Economic headwinds, spread volatility and intense competition for loans in a shrinking primary market are perfectly rational reasons to conclude that launching a debut CLO today would be a brave step, however 25 (18 percent) of the 141 managers that have issued a US CLO since January 2018 were new entrants to the market, creating a healthy and diverse landscape that offers investors choice and the opportunity to pinpoint a manager whose investment style and background matches their investment objectives.
There is no doubt that successfully launching a CLO platform comes with significant challenges but the rewards would appear to be worth the risks and the effort given the continued flow of new managers entering the market. One of the main obstacles to launching a CLO platform is sourcing the equity; unless the manager has access to its own source of funding, be it intra group or from other managed funds, they are required to seek backing from a third party investor who is willing to write an equity cheque and who is committed to do so for at least a few deals.
New managers target a minimum of three or four deals to build a track record. Finding that level of early investment commitment has proven particularly challenging according to some of the newer managers that we have spoken to who are all too aware of the catch 22 scenario whereby investors want to see that track record in place before deciding to invest. New entrants recognise that this makes launching a CLO platform extremely difficult because investors are reluctant to invest in an unproven manager where style and performance is unknown and because, more significantly, new managers invariably pay a wider spread penalty in comparison to seasoned managers and often need to compromise in other areas such as management fees, to get their first deals away. Other challenges exist in terms of finding the collateral in this mature and highly competitive market. Investors legitimately want to know whether new managers will have the traction to demand allocations when desirable loans are issued. New entrants look to negate these barriers by making key strategic hires from within the CLO market to leverage off existing relationships and experience to bolster credibility in the market.
The appetite however is apparent as we continue to see new managers enter the market. For new managers to be successful, and to attract outside investment and hopefully that key anchor investor who is able to commit to the first three or more deals, they need to be determined and have formulated and be able to communicate a clear strategy for launching their platform. With the volatility currently present in the primary market, part of the conundrum for new managers is trying to time the market in terms of both issuing the transaction and getting investors lined up and ready. They look to have a management and operations structure in place and fully operational and show a long term deal strategy and vision so that they can launch aggressively when the time is right.
This influx of new managers to the market, including the return in the past couple of years to primary of managers that have not issued a new deal since before the financial crisis, augers well for the sector as it continues to demonstrate faith in the CLO product. Reasons for entering the CLO market vary depending upon the types of entrant, be they hedge funds, existing middle market lenders seeing an opportunity to create their own CLO platform, managers created from a buyout situation, insurance firms or a well-established investment firm which sees an opportunity to put some capital to work and to get a better rate of return than they might currently be achieving elsewhere.
Some interesting statistics emerge when you start to break down activity between US and EU markets.
- 88% of all CLO Managers have issued in the US CLO market
- 53% of all CLO Managers have only issued in the US BSL CLO market
- 19% of all CLO Managers are middle
market CLO Managers
- 67% of managers who have issued a middle market CLO have also issued a BSL US CLO
- 30% of managers who have issued a middle market CLO have also issued a BSL US CLO and EU CLO.
While some may argue that the decade long expansion is coming close to the end and we are at an advanced stage in the credit cycle, there has not been any real slowdown in the rate of new CLO entrants.
Regardless of the particular circumstances, any new manager in the CLO space will clearly need to be looking ahead to its next couple of deals. It is never a case of issuing one deal to see how it goes. A new manager will need a solid plan, ideally with three to five deals locked in, coupled with a clear management style and strategy that investors can understand and buy into. Furthermore, the structure put in place will often depend upon their funding situation, be it via internal group funding or third party anchor equity investor.
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