A few weeks ago we reported that something "impossible" just happened in the world of structured credit: a CLO had just failed its AAA overcollateralization test, an event that was formerly considered impossible perhaps because it did not take place even during the depths of the global financial crisis in 2008/9.

And as increasingly more "impossible" events took place over the past two months, here is something else that should not have happened. As Bloomberg reports, "in one of the more desperate acts of the coronavirus-fueled credit crunch, a hedge fund last month sold about $100 million of European collateralized loan obligations for about a fifth of their face value." 

The hedge fund offloaded stakes in the lowest-rated tranches of European CLOs to a small group of banks including Bank of America said the anonymous Bloomberg sources, adding that while secondary market trading in CLO equity has been sparse in recent weeks mostly because one can driver a Hummer through the bid and ask, with U.S. deals seen anywhere between 20 to 80 cents on the dollar, depending on the quality of the collateral pool, market participants said.

The recent collapse in cash flows has triggered a record wave of rating agency downgrades with Moody's recently warning it may cut the ratings on $22 billion of U.S. CLOs - a fifth of all such bonds it grades. The ratings agency took action on 859 bonds from 358 CLOs that package leveraged loans into securities of varying degrees of risk and return. The step - which according to Bloomberg affects about 19% of Moody's-rated CLOs that purchase broadly syndicated loans - comes as the underlying debt gets downgraded at a record pace.

As Bloomberg then pointed out, CLOs "are being downgraded at a pace so frenetic that it threatens to overwhelm safeguards that were put in place to ensure the securities' financial strength."