Private Credit CLOs Luring Top Investors Set to Reshape Market

(Bloomberg) — Some of the biggest buyers in the $1.3 trillion CLO market are piling into securitizations stuffed full of private debt, propelling a transformation in the asset class that industry observers say is only poised to accelerate.

Already investors including Japan’s Norinchukin Bank, one of the world’s biggest buyers of collateralized loan obligations, and NatWest Group Plc are scooping up so-called private credit CLOs, according to people with knowledge of the matter. More new entrants are expected to follow suit. That’s a significant change from just a few years ago, when limited visibility into underlying borrowers and a lack of secondary-market liquidity scared off all but the most specialized money managers.

It’s yet another example of how the shift from public to private markets is reshaping the world of credit investing. With direct lenders continuing to grab market share as banks scale back risky financings, there’s simply more debt for them to bundle into chunks of varying risk and return to create CLOs, and fewer leveraged loans for conventional structures. These private credit securitizations have accounted for roughly 20% of total market issuance this year, compared to just above 10% historically, Bloomberg data show.

“We anticipate that private credit CLOs could comprise up to 50% of our financing structures over the next few years,” said Mike Boyle, a portfolio manager at Bain Capital. “Private credit growth is faster than leveraged loan market growth.”

A representative for Norinchukin Bank said the firm wouldn’t comment on specific deals. A spokesperson for NatWest declined to comment.

Direct lenders say they’re turning to the CLO market for myriad reasons. Many need access to more financing as they seek to ramp up lending amid surging demand.

In addition, the cost of capital is now often cheaper than alternative sources of funding, including banks and the unsecured bond market, industry insiders say.

“Direct lenders are seeking diversification of their financing sources and are able to access the capital markets via private credit CLOs in addition to the more traditional, capacity constrained bank financing” said Jane Lee, global head of capital formation for liquid credit strategies at Blackstone Inc.

What’s more, as private lending surges, shops that previously didn’t have sufficiently large loan portfolios or enough sector diversification to attract investor interest are now able to get deals done. In Europe, where there’s been virtually no issuance of private credit CLOs, at least three firms are looking to come to market, Bloomberg previously reported.

Meanwhile, investors are being lured by premiums of as much as 200 basis points versus garden-variety CLOs, in part due to reduced liquidity.

Private credit loans also tend to carry more safeguards — known as covenants — than broadly-syndicated loans, where investors have recently started to push back against some of the riskiest financings.

“The loans are less transparent in a private credit CLO, but there are fewer covenant-lite loans than in a broadly-syndicated loan” securitization, said Michael Schewitz, a money manager at Investec who invests in private credit CLOs.

Moreover, he added, “when a loan is distressed, private credit CLO managers are more willing to work out the problems.”

Some money managers nonetheless remain wary. They cite the difficulty conducting due diligence on the companies and collateral in private credit CLOs, and note that the lack of liquidity both in the securitizations and the underlying loans could saddle investors with steeper losses than traditional structures should credit conditions sour.

Even if demand continues to pick up pace, it will take time for newer lenders seeking to raise financing via the CLO market to securitize their portfolios.

“We took three years to build scale and diversity, with good quality loans,” said Derek Dubois of private lender Deerpath Capital Management, which issued its first CLO in 2018.

The firm has since become a regular issuer, issuing a new CLO earlier this year and recently completing a reset transaction.

Still, many see the continued growth of private credit CLOs as all but inevitable.

Issuance has more than doubled in 2023 compared to the same period last year, even as offerings of traditional CLOs plunged 37%, S&P Global Ratings data show.

“There’s been a secular shift in the loan market where private credit is taking market share from the syndicated market,” said Seth Painter, head of structured products at Antares Capital, an issuer of private credit CLOs. “You’ll continue to see more issuance.”