“Deals Resume in Sale of Risky Loan Funds” The WSJ, Tuesday June 30, 2020, B9.
CLO sales cross $34 billion YTD, $5 billion in June alone as investors re-enter the risky loans market. The Fed’s corporate debt buying program is catalyzing U.S. investor appetite seeking higher spreads ( AAA at LIBOR+1.65) , even as Japanese institutional investors curtail risk taking and have been pulling back.
In 2020 CLO investors need to be especially hands-on to understand the origination processes, servicers, borrowers and quality of underlying collateral. Quality and performance of the underlying collateral is worsening materially more than expected, suggesting that the underwriting process did not consider severity of coronacrisis induced slowdown. In many cases originators had created loans primarily for sale and retained little, if any, interest in ongoing performance. Investors also need to get more deeply involved in the information cycle where excessive reliance on lagging ratings doesn’t help. In the 2008 global financial crisis default and delinquency data was artificially low because of extend and pretend and refinancing. Reliance on historical performance data and statistical models and stress test is insufficient. Investors need to manage the risk that their models are becoming irrelevant to changing conditions in the underlying loans space.