The slicing and dicing of corporate debt is once again causing ripple effects in financial markets.
Most of the investment world had no idea what a collateralised debt obligation was before CDOs nearly blew up the global financial system in 2008.But if you think CDOs have been consigned to the history books, you’re wrong. CDOs, or rather their more upstanding relatives, collateralised loan obligations, are alive and well. Once again, they’re becoming relevant as rapidly rising interest rates create convulsions in credit markets.
The Class A investor gets paid first, and accepts a lower return, and so on, while the lowest ranking noteholders provide the buffer against losses.The excess cash from the interest received on the loans less the financing paid to the debt investors accumulates, and represents the profit of the equity investor in the CLO. It’s really not dissimilar to a bank.
All of this creates incentives for managers of CLOs to keep the quality of their pool in good shape and to deal with loans of deteriorating quality.The net effect is that ratings downgrades of loans held by CLOs is creating selling pressure in the large US and European credit markets. That’s leading to price drops, and increasing the borrowing costs for new deals in the market.
There’s already evidence of deals being pulled, and recognition that those that were completed relied on the previously favourable backdrop.At this week’s Australian Financial Review property summit Blackstone’s head of real estate Chris Tynancollapse of KKR’s tilt for Ramsay Health Care
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