Sankaty Advisors LLC, the credit unit of private-equity firm Bain Capital LLC, set up its first fund investing in collateralized loan obligations as proposed regulations may force banks to cut their holdings of the debt.
The $325 million Sankaty CLO Partners 1 may invest in CLOs raised both in the U.S. and Europe, according to John Wright, managing director at the Boston-based affiliate and one of the managers of the deal.
Sankaty, which oversees 10 CLOs, established the fund as trading restrictions under the recently enacted Volcker Rule may lead some banks to reduce their investment in such risky debt, giving other institutions an edge. Banks own about $70 billion of CLOs, which buy loans used to back leveraged buyouts and saw issuance surge 49 percent last year to $82 billion.
Investors “that face regulation may be apprehensive to get into the market and that offers opportunities for those that aren’t regulated,” Wright said in a telephone interview, noting the new fund isn’t affected by the proposed rules.
The pending regulations weren’t the driving force in Sankaty deciding to raise the fund, Wright said. The firm, which oversees more than $20 billion, started fundraising before the Volcker Rule, under which banks may not be able to invest in CLOs that hold bonds, was released in December.
Additional rules may change the CLO market, including proposed risk-retention, which would require CLO managers to hold 5 percent of the debt they package or sell. Regulators in August introduced the so-called arranger option, which would require banks to hold onto a portion of a term loan they arrange and sell to CLOs without the ability to hedge or offload it.
CLOs are a type of collateralized debt obligation that pool high-yield loans and slice them into debt securities of varying return and risk, typically from AAA ratings down to B. The lowest portion, known as the equity tranche, offers the highest potential returns and the greatest risk because these investors are the first to see their interest payouts reduced when the loans backing the CLOs default.
Issuance of CLOs grew last year from $55.2 billion in 2012, though still short of the $92.8 billion raised in 2007, according to Royal Bank of Scotland Group Plc.
Spreads on existing AAA CLO debt fell to 110 basis points in December from a 2013 high of 130 basis points during the first quarter, according to Morgan Stanley data. They rose to as much as 725 basis points in April 2009. At the peak of the market in 2007, spreads dropped to as low as 23 basis points. Spreads on existing BB debt decreased to 490 basis points in December from 650 on Jan. 3, 2013, according to the data.
CLOs were the largest buyers of leveraged loans in the third quarter, with a 52 percent market share, according to the New York-based Loan Syndications and Trading Association.
Leveraged loans, those rated below BBB- by Standard & Poor’s and less than Baa3 at Moody’s Investors Service, returned 5 percent last year, according to the S&P/LSTA U.S. Leveraged Loan 100 Total Returns Index. U.S. high-yield bonds returned 6.6 percent last year, according to the Bloomberg High-Yield Corporate Bond Index.
Sankaty has invested in CLOs since 1999, primarily through credit-opportunity funds. It has raised five of those types of deals since 2002, with the first four buying structured products, middle-market and distressed debt, Wright said.
Interest for dedicated investing opportunities for the different asset classes led Sankaty to raise middle-market deals in 2010 and 2013, and focus its fifth credit-opportunity fund, which closed last year, on stressed and distressed assets, he said.
“We saw that investors liked to allocate their investments themselves,” Wright said. “This is our first fund that breaks out the structured-credit strategy.”
Wright oversees the fund, which closed in December, with David McCarthy, a managing director at Sankaty. The firm has already invested about $100 million, primarily in U.S. CLOs, though it has the ability to invest as much as 15 percent in euro CLOs, he said.
It will likely use about 20 percent to 25 percent of the fund to purchase portions of its own CLOs, though it has the ability to use as much as 40 percent for that purpose, Wright said.
Sankaty last raised a U.S. CLO in November, a $514.6 million deal with Credit Suisse Group AG, according to Bloomberg data. It will continue to raise its own CLOs, Wright said. The new deal allows Sankaty to build a portfolio of CLO debt and equity investments that is diversified by vintage and manager, which may offer “attractive returns,” he said.
The firm may allocate more capital to the junior debt and equity of deals, which offer better returns, though it has the ability to invest across the capital structure, Wright said.
“We think there are a lot of opportunities in the CLO market, investing in both the debt and equity of the deals,” he said. “A lot of investors are starting to appreciate how strong CLO performance has been.”
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