In the clubby world of smaller middle-market lending, CLO managers are having a hard time obtaining creme-de-la-creme middle market collateral. That is, unless you are able to obtain a member's only jacket in the form of an origination platform. In fact, the majority of MM CLO managers going forward are expected to be seen as part of a specialty manager or orgination platform.
"It is a matter of reciprocity," said Alla Zaydman, a director at Fitch Ratings. "To get deal flow, you have to give deal flow." The growth of middle market investing has led to spread tightening in the broader middle market loan sector, along with shifting underwriting standards. The development is leading certain players to look for ways to get a foot in the door of the more lucrative, smaller middle market lending, market participants say.
Cohen & Co. subsidiary Emporia Capital Management in late November opened up a Los Angeles branch aimed at breaking into the middle market origination business. Shortly after, Emporia was a co-agent, underwriting $45 million of a senior secured lending facility for Airborne Inc. Likewise, New York-based middle market finance company Churchill Financial Holdings last Fall acquired CDO manager Centre Pacific, a venture which created Churchill Pacific Asset Management. Similarly, CIT Group announced earlier this month that it plans to issue its first CLO in the first half of the year.
As the number of players involved in the higher yielding, more opaque world of middle-market lending has grown, so has the scarcity of quality loans, some say. A handful of participants in the small end of middle-market lending, where spreads have been less influenced by technical factors, generally share the deals among themselves. "More and more, at least in today's market, (middle-market loans) are being absorbed by origination-like institutions because they have relationships with their financial sponsors," said Devon Russell, a director at Madison Capital Funding, a unit of New York Life Investment Management that originates middle-market loans.
Cohen's Emporia unit hired Kevin Braddish as managing director and chief investment officer along with three other staffers from PB Capital Corp. in March 2005. The unit, which is approaching $1 billion in assets under management, has since grown to 15 people, with six in the Los Angeles office and the rest in New York. The asset manager is preparing to roadshow the first of two CLOs planned this year. The deals, to be the third and fourth from its Emporia platform, are expected to total about $800 million. The first and second CLOs in the Emporia series closed in 2005 and 2006.
By launching origination capabilities, Emporia will be able to lessen its reliance on the market for deal flow. "We need to be proactive and make sure that we remain as much in control of market developments as possible. That is one of the reasons, if not the biggest reason, that we opted to get into the origination business," Braddish said. According to Braddish, existing relationships have helped the firm obtain smaller, more conservatively underwritten loans for its CLOs, but adding origination capability bolsters that ability. A "meaningful" percentage of Emporia originated collateral can be expected to back future CLO issuance, Braddish said, declining to site specifics.
"I think if you are going to do a MM CLO generally, you need proprietary origination to make it work," said Ken Kencell, chief executive of Churchill. "Being just a buyer, it doesn't really work because you almost need to do your own deals to get deals." Still, breaking into origination is not a piece of cake, he pointed out, adding that a lender needs a significant capital base, staying power and equity to build up a strong unit over time.
By opening a middle market loan origination shop in Los Angeles, Emporia aims to serve what Braddish says is an underbanked West Coast market, along with the rest of the U.S. The asset manager snagged David Ligon and Gary Kirshner from Union Bank of California, where they were group heads of the bank's equity sponsored lending team. The two joined Cohen as managing directors.
MM CLO issuance to grow
Barring any tremors to the currently benign credit environment, MM CLO issuance is projected to grow again this year. High yield loans, including MM CLOs, are expected to be the leading product within the CDO sector in 2007, according to a Securities Industry and Financial Markets Association survey of member firms. The median forecast for funded CDO issuance in 2007 from the group is $369 billion, with the high yield loan and CLO sector producing $109 billion - a 14.7% increase from the $95 billion in issuance last year.
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