Private credit Why CLO Equities - Cash flow modeling and stress testing

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.