Market Wrap

Excess Spread - Curious calls, no prison no problem, SRTs and Streisand

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

Curious calls

AlbaCore Capital’s fourth euro CLO comes with an elegant and beautiful tweak to manage the ballooning belly of the CLO capital structure — rather than have single, unified non-call and reinvestment periods, why not differentiate by tranche?

Different investors at different capital structure points presumably give differentiated value to call protection, so why not pull the lever and see if it results in stronger execution?

As such, the senior and class ‘B’ notes in Albacore Euro CLO IV get a normal 1.5-years of call protection, while the single A to single B tranches get only a year, giving the manager and equity maximum optionality to refi when and if liability spreads improve.

For the junior mezz, any concerns about the lack of call protection are likely mitigated by the juicy upside in a call — as single B and double B notes are usually issued at a discount (in this case 95 and 96.5 respectively), so, an early call gives some upside. For that reason, most partial refis priced over the last year left the single B notes untouched — equity and managers didn’t want to find three or four points of par just to trim coupons — but as spreads have widened, the balance between possible coupon savings and principal costs has shifted.

The market seems to have shifted squarely to a one year non-call / three year reinvestment period (1NC/3RP) structure, just as it did during the post-Covid period.

But we aren’t yet seeing the demise of the single-B note, the other big structural change from the spring of 2020. CLOs typically target at least 12% IRR for equity (at least, that has been the level at which the manager incentive fees kick in, for time immemorial). With Partners Group and PGIM printing single-Bs at 1050 and 1060 (plus a Euribor floor), it starts to look pretty expensive to issue this risk to’re giving away equity-style returns for a debt instrument with a nice cushion underneath.

If you don’t issue it, however, you need to find more equity from somewhere to support a lower levered deal. In a strange sort of way, the extreme trauma of March 2020 might have made this more possible than the relatively mild loan disruption seen in March 2022 — more warehouses were liquidated or restructured, more managers were faced with an existential question of whether it was even possible to stay in the CLO market, and the potential upside from loans pulling back to par was much bigger.

With the loan sell-off more manageable this year (and levels swinging back), recutting capital structures seems to be off the table — it’s more about accepting current levels with gritted teeth, or monkeying about with the call structure to get a deal over the line in its intended form.

Some managers and equity providers can come up with a hybrid approach — issue the costly tranche to themselves, especially if they have a mandate that already invests in CLO tranches. Lots of the capital active at the bottom of the CLO capital structure can flexibility switch between equity and single B in primary and in secondary. This still amounts to “put in more money”, but at least maintains a fully levered structure with the option of a secondary sale down the road.

Yet more interesting is the possibility of the “print and sprint” deal, which reared its tantalising head exactly once in Europe in 2020, with a deal for Fair Oaks. The steady drip of CLO primary since the Russian invasion of Ukraine has consisted of established warehouses finding routes to market — but if you’ve got equity ready, is there a window to bang out a deal and scoop up some value?

Several of the managers who have made it through primary have chosen to boost their deal sizes (CVC, Investcorp, PGIM), which is arguably the same logic as a “print and sprint” — better to have more cash locked in and yet to be invested, lowering the average purchase price of the portfolio and redressing the arbitrage imbalance. You could say they’re “print more and jog” deals.

As markets have partly normalised, and loans have rallied, this window, if it existed, has probably closed — the technical imbalance of a primary loans drought (no sizeable broadly syndicated issue since mid-February) and multiple CLOs trying to get ramped quickly has made the better loan names look expensive again.

Where there’s still value is in bonds, which traded off well before the Russian invasion with rising rates expectations, and still haven’t bounced back — managers with large bond buckets (or which can rapidly redraw docs) will want to lean heavily on this strategy.

It’s back on

If last week was all about playing it safe, bringing low risk funding trades with STS and ECB benefits to market, this week looks like we’re back, cautiously, into “normal” ABS territory, with some spicier non-bank, sponsored and legacy deals looking to sell through the capital structure.

Oodle, a UK non-bank car lender, announced Dowson 2022-1 on Monday, via BNP Paribas and Citi, looking to sell through to the class X, while Morgan Stanley announced Primrose 2022-1, an Irish legacy reperforming loan RMBS offering bonds down to the reserve notes. This was followed on Tuesday by RNHB’s Dutch Property Finance 2022-1, a Dutch buy-to-let RMBS, with four class of investment grade bonds on offer via Barclays, BNP Paribas, HSBC and Natixis. On Wednesday, regular issuer NewDay joined in, announcing credit card ABS NewDay Funding Master Issuer 2022-1 via arrangers BofA and Santander, joined by NatWest Markets and SMBC Nikko as JLMs. This will also, as usual, offer senior notes in sterling and Sofr-linked dollars and sterling mezz down the stack.

These are all very different transactions, but likely reflect the mainstream of the asset-backed pipeline better than the senior funding transactions seen last week — the market has been migrating for years now to focus more on funding fintechs, sponsors and hedge funds rather than the banks or captive auto funders which used to make up the bulk of the volume.

All of these deals apart from Dowson are slated to price after quarter-end, which may have benefits for execution — we have been hearing of some accounts reluctant to put down cash in the last weeks of Q1, concerned about possible fund redemptions at the end of the period. As Q2 dawns, that might be enough to give certainty of execution for these more credit-intensive transactions.

Books on Dowson, though, should put paid to any worries, with coverage of 2.9x, 4.9x, 4.5x and 5.1x for classes A-D. Whatever else is going on, there’s clearly some money out there when the level’s right.

On the Morgan Stanley deal, Fitch Ratings was excited enough to press-release its involvement, as the first European deal where it addresses payments only up to the Net WAC Cap — it says it “previously considered net WAC caps as unfamiliar to market participants outside of US structured finance...since more EMEA RMBS with this feature closed after 2017, Fitch now believes that EMEA RMBS investors are sufficiently familiar with the product for our ratings to address the likelihood of payment only up to the net WAC caps”.

Let’s back up a bit and try to pick it apart a bit. Net WAC Caps limit the amount that note coupons can step up once a deal misses its call — or rather, they tweak the deal waterfall, so that part of the interest on the mezz is paid at its ordinary point in the waterfall, and part of it is subordinated.

The point of doing this is generally to achieve better ratings and/or a more efficient capital structure — rating agencies do not rate to a deal’s call date, but the final maturity of the bonds. Their interest rate stresses therefore assume a post-call capital waterfall and capital structure, with higher stepped-up coupons on the notes. Limiting the interest paid after the call date goes past therefore means better ratings.

This is complicated and, as Fitch says, kind of rare — it’s only really a big feature in low yielding legacy portfolios, such as reperforming loans (RPLs). Portfolios with newly originated collateral tend to kick off enough excess spread that interest stresses aren’t the binding constraint on achieving certain ratings or capital structure. In practice, these low-yielding RPL portfolios tend to be Morgan Stanley-led Irish RMBS deals, but as the agency also acknowledges, there are now quite a few of them.

Fitch’s change here is a signal that it’s up for rating these kinds of issues, and is now ready to be competitive in the market — a lucrative niche, with heavily tranched and complex capital structures (Primrose has seven classes of rated notes). Its ratings on Primose, though, are a notch or two down from S&P and Kroll for most classes, so it might remain the less preferred option for MS’s structurers.

Also worth noting in the Primrose transaction is the presence of Standard Chartered as a co-manager. We talked last week about StanChart’s role as an anchor in recent CLO transactions, and it’s been a big senior investor in RMBS for a long time, as well as a provider of warehouse finance to UK non-banks.

Primrose is a somewhat funkier deal that StanChart’s usual fare though — the closest comparable we can see where StanChart was a lead was the second slice of Project Castillo, Miravet 2020-1, which it led for CarVal. The bank was a JLM, but not necessary an anchor investor in the portfolio, as this role may have come from its investment banking and warehousing activities.

Watch out Godfrey is still about

Rizwan Hussain was sentenced to 24 months in prison for contempt of court on March 11 by a distinctly unimpressed judge, who found he committed repeated and numerous breaches of the injunction, which were deliberate and contumacious, as well as cynical. He noted “the defendant has not cooperated. It is in fact hard to think of a case involving less cooperation”, and that “the overwhelming likelihood is that he will continue to breach the court’s orders unless restrained by a sentence of imprisonment”.

But there’s still the small matter of actually finding him, and it seems that, arrest warrant notwithstanding, his activities are apparently continuing — Mansard Mortgages 2007-2 issued a notice on Tuesday saying that the trustee, Vistra, had a notice from FVS Investments Limited, one of the Rizwan vehicles registered in the Marshall Islands, directing it to appoint various persons, including “Godfrey Hicks”, as directors.

The same old playbook, in other words, launched in the teeth not only of injunctions against the contact but literally while hiding from an arrest warrant. I honestly thought the most recent Rizwan chapter had been closed by the prison sentence but the world is a stranger place than I thought possible.

Polish off

The SRT market is on a bit of a run — as we wrote before, activity is at historic highs, with more originators, more deals, more jurisdictions than ever before, a broadening investor base and much to celebrate in the sector. Let’s add Poland to the list too, as PGGM and mBank have just done the first STS synthetic risk sharing deal in Poland, and the first Polish deal with the private sector (EIF has been fairly active already).

PGGM likes blind pool deals in significant size (it’s by some way the largest investor in the market), and this is the largest ever Polish deal, at PLN9bn (€1.9bn). That makes it the largest securitised pool in the CEE region, as well as the first Polish deal for PGGM and first securitisation for mBank. Parent Commerzbank has done several risk transfer deals in the past, but it has signalled that it wants to divest mBank, launching a sale process which was interrupted by the pandemic.

The argument for blind pools is that PGGM wants to position itself as a partner in the bank’s risk management process, rather than a pure counterparty. By contrast, other firms (Chorus Capital, for example) like disclosed large corporate pools, which makes the investment decision closer to other structured corporate credit products like credit index tranches, correlation trades and CLO equity — the investor can look across various forms of levered corporate credit risk for the most attractive risk-reward characteristics.

But an SRT deal can blow up reputations, if the bank mishandles the product. Since the FT’s Rob Smith wrote up Credit Suisse’s wealth management risk sharing deal, it’s started to cause particular trouble for the Swiss lender, compounded by the political sensitivity following the Russian invasion of Ukraine.

The latest on that is that the unfortunate Credit Suisse is now being investigated by a US congressional committee over the deal, and has to hand over documents running back to January 2017 about its wealth management lending operations.

Credit Suisse has only itself to blame — after the initial story hit the pink pages, it sent a request to investors that turned down the deal to destroy documents related to it, making sure that stable door was firmly bolted after the horse. But the FT wrote about that too, making sure the spotlight stayed firmly on the Swiss bank. Destroying documents is never a good look, and the request made it seem like CS had something to hide.

The actual terms of the letter were also absurd and comical. Credit Suisse said to investors that there had been a “recent data leak to the media” which had been “verified by our investigators”....move over Sherlock Holmes, we have a new sleuth in town, a Credit Suisse compliance officer armed with an FT subscription.

It’s what’s known as the “Streisand effect”, after Barbara Streisand attempted to supress pictures of her beachside mansion in Malibu in 2003. Before the lawsuit, only six people had downloaded the picture; afterwards, 420000 people had viewed it.

The basic CS deal seems to have been reasonable enough — a big SRT bank, with a big wealth management division, decided to use the technology to hedge part of its wealth management lending, including loans secured by yachts, jets, property and financial assets. The presentation deck for the deal revealed, per the FT, some interesting info about Credit Suisse’s yacht lending, and highlighted that the book had some defaults from 2017 and 2018 related to sanctions against Russia. But there was no reason to think the deal was anything other than an unusual SRT trade.

If it had an ugly angle, it was the thin tranche (0-4%) with a highly concentrated portfolio (largest obligor 1.5%) — the law of large numbers is no good here, a couple of accidents and you’re wiped right out.

But whatever the benefits or dangers of the actual deal, it’s definitely not worth a congressional investigation - even the thoroughly pure and innocent might find the idea of lawmakers poring over their private emails a little nerve-wracking.

CS can draw two contradictory lessons from this — the first, which is wrong, is that SRT deals aren’t worth it, they can draw too much heat, too much public opprobrium, and if they do exist, they must be struck under conditions of the utmost secrecy.

The second lesson is that the excessive secrecy is precisely the problem. If Credit Suisse had said “sure, nothing to hide here, no sanctioned loans in the book, here’s some lightly redacted deal terms for everyone to look at”.....then no investigation, no problem, issue goes away.

The disclosures in the pitchbook were no doubt confidential, in the sense that they haven’t been disclosed to CS investors or the public before, but we’re not talking deep dark secrets here. UBS’s wealth management team aren’t going to be poring over the PowerPoint deck in a smoke-filled room, plotting their next move to steal a march on their rivals. If Credit Suisse’s wealth management rivals really want to find out how that business is doing then guess what? They absolutely can, SRT docs or not.

As a reporter I’m talking my book a little here, but the next step in the growth of the SRT market surely should be a greater presumption of transparency. The market has grown and strengthened, but it’s hard for any outsider, including any interested investor, to get a read or a temperature check on the SRT market.

If you’re a prospective LP in a risk transfer fund, ransacking the internet for info on the new market you’re excited to invest in.....there’s virtually nothing out there. Try finding so much as an average primary margin for the last three months, let alone a meaningful quote level, even on the more liquid SRT tranches. The market operates behind a wall of NDAs, unless required to do otherwise — and the wall is far higher than it needs to be to protect the commercially sensitive information of the bank issuers.

We’ve been attending IMN’s excellent Significant Risk Transfer conference this Thursday, for the soft launch of our one-man transparency campaign — updates next week on how that’s gone.

Solar flares

Despite the deep rumblings of a potential solar market, we’re still in the very early days of the market, according to our research so far. Solar loans would clearly help the energy transition, funds have cash to put into the asset class, and securitisation is the logical way to lever it but......where’s the origination?

The answer might be to keep it simple. The successful US solar market works off the PACE tax lien scheme, which requires local legislative approval to work its way into property tax codes, and interacts awkwardly with secured mortgage debt. But the barriers to even building such a product are high. Other semi-official attempts include the UK’s Green Deal loans (basically a total failure, only 1754 households signed up) and various combinations of state-supported feed-in-tariffs and attempts to leverage this cashflow into repaying solar loans.

By far the simplest mechanism, though, is just an unsecured personal loan, with use of proceeds for purchasing solar panels. No security package with awkward enforcement (how do you send the repo man round to take panels off someone’s roof?), no tax complexity, assignable when you move house, no dependence on government subsidies, no regulatory issues.

The problem, though, is that unsecured personal loans tend to be expensive for borrowers, with the interest rates easily chewing through the energy price benefits of any solar installation and then some.

So to make the market take off, you need to be able to take a view on why borrowers for solar panels are a better bet than general unsecured lending. There might be good reasons for that — they’re homeowners, they’re investing in tangible home improvements which can save money long term, they’ve clearly got the financial flexibility to think about the long term — but these are as-yet unproven characteristics, potentially making it hard to ramp up lending in a big way. Until the product is sorted out, solar is going to remain a beautiful dream.

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