Manager Selection A Key Factor In CLO Results Through Crisis
Springfield -- 05/03/2012 --
Collateralized loan obligations, or CLOs, provided one of the few upside surprises for investors through the financial crisis, but an analysis of more than 250 CLOs shows that manager selection was a critical factor in performance, according to Matthew P. Natcharian, managing director and head of structured credit investments for Babson Capital Management LLC.
“If you were in any of the debt tranches of any of the well-performing managers (throughout the financial crisis), you’re very happy with your investment,” Mr. Natcharian told investors during an April 24 roundtable on CLOs sponsored by Bloomberg Brief Leveraged Finance, a daily newsletter published by Bloomberg LP with commentary, data and in-depth analysis for the leveraged loan and high yield bond market.
CLOs are structured credit investments with pools of corporate loans as the underlying collateral and are sold to investors in debt and equity “tranches” of varying degrees of risk and targeted returns. Although CLOs have been lumped together with other structured investments that imploded in the financial crisis, Babson Capital’s analysis of 253 deals and 43 managers showed a 2.2 percent average net loss of collateral – “a phenomenally good number going through the financial crisis,” Mr. Natcharian said – with results ranging from a 7 percent gain for the strongest manager to a 9 percent loss.
Other key points emerging from the roundtable discussion:
- Though nowhere near its 2007 peak issuance of $91 billion, the CLO market is rebounding smartly with more than $10 billion in issuance so far this year, numerous deals in the pipeline, and projected 2012 issuance estimated as high as $30 billion. The investor base for new issues includes both new entrants who are attracted to an asset class that proved itself during the financial crisis – as well as many investors in earlier-vintage CLOs who rode out the crisis and saw the combination of yield and safety that the investments provided. With their high degree of stability and consistent returns up and down the capital structure, more and more investors are coming to view CLOs as an anchor in a broader multi-asset class portfolio allocation strategy.
- Unlike other types of structured credit investments, CLOs are actively managed, which means managers can trade loans in and out to manage the risk profile of their portfolio. This was key to manager outperformance during the crisis as the savviest managers took advantage of forced selling of loans in the secondary market to pick up desirable assets at huge discounts, as bank loan prices fell to all-time lows in 2009.
“Because many investors have stuck it out, and had bought positions before the crisis and had held them and worked through them, they’ve seen the benefit of that active management and have been willing to come back into new issues that are being brought by the most successful managers,” Mr. Natcharian said.
- On a relative-value basis, CLOs currently provide an attractive way to invest in bank loans without the same exposure to losses from loan defaults. For example, Triple A CLO tranches are yielding 135 basis points over Libor and shielding investors from 35 percent net realized losses. Similar value versus like-rated assets can be found further down the capital structure as well. “If you can take a little bit of the complexity and a little bit of the liquidity risk, then you’re getting well paid for taking that bank loan risk if you’re confident in the manager of the CLO that you’ve selected,” Mr. Natcharian said.
Babson Capital, an investment management firm based in Springfield and Boston, Mass., and Charlotte, N.C., is one of the largest global high-yield managers with more than $26 billion in high-yield assets under management, nearly 20 percent of the firm’s $142.8 billion in total AUM. Babson Capital is one of the world’s largest structured credit managers with more than $11 billion of assets under management, including $8.3 billion of cash flow CLOs. In addition, Babson Capital is one of the largest issuers of CLOs. The firm currently manages 34 U.S. and European CLOs totaling $14.7 billion in AUM as of March 31, 2012.
The April 24 roundtable was moderated by James Crombie, editor of the daily Bloomberg Brief Leveraged Finance newsletter. Mr. Natcharian was joined on the panel by Peter Gleysteen of CIFC, John Popp of Credit Suisse, and Justin Pauley of RBS.
To listen to the roundtable, please visit www.bloombergbriefs.com/webcast-clo/.
About Babson Capital Management LLC
Babson Capital Management LLC and its subsidiaries serve institutional investors around the globe and have $181 billion in assets under management as of March 31, 2013. Through proprietary research and analysis and a focus on investment fundamentals, we develop products and strategies that leverage our broad array of expertise in fixed income, equities, alternative, structured products, debt financing for corporations and debt and equity financing for commercial real estate. Based in Boston and Springfield, Mass., and Charlotte, N.C., with offices in New York City and Los Angeles, the firm’s subsidiaries include Babson Capital Europe Limited in London, Babson Capital Australia Pty Ltd in Sydney, Cornerstone Real Estate Advisers LLC in Hartford, Conn. and Wood Creek Capital Management in New Haven, Conn. Babson Capital is a member of the MassMutual Financial Group.