Issuance of European CLOs may be stalled, but 3i Debt Management believes that once the macro-economic picture improves, these structured finance vehicles will resume their role as important players in the region's loan market. That was part of the rationale for the London-based firm's recent acquisition of seven European CLOs from U.S. money manager Invesco.
It is not a view held by all. Unlike the U.S., where CLO volume stands at roughly $18 billion year to date, there have been no new deals in Europe since the financial crisis. Moreover, many European CLOs still in existence have come to, or will soon come to, the end of their reinvestment periods. And some observers fear that regulations meant to reign in the structured finance market (specifically the 'skin in the game' rule that requires CLO managers to retain 5% of the risk in a deal) will impede future issuance, at least for smaller managers.
But the folks at 3i DM, the debt management arm of private equity firm 3i Group, believe institutional players, including CLOs, will one day provide the bulk of the financing for European subinvestment-grade companies, said Jeremy Ghose, a managing partner and the firm's CEO.
It isn't the only firm betting on the future of European CLOs. The Carlyle Group purchased Dallas-based Highland Capital's European CLO business in February, and Blackstone's GSO Capital Partners acquired Harbourmaster Capital, a Dublin-based leveraged loan manager with a number of CLOs under its belt, in October of last year.
Even if these funds never account for most of the subinvestment-grade loan investor base in Europe, the deal helps 3i DM build the bulk it needs to become a global player in the larger debt management game, according to Ghose, who joined the firm in 2011, when it acquired Mizuho Investment Management from Mizuho Corporate Bank.
ASR sister publication Leveraged Finance News spoke with Ghose about 3i DM's strategy for growth - including the Invesco CLO purchase, which increased its assets under management by €2 billion to €6 billion ($7.6 billion) - the recent addition of Andrew Bellis, formerly Credit Suisse's global CLO chief and the future of Europe's loan market.
LFN:With Europe's CLO market in the shape it's in, why buy European CLOs?
Ghose: In the credit space, size matters. There's been a huge amount of consolidation in the last 12 to 24 months, and we have stated very clearly that we want to be a player in the consolidation game. We have the balance sheet and the currency to go buy other platforms, to go buy other mangers, and to seek new funds. So this acquisition very much fits in with our overall game plan, which is to create a global debt program of size.
Right now Europe remains in a bit of a stalemate. We do not have a functioning loan primary market, by that I mean private equity guys are not buying and selling businesses like they are in the U.S. We don't see a steady flow of primary deals in the marketplace. And unless and until you have a steady flow of deals, you're not going to see new CLOs being launched. ... So our angle is a straightforward one: We think that down the road, sooner or later, when the European macro noise subsides, we will absolutely have a working CLO market over here.
Some people fear the market won't rebound and that debt financing for subinvestment-grade companies will have to take another form.
Ghose: The quality, bigger private equity shops are continuing to raise euros in their private equity funds, and when that happens, history shows that that money gets used in terms of buying businesses. However, everybody right now is sitting on their hands and watching out of the window because we have so much uncertainty, with the European macro situation. So I think [the market coming back] is more a matter of 'when' and not a matter of 'if.'
Sixty percent of all financings in the European market are financed by institutional money through CLOs and managed accounts. That cannot disappear overnight, and the European banks are in big trouble. So I think we're going to move more toward the U.S. model, where you have close to 85% or 90% of all non-investment-grade corporate loans financed through institutional money, through CLO shops and so on, and only 10% or 15% comes through banks. We think the banks will retreat because of the Basel 3 regulations, the Frank-Dodd bill, the new liquidity ratio requirement; the banks will slowly and steadily become a scarcer player. And we remain convinced that institutional money will be financing more of the non-investment-grade credit space.
But what about regulations that affect CLOs? Isn't the 'skin in the game' rule playing a large part in stifling the market in Europe?
Ghose: I don't think we're going to get away from regulations, but regulations are not what's holding back this market. What's holding back this market is the macro-European situation, making a lot of people very afraid to make any kind of investment decisions. So private equity guys are sitting on piles and piles of untouched powder, and they will be the first ones to start writing the checks and pull the trigger. But frankly, with discussions about whether Greece stays in or whether the euro survives being on everybody's minds, people are not really focused on CLOs right now.
There has been talk of different types of funds taking the place of CLOs, at least to some extent. What form do you see the institutional loan market in Europe taking in the future? All CLOs or other types of funds as well?
Ghose: I think the form is likely to be varied. I mean that institutional money will take the form of CLOs, down the road; it will take the form of managed accounts, and I think that, over time, we're going to see lifted debt platforms also coming to the market, not dissimilar to your BDCs [business development companies] in the U.S.
Let's talk about the U.S. Do you see the Invesco acquisition giving you a foothold here somehow?
Ghose: Size is important for a number of reasons, and for us, acquiring the Invesco CLOs takes us close $8 billion U.S. dollars in assets under management. And when we do successfully complete a U.S. acquisition, we remain confident that we will have in excess of $10 billion dollars in assets under management in the credit space. Once you go past the 10 billion number, there are only a handful of players who are managing credit funds in excess of that amount.
And that completely changes the perspective in terms of getting the first call, whether you're an investor deciding to invest in our firm or a private equity house looking to raise new financing for their deal. That's why you see massive amounts of consolidation in the U.S. market. If you look at the example of Apollo, a couple of years ago Apollo was not in the credit space, but by making two acquisition, Gulf Stream and Stone Tower, today they are one of the major players in the credit space. By the way, those are the same people who are launching the CLOs in the U.S. The U.S. market is open if you've got a good track record, and if you can pony up with anywhere from 10% to 40% of the equity, then you are able to launch a deal. And the big guys have that firepower in terms of using not only their own internal resources but also the ability to raise new dollars when they're launching these funds.
What would be the optimal way to break into the U.S. market? Acquire a CLO management firm? Or acquire some CLOs and build a staff in the U.S.?
Ghose: We're very much open. I think what's most important for us is to find a team that would fit in culturally with 3i Debt Management. ... And if that meant acquiring an existing portfolio, then we would look into that. If that meant hiring well-known portfolio managers, who have a good, long track record of raising equity and executing deals, we would also look at that. We are not wedded to any particular strategy.But most important for us is to get the right foundation and to find the right set of people. Then to make sure that we can execute, because we would absolutely want to be a major player in the U.S. market. If we want to be a global credit shop then we need to have presence of size in the U.S. market to be relevant, and it is absolutely part of our strategy to go and find that platform or to go and find that manager.
You recently hired Andrew Bellis to lead your global growth initiative. Does that mean that you see CLOs as your primary target area for growth, as opposed to other types of funds?
Ghose: No, Andrew has been very much a player in the structured credit space for the last 15 years. He brings a wealth of experience... he's dealt with the top 30 fund managers globally and he also knows who the relevant investor base is today, whether you're buying triple-A paper or you're buying equity. But the business that we have in Europe today is not just a CLO business; we have managed accounts, a credit opportunity fund, fund of funds private equity, a mezzanine fund. I would best describe us as very much in the credit space, but much broader than a CLO platform. We want to replicate what we've built in Europe in the U.S. We would start with a CLO platform, and we would absolutely be challenging ourselves in terms of growth, whether that means launching a BDC [business development company], for example, or launching a U.S. credit opportunities fund, or a U.S. high yield bond fund.Whichever platform we acquire, we would be looking to diversify in terms of the product. So we don't end up looking like a one-dimensional CLO shop, which by the way, a number of managers in the U.S. are exactly that today. So Andrew is going to help with developing the U.S. business, developing further the European business, and we also have business in Asia, creating a truly global credit business.
