It’s escaped no-one’s notice that the loan market has hit a pocket of volatility. But if CLO managers are reluctant buyers of software credits, then will these names sit bid-less?
9fin recently sat down with Jacob Walton and Ludovic Walter, co-heads of CLOs at Sona Asset Management. Walton and Walter explained their deliberate underweight to software — driven by concerns over AI disruption, inflated 2021-vintage capital structures, and poor relative value. The call has proven prescient as dispersion now defines the loan market.
“You just don't know who's going to be the buyer on the other end, and at what level,” said Walter, referring to software credits. “You just know it’s lower, but don’t know how much lower.”
The conversation also touched on Sona’s new CEO, expansion to the Middle East, and plans for its US CLO platform. The manager has launched marketing of its debut US CLO, Sona US CLO 1, according to 9fin’s database, and is building on its European CLO business having priced Sona Fios CLO VII yesterday (25 March).
1. Sona’s CLOs have some of the lowest software exposure in the European CLO market. Why did you position yourselves this way?
Walter: The position was very deliberate and not by luck. We were very negative on software generally, and it was a function of a couple of topics. There are three leads to that investment thesis.
First, we were quite fearful of AI disruption. We felt that it could lead to sector-wide disruption, which in the end is what happened. The second was that we believe a lot of these companies were purchased in 2020 and 2021 at inflated valuations. The capital structures of many of these businesses were put together based on these inflated valuations. Over the last couple of years, leverage remains very high while the bulk of the industry is at compression.
We didn't think the free capital profile was particularly compelling, and we anticipated a bit of pressure in terms of refinancing these capital structures. The last one was around relative value. A lot of the loans were with relatively low margins and trading above par. So all the convexity was against you.
2. Which software credits do you think are best positioned to bounce back? Do you expect to add risk in this sector?
Walter: If we take a step back, over time, you will have nuances in terms of what credits can fix themselves and others that cannot. Ultimately, there will be a fair degree of dispersion in outcomes.
Looking at some of the broad themes, we believe that names tied to the very backbone of companies — such as those linked to ERP or software — are likely to be able to refinance and will be in a decent position. Businesses that have the whole vertical setup, as opposed to horizontal, are in a better place. Systems of records, for the time being, are in a good position. The big question mark here is if they get layered by AI, and over time, see the margin compression, it could lead to some trouble.
On the other side of the equation, some names could be heavily disrupted: anything related to HR and potentially everything around web hosting. These are the areas currently hit hardest by these dynamics, aside from a couple of idiosyncratic situations. Thematically, these are the ones that have traded down quite aggressively and we expect to remain a bit lower for the time being.
3. How is loan market volatility impacting CLO portfolios and CLO new issue pricing?
Walton: In terms of how it impacts CLO portfolios, it depends on how you're positioned going into these pockets of volatility, and how you're able to position around it and take advantage.
If you are on the back foot from either being over-exposed to a particular name or sector that is underperforming, then the dynamics of the loan market currently make it very difficult to reposition around that because performing credit is priced at quite high levels.
In terms of new issue pricing, there have been a couple of situations in broader credit and CLO specifically, including First Brands, the impact of AI, and the current geopolitical situation in the Middle East. These have led to a repricing of CLO tranche risk. Investors are wary of the impacts of these broader factors and how that plays through into CLO performance, even if they haven't necessarily materialized yet.
We talked about software. I don't think there's a general feeling that we'll see negative or poor numbers coming through from software companies in the short term. But clearly, investors are looking more broadly at credit risk. The realized losses that have been observable and material in portfolios have still come from a relatively small number of idiosyncratic situations.
I came across research showing the 12-month default rate is around 1.4-1.5%, so it's still below long-term average defaults. But the fact they are observable in the market, and managers’ performance around those situations is leading to greater tiering and pricing. I would see that as a general theme. We've seen a dislocation and dispersion in the loan market, and we'll see dispersion in CLO pricing as well, based on performance.
Walter: On the dispersion, you've had software this year, but the dispersion really started in Q2 and Q3 last year, with several issuers starting to post poor numbers. We've seen some credits down 5-15 points in some cases, and they haven't really recovered. We've seen some triple-C downgrades. You've got a pocket of names now trading in the 80-90 quartile with relatively near maturities.
It goes back to one of the topics I raised earlier: the 2021 vintage. You had 5-7-year instruments put in place, and a lot of them are coming to maturity now. You've got that 2028 maturity wall with a number of issuers trading at a fair bit of a discount. It doesn't leave much room in terms of timeframe to fix the earnings path and the leverage. You end up relying on sponsor support. It becomes a bit of a moral hazard trade, and it's potentially going to be not very comfortable.
4. Do you expect the volatility in the loan markets to persist, and what do you think is the best entry point for adding risk?
Walton: In terms of volatility and its impact on loan pricing, you need to go back to the tariff situation of last year. The time period in which loan prices moved has been quite short. So I don't think we've really seen any sustained volatility in the loan market for some time. But do we expect there to be continued pockets of volatility? I would say that the current situation suggests that this is likely.
If you are a nimble CLO manager who is active and looking to take advantage of volatility, there are going to be opportunities. Our view has really always been to go up the credit curve in those situations, and to rely on fundamental underwriting of each credit first and foremost, and then to look at the broader market dynamics.
Whether you define dispersion as volatility or not, that is priced in. For credits that haven't been able to refinance their capital structures, you can see the price impact and the demand impact quite clearly in the dispersion that's in the market. We expect that to persist.
Walter: The current macro events are creating volatility questions. How long is it going to last? With energy costs moving all over the place, if it's a bit longer lived than a week or two, how is that going to filter through issuers and earnings, and then also into the rates picture? Because if you start getting inflation going one way, then you're going to start facing rate hikes in places.
5. In an earlier report, you mentioned the "significant influence" European CLOs exerted over loan market pricing. Is that something that will continue? What’s your forecast for issuance this year?
Walton: The loan market is roughly 70% owned by CLOs, so there is a strong technical dynamic to pricing — particularly when it comes to demand for new issue supply.
In the secondary market, we've seen this most clearly in triple-C assets, including in software. From both a technical and fundamental point of view, if assets don't work for CLOs, the price can drop quite quickly. You get these air pockets in pricing where the CLO bid will disappear, and then there will be a drop to levels where other participants in the loan market, such as distressed investors, step in.
Walter: That's what you're seeing at the moment in several software names. They remain bid- less, so you just know that there needs to be a price correction on some of the loans. You just don't know who's going to be the buyer on the other end, and at what level. You just know it’s lower, but don’t know how much lower.
6. With the recent appointment of a new CEO at Sona, how might this leadership change impact your European credit and CLO businesses?
Walton: Henrik Johnsson joined in January as CEO. As Sona approaches its 10th anniversary, his appointment marks the next phase of the firm’s growth. Sona has built a strong reputation as a trusted partner in European credit, recognized for its expertise and disciplined approach. Henrik brings extensive experience, having spent 23 years at Deutsche Bank, where he was co-head of capital markets in the European investment bank. This combines with the fact that he worked with John Aylward, our CIO, earlier in his career at Deutsche. It gives Sona strong leadership as it continues to grow the business.
From a CLO business perspective, Henrik and John both fundamentally recognize that the CLO business at Sona is part of our long-term growth strategy, and that will continue to be the case. We're going to remain active in this space. We've established the European CLO business, and are now in the early stages of building our US CLO platform.
7. What are your expectations for CLO equity performance in the coming year? In the European market, what specific shifts in risk appetite for various CLO tranches, particularly equity, have you observed heading into 2026?
Walton: In terms of CLO equity, it underperformed on a total return basis last year. There was a repricing of risk driven by broader macro and market-specific factors. But at the same time, relatively strong cash flows are still being generated and distributed. So, I don't think we're going to see necessarily those cash flows being impacted by single name underperformance. There has been some continued spread compression at the beginning of this year, which will weigh on distributions. But ultimately, the broader credit metrics of CLOs are in a pretty good place.
Having said that, based on the current point in the credit cycle that we're at, it's very difficult to give broad generalizations on the performance of an asset class. The dispersion we've seen in the loan market is likely to translate into dispersion in CLO performance. Tail risk has built up in certain areas and transactions, and that will ultimately feed through to performance. But these are long-term vehicles, and the real test is performance over time.
On the debt side, we've seen triple-A and mezzanine tranches tightening potentially quicker than people were expecting from January. In February, we hit a pocket of volatility based on geopolitical factors, and we're currently in a period of price discovery mode there.
But overall, there's a lot of tailwinds with new investors coming into the market at the triple-A level, from insurance to banks. There are new geographies of investors that are materializing. There are good, strong technicals around the triple-As and the mezzanine side. People are seeing good value there, relative to similarly-rated assets in other parts of credit.
8. Sona relocated a managing director to lead a recently-launched Abu Dhabi office. Why have you expanded into the region, and do you expect to see appetite for CLO strategies in the Middle East?
Walton: Sona has had a strong partnership in the Middle East region for quite some time. We see it as an area where we'd like to further strengthen those relationships and build on the growth opportunities we see there. In terms of appetite for CLO strategies, it’s already a very sophisticated investor base when it comes to CLOs and CLO equity. There’s a real understanding of the product. Historically, it has been more focused on the US CLO market, but we do see appetite for European CLOs as well. We will continue to have conversations there and develop our relationships.
9. What's a fun fact about yourselves that people in the market may not know about you?
Walter: In my previous life, I played tennis professionally. My ranking was top 300 on the ATP tour, and I got to play some of the main tournaments and some of the Grand Slam qualifying, including the US Open and Australia Open.
Walton: I grew up in a town called Wigan, which is known for its pies. I encourage everyone to try a ‘Wigan Kebab’ (A pie in a bread roll) if they are ever in the area. I always try and find the best pies available in London.
