(Bloomberg) — There’s a part of the global credit market defying war, inflation and recessionary fears to forge a new record for mergers and acquisitions. And its dealmakers don’t seem done yet.
The buying frenzy is over collateralized loan obligations, the $1 trillion market that purchases leveraged loans and repackages them into bonds of varying risks. Carlyle Group Inc. nabbed Todd Boehly’s CBAM Partners last month to become the biggest manager of CLOs, while Blue Owl Capital Inc. purchased Wellfleet Credit Partners in April to jump start an entry into the space.
The past few weeks have seen no fewer than five acquisitions of U.S. alternative credit shops that specialize in CLOs or bundles of the securitized vehicles. That’s the most ever by this time in the calendar and rivals the record for an entire full year since at least 2010, according to Citigroup Inc. research. Europe is joining the trend with two mergers so far.
“Bigger is better for CLOs. Scale matters,” said Mark Jenkins, head of global credit at Carlyle.
The record-setting deal pace would be impressive in any environment. But it stands in sharp contrast to the rest of the landscape for M&A, which has seen a dip of more than 9% this year as heightened volatility and growing uncertainty mute activity worldwide.
The flurry to grab CLOs shows how popular the higher yields seen in alternative credit investing have become. There’s an imperative for money managers to get bigger and provide more offerings, particularly floating-rate ones as the Federal Reserve and other central banks gear up for what’s expected to be the sharpest rate-hike cycle in decades.
Leveraged loans and CLOs pay a fixed spread over a benchmark rate, and are thus one of the few financial investments of size that provide some measure of protection against rising rates.
“The broad driver has been the consolidation in the alternative credit space,” said Jim O’Brien, CEO of Napier Park Global Capital, which recently announced a sale to First Eagle Investment Management. “It’s driven by both institutional investors looking more aggressively to invest in higher yielding alternative credit products and retail investors coming into the alternative credit space.”
The M&A wave may just be getting started. Potential sellers may be eyeing a lucrative cash-out or the comfort of being part of bigger outfits.
Among the hopeful buyers, credit shop Investcorp has been vocal about its desire to purchase a CLO manager and was among the suitors for CBAM. BNY Credit has put out the for-sale sign on its credit investment arm Alcentra, which has drawn interest from the likes of private equity behemoth KKR & Co, Bloomberg has reported.
“We expect to see more CLO manager consolidation on a global scale,” said Citigroup’s analysts in a recent report led by Maggie Wang, citing intense competition as a factor.
The deals appear to be coming with lofty price tags. Carlyle agreed to buy CBAM for $787 million, a rich valuation of roughly 13 times a measure of fee earnings, according to a person familiar with the matter, who asked not be named as they aren’t authorized to speak publicly.
For some like Blue Owl, the strategy is simply getting into the game. The private credit specialists had no presence in what’s called broadly syndicated loan CLOs, those that purchase loans and churn out bonds, a market that’s doubled in size since 2015. Rather than build in-house, M&A allowed them to ramp up quickly, according to Jerry Devito, managing director at Blue Owl.
Growth is important for CLOs since managers that increase assets tend to do better than peers in both debt and equity performance, said Citigroup’s Wang.
Even for those managers that are briskly expanding their footprint, such growth can come with formidable expenses. The prospect of borrowing to grow fueled Napier’s decision to sell itself, according to the firm’s CEO O’Brien.
“At some point we were going to have to broaden our distribution and product base to remain competitive,” said O’Brien. “It became clear in our two- to three-year view, that we were going to have to borrow to grow or be part of an acquisition that made sense for Napier Park and our investors.”
But some investors worry that bigger might not necessarily be better. When managers who performed well are bypassed for better recognized brands, that distorts the market. And those with massive holdings may not be as as selective when buying assets, the argument goes.
“I expect more mergers,” said Andrew Lennox, senior portfolio manager at Federated Hermes, who invests in CLOs. “They need scale to have relationship with banks and to get allocations. But we are careful to filter out managers that are so big that they just buy the leveraged loan market. Scale isn’t the be all and end all for selecting CLO managers.”
These deals can come with more than just CLOs. Napier also has substantial presence in opportunistic credit and investments such as equipment leasing. Equitable Holdings’ subsidiary AllianceBernstein will get CarVal Investors’ CLOs along with a hefty portfolio of private credit assets ranging from distressed debt, emerging market positions, and real assets like airplanes, ships and gas rights — and it also broadens its geographic reach outside the U.S.
For CarVal, it also benefits by getting access to a lower cost of capital and the ability to keep more assets rather than have to sell them off, said Lucas Detor, the firm’s managing principal.
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