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Firm Attorneys Author Three-Part CLO Series in Bloomberg Law

October 28, 2020

Patterson Belknap Partners Harry Sandick and Jason Vitullo, Associates Jacqueline Bonneau and Nathan Monroe-Yavneh, and members of Bates White Economic Consulting, authored a three-part series in Bloomberg Law concerning collateralized loan obligations (CLOs). CLOs are a structured finance product involving the securitization of a pool of leveraged commercial loans and issuance of debt and equity securities backed by the loan cashflows.

Part I provides a primer on the structure and features of collateralized loan obligations, including the main participants in the CLO market and key transaction documents. Part II analyzes the rapid expansion of the collateralized loan obligation market following the 2008 financial crisis and leading up to the current, pandemic-induced downturn and introduces certain legal consequences of this activity. Part III addresses specific legal disputes that may arise between CLO market participants. 

Part I: CLO Structures, Risks, and Participants

Just over a decade ago, the U.S. economy was brought to its knees by the collapse of the housing market and complex structured finance products such as residential mortgage-backed securities (RMBS), with reverberations around the world. In recent years, a steady drumbeat of economic and legal commentators have declared CLOs to be the “next RMBS,” and sounded the alarm about the potential similar ripple effects of a failure of the CLO market. That drumbeat has begun to reach a fever pitch given the unanticipated and substantial additional stress placed on CLOs due to the global coronavirus pandemic.

If these structured finance products begin to fail in significant numbers, litigation between CLO participants is likely to follow. Before that happens, it is critical for CLO participants—as well as others who may be impacted by a collapse of these products—to understand their rights and obligations and the potential legal claims that could arise if CLOs are indeed the “next RMBS.”

To continue reading Part I, please click here.

Part II: Trends in CLO Collateral and Performance

Prior to the 2008 financial crisis, CLOs constituted a relatively small portion of the U.S. structured finance market, which had been dominated by the more well-known residential mortgage backed securities (RMBS) and other asset backed securities (ABS) such as collateralized debt obligations (CDOs). The significant demand for CLOs over the last decade has in part been driven by the higher returns offered by CLOs compared to other fixed incomes products, along with a perception that CLOs are relatively safe based on historical performance. However, recent vintages of CLOs are not necessarily of the same quality as those that survived the last financial crisis. Moreover, many CLOs have exposure to the industries and collateral hardest-hit by the ongoing coronavirus pandemic. These issues require diligence and prompt action by participants in the CLO market not only to manage the economic fallout, but also to preserve potential legal claims and defenses.

To continue reading Part II, please click here

Part III: Potential Legal Claims Among CLO Participants

In the unprecedented fallout and continuing economic devastation of the coronavirus pandemic, an increase in litigation could soon engulf the recently red-hot world of CLOs. These cases may involve claims by CLO participants that the performance of those securities is not merely a byproduct of broader economic misfortune, but rather a consequence of misconduct in the selection and management of the collateral, or a failure to enforce contractual rights, that amounts to a breach of contract or fraud. 

The final part of this series discusses the types of disputes and legal claims that could arise among CLO participants, and the steps that CLO participants may need to take to preserve potential claims and defenses.

To continue reading Part III, please click here.