The ranks of collateralized loan obligation managers are widely expected to shrink when risk retention rules take effect in 2016; a number of smaller firms lacking the capital to hold on to 5% of their deals will sell themselves or wind their businesses down, the thinking goes.
John Lapham, co-head of leveraged finance at PineBridge Investments, a New York-based asset management firm with 22 CLOs under its belt, thinks the shakeout could come even sooner. That’s because smaller managers are likely to have a hard time marketing new deals, even now, if investors are worried that the business isn’t growing and so may not be able to attract the people and resources necessary to run it well.
PineBridge priced its first collateralized loan obligation in 1999, a year when roughly 40 competitors also came to market. Since then, CLO managers have come and gone with the market’s peaks and valleys—110 firms priced deals in 2006; only three did in 2009.After several years of growth, that number has spiked once more, with the list of firms issuing CLOs this year at the 100 mark and counting, according to S&P Capital IQ LCD.
PineBridge expects to ride it out. The firm has a strong track record, and familiar name and it has already done a deal that complies with European risk retention rules. It doesn’t hurt that it’s owned by Hong Kong-based private equity giant Pacific Century Group, an investment company founded by Richard Li, son of Li Ka-Shing, aka Asia’s richest man.
Lapham, who joined the company in 1995, recently spoke with ASR's sister publication, Leveraged Finance News, about the challenges of today’s CLO market and the “bump in the road” that is risk retention.
LFN: PineBridge has been quite busy on the CLO market these past few years. Do you plan to keep up the pace in 2015?
Lapham: I think we will. The issue, and one of the reasons we were slow to come out with our first deal in 2014, is that we’ve traditionally taken whatever time we need to build a warehouse we’re proud of before we come to market. We haven’t wanted to do the so-called print-and-sprint deals because there’s too much risk of timing it poorly. And given how tight the [secondary] loan market was in the first four months of this year, we relied almost solely on new issues to build the warehouse [for Galaxy XVII], which took about six months before we priced in May. Then with the secondary market opening up, we came back and priced another deal fairly quickly.
Toward the end of 2013 you priced your first European CLO since the crisis; what prompted that decision?
We felt like there were some opportunities in the European loan market, given that banks had gotten out of the business and there was a maturity wall of loans that needed to be refinanced. Certainly at the time, in 2013, our hope was that Europe’s economy would continue to recover. But since then, loan issuance has been more restrained than most people would have thought. And more recently we’ve been concerned that the European economy has been sliding backward. So it has been challenging, and we’re being very selective about how we choose credits.
Do you agree that risk retention rules will bring a spike in volume before they go into effect, followed by a decline in issuance and a manager shake out?
Those predictions make sense. Still, I believe the CLO market will slow down somewhat in 2015 from what has been a pretty frenzied pace this year. And I don’t know how CLO investors are going to approach this interim period of 2015 and ’16. Will they begin even now to take a hard look at those managers [that aren’t expected to exist] and conclude that, even if a deal is issued before the rules go into effect, they may be hampered in other ways? If a firm is not growing and CLOs aren’t important to it, will it be able to attract the kind of people and resources it will need to run a CLO?
How is PineBridge poised to deal with risk retention?
We are very committed to leveraged finance, which includes our CLO business. We see the 5% risk retention rule as a bump in the road, but it’s not in any sense going to dissuade us from pursuing continued issuance of CLOs.
Did the latest European CLO price after the E.U. risk retention rule took effect?
It was afterward and is compliant with 122A, so we’ve already had experience with risk retention in Europe. And while the U.S. rules are probably not going to be identical in many respects the concept is the same.
What kind of structure did you use?
We’re holding the 5% ourselves. We are looking at alternative, originator-type vehicles, but in that deal we held it ourselves. And we’ve already concluded that if we don’t find an originator vehicle that makes perfect sense for us, we will continue to put PineBridge capital into our CLOs to make them compliant.
Will a decline in competition among managers driving CLO yields?
That’s possible. But if you look at triple-As, which are at 150 bps to 160 bps now, on a pure credit basis those spreads are well wide of any real credit risk. And I think they’re that wide because the issuance has been so strong and because there are real capital charges and regulatory issues that surround the market. Moreover, even if we get to a scenario where a lot of the smaller managers are no longer around because of risk retention, that still leaves roughly 50 active managers, which still leaves plenty of opportunities for CLO investors to make distinctions.
What does the investor base of your most recent deals look like? I think we’ve certainly seen an expansion, and it has expanded up and down the capital structure. There is a growing base of superregional banks and insurance companies and, increasingly, some funds that are investing in the triple-A and double-A paper because they see it as an attractive, risk-adjusted product. So the opportunity to do a broadly syndicated CLO with not just one or two triple-A investors, but five to eight is certainly more prevalent now than it was two or three years ago.Do all of your Galaxy CLOs look similar as far as collateral and strategy?
The difference between these CLOs is really a matter of when they were issued. For example, we might like a certain loan, but if it came out at 99 and is now trading at 101, we probably own it in a CLO that was warehousing or able to buy it when it came out at 99, but if the loan is now trading at 101, the CLO that’s warehousing today wouldn’t own it.