​Dominoes are falling in the financial sector according to the pattern set in 2008. Only then it was mortgages driving the mayhem. Now it is zombie corporate credits, kept alive for years on cheap junk-rated loans bundled into collateralized loan obligations (CLOs), which investors were forced to buy because central banks kept returns on everything else artificially low. 

Once the belle of the ball, since the Covid-19 crisis there are evidently too few buyers to provide prices for the banks that peddled the CLOs to value them accurately. According to a piece today in Risk, German lender Commerzbank is in trouble, having been forced to categorize $5.2 billion of its CLOs as Level 3 assets in the first quarter,  meaning they are unable to be marked to market (valued using market prices) and requiring Commerz to use a “mark to model” approach.

That means it more or less makes educated guesses, none of which anyone else believes. In 2008, this was referred to as “mark to myth” accounting when applied to the toxic mortgage securities that torpedoed many banks and brought down Lehman Brothers.

According to the FT, which wondered aloud today if CLOs were “ground zero” for the next stage of the financial crisis, JP Morgan estimates that US CLOs alone totaled some $691 billion at the end of last year, double the amount from two years earlier. In the same time, the market for the junk loans backing the CLOs doubled to $1.2 trillion.

The FT article showed that the Covid-19 crisis has since sent investors fleeing: Yields (which move inversely to prices) on the junkiest BB tranches shot up from around 9 percent to over 16 percent when the crisis hit.

All the investors stuck with this dreck can’t sell it without big losses, meaning they’ll have to sell more liquid assets to meet redemptions, spreading the misery to other markets, if the events of 2008 are any guide. But hey, perhaps the Fed and its counterparts will snap them all up, leaving the banks to repeat their mistakes yet again, and setting the stage for the next crisis. Third time’s a charm.

hen structured credit markets froze up in March, Commerzbank could not find enough real quotes to accurately price its collateralised loan obligations (CLOs). The dearth forced it to shift €4.8 billion worth ($5.2 billion) into the mark-to-model category –reserved for complex, illiquid assets

When structured credit markets froze up in March, Commerzbank could not find enough real quotes to accurately price its collateralised loan obligations (CLOs). The dearth forced it to shift €4.8 billion worth ($5.2 billion) into the mark-to-model category –reserved for complex, illiquid assets.The move increased the German lender’s stock of Level 3 assets by 69% quarter-on-quarter to €9.8 billion. As of end-March, they made up 7.2% of all fair value assets, up from 5% at end-2019.

hen structured credit markets froze up in March, Commerzbank could not find enough real quotes to accurately price its collateralised loan obligations (CLOs). The dearth forced it to shift €4.8 billion worth ($5.2 billion) into the mark-to-model category –reserved for complex, illiquid assets