Just when you thought most of the bad news was out in the open, another ugly problem raises its head.
Remember collateralized loan obligations? They last got press because investment banks were stuck with a whole bunch of them as unsold inventory, and their erosion in value was wreaking havoc on investment bank balance sheets.
CLOs are tranched pools of loans. Generally, the main, sometimes sole holdings would be pieces of LBO loan, although some contained pieces of commercial real estate loans or tranches of other CLOs.
Standard & Poors now warns that these pools did not distribute risk as well as buyer thought. As the Financial Times story reports, buying several CLOs did not necessarily lead to diversification, since many of the same names were sold into many pools. The rating agency regards the problem as sufficiently acute as to be invoking the “systemic risk” bugaboo.
And where were they when these deals were being structured? Shouldn’t this wee problem have crossed their mind then?
From the Financial Times:
Investors in about €80bn ($102bn) of debt issued by complex structured loan funds could be at greater risk of losses than they realise if only a few companies default on their debt.
Standard & Poor’s has highlighted that many collateralised loan obligations – which pool leveraged loans and sell differently rated investment notes with varying risk profiles – have exposure to the same group of borrowers. The default of just one of these widely held borrowers on their debt could have a negative effect on the credit quality of the portfolios of nearly 90 per cent of European CLOs, the agency said in a report.
In fact, the debt of just 35 different borrowers appears in nearly half of the 184 CLO portfolios that S&P rates. In total, those funds hold at least €90bn in assets…
“CLOs defaulting presents a potential systemic risk for leveraged loans. If rating agencies start downgrading ratings and shadow ratings for leveraged loans, then CLOs may suffer significantly as a result,” said Simon Davies, managing director in Blackstone’s debt restructuring team. He added this could lead to unwinding of CLOs which could further depress loan prices.