.

According to the firm's March 2026 summary, CLO issuance in February fell to $40.1 billion across 98 deals. This marks a significant year-over-year decline from the $52.5 billion raised in February 2025 and remains well below the market's recent peak of $54.6 billion in November 2024. This slowdown comes at a time when credit yields are near recent lows—the ICE US High Yield option-adjusted spread is hovering near a tight 298 basis points, a level that historically signals strong credit health and should, in theory, fuel new deal creation.

Unpacking the Issuance Slowdown

The contradiction of soft issuance in a favorable credit environment has analysts pointing to a confluence of headwinds that are tempering activity. While market fundamentals like high base rates and constructive corporate balance sheets persist, the CLO market is contending with what some experts call “late-cycle macro conditions.” Sluggish economic growth, geopolitical uncertainty, and persistent concerns over inflation and interest rate paths are creating a climate of caution.

Adding a new layer of complexity is the disruptive force of artificial intelligence. The software sector has long been a reliable source of collateral for CLOs, but investors are growing wary. The massive capital expenditure required for AI development—estimated by some banks to reach $5 trillion by 2030—could divert investment and create a new class of high-grade corporate bonds that compete directly with CLOs for investor capital. Furthermore, analysts at major banks have identified “AI risk within software” as a headwind, warning that the technology could devalue traditional software companies, leading to downgrade risk for a significant portion of loans in CLO portfolios.

Competition is also intensifying from the burgeoning private credit market. As private credit CLOs move to center stage, they are increasingly competing with broadly syndicated loan (BSL) CLOs for quality assets. This has led to weaker covenants and increased leverage risks, making the arbitrage—the ability for managers to profitably fund a leveraged portfolio—more challenging than in previous years.

A Divergence on Credit Quality

While issuance figures paint a cautious picture, the Egan-Jones report offers a notably more positive view on the credit quality of the underlying assets compared to its peers. The firm notes modest improvements in Weighted Average Rating Scores (WARS) and a stable-to-declining percentage of assets rated CCC+ or lower. Egan-Jones attributes this optimistic outlook to its proprietary rating methodology, which it states uses “probabilities of default that are more conservative than industry standards.”

This perspective stands in contrast to the more granular and, at times, more cautious analysis from other major rating agencies. For instance, S&P Global Ratings recently highlighted a slight uptick in exposure to defaulted assets and negative trends in portfolio par balance and junior overcollateralization cushions. S&P also pointed to a notable decline in the weighted average price of loans across CLO portfolios, particularly in the software sector, pushing some ‘BB’ tranche market value ratios underwater.

Similarly, while Moody’s Investor Service projects a decline in speculative-grade defaults for 2026, it also cautions that tight loan spreads are limiting managers' ability to optimize portfolios and that intense competition is weakening covenants. This divergence underscores a critical reality for investors: the perceived risk of a CLO can vary significantly depending on which rating agency’s model is being used. It highlights the growing importance for investors to look beyond the top-line rating and scrutinize the underlying methodologies and collateral pools themselves.

The Shifting Investor Landscape

Faced with these crosscurrents, institutional investors are becoming increasingly selective. The robust demand for CLOs continues, but it is now highly stratified. High-quality, AAA-rated tranches remain in high demand, with CLO-focused ETFs seeing continued inflows as investors seek a combination of yield and perceived safety. This flight to quality is a dominant theme, with a stable base of support coming from banks, insurance firms, and global asset managers.

However, further down the capital stack, the story is different. Investors are exhibiting a strong preference for CLO managers with proven track records, scale, and experience navigating turbulent credit cycles. This “manager tiering” is expected to widen, with capital flowing disproportionately to top-tier managers who can demonstrate strong underwriting discipline and workout capabilities.

At the same time, private credit CLOs are rapidly gaining traction. Once a niche segment, they are now viewed as a core tool for sophisticated investors. Many who previously focused on BSL CLOs are now allocating capital to private credit deals, attracted by a yield premium, less leverage, and often more conservative structures. This shift is reshaping fund flows and influencing how new deals are structured and marketed.

As the market heads into the rest of 2026, it is clear that the dynamics are more nuanced than ever. While a wave of CLOs exiting their non-call periods is expected to fuel a healthy refinancing and reset market, the outlook for brand-new issuance remains clouded by macroeconomic uncertainty and intense competition for quality loans. Investors are navigating this landscape with a constructive but wary approach, balancing the attractive yields of floating-rate credit against a backdrop of evolving risks and increasing dispersion in performance.