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Victoria Zhuang

9Questions is our Q&A series featuring key decision-makers in the corporate credit markets — get in touch if you know who we should be talking to!

After a furious rally in US CLO spreads to start the year, CLO managers took to the market en masse. The new issue CLO manager base stands at 69 for the year so far, and 87 US CLO managers have priced at least one form of US CLO issuance.

In March, the US CLO market had its busiest month in over two years, according to 9fin data. $30.7bn of US CLOs hit the market last month which is the highest monthly volume since $36.3bn priced in November 2021. This took Q1 2024 US CLO issuance to $74bn, which includes $38bn of new deals.

However, there’s been a lack of new loan supply this year causing loans to trade up on the secondary market. With 40% of loans now trading above par, portfolio managers are finding it harder to ramp their deals cost effectively.

9fin spoke with Stephanie Walsh, head of US CLOs at Bain Capital, about balancing priorities between repricings and new issues, how to actively manage a CLO portfolio with rising triple-C buckets, and CLO creation in a challenging loan environment.

1. With a backlog of legacy CLOs that have yet to be refinanced or reset, and the desire to issue new deals, how are you allocating your time between those competing priorities?

The CLO market is always a balancing act and this year is no different. The activity level so far in 2024 is more akin to 2021 than the two years prior so you have to manage your pipeline carefully and strategically. We've been doing that in a few different ways.

First, it has meant we've needed to adapt to the current market. For new issue transactions we're less reliant on the secondary market and instead warehousing has become a more critical part of the process. Therefore we need to plan not only for this current deal, but for one and two beyond it, in order to adequately ramp a portfolio. That's a big deviation from 2022 and 2023 when we generally ramped over 90% of portfolios in the secondary market.

Secondly, we're focused on the curve. The good news this year is that we've seen a return of differential pricing for shorter versus longer tenor deals. We're also seeing slight differences in the makeup of that investor base. From a planning perspective, we're able to carefully navigate and work on some shorter deals alongside our new issue pipeline, which is typically 5/2 transactions. This allows us to get more done in what is a competitive environment.

Third, you need to be opportunistic. Following the Opal conference last year we decided to launch a reset on 14 December and ultimately priced on 20 December. If you had told me even a month prior that we would be doing that, I would have said it would be a crazy thing to do. We revised our plan because of the openness of the market. Despite the fact that the market remains competitive, there are paths to getting existing refinancings and resets done alongside a new issue pipeline.

2. We’re seeing third-party equity come back a bit this year. As the manager of a captive equity fund, how do you juggle the balance between using the fund and taking on a third-party equity investor?

Our captive equity vehicle has a right of first refusal to majority equity for all of our US and European transactions. We do sell minority equity for most transactions and we've seen a larger group of investors return to the market than in recent periods.

We are able to sell majority equity in our deals after we deploy one of our equity vehicles. Between our first and our second CMV, we did have two third-party majority deals; however, we typically need to purchase majority equity within the CMV.

3. As a CLO issuer in all three markets (US, Euro, middle-market), what are the unique challenges each market poses?

In Europe, speed and strategy of asset ramp is more challenging than the US. Part of that is because the market is about a third of the size, so it takes longer to ramp a transaction. Bigger bond buckets do partially offset that but do not fully abate the issue. Within Europe right now we are thoughtfully staggered warehouses to have a little bit more time to ramp assets, because that is a more significant challenge there.

Secondly, in private credit we remain more focused on the core middle market whereas many of our peers have gone significantly up in market. We generally lend to companies with EBITDA between $25m to $75m, and with tranche sizes generally of $100m to $400m. It allows us to often serve as the sole lender with 95% of deals having financial covenants and low loss rates. It is a differentiator compared to others in the space right now.

In the US broadly syndicated market, the challenges are constantly changing. Last year triple-A strategy and majority equity placement were key focuses. This year, similar to Europe with over 40% of the loan market trading above par, ramps are challenging to source assets. Part of what makes our market interesting though, is trying to figure out what puzzle piece is difficult and trying to find ways to optimize it.

4. With the rise of private credit, does Bain see itself allocating more resources to its mid-market platform?

Our two original businesses dating back to 1998 were our US CLO platform and our middle-market lending group. While it is the ‘golden age of private credit’ we've had quite a bit of stability in our team for a long time.

We feel that for the private credit assets we manage, we have an experienced, dedicated team that is able to deploy and thoughtfully oversee that capital. But as with all of our businesses, we're constantly reevaluating where and when we may need additional resources.

5. We’ve seen a couple of big CLO names recently go into distressed situations and with triple-C buckets rising, how closely are you watching and managing your triple-C buckets and other portfolio tests that could be stressed this year?

We, alongside most managers, are watching them closely. That said, I don't think triple-C tests can be viewed in isolation. First, we need to think about the fundamentals and what names we're expecting to be upgraded in the short-term or taken out. We need to be mindful of issuers that may have seen some declines in performance in the short-term, and we need to weigh those against each other.

Equally important, is the deal structure. We need to look at the vintage of the CLO the OC tests and other tests within the structure Those are really combined as it relates to the impact of what may happen if we're exceeding the 7.5% test.

Triple-Cs have become so much more topical because of how critical CLOs are as buyers for both of the European and US loan markets. Once the name is downgraded, the biggest buyer in the space has a de minimis interest to add from there. This has created a challenging headwind and a technical when downgrades do happen.

SFR is a topical example recently. That downgrade has resulted in higher triple-Cs in particular in Europe, where holdings are larger. Our desk estimates that bids are down three quarters of a point or so on average for the higher dollar priced triple-C's in Europe following the downgrade indicating potential CLO selling.

6. After a furious rally to start the year, spreads have stabilized. Do we need to see the return of some big CLO investors for further spread tightening?

From our perspective we have seen a lot of the investors return, relative to the depth of triple-A availability in the last few years. This resurgence has not only driven the year-to-date deal activity but also the significant tightening and a reduction but not an elimination in manager basis, which was prevalent last year.

Also while most participants are talking about that return of buyers and the ~$9bn of called CLOs year-to-date in the US market, we're also really closely watching amortization.

Around $290bn of CLOs are post-reinvestment. In the January payment date from this year, we saw a factor reduction of around 0.07x in triple-As. Our team is estimating for the April payment date that could increase to 0.1-0.15x which would translate to around $20 to $30bn of repayments just in Q2 alone for triple-As.

Amortizations and calls start to become linked. We think this could be a more significant driver of triple-A demand and also a factor down the stack in 2024 and 2025, which could lead to even further tightening.

7. With $74bn of US CLOs issued in Q1, including $38bn of new issuance, has market fatigue already set in in the US CLO market?

I think participants may be fatigued, but the market is going to go on. I expect we could keep this type of pace through 2024. Managers are actively warehousing to offset some of the ramp headwinds, triple-A repayments can replenish budgets even without substantial increases in appetite and managers do have equity capital.

8. There's been a lack of recent leveraged loan activity and specifically a lack of new issuance for the underlying assets. Can CLO issuance keep up the pace? And is the BSL market in a better position to compete with private credit this year?

Assets are the biggest headwind, but I think there are paths. Called deals are being recycled and there are some green shoots in the second half for M&A activity. Now unlike last year where the bid-ask was wide for M&A, reasonable economic strength and a base case view that the recession is not imminent should lead to more transactions in the space. Banks were also more reticent last year to underwrite debt given 2022, so that drove more borrowers into private credit. That's not the case this year and the financing markets are much more open at competitive levels.

9. What's one thing on your bucket list you're hoping to get to this year, outside of work?

I'm going to answer for 2025 instead of 2024, because I think this year is going to be too busy with CLOs. I've been trying to convince my husband that our boys wouldn't be too young, they'll be six and seven in 2025, to go on an African safari. He seems pretty concerned about it. If anyone has personal success stories of bringing young boys, I'd welcome hearing them.

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9Questions — Stephanie Walsh, Bain Capital — Tackling headwinds in the loan market

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