In the run up to the 'great recession' of 2008/2009, it was unsuspecting European and Asian buyers that supplied the marginal capital required to turn America's plain vanilla, fed-induced housing bubble into a turbo-charged, global financial time bomb by indiscriminately scooping up highly-levered structured mortgage products with absolutely no idea what was behind those products.
Now, it seems that China's lust for levered returns in U.S. structured products has returned and is focused this time around on the CLO market. Per Bloomberg:
Now, a new set of buyers from China are hoping things turn out differently. Instead of snapping up packages of risky derivatives tied to U.S. home loans, they’re buying collateralized loan obligations that bundle together corporate loans to highly leveraged companies. And while such CLOs weathered the last crisis relatively well, there’s already concern that these investors are being tempted to deploy leverage to amplify their returns.
On a recent trip to China, potential new investors expressed interest in the idea of applying leverage for the purchase of CLOs, even at the riskier BB level, Chan said. He estimates levered returns for the BB-rated CLO slice may be almost 20 percent. Leverage is employed using the repo financing market, where short-term loans allow investors to borrow money by lending securities.
"Over the last 18 months, Chinese investors have shown a marked increase in interest, awareness, and desire to be educated about CLOs, and they’re a pretty sophisticated audience,” said John Popp, global head and chief investment officer of the Credit Investments Group at Credit Suisse Asset Management. The company has $46 billion in assets under management, including CLOs that have a market value of $18.3 billion.
“They’ve really learned the product quickly and engage in extensive due diligence,” Popp said. “I expect to see them as steady and growing participants in the CLO market, not as tourists.”
Even though Chinese investors have yet to enter the CLO market en masse, Mitsubishi UFJ believes they could effectively double the demand for CLO new issues in a matter of just 5 years.
In some cases, investment banks and CLO managers have made as many as five trips to Asia this year, adding on special CLO-focused investor conferences in mainland China for the first time ever to raise the product’s profile. The demand to diversify into dollar assets has grown from a wide range of investors, despite Chinese-government capital controls limiting deployment of capital abroad.
While Japanese, Korean, Singaporean and Taiwanese investors have been buyers of U.S. CLOs for many years -- even pre-crisis deals, in the case of Japan and Korea -- mainland China is still a relatively nascent, untapped market.
“Mainland China is the last market for us to focus on, and we’ve been there four times already this year,” CIFC’s Wriedt said.
In contrast to other Asian investors, the Chinese are more willing to invest deeper down the capital structure, or even in the riskiest equity piece.
The Chinese investor base for CLOs may be equal to the U.S. in five years’ time if capital controls are relaxed, MUFG’s Khan said. More than $106 billion of new U.S. CLOs have priced so far this year, and the vast majority of investors are still U.S.-based. Potential Chinese investors include quasi-sovereign or insurance companies, so "even a small percentage of what they will do will lead to a large capital infusion," Khan said.
Of course, not everyone is convinced that investing in 10x levered structured products is such a great idea with yields on highly-levered bank debt hovering around all-time lows...
“It wouldn’t be wise for the Chinese to use leverage at this stage,” said Asif Khan, head of CLO origination and distribution at MUFG. “It’s dangerous territory. Leveraging BB-rated bonds - is that a good idea? Any potential use of leverage by Chinese investors could pose potential risk in case of severe volatility.”
...but what's the worst that can happen? It's not as if Lehman Brothers can liquidate again...