Collateralized Loan Obligations (CLOs) were one of the largest and fastest-growing segments of the structured finance market, fueling the 2003-2007 boom in syndicated loans and leveraged buyouts. The credit crisis brought CLO issuance to a halt, and as a result, the leveraged loan market dried up. Similar to other structured finance products, investors in CLOs rely heavily on credit ratings provided by the rating agencies, yet little is known about CLO rating practices. This paper attempts to fill that gap. Using novel hand-collected data on 3,912 tranches of Collateralized Loan Obligations (CLO) we document the rating practices of CLOs and analyze their existing structures.

Collateralized Loan Obligations (CLOs) are Collateralized Debt Obligations (CDOs) backed predominantly by loans. CLOs played a key role in financing billions of dollars of private equity firms’ leveraged buyouts around the world. As of 2006, Standard & Poor’s Loan Syndications and Trading Association (S&P LSTA) estimated that structured investment vehicles like CLOs represented 60% of institutional participation in the syndicated loan market. The influx of capital from these investment vehicles was so extraordinary that the amount of capital committed to private equity in 2006 and 2007 reached record levels, surpassing the leverage buyout wave of the late 1980s (Kaplan and Stromberg (2008)). However, following the subprime mortgage crisis, investors lost confidence in structured finance credit ratings and CLO issuance virtually dried up. CLO issuance in the first quarter of 2008 was down 85% from the previous year’s level. Leveraged loan originations followed suit, falling 74% in the first quarter of 2008 compared to same period in 2007. Leverage buyout (LBO) lending slowed down to a near standstill in 2008 with issuance levels being the lowest in almost a decade. The rise and fall (and potential resurrection) of the CLO market has important implications for private equity and leveraged loan lending.