Market Wrap

Excess Spread - Starz in their eyez, the return of equity release, Turkish NPLs

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

Large and tight for CVC

CVC Credit Partners seems to consistently score strong debt execution with its new issue CLOs, and the latest Cordatus XXII deal was no exception — increased to €447m, one of the largest recent issues, and featuring a triple-A at 94 bps, the tightest print for a full length deal in the second half of this year. The bottom of the stack, too, came close to recent tights at 925 bps.

As one of the largest managers out there, CVC has a healthy following, and brought in new investors to this issue, but average performance across its 16 deals is pretty much down the middle of the fairway, close to the average for larger cap managers on a variety of metrics, be it WARF/WAS, triple-C bucket, equity NAV, MVOC.

Nonetheless, you can’t argue with the numbers, and consistently scoring a compelling liability cost, if you can pull it off, will keep CVC’s deals doing well.

Lead manager Deutsche Bank had disclosed a position in the B-2 fixed rate tranche, paying 1.95%. It’s not clear, though, whether it’s a treasury investment or a syndicate underwrite to be sold down later. DB has a long history of direct investment in the CLO market, but most banks investing for their treasury book tend to lean on the senior notes, where larger sizes are easier to come by — even the whole €11m tranche won’t soak up many excess deposits. 

Economic spread for triple A notes has tightened recently, partly because of the floor effects rolling off, but also as senior notes have pushed down into the mid 90 bps area, even as the dispersion between given managers has widened a little. According to Prytania Solutions' CLO indices, the economic spread on seniors has tightened around 7 bps in the past week, while AA bonds are around 9 bps tighter.

That bodes very well for supply into the back end of the year, with plenty of juice left in primary leveraged loans — pharma company Synthon’s 450 bps / 99.5 print for example, on a B2/B facility, means a healthy arbitrage available for managers that can swallow concerns about the sponsor and documentation

Generic excess spread available in European CLOs, a proxy for equity attractiveness, has ticked up a little lately, according to Barclays research, from a level which was already driving one of the best years ever.

Indeed, according to BofA research, the current pace of CLO formation puts the European market on track for its best year in the last decade, even leaving aside the massive wave of resets running alongside new issue supply. 

To quote the piece at some length…..“It seems to us that even the most optimistic new issue forecasts will be rendered irrelevant in the next few weeks and depending on whether the markets close in December we may see the new issue volume climbing to €35bn, which is just a 10-14 run deals from here. There is no doubt that 2021 will set up a new post-GFC record for new CLO issuance – the only question is the number.”

BNPP’s research team is also recommending buying short-dated CLO seniors, in its latest credit strategy cross-asset note, pointing to relative value against IG which remains close to all time highs, the relatively flat term curve in the secondary market, and the continued value of the floor at the short end.

So what can stop the CLO train, if anything? Rates people have been freaking out about things like the Aussie dollar short end (me neither) and of course Fed tapering….but credit markets, equities and pretty much every other risk asset seems serenely unruffled.

The human factor might have more impact than market conditions in stopping the party — as in certain other sectors, arrangers, advisers, lawyers and investors are all frazzled by the furious pace of supply, with even summer offering little respite. There may not have been the drastic price appreciation of last year, but many will be happy to close their books come Thanksgiving and enjoy a little Christmas cheer.

But the US may yet ruin holiday plans, as the upcoming end of the Libor transition encourages managers to cram in Libor-linked issues to the final months of the year, benefiting from grandfathering into the new Sofr regime.

Sofr-linked issues have started to emerge, it’s true, but many managers with deals already in the works will want to clear them before year end — and if the US keeps dancing, perhaps Europe will as well.

Starz in their eyez

Now Credit Suisse has finally sold Starz Mortgage Securities 2021-1 — Europe’s first CRE CLO since before the financial crisis — does the deal indeed, as we suggested, help pave the way for the sector to open up?

It’s one thing to put a new deal on the screen, but the nice thing about markets is that price comes through as the ultimate arbiter of success. 

The deal was certainly not a slam-dunk — it was in market for almost a month, possibly a record for a public issue under £200m (write to to tell me about the deal I’ve inevitably forgotten). The initial announcement specified pricing “no earlier than the week of October 18”, but eventual pricing only came on October 29, after very extensive investor education.

Levels looked relatively generous as well — though, relative to what? 

The sterling offered tranches were placed at a substantial discount, 98.84/97.8/97.74/98.94 on the investment grade classes, giving discount margins of 170/225/300/410 bps. That’s well outside initial thoughts of low-mid100s/mid-high 100s/low-mid 200s/low-mid 300s.

170 bps is a pretty juicy level for a triple-A security whichever way you look at it, with the last three sterling CMBS deals printing at 115/80/95, while recent US CRE CLOs, another plausible comp for the 144A deal, have come at levels 120-130 bps over one month Libor recently.

The structure was complex, with a dual currency waterfall across sterling (public) and euros (pre-placed), rather than using a currency swap to ensure a larger single currency deal. Marketing the deal to US investors meant less dependence on the “sterling mafia”, and, in theory, more possible price tension. 

But players in the US CRE CLO market are looking at a $40bn issuance year, so may have been reluctant to do the extra legal and currency work to bother with a sub-£200m debt stack from a new jurisdiction. 

This was always going to be a tricky one — a new asset class sold into a thin sterling CMBS investor base, with an unfamiliar sponsor and high-yielding, challenging collateral.

Total debt cost looks to be in the 250 bps area, against loan margins of 420 bps for the sterling collateral and 432 bps for the euros (which have separate waterfalls at the top of the stack), so it still works for the sponsor - if rather less well than at the sub-200bp WACD implied by the IPTs.

The other relevant comp is bank financing, which, at least down to investment grade leverage levels, probably comes inside the exit levels on display here. Securitisation can offer a considerably better advance rate, and properly matched funding — the debt stack goes down to single-B, with 13% credit enhancement, though the class ‘F’ notes will be retained — but other sponsors looking at the structure may prefer the lower costs and lower leverage in bank structures.

What’s to come in the future? Credit Suisse, among other banks, is warehousing new CRE CLOs, and Starz itself has big plans, with two deals a year likely from this programme, and another planned CRE CLO featuring riskier, more levered property loans, with a lower levered securitisation structure to finance it.

But Excess Spread knows of at least one other European CRE CLO deal ready for launch soon, from a more established property debt fund. The deal will be larger than Starz, with two top tier investment banks on board — easing any concerns about liquidity that might arise in a new asset class with only a single trading desk likely to be active in the bonds.

Early discussions around the Starz deal met with support from a range of other investment banks before the mandate went to CS, with at least five institutions quoting warehouse terms — if I had to guess, I’d assume top European CMBS banks Morgan Stanley, Goldman Sachs, Bank of America and Deutsche Bank — and expectations are high for the launch of the asset class.

Big picture, CRE finance is heading down the route seen in corporate credit, with debt funds aggressively displacing bank lenders, especially in more complex, bespoke or levered situations, and looking to fund in the capital markets. While Starz has moved earliest into public markets, major CRE debt funds like ApolloBlackstone, and Starwood, are all likely looking at the market, and comparing potential funding costs for their origination — either privately, through loan-on-loan financing or bank lines, or publicly, in the new CRE CLO market. It doesn’t take a rocket scientist to recognise that where US capital markets have done years back, Europe can follow too.

Whatever the Starz pricing implies, other deals coming to market will require less hard work, thanks to the trail it blazed, with rating agencies and investors alike — and so hopefully there’s a bright future ahead for the CRE CLO.

ERM…...what’s this asset class?

Bank of America has just sold ERM Funding 2021-1, one of the vanishingly rare equity release RMBS deals seen in Europe, and a deal which has been in the works for around two years.

Just to underline the rarity of the asset class, 2021 has seen *both* post-2008 UK transactions come to market, with the other deal being Cerberus’s Towd Point Mortgage Funding-Hastings1 transaction. The Cerberus deal, however, was backed by legacy collateral carved out of a UKAR (Northern Rock) portfolio, making BofA’s trade the only equity release securitisation backed by newly originated mortgages since 2008.

“Equity release” is what’s called a “reverse mortgage” in the US — typically an older borrower relevering during retirement, allowing them to take cash out of their property. With no real income to cover interest payments, these roll up until the loan is repaid, often through the death of the homeowner and sale of the property. 

Usually there’s a cap in place to prevent the loan rolling up to more than the value of the property, but there’s a long and unfortunate history of adult children finding out that the valuable house they thought they were inheriting is levered up to the nines and has been funding mum and dad’s Caribbean cruising habit for the last 10 years.

That makes deals backed by these assets extremely weird, by normal RMBS standards. Ordinary UK mortgages tend to refi following the expiration of a fixed rate period, typically between two and five years. During this period, they tend to amortise in a fairly predictable fashion.

Equity release, meanwhile, remains outstanding for much longer periods, with loan balances increasing over time, and prepayments correlated not to interest rates or teaser periods, but to death rates.

In ERM Funding 2021-1, the A1 notes (the fast pay tranche!) start paying principal back 61 quarters in….with the second pay starting 102 quarters in. This gives weighted average lives of 20 and 30 years respectively — slow pay and even slower pay. Having any scheduled principal payments at all means tweaking the structure to achieve this, but it’s important to make these tranches eligible for the Solvency II “matching adjustment”. In plain English, that makes these bonds much more attractive for insurers to hold, cutting the regulatory capital which must be allocated to them.

The long WALs and high duration, plus the correlation to mortality rates, make equity release mortgages sought-after assets for certain types of investor — basically, life insurance and annuity providers, for whom it is a natural hedge. Annuity providers buy out a pension pot on retirement, paying a steady income from the assets which stops on the death of the holder.

Put it together, and that’s hugely interesting to a select group of buyers — who have been busily buying equity release portfolios in whole loan format. Rothesay Life bought a £860m UK Asset Resolution portfolio, Phoenix Group bought some of JP Morgan’s (much larger) UK Asset Resolution portfolio, as well as a £300m book from Just Group more recently. Legal & General, Canada Life, LV=, and Phoenix are also originating these assets themselves, and taking and holding them.

So there’s plenty of activity in the sector — it’s just not surfacing in a securitised format.

For RGA (Reinsurance Group of America), which funded the origination which backs this deal, buying loans from more2life, a specialist equity release lenders, the model is different — rather than holding whole loans, it prefers to sell on risk to other insurers, exiting at a higher valuation than it bought the assets and crystallising profit. 

It has sold a full stack deal, including residual notes — the equity — giving up control of the book. But with the £170m and £110m A1 and A2 notes sold at 101.13 and 102.449 respectively, it probably turned a decent profit on the exit.

RGA intends to be a programmatic, if not frequent, issuer, though future deals will probably remain in preplaced club format, targeted to a select group of traditional insurance buyers. 

With so little activity in the equity release sector, some of the closest comparable deals are the UK student loan securitisations — Income Contingent Student Loans 1 and 2. These were tranched up into a regular ABS piece, plus a longer duration fixed rate bond at the top of the capital stack, and, like equity release, have a super-weird payment profile, as cashflows come directly out of the salaries of students earning over a threshold level.

Turkish NPLs, why not?

Nearly three years ago I flew to Athens to attend IMN’s Greek NPLs conference, which was honestly pretty great — the market was just opening up, the Hercules guarantee scheme was ready to roll and banks and advisors were lining up for a piece of the action. Greek NPL sales (and Greek NPL securitisations) had been done before but the government scheme promised many more, much larger portfolios coming to market. I was booked to go again on March 12 2020, but….well, that was a bad time to have a conference.

With my characteristic tact, though, I spent much of the conference asking people not about the bright future in Greece but whether Turkish NPL sales were set to pick up, and what kind of adventurous buyers were looking at the market.

I only got two names — Pimco and Bain Capital, if memory serves — and, to be fair, the question might as well have been “name two large NPL buyers”.

Whether foreign money got much of a look in back then is an interesting question, as the Turkish NPL market was, and remains, dominated by local “Asset Management Companies”. Here’s a nice rundown of the market dynamics and key trends in Turkish NPLs, from the local arm of PWC, which I’m not going to summarise here. They expect NPL sales to reach TRY30-45bn by 2023, equivalent to $3.12bn-$4.69bn, modest by international standards but more than 4x the sales volume in 2018 or 2019.

Securitisation is likely to help this along, thanks to a new law passed in mid-October, allowing the Asset Management Companies to set up securitisation vehicles, which can then issue ABS to foreign investors. It’s not limited to NPL deals — the law will also help reperforming portfolios raise funding through securitisation — but it is the first time Turkish law has allowed for the securitisation of NPLs.

It seems unlikely this will be the huge market that, say, Italian NPLs has been, but hey, it’s a new asset class. It’s new to me as well though, so any thoughts or comments to In the meantime, here’s a note on the new law from Hogan Lovells and another from the local Esin Attorney Partnership.

Correction: Last week’s Excess Spread said that Capital on Tap was owned by Drake Capital Management. That wasn’t right — Anthony Faillace, who controls Drake Management (now a family office not a hedge fund) is the largest shareholder, but several other HNW individuals, including the founders of Paymentsense, are also involved. Here’s a nice article from The Standard on how the business got going.

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