Repackaged Junk Has Never Smelled So Sweet: JPM Forecasts Record $100 Billion In 2014 CLO Issuance

Tyler Durden's picture

If the Fed is looking for definitive proof of bubble euphoria it should look no further than the CLO market: according to Bloomberg, so far in 2014, more than $46 billion of collateralized loan obligations have been raised, after $82 billion were sold in all of 2013. As a result of this epic dash for repackaged trash, JPMorgan boosted its annual forecast for CLO issuance from $70 billion to as much as $100 billion, which means 2014 may end up as the biggest year on record. We assume it is with great irony that Bloomberg summarizes: "The business of bundling junk-rated corporate loans into top-rated securities is booming like never before after the implementation of regulation aimed at making the financial system safer."

The reason for the irony is that it was rampant CLO issuance which helped finance some of the biggest leveraged buyouts in history during the last credit boom: buyouts which in the subsequent year almost without fail flirted with bankruptcy as a result of overleveraed balance sheets and collapsing cash flows, which however found a second wind courtesy of the Fed's ZIRP policies.

Adding to the irony is that the 2014 CLO surge picked up following an early 2014 slump brought on by the publication of the Volcker Rule designed to limit risk-taking by banks which were major buyers of the funds.

This attempt to reign in risk-taking worked for a few months...

CLO sales plunged to $2.55 billion in January, the least since July 2012, according to RBS, following the December publication of the final draft of the Volcker Rule. The rule prohibits banks from investing in the debt of CLOs that own bonds.

Until a loophole was discovered:

After the market developed funds that adhered to the regulation, sales rebounded in February with $9.4 billion raised that month, RBS data show.

What happened next is not only history, it is on pace to become historic:

“The pending threat of risk retention has fueled the CLO-issuance fire,” said Wriedt. “Everyone has been highly motivated to come to market, which is why we are seeing such a plethora of deals.”


CLOs were the biggest buyers of junk-rated loans in the first quarter with 58 percent market share, the most since 2006 when they had a 61 percent share, according to a report from the LSTA, citing Standard & Poor’s Capital IQ Leveraged Commentary and Data. Retail funds came in second at 26 percent.


The deals helped propel issuance of new leveraged loans to $357 billion last year, the most on record, Bloomberg data show.

If JPM's prediction about $100 billion in CLO issuance is correct, 2014 will be an all time record year not only for CLOs but HY underwriting in general, as the yield on average "High Yield" bond drops to never before seen levels matched only by near-all time default lows.

For those lucky few who are not familiar with CLOs, here is a reminder:

CLOs pool high-yield corporate loans and slice them into securities of varying risk and return, typically from AAA ratings down to BB. The lowest portion, known as the equity tranche, offers the highest potential returns and the greatest risk because investors are the first to see their interest payouts reduced when loans backing the CLO default.

Dodd-Frank knew that as a result of Fed's disastrous policies, there would be a yield scramble and tried to forestall the inevitable scramble into securitized junk:

“New regulations, especially the Volcker Rule, have had a significant impact on banks’ participation in this market and is the primary reason CLO AAA” spreads remain wide, Matthew Natcharian, head of the structured credit team at Babson Capital Management LLC in Springfield, Massachusetts, wrote in an e-mail.


CLO managers may also be trying to issue deals ahead of risk-retention rules proposed by the Dodd-Frank Act in order to increase assets under management and income, said Kroszner. The regulation may require CLO managers to hold 5 percent of the debt they package or sell.

Sadly, it failed.

To be Volcker compliant, managers are primarily choosing to issue CLOs that are prohibited from owning bonds or can only purchase the debt at a later date if the stipulation is changed.


While the Volcker Rule hasn’t led to fewer CLOs it has kept the cost to raise the funds elevated.


The average rate paid on CLO portions ranked AAA was about 150 basis points more than the London interbank offered rate in May, according to Wells Fargo. That’s up from a spread as low as 110 basis points on AAA slices last year.

But most amusingly, none other than the Fed has warned about the scramble for repackaged junk yield: "the growth in riskier corporate lending led the Federal Reserve and the Office of the Comptroller of the Currency to warn lenders last year to improve lax underwriting practices. Todd Vermilyea, a Fed official, said May 13 that standards “have continued to deteriorate in 2014” and that “stronger supervisory action” may be needed."

Unfortunately, since picking yield pennies in front of a steamroller is all that matters in determining year end compensation, this and all other warnings will be roundly ignored until it is too late. But who says it will ever be too late: surely this time it's different and this particular credit bubble will never burst.

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JRobby's picture

Cycle of greed.

Never stops.

knukles's picture

Bundle this...
I remember when they were bundling the equity layers in questionable deals with diversification broad enough that it me Moody's and S&P's criteria for investment grade ratings.
That's equity layers, the first to transmogrify into nothingness from other structured deals.


PS  Y'all know, dontcha, that the TBTF's got a bye for about another 2 or 3 years just recently where they were otherwise gonna have to take the CLOs off their own books.  What they were doing is (Get This) taking a piss pot full of lower quality high risk loans and securitizing them with the diversification within Moody's and S&P's ratings criteria for investment grade, bundling the loans on their own books and thus, having the very same exposure but at better ratings for lower capital haircuts

They did this shit last time around, too

What Could Go Wrong #2?

zaphod's picture


Even under the absurd "austerity" and "tightening" I keep being told those evil tea baggers are forcing on the nation, the FED is still printing enough money to cover this 100% in just 1 and a half months. 

In short, yes there is a very simple answer on how JPM is able to package these "products".

Haus-Targaryen's picture

This farce of a system has a few more years in it of insanity I am quickly coming to realise.  Before the world'S central bankers drop the Mic and walk out, they are going to go full on retard in extravagant spending projects. 

Why in Gods name they insiste on building shit houses in the burbs when they could be restoring North-Central and North-Western European Cities with the same cash is beyond me.  When this shit explodes all those houses they built in the burbs as well as the shopping malls and anything else with a roof will get burned to the ground in the chaos.  Why not renovate places like Königsberg or Warsaw ... that way when the SHTF ... at least humanity will have beautiful buildings to look at and not a much larger version of Detroit?

BLOTTO's picture

Pieces of fuckin SHIT are ruling this planet...since day 1.


J.P. Morgan was scheduled to travel on the maiden voyage of the RMS Titanic, but canceled at the last minute, choosing to remain at a resort in Aix-les-Bains, France


Jumbotron's picture

It wouldn't have matter.  He would have been escorted to the first lifeboat off the ship.  Or would have shot his mother getting to it.

Farqued Up's picture

Beware of the obscure MARKIT, the money butchers' cleaver. It is also the upper tranches' friend.

medium giraffe's picture

Calvin & Poors.

How do these RA fuckers still have any credibility after '08?

Jumbotron's picture

Like a dog returning to its vomit

Bay of Pigs's picture

LONG steamrollers then?

Racer's picture

They didn't get punished the last time around so why stop?!

Colonel Klink's picture

Legalized theft with our government's approval, starting with CONgress!

yogibear's picture

JPM, Goldman, etc here's your chance to sell real trash loans and bet against them again. Just like in 2008.

Watch it blow sky-high and make money on it again.

TARP #2.

Janet Yellen and Jack Lew can storm Obama's office and threaten tanks in the street again...

Reuse Hank Paulson and Ben Bernanke's script.

maskone909's picture

mmmm smells like 2007.


so what exactly is the composition of a typical CLO?  is this how corporations are raising cash to buy back stock?

OC Sure's picture

Isn't the CLO just the sale of the spoils from theft?

All the currency loaned out above the capital reserves and conjured by the mulitplier effect is not money. The exchange between the creditor and debtor is one of nothing for something and the medium of exchange in the middle is therefore counterfeit.

If the sale of the spoils translates  into corporations 'raising cash,' then it also represents the insidous nature of corruption and how the private sector is aiding and abetting the thieves.

youngman's picture

If it has a high rate of return..any pension fund will buy looks good on the quarterly report....big bonuses too with those so called paper returns

thamnosma's picture

But why would the boards supervising the fund managers permit this?   They got reamed only a few years ago doing exactly this.

knukles's picture

Bonuses are paid annually.  Defaults not so frequently.

fonzannoon's picture

When HYG is yielding 2% we will be close to popping.

Ban KKiller's picture

I hear Ben Dover is buying. He loves laxitave underwriting. 

Nice and sunny here today in San Fran. Buses are on strike but running...for free fare! Gonna go have a smoke (illegal smoke outside, legal smoke inside) at the cigar bar on Pine. See what the plutocrats are up to. The only thing I can say is I have a better tan. One upmanship bullshit ego basting.

thamnosma's picture

Why are there buyers for this crap with the previous experience only a few years old?  I suppose it's just time to do another rape of pension funds and other institutional monies.  However, any pension fund manager who is buying into this should be fired.  Just stunning -- not that the bankster crooks would offer more of this but that anyone is interested.

FEDupwithDC's picture

I don't get all the negative sentiment on this and don't mean to single you out specifically.  However, there's a reason you diversify instead of holding one single stock in your retirement fund.  What's so bad about buying a package of debt if you're in the AAA-tranche instead of the equity?  In 2008, 8% of issuers defaulted but none of the rated tranches of CLOs did as they held several hundred names.  If you find a spread for a tranche that looks favorable to the risk of an individual name

Isn't the Volcker rule a good thing in that debt can no longer be part of these loan packages?  The bonds caused the problem in '08 while senior secured loans were for the most part ok.

RaceToTheBottom's picture

Until I see some bodies for the previous Tranch rankings, they all are suspect and just a way for .1% to squeeze more money out of the serfs

NotApplicable's picture

Diversification doesn't mean dick when the risk is systemic.

Add to that the fact that the CLOs (et al.) are one of the primary causes of the systemic risk, as they transfer it from individual entities.

Sooo... sure, they eliminate single issuer default risk, but they sure as fuck don't eliminate risk in general, as they merely obscure it as the disease spreads.

Farqued Up's picture

Thanks, but for some of us your good advice comes 5 years too late.

TrustWho's picture

Regulators are implementers of the political-corporate fascist USA government. They are all stealing folks.

TrustWho's picture

a negative vote means you believe the regulators protect the stupid citizens from the big bad billionaires.

pelican's picture

Who cares.  When the crash occurrs again, Wall Stret will get bonuses,the congress will get kick backs and the American people will get ass fucked .

Colonel Klink's picture

CLO, is that Collateralized Looting Options?

NotApplicable's picture

Well, somebody's gotta get a piece of that otherwise non-performing capital pie. Otherwise, entropy gets it all.

pelican's picture

Who cares.  When the crash occurrs again, Wall Stret will get bonuses,the congress will get kick backs and the American people will get ass fucked .

Colonel Klink's picture

By the very CONgress which is supposed to represent the citizens.  I guess it does, the dual citizens.

Farqued Up's picture

You would be well advised to pursue duality for you and your family. When the Shinola hits the air handling unit a get out of Dodge booklet may reign supreme. Commence the process now, it's not like going through the Army chow line.

yogibear's picture

Maybe if you hide it,  Iceland will buy some again. Instead of the Goldman $4,000 suits selling you have JPM suits selling. Different criminals this time.

If you let crap sit around long enough it dries out and doesn't stink.

NOTaREALmerican's picture

Ya gotta hand it them smart-n-savvy people, they sure know how to run a scam.

Yen Cross's picture

  Just throw some moar chairs out there on the floor...The music is still playing and it's last call.. Put your beer goggles on and go find the best looking pig in the dwindling crowd.

Atomizer's picture

Trash picking collateralized loan obligations to repackage pensions. Doesn’t this sound like the housing market and/or Climate disruption program?


Where is all this fucking money being allotted?  What general ledger WH/International bookkeeping received the monies under RICO law discloses? Tap the cherry table Obama.

Cthonic's picture

Who are the consumers of the sub-investment-grade tranches?

Colonel Klink's picture

Pensions and 401k as usual

css1971's picture

You know that in Germany "das Klo" is the vernacular for the toilet. So it's not like the buyers aren't being warned what they're buying.

yrbmegr's picture

Crash. Print. Repeat.

El_Duderino's picture

Majority of problems with CLOs were CDOs of mezz CLOs. Of course the reason this happens has much to do with misguded regulation and the oceans of liquidity the fed is pumping into the systems. So not saying it is natural and won't crash and burn. But just saying...

The Econ Ideal's picture

The ratings on these CLOs are meaningless. Those buying or shorting are smart to do their own due diligence. Between CLOs and the new subprime categories (e.g. auto loans, soon to be followed by another ramp in subprime mortgages) we are developing yet another ripening for a credit market bubble and bust. 

Sokhmate's picture

If you keep repackaging trash, don't you eventually get a brew?

messymerry's picture

OK, I'm confused. Did CDOs magically change their name? I hate being confused, I feel so, so, inadequate. ;-D

messymerry's picture

Ahhhh, OK, I get it. I still function mostly at the piggy bank level. The stress is less...