Excess Spread — Ebola, NoChu, Call me careless


Market Wrap

Excess Spread — Ebola, NoChu, Call me careless

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


The activities of Norinchukin Bank in the CLO market are a subject of endless fascination, and rightly so — at various points in time, the Japanese agricultural bank has been the defining investor of the market, the anchor triple-A by which deals live or die.

So how to parse the news that it’s pulled its recent anchor commitments? Honourable mention first to Creditflux for the superb headline “It’s Nochu it’s me”…the fun police on the follow at Bloomberg went for the more pedestrian “’CLO Whale’ Halts Purchases”.

Two points on this — Norinchukin has been much less active in the past year or two anyway. 2021 saw NoChu refi’d out of much of its European portfolio, as the deals from “peak NoChu” in early 2019 left their non-call periods and were reset. The bank has been active this year, but in very limited fashion. New issue activity has actually been running at a decent clip, behind 2021 but broadly in line with pre-pandemic CLO flow, so it’s clear that most senior bonds have been finding different homes through 2022.

European banks, some of them the treasury arms of CLO arrangers, have been stepping up, though there’s been decent interest from banks without a CLO franchise of their own (Santander, Commerzbank, AIB, Investec) as well. Senior CLO anchor capital has certainly not been plentiful, and these investors have often been able to dictate terms and maturity structures, but it hasn’t been absent this year, just constrained.

It seems that rather more senior bonds than anyone realized had ended up in the hands of real money over the years, given the volume of selling following the “mini-budget” — the perception of the seniors as a “bank tranche” was, apparently, overdone.

Current spreads might have scared NoChu, but if anything, they’re likely to bring some other accounts off the sidelines. Talk to senior investors with some cash to spend, and they’re practically drooling at the moment — some “really nice bonds” (a technical term) have been shown with a 3-handle in the past weeks. That’s the sort of credit spread you’d have got on a B1 loan in 2021, and you’re getting a bullet-proof triple-A. Better yet, rising Euribor has made the ostensibly floating rate asset class (but actually fixed because of the Euribor floor) genuinely floating now.

The second point is…..how long is NoChu actually out for? Senior euro CLOs have never been more of a bargain. It’s a feeding frenzy for investors with long-term holds that can ride out the vol; why on earth would you stay on the sidelines now?

At this point, it’s traditional to point out that NoChu is, frankly, a little weird.

“Japanese investors are super conservative” is usually the polite way of saying it, meaning “not ballsy enough to buy the dip” in this context. But how conservative can it really be? It had a $70bn CLO portfolio; at one point, it was effectively the entire market. Whatever else it may or may not do, it’s certainly got a house view on CLO Triple A.

The other leg of the NoChu weirdness, though, is in its execution habits — commit early to a level, stand by it, and pencil in pricing for a specific date. If it’s a down day, or a down week, or markets are freaking out…..this matters not. The deal is the deal is the deal.

This was evident in Investcorp’s Harvest XXIX CLO, issued in late July. Seniors on that deal, anchored by NoChu, printed at 160 bps, vs a discount margin of 225 bps for Anchorage Capital Europe 6 issued the following week.

It’s this habit, we think, which NoChu is likely to be reviewing.

However “conservative” or strange one’s investing approach, being 50 bps through the market in July can’t have been too much fun.

Let’s assume, for the sake of argument, that NoChu set levels on its planned September deal(s), such as the new CVC Credit trade, in mid August. That’s a nice “conservative” month or so of runway to get the deal syndicated…and would have implied a triple A spread of maybe 175 bps. Fast forward through the LDI-driven sell-off, and some triple A bonds were being shown at 300 bps. Generic spreads were certainly the far side of 250 bps. Perhaps NoChu can wear an instant 50 bps M2M loss…..but 75-100 bps on senior starts to look embarrassing.

I’d think this is just a supertanker slowly changing course — NoChu, quite rightly, wants to get paid properly for its anchors.

Summer redux

While the CLO market is certainly not in good shape, loans have also taken a leg down, with the European Leveraged Loan Index in an 88 context at the time of writing — the lowest level since the post-pandemic period.

So if CLOs are going to happen at all, they need to be the kind of structures that are geared to principal appreciation, not traditional cashflow arbitrage. That’s not really what CLOs are designed for, so it’s an awkward bodge. A print and sprint could work in theory…..but the very small number of actual print and sprints executed in Europe testifies to just how hard this is to execute.

The problem is, even if you really do the sprint part pretty hard, loans have exhibited a distressing tendency to move much more rapidly than CLO liability spreads for the whole year. Carlyle successfully squeezed out a print and sprint in May, but there were a handful of managers looking at these transactions in March, none of which got over the line.

Some of the vehicles were subsequently retooled as low-ramped conventional deals, taking the same basic approach as a print and sprint (loans are cheap) but over a slightly longer period.

The trouble is, some of them are cheap for a reason, and what’s the catalyst for pulling to par? When the cashflow arb doesn’t work and you’re hoping to lock in a one year trading gain….what happens when there isn’t much of a gain?

It’s not a great tragedy for the world, but it does mean equity performance on that CLO is not going to be good — and CLO equity investors might think there are better ways to take a view on loan pricing than setting up new CLO vehicles.

If you start a print and sprint process but run into a loans rally, you’re basically just locking in a poorly performing transaction, so it requires some confidence that the loan market technicals won’t shift, a line of sight to better pricing in future, and the resilience to wear any downgrade or distress the year ahead might hold.

To lose one is unfortunate

Cerberus likes to announce non-calls as swiftly as possible after I file this newsletter on a Thursday, and so it was with Towd Point Mortgage Funding 2019-Vantage2 last week. The FORD is in November, and it was (like Auburn 13), another well-flagged danger call.

The non-conforming collateral was purchased in 2016 by Cerberus as part of the Project Vantage sale from GE Money, and the 2019 deal was the first re-rack after the initial securitisation….the call in question is pretty solidly out of the money, with senior step up to 180 bps, though there has been an appreciable delevering since 2019, with seniors paid down from £410m to £271m.

The non-call notice, like that of Auburn 13, includes the pious intention to catch up at a later IPD when market conditions are better….but like that of Auburn 13, suffers from the fact that there’s no real line of sight to any improvement in market conditions.

The comical lack of political stability is unlikely to convince fence-sitters that it’s time to back up the truck on UK resi risk, and, in any case, even a big sentiment shift is unlikely to get us back to early September levels.

Anyway, one non-call may be regarded as a misfortune, but two starts to look like carelessness — the beginning of an ominous trend. Auburn 13, as we noted a couple of weeks ago, had an SPV ready to go (we understand there were ratings fixed up as well). No such vehicle seems to have been created for Vantage2.

Ratings, especially for relatively low WAC collateral like Vantage, are heavily geared to coupon assumptions….there’s probably no point going off and structuring a Vantage refi deal on current market spreads, as presumably it would be replete with the kind of expensive bells and whistles required to manage the minimal excess spread. The easiest way to keep a handily levered deal in place is to make the post-FORD step up as low as possible…..which is not going to be easy right after a non-call or two.

Speaking of weird bells and whistles for low WAC collateral, we note that Lone Star’s plan for the European Residential Loan Securitisation 2019-NPL 1 and 2 deals is coming into clearer focus. NPL 1 skipped a call in the summer, but plausibly with a combined refi at the November call date for NPL 2 in mind. That’s, at least, what the research folks at Barclays thought, and it seemed legit at the time.

At the beginning of October, the ERLS 2019-NPL transactions published notices saying they’d scored a portfolio sale for the performing collateral.

Now these loans, all €513m of them, have popped up in Shamrock Residential 2022-2, an RPL RMBS arranged by Morgan Stanley. It seems only the senior notes have been placed so far, €323.4m of them once the risk retention (Morgan Stanley Principal Funding) has been taken out, at a 250 bps discount margin.

Given a weighted average coupon of 2.35% on the mortgages, the transaction is replete with features designed to maximise leverage, minimise step-up spreads, and raise enough spread to get the deal afloat. There’s a Yield Supplement Overcollateralisation feature (essentially dribbling principal into the deal as interest). The step-ups are a tiny 100 bps across the stack, there’s a net WAC cap, but there’s also an excess spread trap, a full turbo and a portfolio marketing option to reassure investors that a call will happen. Good thing too — prepayments are sloooow, such that a class G noteholder could see their bond extended from 2.36 years to 19 years if the sponsor doesn’t call.

This is a sensible piece of business though — from a securitisation perspective, non-performing loans are a little like peeing in a paddling pool….the absolute volume may not be large, but it changes the character of the experience quite dramatically. Rating agencies using NPL methodologies will tend to spit out far less favourable capital structures than straight RMBS methodologies.

So the sensible move, if you’re Lone Star, is to lever the reperforming portion of the portfolio separately, before any refi of the smaller remaining non-performing portion. ERLS 2019-NPL 2 had a 46% senior advance rate, based on the mortgage balance, and was only structured to single-A….Shamrock is 68% to triple-A, just to underline the point.

Presumably Lone Star would ideally have placed the mezz as well — max the leverage! — but, like other deep-pocketed sponsors, it likely has reserve levels in mind which aren’t available in the current market. Perhaps they’ll dribble out in the market, or be used to raise some repo finance.

So when will the ERLS 2019-NPL calls happen? Still unconfirmed, but once again, there’s an encouraging looking SPV incorporated.

All the bells and whistles have precedent in the various other Morgan Stanley-arranged Irish RPL and NPL transactions, and if you like this asset class, you’ve probably got your head around it.

But who does? It’s a large asset class now, thanks largely to Morgan Stanley, but it’s still a little off-the-run. Even funds that appreciate the spicier end of securitisation might reasonably prefer the certainty of recent collateral and high excess spreads over unpicking the equity-friendly artifice on display here.

A quick poke around throws up some familiar names — Pimco, Insight and PGIM, for instance — plus Blackstone’s Real Estate Income Fund, and Morgan Stanley’s own Mortgage Investing arm in MSIM.


I was wondering, as I do regularly, how the specialist lenders are doing at the moment, but perhaps I can’t express things better than Guy Harrington, founder of Glenhawk, a bridging and development finance specialist.

Harrington said: “Running a non bank lender at the moment is I imagine like catching Ebola, not ideal”.

Not that Harrington was in poor spirits overall — “it’s tough out there for most, be kind, don’t be a knob and this will all pass one day”. Fair point, we hope so, and well capitalised firms should be able to ride it out.

Glenhawk has a senior facility with JP Morgan, signed in 2020 and later supplemented with a mezz tranche from Balbec Capital (which I thought was more NPL focused, but there you go). Much more recently (announced the day before the mini-budget) was a further £200m from NatWest Markets, allowing it to target £1bn annual origination by 2024.

Before the investment banks jumped it, it was funded by Shawbrook and Insight Asset Management, and according to PropertyWeek, it’s backed by RightMove founder Harry Hill.

So it’s probably on the well capitalised end of things — it owns its mortgages and takes senior funding, rather than passing them straight off to a forward flow arrangement with a hedge fund or PE shop.

That probably makes it more resilient that a platform purely based on origination volumes. Bridging loan volumes are somewhat geared to the level of property speculation. A typical use case might be buying a building to redevelop and flip into flats, for example. An economy heading into recession and a potential housing slump is probably going to see less of this kind of activity in the near term — so if the business needs throughput to keep the lights on, it’s going to struggle.

Capital commitment is key though — and lenders that don’t have deep pockets may not be so sanguine. Last year was an ideal time to launch a specialist lender sale process, with some nice rich prints to set the benchmark. Late 2022, however, is going to be less supportive, especially if buyers can smell the desperation.

What’s worse than Ebola? And who’s caught it?

Miami dispatches

I’ve been stuck in rainy Britain watching the government collapse, but my excellent US colleagues have been reporting from ABS East in Miami — including the last hurrah of Credit Suisse’s securitized products business before the new owners step in (strategy day on Thursday is the one to watch).

Hopefully they carry on booking the clubs under new management — but by then, it could be one of the biggest clients out there, and some other investment bank will be picking up the bar tab.

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