No, CLOs won’t cause the next banking crisis

Secured loan bonds represent less than 1% of all bank securities, but these minor bank holdings have recently gained temporary fame when investors have used an article in The Atlantic as further proof of the need to sell bank stocks.

We disagree with the central point of the article that the US banking system has a short-term problem with CLOs.

Only 137 of the 5,276 institutions insured by the Federal Deposit Insurance Corp. hold CLOs, which are technically called “structured financial products” on call reports.

Aggregate bank securities totaled $ 4.3 trillion in the first quarter, according to FDIC data. In addition, $ 2.4 trillion in cash was held on the balance sheets of all banks.

CLOs stood at $ 104 billion across all FDIC-insured banks in the United States as of March 31.

Additionally, aggregate securities and cash grew by over $ 3 trillion between the fourth quarter of 2010 and the first quarter of this year (crushing the modest $ 72 billion growth of CLOs across all FDIC banks) . We consider the risk for CLOs to be negligible for regulated banks given the limited size described in a recent report by Janney.

It is true that some leveraged loans may default, or undergo changes and tolerance today, then default later in 2020. But remember that CLOs are not static, the managers who created these securities could trade loans when or if a default occurs. .

In addition, most banks that hold CLOs tend to have issues rated AAA and AA.

CLO pricing faced temporary illiquidity during the March collapse in global financial markets, resulting in low prices for mark-to-market purposes as of March 31.

However, over the past 10 weeks, prices for CLOs have improved significantly. Banks CLO ownership is likely experience higher security prices and lower unrealized losses. This in turn translates into a higher tangible book value.

Editor’s Note: This article originally appeared, in a slightly different form, in an analyst note to clients by Janney Montgomery Scott.

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