Pimco Says CLO Losses Will Surpass Those in Prior Cycles

(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. Cumulative leveraged loan default rates in last few cycles were 25% to 30%, with about 70% recovery, MacLean said. In the next cycle, assuming the same cumulative default rate with 60%-65% recovery, there will be increased losses for investors, she said.

“Those losses are going to be borne primarily by CLO equity investors,” MacLean, a bank loan portfolio manager in the Pimco’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, with a scenario of 50% recovery, there would be $150 billion in leveraged loan losses, MacLean said. That’s still a small figure relative to losses in equity markets, she pointed out.

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