Bloomberg News

Blackstone Leads Firms Targeting European CLOs as Deals Fade

November 07, 2011

(Updates with share prices in seventh paragraph.)

Nov. 2 (Bloomberg) -- Blackstone Group LP, the world’s largest private-equity firm, and Ares Management LLC are leading an expansion in European collateralized loan obligations to bolster fee income from managing assets as buyouts slow.

GSO Capital Partners LP, the debt unit of Blackstone, became the largest manager of CLOs in Europe after acquiring Dublin-based Harbourmaster Capital Management Ltd. in early October, tripling its European loans under management to 11.5 billion euros ($15 billion). 3i Group Plc, Britain’s biggest publicly-traded leveraged-buyout firm, said it’s seeking to double its $6 billion credit business.

The U.S. firms are taking over dormant CLOs struggling to raise funds in Europe as deal flow in the buyout market shrivels 76 percent since July, according to data compiled by Bloomberg. CLOs package leveraged loans into bonds of varying risk and generate a steady stream of interest and fees from speculative- grade borrowers as Moody’s Investors Service says that the default rate on the debt may drop to 1.4 percent next year.

“Some private equity firms may want to diversify their revenues sources,” Nicolas Gakwaya, a structured finance analyst at Bank of America Corp. in London, said on Oct. 7. “At the same time less and less pure CLO managers in Europe can afford to be on their own, so they make a good match.”

Private-Equity Benefits

U.S. buyout firms are making inroads into the business of managing the portfolios at a time when rising yields makes selling new CLOs expensive.

“CLO managers benefit from the private-equity firms’ capital access, distribution and name recognition that they often lack without a larger parent,” said Ross Van der Linden, a Charlotte, North Carolina-based managing director at StormHarbour Securities, which advised on four CLO manager acquisitions since 2009 in an interview Oct. 19.

Blackstone shares jumped as much as 3.8 percent today to $14.32 while 3i rose 2.1 percent to 202.4 pence. They were the biggest increases since Oct. 27 for both stocks.

Managers are finding it tougher to raise CLOs as regulators clamp down on opaque securities blamed for the collapse of Lehman Brothers Holdings Inc. in 2008. Loan managers may also be subject to new rules under the Dodd-Frank Act that would require them to retain at least 5 percent of credit risk in deals they package.

Mergers have reduced the number of managers of CLOs in Europe rated by Moody’s to 47 from a peak of 59 in 2008. The top 10 funds account for 59 percent of the market, up from 38 percent before 2008, according to Moody’s.

CLO Price Fall

Only two CLOs have been raised in Europe since 2008, leaving existing funds to without new cash to invest except from redemptions.

The average price for AA rated European CLO slices dropped to 62 percent of face value while A rated notes slid to 54 percent of face value, according to Morgan Stanley data. Leveraged loan prices are down 0.6 percent, according to Markit Ltd.

“CLO management provides more stable revenue streams relative to buyouts,” Guillaume Jolivet, a Paris-based senior analyst at Moody’s, said in a telephone interview Oct. 12. “Becoming part of a large private-equity firm could also help the CLO manager get better access to primary loan market allocations because of buyout firms’ strong relationships with banks.”

GSO Deal

GSO expressed interest in Harbourmaster about two years ago, according to Dan Smith, a senior managing director at the firm in New York.

“We feel we’ve got the scale we are after so the appetite for future acquisitions of CLO managers is significantly diminished,” Smith said in an interview Oct. 6. “Our focus now is on managing the portfolios, integrating the businesses and organic growth.”

3i Debt Management’s Chief Executive Officer Jeremy Ghose said in an interview Sept. 27 in London that the firm is looking to expand in the U.S. buying funds with as much as $5 billion under management as it plans a doubling of its credit business from $6 billion.

GSO took over the management contracts of four CLOs run by AIB Capital Markets Plc at the end of March, adding about 1.5 billion euros of assets. London-based 3i bought Mizuho Investment Management (UK) Ltd., which manages about 3.7 billion pounds in September last year to expand debt unit.

Bank CLOs

BNP Paribas SA, Credit Suisse Group AG, Caja Madrid and Natixis are among European banks that still manage CLOs, according to Fitch Ratings.

Ares Management, a Los Angeles-based investment firm, in August agreed to acquire London and New York-based Indicus Advisors, which oversees more than $2 billion in assets in CLOs.

Washington-based Carlyle Group, the world’s second-largest private-equity firm, agreed in January to buy AlpInvest Partners NV, a Dutch money manager that oversees about 32 billion euros in private-equity and mezzanine funds, to expand its asset- management business.

“CLOs have exhibited resilience through the financial crisis, and that while a recession may push prices down, CLOs should be able to withstand a slowdown,” Wells Fargo analysts led by Charlotte, North Carolina-based David Preston wrote in the research note on Sept. 29. “Insurance companies, U.S. banks and even high-grade accounts will likely re-enter the sector should prices drop substantially,” according to the report.

Cash Flows

Falling default rates improved the cash flows for the riskiest portions of European CLOs, with 80 percent making at least partial payment to their investors, up from 35 percent in mid-2009, according to Citigroup data.

Moody’s expects the default rate for speculative-grade companies to range from 1.4 percent to 2.1 percent by the third quarter of next year, down from 3.1 percent at the end of 2010.

The average default rate for European CLOs was 0.1 percent at the end of September, according to Citigroup Inc. The rate peaked at 4.4 percent in the fourth quarter of 2009.

“For someone that has the firepower and patience, it makes sense to buy European credit funds because it will be easier to expand position and pick your spots in a less crowded market than in the U.S., where you have much more players and the market is more efficient,” Bank of America’s Gakwaya said.

--Editors: Faris Khan, Cecile Gutscher

To contact the reporter on this story: Patricia Kuo in London at pkuo2@bloomberg.net

To contact the editor responsible for this story: Faris Khan at fkhan33@bloomberg.net


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