Collateralized Loan Obligation

Collateralized Loan Obligation


A collateralized loan oblication (CLO) is a structured security that usually holds syndicated corporate bank loans.

  • CLO assets usually include syndicated bank loans
  • CLO liabilities are usually broken into multiple equity and debt tranches
  • CLOs are commonly used by private equity firms to fund deals
  • CLOs typically borrower at 3 Month Libor, while the loans they hold are at 1 month libor
    • This creates potential for interest rate curve risk
    • The difference between 3 month libor and 1 month libor can impact CLO net margins
  • A CLO makes money when the yield it assets is great than that of its liabilities
  • CLOs may have provisions in place that require the manager to take action if:
    • there is insufficient cashflow to pay senior lenders
    • there is insufficient coallateralization
    • there is insufficient diversification
Key Drivers of CLO Equity Returns
  • Prepayment frequency
  • Ability for manger to reinvest cashflow "(typically 4 - 7 year period)
  • Broad credit market risk pricng
  • Spread between interest income and current funding costs (usually LIBOR)
  • Loan asset default and recovery rates
  • Management Fees

CLO Investors

CLO Performance
  • Defaults have been minimal over the full history of CLOs
  • Senior tranches have historically performed well - with almost no losses
  • Equity tranches have have provided high returns from 10-15+%

CLO Criticisms