Investors face new round of damage as CLOs falter

By Tessa Walsh

LONDON (Reuters) - Collateralised Loan Obligation CLO.L funds worth some 100 billion euros (92.31 billion pounds) in Europe are the next ailing asset class set to hurt banks, hedge funds and insurance companies.

Managers of smaller CLOs -- financial vehicles that invest in leveraged loans -- are running out of money to pay investors, staff and bills as rising defaults, downgrades and rock-bottom recovery rates slash their income.

Some smaller CLO funds have already stopped paying the junior management fees that make up two thirds of income to their managers, which will bring layoffs and leave skeleton staffs struggling to manage portfolios.

"All CLOs will have junior fees turned off, if not already then sooner rather than later," a senior loan trader said, speaking on the condition of anonymity.

Inevitably, when the managers of the complex structured credit vehicles suffer, so will investors.

Already, holders of the lowest-rated CLO tranches are losing their interest income which is being diverted to pay senior noteholders, in what is viewed as a prelude to a wipeout that will ultimately see them lose their money.

Banks, hedge funds, asset managers and insurance companies are the buyers of CLO tranches, with hedge funds and asset managers typically piling in the riskiest tranches and banks in the safer AAA tranches.

Any damage from CLOs would follow on the back of writedowns by banks of more than $700 billion (476.8 billion pounds) from credit-related losses since the credit crunch began.