The Collateralised Loan Obligation (CLO) market has been on the rebound since 2012. These structured products, which serve to securitise a portfolio of corporate debt in tranches of differing risk levels, offer investors a wide range of return/risk profiles.
The newer CLO issues, known as 2.0, tend to have a more conservative structure
- Describe the mechanism of CLOs as well as the structuring and management of the transaction’s collateral;
- Study the modelling and valuation of these products;
- Explain the regulatory and accounting issues that arise in the context of CLO transactions.
- Within the broad class of structured credit derivatives, Collateralised Loan Obligations (CLO) make it possible to issue debt tranches of varying levels of seniority, whose collateral is entirely comprised of a pool of leveraged loans.
- Such ‘leveraged loans’ are granted by banks to companies carrying significant financial debt, for instance in cases where they are the object of a Leveraged Buy Out (LBO).
- The basic CLO structure involves the issuance of varying risk tranches backed by a portfolio of medium-risk assets. The most senior—and thus lowest risk—tranche is rated AAA, whereas the mezzanine tranches, carrying higher risk but offering better yields, are rated BB or B. The equity tranche carries the greatest risk, as it is paid out of residuals and is the first to suffer in case of default. CLOs are thus a way of offering investors debt securities with a range of risk/return profiles.
- There are two main types of CLO: Static CLOs, in which the pool of underlying loans remain unchanged throughout the life of the transaction; Managed CLOs, where the manager may actively buy and sell assets to improve returns on the on the subordinated tranches.
- The CLO market nearly halted in the aftermath of the credit crisis of 2008-2009. The market began to pick up again as early as 2012 in the United States, but was slower to regain speed in Europe. New CLO issues have more conservative structures than previously, to avoid a massive downgrade and loss of value of these products in the event of an adverse scenario, hence the name ‘CLO 2.0’ applied to the post-crisis generation of CLOs.