Despite several attempts, the senior loan market has thus far failed to build on any kind of meaningful and sustained momentum. Up to this point, in early March, the efforts have been marked more by the failings of some familiar faces than by the new stars that were expected to materialize out of the shadows of the hobbled lenders.
"There are at least four teams who have tried to fill in the gap, but by and large, nobody can figure out the leverage component," says one marketwatcher, discussing the travails of fledgling non-bank lenders.
Indeed, the sale of Tygris Commercial Finance Group last October to Everbank signaled that launching a non-bank lender in the mold of a CapitalSource or Antares to fill a hole in the middle market is not as easy as it once was.
Others have also run into trouble. CastleGuard Partners, according to market sources, abandoned efforts to launch a senior debt vehicle. The firm launched by Ian Fowler, Victor Viner and Chad Blakeman, was formed last April. Efforts to reach CastleGuard were unsuccessful as of press time.
To many deal pros, the market for collateralized loan obligation vehicles holds the key to senior debt, and while nobody anticipates CLO issuance will ever again approach the $440 billion seen in 2007 -- when the market accounted for roughly three quarters of all senior financing -- many observers are encouraged by recent rumblings of a rebirth.
Theodore Koenig, founder of Monroe Capital, notes that the CLO market to a certain extent has been a victim of mistaken identity, as the backlash against securitization has made it difficult to attract institutional capital. "It was the CDO market, which deals with consumer credit and real estate, that got really crushed; on a relative basis the CLOs have held up relatively well," Koenig says.
Churchill Capital's Randy Schwimmer, head of capital markets at the firm, agrees. "There is a cloud that hangs over the entire industry as a result of the subprime contagion," he says, adding, "but no triple-A investor has ever lost money in this asset class."
Gradually, though, the CLO market is beginning to prove itself out, which Schwimmer says is behind the growing optimism. "The value restoration is crucial," he says. "The assets held by these CLOs have gone from sixty cents or less on the dollar back to 90 cents."
A number of investors have been able to book a quick profit on what, in hindsight, appears to have been an over-reaction. Highland Capital Management, for instance, in February, cemented a 138% gross return on its debut CLO Value Fund, which was raised in late 2008 to target secondary CLO debt and equity.
Other deals also reflect a stabilization. In the second week of March, Babson Capital Management assumed control of five separate Jefferies-controlled CLOs, a deal that underscored some of the consolidation that has already taken place. ING Investment Management and GSO Capital Partners, for instance, have also been buyers of existing CLOs.
The M&A market, however, is still waiting for new issuance, and the best sign for deal pros is that the ratings agencies have backtracked on the slew downgrades issued in the wake of Lehman Brothers' collapse. This is critical to attract institutional money, which coincidentally, is expected to retrench from recent demand for bonds as the Fed starts raising interest rates. Loans and other floating-rate securities should benefit from a rising-interest rate environment.
As it relates to 2010, marketwatchers don't necessarily have outsized expectations. Most will be content if issuance is even just a fraction of what it was three years earlier. Indeed, even the most bullish of forecasts see aren't anticipating a tremendous rebound. According to a January white paper published by Grant Thornton, "the Debt Effect," Wells Fargo has projected a range of $3 billion to $6 billion for new issuance.
The ability of the CLO marketplace to gain any traction, however, really hinges on whether or not the ratings agencies bless the new structures that emerge. According to Koenig, the new normal for CLO debt is going to require "appropriate leverage and appropriate covenants." He adds the definition of "appropriate" will ultimately be determined by the ratings agencies.
Schwimmer, meanwhile, cites he is hearing a lot of "exploratory" conversations in which the banks and institutional investors are trying to settle on what he calls the next "all-weather, more economical" CLO structure. He anticipates that future CLOs will likely have two or three tranches of capital, buttressed by "a significant triple-A tranche." He also expects to see a mix of broadly syndicated middle market assets, which will provide both yield and diversification for investors. Other factors that will play a role include the maturities, the collateral, the nature of the reinvestment periods and the pricing.
"At some point," he adds, "some group will be able to lock it in, and someone on the sideline will say the math makes sense. Then the market will be back in business."
The big unknown, at least for dealmakers, is whether new CLO issuance will go toward the hundreds of billions of dollars in refinancings confronting the debt markets over the next four years or whether lenders will channel CLO funding to new transactions.
Schwimmer sees it being spread throughout the market.
Koenig, however, believes the capital will gravitate toward new deals. "The new issue market is an easier transaction; you're only dealing with the buyer, seller and the debt providers," he says.
Either way, deal pros won't argue with liquidity in any form.