Since S&P Global Ratings rated its first collateralized loan obligation (CLO) transaction 30 years ago in 1994, we have rated more than 18,000 U.S. CLO tranches, totaling nearly $1.4 trillion in issuance (including CLO refinancing and reset activity). To date, through 30 years and several recessions (including the pandemic-related downturn in 2020), these CLO ratings have shown only a modest number of defaults, and they have outperformed almost any other rated asset type.

The CLO 1.0 generation of transactions--those rated from the inception of the market in the mid-1990s through 2009--comprised 4,322 tranches from around 800 cash flow CLOs rated by S&P Global Ratings. The last of these transactions paid down in 2021, and their default history is complete: of the 4,322 ratings, just 40 defaulted, 15 of which began life with an investment-grade rating ('BBB- (sf)' or higher) when originally issued (see table 1).

The CLO 2.0 generation of transactions began in 2010 with the reemergence of CLO transaction new issuance in the aftermath of the Global Financial Crisis (GFC). There were a number of differences between the first-generation CLO 1.0 transactions and the post-GFC CLO 2.0 transactions, including:

• More credit enhancement for the rated CLO notes, especially at the top of the CLO capital structure. For example, a 2006 vintage CLO might have had 26% par subordination for its 'AAA' tranche, but many CLO 2.0 transactions in recent years have had 35% or more par subordination for their 'AAA' tranches, although some CLOs with higher-than-average quality collateral pools may have less.
• Collateral pools that exclude investments in assets other than corporate loans and a small portion of corporate bonds. Most CLO 1.0 transactions had the ability to invest up to 10% of their assets in tranches from other CLOs.
• Transaction documents that incorporate lessons learned from the GFC. For example, CLO 2.0 indentures include provisions intended to prevent or mitigate CLO note cancellation and limit the manager's ability to extend the life of the CLO transaction via trades done after the end of the reinvestment period.

Additionally, the investor base for the 2.0 transactions was (and is) less levered and less sensitive to changes in market value of the tranches than the CLO 1.0 universe had been.

From 2010 through 2023, S&P Global Ratings rated 14,204 classes from more than 1,750 U.S. CLO 2.0 transactions totaling over $1.07 trillion (including refinancing and reset activity). While there was a downturn in the energy and commodities sectors in 2015 and 2016, the CLO 2.0 generation of transactions hadn't seen a full-blown recession until the 2020 pandemic-related downturn, and a modest number of CLO 2.0 tranches have now defaulted (see table 1; the full list of CLO 1.0 and 2.0 tranche defaults is in table 3).

Table 1

In addition to these 60 defaulting CLO 1.0 and 2.0 tranches, we also have eight tranches from eight CLO 2.0 transactions that we view as likely candidates for future default based on the current rating assigned (see table 2). These tranches are currently rated 'CC (sf)', indicating our view that a default is a near certainty, or 'CCC- (sf)', which we view as vulnerable to nonpayment. The CLOs from which these tranches come from are earlier vintage 2.0s that experienced both the energy and commodity downturn in 2015-2016 and the pandemic-related downturn in 2020. While these tranches haven't yet defaulted, they have experienced downgrades to their current ratings due to significant credit deterioration, and the current ratings assigned reflect our view that it is unlikely the notes will get repaid in full by the CLOs' legal final maturity dates. While the notes are undercollateralized (the balance of CLO notes at their level and senior exceeds the balance of the CLO's performing assets, excluding equity), they are deferrable and it may be some time before a payment default occurs (typically when the CLO hits its final maturity date, or the assets are liquidated and the proceeds are insufficient to pay off the CLO notes in full).

Table 2

Since the asset class emerged 30 years ago, CLOs have shown resilient performance through multiple economic downturns. The reasons for this go back to basic CLO structural mechanics and protective mechanisms. First and foremost is the CLO structure itself, with the equity tranche sitting at the bottom of the capital stack, first in line to absorb any losses ahead of the rated CLO notes. Further, in times of stress, the mechanics of the CLO structure work to protect the senior CLO notes, and no CLO note originally rated 'AAA (sf)' has defaulted.

Table 3