Signs Of The Top? Chinese Demand For 10x Levered Structured Products Surges In US... Again

In the run up to the "great recession" of 2008/2009, it was unsuspecting European and Asian buyers that supplied the marginal capital required to turn America"s plain vanilla, fed-induced housing bubble into a turbo-charged, global financial time bomb by indiscriminately scooping up highly-levered structured mortgage products with absolutely no idea what was behind those products.

Now, it seems that China"s lust for levered returns in U.S. structured products has returned and is focused this time around on the CLO market.  Per Bloomberg: 

Now, a new set of buyers from China are hoping things turn out differently. Instead of snapping up packages of risky derivatives tied to U.S. home loans, they’re buying collateralized loan obligations that bundle together corporate loans to highly leveraged companies. And while such CLOs weathered the last crisis relatively well, there’s already concern that these investors are being tempted to deploy leverage to amplify their returns.

 

On a recent trip to China, potential new investors expressed interest in the idea of applying leverage for the purchase of CLOs, even at the riskier BB level, Chan said. He estimates levered returns for the BB-rated CLO slice may be almost 20 percent. Leverage is employed using the repo financing market, where short-term loans allow investors to borrow money by lending securities.

 

"Over the last 18 months, Chinese investors have shown a marked increase in interest, awareness, and desire to be educated about CLOs, and they’re a pretty sophisticated audience,” said John Popp, global head and chief investment officer of the Credit Investments Group at Credit Suisse Asset Management. The company has $46 billion in assets under management, including CLOs that have a market value of $18.3 billion.

 

“They’ve really learned the product quickly and engage in extensive due diligence,” Popp said. “I expect to see them as steady and growing participants in the CLO market, not as tourists.”

Even though Chinese investors have yet to enter the CLO market en masse, Mitsubishi UFJ believes they could effectively double the demand for CLO new issues in a matter of just 5 years.

In some cases, investment banks and CLO managers have made as many as five trips to Asia this year, adding on special CLO-focused investor conferences in mainland China for the first time ever to raise the product’s profile. The demand to diversify into dollar assets has grown from a wide range of investors, despite Chinese-government capital controls limiting deployment of capital abroad.

 

While Japanese, Korean, Singaporean and Taiwanese investors have been buyers of U.S. CLOs for many years -- even pre-crisis deals, in the case of Japan and Korea -- mainland China is still a relatively nascent, untapped market.

 

“Mainland China is the last market for us to focus on, and we’ve been there four times already this year,” CIFC’s Wriedt said.

 

In contrast to other Asian investors, the Chinese are more willing to invest deeper down the capital structure, or even in the riskiest equity piece.

 

The Chinese investor base for CLOs may be equal to the U.S. in five years’ time if capital controls are relaxed, MUFG’s Khan said. More than $106 billion of new U.S. CLOs have priced so far this year, and the vast majority of investors are still U.S.-based. Potential Chinese investors include quasi-sovereign or insurance companies, so "even a small percentage of what they will do will lead to a large capital infusion," Khan said.

Of course, not everyone is convinced that investing in 10x levered structured products is such a great idea with yields on highly-levered bank debt hovering around all-time lows...

“It wouldn’t be wise for the Chinese to use leverage at this stage,”
said Asif Khan, head of CLO origination and distribution at MUFG. “It’s

dangerous territory. Leveraging BB-rated bonds - is that a good idea?

Any potential use of leverage by Chinese investors could pose potential

risk in case of severe volatility.”

...but what"s the worst that can happen?  It"s not as if Lehman Brothers can liquidate again...

Structured Credit Bubble 2.0: Asian Investors Binge On "Boom-And-Bust" CLOs; Issuance Up 97% YoY

Back in 2006, some of the wall street banks (ahem, Goldman) managed to layoff quite a bit of their mortgage risk to unwitting European and Asian investors who, in their desperate "search for yield", had no idea they had just been conned into stepping in front of a freight train.  Now, it seems that the same thing may be happening yet again with another favorite wall street structured product, Collateralized Loan Obligations (CLOs).

According to Bloomberg, money managers in Korea, Japan and China are piling into CLOs, and often into the most junior tranches no less, at an alarming rate which has resulted in a staggering 97% increase in YoY new issuance volume.

Faced with near record-low interest rates at home, money managers in Korea, Japan and China have been piling into complex and increasingly risky structured loan products in America. Their investments in collateralized loan obligations -- including the high-yield “equity’’ tranches most exposed to defaults -- have helped drive a doubling of issuance in 2017.

The bets have performed well so far. But some observers worry that Asian buyers are overlooking risks. Headwinds in the retail and energy sectors have raised the specter of defaults, while Moody’s Investors Service has stopped evaluating one type of CLO product amid concern that buyers will end up holding less creditworthy positions than they anticipated.

“CLOs are a difficult investment universe, and CLO equity is a boom-and-bust product,’’ said Mike Terwilliger, a New York-based portfolio manager at Resource America Inc., which oversees more than $9 billion and invests in CLOs. “Investors need to make sure they’re being adequately compensated.’’

“U.S. CLO equity is starting to look a little less attractive,” Tyler said. “Investors may want to lighten up on this space before there’s a turn in the credit cycle given the illiquid nature of CLO structures.”

Meanwhile, non-U.S. money managers’ share of American CLO tranches with single-A credit ratings more than tripled to 21% last year, mostly due to surging demand from Asia, according to Citigroup Inc.

Korea Post, which manages about $102 billion of savings and insurance products, said in March it had been adding to CLO holdings. Japan Post Bank Co. has made plans to boost exposure to the safest tranches, people familiar with the matter said in January. Gopher Asset Management, a Chinese investment firm that oversees $17.5 billion, is currently raising money for a second global credit fund that may invest in CLOs, said Chief Investment Officer PV Wang.

Some “super-aggressive’’ Korean funds are buying equity tranches, according to Eugene Chun, who helps manage about $100 million of CLOs as a Seoul-based executive managing director at HDC Asset Management. Others are purchasing what’s known as combination notes, Chun said. The products blend investment grade and equity tranches to deliver higher yields while still maintaining adequate credit ratings.

Helped by strong Asian demand, CLO issuance has totaled about $32 billion so far this year, up 97% from the same period in 2016, according to data compiled by Bloomberg.

Of course, the reasoning is fairly simple and quite familiar for those of us who lived through the "great recession".  With all-in yields on even the riskiest U.S. debt hovering at just over 5.5%, much lower than even the 2006/2007 bubble levels...

...wall street has a convenient product that takes "safe" levered loans, packages them up in a nice little bundle and then sells them to folks all over the world with juicy yields and an investment grade rating.  It"s a win-win-win...lower risk, higher yield and IG rating...

Haven"t we seen this movie before?