Linda Pace is a principal and leveraged loan portfolio manager for The Carlyle Group's high-yield group. The high-yield team manages $2.6 billion in leveraged loans, high yield bonds and special situation investments in five CDOs. Most recently, Carlyle closed on the Carlyle Loan Opportunity Fund, a $300 million CLO that will invest in stressed and par loans. Pace discusses the new fund, Carlyle's investment approach and notable events in the market this year.
LMW: Why did Carlyle choose to do a deal that taps the
stressed market?
This is the first time Carlyle has done a deal like this. We have had an excellent track record in terms of low default rates and above market returns in both par and stressed loans. We wanted to use this track record to branch out, away from straight par loan CLO's and create the opportunity to take advantage of value in the market when we see it.
We started ramping the fund using our warehouse [line] back in the spring, so we were able to take advantage of some discounted opportunities, but probably not as many as we would have hoped if we would have started earlier. But we're willing to be patient. We're not going to buy where we don't see good value. It's a long-term vehicle, so if we don't see opportunities early on in stressed or discounted loans then we will be overweighted in par loans. As we see opportunity we will rotate out of par and into discount. [In terms of par versus stressed] we would expect a maximum 50/50 split, but given the current market, we expect to be more heavily weighted in par loans. We'd like to get to 25% stressed and 75% par in the near term and then work to increase the stressed [portion] to as much as 50% over time.
LMW: What type of industries and sectors does Carlyle's loan group consider attractive?
No sector stands out from a discount basis. Looking at what we own, there is a pretty big variety of sectors on the stressed side. We have bought some telecom, some cable, and some auto paper among others. Carlyle's equity investment professionals focus on certain industries, and we tend to gravitate toward those industries in the high-yield group because of the firm's expertise. Our roots are in aerospace and defense, but Carlyle also invests in healthcare, media and telecom, automotive and consumer products. We can and do buy the loans in Carlyle deals, but tend not to buy the bonds because we remain on the private side for our deals.
LMW: To allow the inclusion of stressed assets and the rotation from par to stressed how is the deal structured differently to a more conventional CLO? What does Carlyle look for in an underwriter?
The fund's structure and covenant requirements are in general more flexible than those in a straight par deal. In exchange for getting that flexibility, we did a couple of things. We put in a little more equity and we have the means to redirect a portion of excess interest back into principal if we reach certain limits. The equity piece is $34.5 million, which is 11.5% of the total fund.
Goldman Sachs led one of our other funds and we knew this [deal] was a little unique. We thought they would do well in placing the debt and equity for a fund that was a little out of the norm. In general, Carlyle looks for a couple of things in an arranger, including their execution ability in placing the notes and equity as well as their structuring ability.
LMW: How receptive were investors to the deal?
In the past the equity and mezz tranches were the hardest to place, but this year we found they were among the easiest. The equity was placed very quickly and was even oversubscribed. This deal in particular is a very good story for equity holders because in a worst-case scenario, they are in a 100% par loan deal. So given our default history, which has been very low, they are comfortable that there is a solid floor to their possible returns. To the extent that we do find discounted opportunities, that should be upside to their equity returns. On the other hand that is not an easy story for senior noteholders given the potential for the portfolio to include lower-rated assets in a highly leveraged vehicle.
LMW: What have been notable points of the loan market
this year?
It's hard to talk about the loan market this year without mentioning the bond market, which was very welcoming to issuers. This proved to be somewhat of a double-edged sword in that the capital markets bailed out a number of liquidity constrained credits, but also took a fair share of paper out of the loan market. As a result of this, combined with more investors and more money entering the loan market, bids reached a record high and staying fully invested became quite a challenge.
Deal flow has ebbed and flowed, but there generally has always been something in the market. Second quarter was pretty strong, third quarter not. What's a little concerning is the quality of deal flow. Leverage is creeping up. Pricing is still low and so the risk reward equation is not that exciting.