How Do You Spell R-E-P-O With C-L-O?

• How Do You Spell R-E-P-O With C-L-O?
  by Jeffrey P. Snider, https://alhambrapartners.com/
  There’s trouble brewing in a particular sector of the corporate bond market. It’s not really new trouble, merely the continuation of doubts and angst that have existed for more than a year already. What’s different now is that it is finally causing more open disruptions, and thus sparking our interest as to what it might mean well beyond this specific market or corporate finance. Including and especially what it could do to repo.
  –
  What I’m writing about is CLO’s, or collateralized loan obligations. It’s a fancy term for securitized corporate loans. A bunch of these are pooled together in the same way mortgage loans used to be more than a decade ago. Particular tranches are assigned cash flow and loss priorities, rendering the lower parts of the structure as solid near risk-free securities.
  –
  And, in fact, they are. Even among the worst junk of the housing bubble era, the senior and super senior tranches performed admirably – just as they were designed. I’m still not aware of any that caused actual cash losses, meaning credit. “Thickness”, or the amount of loss protection provided by the tranches above them, was never the issue.
  –
  The whole point of securitization was and remains one goal. As I wrote a few months ago on the topic of repo:
  –
  We can spend an awful lot of time diagramming and detailing these instruments [ABS CDO’s; another form of securitized financial structures] and those like them, what they were used for and why banks seemed so enamored with the type. In fact, I’ve already done so elsewhere (Eurodollar University). ABS CDO’s can be of a couple different kinds but what they all have in common is that they make what is erstwhile illiquid assets into a liquid security.
  –
  What’s so important about that? In a word: repo.
  You can’t show up at JP Morgan’s repo desk with a lot of papers holding title to thousands of mortgages and expect to fund them on the basis of those individual loans. That doesn’t work. For one, the cash owner, the interbank repo lender, wants collateral that is highly liquid because that way the cash owner knows the collateral being received isn’t going to move much while in his possession.
  –
  Though the senior and super senior mortgage bond tranches weren’t realistically exposed to credit losses, they were exposed to illiquid markets and pricing schemes that were unrealistic. The repo market doesn’t care, however, an unforgiving and brutal place where all that matters to the counterparty on the other side is that pricing scheme.
  –
  read more.

end