LONDON, Feb 4 (Reuters) - Leveraged loan bankers and fund managers are welcoming the return of CLOs in Europe, which will help fill a growing liquidity gap, but are mindful of their potential negative impact on the loan market should issuance increase too much.
The willingness to get the CLO product back in Europe has intensified as maturing CLOs are unable to reinvest and the market faces a refinancing wall of $366.7 billion of LBOs set to mature between 2013 and 2016.
The growing desire to bring CLOs back has been spurred by the red-hot US CLO market where around $8 billion of paper has been issued so far this year.
“Where there is a will there is a way, and if it’s an investment banker’s will to get CLOs going in Europe, it will definitely happen,” a leveraged finance banker said.
Fund manager Cairn Capital is marketing a 300 million euro ($410.88 million) CLO which was arranged by Credit Suisse and is Europe’s first new post-crisis CLO. Barclays is also working on a new CLO with Pramerica.
The amount of CLOs will impact the loan market in varying ways. A handful of CLOs totalling 1.5 billion-2 billion euros will provide support to the underlying loan market but will not materially impact it in terms of pricing or deal flow, bankers said.
For there to be a noticeable impact, around ten CLOs need to be issued over the next year, totalling around 5 billion euros. This will cause a modest decrease in pricing and increase the size of deals brought to market. At the same time credit and hedge funds would be able to co-exist in Europe alongside CLOs, allowing a more sophisticated loan market to evolve, bankers said.
“There is a level where new CLO formation allows for a middle ground so CLOs operate alongside credit funds. The CLOs will soak up some of the deals but will not elbow the more market driven money out,” the banker said.
CLO issuance in excess of 10 billion euros would aggressively drive pricing down and push credit funds out of Europe in search of yield, leading to a lack of discipline and the market to overheat, bankers said.
“New CLOs will replace liquidity going out of the market which is a good thing but we don’t want to get to the point where the market is beholden to one source of liquidity. We need a robust market and CLOs should be a participant not the driver,” a second leveraged finance banker said.
Although it is not certain to what extent CLOs will make a comeback, the barriers which prevented CLO issuance for years have abated. The arbitrage just about works in the current climate and will provide equity investors with a 12-14 percent return. Issuance will also not be hampered by regulation such as “skin the game” risk retention rules, bankers said.
Another hurdle is the ability to find product to fill up the CLOs and it is likely that new issues will be filled with a more diverse pool of credits such as FRNs, high-yield bonds and dollar denominated debt. Cairn is rumoured to be using a CLO redemption to provide a ready-made portfolio of loans, though the deal will only be 50 percent ramped at closing.
“A fundamental impediment to new CLO issuance is diversity as it is hard to ramp them up with product -- in the US you could get a 100 names in a week, but in Europe will take around six months to get 60-70 names, the way around it is to fill them up with not just the leveraged loan product,” another leveraged finance banker said.
Some banks, including Citigroup, have begun warehousing debt to fill potential CLOs with, while another investment bank is getting 300 million-400 million euros of product together for this purpose.
“There is enough desire on the part of the managers and potential investors to get exposure to Europe and right now arbitrage is okay. It will be slow and painful on the first two but if pricing stays where it is and there is new loan issue there could be five or so in total this year. The question is whether market conditions hold out to allow the CLO to continue to make sense and if so, how many will be issued next year,” the first banker said.
The second banker said: “If there are CLOs both arrangers and private equity will feel more confident in the availability of debt. The more confidence there is, the more deals there are which means it is easier to raise CLOs. The more CLOs the more deals that come to market. It is self- fulfilling.” ($1 = 0.7301 euros) (Reporting by Claire Ruckin; editing by Christopher Mangham)