Launching a new CLO platform and structuring these products in the new regulatory environment is a lot harder than it used to be, agreed managers and service providers speaking at the 4th Annual Investors’ Conference on CLOs & Leveraged Loans conference hosted by IMN in New York on Wednesday.
“At the end of the day, the managers have to represent their investor base and that means they have to have robust, accurate effective operations and that they can ultimately achieve leverage,” said Tim Houghton, a managing director at Cortland Capital.
Risk retention was the talk of the town at the conference. The speakers said the new rules, which come into force in December 2016, put increased pressure on managers. They have to think about creating sound compliance models and running potential scenarios on loans that might go sour. “It’s not just about good or bad collateral, but thinking how this collateral impacts the overall structure. And this needs to be provided in a timely and accurate way,” said Houghton.
Managers need to have the appropriate infrastructure in place, and often can’t start from scratch “in a garage,” like they used to, said Robert Radzul, senior director at Standard & Poor’s. When it comes to managers establishing CLO platforms, they typically emerge at a firm that has a private debt or lending business in place already. Alternatively, they are spin-outs from an insurer or another platform, where the team have a track record behind them, the panelists noted.
Managers also have to think about registering Delaware or Cayman Islands limited partnerships and how that will impact their taxes. “Aside from risk retention, tax aspects are the biggest factor in structuring and the products will be taxed differently depending on where they are based,” said Houghton.
He added that another big issue for credit managers not already in the CLO space, is the restrictions and guidelines they will become subject to. “There is so much more to managing CLOs, there are concentration limitations and so many more restrictions than you’d have in other investment products and private funds,” said Houghton.
In terms of service providers and trustees, Levoyd Robinson, a managing principal at the Chicago Fundamental Investment Partners, who has worked on CLOs for 25 years, said he has used virtually all of them over the years. “When you walk through that exhibit hall, everyone will swear to you that they’re the best at what they do,” he said. He also noted that the costs of switching service providers are enormous and the providers in question can alleviate that by giving clients free trials. When he goes looking for service providers, he likes to check not just their references but other firms who may have fired them. “You can always find two people who fired you, and we want to know why they fired you. The people who give you references won’t say that. It’s the people that fired you that are probably pissed off and those are the people we try to find when we’re going through dozens of data and technology providers,” Robinson said. “They will not cease, they keep trying to sell you product.”
When it comes to mistakes, panelists said everyone will make them, the important thing is to learn from them. “Try not to make the same mistakes twice, if something doesn’t go right, try to fix it and own it,” said Robinson, explaining that mistakes are inevitable, especially with new technologies and regulations cropping up around the clock. “It’s always a learning curve and things are going to go wrong, but you have to learn from your mistakes,” Robinson added. “I always tell my kids: the road to disappointment is paved with unrealistic expectations. People are often very excited about a new part or a new gadget, but they have to look out for what can go wrong,” he added.
“Mistakes are inherent part of life, if you haven’t made mistakes, you haven’t done anything,” agreed Houghton. “The most important thing is to catch mistakes early.”