[Financial World in Fear] Is the Lehman-like Crisis Again Caused by 'CLO' (Collateralized Loan Obligations)?
Hello, this is Kusuyama.
Without further ado, when you see this news, what do you feel?
↓
＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝
'Norinchukin: CLO balance turning to increase for the first time in two quarters; end of December at 8 trillion yen'
(Bloomberg
https://www.bloomberg.co.jp/news/articles/2020-02-04/-12-k67jwb10
more)
＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝
For those who do not know CLOs,
this news might seem irrelevant.
On the other hand,there are those who feel a strong “fear.”
It is said that CLOs are one of the financial products currently viewed as the most dangerous in the financial markets.
We will explain CLOs later, but
there are whispers that if a situation arises where CLOs explode,
it could trigger a financial crisis surpassing Lehman Brothers.
This is the kind of high risk CLOs pose.
The fact that a public financial institution like Nogincho Bank holds 8 trillion yen in CLOs...
is noteworthy.
Moreover, the source of Nogincho Bank’s funds is, of course, deposits.
Nogincho Bank manages deposits from 10.51 million JA members nationwide.
(
https://www.nochubank.or.jp/about/business/retail.html
)
For those who have deposits in JA, the deposits may be exposed to high risks—this is the reality.
By the way,recently when I typed"Nokin Chogin"
into Yahoo Search and pressed space,
the keyword"Nokin Chogin collapse"
appeared at the top of the search results.
This suggests that many people are worried about the risks of Nogincho Bank's investments.
＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝
What is a CLO?
＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝
“History repeats itself.”
This is something I have consistently conveyed in recent newsletters,
and if the next major financial crisis were to occur,
the likelihood of this CLO acting as the trigger is high.
So, what is a CLO?
I will explain briefly.
First, one question.
What is the biggest worry for a company?
Cash flow.
A company goes bankrupt when it cannot meet its financing obligations.
Even if profits are good,
if you cannot pay what you owe, you go bankrupt.
But even low-credit companies have a chance to borrow money,
which is natural.
However,there remains a possibility for low-credit companies
to borrow money.
That isthe “Leveraged Loan.”
Interest rates are high, buteven with low credit, you can borrow.
Thus,since the Lehman shock,
the Leveraged Loan expanded rapidly.
Of course,
loans to low-credit companies carry higher repayment risk,
but
Such high-risk Leveraged Loans were securitized.
That isCLOs.
In other words, CLOs are financial products whose underlying assets are high-risk
loan claims.
Just hearing about it sounds dangerous.
But there are people who want CLOs.
Because the interest rates are high.
Holding CLOs allows you to receive the principal and interest repaid by the companies,
but since these are loans to low-credit companies,
the interest rates are high.
This product is mainly owned by financial institutions and institutional investors.
In other words, to earn the spread,in Japan Nogincho Bank and
Mitsubishi UFJ Financial Group,
and Japan Post Bank also hold CLOs in large quantities.
By the way,the Bank of Japan published a Financial System Report last October,
which statesthat the total CLO holdings by Japanese financial institutions
amount to about 12.7 trillion yen,
which corresponds to about 15% of the global CLO supply.
(Reference: “Financial System Report”https://www.boj.or.jp/research/brp/fsr/data/fsr191024a.pdf）
CLOs are basically created in America, but
if CLOs go bad, Japan will not remain unscathed.
＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝
The current situation resembles the Lehman era before the crisis.
＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝
And the frightening thing is
that this situation now resembles the lead-up to Lehman,which means the risk could be high.
As I explained, lending to low-credit companies
has the potential to cause problems.
Doesn’t that ring a bell?
The subprime loans of Lehman times were similar.
Subprime loans were housing loans to low-credit individuals,
and the common thread was that the borrowers had low credit.
During Lehman,
the loan assets backed by low-credit borrowers, such as
mortgage-backed securities (RMBS) or
collateralized debt obligations (CDO),
were created,
and as housing loan defaults surged around 2007,
the institutions holding RMBS and CDO suffered huge losses,
leading straight to the Lehman collapse.This time,if repayments from low-credit companies stall,
the institutions holding CLOs will inevitably suffer heavy losses.
“But surely Nogincho Bank won’t go bankrupt,”
you might think,
but considering what happened to Lehman Brothers,
no one can say Nogincho Bank is absolutely safe.
＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝
Is 99% AAA rating really safe?
＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝＝
By the way,how bad it is
is illustrated bythe Bank of Japan report mentioned earlier,
which notes that
“99% of CLOs held by major banks are AAA.”
Also,subprime loans were
loans to individuals, whereas Leveraged Loans are
loans to companies,so compared to individuals,
the likelihood of repayment default is lower.
But that is only a possibility,
and the AAA rating does not guarantee safety,
as humanity learned in the Lehman crisis.
In any case,
given the Fed's money-printing,
we cannot say the global economy is stable,
and at some point in the future a financial crisis will occur.
However, there is no need to fear unnecessarily.
If you are wise,you would rather try to turn that downturn into an opportunity for profit.
Please take care as well.
With that, please enjoy the rest of today as well.
Keizo Shimoyama
