The CLO is part of the structured credit market. The corporate loan market at roughly 1.2 trillion is the loan pool source for the CLO or collateralized loan market. To be more specific, we are looking at broadly syndicated leveraged loans, which are loans of a certain value, typically greater than 350 million that are issued by publicly rated companies and underwritten by a lead bank and then sold off to other banks or institutional investors. We see that there is a great variety in the industries where the company loans are made and sourced. The majority of all corporate loans are sub investment grade, which means the yield on the debt is very appealing, but it also makes them riskier as a standalone credit. However, if we build a special purpose vehicle or SPV and pool 100 or 200 of the loans as they often do, we would then diversify the risk away from exposure to one single credit and benefit from the cash flows of the broader pool. We would also gain diversity in terms of both industry and credit quality, including the size of the loans made to each borrower. There are two other very important qualities of the leveraged corporate loan market, one, seniority and two security. The majority of loans to the sub investment grade market are senior in terms of payment and secured by either a first or second lien on the assets. Senior first lien loans make up the bulk of the loans purchased by CLO issuers. About one half of these loans, or 600 million will end up in the CLO market. With our diverse asset pool in place, we can now look back at the right side of the balance sheet and examine how the securities each representing different levels of risk are created. The original source loans are cashflow generating and that they pay regular interest in principle, when due. Those cash flows are passed on to the security holders. This is done using a payment waterfall in accordance with the seniority of the securities. The tripe A securities sit at the top and are guaranteed payment first, followed by the tranches below. We'll take a closer look at the waterfall in a moment. The equity tranche has the residual claim on all the cash flows. This sectioning of risk makes it possible to market the securities to different investors. The potential losses in case of default flow from the bottom up, the opposite of the payment waterfall. Who are the investors in secured products like CLOs? At the top in the triple A tranche called class A in securitization parlance, we have banks and money managers. The triple A rating of this class A is important for banks in the calculation of balance sheet risk metrics. This is for regulatory purposes. The AA rated or class B tranche is most heavily invested in by big insurance companies. We see more money managers and banks also investing in the smaller tranches of the A and triple B rated, known as Class C and Class D. For the sub investment grade and equity tranches. We see the private capital firms such as hedge funds and also public investment vehicles like Business Development Corps or BDCs. Most sponsors of the CLO Fund will also invest in the equity trash, and in some cases the CLO asset managers. Those who manage the pool of loans are required to invest there as well. There has been changing legislation in the US about forcing the CLO asset managers to own significant pieces of these deals. Locked up risk retention funds are the managers of the funds. These are required investments by fund sponsors to maintain financial interest usually around five to 10% of the entire CLO. A CMV or capitalized management vehicle is a tax structure, typically an LLC or partnership between the collateral manager and the CLO itself. Collateral managers typically have to raise this money as they're not funded to make significant investments, but rather their asset managers. Some investors in CLOs, particularly in Europe, require this locked up risk retention investment.
