Lesson 6 of 6 · 14 min
CLOs: capital structure, tests and the manager
A CLO funds a diversified pool of senior secured loans with AAA-to-BB debt and an unrated equity tranche, and coverage tests force cash toward the senior tranche whenever the collateral weakens.
In short
- CLO collateral is bought with money raised by issuing debt (senior, mezzanine) and equity. Typically 100–225 issuers of senior secured loans; the CLO replicates a firm's capital structure.
- Senior / mezzanine investors may earn more than comparable corporate bonds; equity holders take equity-like risk and must earn competitive returns for the CLO to be viable.
- Flavors: cash flow CLO (most common), market value CLO, synthetic CLO (credit derivatives).
- Lifecycle: most loans bought before closing → ramp-up period → manager may replace loans that meet the selection criteria → loans mature and tranches are paid off. Recourse is limited to the pool.
- Coverage tests: if the overcollateralization ratio (loan principal / CLO debt principal) or other tests fail, cash is diverted to repay the senior tranche, which deleverages the CLO.
- The collateral manager acts like an active bond portfolio manager; its skill drives CLO performance.
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