Collateralized Loan Obligation (CLO)

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Definition: Collateralized Loan Obligation (CLO)

Collateralized loan obligation is a structured product in which multiple corporate loans are taken out from the large portfolio of loans and pushed to the international capital market in the form of tranches.

The tranches formed depending on the maturity date of various loans and risk profile of the borrowers. The tranches is of two types.

1.  Debt tranches: Like the bond it has a credit rating and fixed coupon payments associated with it and has priority while repayment is done.
2. Equity tranches: This tranche will be considered once the debt tranche payment done.

It can even divided into two types depending on the structure.

1. Linked structure: The bank provide some credit support during CLOs transaction to enhance the credit rating of the tranche under transaction.
2. Delinked structure: The bank completely depends on the quality of the underlying loan and the credit rating of the external agency for the CLO transaction.

As each tranche is formed based on the risk of default and maturity of the loan, after the repayment of the loan investor paid first will get less interest than the investor paid last.

Benefits

1 Source of fund: The bank can utilize the fund collected after selling the CLOs in various banking related activities.
2 Liquidity: It provides facility of relatively better liquidity to the bank and hence enhance lending capacity.
3 Less market independent: CLOs are not mark-to-market hence there will be less impact of valuation on the CLOs.
4 Risk return exposure: A high rated tranche will give higher return compare to the similar rated bond.
5 Balance sheet improvement: Proceeds from the CLOs can help to reduce the liabilities in the balance sheet.

Hence, this concludes the definition of Collateralized Loan Obligation (CLO) along with its overview.

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