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News Analysis
Hybrid structure makes its way across Atlantic
by Kathryn Gaw
After months of market buzz, hybrid CLOs have finally arrived and are here to stay.
Combining private credit and syndicated loans in a single package, this innovative form of collateralised loan obligation made its debut in Europe earlier this year and is now set to be rolled out by multiple managers, according to sources familiar with the plans.
In Europe, Sona Asset Management was first out of the blocks with a hybrid CLO and Blackstone is tipped to follow suit by the end of the year. In the US, Palmer Square is preparing to price its own version, with plans for annual issuance. Numerous market sources report that other managers are in talks about hybrids on both sides of the Atlantic, although it remains to be seen how many will get over the line.
Blending liquidity and yield
Until this year, CLOs came in two main categories, based either on broadly syndicated loans (BSL) or on private credit (PC). A blend of the two offers scope to combine BSL liquidity with the higher yields associated with direct loans. However, the impetus behind hybrids differs between markets.
In Europe, hybrids are widely regarded as a solution to the problem of quickly ramping up a private credit structure with suitable loans. Managers operating in the deeper and more developed US market face less of a challenge, as PC CLOs make up around 20% of the total, against just 1% in Europe, where only two such CLOs have been issued so far this year.
“Private credit CLOs are a relatively novel product in Europe and manager utilisation isn’t as embedded as it is in the US,” said Matthew Morris, director managing director, Ares Credit Group — one of the three firms which has issued a PC CLO in Europe. The still tiny proportion of private credit in Europe’s CLO mix is reminiscent of the US market 15-plus years ago, he said.
As it stands, a mere handful of European managers can originate purely private credit deals. Among the three successful firms so far, Ares and Golub have confirmed to Creditflux that they will continue to issue PC CLOs, while a spokesperson for Barings said: “We don’t currently have a European private credit CLO in the immediate pipeline.” Barings declined to comment on whether it would consider doing a hybrid.
In the US market, the motivation behind hybrids is more about capital flexibility and private equity financing strategies than a lack of origination capacity. Larger borrowers tend to move between the two financing channels depending on M&A plans, spreads and performance.
“A lot of people experience friction when you lose BSL assets to private credit and vice versa,” a source familiar with the market told Creditflux. “You’re going to see more and more of those borrowers go back and forth between the two markets over time. The hybrid makes a lot of sense when those assets can just stay in that CLO without having to move from a PC CLO to a BSL CLO.”
Balancing the portfolio
In the first hybrid to appear, the Sona Aclai CLO I, the day one split was around 70% for syndicated loans and 30% for private credit, with the option to adjust the proportions over time.
Palmer Square has had its hybrid warehouse open for more than a year, according to a source familiar with the situation, meaning activity was underway before the talk of European issuances began to swirl at the start of the summer. At present, only Palmer
Square has confirmed plans for a stateside hybrid, but the market is anticipating more US launches as well as European deals.
“On hybrids, investor interest appears to be growing, particularly as managers explore ways to combine the benefits of BSL and PC CLOs,” said Gabriele Gramazio, a managing director in KBRA’s structured credit ratings group.
Interest gathers momentum
After the Sona vehicle debuted, even European managers who had never considered such structures before began to make inquiries, said Gramazio. “Most of these discussions are still at an early stage, so it is difficult to put a number on next year’s pipeline. However, we certainly expect more managers to explore hybrid CLOs over the next couple of years,” he said. Although excitement is growing, at the time of writing only one blended CLO has made it from the drawing board to the marketplace.
Andrea Fernandez, partner and COO of European direct lending at Ares, says there seems to be very strong investor demand both for private credit CLOs and hybrid deals but warned that at this stage it is mostly just talk around the latter.
Meanwhile, Morris says the deals priced in Europe suggest there’s demand for rated debt in this market.
Fernandez adds: “Only time will tell, and while there’s much speculation around deals of that nature, we need to see if they come to fruition.”
