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Manager tiering reaches Europe as credit dispersion rises in mezzanine credit
by Shant Fabricatorian
Long a fixture of the US market, tiering has not played a significant role in Europe, as the differences in spreads between top-performing and lower-ranked managers have typically been modest. But there is growing evidence of differentiation starting to emerge between managers, especially at the lower end of the capital stack.
At the triple B level, for example, the difference between tier 1 managers and lower-ranked ones can now be in the region of 50 basis points. In May, spreads on new-issue triple B notes ranged from 330bps over Euribor for Redding Ridge’s RRE 19, to 450bps over Euribor for Barings’ Euro CLO 2024-1.
“This is significantly more than before. It’s telling us that investors expect a [credit] cycle,” said Bhavin Patel, CIO of Redding Ridge Asset Management Europe.
According to Patel, the shift away from zero interest rate policy has been crucial in bringing about this change. “In a zero interest rate environment, where everything is a home run, investors were comfortable buying liabilities, as everything performed,” he said. “Over the past few years, we’ve seen significant losses and credit mistakes in the market, and mezz dispersion is a real sign that investors are voting winners and losers with their wallets.”
We’ve seen significant losses and credit mistakes
Bhavin Patel
CIO
Redding Ridge Europe
Altice was a wake-up call for investors. Most CLO managers were caught off-guard and at least 90% of European CLOs held some debt from Patrick Drahi’s troubled telecoms outfit. At this year’s Global ABS conference in Barcelona, worries were mostly focused around such idiosyncratic risks.
Nonetheless, European credit dispersion remains an emergent trend, with the levels on display not nearly as marked as in the US. “I would say it’s a new phenomenon, but the breadth of that tiering is not as much as you would see in the US,” said Karan Chabba, head of RCR/specialty finance at Eagle Point Credit.
While triple B tranches have historically performed well, and are unlikely to default unless there’s a serious economic downturn, they remain vulnerable to downgrade risk. Tranches lower down the mezz stack could be hit by high defaults and low recoveries.
“In this market, I’m not surprised at all to see more dispersion between mezz pieces than you would see between triple A pieces,” said Michael Schewitz, a portfolio manager at Investec.
Redding Ridge’s Patel is confident the current movement is the start of a trend. “We may not see a big wave of defaults, but we expect dispersion in individual credit performance to continue, which means credit selection and active management will be key,” he said.
