Advantage Insurance of San Juan, Puerto Rico, is no one’s idea of a financial colossus.
But this little insurance company is making a giant bet on some of the hottest investments around: collateralized loan obligations (CLOs).
That a company with about 50 employees and $4 million of profit is diving headlong into CLOs says a lot about the state of the credit markets these days.
CLOs, relatives of those arcane mortgage investments that blew up a decade ago, have been booming like never before. Beguiled by better yields, insurance companies and others have piled in, feeding a lucrative financial complex built on riskier corporate loans. This year is shaping up to be the busiest ever for CLOs, with over $120 billion of new issuance so far.
Enter Advantage Insurance, which offers private-placement variable universal life insurance and private placement variable annuities, as well as insurance for businesses. The company has invested roughly $60 million of its $96 million of shareholder equity into U.S. CLOs, according to a prospectus the company filed for an initial public offering.
To some, the CLO boom seems eerily familiar. Back in the subprime era, Wall Street bundled U.S. home mortgages into complex investments for sale the world over. When the reckoning arrived, the losses circled the globe.
But those in the industry say CLOs are different. The underlying loans to firms aren’t as vulnerable to rising interest rates as subprime home borrowers a decade ago. Managers of the deals can trade in and out of the 100-plus loans in a portfolio to mitigate against losses. Among the more than 1,500 U.S. CLOs rated by S&P Global Ratings since 1994, only 36 tranches across 21 transactions had defaulted as of mid-2018.
And Walter Keenan, Advantage’s chief executive officer, says he’s confident his CLO play will pay off.
“CLOs offer the best risk-adjusted returns and best value appropriate for our liabilities today,” Keenan said during a visit to New York. “CLOs have a self-healing mechanism in a recession: if the loan market breaks down and there are forced sellers, we will be able to invest in better priced loans to make up for any losses.”
Not everyone is so sure about America’s great corporate debt rush, for which CLOs have served as a crucial enabler.
Corporate lending standards have been weakening. Signs of stress in the credit markets (think General Electric Co.) have set investors on edge. Earlier in November Senator Elizabeth Warren, a prominent Wall Street scold, likened today’s leveraged-loan market to the subprime mortgage fiasco.