Securitization without Adverse Selection: The Case of CLOs

Abstract:     
Collateralized loan obligations (CLOs) have been an important source of capital for the high-yield corporate loan market. In this paper, we investigate whether securitization was associated with risky lending in the corporate loan market by examining performance of individual loans held by CLOs. We construct a unique dataset that identifies loan holdings for a large set of CLOs and find that adverse selection problems in corporate loan securitizations may be less severe than commonly believed. Controlling for borrowers’ credit quality, securitized loans perform no worse, and under some criteria better, than unsecuritized loans of comparable credit quality. However, within a CLO portfolio, loans originated by the bank that acts as the CLO underwriter underperform the rest of the loan portfolio. Overall, we argue that securitization of corporate loans is fundamentally different from securitization of other assets classes because securitized loans are fractions of syndicated loans. Therefore, mechanisms used to align incentives in a lending syndicate also reduce adverse selection in the selection of CLO collateral.

Keywords: Structured finance, Collateralized loan obligations (CLOs), CDOs, Syndicated loans

JEL Classifications: G20, G21, D82

Working Paper Series