CLOs are In; CDOs are Out

Today was the second day of a congressional hearing about the Fed’s move in supporting JP Morgan’s (JPM) takeover bid for Bear Stearns (BSC). On the one hand, Timothy Geithner, president of the NY Fed, said that the takeover was necessary to stabilize the financial markets. On the other, Alan Schwartz, Bear’s CEO, said that Bear might have survived if the Fed had acted sooner in lending money to investment banks.

Geithner also said that markets are still “substantially impaired” and that it is a “classic pattern in financial crises” of “a self-reinforcing downward spiral.". Fed chairman Bernanke said that the bailout wasn’t so much of Bear Stearns but of the market in general.

In the meantime, big investment banks have been showing how much they learned from the financial crisis by repackaging their CDOs (collateralized debt obligations) as CLOs (collateralized loan obligations) and trying to get them off their books. Lehman Brothers (LEH) is the latest in joining the game, creating the “Freedom CLO” which will hopefully free it of its CDOs and bring it into the bright new future of CLOs.

It all sounds a bit like a late April Fool’s joke: banks hoping to rid themselves of toxic CDOs they hold by repackaging them as CLOs. But Lehman is not alone; Deutsche Bank (DB) and Credit Suisse (CS) have also been busy converting CDOs into CLOs. It will be interesting to see whether there is actually any take up for these products now that they’ve been renamed, or whether investors will see through this blatant attempt at dumping their CDOs and other bad debts.

If there aren’t any takers, will the Fed end up buying them off the banks? If nothing else, it could use the paper of the Freedom CLOs to cook some Freedom Fries.

Comments

[helplessobs...:]

If they were peddling these to the retail trade it would probably work. For the investment class you can expect a bit of success followed by lawsuits.

2008 Apr 04 02:54 PM

[timhope:]

Although I have not read the indenture or prospectus, I do not believe that Lehman's Freedom CLO is a repackaging of CDOs. Rather, it appears to be a traditional CLO comprised primarily of Lehman's buyout loans including First Data Corp and TXU debt, among others. If anyone knows different, please elaborate.

2008 Apr 04 03:36 PM

[hollowman:]

Tim, perhaps I am wrong, but that was my understanding, too. I understood this to be their LBO's they couldn't sell outright. They sliced them into CLO's and will be retaining the most risky portion themselves - a far cry from how the CDOs were treated.

2008 Apr 04 04:45 PM

[Fienery:]

That's totally correct, Tim/hollowman. They are repackaging the leveraged loan (senior secured) committments they don't want to sell their underwritten loans at the technically driven prices in the market. So instead they are packaging them up and taking the first-loss bonds on their book. I am not sure if they are taking the equity tranches, though, which is the real 'first-loss' bucket. At current prices, that equity tranche is extremely lucrative.

To make it clear, CLOs and mortgage-based CDOs are different beasts, a fact which has been proven by many historical and results-driven studies by the agencies. The underlying assets in a CLO, corporate loans, can be marked-to-market on a daily basis and have proven their recovery rates even in a falling asset price market.

Hope this helps

2008 Apr 05 09:03 AM

[jerry p:]

CLO's are typically corporate debt and CDO's are various consumer debt, from mortgages, to credit cards, to boat loans to small business loans.

2008 Apr 06 12:09 AM

[tranche:]

Did you even bother to do any research before writing this? This is entirely innacurate in pretty much every way it could be. good job!

The CLOs that are printing right now are balance sheet deals that allow the dealers to offload some of their LBO debt - given the robust structure of CLOs historically looks like a win/win as long as some non LBO debt is also in the deal.

2008 Apr 07 12:36 PM

[This Blog S...:]

Sarcasm works better when you know what you are talking about. That's some of the laziest reporting (though I don't think an opinion blog counts as that) I have ever seen.

2008 Apr 07 12:43 PM

[not even close:]

Read and re-read the above comments. You're "opinion" represents a complete misunderstanding of the product.

What you should have written about is whether JPM took down the senior and posted it to the Fed on 20% margin...

2008 Apr 10 10:22 AM

[This Blog S...:]

Being a fellow business journalist, I really think Seeking Alpha should take this blog entry down. This kind of half-assed, lazy reporting is not helping anybody to understand what went wrong with the industry, the current state of securitization, or what banks and regulators are trying to do to fix the market. I cannot believe the editors actually let this snarky piece of crap appear on the site, unless their goal is to misinform the public. Industry officials reading this, please note that Ms. Cheng is (at least I hope) in the minority; most reporters do their homework.

2008 Apr 18 10:14 AM