CLOs are comprised of loans made to small businesses. Small businesses are inherently risky. CLOs exist because they are a relatively inexpensive form of long term funding. Let’s ponder the type of people who start and operate small businesses and whether or not they get access to competitive bank financing...
Once upon a time, seeing entities willing to write loans to small business was worth celebrating. Amusing that once we find out it’s Wall Street stepping in to facilitate this at a scale the government cannot, it is dangerous gambling.
There is absolutely no problem in making risky loans. But there are many problems with packaging those loans together and selling them to a third party that can't calculate its risk level claiming it's low risk.
An important clarification here: CLOs are sold to multi billion dollar asset managers (technically referred to as QIBs, entities that manage at least $100mm in Assets Under Management or more - the vast majority of the structured products business is dominated by large fund managers).
It is the highest tier of investor "suitability" recognized by the SEC. It's their job to understand these products and they have armies of people for it. It can take weeks to "market" these transactions and plenty of opportunities to sit down with bankers and CLO managers to get smart on the space. There is also a ton of supporting technology and research, all of which is available for free on S&P, Moody's, Fitch, Kroll and Morninstar's websites.
If you cannot sell this stuff to a QIB, who can you sell it to?
You probably think of a locally owned dry cleaner or coffee shop when you hear the term "small business." I know that's what I think of when I hear the term. But in the context of lending, the definition of "small business" (usually lumped together with mid-sized businesses under the umbrella term "SMBs") is usually something like <$50MM in annual revenue, or <100 to <500 employees, depending on who you're talking to. They can be quite large compared to what most people think of when they hear "small business," but they're small when compared to large enterprises.
This categorization speaks less to the size of the businesses themselves, and more to the scales that these banks operate on. After all, $50MM annual revenue or 500 employees seems pretty darn big to me!
Once upon a time, seeing entities willing to write loans to small business was worth celebrating. Amusing that once we find out it’s Wall Street stepping in to facilitate this at a scale the government cannot, it is dangerous gambling.