The outlook for collateralized loan obligations (CLOs) as 2025 approaches is optimistic, driven by a more favourable macroeconomic environment. According to Moody’s latest report, several key factors, including declining default rates, reduced interest rates, and stabilised inflation, are expected to contribute to stronger CLO performance and increased refinancing opportunities.
In both the U.S. and Europe, default rates are predicted to decrease significantly by the end of 2025. In the U.S., speculative-grade defaults are forecast to drop to 2.6% by October 2025, down from 5.6% in October 2024. Similarly, Europe’s rates are expected to fall from 3.3% to 2.7%. This decline is attributed to a “soft landing” scenario, where inflation returns to the Federal Reserve’s target of 2%, the economy continues to grow, and the labour market remains stable. These conditions, combined with lower interest rates, are anticipated to reduce defaults and foster an environment conducive to refinancing.
The CLO market, which represented a significant portion of the $1.4 trillion institutional leveraged loan market in 2024, is poised for even more activity in 2025. With $117 billion in CLOs approaching the end of their non-call periods, $94 billion of these are expected to offer attractive refinancing opportunities. While 2024 saw strong refinancing volumes, the formation of new loans remained subdued. In 2025, however, the combination of lower default rates and more favourable interest rates is expected to encourage more new loan transactions.
The relationship between broadly syndicated loans (BSLs) and private credit is also expected to evolve. As competition increases, private credit lenders are funding larger transactions, often for weaker borrowers. Meanwhile, the quality of credit in the BSL market is improving, with more leveraged buyout (LBO) borrowers achieving higher corporate ratings. This shift, along with greater flexibility in covenants moving from BSLs to private credit, is expected to strengthen the overall resilience of the market in 2025.
As interest rates and inflation continue to decline, the CLO market is set for a significant rebound. With stronger credit conditions and abundant refinancing opportunities, the focus in 2025 will shift from stabilising existing deals to pursuing new ones. This shift will play a crucial role in the broader recovery of institutional leveraged lending.
Volta Finance Ltd (LON:VTA) is a closed-ended limited liability company registered in Guernsey. Volta’s investment objectives are to seek to preserve capital across the credit cycle and to provide a stable stream of income to its Shareholders through dividends that it expects to distribute on a quarterly basis.
