CLOs, The Biggest Buyers of Business Loans
From the Desk of Jim Eccleston at Eccleston Law LLC:
Collateralized loan obligations or CLOs are now the biggest buyers of loans to non-investment grade businesses. They hold about 60% of the debt of companies. Buyers of CLOs include hedge funds, insurers, pensions, and other large investors.
According to a Bloomberg article, a CLO buys loans by selling debt in tranches of varying risk, return and equity. Interest from the loans then goes to pay coupons on the different classes of debt. CLOs differ from collateralized debt obligations (CDOs), which are infamous for the role they played in the financial crisis of 2008, as CLOs provide the ability to reinvest. CLOs typically have a reinvestment period of two to five years. During that time, the CLO managers can sell loans, which trade on the secondary market. The proceeds from the sale of these loans and from interest payments, can be used to buy new loans. CLOs also have self-correcting mechanisms to make sure they can meet interest and principal payments. Despite these risk mitigating factors, the Bloomberg article does acknowledge the risks related to the CLO strategy. Specifically, in a downturn, more companies can default than expected.
Finally, the article shows data on the composition of a few CLOs, which include loans from large companies, all the way down to a maker of car wash equipment and a single bakery.
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Related Attorneys: James J. Eccleston
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