Norinchukin Bank loses $3.7b and halts investing in CLO market

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The Japanese bank that was the biggest buyer of debt used to fund private-equity buyouts suffered a ¥400 billion ($3.7 billion) hit and said it would stop investing in that market. Norinchukin Bank owns about 10% of the $700 billion market for corporate debt that was packaged into securities called collateralized loan obligations. Other big buyers include Wells Fargo & Co. and JPMorgan Chase & Co., which each owned about $30 billion worth of CLOs at the end of the first quarter. Losses on these investments could hamper the banks at a time when bad loans are rising. They could also sour investors on CLOs, which bought roughly 60% of the debt that private-equity companies used for deals in recent years, according to the International Monetary Fund. “We will limit making new investments” in CLOs, Chief Executive Kazuto Oku said. Norinchukin’s ¥7.7 trillion ($71 billion) portfolio of CLOs was invested in the triple-A slices of these securities, and the loss dates back to the end of its fiscal year on March 31. The bank, which serves Japan’s farmers and fishermen, said the unrealized losses were offset by gains elsewhere in its portfolio. The market has rebounded since the end of March, so its losses on CLOs have likely shrunk since then. Prices for the type of securities the bank owns were trading at 95 cents on the dollar March 31 and were nearly 97.5 cents in mid-May, according to data from Barclays. Neither JPMorgan nor Wells Fargo announced losses on their CLO holdings.

Until last year, Wall Street veterans had marveled at the outsize role played by the large but little-known Japanese bank in the market for CLOs. It was a sign of how Japanese financial institutions, faced with negative interest rates on their own government’s bonds and limited opportunities to lend, were searching ever farther afield for high-yielding investments. Like most investors in the safe parts of CLOs, the banks are seeking extra yield for the same level of risk. That strategy blew up in the financial crisis when supposedly safe securities backed by mortgages caused big losses for banks. CLOs have performed better, but as the market boomed, lending standards loosened. When the coronavirus pandemic hit, U.S. companies were carrying significant amounts of debt. What followed were bankruptcies of companies like Hertz Global Holdings Inc. and J.C. Penney Co. Moody’s Investors Service in April placed ratings on 859 securities from 358 U.S. CLOs, worth some $22 billion, on review for downgrade.

An important risk right now is that the mathematical models that created the safe securities didn’t take into account a scenario like the coronavirus pandemic, according to Rod Dubitsky, who headed U.S. asset-backed securities research at Credit Suisse until 2009.

Mr. Dubitsky argued back then that subprime mortgage-backed securities were due for a wave of downgrades, and he recently issued the same warning for triple-A rated CLO bonds. He argued in a recent paper that the securities don’t deserve such high ratings because of the impact of the pandemic on the economy. “The entire concept of triple-A CLOs goes out the window because there is not much diversification left when the entire portfolio is subject to a global economy that is in deep recession,” Mr. Dubitsky said in an interview. In recent weeks, ratings firms Moody’s, S&P Global Inc. and Fitch Ratings have collectively placed more than 1,600 bonds from mostly lower rated CLOs on review for possible downgrades.


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