Structured Credit Bubble 2.0: Asian Investors Binge On "Boom-And-Bust" CLOs; Issuance Up 97% YoY

Tyler Durden's picture

Back in 2006, some of the wall street banks (ahem, Goldman) managed to layoff quite a bit of their mortgage risk to unwitting European and Asian investors who, in their desperate 'search for yield', had no idea they had just been conned into stepping in front of a freight train.  Now, it seems that the same thing may be happening yet again with another favorite wall street structured product, Collateralized Loan Obligations (CLOs).

According to Bloomberg, money managers in Korea, Japan and China are piling into CLOs, and often into the most junior tranches no less, at an alarming rate which has resulted in a staggering 97% increase in YoY new issuance volume.

Faced with near record-low interest rates at home, money managers in Korea, Japan and China have been piling into complex and increasingly risky structured loan products in America. Their investments in collateralized loan obligations -- including the high-yield “equity’’ tranches most exposed to defaults -- have helped drive a doubling of issuance in 2017.


The bets have performed well so far. But some observers worry that Asian buyers are overlooking risks. Headwinds in the retail and energy sectors have raised the specter of defaults, while Moody’s Investors Service has stopped evaluating one type of CLO product amid concern that buyers will end up holding less creditworthy positions than they anticipated.


“CLOs are a difficult investment universe, and CLO equity is a boom-and-bust product,’’ said Mike Terwilliger, a New York-based portfolio manager at Resource America Inc., which oversees more than $9 billion and invests in CLOs. “Investors need to make sure they’re being adequately compensated.’’


“U.S. CLO equity is starting to look a little less attractive,” Tyler said. “Investors may want to lighten up on this space before there’s a turn in the credit cycle given the illiquid nature of CLO structures.”

Meanwhile, non-U.S. money managers’ share of American CLO tranches with single-A credit ratings more than tripled to 21% last year, mostly due to surging demand from Asia, according to Citigroup Inc.

Korea Post, which manages about $102 billion of savings and insurance products, said in March it had been adding to CLO holdings. Japan Post Bank Co. has made plans to boost exposure to the safest tranches, people familiar with the matter said in January. Gopher Asset Management, a Chinese investment firm that oversees $17.5 billion, is currently raising money for a second global credit fund that may invest in CLOs, said Chief Investment Officer PV Wang.


Some “super-aggressive’’ Korean funds are buying equity tranches, according to Eugene Chun, who helps manage about $100 million of CLOs as a Seoul-based executive managing director at HDC Asset Management. Others are purchasing what’s known as combination notes, Chun said. The products blend investment grade and equity tranches to deliver higher yields while still maintaining adequate credit ratings.

Helped by strong Asian demand, CLO issuance has totaled about $32 billion so far this year, up 97% from the same period in 2016, according to data compiled by Bloomberg.

Of course, the reasoning is fairly simple and quite familiar for those of us who lived through the 'great recession'.  With all-in yields on even the riskiest U.S. debt hovering at just over 5.5%, much lower than even the 2006/2007 bubble levels...



...wall street has a convenient product that takes 'safe' levered loans, packages them up in a nice little bundle and then sells them to folks all over the world with juicy yields and an investment grade rating.  It's a win-win-win...lower risk, higher yield and IG rating...



Haven't we seen this movie before?

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Terminus C's picture

Yes, we've seen this movie quite a few times in history.

Extend and pretend.

At this point what difference does it make?

knukles's picture

Probably not a hell of a lot.  A or BBB layers, maybe aftermarkets for, workouts, real big spreads. 
Equity layers?  Best way to unload them would be to re-bundle all the good equity layers and re-sell them as restructured un-fucking godly equity risk take a flyer shit Remember the Alamo deal.

Now that, ladies and gentlemen, is a true example of down and dirty but still falls short of a royal skull-fucking.

Biden/Clinton 2020
maniacal laughter

We're already in hell.  Don't tell anybody.  It's a secret

BetterRalph's picture

I've done "Structured Programming" so a Structured Bubble must be a pre-meditated criminal act.

JerseyJoe's picture

Sucker everyone in so all of these countries have reasons to prop-up the dollar?   Swallow that hook just a little deeper.   The financial version of MAD.    




meta-trader's picture

you can add an extra 1500/USD week after week in your income just working on the internet for a couple of hours each day... check this link...

SoDamnMad's picture

"restructured un-fucking godly equity risk take a flyer shit Remember the Alamo deal".  That is a mouthful. Kudos Kukles.

I wonder how that comes out translated in Japanese?  I am sure with an Armani suit and a big smile you could get that to roll off the tongue to a rich old pensioner.

Chris88's picture

Article is utterly clueless.  CLO cumulative impairment rate from 1/96 - 5/12 is literally 1.43%.  CLO equity investors that held on through the crisis made outsized returns, the highest IRR CLO vintage was 2007.  4 years reinvestment (now 5 with current resets) is pretty damn attractive with a CPR of 25% in a dislocated loan market.  CLO equity makes greater cash returns with greater volatility, it also can benefit from spreads narrowing with refinances on the debt tranches.  

Last year AAA was pricing with discount margins of around 150-160 bps, as of March they were pricing 110-115 bps.  This is even lower in Europe, and there is a great deal of CLO debt demand from Europe/Asia.  How many cash flow CLOs defaulted in the crisis?  Anyone?  When someone finds a cash flow CLO that defaulted, please let me know.  When these instruments breached the junior O/C cushion tests and cash flow was cut off to equity, they paid down the debt waterfall, delevered, and reinvested the now redirected cash flow from not making equity distirbutions and purchased loans at 20, 30 cents on the dollar that later recovered.  This is why the 2007 vintages have the highest IRR of any vintages in history.

Retarded article.  BTW, ZeroHedge, stop conflating high yield bonds with leveraged loans, they are not the same.  Loans float, bonds don't, loans have a recovery rate (long-term) that is over 30 percentage points higher than bonds, loans have covenants/cash flow sweeps (granted broadly syndicated loans are now largely cov-lite).  When you want somebody that actually understands structured credit and leveraged finance to write an article you give me a shout.

fremannx's picture

" When someone finds a cash flow CLO that defaulted, please let me know."


That's the same logic Bernanke et al. used in 2006 for explaining the rise of CMOs. It was bullsh*t then and it's bullsh*t now. When the dominoes start to fall, and they will, you will have all the evidence you need.


"CLO equity investors that held on through the crisis made outsized returns, the highest IRR CLO vintage was 2007."


 Tell that to the little village in Norway. Counterparties don't stick around saying "I think I'll ride this crisis out." They run for the hills like everyone else. Those that held on were fools for doing so and lucky their products even made it through the collapse. Most didn't make it.


"When you want somebody that actually understands structured credit and leveraged finance to write an article you give me a shout."


No thanks.

Chris88's picture

Except that CMOs are a totally different, as are CDOs, and as were the now dinosaur market value CLO.  You just hear "C [blank] O" and assume it's bad, because you're willfully ignorant and itnellectually lazy.  The difference between what I am saying versus him is that I have the benefit of hindsight - I am telling you impairment/default rates from time periods inclusive of the crisis.  This is apparently lost on you.  What cash flow CLO default ruined a village in Norway?  Oh, wait, that had nothing to do with any of my arguments, that was your bullshit appeal to emotion because you're trying to argue something you're laughably clueless about.  Why you insisted on opening your mouth and showing everyone here you're a moron is beyond me.

fremannx's picture

The principle structures are the same. You create traunches of awful crap packaged with highly rated crap, leverage it so complexly the rating agencies have no idea what's in them and hope the good stuff doesn't take a dump. Just like the CDOs, SPVs, CMOs, etc., went south in 2008, so will the CLOs in the next crisis. It will be deja vu all over again. 

The debt market is on the verge of collapse. We are, at best, months away from an implosion of the debt markets that will make the last crisis seem tame by comparison. Collateralized loans, of any type, will go south with bonds, the stock markets, commodities, oil, even metals. Your precious CLOs are't going to "ride out" anything. They will however be worth almost the value of the paper they're written on. 

We seem to disagree less about the nature of the product than the future of the markets. My argument is that no leveraged structure can withstand the coming economic crisis. When the value of the collateral of anything goes to zero, it doesn't take genius to know what happens next.

Chris88's picture

The principle structure is substantially different.  The fact you try to claim they are remotely similar demonstrates you never invested in, put together, analyzed, or sold structured credit.  I do not know why you insist on arguing over something you are on obviously ignorant of.  Cash flow CLOs have reinvestment optionality and are not marked to market, OC/IC tests are based upon part, not FV. If you cannot understand that those are significantly different I don't know what you tell you.  The CLOs sure rode out the financial crisis great, highest IRR vintages were 2007.  How's your theory explain that?

fremannx's picture

Last post. The loan markets depend on the underlying collateral being substantially stable through any perturbations of the financial economy. It matters not which three letter acronym is discussed. Any loan gone bad is only salvageable to the degree something is left to resell to compensate for the losses. That some CLOs survived the 2008 collapse is not surprising given that the primary fault of the collapse was sub-prime real estate, other types collateral survived much better. That won't happen this time. 

A trillion and a half of uncollateralized student loan debt and about as much credit card debt, will overwhelm the debt markets this time and nothing, repeat nothing, will survive... not even CLOs.

Final word is yours.

Chris88's picture

Right, and leveraged loan defaults peaked at 12% in 2009, with a recovery rate of around 70% for a loss-given default rate of around 3.6%. My oh my, what a disaster. If the underlying collateral is so bad, why is the recovery rate on US leveraged loans 70% for a period that includes a financial crisis and spans over 2 decades? Unanswered. If dislocation in loan markets would implode CLOs, why are 2007 vintages the highest IRR?  Unanswered.  How do you assume BSL defaults pick up meaningfully, to be even half of what they were in 2009, when the mezz piece of loan structures is a fifth of what it was, cov-lite prevents technical default, and there is no maturity wall until 2020 and even that one is staggered?  Unanswered.  

You don't have any idea what's going to happen, because you cannot even wrap your head around what already happened.  You think structures between CLOs/CDOs/CMOs are similar, which is a statement that would get you laughed out of any structured credit/leveraged finance shop on the Street.  You cannot answer the most basic questions posed to you, you have not directly answered a single thing I asked.  Again, you never 1) analyzed 2) created 3) minvested in or 4) sold structured credit, so again, why do you insist on having an uninformed opinion?  Student loans don't go into CLOs, genius, CLOs have middle market leveraged loans, they are cash flow based loans to US middle market companies, broadly syndicated (borrowers have EBTITDA of at least $100M) .  All you did was embarass yourself, stick to what you know in the future.  

fremannx's picture

Chris, take a chill pill, man. We disagree. That's okay. One of us will be proven right, the other wrong. Now we wait. If I'm right, it will take less than a year to bear me out. Any longer than that... you win.