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Private Credit 

Owen Sanderson

One spends months bemoaning minimal issuance, but within a few weeks of a primary window opening, the pendulum has swung hard in the other direction, and the question is now whether the supply is large enough to swamp the still-frail recovery.

In ABS we’ve got five different flavours of auto ABS, French credit cards, Dutch buy-to-let and Irish reperforming loans (though nothing from the UK), while there are some 10 active CLO deals in marketing, from managers including Blackstone Credit, Canyon Capital Management, CVC Credit, Cross Ocean Partners, Redding Ridge, Palmer Square, Tikehau and WhiteStar Asset Management.

That’s €3bn-€4bn of supply, with the best part of €2bn in senior CLO bonds to be placed. Triple-A notes screamed tighter since the start of the year, from 220 bps or so to Invesco’s 165 bps print last week via BNP Paribas, but another leg tighter is running into this huge wall of issuance — why bid bonds up when there are deals aplenty to choose from?

More to the point, where’s the €3bn-€4bn of new money in leveraged loans going to come from?

Primary loan markets are still defined by tedium — this week brings a €130m add-on from Aggreko, a $250m-equivalent deal from ERM and a privately placed €200m deal from Renta. Nothing wrong with the credits but this isn’t the kind of dealflow that can match the multiple billions in CLO primary.

The BirchLane Capital liquidations have helped a little.

As a reminder, Anchorage Capital took a batch of hung warehouses off defunct hedge fund BirchLane Capital, probably at the instigation of limited partner CPPIB.

It’s been pumping out a steady stream of BWICs this year with collateral from these facilities, though in relatively small size — the largest list we’ve seen is €93m-equivalent. But much more has likely been moving behind the scenes. BirchLane fell apart last summer, so perhaps the intervening months have seen Anchorage cherry-pick the portfolios for its own funds.

Is the recent BWIC supply just profit-taking on those names which have performed particularly nicely this year? Eyeballing the lists there seems to be a pre-ponderance of decent quality pharma and telco names, plus some large cap market darlings like Refresco, Verisure and Stada. Arguably, that’s just European levfin, but there’s nothing with real hair on it.

Anyway, these are exactly the kind of names that form the cornerstone of CLO portfolios, so any additional supply is helpful and will ease the pressure for bank trading desks trying to source product for their CLO manager clients.

BirchLane or no BirchLane, there’s still a clear supply-demand mismatch, and so the CLO market is back where we were at several points last year — the arb is not going to be great!

The list of managers in market is notable for being mostly firms that can bring their own equity in size or have a business plan that requires issuance to validate it.

That said, presumably there are some ways to navigate the market with skill. We understand Cross Ocean Partners’ latest Bosphorus deal boasts a nice healthy 460 bps weighted average spread, which compares to 3.84 for the market as a whole, or 4.02 for 2022 vintage deals. That’s been achieved not through janky illiquid overlevered B- debt, but through taking advantage of the amend & extends and limited high coupon new issue we’ve seen of late.

Discussions on term structure are likely to be especially important at the moment. If you’ve got a bunch of equity but liability spreads are (you think) due to tighten, doing a deal today and hoping to reset next year is a perfectly valid strategy. The cost of the reset is going to be a drag, but you might end up with a nice high WAS portfolio funded cheap.

Call it the 2020/2021 trade if you will — CLOs with expensive liability stacks in 2020 pretty much all reset in 2021 and are some of the strongest equity performers out there.

But why are senior investors — faced with €2bn or so to buy, a smorgasbord of managers clamouring for attention, and a potentially tightening market in the medium term — going to give ground on call protection?

Most of the deals in market are therefore going to need at least the 1.5 year standard which prevailed through 2021… but at least senior investors are now willing to give managers the runway to actively manage for a good few years afterwards.

One of everyone’s favourite topics in CLO land, especially when we’re surveying the senior investor landscape, is the presence or otherwise of Japanese bank Norinchukin. Bloomberg reckons it is back, TwentyFour AM has some thoughts, and the CVC Credit deal it was due to anchor in the autumn has been dusted off for a return to market.

But the question, as ever, is how NoChu behaves? Is the CLO whale splashing about and breaching in full view of a boatload of tourists, or diving deep and blowing a few bubbles?

Early 2019-style buy-everything NoChu means lots of tightening ahead for senior spreads; highly selective 2022 NoChu just takes a little supply of the table from selected top tier managers. The big rally so far this year may be giving the Japanese bank and its potential managers pause for thought — it typically locks levels well ahead of syndication, so if there’s a sniff of tightening in the air then a NoChu deal can end up looking expensive.

While seniors have screamed in, there’s surely room to go further at the bottom of the stack. Single B notes are pretty much the cheapest product in fixed income, and still too cheap for managers to actually issue in primary.

According to Prytania Solutions, senior credit spreads have come in 23% since the start of the year, and single B just 5% (the rest of the stack between 9.5% and 17%). The same tranche in the US (a less traditional component of the CLO capital structure) is just 0.17% tighter on the year.

Demand drivers are very different here: lots of the funds that play in single B also play in equity; manager tiering is vitally important; single Bs are in the firing line for downgrade risk; and the impact of poor macro conditions on portfolio companies. Buyers here that aren’t pure play CLO folk usually have a broad mandate and can do special sits / credit opportunities type positions, which may be offering better risk-reward right now.

We’ve also flagged the overhang risk for this tranche in the past — if spreads do follow the rest of the fixed income universe in, they will eventually hit a level where the delayed draw or retained tranches structured into almost every primary deal since the middle of last year get issued. How long can gravity be defied?

In consumer markets, the heavy supply seems to be leading to a greater… stickiness… in syndication, though perhaps this is down to operational issues rather than depth of demand.

There’s something ugly about a book update with a 0-handle, as we saw with 0.9x for the first update on FCT Purple 2023-1, and 0.8x on Domi 2023-1.

These subscription levels didn’t last — FCT Purple 2023-1 came up to 1.4x done at the final level of 58, itself tighter from 60 area, while Domi seniors were 2.6x covered at the time of writing and targeting a 5 bps tightening.

So perhaps this is simply that investors in European ABS aren’t really set up and staffed up for seven deals at once, especially in half term week. Admittedly some of the announced transactions are slated for execution next week, but investors still need to do the work. Everything takes a little longer, credit analysis is stretched, RV is a moving target and so orders come in late.

Once the current dealflow washes through and puts out distribution stats we’ll get a fuller picture of the euro ABS backdrop, but one interesting point from the syndication of Dutch RMBS DPF 2023-1 is the very high level of UK participation — 56%.

DPF wasn’t a “Simple Transparent and Standardised” issue, so it’s not a regulatory slam-dunk for bank treasuries, and the big UK-based asset managers who buy euro and sterling alike probably turned out for it. But it’s still a pretty big number for a euro issue… does it indicate a divergence of views? UK buyers are more bulled-up or bouncing back hard from last year’s LDI issues?

Most of this week’s issuance is STS eligible and some of it — VCL 38, Bavarian Sky 12 — is just about the tightest product available in European securitisation, so it’s likely to appeal to a different audience.

But just as we saw with UK product last year, the steep rise in rates can really make a difference. The last good window for auto ABS was in September 2022, when one month Euribor was 22 bps at the start of the month and 67 bps by the end. Now we’re around 240 bps. That risk-free VW bond with a credit spread in the 40s is actually paying proper positive interest. In theory, the rates backdrop should all come out in the wash; in practice, decently positive coupons do seem more appealing.

The exciting part, in some ways, is that we don’t know! The last time we had ABS supply with Euribor over 2% most of the world was on Basel I, SIVs existed, CPDOs walked the earth, and many of the market’s participants weren’t even mulling their first finance internships.

Restructuring in the kingdom of Arendelle

As the father of a three year old girl, it brought me considerable joy that TwentyFour Asset Management’s blog on Blackstone’s Finnish CMBS FROSN-2018 referenced the Disney classic “Frozen” — it’s the best shot I have at convincing her that I do something worthwhile for a living (don’t comment on this topic).

Here’s the piece, from Elena Rinaldi, and as with all of the TwentyFour blogs, it’s worth a read (memo to the other asset management firms out there; get real and get specific, nobody wants to hear that insert).

But it’s unfortunate for Blackstone (via portfolio company Sponda) that bondholders didn’t display as much sisterly solidarity as in the movie.

The long stop on the senior loan maturity was 15 February 2023 (following three one year extension options were exercised), so one might have expected an attempt to address this early. However, matters seem to have been left rather late, with a meeting of the class A1 bondholders called the day before loan maturity to ask for another one year extension.

The A&E for the underlying loan seemed to be structured with some amount of good faith — there was 125 bps on the margin, plus an agreement to pay it down with sale proceeds. There was a new business plan with various reassuring noises, and presumably, given the compressed timeline, the sponsor was expecting an easy tick box exercise.

This… did not happen. The A1 notes met on Tuesday, but missed the threshold to consent to a loan extension. It’s not clear from the notice whether this was down to lack of attendance at the meeting or disapproval. Perhaps half term, Valentine’s Day and busy primary markets tied everyone to their desks?

Anyway, after 5pm on the actual day of loan maturity, the servicer announced it had approved a week of extension to “allow the senior borrower to consult with the servicer on next steps”, with a conference call on Thursday to “gather feedback from noteholders”. Presumably Plan A to avoid tipping in to special servicing is to find out whether juicing the extension offer a bit will be sufficient to get it through.

But per the TwentyFour note, there’s some illustrative issues here for the broader market. TwentyFour disclosed at the end of the piece that they’d sold their position in 2022, but it seems that Blackstone has also been on the sales trail, and essentially traded out of the good assets pre pandemic.

This underlines one of the risks of playing CMBS — negative selection is much more live and dangerous than in resi or CLOs. There’s relatively little chance of an RMBS sponsor taking a prime deal and selling down the portfolio into non-conform territory; there’s somewhat more risk with a CLO, but this is mitigated by long reinvestment periods and active management.

Per 24: “Through 2019 and up until just before the pandemic struck in Q2 2020, the sponsor sold more than 15 properties resulting in debt repayment of approximately 50% of the original value. The assets sold were some of the largest by market value in the portfolio, but also some of the best quality ones (i.e. not particularly “non-core” in our view).”

With this backdrop, is it any wonder that senior noteholders weren’t queueing up to extend? The other problem with CMBS structures can be the prevalence of “tranche warfare”, much in evidence in the aftermath of 2008. Here’s a very good 2010 romp through some of the post-crisis CMBS restructurings from the Paul Hastings dynamic duo of Conor Downey and Charles Roberts.

Essentially, these discussions pit different parts of the capital structure against one another — typically either senior notes vs the rest, or controlling class (the most junior in-the-money) vs the rest.

Senior notes in FROSN-2018 have no special reason to care about whether the loan falls into special servicing, whether the sponsor loses control or, really, the business plan for the underlying assets. There’s a decent tail period on the bonds (to 2028) and they’re going to be made whole. It takes a certain amount of brain damage to be involved in a potential CMBS restructuring, but there’s very little credit risk here. There’s also limited upside. Senior bonds would get paid sooner through asset disposals, but the loan margin increase doesn’t translate to higher bond coupons.

Mezz, especially junior mezz, has much more reason to care — but can’t actually approve the extension.

This is going to become an increasingly live issue as the year goes on, but it’s very dependent on docs and process.

In the Taurus 2019-IT Bel Air loan (which by a happy coincidence was also due to mature February 15), matters were handled very differently. The noteholders had already appointed a representative, there was a meeting before Christmas, several other meetings in January. The A&E package itself also included note margin increases, a lengthening of the bond final maturity, provisions on hedging, early paydown, fees and disposal proceeds.

All the amendments were passed on time, and Wednesday saw the changes implemented smoothly. Admittedly the updated valuation showed a market value decline of nearly 20%, so it’s still a complex credit situation, but this is how one ought to approach loan extension.

One of the basic things you need to know in credit investing is what equity is up to. Doesn’t matter if it’s large cap corporates (is there an activist on the share register? Anchor/strategic holders?); leveraged finance (which sponsor, which fund, how much money has already come out of the biz, what’s the entry point); or even emerging markets (who’s in the government, what are their goals and motivations).

Securitised products are by far the worst large asset class for this kind of thing, despite the torrent of transparency initiatives aimed at the sector. Partly this is habit and structure; securitisation equity is just an anonymous certificate or note, not necessarily listed, not on any register, essentially parallel to the old timey regime of corporate share ownership that’s structured disclosure for limited liability corporations for generations.

I guess I should declare an interest here — I spend a lot of time thinking about the motivations of securitisation equity investors, across CLOs and consumer asset classes, so it just seems easier if I know who to call.

But isn’t this also a gigantic regulatory misfire?

Let’s consider, say, Cerberus, and the Towd Point — Auburn transactions it didn’t call. There’s any amount of public disclosure about the loans in question, you can feed them into expensive software packages and spend many happy hours playing with collateral assumptions and modelling and remodelling payment profiles.

However, the actual thing that determines the bond price is Cerberus’s motivations and probability of calling the deal, and there’s not much out there to help. It’s not clear which fund holds the call option, how the fund is performing, how long the fund life is, who the LPs are and so forth.

It’s worse still where the risk retention belongs to some third party, and there’s no transparency at all on where the equity ultimately lands. You can model mortgage affordability until the cows come home. But doesn’t it matter quite a lot whether the equity holder is out there for a quick buck or wants the portfolio for the long term? Isn’t that far more material to the bond price?

Figuring out equity motivations is a material source of alpha for the funds and traders that get it right, so transparency in this respect would meet resistance. It’s also true that nothing comes for free in finance. Would more transparency and forced disclosure from equity discourage capital from entering the sector? Probably! Equity capital is the life force on which any market depends, so best to encourage it where possible.

But it’s baffling, to me at least, that securitisation, has to cope with onerous transparency rules which touch not a jot on the single most important factor in credit investing.

Prime Collateralised Securities (PCS) brings its rolling show of European securitisation events to London next week, with a day-long session at the Allen & Overy offices. My former colleague Ashley Hofmann, who used to work on Global ABS and the GlobalCapital Securitisation Awards, has been over there since last summer arranging the symposium series and she knows a thing or two about how to run a good event. Also I’ll be there. Here’s the agenda should you need more convincing.

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