CLOs Revisited – Ratings, Risks, and Returns (Third of a Series)

By blocking the Suez Canal last month, the Ever Given made headlines and created a massive shipping traffic jam. Three football fields long and weighing 250 thousand tons (by comparison, the Statue of Liberty is 125 tons), the monster container vessel represents the new global transportation reality: 90% of the world’s goods travel by sea.

To this journalist, the incident also recalled features of CLOs. Here are vehicles that transport 70% of all leveraged loans, each CLO containing hundreds of assets. They also move sideways when stiff market cross-winds blow and worry institutional clients when beached.

CLOs are businesses unto themselves with their own balance sheets and income statements. The loans in which they invest are the assets, the financings that support the investment programs represent the liabilities, and equity investors earn an arbitraged return on the difference between the cost of the liabilities and the asset yield.