Are CLO Collateral and Tranche Ratings Disconnected?

62 Pages Posted: 12 Oct 2020 Last revised: 4 Nov 2020

See all articles by John M. Griffin

John M. Griffin

University of Texas at Austin - Department of Finance

Jordan Nickerson

University of Washington - Department of Finance and Business Economics

Date Written: November 2020

Abstract

Between March and August 2020, S&P and Moody's downgraded approximately 25% of collateral feeding into CLOs and only 2% of tranche values, with rating actions concentrating in junior tranches. This paper examines explanations for this potential rating disconnect. We find no evidence that: rating agency model-implied risk disproportionately affect junior tranches, collateral downgrades were too severe, CLOs accumulated pre-COVID protective cushions, or value-creation through active management. Instead, we find evidence consistent with both non-model considerations by rating agencies and strategic CLO manager trading. The end result is that CLOs are considerably riskier than their current ratings suggest.

Keywords: structured finance products, credit rating agencies, COVID-19, conflicts of interest

JEL Classification: G14, G24, G28, G32

Suggested Citation

Griffin, John M. and Nickerson, Jordan, Are CLO Collateral and Tranche Ratings Disconnected? (November 2020). Available at SSRN: https://ssrn.com/abstract=3707557 or http://dx.doi.org/10.2139/ssrn.3707557

John M. Griffin

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-6621 (Phone)

HOME PAGE: http://www.jgriffin.info

Jordan Nickerson (Contact Author)

University of Washington - Department of Finance and Business Economics ( email )

Box 353200
Seattle, WA 98195
United States

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