CLO Credit Risk
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This two-day course is an overview of the techniques for analyzing the risks in a Collateralized Loan Obligation (CLO). The focus is on the key risks of investing in CLOs, as well as the motivations for issuing/managing CLOs, and the structural elements.
Key Learning Outcomes:
- Use a structured approach (a technique) for analyzing CLOs
- Understand the key risk variables and the inputs for a risk model
- Understand the structural elements of a CLO, why they exist, and their effectiveness
- Understand the motivations for managing a CLO and for investing in a CLO
- Understand the reasons for debt tranching and cash flow waterfalls, as well as the techniques
The goals of this section are to highlight key elements of the CLO market and to establish a framework of analysis for CLOs.
- CLOs in the context of the high yield market
- Why CLOs? Motivations behind the deal
Analytic approach to credit evaluation
- Applying the analytic framework to CLOs: purpose, payback, risks and structure
- Exercise: examining differences in pre- and post-crisis CLOs.
Risks to Repayment
The goal of this section is to consider issues related to the CLO assets and asset managers which could affect repayment of CLOs.
- Defining the underlying assets
- Identifying the key variables which impact likelihood of default and recovery
- Assessing asset credit quality
- Default probability: the use of credit ratings, calculating WARF (weighted average rating factor)
- Recovery rate: examining asset security and adjustments to standard assumptions.
- Impact of covenant-lite loans
- Importance of diversification
- Asset concentration and correlation
- Cash flow analysis: understanding portfolio credit quality under various stress scenarios
- Exercise: using the Portfolio Credit Model to understand sensitivity in portfolio credit risk.
- Scope of manager's role
- Methodology for assessing CLO asset managers
- Key man risk
- Management replacement provisions.
The goal of this section is to understand how the features of CLO transactions address repayment risk and provide returns to investors.
- The role of credit enhancement: loss allocation
- Sizing: how the level of credit enhancement is determined for the target ratings.
- Terms and conditions
- Ramp up, reinvestment and amortization periods
- Class X: the role of excess spread
- Waterfall structures: protecting priority of payments
- Unravelling payment flows: sources, applications and redistribution of funds
- Expected and legal maturity; extension risk, optional redemption features
- Exercise: Unravelling waterfall structures.
- Target portfolio characteristics and managing to dynamic collateral quality tests
- Coverage tests (OC and IC): rationale, definitions and implications
- Events of default; liquidations
- Understanding sales, trading and reinvestment criteria and controls
- Counterparty risk
- Exercise: Examining CLO coverage tests
- Exercise: Evaluating Structural Features of CLOs.
- Bankruptcy remoteness and non-consolidation
- Validity of transfer/perfection of security
- Regulatory issues: risk retention proposals, Foreign Account Tax Compliance Act.
- Relative value: comparing returns across asset classes
- Current market topics: CLOs going static, asset manager consolidation
- CLO market performance.
The goal of this section is to highlight the on-going evaluation of CLO programs.
- Timely and adequate reporting
- Tracking portfolio changes and performance
- Asset defaults, restructurings and recoveries
- Surveillance and rating changes: expectations vs. performance through the cycle.
Who should attend
This course would be ideal for an investment manager who is interested in creating a portfolio of CLOs, a credit analyst covering the risk assessment of CLOs, and any party working with CLOs. From junior structurers, to operations staff, trustees, paying agents, and warehouse facility providers.