CLOs are the dominant buyer of leveraged-loan paper. A manager buys 150 to 250 loans, funds them with term debt that cannot be margin called, and the equity tranche earns the spread between loan income and the cost of the debt tranches.
They are structurally robust because the liabilities are long dated and non-mark-to-market, so a price drawdown does not force selling. The real constraints are overcollateralisation tests, which divert cash from equity to senior notes when too much of the pool is downgraded to CCC.
Example: a $500 million CLO funds with $310 million of AAA at SOFR plus 150 and other debt tranches, leaving $50 million of equity. If the loan pool yields SOFR plus 350, the equity earns a leveraged multiple of that 200 basis point gap before losses.
Related: leveraged-loan, asset-backed-security, seniority, covenant-lite, credit-rating