Business and Personal Finance Dictionary
# A B C D E F G H I J K L M N O P Q R S T U V W X Y Z
- COLLATERALIZED LOAN OBLIGATION (CLO)
Definition: An ABS (q.v.) structure similar to a CMO (q.v.), but with a portfolio of commercial or personal loans as collateral, instead of a portfolio of Mortgage Backed Securities (q.v.) and/or mortgage loans. A sponsor transfers the collateral into a Special Purpose Vehicle (SPV), such as a trust or corporation, which has no other assets and which issues claims. A typical CLO has more than one "tranche" or "tier", and a more junior tranche has more risk of default. Example: A CLO might have senior, junior (or mezzanine), and subordinated (or equity) tranches. The senior tranche, like senior debt, has first claim on the collateral’s cash flows to cover its interest and principal payments. The junior tranche has second claim. The equity tranche claims the residual. For example, National Westminster transferred $5 billion of loans from its balance sheet to an asset-backed trust October 1996 and created an early and large CLO. Application: Some commercial banks have created CLOs to create highly rated bonds and highly speculative "equity" out of a portfolio of loans. A CLO allows a bank to remove loans from its balance sheet and reduce its required reserves, yet keep contact with the borrowers and fees from servicing the loans. Pricing: Predicting default rates is the most difficult aspect of pricing CLOs. In the case of investment grade loans, this is less of a problem than it is with problem loans. Risk Management: Comment: Agencies, such as Moody’s Investors Service and Standard and Poor’s Corp., assign credit ratings. Source: Jodi D'Amico, "COLLATERALIZED LOAN OBLIGATIONS -CHANGING THE WAY BANKS DO BUSINESS," http://www.van-kampen.com/nz/Fixed_Income_Newsletter/23-3.htm.Back