Market Wrap

Excess Spread - Bottoms up, just the right amount of green, Rizwan and the trucker

Owen Sanderson's avatar
  1. Owen Sanderson
15 min read

Bottoms up!

Acer Tree Investment Management, the first debut CLO manager of the year, priced its deal Logiclane I via Barclays last Friday. The levels it achieved — 97 bps on the senior, 180 / 250 / 360 / 700 / 975 down the stack — were wide of IPTs, not surprisingly, given market moves during syndication. CLOs are, to an extent, resistant to rates volatility and central bank moves, as coupons float once Euribor goes positive, but relative value between CLO mezz and other fixed income has got sharply worse as Crossover has blown out.

The Albacore level implies a healthy debut manager premium, compared to BlueBay and Redding Ridge at 92 bps each on the seniors, despite the longstanding experience of the Acer Tree team in European credit. Jonathan Bowers, co-founder of the fund, founded the CVC Credit platform, while the other partners are also 20 year+ veterans of European leveraged credit. But with loans also trading off and new primary squarely north of 400 bps, there’s plenty of arb left in the deal.

Debut manager premium is an interesting concept, well established in the US, but which comes and goes in Europe. 

Managers launching in 2020, such as Albacore, CBAM and BlueBay, came flat or even through established managers, while in 2019, debutants such as Angelo Gordon, CIFC, Mackay Shields, Rockford Tower, and Sound Point, also saw excellent execution.

But there are certainly investors who prefer to see a track record before committing their capital, or at least, want to be well compensated for taking the risk. 

One investor described the “manager bullsh*t bingo” received from roughly 100% of the CLO manager universe. 

As an exercise for the reader, see if you can figure out which of the credit investing strategies below will perform best? (yes I have been a bit selective in my highlighting, but you get the idea)

Bain Capital Credit

fundamentals-driven, bottom-up security selection


fundamental, bottom-up approach to credit analysis


commitment to a bottom-up credit strategy

Onex Credit

rigorous bottom-up, fundamental and structural analysis


focus on bottom-up fundamental credit analysis


using fundamental bottom-up research to identify investments

Blackstone Credit

rely on bottom-up fundamental analysis


a strategy that it describes as fundamentalist and bottom-up

Sculptor Capital

research-driven, bottom-up investment process

*NB 9fin co-founder Steven Hunter was formerly engaged in fundamental bottom-up credit analysis at Barings

I don’t doubt that all the managers above practice what they preach, and manage some excellent CLOs — no particular mockery is intended through inclusion on the list. But it would be refreshing, if not wise, if at least one manager would say “I want to YOLO my way into hot new issues when I think they’ll trade up and run for cover when markets turn red”.

Anyway — given the difficulties of penetrating the curtain of a well-polished PowerPoint, it is better to wait and see what manager strategy means in practice.

When the market backdrop is tough, the marginal investor sets the price. Acer Tree is playing it safe with its first issue, particularly with respect to bond buckets, wanting to show investors some performance in loans before making full use of its bond-buying flexibility. That, of course, dovetails nicely with the rates volatility, fears of central bank tightening, and general risk-off attitude in bondland.

But bonds are a specialist subject for Acer Tree — the firm started off late in 2019, launching its credit opportunities fund in June 2020. That’s now returned more than 30%, up 17% last year. This fund invests mainly in bonds and credit derivatives, with little overlap to the par loan universe of the CLO strategy.

As a smaller shop, Acer Tree can rightly claim nimbleness over more established operations — with only a single deal, and presumably soon another new warehouse to feed, it doesn’t need to buy the market, but can focus on differentiation. Time will tell how it goes — but the team has real skin-in-the-game, with some of their own cash in the equity.

Elsewhere in CLOs, primary markets still seem to be chugging along nicely — though new issue execution is stronger than resets, with “clean” portfolios now at a premium. 

Jefferies produced a rather sweet Valentine’s-themed pricing message for Sound Point Euro CLO VIII on Monday, with investors showing their love by supporting a size increase to a €500m target par, and the top of the capital structure holding firm in the low 90s.

This deal came at 92 bps, a level likely to be matched in Cairn XV, though Cairn was originally talked at 90. A new issue from Tikehau may come a touch tighter, but it’s fair to say the market has found a level.

The bottom of the stack is more worrisome, with discount margins heading for double digit territory. Even Sound Point, generally reckoned one of the strongest managers in Europe, landed at 980 bps. For new issues, that might mean some managers ditching the tranche, but resets have to keep this in place to avoid injecting new equity into their issues. 

The tighter senior pricing compared to the second half of last year, when deals were mostly at 100 bps (+/- 5), more than makes up for the sliding single-B tranche, provided the belly of the capital structure can hold reasonably firm — which means resets will continue, with junior notes issued through gritted teeth.

Goldilocks ethics

Talking to a CLO manager who recently reset a deal, they said they’d updated to roughly mid-market levels of ESG language in their new doc, wanting to be neither behind the market nor to sell their deal as a leader in ESG matters. 

That points to ESG now becoming an increasingly ordinary matter of CLO negotiation, something to be folded into the standard back-and-forth on debt or equity-friendly terms — and where the sweet spot is to be found right in the middle of the pack, on-market enough to attract the keener ESG money into CLO liabilities but no more restrictive than necessary.

But equally, given the 1.5 year+ non-call period lag to redocument a deal — perhaps that’s an argument for getting ahead of an emerging trend?

Prompted by Alex Manopoulous from 9fin’s analyst team, who has been presenting to the European Leveraged Finance Association (Elfa) on ESG matters, I took a look at Carlyle’s run of deals. 

Alex pointed out that, as a private equity shop, Carlyle has been making some of the loudest ESG noises for the longest. 

That hasn’t been the case in CLOs until last year, but 2021 saw Carlyle’s European deals move from zero to hero in ESG-terms — pushing right through from literally no mention of ESG in 2021-1, priced in April, to basic negative screen in 2021-2, in September, to all-singing all-dancing state of the art ESG in 2021-3 in November.

This deal also includes comprehensive exclusions on product categories and conduct, ESG reporting and commitments to sell obligations that lose their ESG status.

The 2021-2 exclusion list included the basics — controversial weapons, civilian firearms, tobacco, palm oil, thermal coal or expanding coal production, and hazardous or ozone depleting chemicals.

Compare this to the product exclusions for the 2021-3 November deal. New exclusion categories added for that deal include recreational drugs, gambling or gambling support services, energy utilities with high carbon density, pornography and adult entertainment, private prisons, oilfield services, opioids, wildlife products, unconventional fossil fuels, coal extraction, payday lending, commodity speculation, and companies involved in controversial practices on land use.

The language involved is also much more sophisticated — take a look at the utility exclusion, for example:

any Obligor which is an electrical utility where carbon intensity is greater than 100gCO2/kWh, or where carbon intensity is not disclosed, it generates more than (i) 1 per cent. of its electricity from thermal coal, (ii) 10 per cent. of its electricity from liquid fuels (oils), (iii) 50 per cent from natural gas or (iv) 0 per cent. of its electricity from nuclear generation. Any utilities with expansion plans that would increase their negative environmental impact are also excluded;”

A big thanks to the folks at EuroABS, by the way, for access to their database — it’s a super-helpful tool for this kind of thing. Use them for all your securitisation repository needs!

Fewer deals the better?

CLO managers with a more turbo-charged attitude to ESG are increasingly marketing themselves on the deals they have passed on — what better way to underline the credibility of an ESG policy than to decline to play a big capital structure which everyone else has bought?

Examples from a couple of the leading ESG-friendly managers include Merlin EntertainmentAllied Universal-G4S, Cobham, and Ultra Electronics — the bigger the deal blanked for ESG reasons, the more powerful the signal? The managers in question wanted their own names strictly anon, so there’s a limit to the power of the public signalling on display here, but it’s something at least.

Perhaps it’s also an argument for a nuanced distinction between the most sophisticated “ESG scoring” managers (NIBC and Fidelity, for example), and those which have tight “negative screens”. 

It’s not necessarily the case that Article 8 > positive screen w/ ESG scoring triggers > negative screen …..what matters for ESG in the world is the extent to which dirty or damaging businesses can access capital. The more loans turned down the better, though by definition this must mean less flexibility to manage a loan portfolio for performance.

But the race for Article 8 continues. CLOs like Fidelity’s latest may be ‘Article-8 aligned’, in respect of their commitments to disclosure, but do not cleave explicitly to any provision of the EU Sustainable Finance Disclosure Regulation — it doesn’t even get a mention in the offering circular.

But we understand there are warehouses now opening which definitively intend to come in “Article 8” format — meaning explicit covenanted compliance with the provisions of the regulation. CLOs, thanks to their exemption from fund management rules, cannot be official Article 8 products, so the closest they can come is to make this contractual commitment.

Managers and arrangers, however, may be receiving a variety of legal opinions on the matter. 

In the Article 8 corner is White & Case’s Chris McGarry, who has been among the strongest voices in favour of a move to Article 8 for the market. White & Case advised the G20 Sustainable Finance Study Group on this in 2018, and has been a consistent advocate for it ever since.

But some are concerned this might cause trouble for managers down the road, given the other regulatory moves in the same area. 

“We question the wisdom of voluntarily complying with regulations such as Article 8 given the amount of other regulatory change coming through in the next year to 18 months, such as UK equivalence to SFDR, EU Securitisation Regulation review, and the MIFID ESG components,” said James Smallwood of Allen & Overy’s CLO team. “You could end up with considerable inefficiencies or requirements to duplicate work to comply with similar but different regulatory standards.”

There’s also the thorny question of sustainability-linked loans, which have proliferated over the last year. 

CLO managers often have a certain level of contempt for these structures, arguing that the targets issuers set themselves are rarely stretching, and the ESG margin ratchet simply constitutes a haircut on the advertised spread. It can also be a pain from a ratings perspective, with agencies having to take a conservative view on the portfolio weighted-average spread, and assuming that the loans will always ratchet down.

But in the case of Neuberger Berman deals, the third of which was priced last week via JP Morgan, sustainability-linked loans count automatically as “ESG obligations”, provided they meet the LMA or ICMA sustainability-linked loan or bond principles. But the presence or otherwise of a ratchet compliant with the LMA principles doesn’t say much about how ESG-friendly the loan in question might be.

Ultra Electronics, for example, a defence company, included an unspecified ESG ratchet at syndication, and had committed to take steps on reducing greenhouse gases and plastic use. But the buyside had more ESG questions about the company’s involvement in manufacturing weapons than about its use of plastic in the process.

Against the grain

This year has been a salutary reminder that when the syndicate desk says “print while you can”, it isn’t always self-serving.

TwentyFour Asset Management’s Barley Hill No. 2 RMBS, a clean pool of low LTV non-conforming mortgages, was talked at low-mid 90s on the senior notes, and was 1.3x done at the time of writing, a signal that the market for specialist lender RMBS has turned from the halcyon days of early January. 

At the start of the year, the flurry of UK buy-to-let activity signalled strong executions ahead — Tower Bridge Funding 2022-1, from Belmont Green, and Elstree No. 2, from West One, both landed at 72 bps for the seniors, with DK’s Stratton 2022-1 at 73 bps, all on healthy books more than twice covered at the top, and multiple times subscribed down the stack.

The rating agencies treat the  Barley Hill deal as non-conforming, implying a premium to BTL deals, but its no beaten-up pre-08 pool — it’s just got a big wedge of self-employed and first time buyers in the mix. Cumulative losses on Barley Hill No. 1, the predecessor deal, held steady at 0 through the life of the portfolio.

There’s a bit of a story to the sponsor. 

TwentyFour Asset Management needs no introduction for most ABS people — it’s been a passionate advocate for securitised products in Europe, and done more than most to democratise access to them through its listed funds, growing along the way into one of the ABS market's heavyweights.

But UK Mortgages Limited, the vehicle which is sponsoring Barley Hill, has been trading below its Net Asset Value since 2018, with a particularly serious puke in the wake of the first pandemic wave (like everything else) forcing various measures to crank the share price back up. UK Mortgages is distinct from TwentyFour’s other vehicles, in that it only acts as a securitisation sponsor — its business is warehousing and securitising mortgages, not buying bonds in primary or secondary. It also had to operate with both hands behind its back, being unable, at first, to issue securitisations below triple-A, and latterly below investment grade, at a time when the broader market was maxing out leverage right through the capital structure.

M&G Specialty Finance looked at trying to buy UK Mortgages in 2020, when the NAV discount was most serious, floating a possible price of 67p, and the firms traded terse RNS statements — “highly attractive and in the best interests of shareholders” vs “materially undervalues” pretty much sums up the content.

After rejecting this offer, UK Mortgages sold two low yielding portfolios it planned to securitise, using the money to launch a £40m tender offer to crank the share price back up.

As of last week, it’s now proposing merging UK Mortgages into the TwentyFour Income Fund (TFIF), a vehicle which invests in a broader range of securitised products, at a price of 84p — a price considerably higher than the M&G offer. TFIF has also spent some time trading below NAV, though it’s at a premium now, but has tracked much closer than UK Mortgages, as might be expected from a fund with mostly listed bonds in, marked at fair value.

Not that they’re always the most liquid assets — recent disclosures show substantial positions in the Lloyds synthetic securitisations of first-time buyer mortgages, a mezz piece in a Together Finance conduit facility, a mezz piece in a bridging loan warehouse, plus various residuals and deep mezz across mortgages, auto ABS, and CLOs.

But that’s partly why it makes sense to combine the two vehicles — TFIF is no longer a vehicle dedicated to trading liquid bonds. Like much of the structured finance world it now occupies a hybrid zone where it can do warehousing, illiquid financing, equity, synthetics or listed securities. Finding value in ABS now increasingly means slotting into the ecosystem of consumer credit as something more than a pure bond buyer, so UK Mortgages’ buy-and-securitise strategy is a natural fit.

The move to a vertical retention structure, the first time this has been used in a TwentyFour deal, also fits nicely with the fund merger — although the double-B notes, residuals and excess spreads notes will be retained at closing, there’s no regulatory obligation to keep hold of these. The rights to the portfolio can be sold easily, if the price is right.

TML (“The Mortgage Lender”), which originated the loans in Barley Hill, was sold to Shawbrook in 2020, which is an increasingly active securitisation sponsor in its own right, issuing TML buy-to-let deals through the Lanebrook shelf. With TML now fully in-house, we might expect that Shawbrook will want its owner-occupied book back at some point...   

The Rizwan updates will continue until morale improves

My legal education continues — I had assumed that Rizwan’s committal proceedings would wrap up with a judgement on Friday, but it seems that will come later (as of the time of writing, we’re still waiting, for the court to pronounce, sentencing and for the man himself to be found).

While we wait for the judgement, some interesting points from the evidence presented in last week’s trial:

Rizwan has previously claimed that Highbury Investments, a vehicle of his used against BMF, Clavis, Mansard and Hurricane Energy, was “owned by the State of Pakistan”.

Andreou Artemiou, an associate of Rizwan’s involved in the BMF attacks, who met Rizwan in prison, was apparently offered £100k per year by Rizwan to work for him. He told a childhood friend that he was “working for a Hussain, who they ‘could trust because he’s a multi-millionaire who knows what he’s doing’”. A quick search of court records might have been advisable at this point.

This childhood friend, a lorry driver by trade, nonetheless had several loan applications linked to his bank account without his knowledge, and his identity used as a director of one of Rizwan’s vehicles, hence his involvement in the matters.

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