Collateralized loan obligation
Collateralized loan obligations (CLOs) are a form of securitization where payments from multiple middle sized and large business loans are pooled together and passed on to different classes of owners in various tranches. A CLO is a type of collateralized debt obligation.
Each class of owner may receive larger payments in exchange for being the first in line to lose money if the businesses fail to repay the loans. The actual loans used are generally multi-million dollar loans known as syndicated loans, usually originally lent by a bank with the intention of the loans being immediately paid off by the collateralized loan obligation owners. The loans are usually "leveraged loans", that is, loans to businesses which owe an above average amount of money for their kind of business, usually because a new business owner has borrowed funds against the business to purchase it (known as a "leveraged buyout") or because the business has borrowed funds to buy another business.
The reason behind the creation of CLOs was to increase the supply of willing business lenders, so as to lower the price (interest costs) of loans to businesses and to allow banks more often to immediately sell loans to external investor/lenders so as to facilitate the lending of money to business clients and earn fees with little to no risk to themselves. CLOs accomplish this through a 'tranche' structure. Instead of a regular lending situation where a lender can earn a fixed interest rate but be at risk for a loss if the business does not repay the loan, CLOs combine multiple loans but don't transmit the loan payments equally to the CLO owners. Instead, the owners are divided into different classes, called "tranches", with each class entitled to more of the interest payments than the next, but with them being ahead in line in absorbing any losses amongst the loan group due to the failure of the businesses to repay. Normally a leveraged loan would have a fixed interest rate, but potentially only a certain lender would feel that the risk of loss is worth the interest that is charged. By pooling multiple loans and dividing them into tranches, in effect multiple loans are created, with relatively safe ones being paid lower interest rates (designed to appeal to conservative investors), and higher risk ones appealing to higher risk investors (by offering a higher interest rate). The whole point is to lower the cost of money to businesses by increasing the supply of lenders (attracting both conservative and risk taking lenders).
CLOs were created because the same "tranching" structure was invented and proven to work for home mortgages in the early 1980s. Very early on, pools of residential home mortgages were turned into different tranches of bonds to appeal to various forms of investors. Corporations with good credit ratings were already able to borrow cheaply with bonds, but those that couldn't had to borrow from banks at higher costs. The CLO created a way for companies with weaker credit ratings to borrow from more institutions than just banks, lowering the overall cost of money to them.
As a result of the subprime mortgage crisis, the demand for lending money either in the form of mortgage bonds or CLOs almost ground to a halt.
In the first half of 2012, a total of 44 new CLOs priced, with market volumes reaching $18.77 billion by the end of June, according to data made available by Creditflux Magazine. This dwarfed the total amount issued for all of 2011, at $12.89 billion. Big names Citi and Bank of America led the way, with Citi arranging 10 deals and Bank of America arranging 7. Big names such as Barclays, RBS and Nomura launched their first deals since before the credit crisis; and smaller names such as Onex, Valcour, Kramer Van Kirk, and Och Ziff ventured for the first ever time into the CLO market, reflecting the rebounding of market confidence in CLOs as an investment vehicle. CLO issuance has soared since then, culminating in hefty $8.3 billion of vehicles pricing in November 2012, the most of any month since the credit crisis of 2008-09.
The market for U.S. collateralized loan obligations was truly reborn last year in hitting $55.2 billion, with new-issue CLO volume quadrupling, according to data from Royal Bank of Scotland analysts. Early growth spurts generally lay the foundation for future healthy expansion. This appears to be where the CLO's primary market sits as 2013 gets underway, with analysts predicting issuances of $60 billion to $70 billion this year. That would get closer to the peak of $92.8 billion in 2007. Indeed, CLO issuance during the first month of 2013 totaled an impressive $9 billion, amid sustained institutional investor liquidity. This was followed up by a healthy $6.5 billion in February, and another $11 billion in March. That brought 1Q 2013 CLO issuance to $26. 2 billion, the most for a quarter since the pre-Lehman bankruptcy period of 2007's second quarter.
U.S. CLO issuance slowed to $16 billion during the second quarter of 2013, however, largely due to 1) tremors felt from the gyrating high yield bond market, which saw a sell-off due to rising rate fears in June, and 2) implementation of an FDIC rule in March requiring higher capital requirements for CLOs. U.S. CLO issuance slowed even further in July, to $3.37 billion, the smallest monthly total since July 2012. The slowdown was caused in part by widening CLO spreads in July - as loan yields snapped tighter during the July market rebound - complicating the arbitrage for new vehicles. Despite this third-quarter slowdown U.S. CLO issuance by late-October hit $57.5 billion, the most in any year since the pre-Lehman era of 2007 and 2008. There was $5.35 billion in CLO issuance in September, bringing the final third-quarter number to $57.91 billion.
- Collateralized debt obligation, securitization vehicle for various debt instruments
- Collateralized fund obligation, securitization vehicle for private equity and hedge fund assets
- Collateralized mortgage obligation, securitization vehicle for residential mortgages
- "CLO volume hits post-credit-crisis high of $8.3B in November". Retrieved 7 December 2012.
- American Banker, Jan. 8, 2013, 4:03 pm ET, By Carol J. Clouse
- "CLO issuance totals healthy $6.5B in February; $15.5B year to date".
- "Amid turbulent markets, high yield bond volume plummets to $12.8B in June". HighYieldBond.com.
- "CLO Issuance Hits $7.25B In June; $16B In 2nd Quarter". Forbes.
- "CLO issuance hits $3.37B in July; slowest month in 1 year". LeveragedLoan.Com.
- "Leveraged Loans: Despite Easing In 3Q, CLO Issuance Hits Post-Lehman High". Forbes.
- "September CLO issuance clocks in at $5.35B; $57.91B YTD". LeveragedLoan.com.