Trouble in paradise

UK specialist lender buy-to-let is the bread and butter of the securitisation market these days — this week alone brings new issues from LendInvest and Lendco, dubbed Mortimer and Atlas respectively.

But all is not well with the origination flow in the sector. Molo, a specialist lender we’ve had our eye on for a while, announced it was suspending BTL origination earlier this week, citing “unprecedented increases in the cost of funding due to spiking inflation and Bank of England base rate rises since the start of the year....for context, the key costs we face are interest rate related. Our key benchmarks in this space have risen over 550% since this time last year”.

Our quick and dirty maths puts Mortimer’s cost of debt nearly 40 bps back of Landbay / DK-sponsored Stratton BTL priced earlier this year, which is definitely painful.

Coverage levels on Mortimer 2022-1 looked decent at 1.7/2.4/2.3/2 down the stack, echoing the pre-Easter pattern of firmer books in the belly of the capital structure. That doesn’t point to a massive move tighter just around the corner, and indeed the class ‘A’ and ‘B’ landed at the wide end of the final range (with the class D, at 240 bps, outside the 220-230 indicated on Wednesday), but deals can at least get over the line on this basis.

Atlas looks like a tougher sell, with coverage of 1.4/0.6/1/0.9 at IPTs as of Thursday morning.....the announcement signalled, though, that there was more robust class ‘D’ demand wider, with 2.7x of interest at “mid-high 200s” rather than mid-200s IPTs. It’s only a £9m tranche so could well be just a couple of accounts, but it shows that this money is well aware of its pricing power in the current environment.

That’s even more pronounced right at the bottom of the capital structure — after the pound of flesh extracted from NewDay for its class ‘E’ before Easter (mid-high 400s IPTs, priced at 535 bps), LendInvest is placing ‘E’ notes at 514 bps and class ‘X’ at 497 bps. Atlas still had these notes listed as “call desk”, but one assumes the conversation on such a call will be quite one-sided.

Execution difficulties are one thing, but throw in swap rates as well, up more than 200 bps since last year, and that’s a pretty brutal squeeze for BTL lenders that can’t easily pass that through to new origination.

Unfortunately, that could be quite a few of them. The good times have been rolling in buy-to-let for a long time, attracting a regular flow of new entrants all competing to serve the same pool of specialist clients which aren’t well covered by the High Street. If securitisation-funded specialists pass through the costs now implied by the capital markets in full, they’ll cede a lot of ground to the deposit-funded institutions — not so much the clearers, but the likes of OneSavings Bank and Shawbrook which operate in the same space.

That doesn’t necessarily mean a crunch right away — most open warehouses will have been struck on more benign, pre-war terms, and likely have some runway for the market to recover before they need to find a capital markets exit. But the basic business is borrow low, lend high, and the first part is missing for now. Market levels will ultimately drive warehouse levels whether lenders like it or not, and this could be even more acute where lenders are feeding the principal finance shelves of investment banks. The mortgage desks at Citi and JP Morgan I’m sure have a very keen eye fixed on their exit levels.

Those institutions which sold to deep-pocketed backers may be feeling particularly smug now — Fleet Mortgages can probably rely on Starling’s £5.8bn of deposits, and Foundation Home Loans is sitting pretty under Apollo/Athene’s ownership.

Regardless of the forward origination flow, there’s a momentum built into the securitized products pipeline. Warehouses are full, there are deals to be done, and if the levels aren’t April 2020-bad, then along to market we go. Time for syndicate to really earn their fees.

Glad rags

I was lucky enough to attend the awards ceremony I set up at GlobalCapital this week.....two years on from the super-spreader event that was the 2020 dinner. Fantastic to see so many familiar faces there, and many thanks to multi-award-winning TwentyFour Asset Management for hosting me.

Well done to all the winners, but particular congratulations to Richard Hopkin for a well-deserved Outstanding Contribution to Securitisation Award — we thoroughly endorse the decision, and it was great to see all the previous winners (Max Bronzwaer, Alex Batchvarov and Rob Ford) on stage with him.

Sorry for the terrible photo. See here for a slightly pensive Colin Parkhill. I believe there will be a full photo library uploaded at some point.

Congratulations are also due to Funding Circle, apparently the whole business/esoteric issuer of the year, truly an excellent diversification to its business model.

Industry awards are inherently a strange thing...If you want to read an account of a truly unhinged awards event, I recommend this David Foster Wallace classic on the Adult Video Awards in Las Vegas (SFW, it’s an essay), which he says “resembles nothing so much as an obscene and extremely well-funded high school assembly”.

Finance awards are a little tamer, we didn’t get a Will Smith incident, never mind a Jarvis Cocker or a Chumbawamba on Wednesday....the weirdest thing I’ve seen in a decade of going to/hosting these things is Alastair Campbell playing the bagpipes, and I think we paid him to do it.

But, they keep the lights on for the mags that run them, which has probably helped my career and personal comp over the years, so thanks all for keeping them alive.

What’s changed in the two years since I last ran the public event?

Well....surprisingly little, given the crises which have characterized the period. Many of the issuers are still the same — Kensington is the biggest RMBS issuer (for how much longer?), VW Germany is still tightest, Pimco’s hunger remains unsatisfied.

Fintech lenders remain a more important client base than banks, and arrangers still fall roughly into two buckets — those focused on the weird private illiquid stuff that pays the bills, and those focused on the flow product that brings the volumes, making it extremely difficult to pick the winners of this sort of thing.

We’re particularly interested in which way the revamped Wells Fargo operation will jump — it’s hired people with a background at the funkier end of the market, but it’s a big commercial bank with a low cost, low risk, type balance sheet....if you’ve been pitched a Wells financing, give me a shout.

Trade the gains away

IMN’s European CLO and Leveraged Loan conference last week was excellent — packed house, general sense of industry enthusiasm that belies the difficult equity arbitrage.

The drinks setup was a different story, with Deutsche Bank seemingly the only bank putting the corporate cards behind the bar. We thought the industry was better than that, frankly. If you’re a manager looking for a CLO arranger, we have no hesitation is saying “head on down to Great Winchester Street and talk to DB”.

We’ve written up conference thoughts and impressions in a separate piece, so won’t retread that here — fixed rate buckets, loan supply, equity arb, senior anchors and of course ESG make an appearance.

One conference comment we did find interesting was from Pearl Diver Capital’s Matt Layton, who plays largely in the equity and junior mezz. He said that Pearl Diver had found zero correlation between high portfolio turnover and par build — managers effectively trade away their returns through the bid-offer on loans, delivering clean, senior-friendly pools with low triple-C buckets, but sacrificing equity returns.

That runs slightly counter to the way a lot of managers hold themselves out — being a proactive trader, a “nimble” portfolio manager is generally reckoned a good thing. Indeed, we visited a manager this week that made exactly this point, holding out their change in style over the last year to be more active.

Loan markets over the medium-long term have got considerably more liquid, but that doesn’t necessarily mean much tighter bid-offers — just an improved ability to actually transact in size in secondary, enhancing the temptations of excess trading.

Testing the new docs

CLO tranche investors might be well advised to monitor the situation at Austrian plastic film manufacturer Schur Flexibles closely, since this could be an interesting test of the new loss mitigation powers in the docs.

One of the biggest documentation changes to CLOs over the past couple of years has been the advent of “loss mitigation obligation” language — basically allowing CLO managers to play restructurings through participating in requests for new money. That should allow CLO money to be more nimble in a workout situation. Struggling companies and sponsors frequently run a strategy that’s essentially “play in the new money, and we won’t screw you”...so it helps if the docs actually allow CLO managers to do that..

LMO terms in CLOs have been evolving — the basic provision can be nuanced around which pots of cash managers can direct into new money facilities, as well as maturity and terms of these facilities, and how LMOs feed through into portfolio tests and triggers.

The Schur loans fell off a cliff in February, slipping more than 30 points over a couple of days — precluding the historic CLO strategy of selling up to a distressed fund when the trouble started.

It wasn’t just a company struggling to keep its business going as margins shrank and debt maturities neared; it was a collapse from respectable par loan to workout candidate overnight, as accounting irregularities emerged. Holders data shows that, sure enough, a bunch of CLOs are still in the loan, though there’s definitely been some selling. From this point, though, recoveries will depend on being able to participate effectively in any recovery.

The sponsors have now mostly walked away from the business, but the restructuring plan at the group envisages €75m of new money, mostly to take out some senior receivables financing, plus an opco/holdco debt split. Who plays it, and on what terms, is still to be determined but the LMO language could change the game. If you want to go deeper on the credit, we have your back — for 9fin subscribers, you can see the full Restructuring QuickTake. If you’re not yet in this privileged elite, editor Chris Haffenden has a discussion in his free-to-read “Friday Workout” or you can request a copy of the Restructuring QuickTake.

Free speech!

We did a lot of work the other day trawling through recent European CLO docs analysing current state of play for ESG exclusions. It threw up a bunch of stuff (clients can read the full piece), but one of the weirdest provisions we encountered was in deals for Barings (2019-1 reset) and NIBC (the most recent North-Westerly).

These prohibited investing in obligors involved in “anti-social publishing (including internet publications” on ESG grounds. It definitely doesn’t mean adult material, because this is specified separately....so what does it mean?

Plenty of people might think the UK’s Mail on Sunday now fits the bill. Maybe it means The National Enquirer? Maybe it means Infowars (now bankrupt)?

We wonder, however, just how antisocial a free speech maximalist Twitter might become.....and whether this might encounter some objections on ESG grounds. There’s clearly a benefit in a “public square” with free flowing discourse....but just how much of a fully unregulated Twitter would be devoted to hatespeech, crypto scams and incitements to violence? And would ESG-minded investors care? Doubtless this will be debated to death in more elevated forums than Excess Spread, but it’s not a trivial issue, with $12.5bn of leveraged debt to shift to back Elon Musk’s buyout.

If you would like to understand more of 9fin's analysis of the Twitter deal, please listen to the latest edition of Cloud 9fin where our US editor Will Caiger-Smith quizzes Steven Hunter, 9fin's CEO, on the deal's structure, how it might come to market, and what Twitter might look like as a credit.

2023 is the new 2021

We had occasion to chat with a long time to a senior figure at one of the debt purchasers the other day who seemed….less disappointed than I’d have thought.

Around the back end of 2020, all of these firms (think doValue, Arrow, Lowell, Hoist, Intrum, iQera, Encore/Cabot) were practically salivating at the prospects for NPL sales in the year ahead, as Covid-support schemes rolled off, and struggling SMEs and consumers felt the full force of the post-pandemic pain.

That….didn’t quite happen. Consumers and businesses came through things better than expected, and banks were well capitalized and thoroughly backstopped, with no desire to dump assets at bargain prices. 2021 was a decent year in terms of NPL sales, but a lot of the transactions were deals that had been put on ice in 2020, rather than newly distressed assets driven by the pandemic.

But the opportunity is apparently ready to knock again. Covid support is really ending this time, and high energy costs, inflation, stagnant wage growth and so on ought to push up NPL ratios at Europe’s banks, and prompt more selling ahead. 2021 wasn’t up to much, but 2023, on the other hand….

The question is not just who wants to buy NPLs, but how they are capitalized.

Most of the debt purchaser firms are mainly funded through HY bonds (9fin’s specialist subject), with securitisation layered in, often as a private short-term revolving facility.

Sceptics on the sector have often questioned the suitability of using bond funding, because it requires constant portfolio purchases to maintain credit metrics — the debt purchasers generally collect from the easiest loans first, so the rate of collections will decay over time and cashflows will shrink. If the flow of portfolios slows or dries up, or if the firms struggle to pay for acquisitions, that creates a squeeze, as it will be harder to collect from the back book, and the “LTV” (debt to estimated remaining collections) will also decline.

Securitisations, on the other hand, are backed only by the assets that back them, and should be cheaper, match-funded, and potentially more levered. They tend to be favoured by the PE/distressed funds who compete with the debt purchasers for NPL portfolios — but much of the economics leaks out to the servicer, potentially one of the same debt purchasing firms.

Of course, it’s also possible to securitise loans which have started paying again — and Lowell has launched Wolf Receivables Financing plc, a UK reperforming securitisation, with a £100.6m rated senior note and £79m junior tranche.

Lowell had existing sterling securitisations, one of £175m and one of £225m, according to its latest earnings, but with only £22m in headroom in these facilities. More importantly, it is using the Wolf deal to partly fund the purchase of Hoist Finance UK, a deal valued at £370m EV — to what extent can the other debt purchasing firms also monetise their re-performing assets to move forward when the NPL boom times get here?