#21, Brian Nolan, Head of European CLO Structuring, PGIM

Brian Nolan, Head of European CLO Structuring at PGIM, joins The CLO Investor podcast to discuss European CLOs and how they differ from US CLOs. 

Episode Transcript

(00:06):
Hi, I am Shiloh Bates and welcometo the CLO Investor Podcast.
CLO stands for collateralizedloan obligations,
which are securities backed by poolsof leveraged loans. In this podcast,
we discuss current news and the CLOindustry and I interview key market
players. Today I'm speaking withBrian Nolan, head of European CLO,

(00:28):
structuring at PGIM.
This spring I saw Brian present at theCreditFlux conference in London and
thought he'd be a good guest to have onto discuss European CLOs and how they're
different from U.S. CLOs. AtFlat Rock, we invest in US CLOs,
so this podcast was alearning experience for me.
If you're enjoying the podcast, pleaseremember to share like and follow.

(00:51):
And now my conversation with Brian Nolan.
Brian, thanks for coming on the podcast.
Thanks so much for havingme. It's a pleasure.
So, why don't we start off with yourorigin story and how you ended up in the
European CLO market?
So, I went to school in Ireland whereI'm from and I moved to London in 2010.

(01:14):
So,
my first three years is not worth speakingabout because it wasn't CLO related,
but that was in Bank of Ireland andthen I moved to Fitch Ratings. So,
my background before I joinedPGIM is in rating agencies.
I spent two and a half yearsat Fitch in the CLO team,
two and a half years ins and p in the CLO team.
And now I've been at PGIM for aboutseven years in the structuring team here.

(01:36):
And what's one thing that youfind interesting about CLOs?
So, I think my original three yearsI was in corporate banking type role
and I think what some peoplemight find interesting,
but what frustrated me was thedifficulty in finding information. So,
you spend so much of your time onvarious websites trying to get reports.

(01:57):
The thing that I loved about CLOs,and this is probably a boring answer,
is you have such a complete setof data that you can interpret
and use and whether that's in the ratingagencies when you're trying to stress a
portfolio or when you're structuringa portfolio on the issuer side,
I just get a lot of comfort from havinga lot of certainty in the numbers that
we're using.

(02:18):
Okay.

(02:52):
So, at PGIM,
is your role more structuringCLOs or are you also
playing a role in the loansthat go into these vehicles?
Predominantly it's onthe structuring side. So,
we're one of the biggest CLO managersboth in Europe and the US and with that
comes quite frequent access to themarket. So, whether it's resets,

(03:13):
refis or new issues. So,
my team is responsible for structuringthe cadence of those deals and when
they're going to market and being asefficient as possible in terms of getting
in and out of the market. Thenwhen the transaction starts,
we're responsible for making sure thebank is doing a good structuring job and
then a lot of the back and forth withinvestors on the CLO documents. So,

(03:34):
we have full-time analysts that do that.
I think the thinking being that becauseof the volume expecting the portfolio
managers to do that on top of theirday job is probably stretching them too
thin. So,
it's very much making sure the structuresmake sense for the platform and then
keeping the machine consistently going.
Okay. So,
are you working on structuringdeals in the US and Europe or

(03:57):
just Europe?
No, I personally work just in Europe. So,
we have an equivalent team in the US thatwould do it for our US deals and we're
in constant communication to understandthe differences between the markets and
usually it's the way that the US innovatesin something first and then they're
explaining it to me so that we cantry and do it in Europe as well.
But occasionally maybeit goes the other way.

(04:19):
As a CLO manager, how doesPGIM differentiate itself?
I'm sure most people haveinteresting answers to this.
I think certainly the first one is quitea difference between Europe and the US.
So,
in Europe PGIM manages loans and bondsfrom the same team out of our portfolio
management team. So,
if you look at our CLOs versus someof our competitors here in Europe,

(04:41):
you will see a much larger proportionof fixed rate bonds in our deals versus
others. So,
I think that's probably the most obviousdifference between US and others in
Europe. In the US that's less soI think up until a few years ago,
Volker restricted any bonds at all goinginto the CLOs and I think even now most
managers just have a small 5% bucket,

(05:02):
so it's less of a thing in the US butin Europe that's a big distinguishing
factor. I would say generally,
and this applies to both sides is we'vegot a very active management style,
so we would have a high churnrate. We have deep resources. So,
I think across the US and Europewe've got 35 credit analysts and 15
people on the desk between portfoliomanagement and traders. So,

(05:24):
that is to allow us to analyzethings quickly, take a view quickly,
and churn the portfolio -mostly through primary. So,
replacing assets that areless good relative value with the primary assets that
come in. So,
I think that is something we would sayover and above what most people do in our
DNA.
So, how big is the European CLO market?

(05:45):
I don't have the number in front of me,
but I think it's about a quarter to athird of the size of the US market. So,
it's materially smaller.
I think it's really since2013 when 2.0s started going.
I can tell you a busy year for us inEurope is maybe 9 or 10 deals in a year
where our US colleagues are inthe twenties and thirties number.
So, that'd be about 300billion or so euros I guess.

(06:09):
Yes.
And then in Europe,
are CLO securities onlydenominated in euros or are there
other currencies that youguys are dealing with?
The vast majority is in euros.
Within the CLOs or you meanthe liability structure?
I'll take both.
So within the CLOs we have a constructhere in Europe called a perfect asset

(06:31):
swap,
which is a derivative that you signwith one or two banks that offer it here
where it basically hedges your FX andis also linked to the underlying assets
such that if the assetprepays you or if it defaults,
the swap is linked to that so you don'tend up with a big mark to market payment
that you need to make.
Interesting.
It is, it's quite bespoke, which makesit quite expensive. So, for instance,

(06:53):
you could have a sterling asset that paysyou 500 over and the cost of the swap
might be a hundred or 150 basis pointsof that. So, the actual real term,
what you're comparingit to on the Euro side,
it has to be something compelling forit to make sense for the costs that's
involved. So,
I would say in Europe I suspectif you looked originally back in

(07:14):
2013, 14 when the loanmarket was much smaller,
you probably did have some of thishappening as people were stretching to get
diversity. As the Europeanmarket has matured,
I think you have a lot more options inEuro loans now that it would be a small
minority of managers that still usethat flexibility. On the liability side,
it's interesting because the vastmajority of CLOs are issued in Euro.

(07:38):
We actually issued theonly GBP Sterling CLO,
so that was back probably aboutseven or eight years ago now.
That was just before Brexit.
It was a very distinctive trade andthat was called a couple of years ago,
so it doesn't exist anymore.
That's the only non-euro deals that I'maware of up until I think there was a

(07:59):
mid-market CLO that was donequite recently, which was GBP Sterling as well. So,
99% of it will be in euros.
How many CLO managersdo you have in Europe?
So,
this is an ever-increasing number as alot of US platforms are moving over to
Europe.
I think if you look at people that haveactively issued a deal in the last year
or two, you're probably talkingabout 50 to 60 managers.

(08:22):
If you actually look at everymanager that has a deal outstanding,
it's probably more like 70 80,
but a large chunk of those have notbeen active for a long time and I think
that's grown significantly.
You probably add high single digitsof managers over the last four or five
years. In terms of newentrants to the market.
Geographically, are most of the managersin London or spread around Europe?

(08:44):
The vast majority will be in London.You have three or four in Dublin,
in Ireland,
I'm aware of a couple inScandinavia and maybe one in Spain
and then a few France maybe. But I wouldsay probably 80% plus based in London.
So,
then talking about getting into the assetsin the European CLOs and how they're

(09:04):
different from the US,
the loans that go into CLOs oftenare created in leveraged buyouts.
Is the continent,
is Europe as friendly to privateequity activity as we are here in the
US?
I think that depends on whether you'relooking at creation or other things that
happen along the lines. So,
I think one thing Europe has - can beseen as a positive or a negative - you

(09:27):
have a lot of regional diversity,
so you have different domiciles butdifferent regulations and different laws.
So, I don't think anything could be asfriendly as the US because obviously it's
very uniform there and very businessfriendly that leads to potentially less
efficiency on the LBO side,
what it does potentially benefit you onthe other side of things is if things go

(09:49):
wrong,
what you can see is thedifferent regulatory regimes in Europe that are maybe
not as sponsor friendly as the US wouldbe do mean that you see things like less
LME activity,
you see a bit more of a relationshipbased interaction between sponsor and
CLO managers versus a transactional one,
which maybe you might see more in the US.

(10:09):
That's very much lookingfor the positives.
I mean up until the last few years whenLMEs started to come through in the US I
think in Europe there wasa lot of frustration with how long things took and the
various hoops you had to jumpthrough in various jurisdictions.
So, in a European CLO,
is it easy to come up with enoughunderlying loans so that you

(10:29):
have the diversity that the CLO requires?
Ultimately I think that is becoming moredifficult as the years go by and more
managers come to the market.So, LBO activity in Europe,
since the interest rate spikesin '22 has really slowed down,
whereas issuance on the CLOside has not really. So,
you're definitely seeing significantdemand for loans where the supply is not

(10:52):
necessarily coming through on LBOs. So,
I think you definitely can struggle todo it in a fast way and I think a good
example of this is maybe printand sprint transactions. So,
I think these happen quite frequentlyin the US and I know obviously the most
about our platform versusour US colleagues and how easy it can be for them to
do a print and sprinttransaction. Whereas in Europe,

(11:15):
while there have beensome done, and we did one,
our original deal in the 2.0era was a print and sprint,
it definitely is more difficult toget that many assets very quickly.
So,
the print and sprint in case people don'tknow is just a CLO is forming without
really any assets in a warehouse or avery small warehouse if there is one and
the CLOs come into life and all theassets are just being bought in the

(11:38):
secondary market.
Yes, in a very short period of time.
Whereas I think the typical warehousingperiod here in Europe is you generally
ramp up those assets over a three to sixmonth period before you issue the CLO.
And to your point around diversity,
I guess this is one keydifference between the markets,
so defining what's an acceptable levelof diversity is quite different between
the European and the US markets. So,

(12:01):
I think your typical US transaction isgoing to have somewhere between 250 to
350 individual obligors,
whereas a European dealis probably half of that.
And I think that's a function of thesmaller market and I would say that
diversity amount hasincreased in Europe over time.
If you go back to whenthe market opened in 2013,

(12:21):
it would not be uncommon to see lessthan a hundred obligors in a portfolio,
whereas now it's probablyaround the 150 number.
Does that tie to your earlier commentabout putting bonds in your portfolios
that it's easier to get the diversityyou need if you're also looking at senior
secured bonds?
That was absolutely one of the key driverswhen we originally issued our first
European CLO 2.0. So, I thinkas the loan market has matured,

(12:45):
it's become less necessary,
but we still think that your top 10 bondideas are going to be better than your
worst 10 loan ideas. So even though itmight not change the number of obligor,
it should give you access toa better quality of obligor.
So, the base rate inyour market is euribor,
am I pronouncing it correctly?
Correct.

(13:06):
So,
the loans are floating on euriborand are they paying 300 over
in the US?
No. Typically if you look backon the long-term averages,
I would say the European market generallyis at a premium to on a spread basis.
A portfolio today is probablysomewhere between 340 and
380 depending on the style of the manager.

(13:28):
Whereas I think in the US asyou said, it's closer to 300.
And So,
what accounts for that premiumover the US does that reflect
liquidity or potentially higherloan losses that you need to be
compensated for?
I think primarily it's driven by CLOs. So,
in Europe the CLO buyer is inexcess of 80% of the loan market,

(13:51):
so we wouldn't have the alternativesto CLOs that the US would have.
And on the other side of the equation,
CLO liabilities generally priceat a premium to the US. So,
in order for the arbitrage to work,
the CLOs aren't floored at a certainlevel and because they make up so much of
the market that technical can sometimesput a floor on where spreads can go

(14:12):
until liabilities comein tighter. Equally,
you could argue the loan market isdefinitely less liquid in Europe we would
still consider it a liquid market, butit wouldn't be the same as the US. So,
you could also imply that there is someilliquidity premium there versus the
European equivalents.
So, then SOFR,
the secured overnight financing rateis the base rate for US CLOs. So,

(14:35):
that's roughly four and aquarter. Where's euribor?
I know that's been coming down.Where does that sit today?
Probably date myself here. Ihaven't checked it recently.
It's somewhere in the two anda half percent area, I think.
Two and a half. So, theECB has been cutting.
Yeah, I don't think wentas high as you guys,
but then we've been cutting as well.
So, then the underlyingloans geographically,

(14:56):
is it mostly the UK, Germany, France,
and maybe Spain or what'sthe country mix there?
I mean the ones you'venamed are generally the top.
I would say the largest countrieswould probably be still below 20%. So,
it would have a regionaldiversity there, the UK,
France and Germany would be the largest.Then you would have Spanish, Italian,

(15:18):
Scandinavians as well as somemore peripheral countries. So,
that is one thing I think a US CLOwill have more obligor diversity,
but a European CLO will have thatregional diversity where you do have some
diversity benefits from havingexposure to multiple geographies.
So,
in the US I think that investorsin CLO equity for example are

(15:40):
assuming a loan loss reserve,
which is a 2% default rateand a 70 cent recovery rate in
prior podcasts.
I've talked about that being maybe alittle bit antiquated or a little bit too
beneficial for the CLO equity investor.
How do those compare to what's happenedin Europe and what investors should
expect maybe going forward?

(16:01):
See, I think the one thing we always sayin relation to this is that A CLO is an
actively managed portfolio. So,
when we look back acrossall of our portfolios over the last 10 years we've done
this analysis and the vast majority ofour deals actually have a positive annual
trading. So, when you take awaythe losses versus the positives,
depending on certainvintages for instance,

(16:23):
if you go out of reinvestment period justbefore there's a downturn and you lose
the flexibility, those vintagescan be the most difficult.
But I would say theheadline numbers in Europe,
the default rate has been materiallybelow that over the course of the 10 year
average. Obviously that will differyear to year and the recovery rate is,
again, this is very idiosyncratic becauseyou're going to have one that's 20 and

(16:45):
another one that's a hundred. I thinkthe average is in the 60 to 70 range
across those defaults that have happened.
So I think the recovery rate is 1- Obviously as the market has gone
cov-lite,
there was a lot of discussion aroundwhether recoveries were going to be later
or worse than long-term averages.
I don't think there's been enough defaultsin Europe ready to get a meaningful

(17:07):
amount of data on that,
but what we have seen so far isobviously on a case by case it can be
wildly different, but if you look atthe average across a bigger data set,
we don't see a huge differencein the long-term average.
So, are the assets leveraged on assetsfour and a half to five and a half
times EBITDA with interestcoverage around three times?

(17:28):
That depends on whose numbers youuse. If you use the company numbers,
that probably sounds about right.I think it differs per industry,
but I think certainly on our numbers weobviously do our own internal forecasts
and look at add backs and what onesare realistic In terms of one-offs,
we would see it probablyslightly ahead of that.
I don't work on the portfoliomanagement side of the team,

(17:49):
I wouldn't be as close tothat data as those guys would.
I think your numbers sound like companyprojections in line with what we're
typically seeing.
Is the reinvestment period in Europe,is it typically five years like the US?
I would say the average isprobably four and a half.
And I would say five years agoit was probably four years. So,
it's slowly migrating and we have seendeals that have done at five as well,

(18:11):
but my understanding of the US marketis it's much more standard to be five in
most deals.
And so what's a good AAA spreadover euribor if you're issuing a
deal today?
So,
today I think the Europeanmarket is potentially starting to distinguish between
new issue and reset andalso between managers. So,
I know you've seen tiering in the USmarket for a long time and I think it's

(18:34):
probably a sign of the European marketmaturing more that we're starting to see
that.
I would say for a new issue deal todayyou're probably looking at 130 or low
130s. For a reset, you're probablylooking at mid 130s and then yeah,
you could see certain deals in thehigh 130s depending on if it's a reset,
the quality of the portfolio andthe manager and things like that.

(18:55):
So,
the spread for European AAAs is prettycomparable to what you find in the US
then.
Today? I think so, yes. I thinkthat has diverged over time,
but as of today it'sactually remarkably close.
So, then for the equity tranche,
is that much more profitable in Europegiven the numbers you went through?
I mean if the AAA financing cost isthe same as the US but the spread is

(19:20):
50 to 80 bips more on the assets,
that should be pretty lucrativefor the equity tranche?
Yes,
so I think down the structure you probablyare a little bit wider in Europe. So,
when you're looking atthe weighted average cost,
you should be wider in Europethan you would be in the US.
But we've done some analysis lookingback since 2018 we've done the high

(19:40):
level arbitrage calculation,
which is the spread on the assets minusthe cost of debt times the leverage.
We would typically see Europebeing somewhere between, and this is proportional,
not eight points higher, butabout 8%. So, if it's 15% in US,
the equivalent would beabout 16 or 17 in Europe. So,
I think it's generallylooked a little bit higher.

(20:00):
The other thing in Europe is we issuea single B tranche in almost every
transaction, whereas I thinkthat's quite rare in the US.
It is, yeah.
Which means you get more leverage, butobviously it's more expensive leverage,
but overall in Europe it'sacreative to the returns.
So, at Flat Rock we also invest in BBs.
What's the spread overeuribor for BB these days?

(20:24):
So, the spread, I think it'sprobably in the low 600s right now.
I think that can be a bit volatile permanager and I think it's demand and
supply and technicals can havea big impact on that market.
If you have a lot of dealsall come at the same time,
that can suddenly blow outto 650, 700 pretty quickly.
And equally in a very strongmarket it could be as tight as 500,

(20:46):
but I think in today's market you'reprobably looking at high five hundreds,
low six hundreds.
Then does the lack of diversitywhen compared to the US,
does that mean that the CLO needssome additional equity capital
to support the BB?
Yes. For instance, AAA,
your typical subordination in theUS is somewhere between 35 and 36%.

(21:09):
The equivalent in Europe wouldbe more like 38 to 39%. So,
you are going to have less leverage acrossyour structure if you just go down to
BBs, you will have to issuemore equity in Europe.
But typically what happens isthey issue single Bs as well. So,
actually if you look for thesame size deal in Europe,
you would generally havea smaller equity ticket,

(21:30):
but because you're gettingless efficient leverage,
you're going to have a more expensiveleverage than you would in the us.
So, what are the economicsthen of the single B?
The single B can be volatile. So,
right now it's probably higheight hundreds, low nine hundreds,
DM probably at a price of 98 or 97.
And then once you issuethe BB and the single B,

(21:51):
how much equity is left in the deal?
Is it 7% or 6% or something?
So the enhancement on thejunior note is 6.5%. So,
for say a 400 million transactionyou could do 30 million or
31 million of equity.
And then is the equity in Europe,
is it typically bought bythird parties like a Flat Rock,

(22:13):
or is the manager putting theCLO equity into their own funds?
So, this has evolved considerably overthe last four or five years I would say.
So,
PGIM is now one of the minority ofCLO managers that is 100% third party
equity. So, in our transactions,95% is sold to third parties.
I think if you look at therest of the top 10 managers,

(22:35):
they all have captive equity funds. So,
it's effectively the managers managingthat money instead of each individual
deal having an individual third party.
If I was to talk aboutpercentages of the market,
it's not all published anywhere,
but I think you're probably out of the50 managers that are currently active,
you're probably talking somewhere betweenfive and 10 of them are third party

(22:56):
equity guys. The rest would be captivefund guys and I would say five,
six years ago that wasprobably closer to 60/40.
So, then are people investingin Euro CLO securities?
I mean these are investors thattheir assets are in euros as well,
or do you think people are like myself,

(23:17):
I'm a US dollar funder if you will,so people give me their US dollars,
they want to return in dollars.
Are you seeing people like me comeacross the pond looking at European
CLOs and just maybe taking thecurrency risk or trying to hedge it?
Or are these more Europeanasset managers who
already fund in euros and the riskreturn of CLO equity or BBs or up

(23:40):
the stack?
See, I would say certainlyon the equity tranche,
if look at our equity investors,
you're pretty close to 50/50 I wouldsay between the US and Europe. So,
we do have a lot of US investors thatrelative value between the US and the
European market at any given timeand any hedging that they're doing is
happening away from the CLO. So,I don't see what that looks like,

(24:03):
but presumably they are hedging itsomehow. And I think similar to the US,
I mean when you go into the debt of thestructure, certainly on the AAA level,
a large portion is coming outof Asia, in particular Japan,
but you would have someUS banks there as well.
So, the AAA through maybe singleA that comes out of Japan.
I mean those are banks that arebuying Euro CLOs and then they have

(24:27):
some hedging program that convertsthose euros back to yen at some point.
Yes. So, these are quite establishedbuyers. They're buying big size. So,
I think this happensbetween the bank and them,
so we're not party toexactly what it looks like,
but that would all be100% hedged on their side.
I think it's a lot easier to hedge AAAswhere you know the cash flows versus

(24:49):
equity, which can be a lot more variable.
Then if somebody is doing relative value,
let's just stay with equity for a secondamongst the two different markets,
I guess it's easy to run your scenariosthrough Intex and presumably the US
CLO equity tranche and a European wouldspit out different projected IRRs.
Would in general that potential investor,

(25:12):
would they see the European collateralpool as a more safe and stable one?
I think that's changed over time.
I would say historically US poolswere always viewed as lower risk and
more diversified and better quality,
especially with the LMEactivity we're seeing in the US.
I think a lot of people are startingto question that. Additionally,

(25:32):
I mean certainly the course of this year,
I was just at the global ABS conferencein Barcelona where we met a lot of
international investors and there'sdefinitely a tone of people that were
historically all in on US maybe thinkingthat diversity away from the US is
maybe the thing to do right now. So,
I think that historically it's alwaysbeen viewed the US is the superior market

(25:55):
and you don't get many Europeaninvestors that don't do US,
but you get a lot of USinvestors that don't do Europe.
But I think there may be a bit of achange given the recent macro events.
So, if somebody were to begininvesting in European CLO
securities, my understanding of themarket is that it's pretty clubby.
Whereas in the US CLO market,

(26:17):
it's a lot of people with sharp elbowsI think and relationships matter,
but the economics of trades is reallythe key driver. Is it possible,
I guess people are doing it,
but you see a lot of investors come overthere and have success in navigating
a market that's more relationship based?
I think so,
and I think you probably distinguishat this point between taking majority

(26:40):
equity and being involved in the warehouseversus when the deal is brought to
market and maybe a minorityis sold at that point.
I think the relationship aspect in Europeis huge in terms of deciding to do a
transaction together and being involvedright from the warehouse stage through
to the CLO.
Where it gets maybe a bitmore transactional is if you want to sell some equity

(27:01):
at the time of your CLO pricing,
I think runs will be sent out to everyoneand everyone will put their bids in.
That will be a lot more transactional. So,
I haven't been involved in the USmarket to know if that follows the same
dynamics, but I think in Europe, andI think this is what most people do,
it's you go to some of these conferencesand all of the managers are there,
and if you sit down with a managerand you express an interest in getting

(27:24):
involved in equity,
I think most of them will go out of theirway to help educate and get anyone up
the curve and explain to them how thingswork. And you probably do that with
multiple managers, so youdon't have a single guy,
but I don't think it's adifficult club to penetrate,
especially if most European managerswill have a US affiliate and if there's a
relationship existingon that side of things,

(27:45):
it obviously makes thingsa lot more easy as well.
But I think it's a fairly open communityand I think the problem certainly from
an equity perspective is the amount ofcaptive funds that are in the European
market means that with those funds,
minority equity is the only piece that'ssold and that is usually sold in the
transactional way on the day of pricing,
whereas the 95% third party guysis still very relationship based.

(28:09):
In the US we have around100 active managers,
and I think if you're willing toinvest in one of their warehouses,
be that equity andparticipate in the takeout,
I think it's probably not too hard tofind many who will take you up on that.
I would say that historically was thecase in Europe you had a big pipeline
and the successful managers generallyhad, and this is in European perspective,

(28:33):
quite a lot of warehouses,
but you might have three orfour open at a given time,
which is probably about ayear's worth of issuance. So,
getting in the pipeline wasgenerally a year in advance.
I would say with the amount of newentrance to the European market as well as
the amount of secondary or in minorityequity that's available at primary

(28:53):
from the retention fund type vehicles,
we've seen that lower down a bit becauseI think there's more supply than there
used to be, and I don't think the equitybase has materially increased. So,
I think it used to be, as youdescribe in Europe as well,
probably less so in thelast couple of years.
So,
one of the big changes to the US marketover the last two or three years is just

(29:16):
the rise of ETFs, theexchange traded funds,
where lots of retail investors now own CLO
securities. Is that somethingthat is beginning in Europe?
I think it's beginning. So,
I think we've got three or four thathave launched in the last year or so.
None of them to the scale ofwhat we've seen in the US yet.
I'm not an expert on theregulations behind it,

(29:38):
but my high level understanding isthe retail investor is a lot harder to
access in Europe,
whereas in the US you can go onto yourpersonal trading app and access a bunch
of these things. In Europe toget it to show up on your list,
you've got to qualify as acertain type of investor,
which means going out of your way toanswer some questions and get signed off.

(29:58):
So, I think the barriers toinvesting are a bit higher in Europe,
but I think if you look atgenerally how things go,
if it works in the US with a lag effect,it's likely to come to Europe as well.
We're just a little bit behind you guys.
Are there any other bigdifferences between European and US CLOs that we haven't
covered?
One thing that is present in EuropeanCLOs that is probably viewed as a negative

(30:22):
in US CLOs is maybe the ESG elements. So,
in European CLOs it's become fairlystandard to have an exclusion list in
your CLOs and you've got a lot ofEuropean managers and a lot of this is
coming from the European investorbase that is very ESG focused.
ESG is the inclusion of environmental,

(30:43):
social and governance factorsin investment decisions.
And a lot of managers are doing a lotof ESG work on their non-CLO funds. So,
you'll see a lot of managers including us,
will put additional ESG information intheir reports as well as having quite a
conclusive ESG exclusion list.
Okay, so ESG exclusion would,

(31:04):
so we're talking about dirty coal andwhat other industries can be excluded or
it would be commonly excluded?
You can have stuff likegambling, tobacco, alcohol,
anything. This can differa lot between transactions,
but I think in a typical Europeantransaction you probably have somewhere
between 20 and 30 exclusions andit would be a lot of the energy

(31:28):
ones, a lot to do withweapons and ammunition,
anything that someonesomewhere has thought that that could be viewed as an ESG
point. So, you probably have, I'mnot an expert on US documentation,
I think there are some exclusionsthat go into US documents,
but I think they existed for a long time.
I would say that it's significantly morecomprehensive in European transactions.

(31:49):
In the US I hear very little talk ofESG and I think it's partially because
of the difficulty inquantifying the criteria.
Any other key differences, Brian?
Maybe the risk retention as well. So,
obviously historically thiswas present in the US as well,
but I don't know how longago, seven, eight years ago,
it was repelled in the US so it's not athing anymore unless you have a manager

(32:13):
that wants to do it foraccessing European investors.
But obviously every deal in Europeis risk retention compliant,
which is a 5% co-investment inthe vehicle by the sponsor or the
originator,
which in the vast majorityof circumstances is the manager or a manager entity.
Or you can have some people use a thirdparty originator where I think it's a
skin in the game thing. So, to qualify,

(32:35):
you basically have to take underlyingrisk on the assets that are going into the
CLO. So I think you,depending on who you talk to,
I mean I think a lot of Europeanmanagers would say it's not needed,
but from an investor perspective,
I think it's probably only a good thingif the manager is required to put skin
in the game as well.You have two ways of solving for this,
which is either a vertical retentionwhere you take 5% of every tranche or you

(32:59):
take it horizontal,
which is you take 5% of the transactionsize in the equity tranche. So,
I think historically wecall them captive funds,
but most of them in Europe started outas retention funds where managers would
go out and raise enoughcapital to do the next seven,
eight deals and be the retention provider.
I think that's evolved a little bit inEurope that people are doing it over and

(33:20):
above just for retention purposes.But I think that's a key difference.
And again, this is maybea European perspective,
but I think when the managerhas a requirement to put 5% of the capital into the
structure,
it does maybe raise the barrier of entryin Europe from a manager perspective.
And also I guess over timethis may be compresses,
but I think historicallyEuropean management fees have been higher than the US

(33:43):
and I think generally what we've alwayssaid is that capital requirement is
potentially part of that as well,
that in order for it to be economicfor the manager to put 5% into every
transaction,
it does have that impact in terms ofthe hurdle rate on the fee side. So,
I think that the retention is quite abig difference and it probably has a
couple of knock-on effects.
So,
European risk retention is something Icome across quite a bit just because in

(34:06):
our US CLOs there is not the requirement,at least for broadly syndicated,
there is not the requirement for themanager to own the 5% vertical strip or
half the equity roughly. But whenyou're selling CLO securities,
there's a lot of investors in Europewho if you want to market the CLOs,
AAA or whatever to them, the CLO needsto be risk retention compliant. So,

(34:27):
even if you're not boundto those rules in the US,
the manager or some affiliatedvehicle needs to buy the CLO
securities so that you can gather upEuropean investors if you want to go that
route.
Yeah, I think you'll knowbetter than me, but anecdotally,
I think someone told me it's somewherearound the 1 in 10 transactions is risk
retention compliance in the US. Soyeah, obviously that's 100% in Europe.

(34:50):
I do a lot of middle market CLOs andthose are actually still on the European
standard. So,
there's still the risk retentioncapital is required here in the US.
As an investor, do you see that asa positive, negative or neutral.
If a manager, let's say they own a5% vertical strip, do I really care?
Not that much. I mean imagine,
so 65% of what they arecommitting to is AAA.

(35:14):
They're comfortable owningthe AAA in their own deal.
It's not a huge vote of confidence for me.
And then 5% of the equity andthe other more junior securities,
I think it's helpful. I meanI would take it if offered.
I think for a lot of CLOmanagement platforms,
they do a lot of deals and to putup 5% of the capital on each one,
I think that's really quitea burden on their platform.

(35:37):
I think probably the ultimate alignmentis we've been in some deals where the
CLO equity is also goinginto the personal PAs,
the personal accounts of theCLO managers so directly in,
and that is I think a verystrong alignment. Let's say a manager hasn't invested
in any of the CLO securities that I'min. So, what's the alignment? Well,

(35:58):
I think it's still pretty strong because1 - there's an incentive fee that could
be material for the managerif they really perform.
2 - CLO management is a competitivebusiness and if a CLO manager doesn't do a
great job with the assets, then they'regoing to struggle to find new investors.
So,
I don't think there's a risk that there'ssome orphan CLO at the manager where

(36:20):
they didn't invest in it and don'tprioritize it like the others.
I just don't see that as a risk.
No, I think a lot of CLO managerswould agree with you on that one.
Certainly from the capital requirementsof building a large platform point of
view.
How easy is it to get allocationsof new loans in Europe?
Relationships still play a key part.
I mean a typical loan that comes tomarket that is well liked by CLOs can be

(36:42):
quite easily six to seventimes oversubscribed. So,
the relationships do become a bigpart of it. And obviously, yeah,
the bigger you are, the moreimportant you are to the bank.
Typically that would leadto better allocations. So,
you could say that maybe the managersthat don't have those relationships are
potentially taking all the stuffthat the other guys don't want.

(37:02):
But I think even as oneof the biggest managers,
while we might get an oversizedallocation, we still on a deal like that,
it's not like you're getting anywhereclose to a hundred percent fill. So,
if you look at the amount of managersacross the market and the amount of assets
in their deals,
I think it's probably gotten a littlebetter than it used to be in terms of new
managers getting allocation andall the different term loans.

(37:24):
My time from banking,
all I know is A and B where A wasamortizing and B was a bullet.
And that's actually one difference Ithink actually with US and Europe that I
didn't cover is the USdeals will generally have a small amortization in them,
the underlying loans, whereasEurope is very much bullet.
So, you don't have the 1% amortization,it's just 0 amortization and.

(37:45):
Exactly.
You're due the principle at the end.
Speaking to our US guys. Obviously whena CLO goes post reinvestment period,
it becomes a bit more restrictive on whatyou can reinvest and the documents are
very prescriptive in terms of the sourceof the funds and what you can do with
that. So,
I know having thatamortization coming in on 250

(38:05):
loans makes things significantlymore complicated in the US to
reinvest post reinvestment period. So,
that's something that we've become moreaware of as we have our monthly meetings
and we talk about what's the workload ineach of the teams and they're spending
a lot of time on figuring outreinvestment and we're going,
what are they doing until wefound out what the reason was. So,

(38:26):
that's an interesting quirk. I dunnowhy that is the case, but yeah,
Europe bullet loans don'thave any amortization.
One thing you mentioned wasthat the management fees are higher in Europe in the
US for broadly syndicated. I would say40 basis points is probably a fair fee,
and then the incentive is 20 over12. The 12 has to be earned in cash,

(38:46):
so it takes a while for thatto be paid to the manager.
Obviously they have to earn it. What'sthe average fee across the pond?
I would say up until maybe the lastcouple of years, if I look back on ours,
the incentive would be the same,
but the headline numberwould be 50 instead of 40.
I would say in the last couple of yearsit's maybe begun to compress a little
bit, so maybe into the mid forties,

(39:07):
but long-term average has alwaysbeen higher than the US and I think
obviously we've got quite abig manager in both markets,
so we can see that over time.
But I don't know if the US is compressingin the same way that Europe is right
now. But up until two years ago,
we didn't really have any strugglesgetting 50 basis points on every deal.
I would say that's maybe more of a hottopic at the moment than it historically

(39:30):
has been.
Great. Well why don't weleave it at that. Brian,
thanks so much for coming on thepodcast. Really enjoyed our conversation.
Thanks for invitingme. I had a lot of fun.