Our analysis suggests UK banks have small exposures to securitisations of leveraged loans via collateralised loan obligations (CLOs). But global banks, particularly US and Japanese, have more significant exposures to CLOs.
This analysis was presented to the FPC as part of their 2018 Q4 round.
Demand for collateralised loan obligations (CLOs) has fuelled the rapid growth in leveraged lending.
CLOs are securitisations where highly leveraged business loans are bundled up and sold in tranches to different investors.
Our analysis shows UK banks have small exposures to CLOs while global bank exposures are more significant (Chart A).
In the banking sector, US and Japanese banks have the largest CLO holdings.
The CLO market, valued at US$750 billion, is popular with Asian investors searching for yield. This could be a global channel for spillovers.
Unlike banks, other investors such as open-ended funds are more likely to invest in riskier tranches of the securitisations.
Open-ended funds can be a source of risk because investors can withdraw funding at short notice, creating potential for fire sale dynamics. If many investors seek to withdraw their funding at the same time, the fund could struggle to sell assets in time to meet the investors’ wants. This risk increases if demand for underlying investments such as CLOs is low.
Regulatory and underwriting standards of securitisations like CLOs have improved since the financial crisis. But CLOs are complex products. It’s uncertain how resilient they will be to an economic stress, which could lead to unexpected losses for investors.
For more detail see our November 2018 Financial Stability Report.