IMN European CLOs and Leveraged Loans conference recap
The mood was constructive at the IMN 10th Annual Investors’ Conference on European CLOs and Leveraged Loans held in London on 4 April, but many market participants - notably investors - seemed to be in wait-and-see mode.
European CLO Market Outlook
Michael Brown, Partner and Head of Structuring and Analytics, Pearl Diver Capital
Luis Leon Carsi, Managing Director - EMEA CLO Primary Co-Head, Jefferies
Kate Lin, Senior Director, Fitch Ratings
Michelle Manuel, Co-Portfolio Manager, Investec
Conor O'Toole, Head of European Securitisation Research & Global Head of CLO research, Deutsche Bank
Chris Porter, Head of Private Equity, Loan & CLO Business Development S&P Global Ratings
Till Schweizer, Senior Portfolio Manager, Partners Group
Middle Market CLOs & Direct Lending
Ravi Anand, Managing Director, ThinCats
Gabriele Gramazio, Senior Director, KBRA
Mark Hale, Chief Executive Officer and CIO, Prytania Asset Management
Daniel Heine, Managing Director, Patrimonium Asset Management
Michael Schewitz, Co-Portfolio Manager, Investec
CLO Manager Roundtable
Nuno Caetano, Director, Invesco
Brendan Condon, Vice President, Deutsche Bank
Gianluca Consoli, Portfolio Manager, PGIM
Madelaine Jones, Managing Director & Portfolio Manager, Oak Tree Capital
Alex Leonard, Senior Managing Director, Blackstone
Gauthier Reymondier, Partner, Bain Capital Credit
Lewis Tan, Principal, Hayfin Capital Management
CLO Innovation and Technological Evolution
Sayed Ali, Sales Director, Broadridge
Aloysius Fekete, Senior Director-Product Management, Moody's Analytics
Lisa Lee, Senior Credit Reporter, Bloomberg
Tim Ruxton, Managing Director, Capital Markets, Alter Domus
Sandeep Chana, Director EMEA - Structured Finance, S&P Global Ratings
Alex Collins, Partner, Cadwalader, Wickersham & Taft LLP
Brendan Condon, Vice President, Deutsche Bank
Ben Gaitskell, CLO Analyst, PGIM Fixed Income
Carrine Kumps-Feniou, Senior Credit Officer, Moodys Investors Service
The Big Screen: Implementing ESG in CLOs
Sukhvir Basran, ESG, Sustainable Finance and Investment – Partner, Cadwalader, Wickersham & Taft LLP
Carlos Castro, Director - Financial Engineering, Moody's Analytics
Sabrina Fox, Chief Executive Officer, European Leveraged Finance Association (ELFA)
Elena Rinaldi, Portfolio Manager, TwentyFour Asset Management
CLO Investor Roundtable
Sharif Anbar-Colas, Portfolio Manager for Structured Credit, Kartesia
Colin Behar, Portfolio Manager, USS
Rebecca Mun, Director (European Structured Credit), S&P Global Ratings
Dheeraj Sharma, Vice President, PGIM
Aza Teeuwen, Partner, Portfolio Manager, TwentyFour Asset Management
The overall atmosphere was relaxed, some conference attendees noted, suggesting that this may be down to market participants taking in their stride the current market volatility. This may also be because this was a shorter week, before the Easter break, or because nobody knows what to expect in the current market, an investor commented on the sidelines of the conference.
The CLO market is going to get worse before it gets better, according to Sharif Anbar-Colas, head of Structured Credit at Kartesia who was speaking on the Investor Roundtable.
“This Macro economic deterioration is going to have a knock-on effect on the asset quality in CLO portfolios, from ratings migration to credit events,” Anbar-Colas said, adding however that it is worth highlighting that because CLOs are actively managed, the portfolio can be rotated.
“We're already seeing a lot of managers play offence and defence in terms of getting ahead of the problems and finding a solution early, or if they're caught in the situation then turning to solutions like Amend & Extend that allows you to keep the asset going without defaulting,” he said.
Manager’s styles matter and will matter even more in the coming months, and some managers have a good record at navigating tough markets, but current portfolio metrics are closely watched and some CLO investors prefer to be on the safe side.
“While the portfolios have proven to be resilient, we are cautious about participating in transactions where the starting point in the collateral is an above average proportion of B-/B3s,” said Michele Manuel, co-portfolio manager at Investec, on the European CLO Market Outlook panel.
In the tough market conditions of these past few months, the more established CLO managers are the ones that have tended to be consistently able to bring to market new transactions, but new names appear from time to time. CLO investors usually see new entrants as a positive, but on Tuesday panellists stressed it is important to think of the set-up that lies behind the managers that want to come into the market.
Having a large number of CLO managers may sound appealing as it would increase liquidity and diversity, but in practice, this is not quite the case, said Aza Teeuwen, a portfolio manager at TwentyFour Asset Management. “Managers need three to five CLOs to really be profitable,” he noted. Otherwise, they simply lack the resources needed to hire enough analyst or retain key employees. “You see it in deal performance and pricing; there is a lot of tiering between the best managers of the weaker ones,” he added.
“We welcome experienced people who are maybe the number two person in a very good institution and they want to make the jump to be number one in a new institution. But if the idea is for an institution to run the deal out of the US with a couple of analysts in Europe but the decisions made in the US, we don't think this is the right approach for the European market,” Anbar-Colas said.
When it comes to new investors, according to one of the panellists, more Asian investors are entering the market, particularly in the AAAs space. But the European CLO market investor base is relatively small at the triple-A level.
European CLO issuance is on a declining trend and there is a little prospect of improvement before the second half of the year. Many CLO managers are waiting in the wings, but activity in the primary leverage loan market needs to pick up first, panellists said.
Some 50-60 warehouses are opened, one panellist estimated. According to Atlantic Star Consulting’s data, 126 warehouses were registered in Dublin as of 2 April. Atlantic Star Consulting classifies all corporate entities that are domiciled in Ireland and match CLO-specific name formats, from the moment of incorporation right up until all debt is listed on an exchange, as warehouses.
The second half of 2023 should be more favourable for CLO formation, supported by greater M&A and LBO activity. Newly-issued loans are attractive as they pay a higher running coupon than loans available in the secondary market. But the notion that CLO primary issuance is fully conditioned by leveraged loan issuance was challenged. One panellist, at the CLO manager roundtable, argued that the secondary market gives CLO managers enough options to construct a diversified CLO portfolio with the type of exposure they are looking for. Another argued that the primary and secondary markets are closely connected, but agreed with the idea that the leveraged loan market secondary market offers man opportunities.
Another statement may have sounded quite blunt to some conference attendees. “There is not such a thing as a ESG CLO,” said one panellist. “Most CLO managers have their own internal ESG ratings, but they are different from one manager to the other. For us, ESG is all about transparency. “
Panellists explained that quantifiable loan metrics are easier to incorporate in CLO documentation. Other variables can be very subjective and understood differently by investors.
If the triple-A rated bonds of a potential “ESG CLO” priced tighter than a non-ESG CLO, then it would be more justified to restrict the range of credits a CLO manager is allowed to invest in, and easier to make the case to a third-party equity investor to invest in such CLO.
The panel on structural advancements discussed a range of topics, notably WAL extensions and uptier priming debt. Panellists explained that the challenge for the parties involved in a CLO is to ensure that the CLO manager has the right tools when some problems arise while, at the same time, make sure there is no excessive market risk in the transaction. This is one key concern with provisions around “amend and extend”. On this specific point, Alex Collins, a partner at Cadwalader, noted that maturity amendments had been a big focus, and he pays close attention to small changes that can be introduced from time to time in documentation; but all in all, the provisions on amend and extend and WAL tests are increasingly standardised and well understood by market participants, he told the conference attendees.
Collins and his co-panellists agreed that the key change in CLO documentation has been the introduction of provisions on uptier priming debt. “This is a new concept, the latest of many different techniques that are now in place in the documentations so that the CLO manager is not left behind when some debt is rolled up into new super senior debt. This is one of many overlapping features that allow the collateral manager to deal with different scenarios otherwise, in a workout or restructuring, there is a risk that other creditors could use to their advantage the inability of a CLO to roll into the new debt,” Alex Collins explained.
Some features that have been present in CLO documentations for a while but left unused can prove useful when market conditions change. This is the case of interest reserve accounts, which are proceeds set aside on day 1 to address any potential interest shortfalls on the first payment date. If unused for these purposes, the proceeds would be used to flush down to equity, said Sandeep Chana, director and lead analyst in S&P Global Ratings’ EMEA Structured Credit team. “Recent trustee reports show that the amounts set aside in these reserve accounts will likely be used to make interest payments on the CLO’s first IPD, which typically we had not seen before. This shows that CLO structurers had thought about potential issues well before they arise and the product is doing exactly what it is meant to do.”
Financial markets are entering an uncertain phase, with possibly a recession round the corner and higher defaults – which are however expected to remain manageable. This will be a new test for the CLO market in general and a first proper test for European CLO 2.0s.
“While we are not positive about the macro-economic outlook, we see that CLOs, as an asset class, are structured well enough to be able to withstand these times as we've seen from previous history in 2008”, said Kartesia’s Sharif Anbar-Colas, pointing out that “European CLOs have evolved massively and credit enhancement for mezzanine tranches has gone up by an entire rating category since the Great Financial Crisis.”
And in such volatile market, opportunities of different kinds abound, several panellists noted.
“As a triple-A investor, I am enjoying buying AAAs at the current levels and am more active in the secondary market because of the price discounts we are able to get here,” said Michelle Manuel.
Till Schweizer, Senior Portfolio Manager, Liquid Loans at Partners Group, explained that Partners Group has targeted some short-dated loans that were likely to go through an A&E process. These loans, once extended, bring extra spread and upfront fees to the CLO structures.
CLO documentation now includes a range of provisions to give CLO managers more leeway to deal with potentially more stressed credits. On the CLO manager panel, the point was made that these new buckets will soon be used and it will be interesting to see how it all plays out. CLO managers will have to utilise this flexibility and some tiering between managers should emerge over time, a panellist concluded.