Next video:
Loading the player...

A collateralized loan obligation (CLO) is a security consisting of a pool of loans organized by maturity and risk. A CLO is very similar to a collateralized mortgage obligation, except that the underlying debt is not mortgages, but rather, different types of loans. CLO’s are usually comprised of millions of dollars of loans to privately owned businesses.

The loans underlying the CLO serve as collateral securing the loan debt. These loans are arranged into different pools (called tranches) by maturity and the risk profile of the borrowers. At creation, the CLO sets a very explicit set of rules for how interest and principal payments are to be distributed among the various tranches.

Investors purchase an interest in the CLO, choosing bonds according to their risk tolerance and investment needs. For instance, one tranche may represent interest and principal payments from the first two or three years of the loans underlying the CLO. This tranche would be less risky than a later tranche that represent interest and principal payments for years 12 through 15 of the underlying loans.

Usually, the lead bank that made the original loans retains an interest in the CLO. It then collects interest and principal payments and distributes those payments to the various investors in the CLO. 

The financial crisis of 2007 and 2008 nearly ended the market for CLO’s. But the market for them has rebounded. Currently, the total value of the CLO market is in the hundreds of billions of dollars.

 

Related Articles
  1. Investing

    What are Tranches?

    Tranches often describe specific classes of bonds within a security that hold different degrees of risks and maturities.
  2. Investing

    A Primer On Collateralized Debt Obligation (CDOs)

    A collateralized debt obligation, or CDO, is a structured financial product backed by a pool of loans. When a retail or commercial bank approves loans such as mortgages, auto loans or credit ...
  3. Personal Finance

    Understanding Term Loans

    A loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate.
  4. Insights

    An Introduction to Government Loans

    Government loans further policymakers' efforts to create positive social outcomes by offering timely access to capital for qualified candidates.
  5. Retirement

    Business Owners: A Guide To Qualified Retirement Plan Loans

    Thinking of adding a loan feature to your company's plan? Here's what you need to know.
  6. Personal Finance

    Why Are Mortgage Rates Increasing?

    Learn how the secondary mortgage market and investor demand affect the cost of home ownership.
  7. Personal Finance

    All About Government Loans

    There are many reasons to seek a government loan rather than one from a private lender. Government loans typically have low interest rates and offer fixed or subsidized options, as well as deferred ...
  8. Personal Finance

    Time To Consolidate Your Student Loans?

    Use these strategies to decide whether consolidating your student loans makes sense for you – and what to do next if it does.
  9. Investing

    What Are Tranches?

    “Tranche” is a French word that refers to a slice.
Hot Definitions
  1. Efficiency Ratio

    Ratios that are typically used to analyze how well a company uses its assets and liabilities internally. Efficiency Ratios ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an ...
  4. Salvage Value

    The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting ...
  5. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  6. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
Trading Center