Why CLO’s Matter (Part Two)

After publication last week, we were concerned we had been a bit rough on our bank friends in dismissing the ability of regulated institutions to adapt as readily as CLO’s when loans became troubled.

An informal survey of those friends revealed that, if anything, we had been too generous.

“You were spot on with your comments,” one long-time loan syndication head told us. “The fact is that banks do fine with double-B and high single-B credits, but our ability to ride through difficulties with lower credit quality assets is extremely limited.”

“Banks just don’t have a lot of flexibility in terms of managing longer-term portfolio problems,” the work-out chief of a regional bank remarked. “To optimize recovery value in a work-out situation,” he went on, “you sometimes have to convert debt to equity. That’s tough to do on a bank balance sheet, but in a CLO, it’s done all the time.”

A money-center banker added, “Once a loan goes to work-out, other factors come into play. Relationship considerations with the sponsor at a local level may get trumped by senior management just wanting to get out of a bad loan. Patience wears thin quickly for a criticized asset.”