Smart investors realised pooled corporate credit investments spread the risk across a wide range of borrowers, and following the 2008 Global Financial Crisis there were surprisingly few corporate defaults. In fact, as rates tumbled lower investment grade and junk debt performed strongly – making CLOs even more attractive. CLOs are now a $750 bln global market. 

But the CLO sausage factory needs constantly fed with new debt to keep churning out new product... Therein lies danger...

Most of the loans making up CLOs are junk leveraged loans – the AAA tranches get paid the interest and principal first and face the lowest risk, while profits go to the CLO equity holders. The theory is simple – although a few loans might go bust in a pool, the others will cover the losses. Have you heard that thinking before?

If you are thinking sub-prime.. give yourself a pat on the back. 

Suddenly there a host of doomsters warning of imminent crisis in CLOs. Bloomberg says Norinchuckin Bank has exited a large part of its CLO book following new financial regulations and greater regulator scrutiny. The Bank of Japan warned its bank charges about ratings and prices of CLOs being vulnerable to substantial falls if market conditions change. Japanese banks are said to hold 15% of the CLO market. Norinchuckin has been one of the largest players in the market – some estimates say it accounts for nearly 10% of the total market!