Bloomberg News

European CLO Managers Seek Life in Listed Funds: Credit Markets

October 05, 2011

Oct. 5 (Bloomberg) -- Mutual funds are helping to fill the gap left by collateralized loan obligations in Europe as borrowers search for ways to refinance 200 billion euros ($267 billion) of leveraged loans.

Vanguard Group Inc. and Fidelity Investments, the two largest U.S. mutual fund companies, are leading a record $833 million of investment in Europe-listed loan funds. NB Global Floating Rate Income Fund and Babson Capital Management LLC, which traditionally invested in loans via CLOs, announced plans to raise $382 million in the equity market to buy the debt.

Hobbled following the 2008 bankruptcy of Lehman Brothers Holdings Inc. and unable to recover amid Europe’s sovereign crisis, CLOs have withdrawn as the biggest loan investors. At their peak in 2007, the funds purchased 62 percent of the debt in Europe, according to Standard & Poor’s Leveraged Commentary & Data. The securities raised 285 million euros this year compared with a record 35 billion euros in 2007, according to data compiled by Bloomberg.

“Listed loan funds could be the new version of CLOs for European investors,” said Joseph Lynch, a Chicago-based managing director at Neuberger Berman Fixed Income LLC, which listed NB Floating Rate Income Fund in an April IPO that raised $507 million. “The CLO market is unlikely to come back in Europe anytime soon.”

Funding Hole

As the “vast majority” of European CLOs wind down by 2015, the companies that depended on them for 61 billion euros of leveraged loans due by 2015 might lose their source of capital, S&P said in an Aug. 25 report.

CLOs pool high-yield, high-risk loans and slice them into securities of varying risk and return.

“The question is what will replace CLOs in Europe,” said Leland Hart, head of loans at BlackRock Inc. in New York, the world’s biggest money manager. “We like loan funds because they give a very solid dividend and a high degree of income certainty notwithstanding the recent debt crisis in the market. Given the price of loans today, the appeal is pretty self-evident.”

Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds worldwide rather than government debentures rose 8 basis points to 277 basis points, or 2.77 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index.

The extra yield investors demand to hold the top-ranked portion of bonds backed by commercial mortgages jumped to the highest since February 2010, according to a Barclays Capital index.

Credit Default Swaps

Spreads on the BarCap CMBS AAA Super Duper Index widened 29 basis points yesterday to 323 basis points, or 3.23 percentage points. Relative yields have climbed from 2.26 percentage points since the end of July as investor concern has mounted that Europe’s debt crisis will hurt bank balance sheets and derail the faltering global economic recovery.

William Lyon Homes missed its second bond interest payment in two months as the homebuilder discusses reorganization with lenders. Garden Ridge Corp. increased the discount at which it will sell a $250 million term loan.

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses or speculate on creditworthiness, fell 1 basis point to a mid-price of 146.3 basis points, as of 11:35 a.m. in New York, according to Markit Group Ltd.

The index typically declines as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Loan Prices Fall

William Lyon, the builder of single-family homes, didn’t pay $7.5 million in interest due on Oct. 1 on its $138.8 million of 10.75 percent notes maturing in April 2013, according to a regulatory filing. The Newport Beach, California-based company said it must make the payment by Oct. 31 to prevent a default.

The S&P/LSTA U.S. Leveraged Loan 100 index declined 1.14 cent to 87.02 cents on the dollar, the lowest level since December 2009. The measure, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has dropped from 94.41 cents at the end of July.

Garden Ridge, a retailer of home décor products, will sell the loan to finance the company’s buyout by AEA Investors LP at 90 cents on the dollar, compared with 93 cents previously proposed, said a person with knowledge of the transaction, who declined to be identified because the terms are private.

Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.

Debt Through Equity

Fidelity made its first investment in a listed loan fund in Europe earlier year by investing in Blackstone Group LP’s Carador Income Fund Plc, which pays more than 10 percent dividend yield, said Eugene Philalithis, a London-based money manager at Fidelity.

“Listed funds allow you to trade more frequently and fund managers don’t have to worry about having to raise funds to meet redemptions,” Philalithis said. “You are getting access through an equity vehicle to buy debt instruments. Market sentiment has an impact on share price but the underlying asset value of these funds is what drives the longer-term performance.”

Carador and Greenwich Loan Income Fund Ltd. rewarded investors with share price increases of 15 percent to 35 percent this year, Bloomberg data show. That compares with a price decline for bonds tracked by Merrill Lynch’s Euro High Yield Constrained Index to 84 percent of face value from 94 percent.

Tetragon, Henderson

Shares of Tetragon Financial Group Ltd., a Guernsey company traded on Euronext Amsterdam that invests in bank loans mainly through equity tranches of CLOs, rose as much as 7.1 percent today to $6.16, the biggest gain since Aug. 12. They have gained 36 percent in the past year while net asset value per share increased 52 percent to $11.77. Henderson Diversifed Income Ltd. rose 2.1 percent today to 73 pence, the biggest increase since Aug. 22.

In comparison, prices of European CLO equity rose about 8 percent this year, according to Bank of America Merrill Lynch’s data.

Issuance of bonds from CLOs in Europe fell to 10 billion euros in 2008 and was zero in 2009. This year’s sole issuer European Capital, a unit of Bethesda, Maryland-based based American Capital, retained about two-thirds of an 858 million- euro deal in June.

Half of the $37.4 billion of loans for private-equity funded buyouts were placed with institutional investors including CLOs this year, compared with 58 percent in 2010, according to Bloomberg data. Issuance of leveraged buyout loans in Europe more than doubled from $16 billion in 2010.

Growing ‘Very Quickly’

European companies acquired by LBO firms will struggle to refinance more than 200 billion euros of debt as investors eschew risky securities, according to a Sept. 28 report by Fitch Ratings.

CLO managers including Avoca Capital Holdings and New Amsterdam Capital Management LLP may follow Babson Capital to create loan investment trusts listed in stock exchanges, according to officials from the funds.

“The market for listed credit funds is growing very quickly in Europe,” said Miguel Ramos-Fuentenebro of GSO Capital Partners International LLP, the investment manager of Blackstone-owned Carador. “We believe there’s no reason why loans shouldn’t suit a very large pool of investors.”

New Amsterdam Capital Management LLP is considering floating some of its assets as a way to grow the business without having to issue CLOs, founding partner John Seal of the London-based firm said. Avoca Capital Holdings won’t “rule out” a similar vehicle, said Alan Burke, the Dublin-based chief executive of Avoca Capital Holdings, which oversees 6 billion euros.

“We will see more funds being created to have shares traded on stock exchanges in the next 12 months, probably quicker,” said Burke.

--With assistance from Lisa Abramowicz, Michael Amato, Mary Childs, Shannon D. Harrington, Sarah Mulholland and John Parry in New York, and Beth Thomas in Tokyo. Editors: Cecile Gutscher, Chapin Wright

To contact the reporter on this story: Patricia Kuo in London at

To contact the editor responsible for this story: Faris Khan at

China's Killer Profits
blog comments powered by Disqus