Collateralized Loan Obligations

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garlandwhizzer
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Collateralized Loan Obligations

Post by garlandwhizzer » Sun Nov 04, 2018 1:32 pm

A new and increasingly popular Wall Street invention. They'll hold up until we hit a recession but what happens then? Hope it doesn't turn out like like CDOs did.
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aspirit
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Re: Collateralized Loan Obligations

Post by aspirit » Sun Nov 04, 2018 2:09 pm

Yes, a standard observation suggests history does not repeat itself, but it does rhyme. :wink:
Time & tides wait for no one. A man has to know his limitations. | "Give me control of a nation's money and I care not who makes it's laws" | — Mayer Amschel Bauer Rothschild ~

FedGuy
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Re: Collateralized Loan Obligations

Post by FedGuy » Sun Nov 04, 2018 2:18 pm

These are not new. They pre-date the financial crisis by quite a bit.

Valuethinker
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Re: Collateralized Loan Obligations

Post by Valuethinker » Sun Nov 04, 2018 4:11 pm

FedGuy wrote:
Sun Nov 04, 2018 2:18 pm
These are not new. They pre-date the financial crisis by quite a bit.
https://www.pinebridge.com/insights/inv ... complexity

late 1980s looks like

firefloat
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Re: Collateralized Loan Obligations

Post by firefloat » Sun Nov 04, 2018 4:26 pm

CDOs are making a comeback too, there has been a large growth in issuance but it's still only about half of what it was pre-financial crisis.

JohnFiscal
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Re: Collateralized Loan Obligations

Post by JohnFiscal » Sun Nov 04, 2018 4:29 pm

I remember reading skeptical articles in Barron's about CDOs, et al, back in the 1980's. I'm glad I didn't buy into any of those. They've come back to haunt the economy several times.

I think that's where/when I learned the word "tranche".

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garlandwhizzer
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Re: Collateralized Loan Obligations

Post by garlandwhizzer » Sun Nov 04, 2018 6:57 pm

I don't think we face the same kind of systemic financial risk now that we had in the housing bubble. I do believe that after a long bull market (9+yrs) in which risk taking in many areas has been well rewarded, investors may have allowed their portfolios to drift toward risker areas. Personally, I do not fully understand complex financial products like CDOs and CLOs and I avoid them. In general I believe stretching for yield in fixed income with junk bonds, CDOs, and CLOs will likely to work until it doesn't. When a recession hits we'll find out how safe these instruments really are. The central thing for investors to avoid is discovering their true risk tolerance in the depths of a recession/bear market with panic selling. If you don't fully understand these products--and I believe that few non-professional investors do--it's probably best to avoid them. Wall Street is always creating new financial products to generate fees and profits. Sometimes they don't foresee in today's interdependent and interconnected global economy how quickly and thoroughly financial disaster can spread from one apparently isolated area after the happy music stops.

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fennewaldaj
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Re: Collateralized Loan Obligations

Post by fennewaldaj » Sun Nov 04, 2018 7:02 pm

garlandwhizzer wrote:
Sun Nov 04, 2018 6:57 pm
I don't think we face the same kind of systemic financial risk now that we had in the housing bubble. I do believe that after a long bull market (9+yrs) in which risk taking in many areas has been well rewarded, investors may have allowed their portfolios to drift toward risker areas. Personally, I do not fully understand complex financial products like CDOs and CLOs and I avoid them. In general I believe stretching for yield in fixed income with junk bonds, CDOs, and CLOs will likely to work until it doesn't. When a recession hits we'll find out how safe these instruments really are. The central thing for investors to avoid is discovering their true risk tolerance in the depths of a recession/bear market with panic selling. If you don't fully understand these products--and I believe that few non-professional investors do--it's probably best to avoid them. Wall Street is always creating new financial products to generate fees and profits. Sometimes they don't foresee in today's interdependent and interconnected global economy how quickly and thoroughly financial disaster can spread from one apparently isolated area after the happy music stops.

Garland Whizzer
Yeah I am not a fan of complex structured products as its hard for a normal person to really see the risk (and apparently hared for professional investors too). Junk bonds are pretty straight forward on the other hand.

nyclon
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Re: Collateralized Loan Obligations

Post by nyclon » Sun Nov 04, 2018 7:42 pm

CLOs actually outperformed most asset classes right through the Great Recession and through today. They've done very well and for several years have surpassed their precrisis issuance levels. Banks are doing very well with them.

One big issue as of late pertains to their collateral - many loans are being issued with light weight covenants, meaning default rates may increase with vintages that have those assets in their portfolios.

These structures certainly exacerbate issues which stem from low rates / too much liquidity.

Valuethinker
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Re: Collateralized Loan Obligations

Post by Valuethinker » Mon Nov 05, 2018 8:57 am

nyclon wrote:
Sun Nov 04, 2018 7:42 pm
CLOs actually outperformed most asset classes right through the Great Recession and through today. They've done very well and for several years have surpassed their precrisis issuance levels. Banks are doing very well with them.

One big issue as of late pertains to their collateral - many loans are being issued with light weight covenants, meaning default rates may increase with vintages that have those assets in their portfolios.

These structures certainly exacerbate issues which stem from low rates / too much liquidity.
I think Moody's and S&P have both written re "cov lite" on leveraged loans.

Traditionally these were safer than HY bonds - earlier repayment of principal & rank ahead in the credit rating.

What I think you are driving at (and I agree) is that at this late stage in the credit cycle, the safety of these assets is beginning to be questionable. Structures have been stretched, and skewed in favour of the borrower, to meet the demand for yield out there. That demand may have become indiscriminate.

And so the credit cycle turns. Sometime in the next 0-48 months, we are likely to see some real blowups. Money imprudently lent on a "pass the parcel" principle, which then winds up burning the hands of whomsoever winds up holding the bag. Shades of the Michael Lewis line "what is it that all the dumbest debt investors in the world were all within 60 miles of Dusseldorf?*" -- the collapse of German financial institutions in the Great Financial Crisis, and the hurried bailout.

My impression is that it is not sufficiently large to take the system down with it (a la Lehman) but I am not in possession of any special knowledge or expertise.

* the dumbest bankers in the world were all within 5 miles of Hollyrood Castle in Edinburgh, Scotland. RBS & HBOS senior management. Briefly one of the world's (top 3) banks by assets and one of the top 25. Just obliterated.

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AtlasShrugged?
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Re: Collateralized Loan Obligations

Post by AtlasShrugged? » Mon Nov 05, 2018 12:23 pm

A new and increasingly popular Wall Street invention. They'll hold up until we hit a recession but what happens then? Hope it doesn't turn out like like CDOs did.
Garland....Pretty confident it will have the same ending as CDOs. Are they really all that different (CDO vs CLO)? Not to me.
“If you don't know, the thing to do is not to get scared, but to learn.”

edgeagg
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Re: Collateralized Loan Obligations

Post by edgeagg » Mon Nov 05, 2018 1:14 pm

To be clear, though, it was CDS (Credit Default Swaps) that really accelerated the financial crisis caused by the CDOs - which brought more and more risky mortgages to the market.The CDS market in 2004 was $6T and over $60T in 2007. CDS were not visible on balance sheets and so an accurate measure of institutional financial risk was not available. So when the subprime MBS started to default no-one knew what others exposure was and a decrease in counterparty trust.

Do we know if there is a similar inflation in CLOs and their risk profile? I don't know the answer. Perhaps someone else here has better knowledge.

OhBoyUhoh
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Re: Collateralized Loan Obligations

Post by OhBoyUhoh » Wed Jun 10, 2020 1:01 pm

Detailed analysis of CLOs in today's environment in theatlantic.com.

Interesting read but im not smart enough to know what changes if any to make.

https://www.theatlantic.com/magazine/ar ... se/612247/


--Will

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