Why CLOs? | Ellington Credit

Fundamentals of CLO Collateral and Structure

Collateralized loan obligations are securitizations typically backed by pools of corporate loans and other corporate-credit related assets.
- Underlying loans are typically senior secured, floating rate corporate loans
- The vast majority of loans carry public credit ratings from major rating agencies such as S&P, Moody’s, and Fitch
CLOs receive principal and interest cash flows from their underlying assets and typically distribute them quarterly.
- Senior debt tranches are paid first, then mezzanine debt tranches, then equity tranches

Illustrative CLO capital structure diagram

CLO Market Overview

Growing Asset Class with Improving Liquidity and Scalability

Global CLO market has nearly doubled in size to $1.3 trillion⁽¹⁾ since 2018 and is now the largest asset class in the private-label securitized products universe.
We believe this rapid growth has meaningfully improved availability and liquidity of CLO mezzanine debt and equity in the secondary market.
CLO market growth has significantly expanded the investment opportunity set, especially as the spectrum of seasoned investment profiles continues to broaden.

Attractive Investment Opportunities

We believe that many parts of the CLO market remain highly inefficient, with much of the increased participation in the space coming from investors focused on adding the most liquid and standardized profiles.
We believe attractive investment opportunities exist for sophisticated institutional investors who are able to conduct thorough analysis of the documents, structures, and underlying corporate borrowers in less standardized CLO investment profiles.
We believe dispersion in CLO collateral performance going forward should continue to provide ample ongoing investment opportunities.
A CLO-focused closed-end fund provides individual investors access to a differentiated investment strategy otherwise limited to the institutional market.

CLOs have historically experienced better credit performance than the benchmark leveraged loan index

Historically, CLO debt tranches have demonstrated resiliency to corporate defaults due to structural features that preserve cash flows in times of stress, such as:
- Credit enhancements in the form of subordinate securities and overcollateralization
- Floating rate notes with excess spread
- Deal triggers that divert excess interest to protect debt tranches
CLOs are typically actively managed vehicles, allowing collateral managers to rotate the assets in their portfolios to react to changing market conditions and credit events.

CLO Equity Overview⁽⁴⁾

CLO equity tranches can offer an attractive return profile for investors, including strong current carry.
The chart below shows historical realized unlevered internal rates of return ("IRRs") by CLO equity vintage, assuming each equity investment was purchased at new issuance and held to the conclusion of each CLO.
- IRRs may be further enhanced by investing in CLO equity at higher yields in secondary markets and/or by actively trading, both of which are core tenets of Ellington’s strategy.
CLO equity vintages between 2003 – 2022 have generated a median unlevered IRR of ~12%, assuming each investment was held from new issuance to deal conclusion.⁽⁵⁾
- However, performance has varied widely between CLOs, and we believe the complexity of the asset class requires strong analytics and underwriting capabilities to determine which investments may under- or out-perform.

CLO Mezzanine Debt Overview

CLO mezzanine debt tranches offer several advantages over other corporate credit sectors including:
- Attractive yield profiles relative to similarly-rated corporate credit investments
- Credit enhancement, allowing structures to withstand significant loss levels
From 2010 through 2024, S&P Global Ratings rated nearly 19,000 tranches and found an average annual default rate of only 0.04% for CLO BB tranches and 0.16% for CLO B tranches.
- These annual average default rates are well below the default rates for similarly rated corporate bonds, as depicted below.

Leveraged Loan Performance and Resiliency Over Time

Past performance is not necessarily indicative of future results

Source: BofA Global Research as of December 31, 2024.
Source: Pitchbook | LCD as of December 31, 2024.
Source: J.P. Morgan.
Past performance is not necessarily indicative of future results. The table is provided for illustrative purposes only. The actual performance of EARN's portfolio may differ from the performance of the CLO equity market as presented. The performance of the CLO equity market does not reflect management fees, performance fees, and other expenses incurred by the fund, which will reduce the returns of EARN's portfolio. Deal vintages from 2023 and later are excluded from the chart due to the limited sample size of fully redeemed transactions from those vintages.
Source: BofA Global Research as of September 30, 2025.
Source: S&P Global Ratings Credit Research & Insights and S&P Global Market Intelligence's CreditProSource: BofA Global Research. CLO default data is through May 2025 and corporate default data is through December 2024.
Source: LCD / Morningstar LSTA Leveraged Loan Index as of September 30, 2025. Past performance is not indicative of future results.

Glossary of CLO Terms

Term	Definition
Collateralized Loan Obligation ("CLO")	A form of structured finance security that is generally backed by a pool of corporate loans or similar corporate credit-related assets that serve as collateral. Most CLOs are issued in multiple tranches which offer investors various maturity, yield, and credit risk characteristics. These tranches are often categorized as senior, mezzanine and subordinated/equity according to their relative seniority and degree of risk.
Leveraged Loan	A type of loan extended to corporations that already have considerable levels of debt and/or lower credit ratings, typically below investment grade.
CLO Deleveraging	CLO Deleveraging occurs as the outstanding debt in a CLO is reduced as tranches are paid down using principal proceeds from the sales or prepayments of underlying assets. Deleveraging generally reduces credit risk for CLO debt tranches, as they generally build credit enhancement (defined below) and recuperate principal balance as the CLO pays down.
Credit Enhancement	Credit Enhancement is a feature of the CLO structure that provides CLO debt tranche investors with a degree of protection against default risk in the underlying collateral portfolio. Credit enhancement may also be referred to as “subordination”, and reflects the amount of credit losses that must be taken in the underlying asset portfolio before a given CLO debt tranche begins to take principal losses.
Interest Coverage Tests (“IC Tests”)	CLO structures typically have several collateral quality covenants and cashflow tests, designed to protect CLO debt tranche investors. Interest Coverage Tests ("IC Tests") are based on the ratio of interest received from the assets underlying a CLO to the interest payments made to CLO debt tranches. If this ratio falls below a pre-specified test value for a certain class of debt, cashflows are diverted to more senior debt tranches. IC Tests are typically measured at the level of each debt tranche.
Loan Accumulation Facilities ("LAFs")	LAFs are generally short- to medium- term financing facilities provided by the investment bank(s) that will ultimately serve as the arranger(s) of the related CLO transactions. Utilizing equity capital provided by the LAF investors and debt financing provided by the investment bank(s), LAFs acquire leveraged loans and other similar corporate credit-related assets in anticipation of ultimately collateralizing a CLO transaction. This period of accumulating assets, often known as the "Warehouse Period," (defined below) typically terminates when the CLO vehicle issues various tranches of debt and equity securities to the market, using the issuance proceeds to repay the investment bank and LAF investor financing.
Morningstar LSTA EU Leveraged Loan Index (“EU LLI”)	Market-value weighted, multi-currency index designed to measure the performance of the European leveraged loan market.
Morningstar LSTA US Leveraged Loan Index (“US LLI”)	Market-value weighted index designed to measure the performance of the US leveraged loan market.
Non-Call Period	Set period of time where a CLO cannot be optionally redeemed by equity holders.
Overcollateralization (“OC”)	Overcollateralization is a credit defense mechanism in CLOs. At issuance, CLOs are typically considered “overcollateralized” because the par value of the assets backing a CLO typically exceeds the principal balance of CLO debt tranches outstanding.
Overcollateralization Tests (“OC Tests”)	CLO structures include several collateral quality covenants and cashflow tests, designed to protect CLO debt tranche investors. Overcollateralization Tests ("OC Tests") are based on the ratio of the par value of the assets underlying a CLO to the outstanding principal value of CLO debt tranches. If this ratio falls below a pre-specified test value for a certain class of debt, cashflows are diverted to more senior debt tranches. OC Tests are typically measured at the level of each debt tranche.
Post-Reinvestment Period	After the pre-specified Reinvestment Period (defined below), CLOs typically face more restrictions on their ability to trade existing assets and to purchase new assets. As a result, proceeds from principal repayments and sales of underlying CLO assets that are not reinvested are generally used to pay down CLO debt tranches following the expiry of the Reinvestment Period, starting with the most senior tranches and paying down sequentially.
Ramp-Up Period	Period during which the CLO collateral manager acquires a portfolio of corporate loans (and other corporate credit-related assets) using the proceeds from the issuance of CLO debt and equity tranches. The Ramp-Up Period is a continuation of the asset acquisition period that typically begins with the opening of a LAF/warehouse.
Refinancing	A type of CLO redemption which involves the issuance of new CLO debt tranches to replace existing CLO debt tranches. New debt tranches typically carry lower coupon spreads, thereby reducing costs associated with CLO liabilities and improving the excess interest in a CLO available to CLO equity investors, all else equal. Refinancings are typically initiated by a majority of a CLO's equity tranche holders.
Reinvestment Period	Period during which a CLO collateral manager can actively trade underlying portfolio assets and reinvest principal repayments to acquire new assets, subject to collateral covenants specified in a given CLO’s indenture as well as any other applicable restrictions.
Reset	A type of CLO redemption that involves refinancing all CLO debt tranches and extending the CLO's Reinvestment Period and final maturity. Typically initiated by a majority of a CLO’s equity tranche holders.
Subordination	Subordination is a structural feature of CLOs and refers to the fact that lower-priority / more-junior CLO tranches absorb credit losses before higher-priority / more-senior CLO tranches. Equity tranches are subordinate to mezzanine debt tranches, and mezzanine debt tranches are subordinate to senior debt tranches.
Warehouse Period	During the Warehouse Period, a CLO collateral manager begins to accumulate the loans and other corporate credit-related assets that will ultimately collateralize a CLO transaction. LAFs (or similar warehouse financing facilities) are utilized during the Warehouse Period.
Weighted Average (“WAVG”) Junior OC Cushion	Market value-weighted average spread (expressed as a percentage) between the OC level and the OC Test trigger for the junior-most debt tranches in a portfolio of CLO tranches.
Weighted Average (“WAVG”) Loan Maturity	The market value-weighted average maturity of the assets (which are typically loans) underlying a portfolio of CLO tranches. Expressed in years.
Weighted Average (“WAVG”) Loan Spread	The market value-weighted average coupon spread over a floating rate index of the floating rate loans underlying a portfolio of CLO tranches. Expressed as a percentage.

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