SMBC Nikko Securities America, Inc. began bolstering its collateralized loan obligation (CLO) team in 2018, hiring for investment coverage, syndicate and structuring functions, as well as secondary-market sales and trading. The move has paid off, and last year the firm, a part of Japan's SMBC Group, one of the largest global financial institutions, arranged six middle market/private-credit CLOs for leading middle-market/private credit lenders, including Apogem Capital, Churchill Asset Management, and Antares Capital.
At least as important, said Raffi Dawson, head of SMBC Nikko's structured finance group, the firm's underwriting volume for middle-market deals in 2023 increased by more than 100% from the year before, to $3.3 billion from $1.4 billion. Dawson, who joined SMBC Nikko following 12 years at Mizuho, where he was co-head of securitization originations, said the firm is also seeking to build its presence in the broadly-syndicated loan (BSL) CLO market. Last July, it led its first such deal, a $404 million transaction for asset-manager Neuberger Berman, and it was the sole arranger on a BSL reset transaction in April for American Money Management Corp., a subsidiary of American Financial Group.
Dawson recently spoke to Asset Securitization Report (ASR) about SMBC Nikko's recent growth and key CLO market trends and issues.
ASR: What factors, aside from the recent hires, have contributed to SMBC's CLO success?
Dawson: A main differentiating factor for SMBC is the distribution network, particularly in Japan. Another factor was deploying capital through warehouse facilities [that enable CLO managers to purchase loans before the CLO prices] in 2021 and 2022, focusing on the business and belief in our clients during those challenging times.
ASR: CLO issuance slipped in 2022, to $116 billion. What does SMBC anticipate this year?
Dawson: Expectations range between $120 billion and $150 billion of new issuance, and our forecast is $135 billion, driven by tailwinds including growth in the investor base, the re-emergence of money-center banks side-lined last year, and general optimism in the macro economy. Inflation is higher than expected, but the credit backdrop remains positive, so the health of the leveraged loan market has improved.
We've seen benchmarks and spreads come down. That should translate into increased M&A activity, which should help the overall private-credit space, new loan originations and, as a result, new CLO formation.
ASR: Starting last year there have been several middle-market/private credit CLOs with balances over $1 billion. What differentiates them from the BSL variety?
Dawson: There will continue to be distinct differences. One is the collateral itself, which tends to be private and held by the originators of the loans, so there has been a premium paid for middle-market paper. BSL transactions are more of a commodity and have much lower underwriting fees for the banks. As middle-market issuance has grown to 20% or more of the market, arranger fees for those deals have contracted slightly, but BSL arranger fees have remained less in comparison.
ASR: What is the middle-market/private credit premium today?
Dawson: Over the last year it has narrowed. In early 2023, BSL AAAs were around 200 basis points and private credit AAAs around 270, and now they're [respectively] closer to 150 and 180. So the basis point difference between the two has narrowed from 70 to a more historically normal 30 to 35 basis points for top tier managers. Our $444.8 million reset for Antares at the start of the year was the first transaction to breach spreads falling into the 190s, and spreads have continued to tighten.
ASR: What caused that continued tightening?
Dawson: Investor demand has tightened the liability side, driven by a healthy macro economy, and the fact that rates should be coming down. I expected rates to fall sooner, but to me when rates are actually reduced is less important than the Fed's rhetoric about when it's going to happen. The equity markets have outperformed anyone's expectations, even while debt yields have remained at historic highs. So you're finding a lot of major sponsors growing their own asset-lending businesses, because with leverage you can create equity-like returns with debt products.
ASR: What about the asset side? Do persistently higher rates put borrowers at risk, even with a strong economy?
Dawson: There will be pockets of leveraged loans that fall into the CCC category, but that's why it's important for SMBC to work with managers who can identify appropriate collateral and provide capital to businesses that will survive and perform even in a stressed environment. The asset side may not contract as much as the liability side, but that's what creates CLO arbitrage.
ASR: What has encouraged large banks to increase investment in AAA CLOs?
Dawson: The driver for that is in part an echo effect from last spring's regional bank crisis, which moved savers' deposits to the large-bracket banks, and they have to put that money to work.
ASR: Will the big Japanese banks remain big AAA CLO investors?
Dawson: No doubt that Japanese bank participation across CLOs increased in 2023. One of our value propositions is the connections we have with Japanese investors and banks, and from their perspective CLOs continue to be attractive. However, Japanese investors and banks tend to be more conservative—they do more work to get there, and once they get there they're committed. They were always investing in BSL CLOs, and now we're seeing increased interest from them in private-credit CLOs.
ASR: Why have private-credit CLOs captured so much interest from Japanese investor interest?
Dawson: Again, CLOs' higher yields, along with their solid structural features and backing by reputable managers. That 75-basis point delta between middle market and BSL CLOs provided relative value, but currently at 30 basis points there is even more interest than we've seen historically.
ASR: Have you talked to any managers of the numerous CLO ETFs that have emerged over the last few years? Some forecast them occupying $50 billion to $100 billion of the overall CLO market. What do you anticipate?
Dawson: In short, we haven't spoken to them yet, but perhaps we should start. That size range surprises me a bit. ETFs have a preference for relatively liquid positions, so I don't expect them to hold a meaningful amount of any particular class. Their participation, though, is very welcome, and their growth is a complement to overall AAA CLO execution and allocation across investors. It's a plus for the industry.
ASR: Is SMBC exploring other new sources of investment for CLOs?
Dawson: We're spending a lot of time broadening our reach even further, not just with Japanese investors but parties in other regions, such as South Korea and Hong Kong, that potentially are interested in not only CLO paper but general asset-backed securities (ABS) where the spread is wider than more generic, flow type of paper. Things like data centers and other esoteric assets that are not too fringe and are part of the broader economic infrastructure.
