Into the Market for Collateralized Loan Obligations
The market in collateralized loan obligations, or CLOs, has become an important market for funding US and European companies in the last 10 years. Investors at the end of March 2022 held $942 billion in CLOs, according to the Federal Reserve, helping fund some of the world’s most dynamic businesses. CLOs have brought investors new ideas in credit and structure. They have encouraged a vibrant loan market that trades and prices regularly. They have introduced the idea of an active manager for the loans that secure a structured transaction. And they have created a new source of attractive return and diversification for many fixed income portfolios.
CLOs have also stood out simply for surviving market stress that bent or broke other structured products. Through the financial crisis that started in 2008, the crash of the energy market in 2015 and the start of the Covid-19 pandemic in 2020, CLO credit continued to perform broadly in line with expectations. As of the end of 2021 for example, none of the 4,870 CLO classes rated ‘AAA’ by S&P since 1999 had ever defaulted, and only one of the 3,281 classes rated ‘AA’ had defaulted. Loans and structure change over time, of course, and some future market could alter that record. But the market has tested the credit strength of CLOs.
Despite the size of the CLO market, it is hard to find a simple guide that lets a new investor to sit down and understand how all the pieces of the market fit together. This is a guide for that newcomer. It starts with the leveraged loan market that feeds into CLOs. It covers the basics of CLO structure. It describes the unique role of CLO managers and their impact on deal performance. It goes on to cover the subtleties of evaluating CLO debt and equity. It reviews the particulars of investing in CLOs at banks, insurers, mutual funds and hedge funds. It imagines ways that analyzing and managing CLOs may become simpler in the future. And it finishes with a view of how the CLO idea continues to evolve.
This guide has relied on the hard work and generous contributions of our colleagues and clients. Sri Ramanujam and Rob McMullen have patiently answered a steady stream of questions about loans, structures, markets and security analysis. Adam Schwartz has contributed his broad knowledge of the market as well. Brian Landy has provided invaluable advice and support to our framework for understanding CLO managers and CLO relative value. Our colleagues in sales and our clients have tested our ideas. Any errors in this guide remain our own, of course. But all of this has made completing this guide at Amherst Pierpont easier than it would have been in other settings.
Welcome to yet another fascinating corner of the world’s debt capital markets.
Senior Managing Director