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Analysis CLOs
The middle market goes mainstream
by Lisa Lee & Tom Davidson
Middle market CLOs were a niche product until private credit began to boom. Now we call them private credit CLOs — and they have taken a greater market share than BSL CLOs
Private credit is one of the hottest plays on Wall Street. It attracts billions of investor capital and headlines across the press. That’s fuelling a boom in the CLOs that repackage direct loans, transforming a previously esoteric part of the securitisation market.
Call them what you will — private credit CLOs or middle market CLOs — these deals are on fire. By the start of October, total issuance had already surpassed the record set for the entire year in 2021. New deals are running 45% ahead of the same period last year. Most notably, private credit CLOs are commanding an ever-bigger share of the outstanding market (see chart 3 below), according to Creditflux data.
1: US MM CLO issuance ($bn)
Source: Creditflux
Predicting the arrival of new managers
“Private credit funds have raised the equity, and once that gets deployed, financing via CLOs will certainly be a critical component to everyone’s strategy,” says Alan George, head of structured products at Golub Capital. “I don’t think it’s going to slow down, especially given the new funds and new managers... are just getting started.”
Indeed, 2024 has seen a couple of fresh faces entering the space. Asset managers Comvest and Willow Tree both made their debuts as CLO managers, with Comvest quickly following up a July print with a second one a few months later.
The dynamic underpinning private credit CLOs has been the rise of private credit, which went from an under-the-radar strategy to a USD 1.7tn market, rivalling the size of the high-yield bond market in only a few years. Rather than move to the rhythm of the overall CLO market, private credit CLOs are tied to the fate of private credit. As a case in point, private credit CLO issuance recovered almost a year earlier than BSL CLOs, which lagged for most of 2023. And as private credit has become better known, private credit CLOs have become better known, too.
I expect to see more arb private credit CLOs
Seth Painter
Head of structured product
Antares
“People are understanding the product better versus 2005 and 2006 when I started doing this. Then, it was very esoteric, very niche,” says Derek Dubois, treasurer at Deerpath Capital Management.
Private credit CLOs aren’t attracting many brand new investors to CLOs. Most private credit CLO investors are those which have invested in BSL CLOs — those already familiar with these securitised structures and the broader market. But increasingly, investors are becoming comfortable with CLOs that repackage illiquid direct loans and offer a yield premium to BSL deals. Japanese banks, for example, are buying more triple A notes from private credit CLOs, according to sources familiar with the matter. And when Wells Fargo returned to purchasing triple As, it bought from private credit.
The popularity has hurt investors. The illiquidity premium to the BSL CLO market has winnowed down to about 25bps to 30bps — from 75bps earlier in the year.
2: New issue CLO AAA spreads (bps)
Source: Creditflux
Private credit CLOs as financing
For managers, the incentive to get into the private credit CLO business differs vastly from the plain-vanilla BSL type that still dominates some 80% of total CLO issuance. Rather than aiming to grow AUM and cull fees, as in the BSL space, private credit shops are using CLOs mainly as a form of financing. They are an alternative to issuing expensive bonds in the capital markets or borrowing expensive debt from banks.
But that is starting to change. While still a small part of the market, an increasing number of private credit CLOs are gaining third-party equity, turning them into arbitrage vehicles. “You are seeing more CLO managers raise third-party private credit CLOs,” says Seth Painter, head of structured product at Antares. “I expect to see more arb private credit CLOs. Right now it’s probably below 10% of private credit CLO issuance, but that’s going to change.”
3: US CLO market share by principal liabilities outstanding
Source: Creditflux
A surface change that perhaps points to a more existential transformation is the name shift from middle market CLOs to private credit CLOs. The underlying direct loans are undergoing a shift too. There are now CLOs that repackage loans made to smaller companies, others that focus on the traditional middle market, and also some formed from portions of the multi-billion dollar loans made to companies that previously would have tapped the leveraged loan market.
“Among private credit CLOs, there’s differences in the size of the borrowers. Some are lower middle market focused, others focus on the core middle market like us, and there’s the upper middle market. Everyone has their own swim lane,” says Kelli Marti, head of CLOs at Churchill Asset Management.
*Based on YTD CLO issuance as of 30-Sep-2024
