Babson Capital Management Chairman and Chief Executive Tom Finke used his keynote address at a CLO industry conference event in New York Tuesday to present a takedown of criticisms of the collateralized loan obligation market, most notably a recent article that equated CLOs to the collateralized debt obligations and mortgage-backed securities that fueled the financial crisis of 2008.
Finke called the article in Fortune magazine “salacious” and “false advertising” in its description of CLOs as “pretty much like” the residential mortgage-backed CDOs that imploded six years ago, or of having a “curiously high” percentage of AAA-rated tranches of securitized loans from speculative-grade companies. The article blamed regulators for “slack government oversight,” and concluded that securitized investments in junk-status companies “aren’t safe investments. If the economy turns— boom, game over.”
“Those are pretty strong words,” said Finke, barely containing his disdain in his keynote address at the Information Management Network’s CLO Industry conference before approximately 1,600 investors, bankers and capital management professionals. “The only way to refute such salacious words is for us to become better proponents of our own industry, and also I think to clearly understand what the differences are.”
The article, “Collateralized Loan Obligations: Our Next Financial Nightmare,” was published this month.
“We are at a crossroads,” said Finke, who has led Babson since 2008 and overseen an expansion of the Charlotte, N.C.-based global investment firm to just under $200 billion in assets. “As an industry we need to invest in a big issue with our market, and that’s a lack of understanding.”
Finke presented his own slides to counter the article, showing that long-term default rates in CLOs dating back 20 years have been negligible, at 2.61% for the lowest-rated B tranches and 2.26% for BB-rated bonds, and non-existent for the highest-rated. “The long-term default experience of CLOs in AAA and AA tranches is exceptional,” Finke said. Despite high levels of corporate defaults after the tech bubble crash of 2000 and the financial crisis six years ago, “senior bondholders [in CLOs] have not experienced personal loss.”
Finke also defended the structural basis of CLOs, which unlike vintage-2007 residential-backed mortgage securities are comprised of assets governed by financial covenants and providing recourse to lenders and investors. “RMBS investors had no transparency” in what they bought, following years of lax, aggressive lending practices, Finke said.
In contrast, managers of CLOs can evaluate and select the assets they invest in. “And furthermore, leveraged loans are still heavily scrutinized by many parties,” he said. “From the underwriting bank’s credit committees to the ratings agencies” and to loan managers themselves.
Finke noted the article did not detail the higher leverage levels of RMBSs or the broader levels of asset diversity within CLOs (in both industry sectors and geography, such as RMBS portfolios dominated by home mortgage originations in Florida and California).
Finke also pointed out few outside the industry take note of the impact a CLO manager’s role and decisions can make in a portfolio’s performance, particularly with their legal fiduciary duties and the multitude of ways managers can earn fees outside of deal structure or investment criteria.
“This is just one article of many we’ve seen out there,” said Finke. “I think it’s just as important that as an industry that we think about how we’re representing the CLO market and the leveraged market outside of conferences like these.
“We need a healthy leveraged loan market,” he added. “The country needs it to finance capital investment. “The problem is the people, the people being the regulators, the government, the popular press, just see leverage and they’re natural reaction to the articles like this is, that’s just Wall Street.”