A novel CDO structure recently put together by GSC Group, targeted toward insurance companies, pension funds and other investors that might well be interested in the European leveraged marketplace - yet hesitant, perhaps, to go whole hog all at once - may be coming at just the right time, given the sudden volatility that has wracked that market.
But regardless of the present wave of volatility, Christine Vanden Beukel, senior managing director of European structured products for GSC Group, said that the defensive, more sober nature of the 300 million ($408.8 million) cash flow CLO is still of great interest to a number of investors who haven't yet been involved with leveraged loans, or for investors who are already participants in traditional CLOs, who are attracted by its lower volatility and rated structure.
"We have had a number of inquiries from investors who requested a more risk-tolerant structure," she said. "There are plenty of investors who are happy to take the traditional nine-to-one leverage structure in CLOs, but there are also plenty of other people who are new to the asset class and want to get familiar with it, but not necessarily through the nine-to-one structure right away. This vehicle could be a first step for them."
The new CLO - GSC's fifth European product to date - has a target portfolio of 90% senior and 10% subordinated debt. It is interesting in that it is less levered than classic CLOs and has a return curve that is less sensitive to changes in both spreads and default rates, thereby making it more stable than other vehicles, Vanden Beukel said. The structure also benefits from good regulatory capital treatment because the equity tranche is in the form of notes, which means that they can be rated, she said.
"We're offering this vehicle as a genuine, different choice to investors," Vanden Beukel said. "Our structure would be attractive to investors who want enhanced returns from leveraged loans without as much volatility as a traditional CLO."
In past years, the European leveraged loan market has attracted a great number of new investors. From a strictly bank-only market, Europe now features a healthy mix of banks, institutional funds, hedge funds and CLOs, the number of which has grown significantly as more parties have priced new vehicles. Even as fears of spread tightening and the difficulty of placing CLO equity have increased, continued demand for loan assets is still spurring the creation of new CLOs.
Vanden Beukel believes there is greater demand for CLO equity in Europe than in the U.S. All the same, the less-levered structure of GSC's new CLO called for twice the amount of equity, she said, and though selling it was not a problem, it was nevertheless a challenge to find that many investors.
"We had to place 80 million of equity instead of 40 million, and that is quite a task," she said. "It did get it done reasonably quickly, but it still took longer than a traditional CLO because we had twice as much equity to raise."
Like other leveraged loan market participants, Vanden Beukel believes that the current wave of volatility - a consequence of the latest subprime debacle in the U.S. - is only temporary. In the U.S., some loan deals have been pulled, but contagion has not spread to Europe, and the overall outlook for European loans is still positive.
"Loan issuance is still on track. Plenty of buyouts are being done, so there is plenty of paper," Vanden Beukel said. "There is certainly competition to get allocations, but we have been managing leveraged loans in Europe since 2000, so this helps us."
While the structure of the new CLO is less aggressive than others, the investment style that GSC will use for it is the same it employs across the board, Vanden Beukel said. "We are very principal, downside protection-oriented investors, and in CLO structures where there is less leverage, we don't get more aggressive in terms of choosing risky loans," she said. "People are buying this vehicle because of the lower volatility it offers, so they won't be expecting us to push things out in terms of getting loans that are more risky."
The most important point about the new GSC CLO is that it offers investors a chance to invest in loans via a structured vehicle that is less aggressive, Vanden Beukel said. It remains to be seen whether other managers will replicate the structure, particularly if the loan market in Europe is really in for a setback.
The new CLO will invest primarily in private-equity-backed loan financings.
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