Pimco plans to dive into CLOs for first time in a decade

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The subprime mortgage meltdown turned Pacific Investment Management Co. off the CLO business for a decade. Now the coronavirus crisis is luring it back.

The investment firm has stayed away from the business of packaging and selling collateralized loan obligations in recent years because of lax lending standards and shrinking margins. That could change as the pandemic sparks a wave of defaults, purging the loan market of its excesses, said Josh Anderson, a managing director at the firm’s Newport Beach, California headquarters.

In the aftermath, lenders with the available firepower will be able to charge higher borrowing costs, toughen underwriting standards and be pickier about what they buy. Anderson said Pimco could issue a CLO later this year, the first time that’s happened since 2006.

“We have been positioning for a shakeout in the CLO market given the similarities with subprime,” he said. “We’ve been staffing up for years but we’re finally here. Hopefully our patience and resources will pay off.”

Anderson says the rapid rise of CLOs over the past decade has created a recipe for disaster. As sales surged, lending safeguards were eroded in defiance of warnings from regulators that the market was piling ever-higher debt loads onto fragile balance sheets. To some, that echoed the run-up to the financial crisis, when Wall Street fed the housing boom-and-bust with its zeal for selling collateralized debt.

The CDOs that blew up the global financial system in 2007 and 2008 were pools of loans to consumers, rather than the businesses that underpin CLOs of today. But just like then, an economic downturn threatens to expose the problems of allowing debt to proliferate in the most vulnerable parts of the economy.

Some of the biggest CLOs are heavily exposed to industries like leisure, retail and energy, which UBS Group AG strategists caution are likely to languish even after shutdown measures are eased.

In the new era of austerity wrought by the coronavirus pandemic, Anderson expects borrowers to beef up covenants and protections on deals they bring to market.

“With risk premiums being wider it’s likely you won’t have to stretch and buy weaker credits to make deals work,” he said. “CLOs will be more discriminating going forward.”

Bloomberg News