BACKGROUND KNOWLEDGE
Added value for investors
RESISTANCE
Secured corporate loans have delivered prediominantly positive annual returns over the past 25 years and and have proven to be robust even in times of crisis.
DIVERSIFICATION
CLOs enable broad diversification across a large number of corporate loans, helping to reduce concentration risk and the likelihood of sigificant losses.
OUTPERFORMANCE
Through active management of the underlying loan portfolios, the various tranches of CLOs can generate attractive risk-adjusted returns ând benefit from changing market conditions.
CLOsprovide investors multiple risk-/return profiles due to the AAA - non-rated tranching.
Within CLOs, investors have the opportunity to invest in various tranches. These typically range from "AAA" to "non-rated" providing a wide range of investment opportunities.
The multi-layered collateralization within the loan pool ensures stability and security.
In addition, we regularly conduct stress tests to test the resilience of the CLOs in different market scenarios.
Key concepts related to CLOs
Collateralized Loan Obligation (CLO)
A CLO is a structured loan securitization consisting of a portfolio of senior corporate loans. These loans are divided into different tranches with varying risk profiles and issued to investors.
Senior Secured Loans
Loans that are secured by the borrower’s assets and are repaid before other debts in the event of default.
Capital structure/tranches
CLOs are divided into different risk levels (“tranches”), which have different repayment priorities. The main categories are:
- Senior tranche – the safest tranche with the highest priority for repayments and the lowest return.
- Mezzanine tranche – medium risk and medium return, receives payments after the senior tranche.
- Equity tranche – the riskiest tranche, which absorbs losses first but has the highest potential return.
Interest (coupon)
The regular interest payment that CLO investors receive on their shares. Senior tranches typically receive a fixed or variable interest rate, while the equity tranche derives its returns from remaining cash flows.
Actively Managed CLO
Are CLOs whose collateral pool – consisting a wide range of secured loans – is actively managed by credit specialists. This makes those differs from static CLOs, in which the portfolio remains static post issurance.
Balance Sheet CLO
CLOs are issued by a bank or financial institution to securitize loans from its own balance sheet and thereby free up capital. Unlike arbitrage-based CLOs, these are primarily used for balance sheet optimization.
Structure and control
Overcollateralization test (OC test)
A test that ensures the secured assets (loans) in a CLO are sufficient to cover the obligations to investors. If this test fails, cash flows from subordinated tranches can be redirected to senior tranches.
Interest Coverage Test (IC Test)
A test that verifies whether the interest income of the CLO portfolio is sufficient to cover the interest payments due to investors in the senior tranches. If this test fails, the payout to subordinated tranches can be stopped or reduced.
CLO Management
CLO Manager
A specialized asset manager responsible for selecting, managing, and monitoring the loans within a CLO portfolio.
Credit rating
A rating assigned by agencies such as Moody’s, S&P, or Fitch that assesses the default risk of the various CLO tranches. The senior tranche often receives an investment-grade rating, while the equity tranche is usually unrated.
Reinvestment Period
The phase (usually 3-5 years after issuance) in which the CLO manager can replace existing loans with new loans to optimize the performance of the CLO.
Default Risk
The risk that a borrower of a loan included in the CLO will not meet their payment obligations, which could negatively impact the CLO’s cash flows.
Cash Flow Waterfall
The hierarchical order in which the cash flows of a CLO are distributed to the various tranche investors. Senior tranches are served first, followed by mezzanine and equity tranches.