Going cheap

The Carlyle Group and Goldman Sachs have begun to market a CLO of leveraged loans that is designed to take advantage of loans trading at distressed prices. Unlike several recent deals and most of the other CLOs in the 2008 pipeline, the transaction is not made up of broken warehouse assets from the arrangers’ balance sheets: rather Carlyle and Goldman have sourced the loans from the secondary market.

The transaction is conspicuous by its sheer size. At €2bn, it is more than six times that of a traditionally managed European CLO. This granularity should give it extra investor appeal. Below the €1.47bn Triple A (Moody’s and S&P) piece there is a full capital structure that is rated down to B3/B– and an equity slice of 8% of the deal size.

Finding a home for that amount of paper, no matter what the price, will be a challenge. The Triple A piece is being marketed at the six-month Euribor plus 85bp area, which on a discount margin basis suggests an appealing plus 150bp for what is a comparatively short four-year WAL. This contrasts with normal CLOs, where the WAL is typically twice as long.

The €85m Aa/2/AA rated B class is talked of at the plus 225bp area and plus 250bp on a DM basis. Price talk on the €90m A3/A– piece is at the plus 325bp area (DM +525bp), that for the €70m Baa3/BBB– piece is at the plus 450bp area (DM +750bp area), the €50m Ba3/BB– piece is likely at the plus 650bp area (DM +1100bp area) and the €80m B3/B– piece is likely to arrive at the +1,000bp area (DM +1,500bp area). All these pieces have a five-year WAL.

Given very limited demand for these junior pieces, it is possible that Goldman may be obliged to retain and delta-hedge them away, as it did on an earlier synthetic CLO it did with Carlyle.

On the face of it, the economics of the deal make a lot of sense. At current levels, loan market prices imply average European defaults in excess of 8%, which is well above Moody’s 2009 prediction of a rise to a little over 3%. This effectively means the transaction is positioned to buy very sound credits at today’s extremely attractive prices.

Furthermore, because many of the loans are thought to have been ramped into the CLO at 92 cents on the euro or lower, the 8% unrated equity piece is essentially free.

“These are money-good loans so there is a good argument they could trade up to 96 in a relatively short period,” a banker away from the deal speculated. “That means the deal will deliver the usual Libor plus 300bp return – but it could well see an extra four to six points of return on top of that.” He went on to suggest that the transaction might feature a call within three years.

Once news of the deal broke, Carlyle was approached with many loan offers, but it responded that it was no longer interested in buying assets. This has led some to conclude that the transaction is now close to fully ramped, adding to the impression that it has taken full advantage of today’s historically cheap loan levels.

Moreover, there is talk that Goldman was one of the main protagonists in helping trigger secondary loan market weakness. Bankers say that weakness had initially been exacerbated by stop-loss selling, as triggers were hit on market value CLOs and, more importantly, by triggers being hit on total return swap-based funds. As the LevX senior traded toward the 90 area, these funds were widely said to have faced mounting margin calls.

While bankers were ready to applaud Goldman and Carlyle for what they deemed a clever trade, some said that the fact that Goldman hadn’t already priced the deal suggested it had not yet lined up all the Triple A investors.

And having seemingly been behind the selling that caused many investors and managers so much angst, Goldman’s ability to distribute to those same clients could be compromised. “They’re not a franchise business – shorting the loan market is not good for clients who buy your loans,” a rival banker said.