Pimco Fires Warning Shot: CLO Losses Will Surpass Prior Cycles

May 30 2019, 3:52 AMMay 30 2019, 8:09 AMMay 30 2019, 3:52 AMMay 30 2019, 8:09 AM

(Bloomberg) -- Collateralized loan obligations, popular with Japanese lenders and yield-starved investors in other parts of the world, will hand investors bigger losses in the next cycle downturn, according to Pacific Investment Management Co.’s Beth Maclean.

The warning that bundled leveraged loans will be the hardest hit part of the loan market during the next slump comes as these structured securities face increased scrutiny by regulators. Still, those losses in a $1 trillion market would be small when compared to declines regularly seen in stock markets, she said.

“Those losses are going to be borne primarily by CLO equity investors,” MacLean, a bank loan portfolio manager in the firm’s Newport Beach office, said in a Bloomberg Radio interview earlier this week. “CLOs own two-thirds of the loan market and CLO equity is the first loss. So even in that scenario where you have 15% cumulative losses, most of that actually hits just the CLO equity, and maybe the BBs.”

Read why Pimco says the credit market is probably riskiest ever

In the next cycle, that could amount to $150 billion in losses.

“That’s not unmeaningful but think about what the FAANG stocks lose sometimes in an afternoon,” she said. “If you put it in perspective that’s not that big.”