Collateralised loan obligation
Capital MarketsA fund that buys leveraged loans and finances itself by issuing rated tranches against them, and the dominant buyer of term loan B paper.
Also written: CLO, CLOs
A CLO assembles a diversified portfolio of leveraged loans, then issues its own notes in tranches from AAA down to an unrated equity piece. Interest from the loans pays the tranches in order of seniority, so the equity absorbs losses first and the senior notes are protected by everything below them.
They matter because they are the structural buyer of the loan market. A large share of every new term loan B is placed with CLOs, so their appetite substantially determines whether a buyout can be financed at all.
That creates a real constraint on the market. CLOs operate within tests on portfolio quality and diversification, so when downgrades push them toward those limits they become forced sellers of weaker credits, which amplifies a downturn.
They are frequently confused with the collateralised debt obligations that failed in 2008. The structure is similar; the collateral is not, being broadly syndicated corporate loans rather than subprime mortgage exposure, and CLO tranches performed comparatively well through that period.