Consequences of CLO Portfolio Constraints

55 Pages Posted: 18 Apr 2019

See all articles by Maria Loumioti

Maria Loumioti

The University of Texas at Dallas

Florin P. Vasvari

London Business School

Date Written: April 12, 2019

Abstract

We investigate the relation between portfolio constraints (tests) that Collateralized Loan Obligations (CLOs) have to pass monthly, CLO managers’ loan trading choices and CLO equity returns. We find that stringent portfolio constraints are positively associated with the influence of CLO junior noteholders and tight CLO market conditions. We document that CLOs with restrictive tests have higher portfolio turnover, rebalancing and diversification, and hold loans for shorter periods, suggesting that managers of constrained CLOs actively administer loan portfolios to alleviate credit losses and costly test violations. We further show that managers of constrained CLOs respond to borrower news differently by trading loans to avoid reporting credit losses and to comply with the CLO tests rather than to generate profits from trading. Last, we examine the economic effects of restrictive portfolio tests and find that these constraints are associated with lower CLO equity returns. Our evidence supports the argument that portfolio constraints lead to divergent trading choices and ultimately to different levels of CLO performance.

Keywords: CLOs, securitization, portfolio tests, equity returns, credit risk, asset management

JEL Classification: M41, G23

Suggested Citation

Loumioti, Maria and Vasvari, Florin P., Consequences of CLO Portfolio Constraints (April 12, 2019). Available at SSRN: https://ssrn.com/abstract=3371162 or http://dx.doi.org/10.2139/ssrn.3371162

Maria Loumioti (Contact Author)

The University of Texas at Dallas ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

Florin P. Vasvari

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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