Europe CLO manager numbers to shrink by 20%-Fitch

LONDON, July 22 (Reuters) - About 20 percent of Europe's 62 managers of collateralised loan obligations (CLOs) are likely to drop out of the market over the next three years in the wake of the credit crisis, analysts at Fitch Ratings said on Tuesday.

Slightly more than half of all European managers have only one or two deals, or less than 1 billion euros ($1.6 billion), under management, Fitch said.

That may not be enough to survive without other sources of income. Managers typically need two to three deals to break even in a benign environment and at least four deals to be a sustainable business over the long term, Fitch estimated.

Manager performance will depend critically on whether they maintained credit standards in the boom years of 2006 and 2007, when about 60 percent of them entered the market, said Manuel Arrive, a Fitch director.

"Their performance will reveal differences between those who had well balanced, defensive portfolios versus those who bought the market under the pressure to do new deals," he said.

A CLO is a portfolio of leveraged loans divided into tranches by degrees of risk. The riskiest, highest-yielding tranches, called the equity tranche, takes the first few percent of losses from any of the loans. After it is wiped out, losses move to the next tranche.

Before the crisis, CLOs played a key role in the financing of billions of euros of private equity firms' leveraged buyouts of European corporations by helping to sell leveraged loans to the capital markets. Taken together, they manage nearly 100 billion euros of assets, Fitch said.

This year, issuance of new leveraged loans has shrunk to levels of around 2004, while loans are smaller and banks are less willing to provide leverage.

REFINANCING DOWN THE ROAD

Loan default rates are likely to remain low this year and next, but after 2011 there will be an increasing need for companies to refinance, and defaults are likely to increase, said Pablo Mazzini, Fitch senior director.

Fitch said the 20 percent manager drop-out estimate is based on the assumption that managers' subordinated fee income, which is based on CLO performance, could shrink by 25 percent, such as in the case of defaults.

Many CLO managers augment fee income by investing in the riskiest slices of the deals they manage, but that also can be a two-edged sword if defaults increase, Fitch analysts said.

Newer and smaller CLO managers tend to be the most vulnerable, because they were more aggressive in issuing deals at the peak of the market in 2007, Arrive said.

Furthermore as the CLO market comes back, banks and investors will increasingly favour stronger managers with established track records, Fitch said in a report issued on Tuesday.

A number of U.S.-based CLO managers are vulnerable, given that 80 percent of them launched European operations in 2006 and 2007, and 60 percent of them have only one or two deals under management, Arrive said.

He estimated that about half of U.S. managers could close their European offices and move management of existing deals to the United States.

Struggling CLO managers are more likely eventually to withdraw from the market rather than be acquired by other managers, he said.

Of the European CLO managers, less than five are fully independent of bigger financial companies, the report said. Some of them may club together to share resources and cut costs without having to merge.

The agency expects to see only a handful of mergers in the next three years, because bigger managers will probably prefer to take over management of existing deals via replacement mandates when the previous managers withdraw.