PT - JOURNAL ARTICLE AU - Rod Dubitsky TI - Practical Applications of CLOs, Private Equity, Pensions, and Systemic Risk AID - 10.3905/pa.8.2.406 DP - 2020 Oct 31 TA - Practical Applications PG - 1--8 VI - 8 IP - 2 4099 - https://pm-research.com/content/8/2/1.21.short 4100 - https://pm-research.com/content/8/2/1.21.full AB - In CLOs, Private Equity, Pensions, and Systemic Risk, from the Spring 2020 issue of The Journal of Structured Finance, Rod Dubitsky, founder of the People’s Economist, examines rating agency models for analyzing collateralized loan obligations (CLOs) and concludes that they are deeply flawed in that they rely on historical data that does not describe the current situation and on assumptions about correlation (diversification) that do not hold true in practice. Dubitsky presents evidence that default likelihoods are higher and expected recoveries are lower than the rating agencies assume in their models. He also highlights problematic practices in the CLO market, including weakened bond covenants and other terms, conflicts of interest in the management of CLO underlying portfolios, and a rising concentration of underlying leveraged loans in the lowest rating categories.Additionally, Dubitsky examines the relationships among 1) CLOs, 2) private equity–sponsored companies that borrow via leveraged loans that are then packaged into CLOs, and 3) pension plans that invest in private equity (PE) funds and CLOs. He argues that a contraction of available CLO-funded credit to leveraged-loan borrowers could cause many to fail, resulting in both increased unemployment and losses to PE funds and their pension plan investors. He concludes that the potential contraction of CLO funding for leveraged loans creates significant systemic risk. TOPICS: CLOs, CDOs, and other structured credit; financial crises and financial market history