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CLOs: Closed market poses threat to managers

Despite the far superior performance of CLOs to that of ABS CDOs, CLO managers on both sides of the Atlantic face a battle to survive in present and future market conditions.

The near disappearance of triple-A investors is making CLO issuance impossible for all but the top tier of managers and will likely contribute to the demise of smaller players.

In Europe, CLO issuance has declined more dramatically than in the US. That said, US volumes are flattered by restructuring activity. In the first half of 2008, fewer than 10 deals priced for less than €5 billion. Compare that with 2007, when approximately 85 European CLOs worth more than €30 billion priced. The reduction in CLO production poses a direct threat to managers that lack scale. This is why Fitch Ratings is predicting a 20% contraction in the number of European CLO managers over the next three years. It says that managers with fewer than two or three CLOs under management are vulnerable to any substantial erosion to their fee base. Over half of European CLO managers have only one or two deals – and nearly 80% of those were launched in 2006 and 2007. Subordinated fees are worth – according to the rating agency – on average 0.42% per annum. The incentive collateral management fee is paid depending on the internal rate of return on the equity tranche.

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