Recent AI-driven volatility within the tech sector is fueling increased dispersion across the leveraged loan market with pronounced effects on CLOs. The price pressure thus far has been concentrated in equity and mezzanine tranches, which are the most sensitive to sector-specific and idiosyncratic risks in the underlying collateral pools. In contrast, senior tranches have remained stable, supported by strong underlying asset diversification and structural credit enhancement.
Beyond capital‑structure effects, the forthcoming analysis highlights:
- growing dispersion across technology exposure;
- performance drivers;
- loan maturity profiles;
- regional differences between U.S. and European CLOs;
- and manager‑level portfolio construction and underwriting.
Software’s Impact
While software exposure is often used as a proxy in CLO analysis, AI-related disruption increasingly impacts adjacent sectors, such as business services and healthcare. We estimate that, on average, approximately 11% of U.S. CLO portfolios and 7% of European CLO portfolios are exposed to near‑term AI disruption, with meaningful levels of dispersion across managers. However, we do expect that certain borrowers within these sectors will demonstrate viable long‑term paths forward.
In the U.S., declines in software loan prices have driven CLO equity valuations near post COVID-era troughs, pressuring BB tranches within CLO structures. For example, average levels on BB market value overcollateralization (MVOC) tests recently fell by approximately 1.2 percentage points to 104%—implying only a four percent cushion before full repayment of BB tranches becomes impaired (Exhibit 1).1
Notably, the share of BB tranches with thin MVOC cushions (i.e., below 3%) has doubled this year to roughly 23%. Meanwhile, approximately 13% of BB tranches exhibit cushions of less than zero—indicating potential principal impairment under further collateral deterioration and reflecting reduced market tolerance for incremental downside risk. Select BBB tranches are also beginning to show pressure in market‑value terms as overcollateralization cushions compress.
Exhibit 1
Lower Software Loan Prices have Pressured MVOC Cushions
Exhibit 1 highlights two CLO managers that experienced outsized price moves relative to the broader market during the recent increase in market volatility, though for different underlying reasons. Despite underweight exposure to the software sector relative to the market (“A”, highlighted in the shaded box above), the first CLO manager experienced higher price volatility driven by idiosyncratic exposure to specific, underperforming software issuers. In contrast, the second CLO manager (“B”, highlighted in the shaded box above) had more concentrated software exposure, resulting in greater sensitivity to sector-wide price declines as well as higher overall portfolio and sector-driven volatility.
Increased Differentiation
While AI‑driven disruption likely represents a genuine fundamental risk to certain corporate credits and may lead to issuer-specific downgrades, the market is increasingly differentiating risk across software business models and subsectors rather than treating the sector as a single risk bucket. As a result, dispersion is expanding across CLOs, with investors increasingly focused on issuer‑level exposure, underwriting quality of managers, and general portfolio construction—allowing them to distinguish between managers rather than focusing on cursory information on software portfolio weights.
For context, Exhibit 2 compares software exposure of 10 U.S. CLO managers (ranked by their weighted average price change since the end of 2025). Exhibit 2 not only shows broad dispersion in performance, but it also reveals significant variations in software allocations, rating exposure, and price changes to software holdings. Given the dispersion evident across these 10 CLOs and mounting concerns about AI disruption, performance dispersion is likely to persist, most visibly across mezzanine and equity tranche pricing.
Exhibit 2
Software Sector Breakdown by Average Portfolio Price Change
Another key consideration is the maturity profile of the underlying loans, which influences refinancing risk and price sensitivity. Managers with a higher share of software exposure coming due over the near-term face elevated downgrade and default risk amidst increasingly stringent market selectivity. This maturity skew is creating meaningful differentiation across platforms. For example, approximately 50% of the software exposure owned by several of the CLO managers in Exhibit 3 will mature in fewer than three years. Conversely, other managers face far fewer software-related maturities over the same period.
Exhibit 3
Software Exposure vs. Near Term Maturities
European Exposure
Software exposure in European CLOs is far lower than in the U.S. However, the broad market selloff in software-related issuers has still weighed on European mezzanine tranches while underscoring the dispersion across European CLO managers.
Exhibit 4 focuses on differing dynamics across European managers. One CLO manager (“A”, highlighted in the shaded box below) experienced larger price moves within its software exposure, despite less concentrated software exposure. In contrast, two others (“B”, highlighted in the shaded box below) saw both higher portfolio‑level price movements and larger software‑driven moves relative to the broader market, consistent with more concentrated exposure driving overall portfolio performance.
Exhibit 4
Declines in Software Loan Prices are Increasing Manager Tiering
Exhibit 5 again highlights the top 10 European managers most exposed to recent software‑driven volatility.
Exhibit 5
Software Sector Breakdown by Rating Bucket
While several managers maintain more concentrated software positions relative to the broader European market—where average exposure is approximately 7%—software loans in Europe generally benefit from longer‑dated maturity profiles, providing additional runway before refinancing pressures emerge (Exhibit 6). That said, European CLO portfolios tend to be more concentrated than their U.S. counterparts. As a result, despite lower headline software exposure, individual issuer risk is higher, particularly in scenarios where idiosyncratic pressure leads to lower recoveries.
Exhibit 6
European Software Exposure vs. Near Term Maturities
The repricing of software loans represents another key inflection point for the CLO market across both the U.S. and Europe. AI‑related disruption has highlighted meaningful differences in portfolio construction, risk management, and manager underwriting discipline. The impact has been concentrated in equity and mezzanine tranches to date, and we expect senior tranches to remain well insulated. Ultimately, this environment is likely to reward CLO investors that have the ability to underwrite underlying loan portfolios at the issuer level, while penalizing those relying primarily on headline levels of sector exposure.
1 MVOC tests are a measure of how the market value of the underlying loan collateral covers the outstanding debt.
References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in the portfolio at the time of publication and, if such securities are held, no representation is being made that such securities will continue to be held.
The views expressed herein are those of PGIM investment professionals at the time the comments were made, may not be reflective of their current opinions, and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither PFI, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.
Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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