All but one of the European CLOs proceeding to market this year so far have had a single investor anchoring the senior tranche — Japan’s Norinchukin Bank (NoChu), a co-operative bank for farming, fishing and forestry.
NoChu has a portfolio of at least $62bn in CLOs globally, likely dominated by triple-A senior tranches. It’s not the only major Japanese bank active in European CLOs (a spate of yen repacks last year went to serve one of the others), but in 2019 at least, it has dominated the market.
That partly reflects how CLOs come together. The senior notes, as in most securitizations, account for most of the capital structure —perhaps 60%, and so the triple-A pricing dominates the overall cost of debt. The equity, meanwhile, is the most complex to place, often relying on detailed discussions between the CLO manager and the investor or investors.
So CLO placement ideally starts with sorting out the equity and the senior — then the mezzanine tranches can be sold in open syndication. If you can talk to just a single account to secure a level that works for the senior notes, it takes off some market risk, and managers can be confident a deal is on the table.
But it is an approach that has its downsides. Money is power, and when a single investor is writing €240m tickets, they’ll expect something in return. That means terms which are friendlier to the senior noteholders and correspondingly, tougher for the equity holders. And in NoChu’s case, the ability to dictate the timeline for the whole process.
The managers on NoChu’s list bring deals when it says they will, and they wrap them up inside a week — printing the senior at the level NoChu says it wants. So far this year, that’s mostly been 108bp, though the Japanese bank is said to have widened its target levels for the latest crop of deals in marketing.
NoChu is doing a lot of heavy lifting, but other investors like CLO triple-As, at wider levels. The rating is good (no jokes about pre-crisis structured finance ratings please) and fundamentally the risk is just a package of diversified corporate credit.
A bank might lend to hundreds of corporates in its home jurisdiction, but appreciate the diversification that comes from exposure to a pan-European or pan-US book of corporate credit, taken at a senior level in floating rate format (with a spread that puts most government bonds to shame).
But the spread level where other buyers might care is consistently outside NoChu’s target. The Japanese bank is not the only investor, but it is the most attractive investor, for the managers that meet its strict criteria.
NoChu’s role is very different to the broad-shouldered one played by JP Morgan’s CIO book immediately after the financial crisis. For example, the US bank single-handedly kept UK and European RMBS alive in the years 2009-2010, when there were no other sizeable buyers. But regardless of the difference of timing, both are markets with one big buyer.
That is because CLOs only work when the spread between assets and liabilities is wide enough to make money for the manager and for the equity holder. With loan spreads tightening faster than CLO liabilities, the arbitrage available is weaker than ever — and looking away from NoChu may render deals outright impossible.
But a situation where the market is dominated by a single account is far from healthy. NoChu itself cannot exit, or even contemplate it. Japanese jitters would create their own mini “taper tantrum” which would wreck the market for months. Regulatory changes in Japan could also send a storm through the CLO market.
It is also bad news for diversity and innovation. NoChu likes its managers large and established. But CLO technology is usable by loan investors of all sizes.
Perhaps the “three men and a Bloomberg” shops have to pay more for their liabilities, but there’s no reason why the likes of Carlyle, GSO and CSAM should be the only ones to raise CLOs.
CLO structures can also be used for more exotic products — infrastructure CLOs, green CLOs, or even stressed CLOs — raising term leverage to go bargain hunting among distressed credits. It’s healthy for a market to take different documentary approaches, balancing risk and control and price between tranches in a different way. A market shaped by the preferences of one investor only will be unhappily concentrated, and all deals will share the same weaknesses.
Thankfully, there is hope on the horizon. Spire Partners is marketing its fifth deal (putting it well below the AUM level at which NoChu will take a look) through Bank of America Merrill Lynch this week.
Market participants are eager to see if the scarcity of triple-A will help Spire overcome the lack of NoChu, and crossing their fingers for the re-emergence of a broader market.