The landscape of finance is marked by evolving risks and shifting opportunities, and one area gaining increased attention is the rise of small and middle market enterprises/private credit (SME/PC) CLOs. While the broadly syndicated loan (“BSL”) CLO market is both very active and significantly larger, the growth of SME/PC CLOs reflects the expanding role of private credit in today’s financial environment.  For investors and market participants, understanding the key differences between these CLO types can provide a clearer path to managing risk and identifying growth opportunities. 

BSL and SME/PC CLOs: understanding the differences 

BSL CLOs and SME/PC CLOs differ in several key aspects, including structure, collateral composition, and risk exposure. While BSL CLOs are typically backed by larger, more liquid syndicated loans, SME/PC CLOs focus on smaller loans. These differences affect their leverage, and overall risk profile, making each type of CLO distinct in its investment considerations. 

When comparing the metric averages of the two types of CLOs, it is important to note the difference in the frequency that the metric is reported in BSL vs SME/PC CLOs. Eight of the metrics in the full report have significantly less coverage for SME/PC CLOs.

BSL vs SME/PC CLO characteristics

• Despite the SME/PC CLO market’s growth, BSL CLOs continue to dominate in scale. As of August 2024, BSL CLOs account for a par of $626 billion compared to $61bn for SME/PC deals still in the reinvestment phase (as of August 13, 2024 data).  However, the growing demand for private credit increases interest in SME/PC CLOs, particularly for those seeking exposure to smaller and less liquid corporate credit. 
• As noted in the previous table, the average BSL deal is smaller, averaging $471 million versus $553 million for SME/PC CLOs. However, SME/PC have a greater variance in size.  Additionally, BSL CLOs generally have more bonds and higher leverage than SME/PC CLOs due to better liquidity and stronger credits. 
• Industry comparison between the two is also more complex for SME/PC CLOs, as only 87% of their collateral falls under a MC Industry, compared to 99.94% for BSL CLOs.  
• The largest industry in BSL CLOs is, on average, 3.5% smaller than in SME/PC CLOs, reducing exposure to concentrated industry risk. High-tech, Healthcare, and Pharmaceuticals industries have greater exposure in SME/PC CLOs as compared to BSL CLOs. 

Collateral quality: managing uncertain risk with greater cushions

• Collateral quality is a key differentiator between BSL and SME/PC CLOs. SME/PC deals typically feature higher exposure to “Triple C” rated collateral when examining either Moody’s or S&P ratings. These deals also have greater variation in their Triple C exposure as indicated by the relative standard deviations. However, SME/PC CLOs address this with greater overcollateralization cushions, providing a measure of protection against downside risk. 
• SME/PC CLOs present weaker Weighted Average Rating Factor (WARF) and Diversity Scores compared to BSL deals. Additionally, the frequency with which these metrics are reported is much lower for SME/PC CLOs, complicating performance monitoring. BSLs also have stronger Moody’s Recovery Rates (“WARR”) and recovery rate cushions. 

Market value and liquidity considerations

• Liquidity represents a major distinction between the two markets. BSL CLO collateral enjoys significantly higher pricing transparency with 99% having pricing service marks compared to only 24% for SME/PC CLOs. This gap in pricing service data makes it more difficult to evaluate SME/PC deals accurately as many net asset value (NAV) calculations rely on limited collateral marks.  
• Trading activity also reflects this liquidity difference. For the six months prior to the main report (published on August 27, 2024), BSL CLOs had a collateral sale rate of 32.6% while the rate is much lower for SME/PC CLOs, at 12.8%. The relative illiquidity of SME/PC collateral may be a concern for some investors, particularly those in junior tranches where active trading is often preferred. 

Refi and reset trends by CLO type

BSL - SME/PC refinancing rate

BSL - SME/PC reset rate

Refinance and reset rates also differ between BSL and SME/PC CLOs. The charts above compare the relative refinance and reset rates by vintage for the two CLO types. When comparing refinancing and resetting trends, SME/PC CLOs show higher rates for 2018-2020 vintages while BSL CLOs from 2022 have been more frequently updated.  The surge in 2023 SME/PC CLO issuance signals continued growth in this segment, reflecting increasing investor appetite for private credit, which may be a desire for wider spreads.

SME/PC CLOs offer distinct opportunities, but demand careful consideration

For investors looking to diversify their portfolios and gain exposure to smaller corporates and the expanding private credit market, SME/PC CLOs represent an intriguing opportunity. However, investing in SME/PC CLOs requires navigating a more complex landscape marked by lower liquidity and less transparency. 

One of the key challenges for investors is the relative lack of data in SME/PC CLOs. With significantly lower coverage for critical metrics like WARF, Diversity, and other data points, evaluating the risk and performance of these deals can be more difficult than in the BSL CLO market.  

Liquidity is another factor to consider. SME/PC CLOs exhibit lower collateral sale rates and fewer pricing service marks which limits their trading activity and makes it harder to establish third-party market values. For investors seeking more actively traded, transparent assets, the lower liquidity of SME/PC CLOs may pose a challenge, especially for those in junior tranches where active collateral trading is often preferred. 

That said, SME/PC CLOs are not without their strengths, and the growing interest in SME/PC CLOs shows that private credit is becoming an increasingly important asset class. However, these investments come with unique challenges that require a more hands-on, vigilant approach. 

For a deeper dive into the distinctions between BSL and SME/PC CLOs, the full report is available on Moody’s SFPortal: Comparison of BSL and SME/PC CLOs (August 27, 2024).