Leland Hart, portfolio manager and cio of performing credit at Warwick Capital Partners, answers SCI's questions

Q: Warwick Capital Partners closed its inaugural BSL CLO transaction – the US$400m Warwick Capital CLO 1 – last month. As a new entrant, how does Warwick’s strategy compare to that of existing managers in the market?
A: It’s a pretty seminal time in the CLO market – when risk retention reared its head in the US and Europe and changed the business model for CLO managers regarding equity capital. While the regulation came and went in the US, the market continued to evolve in terms of how equity was raised and placed importance upon having partners, as managers were less able to rely on selling equity at the time of the deal.

For us, our partners really like the performance profile of CLO equity and realise that also having the commitment of equity beforehand allows you to navigate a market which now has multiple cycles per year rather than cycles that last years. We’ve partnered with our equity from day one; we are focused on CLOs specifically, and we’ve hired a very qualified team of analysts with an average of 20 years of industry experience.

A lot of larger investment platforms have great analysts too – but they will be covering open funds, separate accounts, high-yield, multi-asset funds, in addition to CLOs. That doesn’t mean their analysts aren’t focused on credit, just not specifically for the CLO structure.

What we have is not unique per se, as there are a lot of fantastic platforms out there, but there is a lot of time and thoughtfulness that goes into the structure of a deal, and having this CLO focus and expertise is different to a lot of other firms. Another key piece is that everyone in our CLO business is an owner, so the entire team is naturally encouraged to look not just at their names but the whole portfolio.

Q: What makes now the right time to enter the CLO market?
A: We had warehoused that deal, as we have been acquiring loans at a steady rate since the end of last year. So, it was a combination of what was attainable from a debt perspective, as well as making sure we had the quality of assets that match that, and we felt the total return on the transaction for the risk of the portfolio was decent.

We did benefit from great support from the buy-side community, coupled with a portfolio that we had worked on over a long period of time. It has performed well thus far, along with the loan market, which had a pretty nice run this year. It may have looked like super smart timing, but it was more like a steady march since we started building the loan portfolio at the end of last year.

Q: What is the opportunity for new entrants to the CLO market right now?
A: The top 20 platforms account for something like 45% of the CLO market, but there is certainly room for new entrants. Although only three or four new managers entered the market this year, by seeing who is out there and comparing current volumes with those seen in the past, you can see that things are changing in the market.

A hot-topic issue at the moment is that the market is going through a maturity phase, and issuance has slowed down. There are over 100 platforms in the US, and not all of them are issuing anymore.

Many platforms of material size are seeing reinvestment periods end  – or are at least unable to recommit to deals in their older CLOs. That offers a number of opportunities for those with fresh capital and the ability to help borrowers extend their debt maturities, so it is a massive driver of the market at the moment and into the foreseeable future.

There are some very large firms who used to be able to issue 5-10 deals a year who aren’t necessarily able to do so at the moment, and that has certain implications on the behaviour of those managers who are not only feeling forced to do new deals, but a potential reticence about paying down existing deals. If they’ve gone from asset gatherers to that, their motivation might differ from that of someone who owns their CLO equity. This is a major focus in the market at the moment.

Q: What other opportunities do you see in the CLO market at present?
A: The loan market is very large at approximately US$1.4trn in size, and there are a lot of loan issuers who are looking to amend and extend their maturities. This is usually standard operating procedure, but the number of funds that can extend their loans right now is shrinking because a lot of the deals are post-repayment and have to deal with average life tests.

So, as someone with new capital, that implies that the credit curve will steepen – meaning near-term maturities will have tight spreads and longer-term maturities will have wider spreads for the same underlying credit risk. That is a scalable opportunity for those with fresh capital.

The market has adapted. You’ve seen bond issuance pick up, senior secured bond issuance pick up tremendously, and that’s a natural reaction to the markets that happens rather consistently.

So, the opportunity we see is there are a large number of borrowers that are substantial in size, have been around for years and will continue to be, and they need to access the market and the price at which they are doing that will be attractive to us as investors. So, as investors, it’s great as bigger borrowers tend to do better, so that trend has been a positive one for us.

Q: What is the aim for Warwick’s CLO business going forward?
A: Our goal is to become a consistent and repeat issuer. One of the hallmarks of the CLO market is the importance of vintage diversity, and so we want to be a methodical issuer in the market.

The goal isn’t to try and predict the future, but actually offer our investors real diversification. So, we won’t be doing 10 deals a month anytime soon.

Q: The CLO market has undergone immense evolution in recent years. How has portfolio management changed over time?
A: One of the biggest changes in the loan space over the last 20 years or so is that both the transparency and liquidity of loans has continued to improve. So, as a portfolio manager, you really do have an ability to be active.

The correlating factor to all of that is that price volatility has increased as well. So, when we’re looking at some of the sectors that may have an issue, or we’re looking at a specific opportunity, those become even more actionable because loans are in general more liquid and transparent.

However, they can also be more volatile. The loan markets move closer to the bond market when it comes to the day-to-day execution.

Q: Given the sector-specific impact of ongoing macroeconomic pressures, what pressure does that place on diversification for CLO portfolios?
A: Keeping diversification at an acceptable level is not a problem per se. It is a US$1.4trn market, and the index itself has over 1,000 names. Diversification is one of the reasons that the CLO market has had such a healthy and successful life.

Unquestionably, there are some sectors that are redder on the heatmap than others. Two of these happen to be the biggest – healthcare and technology – but you do also have the telecom-media-cable space and other smaller sectors meriting attention. Navigating through some of those testier sectors isn’t impossible, but there are multiple sub-sectors and names within those that certainly an underlying investor may tire of having to talk about – so we will continue to see some premium being required to get an investor into that space.

For us, without having a giant existing book of exposure, it’s not a bad thing to be getting paid more for the same sectors. But you have to be careful with the amount of lower rated single-Bs, as at some stage people won’t want them anymore and will be unwilling to do the work, particularly in struggling sectors. You may have the great healthcare names or great tech names, but the market during the short and medium term may not care.

Q: Despite macroeconomic difficulty, the CLO market has been getting a lot of good press recently, given the increase in issuance. Do you share in that optimism?
A: Volume has picked up over the last month or two because of recent spread tightening – and so we had a rally in loan prices and CLO costs. There are more than a couple of warehouses outstanding from the last year or two which are looking to find a home.

You have willing issuers, a decent market and a CLO investor base that may seem relatively thin to what was seen historically, while we wait for some of the US banks to return. But there are still a large number of new investors coming to market, so it’s certainly a more diverse investor base. This, however, doesn’t mean everyone can access the market at the same time.

There are a number of reasons to be positive – we’re witnessing CLO liabilities rallying and an increasing number of new investors – but it is always a balance. We are still below the last five years volumes-wise, but it has been steady.

It’s not going to be what everyone wants, and there are reasons for that, but it’s healthy and it’s two-way. Whether you’re buying triple-As or equity, the market continues to prove itself – it ebbs and flows, but the structure works.

Q: And looking forward, do you think the outlook for the market is going to remain positive?
A: Historically, loan prices and the cost of liabilities in the CLO market tend to march together hand-in-hand. There are periods where one is ahead of the other, but it is usually only a matter of months before they come back together again. We saw that between this summer and autumn, where it looked hard in the summer but in the autumn it just worked.

As far as macro or secular changes go, I think it looks positive, as there are still investors that are yet to return to the market fully. Then for loans, when I look at the quality of new issuance, the diversity is decent. It was an incredibly busy September; it wasn’t busy before that and the future calendar of new issues looks a little sparse too. And M&A volumes are low compared to historic numbers – which tends to be the feeding ground for loan issuance.

My gut feeling is that underlying demand for CLO liabilities and equity is absolutely there, but the supply of new loan issues leaves a little bit to be desired post-September. And that means CLO liabilities should continue to strengthen from a price perspective. CLOs are two-thirds of the loan market and have been a relatively consistent theme over the last  20 years, and I don’t see that changing materially.

Claudia Lewis