CLO Sales Climb in Europe as Volcker Sidestepped: Credit Markets

The market for collateralized loan obligations in Europe is heading for the busiest start since 2008 amid signs issuers may be able to overcome new regulations that are crimping U.S. deals packaging junk-rated buyout debt.

At least 2.4 billion euros ($3.3 billion) of the securities have been sold or are being marketed, more than four times the same period last year, according to data compiled by Bloomberg. Issuance in the U.S. dropped 60 percent to $2.55 billion in January, according to Royal Bank of Scotland Group Plc, after the enactment of the Volcker Rule stopped U.S. banks investing in CLOs that include bonds.

With the riskiest portions of CLOs in Europe delivering returns of as much as 15 percent there’s no shortage of buyers, according to Andrew Jackson at Cairn Capital Ltd. Unlike in the U.S., a dearth of new loans which can be bundled into the securities is encouraging issuers to find ways of including bonds and marketing them to investors who aren’t constrained by the regulations.

“As long as the structure still provides people with a good return, the market will work to find innovative ways to deal with regulations,” said Jackson, chief investment officer of London-based Cairn, which issued a 300 million-euro CLO last year. “There’s a lot of pent-up demand for CLOs here.”

Trading Crackdown

Before the financial crisis, CLOs were the biggest investors in European leveraged loans and their appetite for the debt encouraged private equity firms to raise a record 117 billion euros to fund buyouts in 2007, Bloomberg data show.

As the region’s economy emerges from a record-long recession, expanding 0.3 percent in the final quarter of 2013, the new regulations are raising concern that the market for CLOs will wilt, cutting off financing to borrowers that may otherwise not have access to capital.

The Volcker Rule was enacted to make banks safer in the wake of the financial crisis and restricts lenders trading securities with their own money to make a profit.

London-based Alcentra Ltd., a unit of Bank of New York Mellon Corp., structured a 413.5 million-euro deal in January that bypasses the regulations, according to two people familiar with the transaction. The Jubilee CLO 2014-XI BV takes advantage of an exemption provided by the Investment Company Act that allows CLOs to invest in bonds as long as issuers agree not to trade them for profit, said the people.

Ben Larter, a spokesman for Alcentra’s owner Bank of New York Mellon, declined to comment on the transaction.

‘Valuation Merits’

Bonds accounted for 9.7 percent of assets in European CLOs priced last year, compared with 1.16 percent for U.S. deals, Morgan Stanley analysts led by Vishwanath Tirupattur wrote in a note today. “We expect European CLOs to continue to hold bonds depending on the valuation merits,” according to the report.

Money managers in Europe will increasingly seek to take advantage of the exemption, even with its limitations, international law firm Ashurst LLP said in a report last month.

“Demand for European deals at the moment is strong and that may lead European issuers to choose not to comply with Volcker,” said Dagmar Kent Kershaw, the London-based head of credit fund management at Intermediate Capital Group Plc, which oversees about 12 billion euros of assets. “The recovery of European CLO issuance hasn’t hinged upon U.S. banks, since most of them are not active in this market.”

Sales Peak

Sales of CLOs peaked at about 35 billion euros in Europe in 2007 before the market was effectively shuttered following the collapse of Lehman Brothers Holdings Inc. in 2008. The market’s recovery last year coincided with a 47 percent increase in leveraged loans, including refinancing and amendments, to 57.3 billion euros, according to data compiled by Bloomberg.

Los Angeles-based Oaktree Capital Group LLC, which manages about $80 billion, Washington-based Carlyle Group LP and Blackstone Group LP’s GSO Capital Partners LP are among issuers bringing at least another 2 billion euros of deals to the market, according to Bloomberg data.

It will be Oaktree’s first CLO in Europe as it seeks to boost investments in the region and the financing may be completed by the end of June, two people familiar with the matter said last month. Jonathan Doorley, a London-based spokesman for Oaktree employed by Sard Verbinnen & Co., declined to comment.

Carlyle CLO

Carlyle, the world’s second-largest manager of alternative assets, plans to issue a CLO of about 300 million euros by the end of the first quarter, according to two people familiar with the matter on Jan. 9. Catherine Armstrong, a spokeswoman for Carlyle in London, declined to comment on the deal.

GSO Capital is marketing a deal of least 300 million euros, two people familiar with the matter said on Jan. 23, after issuing a 615.7 million-euro CLO in December, the biggest European transaction last year.

European CLOs rated by Moody’s Investors Service suffered no defaults or principal losses since 1999, the ratings company reported last year, and the likelihood of senior portions of the deals incurring losses is “remote,” it said. That’s helping boost confidence in even the riskiest portions of the securities, according to Alan Kerr, a Dublin-based senior managing director at GSO Capital.

“The default outlook remains low, so the conditions for new CLO creation in Europe are positive,” said Kerr, who wouldn’t comment on the new issue.

Default Rate

The default rate for speculative-grade borrowers in Europe is forecast to be 1.9 percent at the end of this year, according to Moody’s, compared with a global average of 2.5 percent at the end of January.

Issuance of CLOs in Europe is forecast to reach 12 billion euros this year, Bank of America Corp. analysts wrote in a Nov. 26 report. GoldenTree Asset Management LP and PineBridge Investments LLC were among money managers that raised almost 7.8 billion euros in the region last year, even as the European Banking Authority tightened rules for issuers by requiring managers to retain at least 5 percent of a deal.

“I’m not sure people believe regulations will prevent investors from coming,” said Matthew Jones, a London-based credit analyst at Standard & Poor’s. “We’ve seen this happening in Europe last year when proposed revisions to the European Banking Authority’s risk retention rules proved not to be a killer of issuance.”

Demand for higher-yielding portions of CLOs allowed Alcentra to cut pricing on the B rated parts of its Jubilee CLO at least twice. The notes offered a spread of 560 basis points more than benchmark rates compared with an initial target of more than 700 basis points, according to data compiled by Bloomberg.

“We’ve had to deal with a lot of new European regulation in the last year and now the market is grappling with the U.S. rule,” said ICG’s Kent Kershaw. “Regulations will continue to be a feature that we have to live with but it won’t stop people from doing deals.”

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