In last Thursday’s video I said the following, with regard to present under-the-surface risks compared to what we faced leading into the last “great recession”:
“…we are going to have to be very thoughtful, very attentive, to the underlying corporate debt market. I can tell you this, it looks a lot like the mortgage backed securities market; where the consumer was in 2006, 7, leading into the 2008 disaster — but it’s all in the corporate sector.”
“…all of the activity that’s going on in the private equity market, the leveraged loan scenario is a scary one — and it’s in these collateralized loan obligations (CLOs). Remember back in ’08 it was collateralized mortgage obligations (CMOs); so same animal, just different things inside of it.”
The following from this morning’s Wall Street Journal speaks to my concerns: emphasis mine…
“Some securities in the $680 billion market for collateralized loan obligations, or CLOs, lost about 5% in October, reflecting worries about rising risk in the complex investment vehicles. The declines were a rare stumble for the CLO market, which has grown by about $350 billion in the past three years, according to data from S&P Global Market Intelligence, fueled by demand from government pensions, hedge funds and other yield-hungry investors.
“We think there’s more volatility coming,” said Maggie Wang, head of U.S. CLO strategy at Citigroup.”
“CLOs resemble the mortgage-backed bonds that imploded in 2008, but very few defaulted in the credit crisis, a key driver of their recent popularity. Prices for their shares and bonds, however, plummeted at the time, and holders who sold out took heavy losses.”
Now some CLO bond prices are falling again. That is because the riskier loans the CLOs own are dropping in value as the companies that borrowed them start running out of cash. CLO bonds rated double-B, which are among the riskiest CLO securities, returned about 10% this year through June. But recent declines, especially last month, erased most of the gains, giving holders a roughly 1% return this year through October.
The fact that CLOs didn’t implode like CMOs did in 2008 is “a key driver of their recent popularity” offers me zero solace! Frankly, that’s the sort of magical thinking (‘home prices won’t go down’) that led to the 2008 disaster.