Monroe Capital took its time stepping back into the CLO game post-financial crisis, with good reason. The middle market that the firm plays in is less liquid and less transparent than the broadly syndicated loan market, so picking up primary loans is key for a collateralized loan obligation. And what better way to do that than to have your own origination platform?
Over the past several years, Monroe has built that platform so its $358 million Monroe Capital CLO 2014-1, which priced in August, was the next logical step for the Chicago-based firm. Deutsche Bank arranged the transaction, which included a $137 million triple-A tranche priced at Libor plus 180 bps.
The deal is also compliant with European risk retention regulations, which allowed Monroe to secure some of the same large European anchor investors that had participated in its 2006 CLO, says Jeremy VanDerMeid, managing director and CLO portfolio manager at the firm. And while Monroe used a third-party originator structure to comply with the E.U. rule, the fact that it originates its own deals could very well give the firm a leg up in dealing with the recently approved 5% risk retention rule in the U.S.Leveraged Finance News spoke with VanDerMeid, who joined Monroe in January 2007 to manage its pre-crisis CLO, about risk retention, warehousing, building a loyal investor base and the challenges of pricing a middle-market CLO.
This is Monroe Capital’s first CLO since the financial crisis. Why now?
In the last few years, we’ve really focused on building up our originations platform. We started with our SBIC fund in 2011, then we did the IPO for the BDC in 2012, and finally we closed on another private debt fund in 2013. These funds give us the ability to arrange and originate our own loans so a middle-market CLO was a logical next step for us.
Not all managers warehouse their deals, but you did. Why?
In the middle market you really need a warehouse; you need more time to build a portfolio through primary loan issuance. Middle-market deal flow tends to be a little lumpier. It’s very different from a broadly syndicated CLO that may or may not use a warehouse—you can’t just price the CLO and then buy a large amount of assets in the secondary market. Our CLO is mostly primary originated deals, and because of that you need a longer runway.
How much of a runway?
I think you need at least six months for a ramp period.
Your recent deal also complies with EU risk retention rules, what was behind the decision to take that step?
First, we have a loyal following from several European investors who participated in our pre-crisis CLO, all the way from the triple-As down to the equity, and we wanted to work with them again. We also wanted the broadest market execution possible, and European investors were very eager to see a transaction in the middle market that they could use to diversify their portfolio. There are not a lot of middle-market CLOs to begin with, let alone European compliant deals. Our goal is to utilize this same structure to launch another middle-market CLO in 2015.
With the EU risk retention rules, there’s some flexibility of interpretation regarding which entity holds the 5%? How is your CLO structured? Does Monroe hold the 5%?
We used the originator structure to comply with the European risk retention regulations. We have a third-party equity partner that was very familiar with our platform and we worked with them. The originator holds the 5% risk retention investment in the CLO and at least half of the deals in the CLO flow through the originator. It’s a little more complicated than other structures, but it’s very transparent. It was really clear to investors that we were creating a structure that works with the European guidelines.
So now that U.S. risk retention requirements have been approved, does the fact that you’ve issued a E.U. risk retention compliant CLO put you ahead of the game?
I think it is still early in the game given the U.S. risk retention rules were just finalized, and the lawyers are still working through potential solutions. But I do think we are in a good position—we’ve structured a European compliant CLO using the originator structure and we have a platform with multiple funding sources and the ability to arrange our own loans. This should put us in a good position to structure a CLO that meets both U.S. and European risk retention guidelines.
What does your investor base look like in the new CLO?
We have a very diverse group, with investors from Europe, the U.S. and Australia, as well as a mix of insurance companies, banks, hedge funds and credit opportunity funds. The key theme up and down the capital structure was investors who had familiarity with our platform. This is critical in the middle market because middle-market loans are not as liquid and the information is much more private than with broadly syndicated loans. So middle-market CLO investors need to spend time understanding how the manager underwrites, structures and monitors the loans.
Is there anything else, beyond regulations, that make issuing a middle-market CLO challenging?
Investors really want new primary loans. This typically leads to a longer investment period and less flexibility to invest post investment period. Our deal has a four year investment period with very clean language post-investment period. Also, a middle-market CLO has to be a natural extension of the manager’s platform. A true middle-market manager needs to have multiple funding sources and a real proprietary origination capability. We have 12 originators spread across the U.S. in eight offices and they are out in the market sourcing primary deal flow for us. A lot of managers say they’re doing a middle-market CLO, and they’ll just move down market and buy some of the larger syndicated names that get shown to everybody. To me, that’s not a true middle-market CLO. A true middle-market CLO is done by a manager that can originate its own deals and access the clubbier transactions that tend to be relationship driven. We’re going to see over 2000 deals as an institution this year. And when you can generate that level of volume, it can really create a unique portfolio for investors. They’re getting access to deals they wouldn’t otherwise see.