Market Wrap

Excess Spread - SRT blues, the Bermudan bid, Dutch deluge

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

Excess Spread will be off next week, returning after Easter. Drop me a line if there’s something cool I should be covering!

If you look up “securitisation” on Investopedia, you find out that “it’s the process of taking an illiquid asset or group of assets and, through financial engineering, transforming it into a security”.

Except in CLOs, where the process is more about taking basically quite liquid leveraged loans and transforming them into somewhat less liquid securities.

That’s been evident since the Russian invasion, the sell-off and the subsequent rally, where leveraged loan prices have mostly been moving faster than CLO liability pricing, creating an attractive opportunity early on for managers that had locked in capital, and more recently, squeezing the CLO arb, as leveraged loan pricing has bounced back faster than CLO liability spreads. The market itself is partly to blame — with a healthy number of new issues ramping hard and no new loan supply, there’s a technical bid pushing loan prices back up.

CLO new issue has therefore slowed down a bit, just as the European leveraged loan market has tentatively returned. Element Materials, MKS, and Delivery Hero, all dollar-led capital structures with euro tranches, are in general syndication, while UK pharma company Clinigen and Spanish Slate producer Cupa Group launched on Thursday. Much of the underwritten pipeline is in pre-marketing, potentially for execution after the Easter break (the lengthy two week syndication standard means anything before then will be a rush job, though Clinigen’s April 20 commitments deadline suggests it is possible to leave books open across the long weekend).

A week or two here and there doesn’t mean much, however — what’s important is that the market is finding its footing again, and will return to some kind of balance in the medium term. The focus remains mostly on clearing the current crop of warehouses, but new facilities are being opened, we understand, with the expectation that there will be a worthwhile market in six to 12 months. Especially since the Covid sell-off in March 2020, managers have focused on making sure their warehouse structures are resilient in all market weathers, with a nice long runway and minimal mark-to-market features.

Manager consolidation is also on the table (sort of). First Eagle Investments bought Napier Park Global Capital, bringing $18.7bn of AUM. But First Eagle (which already has a US broadly syndicated and middle market CLO business) will carry on running Napier Park in the same fashion, with the same team, and, presumably, the same CLO shelf names and approach. First Eagle Alternative Credit, which issues the Wind River and Lake Shore programmes, will also carry on undisturbed as a unit within First Eagle Investments.

WhiteStar has also been active again, acquiring Carson Capital’s CLO operations, which have five reinvesting US deals under the Cathedral Lake brand. WhiteStar, which issues deals branded “Trinitas”, recently acquired Mackay Shield’s European CLO arm, with two outstanding issues, and has already reset the second of the two deals. Neither sale comes with a publicly disclosed price tag, so the most useful print remains Carlyle’s $787m purchase of CBAM, announced last month. This was a smaller deal than Napier Park ($15bn vs $18.7bn), but again, the details matter.

CBAM’s growth in its early years was powered in part by Security Benefit Insurance, a Topeka-based insurance firm also owned by Todd Boehly’s Eldridge Industries. As my former colleague Alex wrote, during 2017 and 2018, Security Benefit bought just under 70% of CBAM’s mezz. The extent to which equity in the CBAM deals was been part of the Carlyle acquisition isn’t clear — but could have a major impact on how relevant it is as a comp.

Napier Park is also a broader business than CBAM, which is a pretty pure-play CLO operation. Napier Park does CLO tranche investing, munis, railcar leasing, aircraft leasing, opportunistic credit, renewables and more, as well as its CLO and par loan activities.

Basel blues

As promised, here’s my rundown of IMN’s Significant Risk Transfer conference....a highly recommended event which is honestly going from strength to strength, just as the risk transfer market is — more people, more buzz, more deals to be done. More banks are active, using the product for a broader set of reasons, and regulators are mostly being helpful now.

My transparency campaign was rather less successful — the industry remains fond of its privacy, and participants generally felt that the investor who spilled the beans on Credit Suisse’s wealth management SRT (the yacht securitisation) had done bad for breaking their NDA.

Santander’s Steve Gandy even stayed tight-lipped about a deal due to be press-released that very day during his panel session — it’s this rather cool IFC-Santander Polska deal on a $730m portfolio, with a climate risk mitigation objective, so that capital saved by the IFC’s guarantee can be recycled into new green lending. The IFC’s press release actually came out Monday, so perhaps he was wise not to jump the gun the previous Thursday, knowing the slow grind of comms approvals at public sector institutions....

The big fear stalking the auditorium at Clifford Chance’s offices in London was Basel, however, where a defective piece of drafting once again threatens an entire segment of the securitisation industry.

This seems to be something of a theme for securitised products — I remember writing about the risks to the conduit business from badly drafted disclosure regs at the back end of 2018, and the industry seems to have had regular “fire drills” throughout the decade-long re-regulation of securitisation, where some highly technical unintended consequence threatens to shut down whole business lines.

At the transaction level, regulators have been pretty supportive of SRT markets of late, with consistent guidance from the EU Single Supervisor giving Europe’s biggest banks predictable parameters for structuring deals. The UK won’t pre-approve transactions, and is rather less flexible than the EU’s Single Supervisory Mechanism but it, too, has been basically reasonable and consistent in applying its rules, and US authorities are starting to warm up to the market.

But the Basel drafting — in particular, the output floor — threatens to make ordinary risk transfer trades essentially uneconomic, by cranking up the capital weight on the retained senior tranche of deals to an unsustainably high level. This threatens to undo the good work of, for example, STS for synthetics, does the exact opposite, and cuts the senior risk weight for European banks.

The aforementioned Mr Gandy was good enough to explain the issue to me, using elevator panels to represent tranched portfolios, but it’s pretty heavy-duty technical stuff, and I don’t think I can do better than pointing to the IACPM, the lobby group for the SRT industry, which has a nice run-down of the issue and a proposed fix.

Other big themes of the event were, inevitably, ESG. The industry seems pretty supportive of the EBA’s approach to sustainable securitisation, which follows the broader green bond market in looking at green use of proceeds, rather than backing deals by green assets.

One issuer made the very reasonable point that banks are pretty keen to hold onto the smallish pool of good quality sustainable assets they have managed to originate, rather than sell the risk out to the market in an SRT — they’re much more keen to move their brown assets off balance sheet and use SRT to recycle capital into new green lending, as in a use of proceeds deal.

There was also a fair bit of chatter about “cliff edge risk”, especially in the context of deals from EU-regulated banks. This is essentially the classic thin-tranche jump-to-default problem.....if a securitisation pool is too lumpy and the tranches too small, the law of large numbers stops being useful in credit work — a small number of accidents can blow up a whole investment.

What’s interesting is that bank regulators appear to care about this in an SRT context. The vast majority of regulation affecting the sector is about making sure banks have genuinely transferred risk to protection sellers, and are not using structural artifice to keep the capital benefits of risk transfer without fully disposing of the risk in an effective hedge structure. Bank regulators want to make sure banks are appropriately capitalised, that’s pretty much the core of the mission.

“Cliff edge risk” only has the potential to hurt protection sellers, which are generally specialist hedge funds with long term capital — who neither want or need regulators to look out on their behalf. Insurers, it’s true, are getting more involved in the sector, but surely the right way to manage these risks is through insurance supervision, not through banking supervision?

Beautiful Bermuda

Sixth Street is getting into the securitisation business (it’s US-first, so it’s called “structured products”), with the hire of Credit Suisse’s Michael Dryden. Securitisation is one of Credit Suisse’s biggest and most profitable businesses, and Dryden used to be global head of it, so he’s practically the definition of a “statement hire”. Credit Suisse had a pretty rough 2021, with Archegos and Greensill, and predictable effects on comp and morale. It’s been losing bankers at a rapid clip, so perhaps it’s no surprise that Dryden sought greener buyside pastures.

What’s most interesting, though, is the reference Sixth Street makes in its release to Talcott Resolution, the insurer it bought last year.

The sweet combo of insurance capital with alternative asset management seems to have turbo-charged Apollo’s asset gathering, thanks to Athene and Athora (more on this later) and others, such as KKR with Global Atlantic and Ares with Aspida seem to be making the same move.

There’s a basic economic rationale to it. On the insurance side, it’s about replacing low-yielding insurance portfolios full of IG corporates and govvies with illiquid credit in all shapes and sizes, and reaping the resulting yield-pickup, while for the asset managers it’s a private permanent capital pool that allows them to write big tickets for the long term, and clip a nice fee for doing so.

But there’s a couple of regulatory wrinkles too, pointed out by the smart folk at Risk magazine. Bermudan insurance regulation allows securitised products and corporate bonds of the same credit ratings to attract the same capital treatment — an approach which prevailed in the rest of the world during securitisation’s pre-2008 boom days, with well-documented effects.

According to Risk, the Bermudan regime also allows excess spread to be booked as up-front profit. We haven’t yet been able to dig into the weeds of it, but the attractions are obvious, if the plan is to reinsure a ton of structured credit assets through Bermuda-based vehicles.

Dutch deluge

The Dutch Securitisation Association pushed its annual Amsterdam get-together from March 31 to April 21, but clearly the repressed energy had to find some outlet. Capital markets transactions seems to have been the preferred route, with four Dutch RMBS deals in market this week.

Athora’s debut Dutch securitisation, Prinsen Mortgage Finance No. 1, is probably the most interesting of the four Dutch deals out this week. We discussed Athora’s role as an permanent capital vehicle for Apollo above — according to the Prinsen book, it has €79bn of assets under administration, and it’s buying Italy’s Amissima from, a deal that will close this year. Just to underline the closeness of the relationship, all of the issuer contacts in the presentation have @apollo addresses....

Anyway, Athora/Apollo has been buying mortgages through the Merius platform, which has been originating assets for a variety of investors — 24 investors are on the platform, with €5.2bn of commitments, according to deal materials.

At least by the ratings, these are damn good loans — getting to triple A with 3.25% credit enhancement makes Storm’s 6% look generous, and Merius’s 0% loss record across all its origination since 2016 isn’t too shabby either.

It’s also notable how long the fixed period on these loans are — WA fixed period is 18.8-years, with WA remaining term of 27.8-years. Mortgage terms and fixed periods have been extending across mortgage markets, but it’s an interesting precedent for other markets....Kensington and Habito in the UK are both writing 40 years loans, Kensington in partnership with insurer Rothesay.

Apollo is selling this deal through the capital stack, with a vertical retention in place, and the resids and excess spread notes on offer on a “call desk” basis. The quality of the pool essentially forces a vertical retention — holding 5% horizontal would blow through both mezz tranches and cut into the triple-A — but we’ll have to see how the aggressive the reserve levels are.

BNP Paribas and Natixis are running the deal, with BNPP providing the swap to bring the long-dated fixed collateral back to RMBS-friendly floating rate.

Obvion’s Green Storm 2022 is the cleanest deal out, and is generally the tightest mortgage programme in European securitisation. Apparently it’s the 47th Storm deal, so if you don’t know the shelf by now I probably can’t help you. The biggest problem is probably going to be getting bonds, with just €500m on offer and the full suite of regulatory benefits attached to the deal. The announcement notices promises “all investors will be well considered for allocation, with possible preferential consideration for green investors” — so get those environmental creds in order.

Flipping through the book though, we did notice a “green construction deposit” scheme run by Obvion. This appears to be an additional two year loan of up to €9k for homebuyers to make energy efficiency improvements. Done right, this could be a way to solve the problems around solar lending we discussed last week — managing the lending for solar or external insulation through an existing mortgage provider can lower costs compared to third party unsecured lending.

The third in the Dutch quad is RNHB’s Dutch Property Finance 2022-1, a mixed but mostly buy-to-let pool, priced on Wednesday at 85/140/190/240 for classes A-D, with an upsize from €250m to €450m, and coverage levels of 1.2x/1.7x/2.5x/2.9x. Classes A-C came below par, unusually for a front book deal like this — possibly the structuring was in place before the Russian invasion rocked markets, and the issuer decided to push for size over squeezing hard on price.

Finally, we have Domivest’s Domi 2022-1. This is pure BTL deal backed by professional landlord mortgages, so more homogenous than RHNB’s deal. This allows it to bear the “STS” label, though not to access the same suite of regulatory and central bank benefits as in Storm and Prinsen. But with a similar triple-A advance rate to Dutch Property Finance, it will be an interesting illustration of the STS/non-STS basis when it prices next week.

Regulator cares about fake tender offer

Thanks to Matt Levine’s always-excellent “Money Stuff” newsletter, we were alerted to the story of Melville ten Cate. According to the SEC, which announced a complaint against him in New York court, ten Cate tried to buy a US aerospace and defence company, making an approach with financing documents the SEC says were fake (naming a member of the Saudi royal family). When that didn’t work, he launched a tender offer for the company’s shares, which the company denounced, saying he had never been able to prove the offer was real and his firm had financing. According to the SEC, he told the regulator in an interview he had “billions of dollars in funds needed for the tender offer held in escrow in a Swiss bank account”.

It also seems that ten Cate failed to pay various service providers, including the printing company engaged for the tender offer, and the New York Times, which was lined up to run an ad for the tender. His Delaware company had also lapsed for failure to pay taxes.

We don’t normally cover US equity markets in this newsletter, but I think it’s a promising sign that regulators are targeting fake tender offers made by individuals with no real resources who make extravagant and false claims. That kind of behaviour can be highly disruptive to securities markets.

If that were to happen, for example, in legacy UK RMBS bonds, we are sure the UK authorities would be all over it and bring forward robust enforcement action.

Car subs step forward

Always on the lookout for new asset classes, we talked at the back end of last year about car subscriptions, off the back of a deal Credit Suisse and Waterfall Asset Management did with Finn. This was a chunky €500m inventory financing, essentially funding Finn’s fleet, and it has yet to see the light in a term deal (perhaps it won’t).

In the same sort of vein, Cazoo, a UK-based car subscription service, announced a €50m ABS deal last week with BNP Paribas, to “enhance its capital-efficiency and accelerate the expansion of its car subscription platform in Europe. The facility has been designed with the ability to easily increase the funding requirement and add additional markets in the future, in line with the growth of Cazoo.”

€50m isn’t quite enough to be kicking off a new market, but these firms are rapidly growing, and, per the release, there’s room to upsize. In terms of credit characteristics, though, “car subscription” financing isn’t a million miles away from leasing — it’s just that the customer base and dynamics are slightly different. If and when these issuers come to the term market, we’d expect the deals to be position as a subset of the broader auto universe.

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