Portfolio Performance Manipulation in Collateralized Loan Obligations
58 Pages Posted: 5 Jul 2016 Last revised: 13 Sep 2021
Date Written: September 20, 2018
Abstract
We examine the discretionary activities that CLO managers engage in to pass monthly overcollateralization (OC) tests. These tests require a CLO’s loan portfolio value, scaled by the CLO notes’ principal balance, to be above a certain threshold. Using CLOs’ granular disclosures, we develop model-free estimates for discretionary loan fair valuation and transaction-based proxies for strategic loan trading. We find a positive association between these discretionary activities and the probability of avoiding an OC test violation. This association varies predictably with junior noteholders’ influence and CLO market conditions. Strategic trading—but not discretionary fair valuation—relates to worse future CLO performance.
Keywords: Collateralized loan obligation, CLO, securitization, managerial discretion, loan fair valuation, strategic loan trading
JEL Classification: M41, G23
Suggested Citation: Suggested Citation