Collateralized loan obligations may not be part of the common vernacular, but their importance cannot be overstated; they hold the key to tens of billions of dollars in potential defaults.
Approximately $88 billion in securitized mortgages are at risk of default, the Wall Street Journal reported, using Trepp estimates. Of those mortgages, 42 percent are backed by apartment buildings and a majority of those apartment loans are packaged into CLOs.
CLOs are a unique financing mechanism for apartment purchases. They are mortgages packaged into bonds and sold to investors. Prior to the pandemic, they were one of the fastest growing segments in commercial real estate finance.
As banks became more cautious following the global financial crisis, CLOs gained popularity because property owners could put down less equity and carry more debt than traditional mortgages allow. Short terms and floating interest rates also enabled owners to sell or refinance quicker.
Those elements were helpful to property owners in recent years. They became less helpful over the past year, however, when the Federal Reserve began consistently raising interest rates, a move that has hampered virtually all types of financing across the industry.
Defaults haven’t become ubiquitous, but they are creeping upwards as the buildings backing the collateralized loans fail to rake in enough cash to cover debt payments. In July, only 0.4 percent of CLOs were delinquent, according to CRED iQ, but that has jumped to 1.4 percent as of the end of April.
The issuance market for these obligations, meanwhile, is cratering. The fears of a slowdown in the midst of the pandemic gave way to rising rents and a sudden boom in multifamily transactions. After $8.7 billion in CLO issuances in 2020, there was a record $45.4 billion a year later, according to CRED iQ.
During the first quarter of 2023, there were only two CLO issuances, according to Trepp. The deals combined to account for a mere $1.1 billion.
CLO defaults carry more risk for lenders than bondholders, as lenders typically hang on to the most junior bonds they create, sending them to the back of the line to get paid.
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Among the major issuers of CLOs are affiliates of Arbor Realty Trust, LoanCore Capital and Blackstone. Tide Equities is also a big embracer of CLOs, using them in part to buy $1.7 billion worth of apartments in 2021.
— Holden Walter-Warner