Both Style and Skill Set CLO Managers Apart
January 2, 2013
Investors have learned that a collateralized loan obligation (CLO) manager’s experience matters. Prior to the financial crisis, many firms were able to issue CLOs despite having very little knowledge of the leveraged loans used as collateral, let alone the structure itself.
They did not survive.
As a result, today’s investors may be willing to pay a premium for a CLO manager’s experience.
However skill isn’t the only thing that sets managers apart, according to Scott D’Orsi, a partner with Feingold O’Keeffe Capital, a private firm specializing in the investment and management of credit, stressed and distressed strategies. D’Orsi, who heads the firm’s CLO business, contends that managing these structures is as much a matter of style as it is skill.
Within the first few years of the life of a CLO, the manager can actively buy and sell assets used as collateral, and in some deals the manager can continue to reinvest interest payments even after the formal reinvestment period has come to an end. D’Orsi says some managers will use this leeway to the benefit of one class of investors over another, and he says this is the way it should be. It provides diversification.
Attractive yields and strong fundamentals have been driving up demand CLOs, and the new issue market is rolling out the deals at a pace not seen since before the financial crisis; issuance topped $7 billion a month in the last thre months of 2012. Feingold O’Keeffe Capital is among the managers returning to market for the first time since the crisis. The firm currently runs two absolute return strategies and CLOs with total assets of $1.4 billion.
ASR’s sister publication, Leveraged Finance News, recently spoke with D’Orise about the year ahead, triple-A pricing, warehousing, and loan covenants, among other things.
LFN: The CLO new issues market has greatly exceeded initial expectations this year. Do you feel like demand for the product is strong enough to sustain the momentum in 2013?
Scott D’Orsi: I think it’s going to stay very robust. There are a lot of green arrows at the moment for CLO issuance—you’ve got a fairly benign default outlook in terms of the collateral, at about two percent; you’ve got well-priced assets in terms of spread, as well as news issuance that continues to be priced at a discount to par. On the liability funding side, there’s been a consistent expansion of the investor base throughout the year. I wouldn’t be surprised if the pace we’ve seen in the last three months continues right through at least the first half of 2013.
An expanding CLO investor base, perceivably across the capital structure, is part of the reason so many deals are getting done. Are there still situations where certain tranches are difficult to place?
D’Orsi: I wouldn’t say it’s ever easy. There continues to be some bottleneck at the triple-A level, but I think that tends to be more a matter of negotiating terms as opposed to a market clearing price. And at the moment, there seems to be a bit of widening in some of the mezzanine tranches, simply because a lot of broker-dealers are trying to get deals done before year end, so we’re seeing a flurry of deals trying to get priced. But I think that is more a phenomenon of the final weeks of the year.
Then do you see pricing coming in?
D’Orsi: I do see the general trend continuing as far as liability funding costs getting lower. I think as you look at triple-As currently pricing in the 140 area, it could probably tighten another 15 or 20 basis points in the relatively short term. CLO triple-A yields, even at those levels, continue to look attractive compared to other similarly rated securitized assets.
With regards to equity tranches, I’ve heard it said that investors in other structured products, notably residential mortgage-backed securities, are showing interest. Is that something you’re seeing?
D’Orsi: It has been taking place in the market over the last couple of months. More traditional residential mortgage-backed investors who are familiar with the CLO product have begun to become more active in the space. The CLO market provides a more attractive yield opportunity than the residential mortgage-backed market.
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