Spread or call protection?

Last Friday also saw two new issue CLOs priced, CVC Credit’s Cordatus XXIII and Blackstone Credit’s Otrano Park, both of which started marketing before the Russian invasion of Ukraine (and which had seniors already spoken for at announcement, a common strategy for CLOs even in the good times).

Levels were elevated, of course, with CVC’s deal touching the 100 bps mark at the senior level and wider through the stack too (single B notes at 1025 bps), with Blackstone somewhat stronger at 96 bps and 1000 bps respectively — though this may be more to do with the timing of any pre-commitments rather than a credit view. CVC and Blackstone are both pretty blue-chip, as managers go, which will have helped clear the market, and keep their pre-existing investors in the deal as markets soured. Both managers will have approvals in place from a full suite of possible anchors, and in CVC’s case, this was even sufficient to support an increase to the deal size.

CVC added a further €100m to the planned €400m issue, which in turn helped the equity story for the new deal — the size increase lowers the ramp percentage, meaning more of the loans in the portfolio will be bought at today’s low levels, rather than in the stronger market that prevailed at the start of the year.

Managers that can print at the moment may do well — leveraged loan pricing has been heading south faster than CLO WACCs, so getting a deal printed and ramping quickly should be positive for performance (if you believe that loans are going back to par....the question of whether the loan market has properly priced in the knock-on effects of the Russian invasion is a discussion for another time).

Longer term, the health of CLO supply depends on new issue leveraged loans, which might be trickier — there hasn’t been a new issue since mid-February, and, although there’s a healthy underwritten pipeline, the exit levels on offer aren’t encouraging.

The next crop of CLO new issues are likely to take another leg wider in pricing — one syndicate manager said a starting point would be 105 bps at the senior level, and the single-Bs are already scraping close to uneconomic levels where better capitalised managers will cease to sell these notes at all. Managers with the flexibility to buy their own junior mezz may still risk it, knowing they have a backstop if they don’t like what the market’s offering.

During 2020, CLO managers returning to market after the shock of the initial pandemic onset frequently changed their non-call and reinvestment period structures, issuing 1NC/3RP deals and refinancing them en masse at the far better levels prevailing in 2021.

After a little back and forth, most 2021 deals settled down to a standard 1.5/4.5 structure (a swing in favour of managers and equity from the 2/4 pre-Covid standard), and that’s prevailed ever since.

But will this happen in response to Russia’s invasion?

It depends partly on expectations. The CLO senior curve is relatively flat — managers and equity aren’t saving very much on senior spread by going shorter, and, indeed, debt investors are likely to prefer locking in an extra year of higher spreads with a long non-call, so might even punish managers and equity for seeking the extra optionality.

At this point, we don’t know whether the war will last three weeks, three months or three years, and how the geopolitics will shake out at the end of it. We’re not going to try to game that out here, there are plenty of freshly minted experts on eastern European history and politics out there with views.

But the economic effects are unlikely to go away fast. With Covid, one could plausibly argue that once lockdowns stopped, a lot of the issues for credit would fall away too, and companies would begin trading as normal again. What’s the path for commodity prices normalising from here?

So is it worth betting that spreads will be tighter in a year or so with a 1NC structure?

Reset expectations

While new issue primary can likely keep chugging along, as long as leveraged loan and CLO spreads stay roughly in sync (and assuming leveraged loan primary comes back), resets and refis are a different matter, with lots of the callable deals that could have been reset this year are now out of the money.

It’s already happening — Bain Capital Credit pulled the planned reset of Bain Capital Euro CLO 2020-1. This was a 2020 deal, as the name implies, so came to market at relatively expensive levels of 110 bps on the triple A. But down the stack, the levels were 185/310/425/700/925, compared to 230/315/415/775/1025 on CVC’s new issue (and a reset would have likely come wider).

New issue levels have been inside secondary (and likely reset/refi levels) for most of the year so far, but it’s been exacerbated by the recent selloff in loans. Better to lend against a portfolio bought at 96, than lend against a portfolio bought at 99 that’s now trading at 96.

We also saw an interesting loans BWIC out in the market on Wednesday — €95m-equivalent, including some very recent financings such as McAfee and Caldic. On the face of it, lending McAfee €5m on February 4, only to sell at a loss just over a month later doesn’t seem like the most sensible trade, so it seems like this seller must have been motivated.

Loan trading levels are a long way from hitting liquidation triggers for new issue CLO warehouses — even March 2020 didn’t produce widespread unwinds, and terms have got more flexible since then.

But if you have an undersized deal to reset (Bain 2020-1 was €275m at issue...), and were putting together a side pocket warehouse to bring the deal up to a standard €400m target par....that might be a reason to sell. Bid-offers have widened in loans

Howdy partners

Not sure it would be my favourite week to launch a new asset class into broad syndication, but Barclays is nonetheless seizing the opportunity, announcing Pavillion Point of Sale 2021-1A, a £500m securitisation backed by 0% APR point of sale loans originated by Barclays subsidiary Clydesdale Financial Services.

The deal was originally slated to come last year (hence the 2021 SPV name), and the senior WAL, at 1.45 years, is pretty short — so it had a limited shelf life to get out in the market.

The execution is intended to be rapid, for a brand-new public asset class — it might price as soon as Friday, suggesting that Barclays had some preliminary conversations ahead of launch. As one banker put it, “you’d be nuts to just throw something out there at the moment without having a good idea where it’s going to land”.

In stronger markets, you’d take a couple of weeks over something like this, but now it’s best to seize windows where they exist.

But despite the pre-positioning, it’s still a real public issue, with some real investor education involved — the investor pack spends a fair bit of time unpacking the innovative elements in the trade, including the mechanics for creating synthetic interest on the portfolio.

Given that the loans are 0% APR, this basically works by selling in the loans at a discount, but it’s not quite that simple, as the different retailers referenced in the pool apply different “Retailer Discount Rates”, and there’s a difference between the “Retailer Discount Rate” and the “Financing Discount Rate” which kicks in some extra excess spread for the deal.

This approach also creates unusual effects depending on the prepayment rate — there’s still excess spread in the deal even at 100% CPR (all the loans repay immediately), because they all repay par and they’re sold in at a discount.

We’d expect this to be simple enough for the kinds of buyers that typically anchor sterling ABS — we’re not talking tourist money, we’re talking securitisation veterans that are going to be happy with even quite a weird cashflow model.

The portfolio is linked to a mix of retailers, of which Apple is the largest portion, at 52%, followed by DFS (sofas) on 21%, Wren (kitchens) on 12%. Next (clothes and furnishings) and British Gas round out the portfolio.

When I saw British Gas my ample hair practically stood on end — surely nobody is offering three year 0% APR terms on paying your gas bill? And what does this loan book look like with gas at current levels??

But it was a false alarm! The loans are basically there to spread the cost of a new boiler. Arguably this is more of a necessity than the discretionary new sofas and kitchen refurbs from DFS and Wren, let alone a new iPhone, but the pool performances seem pretty good for unsecured consumer lending during the warehouse phase.

If I was branding this issue, I’d probably call it something snazzy like “iPhone bonds” rather than Pavillion, but this designation indicates that it’s a deal backed by Barclays’ assets — just like Pavillion Mortgages 2021-1, the book of first time buyer mortgages securitised just before Christmas.

Barclays was the originator, and will be providing 5% vertical risk retention in the new deal (for a price of course), and has the flexibility, according to deal docs, to buy up to 100% of the class As and up to 20% of the other classes (also helping to derisk the execution).

But it’s planning to transfer 80% of the class Y (the deal equity) to a fund — the real, economic sponsor, even though Barclays is the legal sponsor.

Deal docs have been carefully scrubbed of any mention of this mysterious entity, but we’re hearing Elliott Advisors...No response from Elliott and no comment from Barclays, naturally.

This kind of point of sale finance is a little different from the fast moving fintech-power Buy Now Pay Later businesses that are the hot new thing in consumer credit — the mechanics are basically similar, but there’s a very long history of finance for large ticket consumer durables, a lot more regulation, and it’s a lot easier to see why consumers would spread the cost of a new kitchen appliance rather than a new T-shirt.

But a successful execution will still point the way for some of the private BNPL facilities out there to spot their capital markets exits...

Placement privacy

Last week was a tough week to bring anything to the primary market, but it wasn’t a total washout for structured finance, with a new RMBS and a small balance CMBS plus two CLOs sneaking through, with preplacement the preferred syndication strategy.

Paratus’s Stanlington No. 2, the RMBS transaction, was a refinancing of two older deals, Stanlington No. 1 (non-conforming) and Ciel No. 1 (buy-to-let), which are coming up for call this month, and squeaked to the finish line before the weekend, with the pricing message released just before 7pm London time.

Classes A-E were “preplaced”, but it’s worth spending a bit of time on what that actually means. Technically it means the bonds were placed pre-announcement, but, given that the announcement message was pushed out just after 4pm on Friday, it’s actually more like a ordinary syndication, but conducted in private, to a more limited group of investors.

It’s the same strategy that prevailed in the months after March 2020, with banks de-risking the syndication process by lining up the key anchor accounts in private.

Some investors loomed larger than others in the 2020 reopening process, but it’s a well-understood way of keeping primary functioning in difficult times. Sterling RMBS is already dominated by relatively few accounts, so limiting the bookbuild in this way doesn’t cut out any of the make-or-break buyers — it simply trades off the price tension and momentum that comes from having the smaller marginal buyers involved, against certainty of execution.

The levels weren’t pretty — 115 bps on the senior notes, compared to 92 bps on Barley Hill No. 2 a couple of weeks before — but 23 bps for the increased risk of nuclear war, huge spikes in commodity prices, sell-off across risk assets, terrible headlines regularly hitting the wires seems rather reasonable in the circumstances.

Issuers with deals to call, like Paratus, can play it different ways — accept the market levels, as Paratus did, for a refi transaction, delay the call, as a couple of issuers did during 2020 or call the deal into a bank facility and warehouse the portfolio for happier times ahead.

Double no trouble?

Kensington, the biggest RMBS issuer in the market, seems to have opted in part for the latter, announcing a doubling of its warehouse capacity last week from £1.3bn to £2.6bn, incorporating a new £500m facility to call Finsbury Square 2018-2 and 2019-1.

The rest of the size increase is down to a boost in the size of the Sloane Square warehouse , which Kensington (very plausibly!) says is one of the largest UK mortgage warehouse lines for new origination.

Lloyds, BNP Paribas, National Australia Bank and Bank of America are the providers. The facilities were probably worked on ahead of the market volatility which has made public placement difficult, though recent events may have encouraged Kensington to max out the size.

It discloses at Companies House that the old facility cost Sonia+109 bps in 2021, and 108 bps in 2020, though the docs are silent on, for example, advance rate.

If we assume the level is still there or thereabouts....that’s a decent argument for holding back on issuance and hoping for a better window.

Kensington, as we’ve discussed a fair bit here, is up for sale, with Morgan Stanley sellside. Sky News suggested a while back that the mortgage book and the origination platform could be split, with the likes of Shawbrook, or Aldermore snapping up the origination flow and M&G and Pimco vying for the back book assets. But which assets? Held where?

Kensington is a tangle of securitisations with around £3bn in assets disclosed in its Companies House accounts. But the real figure seems to be considerably higher. If you take a look at its investor presentation, that gives a £9bn figure “including loans where the lender holds the legal title but not necessarily the economic interest” (we’d think that includes various legacy non-conforming transactions still outstanding).

Kensington’s website gives a still-more impressive £11bn AUM figure, which it says includes £5.5bn in third party servicing contracts, presumably leaving £5.5bn of Kensington assets....whatever the real figure is, it’s going to be a complicated transaction

Whoever ends up with the FSQ mortgages may wish to chart their own course in the securitisation market — meaning calling into a warehouse adds flexibility.

But it’s also prudent treasury management. Skipping a call on a public deal is going to be a last resort for issuers that depend on securitisation market access for their business model, but they’ll most likely be forgiven if they catch up quickly — TwentyFour AM is the classic example, with its 2020 missed call of Oat Hill.

Worse than skipping a call, in the specialist lender community, is having to press pause on origination — that means dropping off broker radar and losing share. During Covid, when the housing market froze as well, this didn’t matter much, but the housing market doesn’t seem to have stopped because of the Russian invasion, and competition is still hot among banks and non-banks alike.

Showing the flag

While Kensington is the biggest M&A situation in UK specialist finance, it’s not the only one. Masthaven Bank has closed its UK lending book, and it’s now up for sale, with Alantra advising.

We understand it’s been very widely advertised, and the likely appetite is considerable — not only do you have the deep-pocketed Pimco, Apollo and M&G types, but there’s also investment bank principal operations and deposit-rich neobanks looking to match assets.

There’s certainly nervousness about levels, takeout strategies, and availability of mezz capital in the current environment...but that doesn’t mean there’s a broader reluctance to try to source assets for a longer term hold.

The world has changed abruptly since the Russian invasion of Ukraine, but the basic supply and demand mismatch between mortgage buyers and sellers remains — there’s a lot more money chasing higher yielding mortgage books than there are high yielding performing mortgage books for sale.

The sale process for Enra is also said to be at an end, with Elliott Advisors winning out, reportedly for a £350m cheque. Elliott seems to us to be cropping up increasingly often in UK consumer assets....we discussed its bridging loan facility with Tenn Capital last year, and of course, there’s the Pavillion deal above.

We’re hearing other rumours floating around too — several securitisation stalwarts have traded in the last year, notably Fleet Mortgages and Paratus, and more are expected — but nothing we can quite publish yet. Ping us a message if there’s an interesting asset out there!