Why are CLO BB yields so high?

CLO BB yields are high mainly because structural illiquidity, concentration and financing constraints require compensation beyond expected credit losses.

• CLO liabilities are dominated by senior tranches: AAA typically exceeds 60% of the stack, investment-grade tranches account for roughly 85%, and BBs represent only 3–4%, so a 100bp widening in BB spreads raises the deal’s weighted-average cost of capital by only about 3–4bp.
• CLO BBs hold overlapping loan portfolios, with roughly 30% collateral shared across each pair in the article’s illustration; their mezzanine position is typically threatened only after around 8% collateral losses, but systemic defaults could impair many BB tranches simultaneously.
• The CLO BB market is estimated at roughly $40 billion across thousands of CUSIPs, with a narrow institutional buyer base, no pure-play ETF and costly analysis involving waterfall, overcollateralization, interest-coverage and reinvestment modelling.
• Although CLO BBs have essentially no interest-rate duration because coupons float over SOFR, new-issue paper has spread duration of over 5 years, while bid-offer spreads can widen sharply during risk-off periods.
• Scarce repo and total-return-swap financing, regulatory capital charges and negative call convexity further support wide spreads; the proposed NAIC charge is 18.27% for a Ba3 tranche thicker than 4%, versus 28.07% for one thinner than 4%.

Takeaway: The article concludes that CLO BB premiums are primarily payment for illiquidity, mark-to-market volatility, concentration and structural disadvantages rather than hidden default risk; investors need specialised analytics, flexible mandates and enough liquidity to hold through spread cycles, while historical principal impairment in post-crisis BB tranches has been minimal.