The Handbook of Credit Risk Management, 2nd Edition

CHAPTER 12Collateral Loan Obligations (CLOs)

Collateral loan obligations (CLOs) are a special type of asset securitization, where the collateral is composed of loans to noninvestment‐grade corporates. CLOs play a fundamental role in the distribution of such loans, as banks are active in originating and structuring them but are not interested in keeping them on their balance sheet as their probability of default is relatively high and, therefore, they require a high amount of capital. Notes issued by CLOs are purchased by institutional investors motivated by the ability to acquire a diversified portfolio and to receive an attractive return on investment.

Prior to the 2007 crisis, market participants used the more general term collateralized debt obligation (CDO) as collateral could be either loans to noninvestment‐grade companies for CLOs or tranches of mortgage‐backed securities for ABS CDOs. The peak of the market was reached in 2007 when more than $600 billion worth of CDOs were issued globally. As institutional investors completely lost appetite for residential mortgages not guaranteed by government‐sponsored enterprises like Fannie Mae, ABS CDOs do not exist anymore. Today, the market is smaller, limited to CLOs but banks, hedge funds, pension funds, and insurance companies invest new money in CLOs that provide funding for roughly 50 percent of the noninvestment‐grade loan market in the United States, much less in Europe. The other 50 percent of the loans stay on the banks' ...