The first three European CLOs to price since the financial crisis were structured to ease investor worries, and their successively tighter spreads suggest that’s happening, boding well for future deals as they adapt to the current market’s demands.
Cairn Capital, a latecomer to the CLO market (it completed its first two deals shortly before the market collapsed) and the first to return post-crisis, priced the AAA-rated tranche of its €300.5 million Cairn CLO III at 140 basis points over EURIBOR in mid-February and closed the deal a month later.
The second European CLO to price, and the first in a parade of deals sponsored by U.S.-headquartered money managers, was Pramerica’s €300 million Dryden XXVII Euro CLO 2013. It allows for up to 40% of assets to be fixed-income, compared to 10% or less traditionally. The deal priced at 135 over EURIBOR on the floating-rate portion. It was followed quickly by Apollo Management Group’s €325 million ALME Loan Funding 2013-1, which priced its AAA-rated portion at 130 basis points over EURIBOR.
In the market or anticipated soon are CLOs from the Bank of New York’s Alcentra and the private equity firms Carlyle Group and Blackstone Group—all well-capitalized CLO managers headquartered in the U.S.
The tightening spreads indicate investors like what they see. Matthew Jones, lead analyst for structured credit at Standard & Poor’s, said that this generation of European CLOs, dubbed 2.0, broadly resembles that of CLOs issued in the U.S. over the last few years carrying the same moniker.
Both have introduced features such as re-pricing mechanisms, which in the first three European deals permit managers to re-price the notes to maintain sufficient arbitrage as long as bondholders consent; if bondholders don’t, they are paid out at par. Pre-crisis subordination typically rested between 25% and 35%, and for 2.0 offerings so far it rests between 30% and 40%, said Ian Perrin, a senior credit officer at Moody’s Investors Service.
Otherwise, the two generations of European CLOs look similar—unsurprising given that European 1.0 CLOs performed relatively well in the wake of the financial crisis. Perrin said that their diversity scores, the rating agency’s measure of a CLO’s industrial diversification, as well as their models’ assumed recovery rates are also similar.
Andrew Burke, head of leveraged loans at Cairn, attributed the launch of 2.0 CLOs to tightening liability spreads that remain wide compared to those of earlier CLOs—Cairn’s AAA notes in 2006 priced as EURIBOR plus 27—but nevertheless provide for sufficient arbitrage to make deals economical.
“A second factor that was only recently resolved was risk retention,” Burke said.
Ultimately, regulators required the sponsor or a third-party investor to retain a net economic interest in the transaction equivalent to 5% of its nominal value, as long as it was involved in structuring the transaction and approving the assets to be securitized. In the case of the Cairn CLO, the equity portion was purchased by SBCERA, a California pension fund.