tag:blogger.com,1999:blog-3847775060570505785.post1700345928056417963..comments2024-01-09T01:47:48.175-05:00Comments on Finance Guy: The Ratings Charade Continues: A CLO Investigation, Part IFinance Guyhttp://www.blogger.com/profile/00610439870760091838noreply@blogger.comBlogger8125tag:blogger.com,1999:blog-3847775060570505785.post-52762751629957547212015-04-08T11:08:28.621-04:002015-04-08T11:08:28.621-04:00It's been a long time since this article was r...It's been a long time since this article was released but I just wanted to make something clear. CLOs are not my specialties but I think you should consider the illiquidity risk which is clearly different than the credit risk. We all know CLO's assets are far less liquid than any leveraged loan traded in the market...Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-3847775060570505785.post-48141141912474400922013-04-06T10:29:45.594-04:002013-04-06T10:29:45.594-04:00Your first point: If AAA spreads for CLOs are curr...Your first point: If AAA spreads for CLOs are currently 110-115, that would argue for less mis-rating now than there was when I originally wrote this post. Still, regular AAA debt is closer to 30, so the gap is still significant.<br /><br />Your second point: This is a good one, and I will revise the post above to reflect the need to adjust for the call option. But the big question is: What is that option worth?<br /><br />Measuring the value of embedded call options isn’t my specialty. But it appears that such an option isn’t all that valuable. Take this Wells Fargo note: CUSIP 94986RJD4. At the moment, it’s effectively 6-year debt with a simple call option in 2 years. The option-adjusted spread suggests the option is worth 18.5 basis points. Or, if you prefer a longer-dated note: CUSIP EI7197557. The issuer is Bank of America, and it matures in 13 years, with a call in 3 years. The option-adjusted spread suggests that call is worth 39.9 basis points.<br /><br />Of course those examples aren’t CLO tranches, but regular debt. For CLOs though, the call seems to be worth even less. Babson Capital Management studied credit spreads of CLO bonds and found in the first quarter of 2007, they were 22 - 26 bps for the triple A tranche. So even if you assume the investor is assigning negligible credit risk (say 10 basis points, which is paltry) to the asset itself, that leaves only 12 to 16 bps for the call option. (Caveats: I’m not 100% certain Babson didn’t already remove the option value from its spread numbers, though it appears unlikely. Second caveat: the value of a call will vary over time, of course, depending on volatility of interest rates, along with expectations of whether they’ll fall or rise.)<br /><br />So, relating this to the example above -- if you subtract somewhere from 12 to 40 basis points for the call option, you get a good 152 to 180 bps of mis-rating -- which is still a lot. But look, even if you ignore the “over-rating” argument I’m making above, the fact that structuring fees and other costs are shaving 7% off the revenue stream that the loan is kicking out is going to automatically suggest that there will have to be some mis-rating (through clever use of models, and misapplied theories of diversification, etc.) to make this investment palatable to buyers.Finance Guyhttps://www.blogger.com/profile/00610439870760091838noreply@blogger.comtag:blogger.com,1999:blog-3847775060570505785.post-11850335776603229972013-03-18T20:28:22.447-04:002013-03-18T20:28:22.447-04:00Never bothered to check the date this was publishe...Never bothered to check the date this was published, but point 2 stands.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-3847775060570505785.post-38126374633606917132013-03-18T20:27:11.846-04:002013-03-18T20:27:11.846-04:001: AAA spreads are much tighter than 150, currentl...1: AAA spreads are much tighter than 150, currently at 110-115.<br /><br />2: AAA Government Notes (bonds) generally 10 year pieces of paper, that do not have call options. AAA CLO paper is being priced with a call option, b/c the AAA investor assumes their paper (debt) will be called by the deal earlier (through a refinance or another measure). This call option adds X basis points to the deal, which is why AAA debt trades rather high currently.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-3847775060570505785.post-21381944952146487532012-07-04T06:38:27.931-04:002012-07-04T06:38:27.931-04:00Yes, I've heard that argument many times befor...Yes, I've heard that argument many times before. But it's not my point. Is your tinderbox house flame retardant because the fire trucks extinguish a blaze before it hits your front porch? Bernanke's unprecedented central bank activism saved a lot of assets that were probably heading for the crapper.<br /><br />My larger point is that the ratings have to be wrong. You can't extract as many fees as the securitization machine does and have enough yield left over to properly compensate investors for the risks they are taking (assuming you believe in a reasonably efficient market). Leveraged loans in particular will be heavily exposed and highly cross-correlated in a sharp market downturn, giving them a decidedly non-AAA vulnerability.<br /><br />But look: the proof is in the pudding. If the AAA CLOs are really AAA, they should trade close to Treasuries, reflecting their near-risklessness. But they don't. (See above.) And for the heck of it, I checked out a recent CLO; the AAA slice was being priced at 150 basis points over Libor, which is roughly comparable (after making a Libor-Treasury adjustment) to an A or A+ corporate credit, some five levels below AAA.<br /><br />The market clearly doesn't see this stuff as triple A. Rather it's "triple A" (wink, wink).Finance Guyhttps://www.blogger.com/profile/00610439870760091838noreply@blogger.comtag:blogger.com,1999:blog-3847775060570505785.post-67579843699242115042012-06-25T17:36:10.497-04:002012-06-25T17:36:10.497-04:00So tell me, Finance Guy - how much credit losses h...So tell me, Finance Guy - how much credit losses have been substained to date on the senior-most, originally 'AAA' rated CLO bonds? Closer to zero than the train wreck that you are preaching, no?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-3847775060570505785.post-29274272325445089642012-02-12T06:28:40.397-05:002012-02-12T06:28:40.397-05:00Welcome, Sifma.Welcome, Sifma.Finance Guyhttps://www.blogger.com/profile/00610439870760091838noreply@blogger.comtag:blogger.com,1999:blog-3847775060570505785.post-789409030692741832012-02-11T20:28:08.547-05:002012-02-11T20:28:08.547-05:00you are an idiotyou are an idiotAnonymousnoreply@blogger.com