Collateralized loan obligations (CLOs) have positioned themselves to contend with increasing credit risk, but loans that do run into trouble face intensifying recovery challenges, according to Moody's Ratings in recent reports.
The rating agency noted in a September 21 report, "Leveraged Finance—U.S.," that markets are increasingly rewarding quality credits while weaker ones face increasing funding costs, restricted capital access and persistently elevated credit stress.
Citing LCD/Pitchbook data, Moody's also found that the share of Ba-equivalent issuers increased in the first half of 2025 to 31% from 19% during the same period last year; the share of B issuers shares fell to 50% from 62%; and no CAA1 deals were done.
The pace of credit deterioration has normalized.
Spread performance told a similar story: The difference between B2 and B3 loan spreads widened to 90 basis points in the first half 2026 compared to 36 bps last year, as investors sought higher credit quality assets.
Moody's proprietary stress indicators warn of a growing credit risk, particularly in the services and technology sectors, Moody's said. Nevertheless, its rated portfolio shows no indication of ratings-downgrade momentum, and negative outlooks or reviews for downgrades are significantly below 2008 financial crisis peaks.
"This suggests that the pace of credit deterioration has normalized," Moody's said.
For lenders whose credits do run into trouble and require some form of restructuring, the outlook is less benign. Moody's said in a separate report titled "Corporate Defaults and Recoveries," issued September 22, that recoveries in the U.S. will remain under pressure, with first-lien loan recoveries declining to 55%.
Underneath the defaults
Defaults in the U.S. are being driven primarily by out-of-court restructurings, including distressed exchanges (DEs) and liability management exercises (LMEs), Moody's said. Prolonged higher interest rates, in the wake of the Federal Reserve's recent 25 bps hike of the Federal Funds Rate, would increase the likelihood of those loans defaulting again.
"In the U.S., DEs and LMEs have accounted for roughly 70% of defaults since early 2022, while the default rate has remained elevated, at 5.3% in August," Moody's said.
The report noted that loan recovery levels are likely to remain "subdued" because of the proliferation of capital structures that are first lien only in recent vintages. As junior debt has faded in capital structures, Moody's said, uptiering and priming LMEs have enabled super-priority facilities placed ahead of legacy loans to emerge in debt tiers.
"Our analysis of a sample of recent U.S. defaulters indicates that recovery rates tend to decline further when issuers that executed LMEs classified as DEs subsequently re-default," Moody's said. "This is because newly issued exchange facilities dilute existing creditor priority and collateral claims."
In a September 23 "CLOs" report, however, the rating agency noted indications that CLO managers are cautiously disposing of potentially problematic assets at modest losses rather than holding them until a workout becomes necessary.
"Over the past several years, CLO managers have maintained portfolios with collateral quality metrics that indicate that their loan portfolio's asset quality is well above the minimum levels required by their transaction documentation," Moody's said.
