Private Credit Crisis Spreads to CLOs in 3 Stages, Barclays Warns

Turmoil in the private credit market is spreading to Collateralized Loan Obligations, with reports from Barclays and UBS warning that CLO pricing has failed to reflect stress shown by a 50 basis-point underperformance in comparable BDC bonds.

"Investors looking for the next credit weakness will inevitably turn their attention to the CLO market, which has so far been largely unaffected by the BDC collapse," said Gavin Zhu, a credit analyst at Barclays, in a new report.

While the Z-spread on BDC unsecured bonds has widened by nearly 75 basis points to 270 bps since January, the spread on comparable single-A rated CLOs has widened only 20 bps to 195 bps. This divergence comes as redemption requests at some private credit funds have surged as high as 41 percent.

The risk is that forced selling from Business Development Companies (BDCs) will compel a shift from model-based to mark-to-market valuations, triggering a repricing in the CLO market that could reduce 2026 issuance by over 25 percent and spread liquidity pressure to public credit markets.

Barclays: BDC Bonds Signal 50 Bps of Unpriced CLO Risk

The crisis began in the BDC sector, where redemption requests at two Blue Owl funds reached 41 percent and 22 percent, respectively, sending shockwaves through the private credit ecosystem. This has forced a reckoning with the opaque, "marked-to-model" valuations common in private credit, a concern highlighted by JPMorgan CEO Jamie Dimon.

Barclays analysts argue the market is overlooking the deep connection between BDCs and the CLO market. To quantify the risk, they established a framework comparing BDC unsecured bonds to single-A rated CLO tranches. The logic rests on the 1940 Act, which requires BDCs to maintain assets covering at least 150% of their debt. Analysts calculate that BDC assets would need to fall a median of 21 percent to breach this threshold, an attachment point they argue is most comparable to a single-A CLO tranche.

Based on this comparison, the recent market moves show a major valuation gap. BDC unsecured bond spreads have widened approximately 80 basis points this year, while single-A CLO spreads have moved only 20 bps. According to the Barclays model, a 20 bp move in CLOs should correspond to a 24 bp move in BDC bonds. The actual 75 bp widening in BDC spreads reveals a substantial 50 bp of underperformance—risk that the CLO market has not yet priced in.

UBS: Contagion Pathways to Public Markets

A separate report from UBS outlines how this repricing could transmit to the broader financial system. Analysts expect the turmoil to slash leveraged loan and CLO issuance. They forecast CLO creation to fall from a projected $208 billion in 2025 to just $150 billion in 2026, with a tail-risk scenario seeing issuance collapse to between $100 billion and $110 billion.

The primary transmission mechanism is credit quality deterioration. UBS notes that CLO portfolios are already seeing CCC-rated loan concentrations rise to between 4.5 percent and 5.5 percent, approaching a critical 7.5 percent limit that would trigger cashflow diversions and rating downgrades. With UBS forecasting a baseline private credit loss rate of 7 percent for 2026, a substantial wave of downgrades appears imminent.

UBS identified four key channels for contagion into public markets:

1. Investor Overlap: Insurance companies, pension funds, and retail investors have significant holdings in both private and public credit.
2. Forced Selling: BDCs, which hold an average of 10 percent of their portfolios in syndicated loans, may be forced to sell these more liquid assets to meet redemptions.
3. Valuation Correlation: Private credit valuations are highly correlated with public leveraged loans.
4. Issuance Patterns: Issuance in the US and European leveraged loan and high-yield bond markets are historically linked.

The consensus from both banks is that the CLO market is the next domino to fall. A repricing is seen as inevitable, and should the AI-driven disruption in the software sector—a key source of private loans—continue, the crisis could rapidly escalate from a niche credit story into a systemic event.

This article is for informational purposes only and does not constitute investment advice.