LAGUNA NIGUEL, Calif. - New CLO managers continue to be a thorn in the side of more seasoned players, who equate managing a deal in the currently benign credit environment to riding a bike with training wheels that investors can't see.
What's worse, the influx of new managers has tightened asset spreads, making it more difficult to ramp deals without increasing buckets for higher yielding, but riskier, collateral, market participants said at Opal Financial Group's CDO Summit held here last week.
"Every day you look up and there is a new manager hanging up a shingle," said Steven Oh, a managing director at AIG Global Investment Corp. Fifty-seven new managers entered the market between 2004 and 2005 alone, according to Robert Radziul, a director at Standard & Poor's. Out of those, 49% may have had experience with the underlying collateral, but lacked experience with CDO technology. "It is one thing to understand the credits, but another thing to understand the adventure," Radziul said.
Knowing how to effectively handle a CLO portfolio in a rougher credit environment will expose less talented managers, market players said. "A cycle in and of itself doesn't keep us up at night, because we know it's going to happen," said Andrew Cooney, managing director and chief financial officer of Four Corners Capital Management, adding that how one sets up and manages the portfolio is what makes the difference. But others, such as Oh, said that if a turn in the credit cycle brings systemic risk and not idiosyncratic, or credit, risk - all managers will be affected in some manner.
One investor said his firm was waiting until 2007 or 2008 to begin investing in CLOs because of deteriorating underwriting standards in the underlying collateral. Others added that allocations for higher yielding, but often riskier, collateral such as second lien and middle market loans are important to keep an eye on. Not all second liens are the same, however, and a solid definition for "middle market" is not easy to come by.
"Middle market loans, I think, are fine as an asset class, as long as you have the staff to handle them," Four Corners' Cooney said. "Picking them up just for spread, that is where you are going to get in trouble, in the buckets, in the migration."
As for the rest of new managers entering the CDO space in 2004 and 2005, 18% were an old CDO team that had migrated to a new firm, 26% were CDO issuers entering a new sector for the first time and 7% were European managers bringing their first U.S. deal, according to S&P.
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