Directing traffic

After a pleasant week in the English Riviera, enjoying the pastry and cream-based cuisine for which the region is famous, I returned to work to see that the securitisation market had been a little, uh, underwhelming in my absence.

The three consumer transactions in market, M&G’s Mulcair No. 3, Apollo’s Prinsen Mortgage Finance No. 1, and Domivest’s Domi 2022-1 all saw lacklustre subscription levels and soft executions.

The trouble had seemingly started the week before, with coverage levels on Orbita and NewDay far from slam-dunks, and only the ultra-prime Green Storm 2022-1 sailing through the market. Even Storm, though, approached the market cautiously, showing a lot of leg to get early interest in the book — tightening 8 bps from IPT to final of 20 bps is a big move for a blue-chip shelf.

So what’s going on here?

First off....the market just wasn’t strong enough to support the dealflow. Banks eager to move through their pipeline may have misread the firmness of conditions at the end of March and first week of April — perhaps there was just too much supply given that the green shoots were only just emerging.

But it’s worth looking closely at the specific ways in which the market has been weaker. It looks like investment-grade mezz has been holding up well, and even rallying, while the top and bottom of the capital structure has struggled.

Prinsen, as an inaugural issuer, seems to have been the biggest casualty — €225m out of €338.6m senior tranche got sold, at 55 bps from mid 40s IPTs. The mortgages in the deal are so good there’s very little mezz to go round (the class B and C were only 1.75% and 1.5% of the capital structure), so the senior is very much what counts here.

As usual for triple-A bonds, the question is not so much “will this bond be credit-impaired”, as “will this bond be called on time”?

The extension risk protection here is broadly on market — a 1.5x step-up isn’t much to write home about, but full turbo after the call date ought to be reassuring.

Still, it’s a new shelf, and Apollo as a sponsor in other markets has something of a.... mixed record on creditor-friendliness. The Prinsen shelf will be a regular issuer in the future, so there’s an incentive to play straight but.....investors won’t have a call track record to look at until December 2026. Apollo does now own Paratus, so there will be plenty of Twin Bridges issues where it can show respect for the FORD (First Optional Redemption Date), but it does have a reputation to overcome.

Being an inaugural issuer in the week before Easter is also going to be a tough sell. If junior PMs are manning the desk while the seniors are on holiday, extracting large tickets for a brand new shelf is going to be tricky.

But that doesn’t apply to the other deals, which are well-established platforms — Mulcair No. 3 is largely a refi of Mulcair No. 1, and it’s the fourth Domi deal.....so it seems the market itself was just not that great. Senior investors evidently aren’t axed to chase deals; if the price isn’t right, they’re happy to pass and wait for the next one.

Execution is harder to parse for the junior mezz, but a bunch of the recent deals started out with junior tranches offered to market which didn’t get sold.

Apollo originally looked at selling ‘XR’ and ‘R’ notes in Prinsen, M&G looked at selling class ‘F’ in Mulcair. The week before, Close Brothers retained its ‘B’ and ‘C’ notes in Orbita, while NewDay jammed its class ‘E’ through the market at a rather unpleasant level — 535 bps from IPTs of mid-high 400s, esssh.

One can presume Apollo and M&G have pretty developed ideas about where their mezz and equity ought to price, and deep enough pockets to hang onto tranches if the market doesn’t share their views. But the funds active at this end of the capital structure are also pretty hot on value — and conscious that only a few accounts are active in these spots at the moment.

So offer fails to meet bid, and bonds get retained, to everyone’s detriment.

But the securitisation machine is still working, with four new issues announced this week, at the time of writing. With a stacked pipeline heavily compressed by the Russian invasion, there simply isn’t time or capacity to sit around hoping the perfect execution window comes along.

At least, in the issues announced on Wednesday, it’s unlikely they’ll be treading on each others’ toes. Clydesdale’s Lanark 2022-1, a UK master trust RMBS, is unlikely to cannibalise LendInvest’s Mortimer 2022-1, which in turn won’t cannibalise Hill FL 2022, a Dutch lease ABS with an STS designation.

The last deal is probably most interesting, because it’s an inaugural for Hiltermann Lease Groep. Yeah, me neither, but it turns out it’s an Elliott Advisors portfolio company. Elliott as performing consumer credit investor is something we’ve been seeing much more lately — the Barclays point-of-sale book was said to be Elliott-sponsored, it’s been doing bridging loan deals....and probably more besides.

Thursday brought Atlas Funding 2022-1 from Lendco, which, as another prime specialist lender BTL deal, will be targeted at a similar audience to LendInvest’s Mortimer. But neither transaction is so huge it should swamp the market. Lendco has probably been waiting to launch for a while.....the pool cut is dated 31 January 2022, so it was likely pencilled in for Q1 but pushed given the conditions.

Investors in charge

Investors are also in charge when it comes to CLOs, though the symptoms are different than in consumer assets — a dearth of priced primary, rather than heavy supply of deals which struggled.

There’s plenty of supply either waiting in the wings, or marketing...we hear Barings, Invesco, Angelo Gordon and KKR in market, and there’s even a reset in the offing, following last week’s cleansing notice out from CSAM’s Madison Park Euro Funding XV.

This is effectively the last deal from the Before Times — it snuck through the market to price on March 11 2020, the day the World Health Organization declared Covid a pandemic, and, pretty much one of the worst sessions ever in markets. The levels were wide, at 120 bps on the senior and 1050 bps on the junior, but less bad than one might have imagined given the absolute bloodbath in pretty much all tradeable assets that day.

Even if the reset just matches the levels achieved in March 2020, the trade is probably about flushing out some par. March and April 2020 was a pretty good time to ramp, a wonderland of bargain-hunting for the bold investor with money to spend, but this is likely still trapped in the structure, and as a “pre-Covid” deal (just about), it will have just come out of non-call.

As in consumer assets, the tone is firming up in the belly of the capital structure, but the top and bottom seem softer. Investment grade mezz is still cheap to comparable assets but becoming more sought after, but senior investors, of which there are few enough at the best of times, are seemingly not inclined to chase bonds tighter.

ICG’s Euro CLO 2022-1 placed senior bonds at 115 bps before Easter, in line with BlackRock, the only other primary print this April — in historical context, a reasonable level, but well wide of the pre-war low 90s levels, even as other IG asset classes creep back to pre-invasion prices.

The big problem for the market remains the equity arbitrage — as we wrote before heading off for hols, loans rallied much faster and sharper than CLO liabilities, closing the potential “print and sprint” window almost as soon as it opened. Bargain-hunting was likely fruitful for the first few post-invasion deals, which could aggressively ramp before loans snapped back, but bargains are now hard to find.

Primary loans are back, with Cupa and Clinigen trades priced this week, at or inside the tight end of talk — it’s going to be a challenge for CLO managers to deliver decent returns until some balance returns to the market. A potential wild-card for loan supply is the LBOs which were earmarked to come with big secured fixed rate bonds in the capital structure. Arrangers are likely to find an easier exit if these structures can be recut into secured FRNs or TLBs and sold into the CLO market, which could be pretty helpful in keeping the machine running this year.

Either way, the rubbish arb means a decision for equity. Warehouses these days are long term and flexible, but they’re still more expensive and less levered than a term deal.....but doing a bad term deal, especially one assuming a call in a year or so, locks in enough legal and arranger fees to make a good argument for waiting.

We’ve spent most of the day on Thursday at IMN’s CLO and Leveraged Loan conference in London, a sold-out event which, notwithstanding the thin supply of late, was a pretty fired-up bullish event. The vibe is very much a pause rather than a problem.

We’ll be bringing out some further coverage, but some themes we thought were interesting include....

• Will the larger fixed rate buckets be a permanent feature of the market? Managers coming to market at the moment have an incentive to scoop up cheap bonds (if they’re able to), and recent docs have sought to boost fixed rate buckets....but fixed rate liability buyers are thin on the ground, so creating liability stacks with large fixed portions might be a challenge.
  
• Will the Japanese anchors come back? To be honest this has been a theme of basically every CLO event I’ve ever been to, but it genuinely is one of the possible catalysts which could bring the arbitrage back into balance. But if they’re only interested at spreads above 110 bps, that’s not much help, and they could disappear as soon as they arrive.
  
• What happens to the manager universe? Europe’s CLO market is about a fifth of the size of the US, but it has around half as many CLO managers.....and one panellist at least reckoned a potential 10-15 new managers looking. Does that mean there’s too many? That’s a popular view. Even when there were 30-40 active managers in Europe, many expected a wave of consolidation just around the corner. Now there are more than 50, and it still hasn’t really happened, besides a few situations we’ve batted around in these pages before. So is there a catalyst for a broader move?
  

Regulation is fine actually?

The European Banking Authority published its “Final Draft Technical Standards on the risk retention requirements for securitisation” last week, a long-awaited paper which, on our basic read, doesn’t say anything much out of line. Of course, this still isn’t actually the law — it needs to be adopted by the European Commission, and published in the Official Journal — but it’s another step closer to actually knowing what the rules are for securitised products in Europe. The consultation process has got the securitisation industry out of a few jams over the years, but the extreme length of the whole rulemaking process has created its own issues....

As a recap, European policymakers pushed through the “quick fixes” in 2020 (”quick” in this context meaning only requiring a couple of years) amending existing securitisation and banking regulation to try to respond to the presumed impact of the pandemic. New securitisation rules had gone live only in 2019, and the problems were already apparent, so this leapfrogged the usual five year review timeline. The idea was that securitisation markets could assist with the expected mountain of post-Covid non-performing loans, and help to recap Europe’s banks.

The NPL wave hasn’t quite materialised, and Europe’s banks are, on paper, as good as they’ve been in a decade, but no matter — it was a worthy intention. The most consequential change is a set of provisions allowing NPL servicers to be risk retention entities, but there are other tweaks too.

What hasn’t changed is a requirement that retention entities be entities of substance. This is a legal term of art, and doesn’t necessarily mean what you might expect. It’s not ok for an SPV to be formed purely to hold a risk retention, but it’s perfectly fine for a risk retention vehicle, whose main purpose (but not Sole Purpose) is to buy risk retention pieces, to go out and raise related party funds to do so.

It’s a pragmatic response to a kind of dumb rule — risk retention for CLOs in particular never really made sense; it was an awkward copy-paste of a concept designed to stop banks stuffing their crummy mortgages into securitisations and keeping the good stuff for themselves. Even this, as I write it, doesn’t make loads of sense....one might think that banks distributing equity in their crappy loans outside the banking system to hedge funds was a good thing, at least from the perspective of banking regulators, but here we are.

Anyway, the point is...no major landmines in the new risk retention rule. Regulators have a charming habit of dropping new rules just before holidays, and so most of the usual smart law firms haven’t yet done their detailed work on the proposal, but it’s mostly in line with the draft, and providing a touch more certainty.

One issue for CLO markets which hasn’t been sorted out by this paper or any other is.....what happens if noteholders vote to replace a manager? It’s a pretty standard right in CLO docs, though rarely exercised.....but if the collateral manager, or some related entity was the risk retention entity, how does the new manager step in? As drafted currently....it kinda can’t, making a bit of a nonsense of the rules.