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After sitting out much of the first half of 2020, institutional CLO debt and equity investors are increasingly shifting allocations back into CLOs due to the confirmed safety and resiliency of the investment vehicle, continued low rates and a favorable regulatory environment. Despite loan spreads near historically tight levels, we expect liability spreads to continue to fall – which will make for favorable spread arbitrage conditions underpinning a healthy CLO market. Analyst consensus projects $90B-$110B of new CLO issuance (13-16% growth),1 and we expect to see significant expansion in both CLO issuances by established managers and new CLO platforms built by entrants to the CLO market.
In 2019, many start-up CLO managers entered the space and several long-dormant CLO managers brought new CLOs to market. This growth dropped significantly in 2020 due to the challenging market conditions, particularly around raising equity. The CLO market is highly tiered based on track record and perceived manager skill; top-rated managers have much greater access to Equity investors, which is a key constraint and driver of CLO issuance growth. New managers who have built a strong platform and track record have seen tremendous growth. Other managers have taken a different approach by engaging in strategic partnerships with lenders to raise equity to support significant growth.2
As CLO managers are entering (or re-entering) the space and launching new CLOs, many are encountering the challenge of scaling their accompanying Loan Operations. CLO Operations are very labor-intensive, requiring setting up complex assets and accruals, managing notices and pay-downs, reconciling cash and positions, and settling loan trades. For each of their CLOs, managers will typically also tie out Compliance results and the underlying positional information against a trustee report on a monthly basis – an incredibly tedious process.
Because of this, many CLO managers are starting to recognize the strategic benefits of outsourcing Loan Operations/Middle-Office functions. Outsourcing is an attractive alternative to the large footprint of hiring and growing an in-house team of Loan Operations staff. As hiring costs and overhead increase, many managers I speak with are increasingly viewing Loan Operations as a commodity, finding it more cost-effective to outsource this part of their business. This P&L equation has received increased scrutiny since a CLO platform requires significant scale to be profitable.
Managers also see a clear benefit in the flexibility of an outsourced model as their scale and corresponding business needs change. An outsourced Loan Operations model frees up managers to focus on alpha-generating decisions and hiring to climb the CLO manager rankings and thereby attract investors and lock in favorable liability spreads.
To reach the scale necessary to achieve profitability, CLO Managers of all sizes are increasingly recognizing a need for applications that are well-suited to the nuances and complexities of their business. Many managers with existing proprietary systems are recognizing the advantages of buying versus building by embracing the trend towards cloud-hosted vendor applications, which includes the added benefit of expensing vendor fees to their funds. CLO managers with vendor systems that are not well-suited for the needs and complexities of the CLO space are seeing major bottlenecks and the need to invest in applications that can handle their growth.
Allvue’s powerful CLO software was specifically built to cover the full investment lifecycle needs of CLO managers. Key features include support for streamlined Loan Trading (including integrations with leading execution venue and settlement systems), modeling interest and principal waterfall payments, and a robust CLO Compliance calculation engine with native support for Pre-Trade, Post-Trade and Hypothetical trade scenarios. Our Investment Accounting and Loan Servicing offering were designed specifically for the nuances of CLO Loan accounting and trade settlement and is seamlessly integrated into the front-office – a gap in the offerings of many of our competitors.
Managers have also realized the added benefits of having a single well-integrated solution that can handle their front-, middle-, and back-office operations. A single solution streamlines increasingly core functions like data management and reporting, eliminating the inefficiency and redundancy stemming from poorly-integrated disparate systems.
Building on our success with the largest CLO managers (19 of the 25 biggest CLO managers currently use Allvue for their CLO business) we have recently launched new solution offerings specifically targeted for the needs of start-up, small, and mid-sized CLO managers. Growing managers can take advantage of offerings aimed at their specific needs with confidence, knowing that our modern technology can handle their expected growth.
2 https://www.creditflux.com/CLOs/2021-02-18/CLO-pipeline-all-bases-expand-as-more-absentees-join-bonanza https://www.creditflux.com/Funds/2021-01-05/2020-wrap-CLO-funds-bloom-despite-rocky-ground