Right now, the problem is just monstrously high rates, as UK inflation prints come out more stubborn and resistant than expected. I refinanced myself in May, which felt painful at the time, but put me on the right side of a trade for probably the first time ever. Now I can put the extra cash I raised for an extension on deposit and earn a nice spread doing so. The Bank of Owen is in business!

But clearly this is not a happy situation for originators, banks, the guardians of the UK’s macroeconomic health, and particularly not for borrowers coming up to the end of their fixed rate periods. 

The UK regulator used to require a interest rate stress of three percentage points over SVR (the reversion rate on most UK mortgages), a stress level which, applied to any five year coming up for refi, is well inside what’s available in the market. This affordability stress has now been removed; if it was still in place, nobody would be getting home loans of any description.

Much has been made of the limited utility of monetary policy in the UK — the large number of mortgage-free households (either those stuck in rentals or those who have paid them off) means that rate hikes only hit a limited subset of households. These particular households therefore need to be hit particularly hard to bring down inflation, or so goes the theory.

The immediate impacts on the securitisation market are going to be felt through limited origination pipelines. 

With absolute rates this high, borrowers that are in a position to defer home moves are going to do so; more complex credit histories and incomes might simply price people out of the market, rather than push them from High Street to specialist. The rapid sterling rates moves in 2022 were a huge challenge for the specialist lender community, but offered an opportunity for deposit-funded institutions to take market share; with the latest round of price shocks, nobody really wants to be a hero, and there may not be that much market left to take share of.

Limited origination means limited supply in the securitisation market, which was already reduced to the crumbs left by the deposit-takers; get bonds while you still can?

Not that you’d know there was a coming supply squeeze, looking at the primary market right now. 

In the UK this week we have NewDay Partnership Funding 2013-1 marketing, TwentyFour’s Oat Hill No. 3 marketing, Lloyds Banking Group’s second Permanent deal in as many months priced, and a UK equipment lease ABS debut from Haydock Finance, Hermitage 2023, announced. In euros, we have Santander’s SC Germany Consumer deal, a German auto ABS remarketing for CreditPlus, and a full stack buy-to-let offering for Irish non-bank Dilosk. It’s a rapid return for Dilosk, which was in market with Dilosk 6 in April, and it looks like it takes out some kind of bridging facility — the portfolio comes from Dilosk 3, called in April last year.

Senior strike?

The distinctive element across several recent deals has been some kind of senior anchoring, preplacement, or derisking. 

Oat Hill has a fully preplaced senior loan note tranche, at a rather nice 100bps coupon (is it at par?), SC Germany 2013-1 has €115m of protection in the senior, NewDay has £180m of senior protection, CreditPlus is reoffering only part of the senior, and Hermitage has preplaced all of its senior class (£75m in loan form going to Citi). While I was off, we had preplacement and protection in Santander Consumo 5 seniors.

What’s going on here? The market retreats to preplacement when times are tough, volatility is high and execution uncertain, but that’s palpably not the case. Crossover is at the tightest point of the year, mezz books are healthily oversubscribed. There are credit worries out there, but not really at the senior end of the capital structure; you don’t expect much extension risk from the likes of Santander.

The basic conceptual problem with anchoring a deal is that you lose some of the price discovery and discipline that comes from a syndication. Buying a lot of bonds or anchoring a deal should entitle the investor to a better price; you have provided certainty and size and for that you get paid. From an issuer’s perspective, it’s about pricing the certainty of execution that an anchor can bring, a question which depends on the market backdrop.

Rather than indicating a dearth of senior investors, I think the spate of senior preplacements indicates a particularly strong bid from those institutions which are playing in senior — preplacing a senior note is not a backstop of last resort to get a deal away.

In other words, the amount that the anchor investors are charging for certainty is small — the tiny premium over the theoretical open market price means it’s easy to agree.

Citi bought a lot of deals last year too, but it looks like it wasn’t just bottom fishing at a time of difficult execution; the point was not so much to help a struggling transaction find a home, but to find attractive investment assets for the bank.

I am using Citi as a shorthand, but there’s a range of big ticket senior anchors out there — NatWest, Lloyds and Barclays will all buy deals, especially UK RMBS, the European Investment Bank is active (buying Santander Consumer 5 and BBVA Consumer Auto 2023-1), BNP Paribas is buying (maybe the balance of the Hermitage seniors?).

As Bank of America’s research team put it (in reference to the EIB): “In the current market conditions, an anchor investor is necessary as means to derisk deal execution: investor demand is both strong and volatile, and as the song goes: ‘a spoonful of sugar makes the medicine go down’.”

Different anchor investors have different constraints. 

For some bank risk teams, it’s important not to buy the entire tranche, because what if you’ve paid the wrong price? Is it the right price if the rest of the tranche is bought by another bank anchor? Safety in numbers! Is it important to be able to trade the bonds? Is it important not to be able to trade the bonds (as in the case of the Citi loan notes)? 

Is the bond buying in question from a ring-fenced institution? What’s the cost of funds? Is it economic to fund through the money market? Does money market funding look awkward if the bonds get extended? Should an anchor get better docs treatment? 

I actually think this is not a bad place for the market to be. 

Bank balance sheets are the most efficient place for highly rated bonds to live; the right profile for a healthy securitisation investor base probably does feature banks in the senior, asset managers (and hopefully insurers) in the IG mezz, hedge funds in the junior mezz and resids. The CLO market has been in rude, unkillable health despite total regulatory neglect, and the senior anchor is completely standard there; it’s a real sign that securitisation banks are putting their money where their mouth is.

School’s out

The CLO primary market has been on pause for more than a month, but, as far as we can tell, for basically no good reason. The arbitrage hasn’t been great, but it hasn’t been great for more than a year, spreads have gone nowhere interesting since Barcelona, loan supply remains dominated by A&E flow not new money LBOs….so why the air pocket?

Well, we suspect that managers are approaching the market now as a sort of least-worst option. Get a deal done now and there’s at least a bit of primary to look at, secondary liquidity hasn’t hit full August torpor, and so you can do a lot of ramping before settlement. Ramping in August is no good, and if you get a deal now, there’s potentially room for another before year-end (if you’ve got the equity).

That’s supported by the sense that a few of the deals floating around the market have been floating for quite some time. Prints now are indicative of managers finally deciding to go, rather than seizing an opportune window.

Palmer Square has been first out of the gate with Palmer Square European Loan Funding 2023-2, its static shelf, printing via programme arranger JP Morgan. Seniors came at 170 bps, somewhat tighter than the talk for the various other deals out there (we’re hearing Bain, Nassau, Investcorp, Cairn all marketing transactions) but not a huge basis; static deals remain a niche pursuit.

For the broader CLO market, we’ve been wondering about the delicate balancing act around loan A&Es. Much has been written (including by 9fin) on the increasing proportion of CLO vehicles which are dropping out of reinvestment period this year and next. 

Assuming everything is more or less fine with a particular company, an A&E should be a matter of price — unless CLOs are constrained by deal documentation, particularly the operation of the WAL Test, from agreeing to extend. We’ve written a fair bit here and here about the particular constraints and how they work

But arguably, culture and implicit pressure provides an equally large constraint on manager behaviour. 

Even if managers can work their docs hard or find loopholes to allow themselves to be dragged along into an extended loan, should they? 

Triple-A investors want their money back; they want amortisation cashflows to recycle into secondary at 180bps or more. If triple-A availability is the binding constraint on new issue economics, then the last thing managers want to do with existing transactions is annoy the relatively limited and clubby world of European banks who have mostly been buying primary deals. 

Equity would rather have the amended loans, but hopefully equity holders in 2018 and 2019-vintage transactions are feeling relatively cheerful anyway, with spreads locked at some of the market’s lowest levels.

The strong A&E flow is creating its own particular dynamics in the leveraged loan market — lenders who do sign up for an extension are temporally subordinated to the outstanding stub of the old loan, so if this gets too large, the whole A&E could fall apart. As CLOs hitting their WAL Test increase, and triple-A investors exert their influence, roll rates are going to fall, stub sizes will increase, so the window for an A&E will also close. Better, in other words, to move early before everyone else does, before you absolutely have to, and while there’s still room for enough CLOs to consent.

The missing piece is new money, and this is key to the apparent resilience of CLO supply. 

There are have been almost no new money LBOs in Europe this year (Envalior was the only big ticket loan and a lot of that went to private credit) but more than €10bn of CLOs printed. 

What gives? CLO managers certainly complain about lack of product, but A&Es help to close the gap. By our count, there was €32bn of leveraged loan supply in euros in the first half, of which 54% was A&Es. If there’s 25% new money in those, that’s more than €4bn of stealthy supply slipping into the market and helping to close the gap to the CLO market total.

Cat call

Trustee notices are usually drafted to be as boring as possible, but occasionally there’s a little sideswipe that raises a smile. Noteholders in troubled Spanish SME loan deal Gedesco Trade Receivables 2020-1 were invited to a meeting on Tuesday to talk through options and grill the servicer, Gedesco, “to the extent the Servicer does indeed join”. 

The trustee pointed out that “many questions raised to date are more appropriately answered by the Servicer and will therefore be reserved until the Servicer joins.

We’ve discussed the deal before, and there’s a lot to unpick — a lawsuit in the US and in Spain between the sponsor and the originator, dragging in the principals, some alleged self-dealing, an extraordinary surge in delinquencies since the revolving period ended. Performance has actually improved this month, showing that the peak default rate (40%) was reached in April and now we’re back down to a mere 36%!

I’m still hoping to find out what the noteholders discussed this week, but we can take an educated guess. If I was in this deal, I’d want the servicer gone pronto. Whatever the outcome of the legal issues, it’s clear that something has badly broken in the servicing process to allow defaults to rise this high. The legal noise is at best unhelpful, at worst deeply damaging, and the tone of the notice strongly suggests relations are breaking down.

The backup servicer in the deal is Copernicus Servicing, which is basically an NPL / distressed asset shop (so 40% defaults is right in their wheelhouse?), but kicking out Gedesco and bringing in Copernicus may not be straightforward.

Servicer Termination Events are quite limited; failing to pass on payments, insolvency, or a failure under the servicing agreement which also results in a Material Adverse Effect AND continues unremedied for 60 days after giving notice. A glance at the servicing agreement section of the Gedesco doc doesn’t offer much of a potential angle either — it essentially commits Gedesco to apply the same standard to the securitised loans as it does to the rest of its portfolio, plus passing on payments in a timely fashion. 

If the collapse in portfolio performance came from Gedesco’s salesforce no longer offering to roll loans, this doesn’t seem like an obvious breach of the servicing standard, and so gives no reason to activate a Servicer Termination (even if you can meet the “Material Adverse Effect” standard). Let’s also remember that Gedesco holds the subordinated tranche, so whatever has gone wrong here, it isn’t something that’s easily remedied by bringing Gedesco, as an institution, into line.

So, continuing our line of speculation…I think we’re in extraordinary resolution territory here. The original deal documents don’t leave much of an angle for bondholders to get control of the situation, so changing the docs is the only way. I don’t think Gedesco is very widely held, and at least one trading desk is involved, but it is probably time to get a noteholder group formed, appoint an adviser, and tool up for a long fight.

Mudlarks

You can hear me discussing the situation at Thames Water on our Cloud 9fin podcast this week, so I’m not going to reprise too much of that here. 

I think the really interesting element of the whole business is the game theory between the Thames shareholders and government / Ofwat — specifically, who leaked the original story about potential nationalisation and why?

The situation before war was declared seems to have been that the shareholders were dragging their feet over kicking in the planned £1bn equity injection, which had been promised in the middle of last year.

Thames needed the money to get out of the penalty box, make some needed investments and bring down leverage, but it didn’t need it that much; it had no near-term maturities, ample liquidity, market access and so forth. Even the now-maybe-toast Kemble bonds were trading at a refinanceable 500 bps or so over Gilts. Hostage to fortune but let’s be real, the WBS bonds are gonna be fine whatever happens. Much too damp to be a burning platform. 

My hypothesis is that whoever leaked the nationalisation scheme was trying to accelerate this capital injection; there never was a real danger of nationalisation, or of Thames getting into any meaningful financial difficulty. 

But you’d only do this if negotiations in private had already collapsed to such an extent that public pressure was required; one or more of the Thames shareholders wasn’t keen to put anything into an asset that paid no dividends and drove so much public opprobrium.

The public pressure, in its own terms, worked; £750m of the originally planned £1bn is coming. A missing £250m is not trivial, even for a £19bn company, but the capital injection follows £500m last year and it is (as interim Thames CEO Catherine Ross told MPs on Wednesday) the largest investment in the water sector since privatisation.

Indeed, it has prompted an even more generous offer; £2.5bn over the next regulatory period (AMP 8), subject to unspecified conditions. This sends the ball back to the UK government, with added spin. 

The as-yet-unspecified conditions are presumably “let us make profits” — give the shareholders a line of sight to running Thames as a profitable and dividend-paying enterprise. No path to profit, no equity injection. But the politics of giving the water companies an easy ride are just terrible at the moment. Ofwat is taking the brunt of the blame for the concerns about Thames, so needs to talk tough for the next “AMP8” licence cycle from 2025.

Big picture, the investment Thames needs can either be funded by shareholders (and recouped from water bills) or funded by the government (through some kind of nationalisation and forced recap). The politics of both are roughly as appealing as a bath in a sewage farm, so expect a lot more toxicity before the headlines die down.