Market Wrap

Excess Spread — Getting long, new investors, the Barclays playbook

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

Time to get long

We’ve been working on a piece getting into the weeds of CLOs and amend & extend transactions. This is likely a big theme for the year ahead — we’ve already got a few of the biggest beasts in European leveraged finance looking to push maturities (Altice France pushing out €8bnEG Group contemplating a similar wall in 2025). At the same time, more and more CLOs are dropping out of reinvestment period (36% by the end of the year, possibly), and WAL Tests are an increasingly important constraint.

(If you are not a client and would like to request a copy of our news on Altice or EG Group please complete your details on the forms.)

Anyway, one interesting innovation we came across on our travels concerns the WAL Test itself.

At the moment, it’s kind of a dumb mechanic… it’s a weighted average of all the maturity dates of the loans in a CLO portfolio. The thing is, though, no loans ever actually mature.

In virtually every leveraged loan situation, sponsors will want to address their maturities more than a year before technical maturity, to avoid them “going current” from an accounting perspective, and causing trouble in audit opinions or for directors’ duties.

If the sponsor isn’t in a position to refi, then there’s much more wiggle room in addressing matters through restructuring negotiations than through simply leaving some borrowing to run to maturity, failing to pay and walking away.

In other words, the one thing that almost never happens (TLBs running to maturity and repaying) feeds straight into the main mechanism for controlling CLO portfolio profiles.

WAL Tests calculations are a fairly hard constraint. But in certain deal vintages, there’s a lot of flexibility to simply push out the test date, typically with some limitation (12/15/18 months). For older vintage deals, this was with the consent of the controlling class, but more recently it’s been common to give the mezz a voice, requiring the consent of all classes of rated notes (an appreciably harder admin burden then getting sign-off from a single triple-A anchor).

But this is still kind of mechanistic and not terribly risk sensitive. We hear that an entirely different approach is in the works, which pegs the WAL Test to deal performance… though this has yet to be tested with rating agencies or in the market itself.

The incentive for managers and equity is obvious — if a deal is going well, you want to be able to run the position! Managing loans, and continuing to do so, is kind of the point of the CLO thing. Restrictive WAL Tests do lead to perverse outcomes towards the end of a deal’s life cycle. Managers may end up degrading performance to stay compliant or be unable to take advantage of market opportunities to the fullest extent.

But it’s also obvious that investors may not be wildly enthusiastic about any further attempts to monkey around with one of their traditional protections.

That’s an ideal time for me to segue into a rather interesting piece this week from Michael Schewitz, one of the PMs on Investec Bank’s CLO investing team, titled “Bought all those CLOs at par? Who’s sorry now?”

Schewitz has often made a point of emphasising the optionality senior investors give to equity in CLOs… and arguing that it’s mispriced.

As he puts it: “I have consistently emphasised one point. This was that the senior investors in the debt stack were giving the first loss or ‘equity’ a fantastic free option due to call flexibility on the CLO debt. Further, this option generally did not appear to be priced by senior note investors. Notwithstanding my own good advice, I am embarrassed to say that way too often and pushed by the market, I also fell into this trap.”

He has a decent stab at trying to value the option, but it’s not easy.

AAA investors though can and should take a stab at valuing the option for their own book. If you are being charged a premium to take out long funding by your organisation's treasury in order to purchase a CLO (as I am) then the early repay hurts. This is because you are funding your book at a level higher than necessary as you probably geared your funding conservatively to a longer expected life of the transaction…

… Valuing this optionality is difficult. My gut feel, however, is that currently about every year that a manager has the right but not the obligation to call and can still reasonably reinvest, is worth about 10-15 basis points of spread on the AAA. On most transactions then, this would translate into about 50-75 basis points (0.5%-0.75%) of price on the AAA for a typical BSL new issue. Of course, this price will always vary given market conditions. It is no surprise that in 2022 we started to see transactions coming with this. I also think that toward the end of last year, secondary AAA trading at discount probably had a lower overall discount margin of 10-15 basis points per annum spread than equivalent AAA priced at par. This gives a sense of the value of the option given by the AAA.”

Where I’m going with this, I guess, is that a massively more flexible performance-dependent WAL Test structure makes this problem worse. Less certainty about the duration of the asset, and making this itself a dependent variable of portfolio performance, makes valuing the call option even harder.

Schewitz’s other basic point still stands though — if markets heat up sufficiently, investors will give on structural features, probably including this latest tweak.

In 9fin’s review of the PortAventura A&E transaction, one lender gave us a slightly tragic quote which kind of sums up the decade or so to the start of 2022… and perhaps the decade to come.

“We’ll complain, but we won’t refrain from investing,” the second lender said. “They’ll likely get it through.”

Maybe flexibility on the WAL Test would be sufficiently valuable that it’s worth a give elsewhere. Could we see longer non-calls to match the looser WAL Test?

Showing up for senior

The primary market appears to be humming along nicely, as you’d expect against a backdrop of positive credit conditions, with a bunch of managers in the market — Partners Group, GoldenTree and Capital Four Triple-As are testing the 200 bps mark, and credit spreads are tighter down the stack. In other good news, we note that Vedanta Bagchi has a new gig.

Bagchi was co-PM for the Commerzbank treasury book, a sizeable buyer at the top of the CLO capital structure, and a regular on the conference circuit, fighting the good fight for the rights of debt investors. So it’s interesting that the new gig is Portfolio Manager and Global Head of Structured Credit at neobank/payments platform Revolut, a new position — it’s a strong signal that the firm’s looking at swinging some balance sheet into the CLO market. Given that it’s a regulated bank, we’d expect it to be active at the triple-A end of things, much like Commerz.

Revolut is a private company, so we only have a balance sheet up to the end of 2020 (UK Companies House notes that the latest numbers are overdue). Presumably it’s also been growing fast (customer deposits were up 96% in 2020), so it’s frustratingly hard to get a sense of potential scale two years down the road.

It had around £4.5bn in cash at the back end of 2020… but much of this was segregated customer funding held with other banks, and matters have likely moved on (Revolut launched a bank in 10 European markets last year and is seeking a UK banking licence).

Anyway, it’s a potentially sizeable investor, Bagchi’s hire looks like a statement of intent, so three cheers for a new triple-A buyer.

If there’s an issue with the CLO market at the moment, it’s not tranche investor demand, nor managers’ desire to print, but the availability of collateral.

As one levfin banker put it to us: ”If we had a pipeline of nice credits at 500 bps and 96, CLO managers would be queueing around the block to print new deals and take them off us. But we mostly have a pipeline of best-efforts refis and A&Es, there’s very little new money still.”

Sponsors bankers hint at some background rumblings, and there are a live situations — a €1bn tussle between Triton and Bain Capital over Finnish construction industry supply firm Caverion, for example, enlivening a market that hasn’t seen much in the way of P2Ps for months. But even that’s not going to through off enough new debt to move the needle, and any sponsor activity now is unlikely to result in new leveraged loans for months.

The end of an era

Many older folk in the securitisation market nurse a bundle of resentments about the London market’s paper of record, The Financial Times, mostly dating from the era when Gillian Tett was writing about the market ahead of and around the global financial crisis.

Tett herself has been gently mocked from for her account of Saving The World From Securitisation; she also has a somewhat unhealthy obsession with D-Leverage, the rock band which played at Global ABS 2007. As bassist Adrian Carr pointed out in the letters pages, she misinterprets the etymology of the band’s name (it is a tribute to D:REAM rather the cod-reggae-esque Da Leverage), but she was still banging on about the band when she was invited back to the conference as a keynote speaker in 2016.

I don’t share this resentment (there’s been some great reporting from the Pink Pages) but I kinda get it, and this week brought two reversals — a relatively enthusiastic endorsement of the market from regulation editor Laura Noonan, reporting on an equally positive move from the European Parliament.

Maybe it’s a little mean to call the market moribund, as Banca IMI’s Paolo Binarelli points out (I certainly feel busy trying to write about it), but it could certainly do with catching a regulatory break. Full parity with covered bonds would be nice, but every little helps.

Essentially, this would cut the capital allocated to investing in securitisation tranches, which has been one of the really big asks for the industry. One can go back and forth on how important these capital issues actually are — bank treasury demand seemed to come back to the market in a big way last year, driven by positive base rates and juicy credit spreads. If there was reluctance to go big on securitisation tranches in the post-crisis years, deeply negative Euribor and competition from the ECB’s asset purchases needs to take part of the blame.

Still, it’s a strong signal, and it comes straight from the French and German treasuries, which have not always been huge supporters of the market in the past. We understand that the European Parliament vote on Tuesday evening passed, so the next step is trilogue, where the three main EU institutions, Council, Parliament and Commission hash it all out.

Much can still go wrong, but Parliament has, historically, thrown some of the biggest spanners in the works of regulatory reform (who remembers Paul Tang and 20% risk retention?).

As one securitisation policy specialist put it… ”Sanity may prevail”.

The Barclays playbook

We talked about this year’s rather extraordinary market opener, Bridgegate Funding, a couple of weeks ago, but we’ve sniffed out answers to a few of the curious questions we raised at the time.

The deal, dubbed “Project Typhoon”, was driven in part by increasingly rigorous regulatory stress testing of the Lloyds Banking Group book. As we noted a couple of weeks back, these mortgages are some of the ropiest loans ever to be packaged into a “performing” RMBS, so presumably they get whacked pretty hard in a stress-testing scenario.

They’ve been hanging around for more than a decade (originator The Mortgage Business, cool name if annoying to google, closed books in 2008), but selling them on probably meant taking a loss, and just sitting on the book with light-touch servicing didn’t especially hurt (until the stress testing ramped up).

It’s also worth noting what’s been going on at the top of the Lloyds group — Charlie Nunn took over as chief exec in 2021, William Chalmers was in seat from 2019, and Cecile Hillary took over as treasurer in 2021. So that’s a pretty comprehensive management revamp, plus a year or so to actually get this portfolio out the door. No wonder it wasn’t tackled earlier.

As we assumed, Lloyds is indeed keeping the senior notes for its own purposes. They may not be eligible HQLA bonds, but they will still do as repo collateral, and the economics are attractive. The deal had to be structured “on market”, or it doesn’t count for BoE purposes, but it’s a somewhat elastic concept, and anyway what is “on market” for £2.3bn? It’s probably a different price level from the £5m-£20m BWIC pieces that were signalling a tighter level…

Nobody that knows about it wants to tell me definitively that it was Pimco (and the deal docs merely disclose a “Significant Investor” which is “one or more third party investors”) but I think we can work with that assumption.

Pimco might have won, but it was marketed, we understand, to a high single-digits number of accounts. I’d be keen to hear thoughts on who deserves a place on the long list, but pulling names out of a hat, I’d guess Pimco, DK, M&G, Blackstone, Apollo, Cerberus, Fortress, Lone Star, Elliott.

TMB (the originator, we understand) is not being sold at the same time — we assumed the servicing would need to be fairly hands-on to make this trade work, but Lloyds, along with every other High Street firm, is not going to want to wear the risk of a more vigorous firm torching reputations with a round of repossessions.

Lloyds is keeping the risk retention, but I hadn’t quite appreciated that we’re talking about different bits of Lloyds.

Rather than being Lloyds the mortgage-lending selling institution, the risk retention is actually held by Lloyds Bank Corporate Markets (the investment banking arm), its first risk retention position for a sponsor client — a helpful selling point for winning future business from this community. There aren’t many banks doing these trades (Citi and Barclays, mostly), and a little competition is probably healthy.

Of course, there’s a bit of personal and institutional history here. When the Barclays securitisation business began ramping up in 2017, following the hire of Cecile Hillary (now Lloyds treasurer) and Matt Weir, the ability to offer risk retention was an important part of the offering.

The head of the Lloyds asset-backed business is Miray Muminoglu, formerly of Barclays treasury and even more formerly on Barclays ABS syndicate. For that matter, Allen Appen, head of bond finance, is also ex-Barclays ABS, though he left well before the risk retentions started coming in.

So it’s not a total exaggeration to think of this as the Barclays playbook rolling out at another UK clearer…

Anyway, Lloyds is charging 8 bps on this occasion — we’re not sure if that is on market (please do write in). The Ripon refi early in 2022 allocated retention holder Barclays X1 and X2 certificates both paying 7 bps for a 14 bps total, so it certainly looks cheaper, but there may be some subtlety in the structure I haven’t appreciated.

It’s an open question, though, how many investors are likely to use third party investment bank retention structures. Nearwater Capital Markets has been pushing from its heartland financing CLO risk retentions to become a dominant force in consumer asset classes too.

The Nearwater proposition is simple and very attractive — 100% non mark-to-market financing against vertical slice risk retention (i.e. risk retention where a sponsor owns 5% of every tranche, rather than a subordinated piece).

Effectively, this means sponsors don’t have to put any money down at all to comply with their “skin in the game” requirements. They’re still on the hook, because Nearwater’s financing is a repo, with recourse, but no actual money needs to be committed. Securitisation people basically love leverage, and this is a way to eke out a little more.

More recently, we hear, investment banks have been disintermediating Nearwater on some trades. Nearwater offers the 100% repo, but it doesn’t actually have an ABS trading desk. It just rehypothecates the bonds straight back to the market, where the most natural counterparty is whoever happened to arrange the deal.

So why not cut out the middleman? There’s an argument that skin in the game without any actual money down is not strictly in the spirit of risk retention, but what even is the spirit of risk retention? It was designed to fix a particular pre-crisis problem which may not even have been a problem. All that’s left is the rules and everyone’s got comfortable with those…


A few months back, we had the considerable pleasure of interviewing James Ruane of CDPQ’s Capital Solutions team, which basically has a very flexible and cool investing mandate across complex corporate credit, pref, opportunistic credit and asset-backed — anything from song libraries to mining royalties to aircraft engines.

Now the team has unveiled its first asset-backed deal in Europe, a £100m financing for electric vehicle subscription firm Onto. The deal comes alongside Pollen Street, a veteran institution in the private asset-backed markets, which has been funding Onto since 2021, and it’s not so large that it’s going to blow the doors off. But it’s not small either, and it’s a very cool and growing sector.

CDPQ and Pollen Street are both senior lenders to an SPV owning cars, which are then rented out to Onto’s customers. The group has a fairly complex fleet management back-end, with telematics, dashboard cams and other monitoring technology, aiming to manage the value of the fleet and sell at an optimal time.

Onto hasn’t always had such well-regarded financing counterparties — in 2020, it appears to have done a deal with now infamous Greensill Capital — but apart from such missteps it appears to have been growing quickly. That’s probably good news for CDPQ, whose pockets are considerably deeper than required to co-participate in a £100m ticket, and will doubtless want to grow with the business.

But the banks are also clambering all over the car subscription industry — we wrote in 2021 about Credit Suisse and Waterfall Asset Management’s €500m deal with Finn — so how long will Onto stick with non-bank partners with presumably higher return targets?

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