Dick D'Addario, senior portfolio manager at the New York-based investment firm Avenue Capital Group, and his colleagues have just closed a new $500 million collateralized loan obligation (CLO), their company's third such vehicle thus far.
After launching Avenue's CLO business in the middle of 2004, the Avenue team, in conjunction with Bear Stearns, has managed to put together and price a series of CLOs in quick succession. Yet D'Addario is the first to admit that being in the CLO business is not an easy game these days, even for those managers who can get their hands on new paper in what continues to be a tight and very competitive loan market.
"There are many new issues, but there are also a lot of CLOs in the market, so you continue to have a challenging environment consisting of tightening new issue spreads and rising secondary market prices," D'Addario said. "You also have to give your equity investors strong returns, which means that you need to work especially hard to find suitable assets in an environment like the one we have today."
For D'Addario, though, one key to success in the CLO business lies in being realistic from the outset. "We try to model a realistic spread for our investors, because if we promise them something out of the ballpark, we might not be able to reach it, and that will result in disappointment," he said. "It is far better, we have found, to have a conservative, yet realistic model that gives us some cushion in the event that the market becomes even more challenging in the future."
Even in a world where many are still arguably bent on getting the highest returns they possibly can, this approach has evidently worked for D'Addario and his team, as they have been able to attract a group of investors that understand the dynamics of this challenging business. "A lot of our investors like us for the overall Avenue platform, which combines both distressed and par loan research capabilities, and the concomitant thorough credit process that each discipline requires. They are willing to go with the realistic returns we offer," he said. "Since we are fortunate to have relationships that provide us with investment opportunities, I do not see the need to reach down the credit spectrum, as it would be going against what [we] have always done."
According to D'Addario, Avenue, as a firm, has had a long and successful track record in the area of distressed bonds and bank debt. Having access to Avenue's highly experienced distressed debt analysts is a big plus for his CLO group, D'Addario said. This is the key reason that will differentiate the firm from many of its competitors when default rates finally begin to tick up from these historically low levels, which make all managers look pretty good. "During the good [low default] times, we consult with Avenue's distressed analysts on complex structures, especially in the utilities and oil and gas industries, to make sure we are not missing anything," D'Addario. "In the bad [high default] times, we work closely with the distressed team to decide which names we want to go through a workout with and which names we prefer to sell outright. In the long run, this capability will hopefully differentiate us from the rest of the crowd. Only time will tell."
Avenue's bent toward investing in higher quality assets (very few second liens or triple-C-rated assets figure in the various CLOs) has attracted a range of investors that want to see steady returns, D'Addario said. That said, though, raising a series of CLOs in quick succession also has its challenges. Investors typically want to see some sort of a track record from one structure before they invest in another, he said, so this means that each new Avenue CLO consists of a number of investors that have not invested in Avenue's prior CLOs, and those investors require a fair amount of education on Avenue, the team and its credit philosophy and process. Despite this challenge, Avenue has found success with a tried and tested manager like D'Addario. The longer-term question for Avenue, though, is whether the firm will choose to continue to grow the CLO business or to cap the amount of assets that the team will manage. While it has been a good run thus far, D'Addario believes that every business needs to stop for a breather every now and then, and take stock of itself. He therefore proposes to evaluate Avenue's CLO business together with the firm's managing partner when it reaches $3 billion in assets under management, which should happen sometime toward the beginning of 2007 (currently, the Avenue CLO fund stands at about $1.6 billion).
For now, though, CLOs are still the name of the game, and the company's third CLO closed with $500 million in assets under management. Avenue's first CLO, which closed in December 2004, had $400 million in assets under management, while its second closed at $450 million. Avenue also did a $250 million total return swap for a private client last August.
Avenue is managed by Marc Lasry and Sonia Gardner, both veterans of the distressed securities market.
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