Goldman Sachs Constructs New Deal-level CLO Arbitrage Spread Metric

Overview

This report proposes a new measure of CLO arbitrage spread based on deal-level transaction and tranche data, aiming to more accurately capture the true excess returns of CLO equity investments. The study finds that with market maturation and the rise of captive equity capital, arbitrage opportunities in USD broadly syndicated loan (BSL) CLOs have undergone structural compression. Although reset and refinancing activities have reduced liability costs, concurrent narrowing of asset-side spreads has limited the actual improvement in economic benefits. In contrast, while EUR CLOs display wider arbitrage spreads, this premium may primarily compensate for weaker regional fundamentals rather than representing a pure valuation discount.

Core views

The structural compression of USD CLO arbitrage space is the core finding of this report. Utilizing a new metric built from Intex deal-level data, the narrowing of USD BSL CLO arbitrage spreads over the past two years has been significantly more pronounced than in the EUR market. The report identifies an important driver of this trend as the growth of 'captive equity funds,' which prioritize cross-vintage allocation and deployment continuity over maximizing entry spreads on individual transactions, thereby reducing sensitivity to deal-level arbitrage spreads and compressing overall equity return expectations. For deal-picking equity investors, this means the cushion available to absorb credit losses is thinning. The economics of reset transactions have diverged significantly between USD and EUR markets. The conventional view holds that resets improve returns by reducing liability costs, but data shows that since 2023, asset-side spreads in the USD market have often narrowed faster than liability-side improvements, resulting in only marginal net arbitrage spread improvement (less than 20bp) post-reset. Conversely, the EUR market has seen approximately 50bp improvement in reset transaction economics over the same period, benefiting from more moderate asset-side repricing and more reinvestment-friendly loan supply. This indicates that when evaluating existing CLO values, one cannot simply equate liability spread narrowing with improved profitability. The relationship between manager tier and arbitrage capability differs markedly between the two markets. In the USD market, Tier 1 managers leverage significant liability-side pricing advantages to achieve lower financing costs without sacrificing excess spread, resulting in slightly wider arbitrage spreads than lower-tier managers. In the EUR market, the opposite holds: Tier 4 managers have wider arbitrage spreads, primarily because EUR market AAA liability spreads show minimal differentiation across tiers (less than 6bp), with competitive differences manifesting more in asset acquisition capabilities, allowing lower-tier managers to achieve higher notional arbitrage through wider-spread assets. The wider spreads in EUR CLOs are not a 'free lunch.' Although EUR CLO equity appears more attractively valued than USD, and IG tranches can offer positive carry relative to USD counterparts, the report cautions against complacency. EUR loan market default rates have trended upward over the past two years, the macro policy environment is relatively unfavorable, and with the 2028 maturity wall approaching, current excess spreads largely represent compensation for potential credit losses. Therefore, investment opportunities in the EUR market are more evident in relative value at higher debt tranches rather than purely chasing wider spreads at the equity level.

Analysis framework

The report abandons the traditional rough estimate of 'new-issue loan spread minus CLO weighted average debt cost' in favor of a bottom-up microdata structured analysis approach. By integrating Intex deal-level transaction data and tranche information, it constructs a 'deal-matched arbitrage spread' metric covering the full lifecycle of issuance, reset, and refinancing. The analysis proceeds along three dimensions: first, time-series comparison, tracking the long-term evolution and structural drivers of arbitrage spreads in USD and EUR markets; second, event-driven analysis, pairing original issuance vintages with subsequent reset activities to quantify the actual contribution of asset-side and liability-side spread changes to net returns; and third, cross-sectional layering, comparing arbitrage results by manager rating groups to identify the sources of competitive advantage in different markets (liability-side pricing power vs. asset-side acquisition capability). The core of this methodology lies in distinguishing between 'nominal spread' and 'realized spread,' and emphasizing the decisive impact of asset-side dynamics on arbitrage economics.

Methodology notes

• Fixed Income & Credit AnalysisSpread analysis

  Deal-matched Arbitrage Spread

  Unlike traditional methods using market averages, this metric precisely matches each CLO transaction's actual asset portfolio spread with its corresponding liability cost based on deal-level data. It eliminates index weighting bias and more accurately reflects the excess returns managers actually locked in at specific points in time, particularly suited to capturing spread changes in non-new-issue scenarios such as resets and refinancings.

• Industry/Sector Analysis FrameworkSupply-demand framework

  Captive Equity Capital's Reshaping of Pricing Mechanisms

  The report notes that the rise of 'captive equity funds' in the USD CLO market has altered the demand function. Such capital does not aim to maximize spreads on individual transactions but pursues cross-cycle allocation continuity, causing equity demand to become less sensitive to immediate arbitrage spreads. This is the key supply-side logic for understanding why arbitrage spreads structurally compress as markets mature.

• Fixed Income & Credit AnalysisSpread & Asset Quality

  Asymmetric Movements in Asset and Liability Spreads During Resets

  When analyzing CLO reset economics, one cannot look only at liability cost reductions. The report emphasizes the need to simultaneously examine asset-side repricing effects: during periods of high risk appetite, asset-side spreads often narrow concurrently or even faster, potentially fully offsetting liability-side improvements. This analytical paradigm reminds investors that improved financing convenience does not automatically translate into enhanced project profitability.

Key data

• USD CLO Reset Economic Improvement<20bpSince 2023, net arbitrage spreads for USD BSL CLO resets have only marginally improved, far below the narrowing of liability spreads
• EUR CLO Reset Economic Improvement~50bpOver the same period, EUR market reset transaction economics significantly outperformed USD, benefiting from more moderate asset-side spread compression
• EUR BSL AAA Tier Spread Range Across Managers<6bpEUR market liability-side pricing is highly homogeneous, with manager differentiation primarily in asset-side execution
• EUR Tier 4 vs. Tier 1 Manager Asset Spread GapNearly 50bpEUR lower-tier managers achieve higher notional arbitrage through holding wider-spread assets
• USD Middle Market CLO Arbitrage SpreadApproaching 300bpPrivate credit CLO arbitrage space has converged to this level, aligning with direct lending spread trends

Impact & implications

For CLO equity investors, the structural compression of USD market arbitrage space means stock selection and timing have become even more critical, with blind market-beta following unlikely to replicate historical return levels; reset strategies must be reassessed to avoid overestimating value creation from liability restructuring. For the EUR market, despite more attractive surface valuations, investment decisions must incorporate more credit cycle considerations, with excess spreads viewed as risk premium rather than pure alpha. By comparison, EUR IG tranche debt offers more deterministic relative value opportunities in the current environment. For CLO managers, competitive barriers in the USD market are accelerating toward liability-side pricing capability, reinforcing headwinds; in the EUR market, asset acquisition and portfolio construction capabilities remain key differentiators.

Risks

• EUR loan market default rates continue rising, and current wider spreads may be insufficient to cover future credit losses
• Continued inflows into USD captive equity capital may further depress equity returns and cushions
• EUR market 2028 maturity wall approaching, refinancing pressure may intensify asset price volatility
• Asset-side spread compression in reset transactions exceeds expectations, leading to worse-than-anticipated economics

What to watch

• Relative speed of asset-side vs. liability-side spread movements in USD and EUR CLO reset transactions
• Fundraising scale and allocation behavior changes of captive equity funds in the USD market
• EUR loan market default rate trends and macro policy environment evolution
• Divergence trends across manager tiers in liability-side pricing and asset-side acquisition capabilities