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Jeudi 25 Avril 2013

Fitch: Ability to Source Loans, Retain Risk Key for European CLO Managers

The ability to source loans and retain risk will be key for CLO managers launching new European CLOs, Fitch Ratings says. The cost of funding for European CLOs has come down to a point where CLO economics are once again starting to look viable for new issuance - CLOs can deliver low double-digit returns for equity tranche investors. Meanwhile, CLOs are becoming more appealing to credit investors in a search for higher yielding, less interest rate sensitive credit asset classes.

The re-opening of the European CLO market is positive news for CLO asset managers whose long-term business viability is nevertheless less reliant on CLOs than in 2008. In the absence of new CLO issuance, managers had no alternative but to diversify their loan management platform to different vehicles. Fitch estimates that CLOs represent now one third of the total assets under management (AUM) of the top five CLO managers versus two thirds in 2008.

Managing loans through segregated accounts, European regulated open-ended funds (Qualifying Investor Fund, Specialized Investment Fund) or closed-ended listed funds, as well as expanding cautiously to high yield and special situations have been the main growth avenues of CLO managers since 2008. Meanwhile, CLO managers have either consolidated or exited the market, resulting in a 25% drop in the number of CLO managers active in Europe, in line with Fitch's forecast of July 2008. Blackstone GSO, 3i and Pramerica stand out as the most active consolidators in Europe.

While investors have become highly discriminating, the criteria for successful launch of a new CLO remain substantially the same: track record, staff experience, strong credit process and solid infrastructure. However, three main differentiating factors between asset managers have emerged since 2008. First, investors are now in a better position to assess the impact of a manager's behavior on CLO performance, particularly in a period of stress. Prior to 2008, there was little differentiation between managers based on performance.

Second, the regulatory requirement to hold an economic interest in the transaction may exclude some managers who do not have the balance sheet capacity or cannot find an investor willing to retain risk on behalf of the asset manager. Lastly, experience in managing high-yield bonds or special situations may also be welcome by investors as the new CLOs may include more high- yield bonds and more distressed loans than pre-crisis.

Yet the current loan and structured credit market brings a number of challenges to CLO managers. First, the new issue market may be insufficient to satisfy the existing and new CLO demand. The preponderance of recycling of legacy deals, high prices and multiples and the little need that corporates in core European countries have to raise cash by selling assets to sponsors add to the supply constraints on new loans. Furthermore, the primary loan market suffers from the shift from bank loans to high yield bonds to bridge the funding gap. In addition, once the loan has been selected to enter the initial collateral pool, the asset manager needs to buy it at the best possible price to maximize the arbitrage (the spread differential between the assets and the liability). Lack of long warehousing capacity also puts pressure on managers during the ramp-up period. Therefore, in a context of heightened competition for loans relative to the available supply, differentiating factors among managers are access to the market and relationship with banks, in terms of sourcing and warehousing as well as ability to time the purchase.

Fitch reviews CLO managers in connection with CLO ratings to assess their suitability for the transaction. Fitch also publishes CLO Manager profiles which are short reports on CLO manager capabilities and resources.

Additional information is available at


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