My clients have known for a long time that the nucleus of the next crisis will be in the over-leveraged corporate bond market. This notion was confirmed recently in an article from the Wall Street Journal: companies that borrow in the junk loan market are now in a far weaker condition financially than they were prior to the Great Recession. Borrowers with loans Moody’s Investors Service rated with the worst rating in the junk-debt category — B3 or lower — made up 38% of the market in July compared with 22% in 2008.
The Bank of America (NYSE:) calculates that about 29% of outstanding leveraged loans will likely default in the next credit recession.
Again, from the WSJ: CLOs are highly susceptible because they use borrowed money to buy leveraged loans, boosting the yield, and the risk, of the investments. CLO managers issue bonds to buy bundles of leveraged loans, then use cash flow from the loans to pay interest and principal on the CLO bonds, pocketing the difference. When…
