Jeff Reemer
If investors are concerned with defaults in today's uncertain environment, how do you think about stress testing CLO equity returns and what are the assumptions that you use?
Ian Gilbertson
Invesco has been refining our stress testing process since issuing our first CLO back in 1999.
CLO equity performance is sensitive assumptions like default and recovery rates, prepayment speeds, reinvestment characteristics, call timing, liquidation prices. So all of those factors go into how we stress test. Invesco typically applies conservative assumptions when we're stress testing, yet we continue to see scenarios where a manager who's capable within the asset class could deliver equity returns in the low to mid teens.
Additionally, there's potential for upside to CLO equity investors in scenarios where performing loan spreads widen due to an increase in new money loan origination. This could improve equity cash flows for CLOs that benefit from that locked in financing at costs that are near post-crisis tights currently.
Moreover, majority equity holders often benefit from the option value of refinancing or resetting a CLO. A trend we've seen exercised frequently in 2025.
Through the first ten months of the year. US CLOs have refinanced or reset just under $300 billion, a 35% increase over the year-to-date pace in 2024, which itself was a record year. While Invesco does not typically model in the benefit of future refi or reset transactions, the upside for equity investors is real.
In today’s changing credit environment, stress testing CLO equity returns is a critical part of risk management. Invesco has been refining its stress testing methodology since launching its first CLO in 1999, incorporating key assumptions such as default and recovery rates, prepayment speeds, reinvestment characteristics, and liquidation values.
Even under conservative scenarios, experienced managers have demonstrated the ability to deliver equity returns in the low- to mid-teens. CLO equity investors may benefit from widening loan spreads, locked-in low financing costs, and the option value from refinancing or resetting CLOs—a trend that has accelerated in 2025. While these refinancing benefits are not typically modeled, they represent a meaningful potential upside for equity holders in the current market.
We are a leading, long-tenured private credit manager, using a conservative credit process to pursue opportunities across syndicated loans, direct lending, distressed debt, and special situations.
CLO equity offers institutional investors the potential for competitive income, diversification, and growth, enhancing portfolios beyond traditional fixed income and private equity.
Discover how CLO equity investors manage downside risk and leverage market volatility through active credit risk strategies.
Explore how CLO equity can deliver stable returns in a declining rate environment through active credit selection and expert management.
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Source: BofA Global Research, S&P LCD, Bloomberg, Intex. November 2025.
All data sourced to Invesco unless otherwise indicated. As of September 30, 2025.
Investment risks
Investments in private credit and private debt—including leveraged loans, middle market loans, mezzanine debt, and second liens—are speculative and involve significant risks. These securities are generally illiquid, lack a secondary market, and may need to be held to maturity, which can result in liquidity constraints and difficulty exiting positions. Borrowers often have high leverage, increasing default risk, particularly in adverse economic or interest rate environments. Competitive pressures and excess capital may lead to weaker underwriting standards, raising credit risk and reducing potential recoveries. Private market investments also carry risks related to limited transparency, higher fees and expenses, longer investment horizons, and regulatory considerations. Additionally, these securities may be sold or redeemed at values different from the original investment amount and are considered to have speculative characteristics similar to high-yield securities. Issuers are more vulnerable to changes in economic conditions than higher-grade issuers, and investors may face liquidity strain from capital calls during periods of market stress. These factors can materially impact investment performance and principal value.
Structured finance securities such as Collateralized Loan Obligations (CLOs) entail a variety of unique risks. The performance of a CLO is affected by a variety of factors, including its priority in the capital structure of the issuer thereof, the availability of any credit enhancement, the level and timing of payments and recoveries on and the characteristics of the underlying receivables, loans or other assets that are being securitized, remoteness of those assets from the originator or transferor, the adequacy of and ability to realize upon any related collateral and the capability of the servicer of the securitized assets. Highly rated tranches of CLO Debt Securities may be downgraded, and in stressed market environments, even highly rated tranches of CLO Debt Securities may experience losses due to defaults in the underlying loan collateral, the disappearance of the subordinated/equity tranches, market anticipation of defaults, as well as negative market sentiment with respect to CLO securities as an asset class.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. This should not be considered a recommendation to purchase any investment product. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please obtain and review all financial material carefully before investing.
United States
Issued in the US by Invesco Senior Secured Management, Inc., 225 Liberty Street, New York, NY10281, USA. Invesco Senior Secured Management, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.
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