(Bloomberg) -- The riskiest parts of collateralized loan obligations backed by loans to smaller and mid-sized companies can offer good value, according to John Kim, chief executive officer & chief investment officer at CLO investor Panagram Structured Asset Management.
Panagram, a subsidiary of Eldridge, manages about $14.4 billion of holdings across CLOs, asset backed securities and commercial real estate. Kim spoke to Bloomberg's Carmen Arroyo in a series of interviews that ended on April 11. Comments have been edited and condensed.
Where will small and mid-sized companies go for financing if they can't access regional banks?
They may have to seek financing from alternative lenders. Private credit funds are just going to get bigger, allowing themselves to lend more and go into new corners of the market. They'll start doing equipment leases and other asset financings that banks were previously doing. That activity will probably end up driving securitization as well, both public and private.
However, if a company was very reliant on regional banks for financing, their cost of capital may become more expensive and restrictive. It's hard to replace loans from banks, since private credit capital can be much costlier and the terms can be more onerous for the borrower.
How do you see returns for CLO AAA and equity changing in the near term?
Demand for AAAs is still challenged as banks, the biggest buyers, are facing too much uncertainty and volatility around their balance sheets. And other products may be more attractive than CLOs in the short term given banks' limitations on lending. But over time, demand will likely increase and we will see some tightening. CLO issuance will also depend on the health of the loan market, not just on AAA demand.
Read more in this week's Credit Brief: Green Shoots for Banks?
Loan prices dipped briefly and you saw some activity pick up with a few print-and-sprint CLOs coming to market buying in the 97 cent area. The equity arbitrage works acceptably well there. Managers that have warehouses open and are largely ramped at higher prices are stuck. They can do static deals and work their way out of the portfolio or, if they have captive equity funds, they can print deals now with more expensive debt and try to refinance them later.
CLO issuance slowed in recent weeks. Why?
Loans have rallied a bit recently and print-and-sprints don't look as good on paper anymore. Add to that a lack of new loan supply, and the challenge of selling AAAs at a reasonable level, and it becomes difficult to make the numbers work for equity. Tier 1 managers can justify printing new deals because they can drive down CLO liability costs to a certain extent. Ultimately, though, the CLO market depends on balancing loan supply and demand, and the supply side of the equation is very weak right now.
Where are you seeing value outside of BSL CLOs?
We've seen value in middle market CLO equity. Although that tranche is not widely available, the arbitrage there is very healthy because of the return premium we are seeing in the assets. Middle market liabilities haven't widened as much proportionately as broadly syndicated CLO debt, while asset spreads have continued to widen. But in those deals investors really have to trust the managers, as they often originate the debt.
Although we are always worried about defaults, these portfolios are quite diverse. Our main concern is if borrowers cannot service their debt; before a company gets to that point, lenders and borrowers can work together to manage a deteriorating situation. For the most part, private equity sponsors have so far been quite supportive of their companies, adding new capital when necessary.
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