European CLO pricing drought ends, but timing of further new issues remains uncertain
Pitchbook
7 min read
The pricing of Palmer Square’s latest European static vehicle brought to an end a lengthy fallow period in the European CLO space.
Before Palmer Square’s offering on July 12, the last deal to print was the €400 million Glenbrook Park CLO for Blackstone back on June 9, and the resulting absence of European CLO new issues came as a surprise to some — particularly given that a number of deals were expected to closely follow the Global ABS conference in Barcelona in June. According to LCD, the month-long gap was the longest period in the European CLO market during which no deals priced (excluding the usual December/January hiatus) since March-April 2020, when the onset of the Covid-19 pandemic put a pause on issuance.
While those deals failed to materialise in the anticipated timeline, a number of managers are now understood to be in the market following Palmer Square, which is the first CLO to price since Fidelity, CVC and Blackstone cleared the market in the first full week of June.
Other managers that have been in discussions with investors are said to include names such as Nassau, Bain, King Street, Sound Point, Investcorp, ICG and Pemberton. However, the “timing for all is pretty fluid, given market conditions,” commented one CLO note investor. Another source added that while these names feature on investors’ pipelines, some managers have indicated they have little intention of issuing soon. “For some, a lot of things need to line up first,” said the second investor.
Beyond those names, various other deals are in different stages of pre-marketing — including some newer managers that participants concur are likely to pay more on the liability side. This would appear a reasonable assumption, given the 210 bps triple-A spread on European debut issuer Signal Capital Partners seen in May.
Managers that have spoken to LCD say liability demand is indeed strong — particularly for mezzanine tranches — and that accounts are showing a willingness to put cash to work. However, the triple-A investor base remains thin, with large anchors currently sparse, which some suggest explains the gap in activity. “On triple-As you might have five to six investors that can do €25-30 million tickets, one-to-two on €50 million tickets and a couple on €80 million. On a new deal, the maximum ticket you can expect to see is €100 million,” said one manager. “Broadly syndicated is the way to go at the moment, which is perhaps why we’re seeing a slowdown,” the manager added.
“Nowadays managers won’t launch unless they have a high certainty of execution,” said an investor, who added that more triple-A investors are doing the bulk of their work in pre-marketing as deals can progress quickly once announced.
Captive equity With few drivers for change on the asset and liability side, CLO managers remain in two camps — those with captive equity that will continue to issue over the coming months and build AUM despite sub-optimal day-one economics, and those requiring third-party equity that will remain constrained. “Those reliant on third-party equity have no interest in issuing due to the arb,” said an investor.
Even after adjusting fees and pulling other various levers, participants note that modelled equity returns are in the high single-digits at best, but more realistically in the low single-digits. “If liabilities are high then equity makes no sense versus double-B or single-B notes. Even double-B and triple-B paper makes more sense than taking equity at the moment,” said a manager source.
“Given the cost of capital is 300 bps-plus on CLOs, versus a 300-400 bps spread on the assets, you don’t get a double-digit cash return for the equity, while equity investors aren’t willing to lower their return hurdles. Given over the next 12 months we are likely to see the most challenges, then why compromise returns now?” said one market participant.
Given managers with captive equity, risk-retention funds or access to multi-strategy funds are best placed to issue in the current market, sources concur that more firms are looking to raise retention funding to solve the equity conundrum. But the fundraising environment could be tricky for some, sources say. “From what we’re seeing, it’s difficult,” said one manager. “There’s not a whole lot of appetite. The arb is tough so the task is to show investors where it will be in the future, and show them that things will rebalance. So there’s an education process — it’s a tough proposition right now.”
Nevertheless, participants note that the appetite is there for those larger managers with a proven track record, as evidenced by the recent close of CVC’s third CLO equity vehicle — CVC CLO Equity III — at its hard cap, with $800 million of commitments. This has allowed CVC to price three deals in Europe and four in the US so far this year.
Issuer profile In Europe, CVC and Palmer Square are now tied on three deals this year (two statics and one reinvestment vehicle for the latter), while Blackstone and Invesco have priced two deals apiece.
Reflecting the current issuance dynamic, of the managers that priced three or more vehicles in 2022, PGIM and Hayfin have yet to come to market this year, while those that priced two deals in 2022 and are yet to print so far this year include Investcorp, Carlyle, Napier Park, Neuberger Berman, Onex, Bain, Sound Point and Spire.
Issuance conditions have remained broadly challenged since Russia’s invasion of Ukraine, and eight managers — including BNP AM, Brigade, CIFC, Oak Hill, Rockford Tower (King Street) and Fair Oaks — have not issued since 2021 (this figure also includes Assured IM and NIBC, which have since been acquired by Sound Point and Aegon, respectively).
Long-term view Despite CLO issuance remaining effectively shut for some, participants note that every active CLO manager is likely to have a warehouse open, with many taking a long-term view and steadily ramping from loan primary, or more specifically, via amend-and-extends. As consensus estimates put the number of CLOs in a given deal that can’t roll at 15–25%, managers have been able to pick up additional paper at attractive levels on most deals.
“Ramping in primary makes sense, but you might see some managers ramp opportunistically if secondary levels fall. Some are well-positioned if the market turns. Everyone has something in the works,” said one investor.
However, there is little expectation that secondary loan levels will fall over the short-term, and despite drifting wider over the past few weeks, managers that have spoken to LCD expect loans to grind higher in secondary over the summer. As for the prospect of liability tightening, there remains no obvious driver, save for a handful of new investors expected to enter the space.
Reset button One source of CLO issuance talked up by some is the prospect of resets, an option that some participants are currently exploring in order to push out reinvestment periods, according to sources. The last such deal to price in Europe was the €406.55 million reset of Madison Park Euro Funding XV CLO for Credit Suisse Asset Management, back in April 2022.
“Some 2020/2021 prints are at the same high level as triple-As now, but even if it’s sub-optimal it still makes sense to reset,” said one manager. According to sources, roughly a dozen resets are in the pipeline in the US, while so far in Europe only a few are being explored.
“There will be idiosyncratic opportunities such as Barings that printed at +220 bps, but the opportunities may not be there for others yet beyond the odd one,” said another manager. “If triple-A liabilities fell to 155-160 bps, then there would be more room for such transactions”.
