Collateralized Loan Obligation [CLO]

A Collateralized Loan Obligation (CLO) is a structured credit product that pools together 100-250 leveraged loans to companies and issues tranches of securities with varying risk levels. A typical $500 million CLO might have: AAA tranches (60-70%, first priority), AA to BBB tranches (20-25%, mezzanine), and equity tranche (5-10%, first loss). CLO managers actively trade loans to maximize returns while meeting coverage tests. For example, if loan defaults reduce overcollateralization ratios, cash flows redirect from equity to pay down senior tranches. CLOs differ from CDOs by focusing on senior secured loans rather than various debt types, with lower historical default rates. The leveraged loan market feeds CLO creation, with CLOs buying 60%+ of new leveraged loans. During COVID-19, CLOs weathered stress better than 2008-era CDOs due to better structures and collateral quality. CLO equity can yield 15%+ returns in good times but faces first losses. Regulatory capital treatment favors banks holding AAA CLO tranches over whole loans. The $900 billion CLO market provides crucial financing for leveraged buyouts and corporate acquisitions.