Pressure still increasing for CLO managers to consolidate

Optimism in the structured credit market has not alleviated the strain on CLO managers, many of which remain under pressure to consolidate or transfer the management of their deals to different firms. CDOs have also been increasingly subject to manager changes, although this trend may already be past its peak - particularly in the case of ABS CDOs.

Last week, for example, it was announced that Babson Capital was the likely replacement manager for two US CLOs - Clear Lake CLO and St James River CLO (see last week's issue). Meanwhile, Prudential Investment Management announced that it would be taking over the management duties of Duane Street CLO V from DiMaio Ahmad Capital. A number of other consolidations were announced over the summer months (see table below for details).

"Pressure is still increasing for CLO managers to consolidate," confirms Manuel Arrive, senior director in Fitch's fund and asset manager rating group. "Although technicals have improved over the past few months, fundamentals are still deteriorating. Loan defaults are expected to increase and peak in 2012, so it is likely that more management fees will be cut off, leading to more consolidation."

He adds: "I expect to see more consolidation of CLOs than CDOs. Within ABS CDOs, manager transferrals/consolidation is not finished, but there is less appetite to take on these sorts of deals."

Scott Roth, principal at Ventras Capital Advisors, agrees: "A number of ABS CDOs are now at the point where the controlling class may decide to liquidate the transaction. A manager would probably be less interested in taking on such a deal if one month later the investors decided to liquidate the deal, for example."

He continues: "In many cases, trigger breaches after rating downgrades or overcollateralisation test failures have driven the transfer of CDO management. By now, the bulk of those triggers will likely have been breached and, while there may be more CDOs that will transfer management duties, the majority have probably already taken place."

Patti Unti, also principal at Ventras Capital Advisors, says that the general health of CDO managers should be considered, however, particularly in the commercial real estate area. "Managers will be aware of increasing defaults and will see their workload increasing and management fees going down - it may not make economic sense for them to continue managing those deals," she notes.

Since June the sentiment among credit asset managers has improved and there is now a lot more optimism in the sector. Leverage is returning to the credit hedge fund space and investors are moving back to the sector: those with increased yield targets are starting to accept more leverage, given current spread levels. However, managers are still finding it difficult to raise capital for new products, notes Arrive.

He adds that narrowing spreads have put some strategies, such as long-only/beta, under more pressure. "Long/short credit arbitrage strategies are becoming more popular, on the other hand," he says.

Meanwhile, managers that previously focused their efforts on the CLO and CDO space have been broadening their scope. Several have diversified into other asset classes within structured finance and others into credit more broadly.

One recent example includes Harbourmaster Capital Management, a European leveraged loan manager who in August launched a business providing advice and asset management services to institutional clients, solely focused on portfolios of ABS. Another example is Faxtor, a European CDO manager, which was integrated more fully into its parent company IMC and has recently closed a distressed US mortgage fund (SCI passim).

On the infrastructure side, several credit asset management firms have recently been investing in sales and marketing and client services - some in-house and some outsourced. "There are two reasons for this," Arrive explains. "First, CDO managers used to rely on investment banks to distribute deals and now this is no longer possible - they need their own resources. Second, the asset managers need staff with familiarity and specialist knowledge of fund investors. Investors are also demanding improved client service - particularly involving reporting standards and transparency."

AC

 Publicly announced manager changes