Query by THE: What is COLLATERALIZED loan obligations? what are the Rewards and problems.?thx?
Greatest answer:
Answer by Homer J. Simpson
A CLO is a security that is backed or collateralized by a pool of loans- anaogous to a mortgage that is collateralized by a creating. Typically, there are several securities that are backed by the identical pool of loan. For example, some securities may well start off to pay off immediatly, whilst other individuals never commence to pay for years. As yet another example, some securities might have senior claims, although other people have junior claims to the loans.
The advantages include, immediate diversification- akin to investing in a mutual fund rather than a single stock-, capacity to invest in modest or precise increments alternatively of the lumpy loans, distinct types of danger (interest price, prepayment, credit, and so forth) can be parsed out to these investors who have the greatest tolerance for every kind, institutions with the loans have a a lot more effective vehicle to unload some or all of their portfolios- this assists them handle risk and liquidity requirements.
One problem is that the structures are often complicated and call for a lot of experience to fully realize. THey can also be fairly illiquid- especially smaller sized CLOs. Understanding the monetary statements of a securitizer is also a small more hard- but only a little bit!
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Ignore the following poster’s confounding explanation. He is confusing about 4 different items- only a single of which is slightly related to CLOs. A CLO just offers a firm with access to an option supply of capital other than the standard stock and bonds.
As for the accounting the the poster eluded to: any securitization, such as a CLO can be structured as off-balance sheet OR on balance sheet. If on-balance sheet, the loans and debt are carried at their historical value. It for that reason seems as if the firm just issued some bonds and did nothing at all to the loans. If off-balance sheet, then the loans are replaced by the money received from the CLO investors and any securities retained by the firm. The retained securities are carried at what the firm estimates is their fair market value. This is exactly where some securitizers have gotten into trouble. They make unrealistic about the timing or quantity of cash flows, which result in high valuations. When the faulty assumptions are realized, the updates lead can lead to huge write-down or impairments.
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