A slew of big-name managers are seeking to raise debt for collateralized loan obligations, not letting tightening spreads on loans deter them from taking advantage of an improving credit environment and low-cost financing for the liabilities. The Blackstone Group, INVESCO and Sankaty Advisors have all entered the pipeline in the last few weeks, joining a list of blue-chip names raising debt that includes The Carlyle Group, Octagon Credit Investors and Eaton Vance, according to analysts and investors.
This heavy buildup is occurring despite a tightening of spreads on the underlying collateral due to paydowns of institutional loans. "Asset spreads on institutional loans have come in significantly within the last month," stated Sunita Ganapati, head of structured credit strategy at Lehman Brothers. "The CLO arbitrage level--the difference between asset spreads and all-in funding costs--for June was approximately 130 basis points, based on Standard & Poor's loan index, which is very tight," she explained. She noted that in May the arbitrage level was north of 200 basis points and has hovered between 200-250 basis points for the last couple of years. "If last month is an indicator then new loan deals do look less attractive, but when put into the context of the improved default and recovery rate environment, the compressed spreads are less significant," she said.
A loan investor also argued that what he sees as the temporary shrinking of underlying spreads is far less important than the funding costs. "It does not really matter if the loans are priced at [LIBOR plus] 325 or 300. [Pricing on the loans is] far less significant than the cost of the ten times leverage you are taking on," he said. The blended costs for an established manager can now be as low as LIBOR plus 60 basis points, he explained. The amount of time managers have to buy assets has also made a difference. "CLOs now have longer asset accumulation periods and temporary loan spread movement is not as important as it once was," stated Jeff Prince, associate for Wachovia Securities CDO research group.
There are two issues that are keeping the cost of the liabilities low, explained Elizabeth Russotto, senior director for Fitch Ratings. Managers are not issuing expensive below investment grade debt, she noted. The second issue is that equity holders are not looking at the type of equity returns they used to expect. As a result, "managers are less inclined to swing for the fences," Russotto said. Managers responsible for the CLOs in the pipeline and the underwriters leading the deals either declined to comment or did not return calls.