Japan’s financial regulator is closely watching global credit markets for renewed signs of stress because there’s no guarantee that support measures will keep borrowers afloat during the pandemic.
Five major Japanese banks held a combined 13.6 trillion yen ($126 billion) of CLOs as of March 31, disclosures show. The biggest investor, Norinchukin Bank, pledged to keep cutting back on purchases this week after booking a 400 billion yen paper loss on the products last quarter. By contrast, Japan Post Bank Co. said it plans to add to its holdings even after logging an unrealized loss of 121.9 billion yen.Moody’s Investors Service put hundreds of CLOs on review for downgrade last month, though it excluded AAA rated tranches.
Authorities in Japan have been growing increasingly concerned about financial institutions’ exposure to CLOs. Prices could fall as much as 30% should top-rated bonds be downgraded to AA or A at a time of market stress, the Bank of Japan said in a report last October. Rating cuts may also lead to higher capital charges for banks because lower-rated securities would carry a higher risk weighting.
Lenders have so far been insulated from CLO price drops because they focus on holding top-rated debt until it matures and don’t need to realize losses until the value of the securities falls by 50%. AAA rated CLOs touched 92 cents on the dollar in March and have since recovered to trade at almost 98 cents, according to a Palmer Square index.
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