1. How do you view static CLOs?

Lee: European static CLOs have been popular with opportunistic equity investors who are looking to take advantage across market dislocations. We typically see static deals in periods of dislocation but it also works well when you have more normal market conditions with both a private and a spread arbitrage — amplified within a higher levered structure.

In static deals, the aim is to maintain exposure to a levered portfolio. It’s also the same reason we focus on assets that are not expected to pre-pay in the near-term.

Given that higher quality nature, the structure can achieve a higher degree of leverage. Reinvestment CLOs are typically around 10x levered while static deals can have 12x in a ‘normal market’.

2. Do you expect to issue static CLOs on a regular basis?

From our perspective, the static deals are a distinct product line that should be able to co-exist alongside regular reinvesting CLOs in Europe similarly as in the US.

When we look at overlap in assets, the overlap in a static CLO versus a reinvesting CLO is far lower than the overlap between two reinvesting CLOs.

The portfolio composition on a static deal is a lot higher quality and ideally with less noise, given you are not able to actively manage the risk — once you price and close the deal the assets in the portfolio are ideally the same from day one until redemption.

On the liabilities side of the equation, we noticed in the US the investors at the short end of the curve are not necessarily the same as those active in primary longer reinvesting CLOs.

3. What’s the triple-A investor buyer base?

As mentioned, there is a different buyer base for short-duration. What’s great to see in Europe is that there is a term curve where investors are able to price risk. It’s a start to developing the middle part of that curve.

Investors also have a great appreciation for a level of certainty that the static transaction provides. I think there’s also greater liquidity for static tranches themselves. 

In a reinvesting CLO, what you have today is not necessarily the thing you will have tomorrow. A static is what it is. From a tranche perspective, debt investors benefit from what the structure is.

4. What’s your outlook for the loan landscape in 2024? 2023 activity has been driven by A&E. How much longer does that trend have to run and where are we going to see supply?

Leonard: At a headline level, issuers have done a good job at pushing out maturities over the past two years and looking at the next 12-18 months we remain constructive issuers will be able to address 26/27 maturities.

If you look at the momentum of the loan market over the last number of months, with the exception of volatility experienced in the past couple of weeks, the market remains broadly constructive.

If you look at the footprint where the private credit market has stepped in over the last 12-24 months, they’ve taken around 80% of LBO activity. Historically they were working on the margins on more challenged credits, but recently they have been able to step in and focus on the better quality credits as the public markets stepped back.

As the public markets return, good quality credit is no longer a low-90s market but a high-90s market. We are getting closer to a point where the public markets look like an attractive financing option again. As a result, public markets are getting closer to be able to compete again.

Private credit deals coming out of non-call periods is potentially a place where we see a pick-up in terms of new supply to our markets.

M&A activity on the other hand is probably a bit more challenging to foresee if the short run with uncertainty around financing costs, high valuations and more equity needed in deals to put to work (equity tickets are now 50% rather than 40% of deals).

Just before the volatility we saw the return of actual refinancing. That is off the table for the moment.

5. The private credit and BSL markets are increasingly becoming intertwined. Is a private credit CLO on the cards for Europe?

Lee: Private credit is far more developed in the US and middle market CLOs have long been a financing source for many BDCs. The re-branding of middle market as private credit illustrates that many companies being financed via private credit are companies that previously accessed financing via the broadly syndicated market.

There is a blurring of lines between private and liquid credit also as it relates to CLOs — we see this both on the assets where large loans are being financed in the most efficient market and we see this also with CLO liabilities as CLO debt investors benefit from the premium/ wider spread for the more limited liquidity and transparency of the underlying loans that sit within private credit CLOs.

In our view, the pendulum swings both ways and investors would be well served to be familiar with the collateral in both — specifically collateral that is not overlapping, which helps guide a view on the relative value of the liquidity in the more transparent, liquid BSL CLOs. This is a very balanced way of viewing private and liquid credit.

In terms of when we may see private credit CLOs in Europe, that depends to a large degree on managers building a portfolio that is sufficiently diverse to support CLO formation.

6. What are your key concerns for European CLOs? Do you have any thoughts on the default rate and how will the market be affected with around 40% of CLOs coming out of reinvestment period?

Leonard: At a very high level, I would say in terms of collateral performance, a lot of the indicators of stress looks reasonable. The below 80 buckets in Europe, for example, that’s less than 3.5% and triple-C baskets are in a slightly higher range. The below 80 bucket in Europe provides a good indication of where you’d see potential future default levels — and is consistent with the market guiding 3-3.5%. We continue to track Q3 numbers, but Q2’s we would say were marginally a beat on average — so half of the portfolio is up versus guidance, a quarter in line and the balance down.

What we’ve seen is clearly a lot of businesses are aware of the recessionary environment and they are doing a good job in terms of managing costs and passing costs through.

We’re also very focused on rates, which are going to be stickier for longer, and the ability for those businesses to manage hedging higher rate costs. We remain broadly constructive over the next 12-18 months.

In terms of deals coming out of their reinvestment period, if you look in terms of new issuance technical, the BSL market is down 40% in volume and CLO creation is down 10%. The technical remains quite strong and we’re less concerned around the deals out of reinvestment period’s ability to support A&Es. We’ve seen the ability of the sponsors to support good quality credit. The market has also been able to support and where CLOs can’t, there’s an ability to reallocate to other pockets. CLO creation, as mentioned, also remains relatively constructive in terms of providing new demand in the market.

All that said, our focus is on quality, being defensive, and actively managing the portfolio to de-risk.

7. 9fin has reported on several European CLO managers raising money for captive equity fundraising. How’s the fundraising environment been?

Lee: The regulatory risk retention requirement in Europe means there is a very active marketing of captive retention funds. With many managers seeking to raise capital, and actively marketing, we find there is a broad investor base that is more knowledgeable and well informed about the asset class.

The fund format works well for some investors that are accessing the asset class for the first time and may not necessarily have dedicated resources to invest directly in CLOs, particularly control CLO equity.

Leonard: I agree with Jane. It is a challenging market out there to raise capital. But we also view it as a good time for CLO equity.

If you look at our track record, we’re very solid through a more benign credit market when rates were low. But where we are seeing more outperformance is through volatile markets where you can opportunistically pick up assets and have in built optionality either via pull-to-par or potential to refinance or reset the deals. It is attractive for CLO equity.

8. Many people in the market expect there to be consolidation this year. Is CLO M&A on the cards?

Lee: We look at everything in the CLO space, including acquisition opportunities. Given the explosion of new managers and a more challenged issuance environment, we do expect to see a pick up in M&A.

As many as 40% of managers haven’t issued this year — that’s a lot. So it is possible that some managers may withdraw from CLOs and sell management contracts. In more challenging times, you get a pick up of M&A opportunities.

9. What’s your favourite holiday destination?

Leonard: Anywhere on the west coast of Ireland, ideally on a sunny day. To pick a spot, Donegal.

Lee: Maui, for the warm water, good winds and waves for kite surfing.