CLOs

it's Patti Hirsch here at marketplaces here to talk to you about cielos of collateralized loan obligations okay we've seen these in the news recently because collateralized loan obligations are kind of an engine of the economy and they recently Citigroup said that it is going to start it's going to put out the first CLO that we've seen in about a year so it's big news okay for the economy know if you look at the phrase Claire's own obligation it looks kind of similar right we've seen a lot of this before can we take out the word loan okay put in debt so it's a CDO or put in mortgages the CMO or a bond it's the CBO okay so essentially a collateralized loan obligation is a securitization just like all of these things so just to remind you how the old securitization works okay I'm just going to give you a quick overview of this again so here's our heir take an investor or a manager one of these cielos okay his name is John okay and he wants to create a CLO a collateralized or not a securitization instrument so what he does is he goes out to a bunch of a bunch of powers of his these are a bunch of investors and he says hey guys you know you can trust me can you lend me ten million dollars okay so these guys put together ten million bucks I can lend it to John and John goes out and he buys a bunch of loans can he puts them into a box okay now these all loans like like all good loans these loans throw off an interest a little bit of interest every month say three percent here four percent here five person here whatever it may be and at the end of the month all that interest for Low's out of the out of the vehicle to sort they call this so we're going to make a slip like a our old model of the champagne bottle okay another month the cork flies off and the interest which is pure cash flows out and it flows through a capital structure that John is created okay and this looks a bit like a pyramid of wine glasses like you get at a wedding you know so these wine glasses are all set on a nice silver tray okay what happens is the money from this from these loans flows out and if everyone's paying their loans or paying the interest on other ones it flows out through the capital structure and collects in the bottom which is called the equity okay so what happens is each of these parts of the the structure is rated now clearly the top glasses is least likely to end up empty its most likely to get filled therefore there's very little risk if you have this so it's rated triple-a and it's priced accordingly you can say 1% interest next one is Double A rated a little more risky 2% interest next is a little more risky triple B say 5% interest and then the last tranche is most risky at all BB say 7% interest because the reason this is risky risky area is because say a couple of these air loans or the people who borrowed this money or so to take a couple of these loans default and there's no interest being paid means that less money is going to flow out through the capital structure so it's more likely that these lower tranches won't get filled up especially what John does is he takes this this 10 million dollars okay and he he's bought all these loans with it and he apportions this part of the capital structure up so that each of his investors gets a little slice depending on how much risk they want and how much exposure they want they get a little slice they get a each of them gets some securities based on this model okay that's the way securitization worked so the most important thing about the cielos is to ask where these loans come from okay these because these are aren't like in most M securitizations the the things that go into the bottle are the whole item like whole mortgages in the CMO in a collateralized mortgage obligation you know whole bonds go into the bond obligation whole credit cards into the into the asset-backed security but in this case or credit card obligations I should say but in this case there are little slices of the loan and so how does how does how do how does it get hold of these little slices okay with the way this works is through a syndication process so you know a couple of years ago or say up until very recently in fact even now there are lots of say burger bar owners okay who are out there they are looking for money that can go into the banks and saying please please lend us money because we want to we want to expand into Illinois or we want to we want to expand into China you know these are the guys that they say they want to expand they say they want to build new burger bars hire people make money that's been very very difficult to get money out of the banks the reason is because one of the because the banks look into the future and they say well we don't like to look at the economy or we don't labor look at your business so we're not going to lend you money but it's not just the banks they're looking to the future in seeing that it's also guys like John so John's doesn't want to have a bottle that's filled up with loans with dodgy loans that could go bad in a bad economy he wants he wants to fit he's only gonna want to fill this bottle up when he thinks that you know the economy's about to improve so now John has created this CLO suddenly there's some demand for this Lisl bits of loan so now let's say here's his Fred's but Fred of Fred's burgers okay Fred Fred's burgers very happy all right because he's gone out to the bank and the banker here he is and is the banker at JP Morgan he said all right and yes I'd be happy to lend you some money in fact I'll lend you a billion dollars okay here's a banker at JP em he's going to lend him a billion dollars and what JP Morgan does he takes that loan and he breaks it up into little bits because he doesn't want to lend a billion dollars himself he doesn't want that kind of exposure to one company and also he doesn't want to have a billion dollars in loans bang on his balance sheet because then he has to have more capital okay more cash in his accounts because of capital adequacy requirements so what mr. JP Morgan does is he breaks this thing up into little bits he looks for other lenders in his syndicate because this is called a syndication okay so he creates a syndicate of lenders and that those include other banks okay they include funds hedge funds and the like and they also include people like John people who create these cielos so John gets one of these little bits okay once the syndication occurs John gets this little because he's in this syndicate gets a little bit of this loan pops it into his bottle with a whole bunch of other loans from other borrowers like Fred okay so he's now got this bowl full of little loans and you can see that job how John is now why it's so important that the collateralized loan obligation market improves because if there are lots of people like John that means there are lots of bottles out there and lots of people like John going come on come to the banks come on come on we need to fill our bottles make loans make loans out to these guys that we can we've got you know stuff to put in our bottles and we can make money down the line now JP Morgan says okay well I can I can certainly find people that want money there's lots of those people out there so we can originate loans a as it calls agent these syndicates and follow all this money through the system and into these into these cielos of course there's a problem because John and indeed JP Morgan are looking into the future in saying how what's the future going to be like and the only reason that John is is recreating these CLO is as starting these celos again is because he thinks the economy is going to be good he thinks economy is going to be good you know these guys are going to make money which means I'm going to make money of course the risk is if the economy doesn't improve say we go into a double-dip and we start to see more and more and more and more and more of these loans going bad in a bad economy well it means that there's going to be less money going through here so it's bad news for these guys it means John is going to be very reluctant to do more CLO so it's bad news for these guys because they're not going to be able to get loans from the banks and that's going to leave everybody in the entire system including us here very badly needing a drink okay all right okay nobody oh my glasses okay

Channel: Marketplace APM

Views: 89,706

Rating: 4.9239907 out of 5

Keywords: marketplace, whiteboard, clo, collateralized, debt, obligation, citi, loans, banks, securitization, business, money, economics, paddy, hirsch, Borrow, Spend, Cost, Supply, Demand, Big banks, Put up dough, Stake, Trust fund, Exchange, Barter, Vend, Offer, Auction, Traffic, Unload, Deal, Dump, Hustle, Recession, Austerity, Financial crisis, Thrift, Layoff, Field, Trade, Work, Career, Livelihood, Occupation, Vocation, Commerce, Financial affairs, Money, Accounts, Economy, Analysis, News, regulation

Id: OXcvkVrjQjM

Length: 8min 1sec (481 seconds)

Published: Tue Mar 16 2010