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Owen Sanderson

Consolidation has been just around the corner for the CLO market for….I don’t know, five years at least? CLO managers need a certain scale to pay the bills, and for pure-play CLO shops that means at least three deals, ideally more — it’s the same work to keep track of European loans whether it’s for a single €400m deal or for €2bn of AUM. 

Average manager size has been creeping up regardless, as the small startup shops of 2017/ 2018 mature into solidly mid-sized managers with deal counts in the high single digits, and fewer new entrants join the market.

But 2021 has seen a trickle of CLO M&A activity start to emerge — Cross Ocean Partners taking on the Bosphorus platform from Commerzbank (a bank-owned anomaly in today’s market), and HPS buying Bardin Hill, for example. 

Most recently, WhiteStar Asset Management has finished its study of the right entry strategy for Europe with the purchase of the Mackay Shields Europe platform, led by Brian McNamara and Conor Power. The buyout comes with two CLOs under management — Mackay Shields was a 2019 debutant in Europe — as well as a broader support team of analysts.

That’s potentially big news because WhiteStar Asset Management is a very sizeable shop in the US, recently pricing its 18th issue under the Trinitas brand. It’s owned by Clearlake Capital Group, a privately held investment firm, with senior management mainly drawn from former execs at Highland Capital Management (it’s also Texas-based) and has been working on its entry into the European market since hiring asset management exec Gordon Neilly in April this year.

New European CLOs from WhiteStar will be branded “Trinitas Europe”, and the firm also plans to launch a credit opportunities fund in Europe, with more potential team hires down the road in other related sectors.

Mackay Shields is a generalist fixed income shop based in New York, with investment grade, munis, EM, high yield and various other funds, as well as a substantial US bank loan and CLO operation. 

Increasingly, though, CLO management in Europe seems to be embedded within more alternative approaches, sitting alongside special sits, credit opportunities, structured credit and the like. More and more managers are also owned by groups with PE investments as well — all the European managers with more than 15 deals outstanding, with the exception of PGIM, fall into this bucket.

So who else might be joining the market next year? 

One of the biggest loan shops in Europe with no active CLO platform is M&G, which, Excess Spread understands, has historically valued the flexibility of investing in leveraged loans outside the confines of a CLO structure. But given that M&G has the infrastructure and the people in place for large-scale loan investing, sure a CLO operation is a no-brainer?

It had a CLO operation before the financial crisis, issuing five deals under the Leopard shelf, but these deals didn’t have the greatest reputation for performance. Nonetheless, it’s been a strong and successful presence in European loans since the Leopard deals wound down, and has been at forefront of the moves to incorporate ESG in the loan market, with one of the only Article 8-compatible senior secured loan funds out there (Invesco has another one).

With CLOs also making the turn towards Article-8 aligned structures, could now be the time to turn back to CLO issuance?

A bigger pool of potential European debutants is surely the US, which has provided most of Europe’s new entrants in the past few years.

2021 saw a disappointing four managers joining the market, the lowest rate since 2017, according to Bank of America research, but three of those four were established US managers. 

The larger US managers have the resources, expertise and positioning to start European platforms. The European loan market is smaller, controlled more heavily by sponsors, and with worse documentation, but the CLO fees and the arb are better, and the loan market is becoming increasingly transatlantic — US managers will have already done the work on the big cross-border issues.

AGL Credit Management, with 11 US deals, MGX Asset Management with 21, must have at least considered the transatlantic opportunities, while ZAIS, Six Street, Symphony, First Eagle, and Benefit Street among others are also in the “why aren’t they here already” bucket.

US giant Octagon, with 35 deals outstanding, tried to enter the European market in 2007, a less-than-auspicious time for establishing a new structured credit shop, eventually selling its single deal to Ares. Perhaps they’re still scarred by the experience, but parent Conning Asset Management is now looking at European securitisation again, hiring former Credit Agricole trader Benjamin Bouchet in September….

We’ve also seen representatives of Canyon Capital Management sniffing around European CLO conferences, so...maybe another one to watch

Prices for the post-Omicron crop of CLOs held in impressively, with some softening at the bottom of the capital structure, but overall capital costs remaining attractive. Managers are reporting, however, that debt investors, especially in investment-grade tranches, are becoming increasingly assertive on docs.

The peculiar structure of the CLO market’s investor base inverts the usual hierarchy of financing markets. 

Usually, as debt instruments get closer to equity, the level of negotiation and tailoring increases, as does the timeline for credit work. This makes intuitive sense — the riskier the instrument, the greater the need for detailed diligence.

In CLOs, however, the concentration of investors at the top of the stack means that the stipulations, negotiations and timelines are far longer for triple-A bonds, which will be money-good until we’re all eating beans in our bomb shelters, than for the single-B or double-B tranches which are actually wearing most of the risk in a deal.

But there are some major-league mezz investors that can anchor full tranches, and some of these have their own sets of difficult stips.

We’re hearing a certain amount of resentment about refi deals which push out deal WALs — with the consent only of the senior bonds. Refis of Toro 7, Dryden 66 and Anchorage Capital Europe 1, among others, have included WAL extensions, and in some cases non-call extensions too, and mezz investors now want better protections against getting extended against their will.

Flushing trading gains is also said to be a hot button issue. For some time, debt investors have been pushing back on the definition of trading gains, with a calculation mechanism taking the higher of purchase price or par.

This means that if a manager buys a loan at 98, which rallies to 101, it can only book one point of trading gains, rather than three. That’s meant managers flushing gains out to equity through refis and resets, rather than from the trading gains account — though debt investors are now also seeking to limit the flexibility to flush gains on refis.

Put together, this probably points to more resets down the road, as, despite the expense involved, refis are becoming less attractive and more constrained.

I’m very fond of Fleet Services, on the UK’s M3 motorway. If you’re headed to the beautiful countryside and coast in the south-west of England, it symbolises the moment you shake off London traffic and have the open road ahead of you. The only thing which could improve it is knowing it is being financed in a securitisation, and now that moment is here. 

The deal is Highways 2021, from Goldman Sachs, which priced last week, and funds the purchase of eight motorway service stations (including Fleet) let to Welcome Break by Blackstone Infrastructure and Arjun Infrastructure.

It’s a portfolio with a bit of history — it was sold to M3 Capital in 2013 by one of Robert Tchenguiz’s acquisition vehicles, with the proceeds used to pay off financing from RBS. Half of Fleet also burned down in 2016, requiring a £20m replacement building to be constructed.

M3 put the book up for sale in February 2020, but, uh, we all know what happened then. Excess Spread doesn’t have full insight into the sale process during 2020 but safe to assume that assumed bid levels when the sale starts weren’t necessarily there once the pandemic started to bite.

The portfolio eventually traded in October this year, backed by a Goldman loan, which yielded 235 bps over Sonia — and was rapidly taken out in last week’s CMBS with a blended debt cost of ~187 bps. 

Few motorway freehold portfolios exist, with only 95 or so motor services in the whole UK and firm guidance limiting the possibility of building more facilities. But this gives the assets, despite being let mainly to retail concessions, an infrastructure-like flavour (underlined by the sponsors here being two infra funds), as they’re an integral part of the UK’s transportation network, with high and stable usage. 

These assets are fully let to Welcome Break, which sort of implies they should be credit-linked to this firm (itself partly owned by co-sponsor Arjun Infrastructure), though it’s highly likely that other managers would be able to step in to run the service station concessions if Welcome Break got into trouble.

Highways had the misfortune to be in the market when the Omicron variant news hit the wires, which, combined with thin end of year liquidity, led to levels down the stack landing outside IPTs. Perhaps January might have brought tighter pricing, but the rapid recycling of risk before year-end and still attractive exit level for Goldman may have had its own attractions.

It’s been a big decade or so for securitisation regulation, and few have fought for the product more tenaciously than Richard Hopkin, who joined the Association for Financial Markets in Europe’s Securitisation Division in 2010 (the same year your correspondent started writing about these markets). We’ve collaborated a number of times since then, with yours truly compering an annual securitisation roundtable for Afme in my former role.

But he is retiring at the end of this year, with Shaun Baddeley, the former head of Santander’s securitisation business, taking over as managing director in the securitisation division.

There’s a ton of wood to chop for Shaun — the rounds of consultations, revisions, regulatory technical standards, implementing technical standards, directives and regulations that have kept Richard busy for more than a decade show no signs of slowing down.

Happily though, the industry is now in a position to hope for encouragement from regulators, rather than fighting a defensive battle warding off the worst excesses.

Top of the agenda is going to be potential recalibration of capital requirements for securitisations. The European Commission has asked the “joint ESAs” (the three big pan-European regulators) for a report on whether to recalibrate capital requirements for securitisation — though with no response required until September 2022, any potential regulatory changes could be kicked into the long grass, and perhaps arrive only in the last year of the present European Commission where few new initiatives tend to get signed off.

“What we would like to see is clearly improved treatment from a capital perspective, to bring back a large segment of investors that have not looked at the product since the financial crisis - insurers and banks in both the public and private markets who were formerly important buyers of this product,” said Baddeley. “We need to continue to educate official institutions, provide more data to them demonstrating the stability of the product, and get to a point where this product can flourish in the way it should. That also means ensuring it’s treated equitably from a regulatory perspective.”

The last decade has seen a move from securitisation as pariah product post-crisis, to regulators realizing it can be a crucial vehicle for channelling funding to SMEs and managing the sale of non-performing exposures. 

According to Hopkin, the crucial moment for the change in tone was a 2014 paper from the Bank of England and European Central Bank arguing the case for the benefits of securitisation. 

“It was a very good piece of work, and it did change the direction of everything,” said Hopkin. “Before that I couldn’t even get anyone to return my calls, but after that we could start to engage properly with authorities”.

Even so, the flow of regulation was intense. Pre-2008, rating agencies were unregulated entities, and three full EU-level rating agency regs followed in quick succession. Banks have been re-regulated with CRD III and IV, and concepts such as risk retention have evolved through at least three iterations. 

That’s before we even get to the mamooth Securitisation Regulation, the flood of implementation details, and the associated “Simple Transparent and Standardised” concept — which was partly pre-figured in the first incarnation of the “Prime Collateralised Securities” label.

The re-regulation of securitisation wasn’t a smooth process, with what Hopkin calls several “fire drills” along the way — most notably the 2016 initiatives from the European Parliament to crank up risk retention requirements from 5% to 20% or 30%. This is most commonly associated with Dutch MEP Paul Tang, but was supported by several other left-wing MEPS, and would have fatally damaged European securitisation if passed.

Even when European regulators are actively trying to help, they can still add to the admin burden for market practitioners, and that’s certainly been the case for securitisation — the 2017 Securitisation Regulation was supposed to bring unprecedented transparency and regulatory benefits to the market, encouraging investors back to the product, but ended up imposing additional disclosure and reporting burdens far above and beyond what actual bond buyers ever wanted. With friends like these....

Fixing some of these concepts is also high up on Shaun’s agenda, with the Securitisation Regulation heading into the European standard five year review next year. Some legislators and regulators, especially in countries without a developed securitisation market, are concerned that the lighter-touch approach to “private” securitisations is being used as a tool to evade some of the Regulation’s provisions — rather than reflecting mainly deals financed off bank balance sheets or conduits instead of through ISIN securities.

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