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CDO Market Lowlights


As of mid-March, about $36 billion of loans has been made this year, more than in the previous 10 years combined...


The June edition of Bloomberg Magazine carries a piece raising several warnings about the current m.o. in the Collateralized Debt Obligations (CDO) market. These are the same kind of "issues" many of us in the 'Ville spotted for more than two years in the subprime mortgage and housing areas, and for two years what we wrote provided a seemingly endless supply of comic relief. Until of course the whole thing came down as the house of cards that it was, and the rest, as they say, is history. So in the spirit of keeping readers laughing for the next two years (perhaps more, perhaps less), here are some of the CDO lowlights identified by Bloomberg:

  • CDOs are financing a record number of corporate loans to low-rated borrowers that forego standard investor protections... As of mid-March, about $36 billion of loans has been made this year, more than in the previous 10 years combined...

  • When you talk about no-documentation loans, you can't have any less of an [underwriting] standard than that. Lenders lower their standards and tell themselves they can put the loans in the CDOs... like that's somehow burying its toxic waste.

  • Investors need to worry a good bit about subprime delinquencies spilling over into the CDO market. The scenario where the BBB's all blow up is a reasonably possible scenario.

  • The Dallas Police & Fire Pension Fund invested in its first CDO about two years ago to boost returns, according to Richard Tettament, administrator of the $3.2 bln fund. "We were beefing up our risk, and we were hoping for a greater return," Tettament says. "We have an unfunded liability to pay off." Tettament says he isn't sure what type of collateral backs the CDO, though he thinks returns exceeded 20 percent last year.

Let me see if I understand the thought process in the last paragraph: if returns are low and you are trailing your hurdle rate, the solution is: jack up the risk, start hoping, avoid finding out what your higher risk investment consists of, and don't bother finding out whether the higher risk has actually resulted in a higher return. So that's the way to work yourself to the helm of $3.2 billion dollars!!!

If a Bloomberg piece is not enough to convince you, you might want to consider that serious concerns about current corporate lending standards have recently been echoed by the likes of the founder of the Carlyle Group, the annual IMF Global Financial Stability Report (which is being pushed by most managed care providers as a formidable substitute to Lunesta), and lastly by Blackrock's CEO Larry Fink, who recently suggested that "standards of lending to highly-indebted companies "have deteriorated to levels that we never… dreamt we would see."

Just boys crying wolf I suppose.

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