A New CLO for the European Structured Market…. or not?

The private credit sector has seen significant expansion in recent years as an increasing number of companies, including larger corporates, turn to non-bank lenders and private markets for financing. While traditional banks and public capital markets remain critical for established enterprises, alternative asset managers (AAMs) have become essential providers of credit globally, including in emerging markets. Initially established by private equity firms, many AAMs expanded into credit, transforming into comprehensive capital providers for firms less able or willing to access conventional financing.

The private credit market now spans a diverse range of transactions implemented through specialized funds, with assets under management growing nearly 20% annually since 2015. This growth accelerated during the COVID-19 pandemic, which caused public markets to falter amid heightened uncertainty and volatility. For investors—predominantly large institutions such as pension funds and insurers—private credit offers long-term, stable returns that align with liability profiles while avoiding excessive volatility.

This demand spurred innovation in structured finance, leading to the development of a new CLO market in the U.S. by the mid-2010s (private transactions existed even before the GFC but they were differently structured and served other purposes). Over time, middle-market CLOs (MM CLOs), securitized portfolios of loans to smaller borrowers, have captured an increasing share of the US CLO market, rising from 4% a decade ago to over 15% today. Recently rebranded as "private credit CLOs," these products reflect the diversity of underlying assets sourced outside the broadly syndicated loan (BSL) market.

The “size of the underlying targets” has diminished in significance to avoid reliance on qualitative and discretionary criteria. This explains the new name.

The European Perspective

In Europe, private credit CLOs have gained among sophisticated investors traction as a distinct asset class over the past five years, offering diversification and yield premiums over the BSL CLOs.

Last week, Barings, in collaboration with BNP, successfully priced the first European public middle-market CLO denominated in euros. This follows an earlier attempt in 2019, when the Spanish Alhambra CLO, managed by Be-Spoke, debuted with a €280 million portfolio. That transaction, comprising over 50 loans to Spanish SMEs, faced considerable challenges from origination to distribution. The performance of that CLO underscored the difficulties in developing this new market, compounded by Europe’s regulatory constraints under Solvency II and Basel III which limit the investor base.

The Barings transaction, a promising milestone, represents a more robust approach, featuring a larger, more diversified asset pool managed by an experienced team. The static structure of the deal provides spreads that offer a meaningful pick-up compared to European BSL CLOs. The deal’s weighted average cost of capital (WACC) stands at 253 basis points, higher than the 205–210 bps typical for a BSL CLO. The spreads were appealing against European static deals involving leveraged loans and high-yield bonds, which price today with a WACC around 150 bps over Euribor. The last column indicates the pick-up yield (on average) over a common managed BSL European CLO. The B tranche appears slightly expensive in price level, although I have repeatedly highlighted in the past that Bs tranches, in some cases, do not reflect the true/fair yield market value because they are retained by the same manager within their own retention vehicles or other portfolios. The true value signal is more evident in secondary market prices- when they trade- than in primary deals. Structural subordination to BBBs and BBs is in line with normal European CLOs even if I notice that the IG notes benefit from a ticker BB tranche than common BSL CLOs (a 3% difference). A rating necessity for the capital stack.

The Barings MM CLO- rated by S&P and Fitch- marks a pivotal step for the European private credit market, signaling the ability of major credit platforms to originate and securitize private corporate loans into structured products. Although future European MM CLOs may differ significantly from their U.S. counterparts—featuring varying leverage, distinct subordination levels, and unique capital structures—the Barings transaction highlights their potential for yield enhancement and risk diversification, driven by diverse credit profiles in the pool and reduced overlap compared to traditional BSL CLOs.

Worth noting is how a U.S. Private CLOs typically provide a 30 bps premium over BSL CLOs for AAA-rated tranches. In the case of Barings the premium is only 17 bps. However, structural differences, such as Barings’ 38% AAA subordination level compared to 41–43% in the case of MM U.S CLO ( here, due to a bullish market, the trend is tightening from the 44% level of just 2 years ago), or static vs managed, make direct comparisons difficult and, allow me to say, baseless at this stage and in this particular case. Attractive factors for BSL CLO AAAs, AAs and As, such as credit risk remoteness, limited interest rate risk and low credit beta sensitivity, also hold for the Barings MM CLO. For sub-IG tranches (rare in the US private credit CLO market) qualitative differences with other underlying portfolios can bring on the table other considerations which are more technical and complex (collateral valuations and relative values, for example).

The Barings transaction sets the stage for further innovation and growth in Europe’s structured finance market and highlights the growing importance of private credit as an asset class, offering investors a compelling risk-return profile and access to the private space- I like this definition- in a “credit enhanced form” derived from the structural enhancements of the securitization, and active management.

For those investors considering entry into this market, understanding the nuances of private credit CLO structures (including liquidity) and the credit expertise of originating platforms from credit selection to work-outs, will be critical. Managers with a significant presence in the direct lending or private credit market, on their side, must embrace the complexities and time-intensive nature of these deals to unlock their full potential. All the issues and challenges appear manageable but there is one certainty: the sector warrants more attention (and more courage).

The concern? Tailor made transactions will prevent the European private credit CLO market to go mainstream. Private credit CLOs today can be defined as “arbitrage deals” (20y ago this was not the case) like their big brother BSL CLOs which are a commodity product. In Europe there is the risk they will remained confined in “exercises of style or cases studies” for niche participants.

“it is not the mountain we conquer but ourselves” (Sir Edmund Hillary, mountaineer and explorer).