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Synthetic CLOs Using TRS Increase

Synthetic collateralized loan obligations using total return swaps are becoming increasingly popular.

Synthetic collateralized loan obligations using total return swaps are becoming increasingly popular. The structures, which focus on generating and keeping excess spread, are being used more often in the tight spread environment, according to Inna Yulman, director at Fitch Ratings.

The transactions are typically four to six times levered and give access to a portfolio of senior secured loans. Their primary form of credit enhancement is the excess spread between the costs of financing the reference portfolio and the interest and fees generated by the loans, Yulman said.

These transactions differ from traditional CLOs in that they issue two to three classes of mezzanine securities rated single-A to triple-B, instead of issuing securities through the full capital structure. They also use market value performance tests instead of overcollateralization and interest coverage tests, she noted.

Yulman said she expects more of these transactions because of growing demand. "[TRS CLOs] seem like a good investment because returns were good in the past and default levels have been fairly low," she said.

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