Credit Market Fall-Out #12 – The CLO Market is All But Shut Down

This article from Market Watch discusses the CDO market (mortgages) and its effects on CLOs. Basically the demand for these types of debt instruments is coming to a close. It will take some time for the markets to clarify, that is determine who is going to take the losses in the CDO markets, before demand for CDOs and CLOs increases. As a result of this uncertainty in the credit markets expect more bad days in the stock markets.

The market for Collateralized Loan Obligations has almost shut down in recent weeks, making loans for leveraged buyouts and corporate borrowing harder to sell, experts said Thursday.

CLOs are packages of leveraged loans that are sold by investment banks to hedge funds and other institutional investors. Roughly $100 billion of the vehicles were issued in 2006 and about $58 billion were sold in the first half of 2007, according to Steven Miller, managing director of Standard & Poor's Leveraged Commentary & Data.

The fast-growing market helped fuel the leveraged buyout boom in recent years, which in turn has been a major driver of stock market gains. However, that trend has stopped abruptly in recent weeks, Miller and others said.

"It's absolutely shut down for any new CLOs in the last two weeks," said Kingman Penniman, president of KDP Investment Advisors, an independent research firm focused on high-yield bonds and leverage loans.

Existing CLO deals continue to progress, Miller said, "but the market for brand new deals getting a financing line and warehousing has shut."

"That's very important," Miller added. "The CLO market has been the cornerstone of the leveraged loan market. Lower demand from CLOs means it's harder to sell loans."

Part of the problem is that many of the natural buyers of CLOs also bought Collateralized Debt Obligations (CDOs), KDP's Penniman said.

CDOs are a bit like mutual funds that buy asset-backed securities. Those vehicles snapped up a lot of the riskier bits of subprime mortgage-backed securities in recent years, helping to fuel the housing market boom. But subprime mortgage delinquencies have jumped and some CDOs have been downgraded, leaving investors suffering losses.

"When these investors started to realized there were problems and losses in CDOs, that caused widespread concern and risk aversion that basically shut down the CLO market," Penniman explained.

Another concern for investors is that there are more than $200 billion of leveraged loans and about $100 billion of high-yield bonds that need to be sold in coming months, many of which will help finance leveraged buyouts that have already been announced, Penniman and others noted.

"Investors are holding back, knowing dealers have large inventories," Chris Flanagan, head of global structured finance research at J.P. Morgan Chase

"Investors are still grappling with the implications of subprime turmoil" and remain "unwilling to step in until there is more clarity," he added.