The Future of Loan Portfolio Management : An Overview of Synthetic Collateralised Loan Obligations

This article discusses the use by banks of synthetic CLOs (Collateralised Loan Obligations) to manage the credit risk on their loan portfolios and free up the risk capital allocated to such portfolios.The article compares synthetic CLOs with conventional CLOs (in essence, a synthetic CLO involves the issuance of debt securities backed by credit derivatives referable to a pool of loans whereas a conventional CLO involves the issuance of debt securities against the actual pool of loans) and outlines the key advantages of the former over the latter. In addition, the article explains the legal structure of the three main types of synthetic CLO, viz: where the sponsoring bank transfers the credit risk on the entire pool of loans; where the sponsoring bank retains the first loss position in respect of the pool; and where the sponsoring bank retains a super-senior risk position, in conjunction with the first loss position, in respect of the pool of loans