A special purpose vehicle (SPV) with securitization payments in the form of different tranches. Financial institutions back this security with receivables from loans.Banks throughout the world are increasingly utilizing a new asset securitization structure known as a “collateralized loan obligation”, or “CLO”, to meet their financial objectives. CLOs enable banks to sell portions of large portfolios of commercial loans (or in some cases, the credit risk associated with such loans) directly into the international capital markets, and offer banks a means of achieving a broad range of financial goals, including the reduction of regulatory capital requirements, off-balance sheet accounting treatment, access to an efficient funding source for lending or other activities, and increased liquidity. This article summarizes the benefits to banks of undertaking a CLO, discusses important rating agency and legal considerations affecting the structuring of a CLO, and describes the steps required to complete a CLO transaction.
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
Collateralized loan obligations are the same as collateralized mortgage obligations (CMOs) except for the assets securing the obligation. CLOs allow banks to reduce regulatory capital requirements by selling large portions of their commercial loan portfolios to international markets, reducing the risks associated with lending.