CLO Portfolio Risk Mitigation

CLO Portfolio Risk Mitigation

Christos Danias

20 years: Credit & structured finance

In this video, Christos will answer some questions pertaining to the key features and mechanics within a CLO to protect your debt.

In this video, Christos will answer some questions pertaining to the key features and mechanics within a CLO to protect your debt.

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CLO Portfolio Risk Mitigation

12 mins 9 secs

Key learning objectives:

  • Understand how debt is protected and what makes a good portfolio

  • Define the portfolio profile tests

Overview:

Debt can be protected by controlling asset quality and repaying the debt quicker. A good CLO portfolio checks and mitigates the risk of default by running asset and portfolio tests to ensure repayment.

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Summary

What mechanisms are in place to protect the CLO?

So, how can we protect the debt?

  • Controlling the quality of the underlying assets
  • Accelerating the repayment of the debt, when things don’t go to plan. The quicker you get repaid, the lower your risk of not getting repaid

If things go wrong you can have defaults in your assets and resulting losses, leaving you with insufficient principal to repay your debt. Or you can simply have asset deterioration, where the quality of your assets gets worse. In the pool, there may well be assets that have not defaulted yet, but they have got bad enough that rating agencies now view them as more likely to default. You can also have shortfalls of interest, your assets not yielding enough to cover the interest payments due on your debt.

What defines a good portfolio?

  1. Assets in the portfolio need to be of  good credit quality, otherwise, they can default
  2. The asset pool needs to be diversified
  3. The interest produced from the assets, must be sufficient to pay the interest due on the Debt
  4. Your underlying assets must repay promptly enough, to redeem your debt as scheduled

What are Portfolio Profile Tests?

Mechanics are in place, to ensure that throughout the life of the CLO, the debt is protected. This is done by the portfolio profile tests, which make sure the portfolio manager maintains a high quality, diversified portfolio and the diversion tests, where interest payments and scheduled principal payments are used to redeem the Notes early.

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Christos Danias

Christos Danias

Christos has worked in structured finance for over 20 years. He started out as a securitisation structurer and later worked at Credit Suisse. There, he transitioned into CLOs and ended up running BNP’s primary CLO business until the financial crisis. After a stint setting up a paddleboard business, Christos went back to work as a trader and sales, focusing on CLOs primarily.

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