CLO Issuance Is Stepping Up Despite Threats

In one sign of the market’s resurgence, The Carlyle Group announced March 27 that it had closed a $510 million collateralized loan obligation fund, the firm’s second new-issue CLO in less than a year.

Carlyle Global Market Strategies CLO 2012-1 is designed to invest in corporate leveraged loans and high-yield bonds and has a reinvestment period of four years. Carlyle’s last new-issue CLO fund closed in July 2011 at $507 million. 

Fitch Ratings said the notes perform strongly in its cash flow modeling analysis.

The new Carlyle CLO is an example of what market watchers are calling “CLO 2.0.” Participants at a New York conference in March, sponsored by the publisher Information Management Network, said that the new CLOs coming to market in the wake of the financial crisis feature shorter reinvestment periods, more homogenous structures, cleaner collateral pools and a greater focus on diversification.

In fact, CLOs made up of mid-market loans actually perform better than those containing broadly syndicated loans, said Mitchell Goldstein, a senior partner at Ares Management LLC, a private equity firm and CLO manager based in Los Angeles. “In workouts in the middle market, everybody is aligned because you don’t have vultures,” Goldstein said at the IMN conference. Mid-market CLOs offer a lot to like, he added. “Defaults tend to be lower. Recoveries tend to be higher. Leverage tends to be lower. Spreads tend to be higher.”

The issuance of new-money CLOs has stepped up as well. According to Thomson Reuters Loan Pricing Corp., which tracks debt markets, more than $5 billion in new CLOs have reached the market this year, pointing toward full-year issuance of $25 billion to $30 billion. As recently as January, LPC was forecasting 2012 issuance in the $15 billion to $20 billion range, only a modest increase from 2011’s $12.8 billion.

And the market has been largely successful in negotiating a “wall of maturity” that was threatening the termination of many reinvestment periods by 2014. According to the LPC Collateral database, 57 percent of the dollar volume of loans held by CLOs issued pre-crisis are now maturing in 2016 and beyond.

The greatest challenges facing the CLO market are regulatory according to the New York based trade group Loan Syndication and Trading Association. “There are three existential threats to CLOs: risk retention, the Volcker Rule and the Foreign Account Tax Compliance Act,” Meredith Coffey, the association’s executive vice president of research and analysis, told Buyouts. “The reason CLOs are doing so well right now is because none of those are in effect yet.”

The risk retention rules, for instance, are meant to require that CLO issuers keep “skin in the game” by holding at least 5 percent of the fund’s assets on their own books. The looming requirement already is leading to consolidation in the industry, leading to fewer but larger CLO managers.

To use Carlyle Group as an example, the firm has added approximately $11 billion in CLOs since August 2010, including its acquisition of the issuer Churchill Financial Group LLC in late 2011 from buyout shop from Irving Place Capital and its purchase of four management contracts on €2.1 billion ($2.8 billion) in European CLOs from Highland Capital Management, among several other deals. Carlyle Group said it now manages more than $17 billion through 34 structured vehicles, primarily CLOs.

“I think boutique managers are going to become a smaller and smaller part of the space,” said Christopher Allen, a senior managing director at the CLO issuer Apidos Capital Management LLC at the IMN conference. His own shop is an example of the trend. In January, the listed money manager Resource America Inc., Apidos’s parent company, agreed to sell the unit to the European buyout shop CVC Capital Partners Ltd, which plans to combine Apidos with its own Cordatus debt unit. The combined operation will manage $7.5 billion of assets across 21 vehicles in the United States and Europe, the companies said.