Across the $700 billion in US CLOs outstanding, pointed questions have been raised regarding the amount held by banking institutions, versus the amount held by the shadow banking system of insurance companies, asset managers, hedge funds, and other credit funds.
Lawmakers and regulatory agencies, charged with monitoring potential risks to the financial system, have expressed concern over whether enough data exists to track the holders of CLOs,
“We know $90 billion of the $700 billion in CLOs (or 13%) is held by U.S. banks, but what do we know of the remaining 87%?” one lawmaker asked during a recent Congressional hearing about systemic risks in leveraged loans and CLOs.
That data can be found through a combination of public filings, call reports by regulators to the U.S. banks, as gathered by S&P Global Market Intelligence, and additional data from Citi Research.
Banks remain big AAA buyers; more managers hold onto equity
Banks make up about 45% of the buyers in the senior-most AAA rated tranches of newly issued CLOs this year, while money managers make up 30%, and insurance companies 20%. Mutual funds and pension funds account for less than 5%, according to Citi Research analyst Maggie Wang.
Lower in the capital structure, for mezzanine tranches, money managers and insurance companies make up the lion’s share of buyers at 40% and 30%, respectively.
And in the equity, more than 80% is held by asset managers. Wang attributes this to the necessity for CLO managers to retain their own equity on deals they issue. The arbitrage, after all, has become more challenging (which has led to lower returns to equity holders, all else equal).
By comparison, in 2018 asset managers made up about 40% of the equity buyers, while hedge funds made up closer to 20% and structured credit funds 25%.

Japanese banks grow AAA holdings
Japanese banks have become some of the most active buyers of AAA rated CLO paper, as CLOs are one of the few such highly rated assets that help the banks approach a targeted return of 1%. The 20-year negative interest rate policy from the Bank of Japan has sent yields elsewhere well below that.
The 10-year Japanese government bond currently yields –0.13% while a 10-year U.S. Treasury bond after currency hedging yields –0.65%. And a recent “high-yield” bond issue for Aiful Corp. due in 1.5 years that was rated BB by a local rating agency priced with a coupon of 0.99%.
Norinchukin Bank, a cooperative for farmers and fishermen, has notably built a global portfolio of $68 billion (¥7.4 trillion) in CLO paper, up from $62.6 billion (¥6.8 trillion) at the end of 2018 and $35 billion (¥3.8 trillion) a year earlier. Its CLOs in the U.S. and Europe make up some 7% of its total investment portfolio.

Chart source: Norinchukin quarterly investor earnings presentation.
Behind Norinchukin, Japan Post Bank holds $10.6 billion in CLOs while MUFG holds another $1.6 billion. All of the banks’ holdings are limited to the senior-most AAA tranche.
The Japan Financial Services Agency (J-FSA) has taken note of the growing holdings of the banks, and has required all of them as of April 1 to provide more information on their due diligence processes. The J-FSA is attempting to ensure that the CLO manager is analyzing the different covenants and other investor protections, and that if the CLO manager is indeed retaining the risk in its transaction, that it is not also the originator of those underlying loans. The goal is to thwart the risks associated with some of the pre-crisis originate-to-distribute models.
Those regulations appear to have had an effect on the banks.
At one point in January, following a volatile end to 2018, a handful of Japanese banks were the only buyers of new CLO AAAs. The AAA tranche makes up about 60% of a CLO’s total financing costs.
The rest of the AAA buyer base, composed primarily of banks and money managers, has returned, and over the past few weeks the Japanese banks have dialed back their purchases, possibly in an effort to prove to the regulator that the market can continue to function without their presence.
CLO managers that normally may have sold a sizeable portion of the AAA tranche to the Japanese banks have instead sold to a number of buyers across the U.S. and Europe, including the treasury groups of some of the largest U.S. banks.
US bank holdings remain around $90 billion
CLOs have also drawn the interest of U.S. regulators, such as the Federal Reserve. Banks in the U.S. collectively have amassed around $90 billion of CLO holdings, as previously highlighted by Fed Governor Lael Brainard at a presentation for the Peterson Institute for International Economics in December.
Wells Fargo is the largest domestic bank buyer of CLOs, holding $34.6 billion, or about 2% of its total assets, followed by J.P. Morgan at $20.5 billion and Citi at $18.1 billion.
Other banks, including Stifel Financial, Bank of New York Mellon, TD Bank, State Street, BankUnited, PNC Financial, and Banc of California, have CLO holdings topping $1 billion.

Insurance cos. hold $122 billion; growing rapidly since 2016
Insurance companies have also been taking a more prominent role in the CLO buyer base since 2016. As of the end of 2018, they collectively owned about $122 billion, according to data released today from the National Association of Insurance Commissioners (NAIC).
Among the different insurers, life insurance companies held the majority, at $94 billion, followed by property and casualty insurers at $24 billion and health insurers at $3.5 billion.
And as analysts at Moody’s wrote last week, purchases have grown rapidly, with life insurers buying over $14 billion in 2Q18, compared to purchases that were less than $1 billion a quarter leading up to 3Q16. The pace of buying has slowed since the highs, to about $11 billion in the third quarter last year and $10 billion in the fourth quarter.
Of the insurance company holdings, 35% are rated AAA, 14% AA, 9% single-A, 8% BBB, and 2% BB, while 32% were unrated.
Firms such as Reliance Standard, Fidelity & Guaranty Life, and Global Atlantic have the highest CLO holdings as a percentage of their cash and investable assets. They range from nearly 15% for Reliance Standard to a little over 10% for Global Atlantic.
U.S. life insurers with the greatest total CLO holdings (by book value) otherwise were Prudential Financial at $6.9 billion, MassMutual with $6.6 billion, Global Atlantic with $5.5 billion, MetLife with $4.5 billion, New York Life with $3.6 billion, Great American Life with $3 billion, and Fidelity & Guaranty Life at $2.8 billion, according to S&P Global Market Intelligence.
CLOs—not CDOs
It has been over 10 years since last financial crisis and levels of corporate and securitized debt have grown quickly since then, leading to more concerns about the potential risks to the financial system.
Terms on leveraged loans have been getting more aggressive, and many of those loans (about 60% by LCD’s estimate) are being packaged into three-letter securitizations, which are then being purchased in large part by overseas investors, reminding many of the pre-2008 CDO machine, the end of which saw some tens of billions of dollars in losses across the financial system.
Yet part of the reason why a number of banks, insurance companies, and other investors have been comfortable building their holdings is that CLOs performed astoundingly well during the financial crisis, compared to the similar sounding CDOs that were often filled with fraudulently underwritten subprime mortgages.
No AAA or AA rated CLO has lost principal so far, with only 0.1% of single-A tranches, 3% of BBB tranches, and 6% of all BB rated tranches taking losses, according to Moody’s. In comparison, 43% of CDO tranches that were originally rated AAA ended up taking losses, a number that would jump to nearly 63% for tranches originally rated BB.
However, while few who focus on the market expect the same magnitude of calamity, losses could still be higher at the end of this credit cycle, as leveraged loan investors’ protections have been whittled away.
Famously, most of the $1.2 trillion U.S. leveraged loan market is now covenant-lite. By last check, cov-lite accounted for 79% of loans in the S&P/LSTA Leveraged Loan Index, and many market participants have conceded that, going forward, the recovery rates on defaulted loans will be lower than the roughly 70% historical recovery rate on first-lien, secured loans.
Still, a significant number of loans would need to default before any of the senior CLO tranches take principal losses. As research analysts at Wells Fargo, led by David Preston, have shown, assuming a historically lower recovery rate of 65%, 36% of loans would have to default before the single-B tranches start to take principal losses. That number jumps to 42% for a BB tranche and 55% in defaults before the BBB rated tranche takes a loss.
Source：LCD