Market Wrap

Excess Spread - Sun sand and inflows (we hope), 1x is all you need

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

The beatings continue

Normally journalists love a bit of bad news but this is getting a bit much. We’re going to try to stop this newsletter being too much of a downer and search hard for some good news, but there’s just a lot of ugliness out there.

We’re still the best part of a month off IMN and Afme’s Global ABS in Barcelona, but after last week, there’s a sense it can’t come soon enough (especially after the three year wait; we’re not going to count Edgeware Road in September). Might just be my imagination but I think people started signing off their phone calls “see you in Barcelona” extra-early this year.

It serves as a marker, a short term reason to pause, sit on the sidelines and hope that some kind of stability has returned to markets by then. The heady mix of sunshine and strong liquor will hopefully add up to greater confidence in the ABS market, and a return to more orderly executions.

Fund limited partners will also have their own foreign junket, with SuperReturn International running the same week as Global ABS (Excess Spread’s colleagues are attending). Hopefully their GPs will make the correct soothing noises so the outflows ease up.

Straining hard for a bit of good cheer here….the market can absolutely cope with wider credit spreads, if they’re wider but stable. Securitisation is a very efficient tool for financing loan portfolios, and paying away more credit spread to investors doesn’t add up to a crisis. Securitisation sponsors can suck up lower equity returns and lower excess spread, within reason.

But this level of risk-off volatility is highly destructive, and the deep mezz market is essentially now closed.

There’s a bunch of reasons for this, some general, and some specific to securitisation.

Broader markets were obviously terrible, equities went straight in the bin on Thursday afternoon last week, then found some even deeper bins to get in the following week. Risk has been very much off. That’s been the case for every asset class…elsewhere I’ve been writing about the HY bond for CVC’s investment in LaLiga, which also had the misfortunate of launching before the US came in on May 5, just like auxmoney’s Fortuna 2022.

The more securitisation-specific reasons link back to fund outflows.

For most of the past decade the problem in European securitisation has been lack of product to purchase, not lack of cash allocated to securitisation. There were deep-pocketed investors around ready to show up in size, all you had to do was figure out what price was right. But now, and ever since the Russian invasion, funds are having to worry about outflows and run high cash balances.

To take just one random example — Pimco saw €13.6bn of outflows in Q1, according to Bloomberg. Normally Pimco is the kind of account you can turn to when markets are running scared, that will anchor struggling deals for the right price. But with this kind of move, they probably have to look after number one for a bit; it’s not the time to be putting on new illiquid positions.

Securitised products have also been something of a victim of their own success at the senior end. Fund managers specialising in the asset class have been singing the praises of its floating rate characteristics for the best part of a year, ever since the whispers of rate rises started to emerge as a concern — here’s TwentyFour Asset Management from March 2021, here’s M&G from March 2022.

That’s played out so far this year — the duration in fixed rate has meant big price declines in IG and HY bonds. These are going to be overwhelmingly money good, so nobody really wants to take the cash hit of selling now……so when the outflows do come, much better to sell something that’s still in shouting distance of par, like ABS, if you need the comfort of some extra cash.

BWIC flow has accordingly been pretty large, with nearly €800m of bonds out last week. This isn’t much compared to any liquid market, but it’s a higher activity level than any week of the past 10, according to Deutsche Bank’s research team. Most of the supply was in CLOs, but with decent chunk of non-conforming and auto ABS paper.

At the bottom of the capital structure, the ABS-specific hedge funds know perfectly well that they have issuers over a barrel — and have plenty to do in secondary — while opportunistic credit funds with a broader mandate are in a target-rich environment and don’t need to get involved. You can buy secured bonds from a basically decent company with a reason to exist (say United Group 2028s) at 8%; If you like securitisation generally there’s CLO BBs at 900 bps; junior ABS mezz at €+750 bps might be wide compared to past levels but there’s a lot of other assets on the menu right now.

So who’s going to save us?

In ABS land, the white knights historically have been major bank treasuries, swooping to the rescue once levels look juicy enough.

JP Morgan CIO (aka The London Whale) in the aftermath of the financial crisis was the most notable example, pretty much saving the market single-handedly. That was when I started covering securitisation, and more or less every conversation 2010-11 eventually worked round to “so what’s JP up to at the moment”.

But one could also point to Norinchukin in CLOs in early 2019, nursing the market back to health after the sell-off in late 2018, or indeed the selective Standard Chartered investments following the Russian invasion of Ukraine this year.

Bank treasuries still have to manage their liquidity, but the rhythm is different from the asset management sector, and so are the reasons for outflows. They can take a view that current levels are mispriced and will come back. Mind you, StanChart is definitely underwater on its March purchases, and the trouble with the bank treasuries is that they can look everywhere — there are plenty of other bargains to be had at the moment.

1x is all you need

Auxmoney’s Fortuna 2022-1 was announced on May 5, just before the full meltdown on Thursday afternoon, and one might have expected an execution last week. But pricing eventually came the following Tuesday, and it was not pretty, with some big cash discounts down the stack….class C, D and E at 96.68/95.5/95.

The class B and C had to be helped over the line by the trading desk of one of the leads (Citi arranger, BNP Paribas joint books), and even on the class A and class D the bonds were exactly 1x done. The bottom of the capital structure was retained — there’s a level where it’s just pointless placing bonds.

The days of expecting a smooth 5 bps slide in from IPTs to a nicely twice-done book are clearly behind us, and the new success criteria is “deal gets over line”, which it did. A deal exists; that’s good enough.

It’s important to recognise that these bonds are pretty good from a credit perspective. Yes there’s cost of living pressure and rate rises and stuff but…the rated mezz is gonna be just fine. There’s extension risk, but only just. Even on 0% prepayment rate the E notes pay back inside four years.

So the five points or so on the D and E notes is a participation trophy for whoever’s still out there looking at mezz in primary, a reward for simply showing up.

PSA Spain’s full stack deal was announced on May 6, and spent the last week out in market, with most of the stack listed as “call desk”, an ominous sign. The issuer’s cautious comment that all of the tranches could be retained in part or in full was there from the beginning, but the withdrawal option was exercised on May 19. The deal will be fully retained and “the intention will be to sell the deal to investors at a later stage”. Can’t blame them really.

Neither transaction seems likely to inspire much enthusiasm from other issuers or syndicate desks, and yet deals there continue to be.

VW’s German lease deal, launched on Wednesday via Credit Agricole, we don’t rate as much of a signal — it’s an issuer that takes a sort of pride in a hard-as-nails, no matter the conditions approach to market. It’s basically unkillable, and it probably doesn’t make a lot of difference to VW as a whole if it places bonds at 12 bps or 50 bps.

But enquiring minds are wondering what Deutsche Bank knows that nobody else does.

It hit screens with Ulisses No. 3, a Portuguese full stack auto ABS for 321 Credito, this Tuesday. As the name implies, it’s an increasingly familiar shelf (the last deal, also led by Deutsche, was in September 2021) but…’s still a full stack deal launched into a market that seems broken, with no anchor interest declared at the outset.

Again, nothing wrong with the deal — the September print saw seniors at 35 bps! — but it’s not a defensive trade, and if ever there’s a time to hunker down, it’s now. Just like the other big securitisation banks, DB probably has a substantial pipeline to get through, any deal cleared definitely helps….and, hey, maybe this is the trade that turns sentiment. Never say never. Good luck!

The substantial pipeline itself is a bit of a risk — it’s good that the market has so much financing out there, and securitisation banks can take the carry (especially in warehouses with step-up options) but supply could easily swamp a frail recovery. If the first sign of green screens brings a ton of deals out all at once, that won’t help stabilise spreads, so a little tact and delicacy post-conference may be needed.

Single-B suffering

The terrible backdrop last week knocked the syndication for Angelo Gordon’s Northwoods Capital 26 sideways. A strong anchor of 112 bps at the top of the stack gave way to chaos further, as the double-B notes, sold at 93, breached the 900 bps DM level...roughly the single-B level of last September.

The single-B DM at a 90 cash price was quoted as 1175 bps, though, as we discussed last week, this quoting convention understates the economics — the deal has a 1NC/2RP structure (like Capital Four IV), and a call in 18 months or so would return 10 points, plus the 963 bps coupon.

We hope, for the firm’s sake, that it’s placed these bonds somewhere close to home, otherwise this bond is going to be punishing.

Angelo Gordon was followed this week by Invesco, printing Euro CLO VIII via Jefferies, which took an innovative approach to solving the single-B problem, adding a turbo feature which diverts 20% of residual interest payments to the junior class. On a DM basis it came in tighter than Angelo Gordon, at 1050, plus Invesco has opted for a 2NC/5RP structure, so it isn’t staring down the barrel of an eight point call premium next year, but with a cash price of 92 this is still a painful piece of the capital structure.

Both these deals also underline the basis between fixed rate and floating — 225 bps to 350 on Invesco and 230 bps to 315 on Angelo Gordon. If you assume the deals run to the end of reinvestment, this is pretty much in line with five year and two year swaps respectively, but expensive looking at the swaps curve to the end of non-call.

There’s a wide split on senior spread too — AG’s 112 bps looks below market, given recent deals, but 120 bps for Invesco looks wide, perhaps indicating a steep term curve for CLOs. Still, the flexibility to manage through a recession (and less fee drag from an early reset) continues to split managers on their approach to term structure.

If we’re looking for silver linings in all this though, at least conditions are probably worse in the loan market — now there’s a broad-based selloff and quality loans can be scooped up at 95 or 96, the arbitrage might be back in better shape.

Debt costs seem to be coming in at 240-250ish, which, given the loan levels on offer, might just work. For managers that can max out fixed rate, the opportunity set is larger still, as long as you can get comfortable that the rates risk is all in the price now.

Huff and puff

We dug a little further into the Wolf Receivables deal from debt purchaser Lowell this week. There’s a full writeup for 9fin subscribers here, but the TLDR is that it’s a neat capital solution for the debt purchasing firms, which generate lots of reperforming assets (RPLs) but aren’t necessarily monetising them in the most effective way.

Many of these firms have revolving securitisation facilities backed by the NPL portfolios — Cabot Financial and Arrow Global, for example — while others are involved in sponsoring term NPL securitisations (Intrum and Arrow).

But monetising RPLs could be increasingly important, especially with bond markets, where the debt purchasers raise most of their term financing, in pretty terrible shape right now. The deal was bought by two real money asset managers; it’d be nice to see this client base grow, and arranger Alantra is doing its best to make that happen.

Fixing FTBs

We’re still struggling for good news, but UK housing secretary Michael Gove is trailing a new policy that’s pretty interesting — compulsory state mortgage insurance for high LTV lending. The basic concept is not that different to the existing first-time buyer (FTB) mortgage guarantee, updated last spring, in that it derisks high LTV lending for the banks, but it looks like the structure will be different.

Instead of the highly structured UK guarantee scheme, which covered the 95%-80% slice of a mortgage and left lenders with 5% of net losses over 80%, Gove appears to be looking at Canada-style mortgage insurance for the whole loan. Presumably this would mean banks can 0% risk-weight the mortgages in question, as they’d become sovereign risk, meaning an attractive return on regulatory capital.

That’s clearly been a problem for the UK banks, given the spate of FTB risk transfer deals from the UK clearing banks (Syon Securities for Lloyds is the longest-running shelf), but it can also be seen as a signal that there’s a mismatch between regulatory capital costs and market risk perception. When the market says an asset pool is less risky than the regulator thinks, sell the assets to the market.

Looking at the Canada scheme, said to be the model for Gove’s thinking, it doesn’t look like it will be all that attractive to the hard-up first time buyers it is targeting — there’s a 4% premium for loans at 90-95% LTV, which presumably comes on top of the cost of the mortgage. With Nationwide currently charging 2.84% for a 92% mortgage… this really the answer to cutting the cost of high LTV borrowing?

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