Market Wrap

Excess Spread — Arms race, can-kicking, winning the worst prize

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

Chicken, meet egg

So it’s August and boring and lots of people are still out, but enquiring minds are turning to September supply. Unfortunately the classic CLO-loan dynamic is at play…there’s plenty of CLO transactions that want to come (we hear 15 or so), but CLO managers want to know that there’s going to be adequate loan liquidity, and preferably some primary supply, before they rush to print. Who’s willing to jump first?

Any jumping at all depends on conviction about the summer rally, which has been sorely tested by the energy price rises and market vol this week. But there was plenty of scepticism doing the rounds anyway — thin liquidity and a lack of any real directional conviction seems to have driven the melt-up towards the beginning of the month, which isn’t exactly a firm basis for a primary revival.

In European loans specifically, it seems that the relatively decent CLO supply in July and early August caused a bit of a technical squeeze. Some of the deals were old full warehouses, but some were pretty empty and under pressure to ramp….that’s the view of Tyler Wallace at Fair Oaks Capital, anyway, who answered our 9Questions this week, and we hear similar views from the sellside too.

Tyler also gave a succinct rundown of the key sectoral and credit points to look for — ability to pass on costs, non-cyclical businesses, healthcare, tech, pharma — all of which seems sensible enough, but most funds seem to have the same broad-brush views, so there are probably some pretty crowded trades in the most favoured loan names.

Whether a single-digit number of CLOs ramping ought to be enough to move around a €350bn asset class is a fair question — each CLO can only take max €5m in a given issue — but that’s August for you.

While CLO managers are keen to come if possible, we hear primary loans is unlikely to start with a bang. There’s some presounding occurring, but private credit, term loan A, dollars and other more resilient capital sources have chipped away at the underwritten pipeline, to the point where we could be in for some disappointment on volumes.

One pretty top tier institution told us they had two to three bond deals and a couple of loans lined up….that’s an absolute bounty by the standards of the summer, but it’s some way off a full market rehabilitation, especially if, as seems likely, some deals lean more heavily on dollars or direct lending to cut the quantum that needs to be placed in euro syndicated format.

Better buyers, however, are definitely emerging in CLOs. Prytania Solutions (my generic spread providers of choice) once again circulated a full stack of green in their weekly update, with their single A level back to the not-especially-amazing levels last seen in June, and Euro triple A at 175 bps. Buyers that were nibbling around the edges have been looking at bigger tickets; hopefully even a decent supply wave won’t swamp demand.

To take a big fund more or less at random….per the last round of disclosure, Insight Investment’s £3.6bn liquid ABS fund, which invests across ABS and CLOs, was running a 15% cash balance — that’s most likely a mix of caution, carry, thin liquidity and a lack of primary. But if other funds are positioned similarly, potentially there’s a lot of dry powder that could come in if there’s some conviction on market direction.

Arms race

The CLO team at Millbank has been spending lots of time explaining the “priming debt” language that’s been added in to the latest Bain Capital Euro CLO deal, arranged by Barclays a few weeks back. Here’s IFR’s Richard Metcalf on the subject, or Creditflux if you prefer (and have a login).

It’s the latest tweak making it easier for CLO vehicles to participate in more complex restructurings, following on from the addition of “loss mitigation” language in 2020. This in turn evolved through 2021, with adjustments to the precise mechanics of investing in loss mitigation obligations — what proportion was allowed, how these flowed through to WAL tests and par calculations. The new language appears to push things a little further, allowing CLOs to provide new money which “primes” existing loans held by the CLO - a common move for a company in distress, which involves adding new super senior debt, or pledging collateral extracted from the existing security group to new creditors.

It’s probably more evolution than revolution — if CLOs are to be permitted to play in new money, and expect to stay invested through a workout rather than run for the hills at the first sign of trouble, then surely the CLO vehicle should have the maximum possible freedom of action in a restructuring situation?

The CLO changes partly reflect long term trends in leveraged loan documentation — as has been exhaustively documented, including by the excellent legal team at 9fin, things have been trending in a sponsor-friendly direction for a while, making it harder to trigger default (no maintenance covenants), easier to shift collateral around, and harder to sell loans to the dreaded “loan to own” funds (thanks to whitelist/blacklist provisions).

We’re hearing these are starting to bite hard in some credits (GenesisCare is said to have a particularly restrictive whitelist) which might be showing up in more severe price declines than is justified by credit metrics — nobody will want to make markets if the natural buyer base can’t buy.

If the basic moves of “flog it to distressed fund who will take the keys” doesn’t really work, then naturally that means CLOs, as the largest group of par loan investors, need more in-house tools.

The long-term convergence of credit strategies also plays in this direction….big CLO shops increasingly also house credit opportunities, special sits or distressed strategies under the same roof — maybe at a different bank of desks, but the likes of Oaktree and GSO don’t have any shortage of workout expertise to draw on.

Like most innovations, the priming language emerged first in US deals (Richard says it was Napier Park that kicked it off with Regatta XXII in May) but crossed over here quickly. The larger US loan market has seen more vigorous and varied restructuring strategies, bringing matters to a head earlier, but also pumps out far more CLOs to a far deeper investor base, making it more fertile ground for any docs changes.

So what’s the endgame? Loss mitigation language has not been totally free of controversy. Fans of the flexibility present it as win-win for debt and equity alike, but senior investors are often more grudging in their acceptance. It’s not necessarily the language itself that’s the problem, but the implications for manager strategy — if CLOs are more readily able to play restructuring situations, managers may feel empowered to do more bottom-fishing in their investments, and might feel comfortable with higher B3 and CCC percentages.

For senior investors already involved in a deal, that’s a bad thing, but it’s basically good for the market as a whole. CLO technology is flexible and pretty powerful, and clearly has extensive application beyond the “B2 at 99, missionary with the lights off” world. More managers playing more complex situations should mean more variety and dispersion in the CLO universe in Europe, less cookie cutter deals with the same 10 big capital structures over-represented in portfolios.

Before the pandemic hit, Ellington was nosing around an “enhanced CLO” trade in Europe (basically a bond-heavy deal with a spicier approach to credit and less leverage through the CLO vehicle). There’s a few of these trades out in the US, but the pandemic killed the plans, and the Ellington team moved over to Nassau Corporate Credit (where they’re working on their second European CLO).

There’s no reason why such a structure couldn’t emerge again one day, but as regular CLOs get more distressed flexibility….maybe they’re already “enhanced”?

World-class can kicking

There’s been a lot of discussion about the horrible reality of energy bills coming down the tracks in the autumn, but not very much about securitisation. We’re here to redress that balance!

The basic political issue is pretty obvious — if customers in Europe and the UK have to pay market price for their energy, it is going to hurt a lot. Small businesses will go under, struggling households will be pushed into dire poverty, just about managing households will struggle. So governments are under pressure to somehow bridge the gap. They can either give money to customers/businesses directly, or subsidise energy prices so the full pain isn’t passed through, but either way it will cost money. There’s already a certain amount of dissembling around this….an energy bailout could pay for itself because it will maintain economic growth at a higher rate? A bailout that cuts inflation also cuts payments on index-linked govvies, so you could follow the UK Labour Party in considering that part of it kind of a freebie?

Anyway, the money can come direct from government budgets, or it can come from the masters of debt in the securitisation industry.

There’s a direct precedent in the shape of the Spanish FADE securitisation transactions (securitising the “tariff deficit” of the Spanish electricity companies) and the Portuguese Volta deals (securitising the deficits accrued by Energias de Portugal). The utility companies are allowed to recoup the costs of being forced to sell energy below market price over a number of years, through surcharges to bills down the road — with a government guarantee wrapper, in the case of the FADE deals.

Clearly this doesn’t solve anything — the market price is still what it is, the bills get paid eventually — but it does smooth the impact over years or decades, and gives central government a way to mumble and swerve the political impact of a direct bailout with new government debt. Guarantees don’t count, right? Who even adds up the contingent liabilities of sovereigns?

The structuring here isn’t rocket science, it’s just a pile of receivables with a government wrapper — and it doesn’t really do anything to expand the potential buyer base (it’s going to be the same big bond funds in a tariff deficit deal that would buy Gilts, OATs or Bunds). It’s a political sleight of hand, borrowing money from a pocket marked “future energy bills” rather than a pocket marked “future tax receipts”. But so what? Political sleight of hand is often what politics is.

For the struggling consumers of the UK, such a plan depends on actually having a functioning government — TBC — and energy companies are apparently pitching a different form of guarantee, in the form of loans to, uh, energy companies. But whether UK or not, there’s a lot of potential in these structures, and we could find a major European tariff deficit asset class is just around the corner.

A prize nobody wants to win

Poor old Davidson Kempner has, I think, the unfortunate distinction of being the most Rizwan’d institution in European securitisation markets, in terms of numbers of DK-controlled deals attacked / volume of spurious litigation. It’s not just the deals DK controls, either — it was one of the potential bidders when KPMG was shopping the RMAC portfolio (Project Grosvenor) around, before it emerged that RMAC was in fact not for sale, and not owned by Rizwan. I don’t think it’s personal….other institutions have done more to push through Rizwan’s bankruptcy, contempt of court x2, arrest warrant etc… it’s more likely to be a side effect of DK’s position in the market for legacy UK mortgage collateral. DK is one of the biggest buyers of such assets, which are also Rizwan’s favoured arena for his activities.

The recent Hawksmoor refinancing took out three Rizwan targets (2x Clavis Securities deals and Stratton Mortgage Funding 2019-1), in addition to the main Hawksmoor portfolio.

A total of five court claims relating to Stratton have been filed in the month or so since the mandate was announced, none of which bear Rizwan’s name, but certain features are familiar — claiming to act in the name of a given issuer, a new round of SPVs in obscure jurisdictions (Cyprus seems to be the new favourite). There has also been a prompt responses from the legal system, which is becoming wearily familiar with how these things go (there’s a judicial order on one of the cases from this Monday). The UK legal system makes it a pain to dig up all the details on the filings but, once more into the breach we go.

For people with more constructive hobbies than Rizwan-watching, there’s an update to the market from the Stratton 2019-1 issuer, saying, as you might expect, that “each of the Claims is baseless and without merit and therefore that none of the Claims will affect the Issuer’s obligations to redeem all the Notes”.


We discussed debt purchaser Lowell’s Wolf Receivables ABS deal earlier this year — it’s a rated reperforming loan securitisation backed by unsecured assets, which basically monetises the back book for Lowell. It allowed Lowell to raise a cool £100m of funding at 4%, at a time when its bonds were trading well in double digit yield territory (still are, actually). Arranger Alantra extracted a decent advance rate too, despite DBRS’s decision to rate it under an NPL methodology.

Anyway, Lowell revealed on its earnings call on Thursday that it sold the Wolf juniors in August, paving the way presumably for a deconsolidation of the book. The sale was after the June balance sheet date, so we can’t try to backsolve the price just yet, but it was £80m notional, and the deal appears to be performing better than expected (who knows how the “cost of living crisis” will flow through).

Securitisation certainly seems to be working well for Lowell, which also said on its earnings call that it struck a £170m deal to fund its purchase of Hoist UK. No immediate details were forthcoming, but this is more likely to be a private bank-funded NPL deal, rather than a distributed RPL trade like Wolf (admittedly there were only two investors in the Wolf seniors, but it still counts).

In similar vein, Nordic debt purchaser B2Holding closed a private securitisation with Pimco in August, a deal that’s been in the works since February. Like Lowell, it’s the back book, but of secured loans. Headline terms are that it’s a €166m deal, with options to extend by €14m and €10m, it pays 455 bps, and matures in 2027 — but you’d have to ask the deal parties for more.

These trades might not be broadly marketed, but they are signs that the funding structures of the debt purchasers are shifting away from the traditional HY bond approach towards a more blended mix of third party capital. 9fin subscribers can see the slightly more fullsome discussion.

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