Big banks left on hold after ‘catastrophe’ in subprime lending market

The big banks that help asset managers embed risky loans into investment products are sitting on billions of dollars in debt tied to companies most exposed to an economic downturn.

Lenders on both sides of the Atlantic have over 100 lines of credit open to vehicles known as Secured Loan Bonds, which are among the largest sources of funds for businesses that do not have ratings. premium credit, according to people familiar with the arrangements.

Funds such as the debt-investing arms of private equity firms Blackstone and Carlyle are the biggest managers of these CLOs, which have made great strides since the last financial crisis as traditional lenders pulled back more lending. risky.

Investment banks still have exposure, however, as they provide “warehouse lines” to CLO managers who help them build loan portfolios. The value of those assets fell this month, amid growing doubts about the ability of heavily indebted companies to withstand the big hits in the economy.

The effects on the CLO market have been “a disaster,” said Chris Acito, managing director of Gapstow Capital Partners, which invests in these vehicles.

Between March 1 and March 20, the credit ratings of around 140 issuers with loans held in US CLOs were either downgraded or warned of possible downgrades, with a share representing around 10% of total assets. of CLOs under management.

“It’s quite remarkable to see what’s going on right now,” Mr. Acito said.

Bankers, investors and lawyers involved in the CLO business estimate that there are 40 to 50 of these warehouse lines in circulation in Europe, and around 60 in the larger US market.

CLO managers use the lines to fill in gaps before raising funds in the asset-backed bond market, sliced ​​into variable security installments. The riskiest items are hit first if businesses don’t repay their loans.

Active warehouse lenders include large banks such as Citigroup and Credit Suisse, which provide CLOs with temporary facilities and then earn commissions by selling the asset-backed bonds to investors.

But when the bond market seizes up, as it does now, banks can get stuck taking the risk longer than expected, putting their balance sheets on the line. Lenders have also largely moved away from including once-standard protections that would allow them to withdraw lines if the value of the underlying business loans were to drop sharply.

“It appears that most of the CLO managers have relatively long maturities on their warehouses, at least an additional 12 to 18 months, and most of them do not have mark-to-mark triggers,” said Aza Teeuwen, portfolio manager at TwentyFour Asset Management.

While banks have fewer leverage when the loan market deteriorates, a CLO manager took matters into his own hands earlier this month.

Ellington Management, a Connecticut-based fund manager, put nearly € 70 million of higher-risk corporate debt on the block in mid-March, according to investors who were approached to buy the loans, as he sought to repay part of a warehouse line from British bank Barclays.

The bulk of the loans Ellington has sought to abandon since his first European CLO was to NSO Group, a controversial Israeli cybersecurity firm, which has come under fire for helping governments hack WhatsApp messages.

Ellington has sold a large chunk of the loans, but it is still looking to rebuild its first European CLO and its warehouse line has not been liquidated, according to two people familiar with the matter.

Ellington has carved out a niche in the United States for so-called “enhanced CLOs,” which buy loans riskier than a typical CLO. A November report from a rating agency said Ellington’s European warehouse was backed by more than 20% of highly speculative ‘triple-C’ rated loans – nearly triple the levels CLO managers normally aim for .

Ellington and Barclays declined to comment.

Priscilla C. Carnegie