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Michelle D'Souza

The European CLO market gathered at the Opal conference last Tuesday (8 October) in the London Marriott Hotel Grosvenor Square and, well, let’s just say the tone was slightly less bullish than Global ABS Barcelona in June and more focused on tail risk (we're not sure the weather helped either).

That’s hardly surprising. As one panellist put it: “Valuations are higher, liability spreads are tighter but fundamental credit risk has been increasing across the year.” 

Since the summer there have been a few big corporate ratings downgrades, including the likes of Altice France and International (with even senior loans looking like they could take a haircut), Kloeckner Pentaplast and Cerba. 

Still, market participants are constructive on CLO performance thus far this year and optimistic about green shoots appearing for M&A. 

CLO supply in October appears robust, with managers eager to finalise deals before the upcoming 5 November US presidential election and in case conflict escalates further in the Middle East. 

This has led to accelerated deal timelines with one investor highlighting European CLO managers are trying to price roughly 40 deals before the US election.

With the conference on Tuesday, some sore heads on Wednesday after post-conference drinks, and a ton of manager and investor meetings, only two European CLO officially priced last week (though it has since emerged that Barclays priced UBS AM’s Madison Park Euro Funding XVIII on Friday 4 October. 9fin previously reported on the manager's return to primary with deal marketing).

9fin understands Redding Ridge priced the reset of RRE 3 via HSBC on Friday, having reported on the deal marketingearlier in the month.. Sources say the triple-As priced at Euribor+129bps with the rest of the cap stack at 185/220/300/405/590bps.

BlueBay paired with Citi on the €411m BBAM European CLO V, which featured the seventh European loan triple-A delayed draw tranche this year, according to 9fin data. The deal’s triple-As priced in line with reported price guidanceat Euribor+130bps. The deal is 10.7-times levered with a 202.9bps cost of debt. 

It was also the second time BlueBay and Citi worked together, having priced BBAM European CLO IV in February, which also included a delayed draw loan tranche. 

Pipeline builds, BNP Paribas co-placement agent, Blackstone retention fund

At least six new issue deals were added to the European CLO new issue pipeline last week, according to sources.

European new issue pipeline; Source 9fin data

9fin reported JP Morgan officially launched marketing for Pemberton Asset Management’s second €232m-ramped European CLO, Indigo II. And Palmer Square Capital Management is understood to be marketing another new issuestatic European CLO, Palmer Square European Loan Funding 2024-3, also via JP Morgan. 

2023 debutant Arini, has paired with Bank of America, and is pre-marketing its fourth European CLO, Arini European CLO IV. 

Polus is understood to be pre-marketing a new issue Cairn CLO XIX via Jefferies, with the pair looking to price the deal end of October. Sources tell 9fin that deal is €176m-ramped. Napier Park meanwhile has paired with Barclayson Henley CLO XII, which is expected to price at the end of this week.

Finally, CVC Credit is back with a new issue, Cordatus XXXIII, with BNP Paribas marketing the 43%-ramped deal. 

Speaking of BNP Paribas, 9fin reported at the start of October that it had its first ever co-placement agent role on the upcoming Onex Credit Partners Euro CLO 2024-11. 

Many in the market made an educated guess this was involved taking on the deal’s triple-As, but three sources told 9fin this co-placement role was actually BNP doing the warehouse of the deal and had nothing to do with syndicating the triple-As. 

Sources say BNPP provided a long-term warehouse to Onex, and multiple deals will get done out of it. It’s likely BNP will be co-placement agent on a few Onex deals going forward, one source said.

European repricing pipeline; Source: 9fin data

European CLO repricings continue to flow with at least five deals added. Last week also brought the marketing of the first refinancing since 8 August (CVC Cordatus Loan Fund XXIII, which was split into two pricings). 

Blackstone Credit emerged with marketing for a refi of its 2023-vintage deal Bushy Park, following a notice to investors. The deal comes at a time when resets have dominated the market. Bank of America is arranging the transaction. 

The pair originally priced the €390.1m Bushy Park in February 2023 with triple-As at E+170bps and a delayed draw single-B tranche (which it later issued in April this year, pricing at E+825bps).

The transaction is unusual for a refinancing, both because IPTs on the refinanced single-B tranche come in wider than the current coupon at low-mid E+900bps (95h), and because the notional amounts and par subs have been tweaked. This actually makes the transaction more like a reset without a corresponding WAL or reinvestment-period extension, says one source.

Three sources tell 9fin this is because Blackstone’s risk retention fund cannot participate in resets as it is winding down. This is said to be a similar story to Blackstone’s refi of Clonmore Park in the first quarter of the year.

Meanwhile, 9fin reported Société Générale won its first ever sole CLO arranging mandate in Europe, with the bank marketing a reset of Five Arrow’s Contego CLO XI. 

Barclays is understood to be resetting Alcentra’s 2014-vintage Jubilee CLO 2014-XII. That deal was reset in 2017 and refinanced in 2021 (triple-As at E+60bps), and left its reinvestment period in October 2021, although it didn’t begin repaying principal until October 2023, according to data from 9fin and Moody’s Analytics. 

9fin sources indicate price guidance for the deal is 130/195/230/340/625 (99.75) and 950bps (95), as of Thursday (10 October).

KKR is resetting Avoca XI via JP Morgan. That deal originated in 2014, with the CLO reset in 2017 and later refinanced in 2019. It left its reinvestment in June 2021.

Finally, a short-dated reset was added to the pipeline. This time, Hayfin and Jefferies paired up and are marketing a reset of the 2020-vintage Hayfin Emerald CLO V, with triple-As subject at E+121bps.

European CLOs exploring repricing options; exploring redemption or liquidation *exploring delayed draw issuance Source: Euronext, 9fin data

Managers continue to explore resets and refinancings of deals, with several notices sent to investors. 

Guggenheim could make a return to the European CLO primary market, with investors exploring a reset of the firm’s inaugural European CLO, Bilbao CLO I. It has been around two and a half years since the manager priced a new issue, with Bilbao CLO IV in February 2022.

Investors in Alcentra, HPS and Investcorp deals are exploring refinancing options for Jubilee CLO 2018-XX, Segovia European CLO 4-2017 and Harvest CLO XVIII, respectively. 

A notice today (14 October) also reveals Carlyle has cancelled a notice of redemption for a legacy CBAM deal,Bastille Euro CLO 2020-3, “due to the inability to satisfy the conditions to the redemption proposed to occur on the proposed redemption date”

Despite the relative lack of issuance, last week produced no shortage of valuable insights and talking points, as the European CLO market gathered for Opal’s annual European CLO conference, which we’ve digested for 9fin readers below in nine key themes. 

1. Considerable triple-A tightening YTD, but expect stable spreads 

CLO triple-A spreads have tightened a lot since January, from E+170-150bps to a rather sticky E+128-130bps. There appears to be no short-term catalyst for substantial further tightening, especially given the constant supply in the market, panellists said.

In addition, there have been a few short-dated resets and refinancings, which often have a different buyer base. Existing triple-A investors are likely to receive capital back, but reinvestment decisions will depend on the relative value of other investments. This could serve as a positive catalyst, as August repayments have yet to fully impact the market, which may contribute to tighter spreads.

The regional investment landscape is widening and growing, panellists said.

The US and Asia (chiefly from strong Japanese interest) remain primary sources of investment outside of Europe, but the CLO market is increasingly attracting investors from the Middle East, Asia, and Latin America (the latter mainly for CLO funds, as reported). 

Additionally, there has been interest from south east Asia, including investors from Singapore and Taiwan, who tend to focus on dollar-denominated assets due to their familiarity with the US market. The same trend applies in Australia, while a select few investors in the Middle East are engaging in European investments. 

In Europe, there has also been progress in engaging medium-sized banks, facilitating ticket sizes of €20-30m.

Down the cap stack, the double-A and single-A investor base is thinner than it has been historically. A few large investors continue to dominate IG mezzanine tranches, making it easier to build a book when those investors are involved (although it can be challenging when they are not involved), panellists said. 

Lower mezz tranches are “primarily a pricing exercise, with relative value considerations compared to the US and adjacent markets, though a premium remains in comparison to the US,” said one panellist.

2. Warehouse approach shifts, third-party equity emerges, liquidation value focus

Selling third-party minority equity has proven to be much easier than in the past two years. 

January and February in particular were supportive for primary equity sales, as rating agency leverage rose while loan prices remained stable and liabilities tightened, panellists said. Many managers successfully sold equity to third parties during this period. However, by March loans rallied.

Equity continues to hold potential for medium-to long-term investments, but it has become somewhat stretched due to a third wave of loan repricing. Still, various strategies are being employed including taking fees down to 40bps for managers and earning warehouse carry.

New pockets of third-party equity demand have emerged. With the right distribution channels in place, family offices and high-net-worth individuals are beginning to take a keen interest in CLO products, one panellist said. 

“Many portfolios are now tailored for investors who can manage duration and volatility, placing a strong emphasis on cash yield and long-term value creation,” said one CLO manager.

Motivations of equity investors however are evolving.

There is now a “stronger focus on achieving a solid NAV and understanding the liquidation value of CLOs”, an arranger said, rather than solely concentrating on higher running cash-on-cash returns. Investors are prioritising defence within their portfolios, creating opportunities for managers to distinguish themselves.

The approach to CLO warehousing is also shifting. There is a record high 100 warehouses, and it’s unlikely managers will run them in the same way as in previous years, panellists said.

In the past, it was common to ramp warehouses to €150-200m before pricing. However, the experiences of Covid-19 and throughout 2022 have led to a more cautious strategy. As the market transitions from a principal-only environment to interest-only, the need for greater warehouse capacity is becoming evident, driven by more managers and an uptick in deal volume.

Panellists also discussed variations among deals.

Most recently ramped warehouses have involved variations of similar deals, with many assets sourced from the secondary market. It has been quite straightforward to ramp these deals; when faced with assets that cannot be extended, managers can transfer assets to other CLOs, panellists said. However, 2024 and 2025 vintages are expected to differ a lot, with increased volumes anticipated based on conversations with origination teams and sponsors.

3. M&A green shoots appear, but loan repricing and EV valuations are concerning

The loan market is poised for high activity, with about $40bn in new primary loans expected to enter over the next six months, according to one CLO manager. This is good news for managers, with the majority of 2024 primary deals consisting largely of refinancings and add-ons.

Enterprise valuations were brought into the conversation. While stock markets are reaching all-time highs, the broader market is witnessing a decline in EVs.

This is particularly evident in the LBO market, where PE firms are buying large businesses, such as laboratories and veterinary services, to create scale and pursue additional acquisitions. The number of adjustments in these transactions is, however, substantial, leading to potential challenges for those unable to deliver operational synergies. Investors should watch out for firms reliant on government contracts, which are increasingly under fiscal pressure. 

However, there are signs of recovery in M&A activity. Panellists believe the worst is behind us, with interest rates starting to decline. The path forward for sponsors, which have faced considerable challenges over the past two years, will be critical.

The ongoing wave of repricing also raises important concerns. If this trend continues unchecked, it could pose challenges for European CLO portfolios. With spreads tightening to around 375bps, the situation may become untenable if liabilities do not adjust accordingly.

Has a lack of pure M&A-led primary markets led to challenges with warehouse ramping? Well, panellists expressed differing views.

“The introduction of new primary loans often comes as a surprise and tends to taper down secondary prices, providing additional investments,” said one manager, adding the frequency of loan BWICs from called CLOs also makes assembling portfolios in the secondary market feasible.

“You can form a CLO and source assets,” said another manager. “But if it was to continue like this for three years, the fact is there is a shortage of collateral at some point in time. But private equity is motivated and there’s plenty of dry powder.”

Nevertheless, supply constraint is driving spreads lower, making secondary offerings less attractive, particularly those lacking call protection. Investors may find themselves purchasing assets at prices like 101, only to face the risk of repricing shortly thereafter, another panellist said.

That said, managers are also more comfortable buying assets above par. 

“Total return investors are now more comfortable purchasing assets above par,” said one manager. “375bps plus Euribor means you can burn half a point of premium quite quickly without adversely impacting your portfolios.”

4. CLO market grabs 80% of loan market share

The bid for single-B loan paper has been limited with low inflows into SMAs. As such, the CLO market has taken even more market share, with several panellists agreeing this has risen from around 60% to 80%.

“There’s always moments where it gaps out and you see aggression from other realms of single-B buyers, be it Asian investors with different return targets, large SMA accounts, NAV based funds and other investors who aren’t solving for the same CLO arbitrage,” said one manager. “That’s not been the case over the past few years, whether it’s around issues with settlement, or regulators not allowing retail to invest.”

While a diverse buyer base means more liquidity, one panellist argued there are enough pockets of the market looking for dislocation money. And with CLOs at 80% majority, they should have more power to negotiate docs and whitelists.

H1 2024 was primarily focused on resetting deals from the 2022 and 2023 deals, vintages associated with high costs of debt. And many early 2023 deals are also expected to reset in the fourth quarter, with non-calls ending soon. These deals, if functioning well, are likely to be upsized (sometimes using sidecar warehouses) and have their leverage increased upon reset.

But a wave of transactions involving older vintages is emerging, including deals with triple-As below E+100bps. Motivations for this include how hairy the portfolio is, who the equity investors are, and their desire for a fresh reinvestment period.

Another factor includes whether equity investors want to contribute additional equity into the deal, especially if they can do so at discount to NAV (which can be more attractive than entering a fresh deal with challenged arbitrage due to current loan pricing).

Roll coverage is of course dependent on portfolios, panellists said. But resets offer investors a well-identified portfolio and a short settlement period, which aids cash management. Investors can also engage managers to clean up the portfolio and eliminate high triple-C tail risks, along with implementing structural changes such as adjusting leverage.

European CLO refis remain subdued versus the US. This is because resets in Europe often need less additional equity due to stronger performance, panellists said.

We know about resets and refis, but what on earth is a rehash? A refi typically involves lowering margins on notes, particularly senior notes, with minimal changes to documentation and perhaps a WAL test. Resetting can involve changes to structures, WAL tests, and specific dates.

Some transactions have adopted a hybrid approach — a rehash.

“Some deals are restructuring without changing dates while recapitalising the structure — leading some market participants to refer to these as 'rehash' or 'reset-like' transactions,” said one panellist. This trend is likely to see diverse vintages come to market, even as funding costs decrease, they added.

6. Lower par subs and extension risk among documentation concerns

Some panellists highlighted extension risk related to A&E activities as a concern. Many deals aim to “maintain or improve” performance for deals now facing deteriorating WAL tests. But a recent review of 40 deals indicated some portfolios are flatlining, with limited ability to pass WAL tests post-reinvestment period.

However, panellists noted the A&E debate is largely a reflection of the past two years not the next two; A&E should only occur when businesses cannot be sold, while full refinancing is preferred to extend liabilities by five to seven years. Panellists anticipated increased M&A activity and straightforward refinancing, with no major maturity wall in Europe over the next 18 months.

Finally, credit enhancement levels are reverting to earlier market conditions, with triple-B par subs, for example, falling from 14.5% to around 13%, and triple-A par subs decreasing from 38% to sometimes even 36.5%. An absence of single-B OC tests was also spoken about on several panels.

7. LMEs and discipline keep market up at night

Panels addressed concerns around the aggressive behaviour of LMEs in the US, which is driving down recovery rates — an issue not yet seen in Europe. The long-term outcomes of this trend remain uncertain.

They cautioned about potential risks when small pari-passu euro term loans are placed alongside US dollar tranches. These arrangements may seem fine at issuance, but there's a risk that US lenders could seek to extract value from European lenders by subordinating European loans or up-tiering US term loans.

The need for the market to take a broader perspective was also discussed, with warnings against myopia in focusing solely on immediate returns, or "day one arbitrage”.Rather, investors should focus on whether the structure is sound, the collateral is appropriate, and whether the manager has the necessary technology to monitor performance.

Finally, panels noted the growth of the private credit market, highlighting that many investors who previously focused on loans SMAs are shifting their allocations to private credit.

8. Strong CLO performance as defaults remain subdued – for now

Rate cuts leading to lower capital costs could greatly improve cash flow for portfolio companies. The positive outlook is further supported by the unexpectedly strong performance of US consumers.

Loans have demonstrated robust performance over the past two years, with some CLO equity distributions consistently exceeding 5-6% on a quarterly basis. Achieving 10% returns for loans may not be feasible in the near future.

Only 3% of European CLOs outstanding are breaching coverage tests, versus 18% in the US. For triple-C tests, only 3% of European CLOs inside reinvestment period are in breach, whereas that figure is 17% in the US.

The stats are exacerbated when looking at deals outside their reinvestment period. 22% of European CLOs outside RP are in excess of their triple-C bucket, while in the US that figure is 74%. Panellists were undecided whether this was because Europe is lagging, or if credit performance is decoupling between Europe and the US.

Default expectations are set at 4-4.25% in Europe, while the US figure has increased to 5.5%, reflecting broader economic pressures. Additionally, one investor highlighted watchlist exposure across CLO platforms has risen a lot, with some platforms increasing by 30%.

Many challenges stem from capital structures that are ill-suited to withstand higher interest rates, as well as sector-specific issues affecting certain industries. But there have been signs of recovery in cyclical sectors.

Looking ahead, panellists observed that only a small percentage of the CS index is set to mature in the next two years, with only 2.5% trading below 80. 

Investors underscored the importance of manager selection, both from a quantitative and qualitative perspective, discussing several factors they assess.

For equity investors, annualised CLO equity returns can vary widely, with some differing 10% annually, panellists said, making selection critical. Tracking individual credits, cumulative par build, and cash drag were some ways investors tracked managers. 

With debt investors, the conversation shifted to the intricacies of portfolio construction and management, particularly concerning B3-rated names.

Some voiced concerns over firms’ shifting investment philosophies (i.e promising a conservative portfolio that might not be upheld), while others highlighted sector complacency, urging caution in selecting subsectors, especially as historical strongholds like media and telecoms have seen increased leverage and complex capital structures. The panel emphasised the need for discipline in decision-making, recommending early exits and par burn strategies to mitigate risks.

Managers' internal processes and adherence to performance metrics were also discussed as key factors for success. In addition, qualitative aspects, such as accessibility to managers when problem credits arose, were viewed as essential.

Likewise, “stability within the investment platform and a clear equity strategy” were deemed vital.

Panellists pointed out the mark-to-market risk associated with CLOs, particularly during liquidation events. If transactions cannot be called due to widespread syndication of equity, the debt may begin to amortise, creating increased economic risk for mezzanine investors. A robust equity strategy is essential for facilitating deal issuance and maintaining liquidity, they said.

Finally, daily liquidity was identified as a crucial component for tier one investments, contributing to competitive secondary trading.

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