January 21, 2016 9:15 am
ith credit markets in a generalised wobble, this could finally be the year for European collateralised loan obligations, long overshadowed by their bigger US cousins.
CLOs package corporate loans into tradeable securities — including equity and bonds issued in various tranches of riskiness — giving investors exposure to adventurous corners of financial markets. Managers buy the debt that private equity groups and big corporations use to fund takeovers and leveraged buyouts.
In the US the CLO market has been shut amid the wider sell-off in credit. Europe has stayed open for business.
The first offering of the year was in Europe, launched last week by Oaktree Capital. Also last week BlackRock, the biggest asset manager in the world, began marketing its first European CLO — a €410m deal.
This is a turnround for the European CLO market, which relaunched only two years ago as the region emerged from recession, as part of a securitisation market scarred by the crisis of 2008.
So far, this has been a stuttering restart, with a lack of lending, changing regulation and difficult economics all hampering the market’s long-awaited revival.
But now a sell-off in the US leveraged finance market, which is more exposed to debt issued by shale oil and gas producers hit by the decline in crude prices, presents an opportunity for the European market.
“The US market is grappling with loan price decline, which has hurt CLO equity valuations and has reduced interest for part of the buyer base in the market,” say Ratul Roy, Maggie Wang and Andy Chen at Citigroup in a global outlook for the industry. “Euro loan collateral looks cleaner by comparison.”
Expectations for growth in the European market in 2015 were frustrated because of the difficulty of finding investors for all the different parts of CLOs, says Franz Ranero, a partner at Allen & Overy. “It was a very quiet fourth quarter. These being arbitrage deals, you need the stars to be aligned and for investors to be there across the capital structure.”
“I’m a lawyer, so I don’t say this lightly, but I don’t think it was about regulation holding back the market. Rather it was pure economics — pure arbitrage.”
Investors often seek to exploit the difference, or arbitrage, between yields on the underlying loans and the CLO debt itself.
“As long as that difference between the loan yield and the CLO financing remains attractive, the attractiveness of CLOs isn’t affected,” says Roger Coyle, partner at Fair Oaks, a credit manager that invests in the products.
“Loan price volatility is positive for CLOs,” he adds, if the vehicles are able to buy at lower prices.
Given the lack of energy exposure, European loan prices have not fallen as much as in the US. However, CLO investors may also be drawn to the collateral on offer from the region’s relatively robust buyout market.
At the end of 2015 the US market for buyout finance was already struggling. The symbol of these worries was the failure to find funders for a package of debt that the private equity group Carlyle assembled to fund its $8bn takeover of Veritas, a data storage business, one of the year’s biggest LBOs.
Other deals have also struggled in syndication, including private equity firm Apollo’s takeover of OM Group and generic-drug maker Lannett’s purchase of a rival.
Loan price volatility is positive for CLOs
- Roger Coyle, partner at Fair Oaks
Deals have not so far struggled in European leveraged loan markets in the same way. The fact European buyouts are smaller in size may also attract CLOs, which have limits on how much exposure they can have to a single deal.
On the other hand, there is also growing competition from private debt funds extending increasingly large direct loans to buyouts in the wake of banks stepping back from the market — such as Ares lending €250m to fund Eurazeo’s buyout of Fintrax late last year.
There are still question marks over the growth of the European market. One catch, says Citigroup, is the relative lack of leveraged loans made in Europe and new risk retention rules.
These rules, which state that issuers must hold 5 per cent of a securitisation themselves to maintain “skin in the game”, have posed problems — especially for CLO managers who may not have large balance sheets, leading to consolidation among managers and less variety in offerings.
“There’s no doubt that it is somehow limiting the issuance,” said Ian Perrin, a managing director at Moody’s, the rating agency, adding that some managers have been able to fund risk retention through bank loans.
Regulatory changes in the securitisation industry, which include risk retention, have also triggered uncertainty among investors. New Brussels rules for “simple, transparent and standardised securitisation”, which aim to revive the ailing European market, do not at present include CLOs.
“There’s a limited number of investors in Europe — there’s uncertainty by insurance companies about how risk retention will affect them,” said Mr Perrin. “It’s the same thing with banks. Everyone is waiting to see what will be the impact of their own rules, so that’s affecting the market.”