Part 1: An interview with Marc Utay, Founder and Managing Partner at Clarion Capital Partners, on the opportunities in the structured credit space

Introduction

Marc Utay, Founder and Managing Partner at Clarion Capital Partners, sat down with ION Analytics to share his expertise on finding opportunities in the private credit space. With 40+ years of experience on Wall Street, he provides valuable insights into the nuances of the CLO (Collateralized Loan Obligation) market and the advantages of being an independent player.

Part 1 of this blog series covers Marc’s tenured experience, engaging investors and addressing CLO misconceptions, the importance of alignment with limited partners, and the barriers to entry in the CLO Market.

The full ION Analytics interview can be found here.

The Clarion Origin Story

Let's start with your individual background first, and how Clarion Capital Partners was formed.

Marc: Thank you. I have been on Wall Street now for over 40 years, hard to believe it when I say that. But I started in the 1980s at Drexel Burnham Lambert, where I started as a generalist, and then was one of the first of three members of the Leveraged Buyout Group with Leon Black, who went on to found Apollo. We built a business, the first one on Wall Street that financed leveraged buyouts in the capital markets. After Drexel, I was one of the managing partners of Wasserstein Perella. I was on the Management Committee and ran several industry groups, including leverage finance.

And then, in the time of the millennium, right around 2000, I formed Clarion Capital Partners where we have two businesses. One is a middle market, private equity business, where we’re principal control investors, and the other, which is about 5 or 6 years old, building on a very long credit history that I had, is a structured credit business which invests in the securities of Collateralized Loan Obligations, or CLOs.

Why CLOs?

So you started the second business 5 to 6 years ago, and the private credit business evolved since the time you started working on Wall Street. Why exactly did you choose this niche?

Marc: We had always intended to diversify our business over time into credit given our long history, and at the beginning of the firm we ran a very successful value credit business for our original backer. The question, though, as our private equity business matured, was which part of private credit would we want to be part of. One of the challenges, because at the time we were at the top of a bull market, and it's very hard to get comfortable with the risk/reward of private credit at the top of a bull market. It feels like you're not really getting paid for the risk that you're taking.

So, we had been approached by a gentleman who built one of the largest businesses on the street, investing in the securities of CLOs, and he came to us with a very interesting thesis. Even though we were very familiar with the basic structure of CLOs, I must say this was not something we were aware of, and his argument was that CLOs could be counter cyclical. That in a credit downturn, you would absorb losses from the distress at the companies. But that if the credit spread widened by a hundred basis points you could be compensated, more than compensated, for the losses you were taking. And counterintuitively, the best time to own CLOs might be a time of credit stress. So we spent about 6 months vetting that, working through all the math with him, looking at all the historical numbers, and we came around to the fact that he was right, that it was counter cyclical, and that made a very good entry point for us in our private equity business.

Any business we go into, we want to believe that we're going to provide real alpha. That's something we want to put our own money in, and indeed, in Clarion funds we've put up at least 10% of the money in every fund we've had. So we treat investors’ money like our own money, and we wanted a good risk/reward, and he convinced us that we could have that in structured credit at the peak of a bull market.

Investor Reaction to CLOs

When you were about to launch the first fund and you went out to investors, did any of them have experience in CLOs before? And if so, what were their remarks about other funds they put money in?

Marc: It's interesting. CLOs are, despite the fact that it's the main financing source for leverage loans, which is over $1 Trillion, wasn't a marketplace that many people have a lot of experience in. So most investors didn't know it. The second thing we found out is those investors who did know it broke into 2 groups. The first group were people who were aware of it, but had invested in collateralized debt, mortgage-backed securities, and such. And remember, we were only 5, 6 years outside of the losses in the great financial crisis when we started to work on this, and there was some confusion as to what the experience of CLOs was through the great financial crisis versus other structured credit.

Then the other really interesting thing was, if you were a European, the whole argument wasn't true. That in Europe, for some reason, the experience of CLOs is very different than in the United States, and therefore European investors had a very negative view if they had a familiarity.

Investor Reaction to CLOs—US versus Europe

How much does the US Business in CLOs represent towards the total of the $1 Trillion+ versus the European one? And would that make the investors comfortable?

Marc: The European market is much, much smaller and probably in a few hundreds of billions. This is not where we invest, but what I can say is that we were able to show the experience and the data set. And to the European investors, we were able to convince, not all but some of them, the reasons that it worked in the US but not in Europe were structural deficiencies in Europe, and those were twofold. The first is it's just a much smaller market, so there are far fewer leveraged loans, and they tend to be fairly large. And there are far fewer CLOs. So what you found is that the ability to create alpha was really not there because you couldn't easily trade in and out of loans. Everyone owned everything, and when people wanted to go to the exits, everyone was trying to exit at the same time. Now, that's something that does exist in the US, but not to the same degree.

The overlap between US CLOs between different managers can be 40% if they are a similar vintage. Then when you looked at the losses, the bankruptcy laws in the US are far more predictable and do not vary that much from State to State. They can differ by Federal court, but those are smaller differences. And in the UK versus Germany versus Spain versus Italy, you can talk about really different laws, therefore, very different experiences in terms of what the recoveries would be if you had a distressed situation.

Barriers to Entry into CLO Fund Management

What are the barriers to entry? Can anyone come set up a shop like yours? Is that the knowledge?

Marc: I think there are two barriers to entry and like everything on Wall Street, nothing is an absolute barrier. Anybody who wants to spend the time and spend the money can compete, but there are two things. The first is that a plus in the business is the amount of data that you have available to you and the software packages and platforms that are available to help you manage it. Those are extremely expensive and unlike any software we use on the private equity side, we’ve additionally invested a significant sum of money on programmers and quants overlaying an analytical framework, and an automation platform that allows us to look at a lot of different positions in a very short period of time.

So you could do all that, but you probably are not going to be able to get there fast. So someone can do it but they really have to be committed to it, as it’s not a “drive by” kind of asset class. We love when we hear that hedge funds are dipping their toe in CLO securities, because they’re not going to invest the money and the time to do it as well as we do it. 

The second part is that the basic structure is proven to be very durable. I mean give people credit who designed it, there have been de minimis losses across CLOs and part of it is because of all the nuances of the structure. So if you’ve been in this asset class for a long time like our team has, you understand all of the nuances of all these different tests and how managers are going to manage around them. And it isn't that you can’t learn that, but there’s a big difference between knowing it and living with it for 10-20 years and trying to get up to speed quickly. It’s an arcane little part of the world, but one where we think there’s a lot of alpha if you’re willing to put in the time and the money.

Stay Tuned for Part 2

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