European CLO managers are edging closer to a type of deal not seen since the financial crisis multi-currency tranches.
Edwin Wilches, a portfolio manager at Prudential Fixed Income, said that there have been a handful of collateralized loan obligations recently that are primarily denominated in euros but have a single sterling tranche.
It’s easy to see why. Collateral is relatively scarce, given the relatively small size of the region’s syndicated loan market; limiting collateral to euro denominated loans makes it that much harder to source deals. But multi-currency deals are more difficult to manage than single-currency deals.
“Pre-crisis there were deals with multi-currency senior tranches, a dollar tranche and euro one,” Wilches said at IMN’s ABS Vegas conference Tuesday evening “One lesson from the crisis is that these deals are incredibly difficult to manage, especially once you start to wind down, or deleveraging,” he said. “On the asset side, the balance sheet has to maintain a ratio of euros to dollars. That’s difficult if you have a default or experience a prepayment. That ratio can change really quick. You get a lot of currency risk really fast.”
We’re not quite there yet. Wilches said that, so far, the euro-denominated CLOs with sterling tranche have buckets for sterling loans that are pretty small, 10%.
Still, there has been talk that some larger banks are considering deals with multi-tranche structures. “The way you try to address risk is through swaps or other derivatives, but you quickly have counter party risk. It’s complicated,” Wilches said. “For the moment, my gut is that investor appetite for either a euro or dollar tranche ...[the market] hasn’t gotten to the point where [we’ll see] a creative, funky structure.”
The portfolio manager added that at least two more U.S. CLO managers are planning to issue in the European market to take advantage of the cheaper funding available there.