Aug. 26 (Bloomberg) -- Loans that default in middle-market collateralized loan obligations may have greater impact than assets in CLOs that bundle debt from larger companies, making the selection of a manager more important, according to Wells Fargo & Co.
In broadly syndicated CLOs, “from a AAA investor perspective, you’d need massive defaults with very low recoveries to cause a principal loss,” according to Dave Preston, a Wells Fargo analyst. “In a middle market CLO, because the assets are unique to that CLO, you’re depending on the manager more,” said Preston in an Aug. 22 telephone interview.
Managers in the $2.3 billion middle-market CLO segment often originate and underwrite the loans included, making the debt exclusive to the CLO. That means a single loan defaulting will have a greater impact, Preston said.
CLOs with larger loans in the portfolio typically have more commonality among the loans in the AAA portion and the pool of debt is also larger, which provides greater protection, Preston said.
In both cases, the number of defaults required to cause a loss of principle in the AAA portions is high, he said. There are fewer loans in a middle market CLO, so that each asset is more important, Preston said.
Rising demand helped push CLO issuance in the broadly syndicated market to $60.6 billion globally this year, the most since 2007, according to JPMorgan Chase & Co.
CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return.
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