Structures and complexity to suit remaining investor base

European CLOs are experiencing a shift in structure and complexity in order to meet the demand of investors who are still able to part with cash for the asset class. While industry experts at this week's ESF/IMN conference on 'European CLOs, Structured Credit Products & Credit Derivatives' said that demand for CLOs remains, less leveraged, simpler two-tranche structures are expected to make up the bulk of such issuance in the European market over the next few months.

"There is still some investor demand for CLOs, but I expect to see the development of less structured products to suit particular investors who have capital available and an appetite to invest in the underlying asset class on a less levered basis," said Simon Perry, md and head of European CDOs at UBS.

Mark Moffat, md and co-head of Harbourmaster Capital Management, confirmed that he is tending to see a shift towards lower levered, two-tranche CLO structures with a triple-A and an equity piece. "If the triple-A investor base returns, I imagine demand would exist for exposure to pure credit risk, not a combination of credit risk, FX risk, market value risk, counterparty risk etc."

Shaun Baddeley, executive director of global securitisation at Santander Global Banking and Markets, added that he expects to see more reverse-enquiry bespoke deals, and possibly some plain synthetic deals and portfolios that are not vulnerable to cyclical downturns.

Concerns over where the volume of buyers for triple-As will come from over the next few years in the primary market - even in the case of the most simple structures - was discussed at the conference, although panellists were confident that investor appetite for mezzanine tranches down to equity remains. Mark-to-market CLO investors remain firmly on the sidelines, but the gradual re-emergence of some non mark-to-market accounts was seen as a positive.

However, panellists commented that it is proving difficult to persuade investors to enter the primary market while forced selling continues in secondary - where, in some cases, a pick-up of nearly 30% on an equity tranche is possible at present. Indeed, the events of the past couple of weeks have forced some holders of CLOs to sell at relatively distressed levels in order to obtain any cash or liquidity possible, with triple-As seeing the most activity.

Defaults and their impact on CLO structures were also debated at the conference. A number of attendees were of the opinion that, while defaults are expected to rise, the levels are unlikely to impact European structures too much.

"If there is not a spike in defaults in 2008/9, then I don't think we will see one at all. Defaults might reach double figures, but we're not going to see anything that breaks CLO structures, as they are designed to cope with higher default levels than we're currently seeing," David Matson, md of IKB Fund Management noted.

Harbourmaster's Moffat concluded that, in order to help broaden the CLO investor base, default and recovery data over 2009 and 2010 would need to be seen.

AC