The vehicle that finances a large portion of leveraged companies globally is issuing even more significant warning signs than those observed during the pandemic.
Let's get to the basics
What are CLOs?
CLOs (Collateralized Loan Obligations) are structures that bundle hundreds of corporate loans and sell them in tranches to institutional investors. Think of them as "more sophisticated relatives" of the CDOs of the 2008 crisis. In the US, they represent approximately US$1 trillion in assets, divided into:
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US$900 billion in the reinvestment period (actively managed, meaning the manager can exchange low-quality loans for better ones);
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US$100 billion OUTSIDE THE REINVESTMENT PERIOD (frozen portfolios, with no possibility of altering the loans).
What do I need to know? CLOs that have exited the reinvestment period, when managers can no longer replace low-quality loans with better ones, have a default rate of 40%. This means that the value of the loans no longer covers the CLO's obligations, and payment on the riskiest tranches is suspended.
Key Points:
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The divergence reflects a credit quality issue, not a liquidity issue. IMPORTANT!
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As more CLOs exit the reinvestment period, pressure has increased.
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Loan downgrades are accelerating weekly.
CONCLUSION:
If you have exposure to credit, high-yield, or global private debt funds, it's worth asking yourself:
"What percentage of the CLOs in my portfolio are frozen versus actively managed?"
This discussion is happening right now in the best Multi-Family Offices.