By Claire Ruckin
LONDON, May 9 (LPC) - Banks and fund managers are struggling to fill and issue around €16bn of new European Collateralised Loan Obligation (CLO) funds as leveraged loans remain scarce and the extra time required to ramp funds is increasing the risk for arranging banks.
The CLO pipeline has hit a new high with more than 40 CLOs being warehoused as more managers try to issue funds after record issuance of €26.95bn in 2018, according to LPC data.
“People want to downplay the number of warehouses out there. It’s not far off of a year’s worth of supply,” a head of leverage finance said.
Despite increasing competition, CLOs are still the biggest buyers of leveraged loans. The funds provide income for banks arranging the deals, managers and equity investors, but the model is coming under increasing pressure.
Banks are having to extend warehousing ‘ramp up’ periods as they struggle to source the underlying leveraged loans, which is hitting fee income. Arrangers are also sacrificing fees to issue ramped CLOs as fears of an economic slowdown rise.
“People are kicking the can down the road. They are hoping to issue CLOs because giving money back is bad for banks and managers, especially if it’s because they say they can’t find product,” a head of capital markets said.
Europe has around 45 CLO managers, compared to 13 in 2013, when the market re-opened after the financial crisis. Established managers are raising several new vehicles and new managers such as Fair Oaks Capital, CVP, HPS Partners and Angelo Gordon are also raising new funds.
The main issue is the lack of loans to put in new CLO warehouses after volume hit a 10-year low in the first quarter. Warehousing new CLO funds is now taking up to two years, compared to three to six months previously, and arranging banks are offering a one year plus one year extension model.
As well as tying up capital, extended ramp up periods are also leaving arranging banks vulnerable to potential mark to market losses if the assets that they are holding in the warehouses drop in value. Five or six banks provide the bulk of Europe’s CLO warehouses, including Citi, Credit Suisse, Goldman Sachs, Morgan Stanley, Barclays and BNP Paribas.
“Warehousing burns banks’ Risk Weighted Assets (RWA) and its not attractive to hold warehouses for some time. If you’re on risk for longer, you’re vulnerable to a market shock,” a senior loan investor said.
CLO warehousing is also affected by arbitrage, which is the difference between the value of the assets and the liabilities. As the arbitrage is squeezed, managers and banks are cutting fees from around 100bp to as low as 25bp to attract equity investors.
Banks usually earn 1% on CLO debt and 5% on equity, but some banks have wiped out their fees by selling equity in the high 70s to clear several CLOs for new managers this year.
“For all intents and purposes it is a broken market but we are just about getting away with it. CLO managers and bankers are giving up some fees to make the arbitrage work and keep the market alive,” a senior banker said.
The large number of CLO warehouses is worrying market participants as an economic downturn draws closer. First losses on CLO warehouses of around 5-8% are typically taken by CLO managers and a few structured credit and hedge funds, but any further drop in value would be taken by the banks.
“If you break through first loss then it is the warehousing banks that are on risk and take the hit. If the market turns it will definitely break through the first loss,” a leveraged finance banker said. (Editing by Tessa Walsh)