Arrangers’ attitudes holding back CLO market, says PM

The attitude of managers and arrangers is holding back the CLO market, with weakening deal terms and pre-placement of triple-A tranches a particular problem, said Balint Vogavolgyi, senior portfolio manager at Aegon during a panel discussion.

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“Every time the managers can get looser language, the deal terms are changed immediately without anybody highlighting them,” said Vagvolgyi. “So basically, every time you buy a deal, you have to read 300 pages of documents.”

Other panellists on the CLO investors and researcher’s panel pointed to complexities and details such as the treatment of trading gains, par flush, and the approach to triple-C buckets.

David Nochimowski, global CLO and ABS desk strategist at BNP Paribas, said: “Artificial intelligence can maybe bring some value here — you need to be able to extract from that 300 page document whether a deal is more debt or equity friendly.”

Nochimowski also wanted to see much better disclosure in the underlying loans. Regulators and politicians have increasingly focused on the leveraged loan market, where deal documentation has become less and less debt friendly in recent years.

“Real Ebitda numbers, rather than adjusted, real leverage levels, a standardised definition of covenant-lite would all be helpful,” said Nochimowski. “There’s a lot of work to do there.”

Pre-placement of triple-A tranches was also criticised. Japan’s Norinchukin Bank anchored many of the deals early in the year, dictating the timeline of CLO syndications, and effectively setting the price. NoChu consistently bought around 5bp inside more broadly distributed deals.

“Just imagine that a year ago, you decided you wanted to invest in European triple-As,” said Vagvolgyi. “You made a business case, went to product approval, got risk and compliance onside, and got your mandate. Then you went to market, and there was nothing to buy. Even if you offered to match those prices, you’d be sitting there with your investment mandate and nothing to feed it.”

Other panellists argued that investment banks and managers were doing everything they could to keep the market going, including buying their own equity or selling on uneconomic terms — despite underlying problems with shrinking arbitrage, an oversupply of managers, and an undersupply of good quality collateral.  

“At this moment, there's too much interest in keeping the CLO machine running,” said Arthur Rosenbach, head of ABS and research at Bank Leumi. “At the end of the day though, less loans available, and less attractive arbitrage will probably cool down supply along the road.”

Another major trend in CLO structuring has been the growth of environmental, social and governance principles in the market, which was heavily discussed in an earlier CLO panel. Fair Oaks’ European debut was marketed as an ESG CLO, as was Permira’s Providus CLO I, a €362.5m deal that was priced in March 2018, and was first to exclude certain industries based on UN principles and first to include documentation relating to ESG criteria

“It is essentially just trying to limit the exposure of the CLOs to make sure that the CLOs don’t have exposure to certain industries like tobacco or oil and gas and so on, so that is probably a step in the right direction, from the perspective that ESG is a very topical thing at the moment for the CLO industry,” said Nikunj Gupta, head of European CLO new issue at Deutsche Bank. “The question is how far does the ESG criteria go in the future?”

“What we have seen so far is this exclusion of certain industries in the portfolio rather than inclusion, [where issuers are] willing to have more exposure to greener or more social-oriented companies,” said Carole Gintz, associate managing director at Moody’s. ”And what we could say is that the sectors that have been excluded — at least in Europe — do not represent a large portion of the market today.”

Many recent CLOs have begun including new structural changes such as turbo features and split equity tranches. While newcomers to the CLO 2.0 space, many of these features were seen in pre-crisis CLOs.

“I choose to call them differentiation rather than innovation as I do not think there has been anything which has been particularly innovative in [terms] of improving the structure,” said Dimitris Papadopoulos, head of structured syndicate and CLOs at Natixis. “In all of the things which have been mentioned, I think all of them have been invented to address specific requests from specific investors.”