Bloomberg News

CLO Market Would Weather a Default by Greece, Wells Fargo Says

September 30, 2011

Sept. 30 (Bloomberg) -- Collateralized loan obligations will be able to weather an economic slowdown and there’s unlikely to be a flood of sales even if Greece defaults, according to analysts at Wells Fargo & Co.

European banks are more likely to use CLOs as security for loans from central banks or foreign lenders should the financial crisis deteriorate, analysts led by Charlotte, North Carolina- based David Preston wrote in a research note yesterday. Lenders in the region hold as much as $100 billion of top-rated CLOs, or about 50 percent to 70 percent of all triple A issuance, according to the report.

“We believe CLOs have exhibited resilience through the financial crisis, and that while a recession may push prices down, CLOs should be able to withstand a slowdown,” according to the report. “This is not to discard the possibility that European banks may take a more measured approach to their CLO holdings and slowly sell them over the next two to three years” as they need to raise capital, the analysts wrote.

Global markets have been roiled by Europe’s sovereign debt crisis that has already forced Greece, Portugal and Ireland to seek international bailouts. The government in Athens is struggling to meet the conditions of a deficit-cutting program to ensure it gets its latest emergency loan of 8 billion euros ($11 billion) and avoids the euro-region’s first national default.

Attracting Buyers

CLOs will be resilient because the corporate default rate is likely to stay low for the next 12 months and sales would drive spreads wider, attracting buyers, according to the analysts. AA rated notes offer the best value while junior- ranked mezzanine tranches will be attractive to investors who aren’t worried about short-term price movements, they wrote.

“Insurance companies, U.S. banks and even high-grade accounts will likely re-enter the sector should prices drop substantially,” according to the report.

Spreads have widened this year, with BB rated tranches of U.S. CLOs climbing to about 1,300 basis points, from about 900 at the end of June and AA portions at 450 basis points from about 300, according to Wells Fargo. Top-rated super-senior CLO spreads jumped to 175 basis points from 150.

CLOs package high-yield loans into securities of varying risk and return, including equity portions designed to absorb losses first and protect holders of top-rated bonds.

--Editors: Paul Armstrong, Cecile Gutscher

To contact the reporter on this story: Patricia Kuo in London at pkuo2@bloomberg.net

To contact the editor responsible for this story: Faris Khan at fkhan33@bloomberg.net


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