CLO, CLOs: Collateralized Loan Obligations

By: EconomyWatch Content   Date: 8 February 2010

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 Collateralized Loan Obligations or CLOs are asset securitization structures involving the issuance of securities or bonds backed by multiple middle and large sized business loans. The securities are issued in tranches, with each tranche representing varying levels of risk and returns. The purpose of issuing CLOs is to expand the supply of willing business lenders so as to reduce the cost or price of taking loans. The banks benefit by selling off their loans to external investors or lenders to facilitate lending to a larger number of customers while earning fees for themselves.

 

Process of Issuing CLO, CLOs: Collateralized Loan Obligations

The regular lending process involves the lender issuing the loan at a fixed interest rate while bearing the risk of default by the borrower. The issuance process of CLOs involves the pooling of various business loans by an SPV and the issuance of securities or bonds in tranches. Each class of the security is entitled to more interest payments than the category lower to it and is similarly ahead in the line in absorbing the losses arising from the underlying loan group.

 

The loans used for the issuance of CLOs are either syndicated loans or leveraged loans. These loans are usually issued with the intention of their being immediately paid off by the collateralized loan obligation owners. Also, these loans are generally issued to businesses owing an above average amount of money for their type of business.

 

The pooling of multiple loans and their use for the issuance of different classes of securities results in the creation of multiple loans with the safer ones carrying lower interest rates and the riskier ones higher interest rats. The process attracts both conservative investors as well as investors who have a high risk appetite.

 

Types of CLO, CLOs: Collateralized Loan Obligations

CLOs can be divided into linked and de-linked depending on their structures. In the case of linked CLOs, the lending bank provides some degree of credit support whether implicit or explicit to the transaction so as to improve its credit rating. In contrast, in case of de-linked CLOs, the issuer relies totally on underlying loans and the third party guarantees or support for the credit ratings of the issue. In this case the credit rating of the securities or bonds to be issued is separate from the credit rating of the lending bank.

 


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