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Sancus boss on moving from buyer to manager in a booming CLO market

Olga Chernova 575

So far, despite the constant market chatter, consolidation among CLO managers has yet to occur. Instead, new firms are popping up as buyer demand rises in the hunt for yield. That has included Sancus Capital Management, which arranged its first deal recently having spent eight years as an investor in CLO equity and mezzanine paper.

Sancus, the California-based hedge fund, closed its inaugural CLO, a $308m deal named Trysail 2021-1 at the end of June. It was part of a wave of new managers looking to make the most of a CLO market that has been buoyant as the Covid-19 pandemic has receded.

Spreads on senior CLO tranches hit around 200bp at the nadir of the pandemic but have since tightened by about 90bp. The leveraged loans that ratings agencies downgraded last year, have enjoyed the reverse this year, leading to many upgrades of CLO tranches.

Such resiliency and performance has attracted new investors to the market, allowing some experienced hands to switch roles to become CLO managers, with other firms also looking to join them. 

Olga Chernova, founder and chief investment officer at California-based hedge fund, talked to GlobalCapital's Paola Aurisicchio about why it chose this moment to move to CLO management and why the Covid-crisis has provided more opportunities than set-backs.

GlobalCapital: As an experienced CLO equity and mezzanine investor, what  brought you to the manager's side?

Olga Chernova, Sancus Capital Management: Since 2013 we have invested in CLOs up and down the capital stack and during our experience, we have met all of the managers. We had the benefit of learning from the best. Becoming a manager came for us as a natural progression.

Last year we invested in a transaction with East West Investment Management, and we liked their management style a lot. We met Andrew Maria, back then the lead CLO portfolio manager at East West Investment Management platform. We have debated for long time to move to the other side, but we never had the opportunity. Then, everything came together. We had the opportunity to hire Andrew as senior portfolio manager in December 2020 and soon after we issued our first CLO.

Is there a manager's style that you admire and has inspired your platform?

There are a lot of managers that we admire. We appreciate the active management and the ability of certain managers to relentlessly build par, which also keeps the portfolio less risky.

We also value managers who stay on top of prepayments and are proactive. Large cash balances are a drag on CLO equity cashflows. CLOs are arbitrage vehicles and not having cash sitting around is very important.

The CLO market is enjoying a cascade of new issue deals, alongside resets and refinancings. How did you convince investors to bet on your first CLO when they can pick more experienced managers?

We were very pleased that investors paid a lot of attention to our transaction, particularly in this busy year with so many options in the market. Of course, a new issue from a first-time manager always comes at a discount which was attractive to many. We had a broad participation from investors, some of who we met for the first time.

We think that successful pricing of our first CLO is a testament to what we have built at Sancus Capital Management and the experience Andrew Maria brings as portfolio manager.

When did you open a warehouse? Has the portfolio been built with names less impacted by Covid?

We opened the warehouse at the beginning of the year, focusing on the new issue market rather than the secondary market.

Today, portfolios are overall much cleaner, but not as pristine as they were in 2020 when there was an opportunity to buy loans at cheaper prices. Nobody would put a name adversely impacted by Covid in the portfolio, but a lot of loans bounced back quickly and are no longer considered vulnerable to Covid.

Your inaugural CLO is a $308m transaction with a three year reinvestment period. Why did you opt for a short reinvestment period rather than the more common five year duration?

Mostly because we are a new manager. As we were paying a premium on our liabilities as a new manager, we thought it made sense to issue a deal shorter in duration rather than a longer transaction.

Once our deal exits the non-call period in 2022, we should be in the position to refi our transaction with less premium.

Do you plan to issue other deals this year?

We hope to issue another transaction in 2021.

Did you retain the equity? If so, do you plan to always retain the equity?

We retained the majority of the equity and we had a third-party equity investor. We are comfortable to retain our own equity, but we also hope the returns we generate will attract other equity investors to the platform.

As an equity investor, we hope to create a platform that is attractive for outside capital.

You were the developer of the applicable margin reset (AMR) feature, the innovative way to refi a CLO through an online auction that ran on the KopenTech platform. In this market environment, what is its advantage as opposed to the traditional way of repricing?

The AMR feature has been created with the intention of making CLO refinancings more efficient, transparent and cheaper since the process doesn't require hiring rating agencies, legal counsel, and arrangers. Rating agencies have been very busy this year with the high volume of refis and resets.

There were delays and CLO managers were in line to get their transactions repriced.  With the AMR feature, CLO participants would not have those issues.

We embedded the AMR feature in our CLO and the biggest advantage will be to refinance the deal faster and cheaper.

Trimaran Advisors has recently refinanced a $660m transaction via an AMR auction. It was the largest transaction so far and it was successful. If a jumbo deal is able to refinance successfully using an AMR auction, the process should be much easier for a smaller and shorter transaction like ours.

For new managers who are betting that their liabilities would trade tighter a year from now, AMR holds additional attraction.

Overall, I would say that Trimaran’s refinancing of its $427mm triple-A tranche online is a testament to how far the CLO market has come. The market now has diverse pool of investors. Three years ago, a refinancing like that without the lead arranger was unthinkable.

Some CLO sources predict consolidations among CLO managers, but mergers have yet to materialize. In the meantime, more new managers are expected to enter the market. What are the opportunities today and why is this the right time to become a manager?

CLOs proved to be resilient during the 2008 financial crisis and were able to successfully navigate the Covid-crisis as well. Some market participants and journalists were predicting the end of the leveraged loans market, but CLOs once again emerged unscarred, delivering very good performance for both equity and debt investors.

The asset class has grown and matured from being a very small and clubby market to a large space with a variety of investors. 

From that perspective, it is the right time to enter the CLO market. There is a better set of investors. It is exciting. On the flip side, the market has more competitors and it is more difficult to buy collateral.

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