Market Wrap

Excess Spread - Requiem for Kensington, Rizwan and the Viscount, statics and synthetics

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  1. Owen Sanderson
14 min read

Square off: A Requiem for Kensington

It’s finally here — confirmation that Kensington has been sold to Barclays, and more importantly for the wider securitisation market “following completion of the transaction KMC will retain the majority of mortgages that it originates.”

In other words, what we feared would happen has come to pass — Kensington, specialist lending and securitisation pioneer, is intending to get out of the market. So let’s look back at what’s been achieved.

From its first origination in 1995, Kensington has been a genuine innovator. I’ve lost access to the archives of my old publication, but a brief search shows that even in the late 90s the treasury team were pushing the boundaries, with the first UK non-conforming bond in euros (prior to the actual launch of the euro), followed shortly afterwards by the first in dollars, and the first deal in 144A format.

In latter years, innovative transactions include the first social RMBS, and the first UK green RMBS, plus products like shared ownership mortgages, long term fixed, “hero mortgages” for public sector employees and much more. Kensington was the most active RMBS issuer of recent times, the de facto benchmark for specialist lending RMBS, and lit the way for the smaller lenders eyeing up their route to the big time. Losing this issuer means losing volumes, but also losing a pathfinder institution.

Decomposing the purchase price — and what Barclays is actually buying — is a little tricky. Talk ahead of the announcement was £300m-£400m, and that looks pretty much bang on, with the expected £2.3bn transaction including £2bn of mortgages (exact numbers dependent on origination volume, hedge valuation and so forth).

As a platform, though, what exactly is it? People, underwriting technology and systems, brand, and relationships, right? Barclays, with some £156bn of its own home loans, presumably has some of its own mortgage tech and plenty of brand recognition to be going on with. One would think £300m would go a fair way towards hiring some of the best people at Kensington or indeed anywhere else. It is the lower end of the initial talk, but have you seen markets?

Starling’s purchase of Fleet Mortgages last year for £50m was against a very different backdrop (though Starling was also reportedly the underbidder for Kensington).

We’ve talked about the predator-prey dynamic that might emerge in specialist finance, as difficult funding conditions and rising rates squeeze the economics for some.

Kensington, especially as a single package deal, is likely to be very much at the predator end of the spectrum when backed by Barclays’ balance sheet, and perhaps that’s the play — use Kensington as platform for some consolidation?

There’s also the question of what happens to Kensington’s capital markets and treasury team. Presumably going from most frequent RMBS market issuer to originating on-balance sheet for Barclays requires a smaller funding operation, and the team themselves may have higher ambitions than turning out the lights on the various storied securitisation shelves (most of the back book is likely to trade away elsewhere in any case).

The deal hasn’t closed yet, but if you’re working at one of several institutions building out a securitisation business…you could do worse than look at the most experienced RMBS issuance team in the industry.

How messed up is the CLO market?

Spreads are at levels not seen since the depths of the Covid crisis, with a CLO debt stack costing north of 300 bps over Euribor….getting on for double the spread seen at the tights last year. Each lurch wider over the last two months has not been followed by consolidation and stability, but by another round of punishment.

But here’s the thing — pretty vanilla middle of the fairway healthcare leveraged loans, like Inovie and Affidea, are pricing at spreads north of 500 bps with fat OIDs. The historical rule of thumb on CLO arb has been 200 bps+ of excess spread, so this ought to be workable on that basis….though perhaps if CLO liability spreads are 1.5x-2x from historic levels, then excess spread ought to be 1.5x-2x as well?

Anyway, it seems worth distinguishing possible “front book” — CLO spreads and levloan spreads today — from the “back book” of warehouses filled with collateral paying 350 bps-400 bps, which are only getting more stuck as the market widens.

So how much does the stuck backlog affect the possibility of new deals with market-level collateral?

Non-captive equity providers are unlikely to want to do much in the way of new deals, print-and-sprints etc unless there’s a line of sight to terming out their existing warehouses. Banks might well have the balance sheet to put on more warehouse lines (at much wider spreads), but that’s not much good without equity in place.

The turn in the market also makes raising funds for CLO equity investing harder — in good times, there aren’t many bond-like products advertising returns north of 15%. Today, there’s a ton of halfway decent high yield bonds yielding in the teens. Just as in the post-Covid period, distressed funds are sensing opportunity and seeking allocations from LP “alternatives” or “illiquid” buckets that might have once gone into CLOs.

CLO equity funds also have awkward questions to answer about their existing portfolio. The overwhelming majority of CLO equity NAVs in Europe are now in negative territory (82% according to Barclays), meaning if you sold the loan portfolios tomorrow they’d be wiped out. Single B MVOC (market value overcollateralization) is also hovering near or below 100% for many managers, implying this tranche too would be pretty much gone.

That’s not the whole story, but it’s an ugly stat. Liquidation value is in theory, active management is in practice. Equity is still mostly paying distributions, and single Bs are still paying coupons. By design CLOs are not market value instruments (unless loans start trading below 80), so managers in reinvestment should still be able to take advantage of some opportunities. Most of the IRR for CLO equity should come in the lifetime of the deal, from the excess spread baked into the transaction — not from the terminal value — and the whole point is that equity NAV is highly volatile. It’s a highly levered exposure to leveraged loan prices….it could bounce back as quickly as it’s fallen.

Still “buy our product, the NAV is negative” might be a tricky pitch to make if you’re raising new money to allocate to the strategy.

Not so for every manager, though. Word reaches us that CVC Credit Partners successfully raised a $400m risk retention vehicle, closing just before Global ABS. CVC was pretty early in the risk retention vehicle game, with a $600m vehicle closed in 2017, and its US shelf, Apidos, is compliant with European risk retention rules.

But now more than ever, having captive equity capital is essential — and $400m is a pretty hefty reload of capacity, which should easily cover the next 10 deals (potentially more with some financing).

Statics and synthetics

On the question of the back book — we touched on the possibilities of doing static deals to get through some of the market difficulties, through a more efficient structure and (possibly) tighter credit spreads on the liabilities.

Other than Palmer Square, managers don’t seem to like doing static trades, and it probably locks in a poor performance in the moment, but my former colleague Richard Metcalf has also picked up some of this chatter over at IFR, citing Hayfin and Sound Point as managers said to be mulling a static exit.

As he notes, though, static deals mean shrinking the pool of triple-A buyers still further — arguably down to one anchor account. He doesn’t name the investor in question, but it’s everyone’s favourite Major West Coast Fund Manager, the deus ex machina of European securitisation.

So that just shifts the problem — sure, Pimco is probably there at the right price, but does it want to bail out the whole European CLO market with several yards of triple-A anchor?

It’s not even clear the economics would work for a static.

Looking at the last Palmer Square static deal compared to Hayfin IX, which priced the same day (March 17), the tranche spreads were basically in line, by rating (105 vs 107 on seniors, 800 vs 790 for the double B).

The more efficient capital structures (Palmer Square static deals have low 30s par subs at the senior level, vs 38-40 for an actively managed transaction) help a lot, taking the overall cost of debt for Palmer Square 2022-2 some 40 bps tighter than Hayfin IX.

But for managers that were well ramped prior to the Russian invasion, the economic gap is much much larger than 40 bps — static or not, there’s still going to be some pain to take.

One curiously missing piece from the senior CLO investor base is the levered investor base….especially if we see spreads touching bottom, a 4x levered triple-A at 200 bps seems more attractive than taking your chance at the bottom of the stack. We have bank treasuries (sometimes), we have the likes of Alcentra and Axa, but could we have hedge fund money that’s usually in double Bs taking levered positions higher up the stack?

While nerding out a little on this topic, we noticed that PGIM’s Securitized Credit fund has a bunch of synthetic longs on European CLO tranches — it has sold some credit protection on deals for Barings, Carlyle, HPS, ICG and Investcorp. CDS exposure to structured credit tranches has been a bit, uh, disfavoured since the financial crisis, so this stuck out a bit. Take a look at the fund disclosures.

Arguably it would be more use to the market if PGIM showed up with cash and anchored some actual deals, but we wonder if this is actually one leg of the CLO floor-stripping trade that some trading desks put on, taking advantage of the fact that some CLO senior investors didn’t seem to be fully pricing the benefits of the embedded Euribor floor. With the rapid steepening of the Euribor curve this arb is now very much in the rear-view mirror, but it worked last year.

One way to extract the Euribor floor value is just to own the (floored) CLO bond and sell an interest rate floor on to the market, but a more complete way would be to hedge out the credit of the CLO bond as well — by, for example, buying synthetic protection from an experienced CLO investor.

The counterparty for all these transactions was Goldman Sachs, which, to be fair, seems to have done all of PGIM’s structured credit and RMBS CDS trades across US and Europe. But I certainly wouldn’t put it past the clever folks at The Squid to have put on the floor-extraction strategy last year.

Bloomberg reports that NorinChukin Bank is back in town, anchoring the triple-A for Investcorp’s latest Harvest deal, after watching the market for a while looking for entry levels.

If the levels cited in the article are right, and it’s coming in at 155 bps on the senior, that’s miles through the secondary market — but then, NoChu is a pretty weird investor, with its own weird list of stips, and a preference for sole anchor roles. The levels on offer for €5m here or there in secondary don’t matter to NoChu if the managers in question aren’t on the list and the deals in question don’t have NoChu-designed docs.

A more meaningful NoChu presence substantially inside secondary will further widen the gap between managers — those which are on the list and can bring their own equity will be able to keep printing, those which aren’t will remain stuck.


Premium Credit is in market with a deal that could help to thaw conditions in European ABS

It’s massively wide of the last outing — IPTs are 140 area, low 300s, low 400s for class A/B/C, compared to 75/120/170 in 2021 — but the collateral is paying north of 14%, so there’s some wiggle room built into the structure. Rising rates and a difficult backdrop are most punishing for issuers with low-yielding, pre-rate hike collateral to securitise — Premium Credit, which has a highly specialist and high yielding product funding insurance premiums, is in a different category.

It’s also had the good sense to approach the market cautiously, with a protected order already lined up for 50% of the class A, size flexibility coming from the master trust structure, and realistic market-rate pricing.

As of Wednesday, the softly-softly approach looked to be working — the book update contained numbers >1x, which is very much the benchmark for success these days. The 1.4x on the senior excludes the protected order, and the class C is only just covered but….this looks like a relatively orderly syndication for a change.

Another leg wider in Crossover as of Thursday isn’t the ideal backdrop to finalise execution, but as of lunchtime it looked like the deal was hanging together — senior coverage outside the anchor was at 2x, class B at 3.5x, and class C at 2.7x, with spreads firmed up at 140, 310-320, 410-420. That might even be enough for an upsize….coverage levels are based on a £350m deal, but there’s enough collateral for £486m.

Swamping investors never goes down well, but the book is likely to be realistic and actually desirous of bonds — nobody is going to be putting in massively inflated tickets they don’t want to be filled in the current backdrop.

There’s a lot to like about the Premium Credit business (owned by Cinven) — because the financing is linked to essentials like insurance or professional accreditation/association fees, underlying performance is strong. SMEs or sole traders cannot carry on their business without insurance cover, and this gets pulled if they don’t pay their debts. It claims an average loss rate of 20 bps in commercial, 1 bp in personal, 0 bps in educational lending (school fees), and 26 bps in other specialist.

So is it a market reopener, or an idiosyncratic success story, where good collateral and plentiful excess spread have come together?

Checks out

As it suggested last year, the Bank of England’s Financial Policy Committee is now dropping the “affordability test” recommendation from August 1. This means lenders will no longer have to stress affordability to 3 percentage points above the reversion rate — though will still have to abide by rules of responsible lending, an assumption of a 100 bps increase in rates, and incorporating market expectations of rates changes. The “LTI” (loan-to-income) limit of 4.5x still applies, despite being deeply strange.

As the “Credit Me” blog notes, this LTI limit only applies to 85% of a bank’s mortgage book, a strange idea in itself….are loans above this limit risky or not?

“Either these loans are fine, in which case why should they be restricted? Or the metric correctly indicates that borrowers are over extended, in which case why allow any of them?” Quite.

The rising rates since December, when dropping the affordability test was mooted, makes the measure more necessary, but less impactful — because rates have risen to such an extent that the 100 bps stress is close to where the 300 bps stress would have landed in December.

“While there is uncertainty about how reversion rates could respond, this could mean that stress rates could reach close to end-2021 levels within the next 12–18 months, even if lenders were to apply only the minimum stress rate of 100 basis points over reversion rates specified within Mortgage Conduct Of Business rules ,” writes the FPC. “This suggests that the short-term impact on market access and house prices could be limited.”

Substantially sillier is the situation emerging in France (admittedly a much smaller RMBS market than the UK).

Check out this Twitter thread from Johannes Borgen (anon account, but top follow for all things banks) for the full rundown, but basically, French law stops banks charging more than 30% above the average rate for the last quarter. Given rising rates, that will condemn the French banks to losing money on every mortgage they write in Q3, presumably leading to a credit squeeze, or just a straight hit to profits. The problem isn’t going away either….even if all the mortgages written in Q3 are at 30% above the previous quarter, 30% above that for Q4 is still going to be too low. Rising rates are weird, man.

Rizwan and the Viscount

Ahead of his appeal hearing on July 5, Rizwan Hussain, or rather his SPV collection, seems to still be actively filing court claims — and to be somehow mixed up in the affairs of William Waldorf Astor, the heir to the Viscount Astor… English Lord descended from the one-time richest man in America (the aristo habit of calling every firstborn male William Waldorf Astor makes it confusing, but I think it’s either William Waldorf Astor IV or V we’re talking about).

Beyat Holdings, the Rizwan SPV used in attacks on Mansard Mortgages and Hurricane Energy, seems to have filed suit against a collection of Astor-linked investment vehicles, including Aegean General Partner, Baffin Holdings, Long Harbour Investments, Longevity Partners and Way of Life Management. As far as I can tell, these mostly seem to be vehicles for owning freeholds and collecting ground rents — an interest, indeed an enthusiasm, of Rizwan since the Fairhold Securitisation days.

The court filing doesn’t tell us much, because it doesn’t yet include the “Particulars of Claim”. It only says that “following a legal and valid assignment of the relevant rights, interests, title and benefits of certain members of the Watson family, the Claimant seeks damages against the Defendants for i) an unlawful means conspiracy; and further, or in the alternate [ed. this is a classic Rizwan phrase used as evidence in the BMF contempt trial] ii) causing loss by unlawful means, with respect to the interests and rights of the Watson Individuals (and now the Claimant).”

So whatever is going on, it’s something to do with the Watsons. Annabel and Amanda Watson are names which have appeared in previous Rizwan activity, though the evidence they exist is not totally conclusive.

But this Watson reference seems more likely to refer to Eric John Watson, given other Rizwan-related lawsuits that have lately appeared. Tilman Holdings (a Rizwan SPV) has filed a claim against this Watson, plus William Waldorf Astor and James Stacy Aumonier (who works in Astor’s investment management business).

Eric John Watson is a name of considerable interest — any Kiwi readers will no doubt be familiar. Pre-crisis he was the owner of Hanover Finance, a New Zealand non-bank lender which collapsed in the 08 crisis, and since then he has managed money through his private firm Cullen Investments. He was one of New Zealand’s richest men, and owned high profile rugby team the New Zealand Warriors.

But he’s had long-running legal difficulties of his own, thanks to a long-running dispute with Kiwi billionaire Owen Glenn, and was sentenced for contempt of court in 2020. I can’t really do better than link to this piece for some background, though this piece is pretty spicy too, and this judgement from the Jersey courts might be of interest to the legally-minded.

To add to the confusion, there’s yet another court case on file, this from the various Astor vehicles as claimants, purportedly also targeting Eric John Watson, William Waldorf Astor, and James Stacy Aumonier as defendants.

Previous Rizwan-linked court cases have been filed in the name of SPVs he does not in fact control, often against the legitimate directors and officers of these SPVs, making it slightly painful to sort out who is sat on which side. It’s not clear whether that’s happening here, as the court info isn’t yet available, but it would fit the previous MO very nicely.

I have yet to convince my employer to hire a full-time Rizwan correspondent, so if you have any shortcuts through this tangled web I would love to hear them — drop me a line on

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