Private credit CLOs are a burgeoning asset class in the US, but are yet to come to fruition in Europe, within the public domain.
In this interview, Ares’ Blair Jacobson, partner and co-head of European credit, and Andrea Fernandez, partner and head of product management and investor relations, European credit and corporate secondaries, talked to LFI about the path ahead for private credit CLOs in Europe.
They discuss asset diversity, potential structuring, and currency options, as well as the obstacles to development and the outlook for asset supply.
Q: CLO market players cite challenges to issuing a European private credit CLO, including the need for sufficient diversity. How viable do you think the asset class is in Europe?
Andrea: We are exploring the market, as we think all the key components necessary to set the stage for private credit CLOs in Europe are there.
Identifying the right investors for the equity piece within the structure remains a key consideration, but on the debt side we have certainly seen a recent uptick in interest from insurance and pension capital.
We hear of many parties looking at potential structures, but there are few firms with sufficient origination capabilities to create diversification in their portfolios.
If the opportunity looks right, we feel we’re well positioned thanks to the diversity across our capital pools.
Q: What could the market expect in terms of structures? Would deals reference static portfolios?
Blair: The market has to walk before it runs. It’s likely any initial transaction would have a simple structure with a limited number of counterparties – more like a private structure, potentially with a single debt tranche.
Andrea: Starting out on a bilateral basis with a single investor account which can be customised may be an initial entry point into this market.
Whether it’s static or revolving would depend on appetite from the debt investor(s).
Q: Currency mismatches have also been well-flagged as a challenge for potential PC CLO structures in Europe. How might this be addressed?
Blair: As the UK market is the single biggest direct lending market in Europe, there may be a case for issuing the debt of a private credit CLO in sterling.
There are also, potentially, more capital providers of debt tranches for whom sterling would be a natural fit.
Q: How many assets would a PC CLO need to reference in order to be viable?
Blair: If a deal is going to be rated, it would likely need to be backed by a pool of 50+ names. Ideally, a rating agency would rate all the assets, or a high proportion of them.
Q: What has held back progress in the asset class so far?
Blair: Private credit CLOs need scale and diversification for the asset class to work.
The US private credit market is much larger and much more mature than Europe, and that’s why the US middle-market CLO asset class has been able to get established. In Europe, we currently have around 600-800 mid-market deals per year and this year deal flow has been at the low end of that scale.
Added to that, much of the direct lending in Europe has been historically via sole lenders, although club deals with several fund managers collaborating are becoming more prevalent.
Ramping a deal of suitable assets is therefore not as straightforward in Europe.
Q: What are your expectations for deal flow within the European private credit market over the next 12 months?
Blair: The outlook for deal flow is strong as the fundamental building blocks are in place, including stable macroeconomic growth, declining inflation and interest rate cuts.
These are powerful trends especially when combined with an overhang of private equity assets that need to be sold, limited partners focused on DPI and record private equity dry powder.
In fact, recent data has indicated a significant rebound in activity in the second quarter, which we expect to continue throughout the year and into 2025.
Q: Will we see a European private credit CLO come to market by the end of this year?
Blair: We’re not hearing that. But a year from now, would I be disappointed if someone hadn’t planted a flag in this market? Yes.
Anna Carlisle
anna.carlisle@levfininsights.com
+44 (0)20 7469 0981
Kerstin Kubanek
kerstin.kubanek@levfininsights.com
+44 (0)7442 014 521
