Glossary of Terms
Investing in Collateralized Loan Obligations (CLOs) and private credit involves navigating a wide landscape of financial products and concepts. This glossary encompasses key terms essential for understanding these investment areas.
CLOs are structured credit products backed by pools of loans, segmented into tranches with varying risk and return profiles. Key to these investments are senior secured loans, which have priority in case of default, and junior or subordinated loans, which carry higher risk and returns. Understanding credit risk, yield, and the implications of default is crucial for investors.
Leverage, covenants, and spreads are fundamental concepts that influence the structure and attractiveness of these investments. Private credit, encompassing non-bank lending and direct lending, offers bespoke financial solutions, often involving mezzanine debt and syndicated loans. Recovery rates and floating rate loans are important for assessing potential returns and risks.
Investment strategies also consider the credit quality of loans, distinguishing between investment grade and high yield (or “junk”) bonds. Effective asset management and thorough due diligence are essential for making informed investment decisions in these markets.
This glossary aims to provide a foundational understanding of these terms, equipping investors with the knowledge to navigate the intricacies of CLO investing and private credit.
Asset-backed Lending (ABL)
Loans that are secured by some form of collateral.
Asset Management
Asset management is management of investments on behalf of clients, including the selection, buying, and selling of securities to achieve specific financial goals.
AUM
AUM refers to assets under management.
Broadly Syndicated Loans
Broadly syndicated loans are underwritten by banks, rated by nationally recognized statistical ratings organizations (NSROs) and often traded by market participants.
CLOs
CLOs, or collateralized loan obligations, are structured finance products that are backed by a pool of assets other than leveraged loans.
Covenant
A covenant is a clause in a loan agreement that requires the borrower to meet certain conditions or forbids certain actions, aimed at protecting the lender’s interests.
Credit Ratings
Credit ratings are opinions about credit risk. For long-term issues or instruments, the ratings lie on a spectrum ranging from the highest credit quality on one end to default or “junk” on the other. A triple-A (AAA) is the highest credit quality. A C or D (depending on the agency issuing the rating) is the lowest or junk quality.
Credit Risk
Credit risk is the risk of loss due to a borrower’s failure to make payments as agreed.
Current Market Value
Current market value or face value amortization is the process by which the CLO repays its financing after the reinvestment period ends.
Default
Default refers to the failure of a borrower to meet the legal obligations or conditions of a loan, such as not making scheduled payments.
Direct Lending
Direct lending is form of private credit where lenders provide loans directly to borrowers without intermediaries like banks, often used by middle-market companies.
Due Diligence
Due diligence is the process of thoroughly investigating a company or investment opportunity to assess its risks, benefits, and financial health before committing capital.
Flat Rock Global CLO Equity Index
The Flat Rock Global CLO Equity Index can be found on the Flat Rock Global website.
Floating Rate Loan
Floating rate loan is a loan with an interest rate that fluctuates with the market rate or an index, offering protection against interest rate risk.
GFC
GFC, or Global Financial Crisis, was a period of extreme stress in global financial markets and banking systems between mid 2007 and early 2009.
GSE
GSE, or government-sponsored enterprise, is a type of financial services corporation created by the United States Congress.
High Yield
High yield refers to bonds or loans that carry a higher risk of default but offer higher returns to compensate for the increased risk, often referred to as “junk” bonds.
Intex
Intex is a software market participants use to model CLO securities.
Investment Grade
Investment grade is a rating that indicates a relatively low risk of default, typically assigned to bonds or loans with high credit ratings.
Junior Capital
Junior capital is financing that has a lower priority claim in debt repayment to a secured term loan.
Layering of Debt
Layering of debt refers to the company taking on additional debt with a higher seniority than the existing debt. Layering is not permitted in most first lien loan credit agreements.
Leverage
Leverage is the use of borrowed capital to increase the potential return of an investment, which also increases the potential risk.
Leveraged Loans
Leveraged loans are corporate loans to companies that are not rated investment grade.
LIBOR
LIBOR, or the London Interbank offer rate, was a broad measure of the cost of borrowing cash overnight for banks on an unsecured basis, leveraged loans or corporate loans to companies that are not rated investment grade broadly.
LIBOR Floors
LIBOR floors on loans protected the loan investor at times when LIBOR was near zero. LIBOR floors increased CLO income, but CLO note investors do not receive floors on the base rate. The market has transitioned from a LIBOR base rate to a SOFR base rate.
LIBOR Spread
LIBOR spread is the difference between the highest and lowest rate of the London Interbank Offered Rate
LME
LME, or liability management exercises, are an out of court restructuring of a company’s debt in which the lenders take a haircut on the principal balance of their loans.
Loan Spread
Loan spread is the percentage difference in current yields of various classes of fixed income securities versus Treasury bonds.
Mezzanine Debt
Mezzanine debt is a hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in the company in case of default, after senior debt has been paid off.
Middle Market Loans
Middle market loans are usually underwritten by several lenders with the intention of holding the investment through its maturity.
Morningstar Loan Index
Morningstar Loan Index serves as the market standard for the US leveraged loan asset class and tracks the performance of more than 1,400 USD denominated loans.
Par Build
Par build refers to building the par balance of the CLO loans where each that hasn’t defaulted is counted at its par value.
Private Credit
Private credit refers to non-bank lending where private investors provide loans directly to borrowers, typically involving less liquid and more bespoke financial structures compared to public debt markets.
Rated Feeder
A rated feeder is a structured credit vehicle secured by the LP interest of a private credit fund.
Recovery Rate
Recovery rate is the proportion of a loan’s value that is recovered by creditors after a borrower defaults, usually expressed as a percentage.
RMBS
RMBS are residential mortgage-backed securities.
Senior Secured Loan
Senior secured loan describes a is a loan that has priority over other debts in case of borrower default, and is backed by collateral.
SOFR
SOFR, or the secured overnight financing rate, is a broad measure of the cost of borrowing cash overnight, collateralized by Treasury securities.
Spread
Spread is the percentage difference in current yields of various classes of fixed income securities versus treasury bonds or another benchmark bond measure
Spread Tiering
Spread tiering refers to different CLO managers being able to finance their CLO at different rates.
Syndicated Loans
Syndicated loans are underwritten by banks, rated by nationally recognized statistical ratings organizations and often traded by market participants.
Tranche
Tranche is a portion of a CLO or other structured financial product that is divided by varying levels of risk, return, and priority of repayment.
WAS
WAS stands for weighted average spread of the loan portfolio.
Yield
Yield is income returned on investment, such as the interest received from holding a security. The yield is usually expressed as an annual percentage rate based on the investment’s cost.