Collateralized Debt Obligations (CDO’s) are a type of structured financing in which loans are funded based on the cash flow generated by specified company assets. The cash flow producing assets then stand as collateral to secure the funds loaned to the business. While this basic description may sound relatively simple, the actual structure of a CDO can be extremely complex.
One of the reasons for this structural complexity is that CDO’s are divided into different risk classes, also known as “tranches”. Each “tranche” carries a varying degree of risk with the senior tranche being the most secure sector of the loan pool. Next in line are the subordinated tranches which, because they carry higher payment and default risk, offer higher interest rates and/or lower prices.
These subordinated tranches act as shock absorbers for the senior tranche by accepting payments of interest and principle only after obligations to the senior tranche have been satisfied. The subordinated part of the loan pool can have its own hierarchy where, once payments are made to the senior note holders, certain subordinated tranches can receive payments before other subordinated holders. Still, in cases where interest and/or principle payments are not sufficient to cover all tranches in the pool, subordinated debt holders may end up with disproportionately large losses while holders of the senior tranche can, at least in theory, be made whole.
Businesses utilizing CDO’s for access to capital general see the following benefits:
- The potential for approval when traditional loans aren’t available.
- A faster timeline than traditional loans from inception to funding
- Lower overall interest rates
Structured finance using CDO’s is often the lifeline businesses seek when other methods of obtaining needed capital are unavailable. As structured by Dmitrij Harder and the team at Solvo Group, access to capital can be achieved faster and cheaper than traditional methods.