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Owen Sanderson

Securitisation markets appear to be in decent shape from a “demand to buy bonds” perspective — everyone’s been trying to get long into the Santa rally, most on-the-run asset classes are undersupplied and oversubscribed, and things look promising on both sides for January.

But the bread and butter asset class for European securitised products is UK specialist lender RMBS, and here the outlook might be less rosy. UK Finance, the trade body for the UK’s lending industry, published its 2024 forecast this week and it makes for concerning reading.

Origination volumes have collapsed this year — UK Finance says 28% lower in gross mortgage lending, 23% lower in lending for house purchase — and this has likely fallen disproportionately on the specialists. The fuel for securitisation comes from buy-to-let (mortgages for purchase down 53% in 2023, expected to drop a further 13% in 2024) and lending to borrowers poorly served by the High Street, whether that’s near-prime, niche prime, complex prime, non-conforming or any other branding.

Affordability in a high rates environment is the main constraint — though swap rates have started to drop again, it’s disproportionately the already-struggling borrowers who have been pushed from “mortgage” to “no mortgage” in 2023. Prime borrowers are feeling the pinch, but still find themselves financeable.

While house purchases and remortgaging have both collapsed this year, product transfers have been booming, up from £198bn in 2022 to £219bn in 2023. These allow borrowers to stay with the same lender, avoid being switched onto Standard Variable Rates but, crucially, avoid a full re-underwriting, with new affordability check. The Intermediary Mortgage Lenders Association, which has a different dataset, said in November that 19% of business was product transfers, higher than any other category.

But even if lenders aren’t re-underwriting product transfers in full, securitisation investors will be — LTVs will be higher, Loan to Income will be higher, stress tests will hit them harder, prepayment rates will be lower. Rating agencies may haircut assumptions still further, since they tend to take a conservative approach — where valuations or income data haven’t been updated, they will assume the worst.

To the extent that the “front book” collateral coming to market in 2024 is full of product transfer loans, it will probably be in worse shape, achieve lower advance rates and more expensive structures than in the past.

The dire state of origination also matters for the actual institutions involved in the market (and hence for their access to capital and ability to keep calling deals). 

Lenders with a capital-lite approach, selling their origination straight into forward flows, are highly geared to the fee streams from new origination. There’s no steady stream of cashflows coming off residual notes to cushion the blow of the tough backdrop.

So we wonder if 2024 brings consolidation or shake up of the sector. Every mortgage lender is a little different, and products do change, but fundamentally there aren’t that many moves left in the residential lending business. There are only so many flavours of residential loan that need to exist, and a tough market means tough choices for firms that aren’t doing enough volume.

We wonder particularly what the plan is for the venerable Capital Home Loans business, owned by Cerberus since 2015. 

CHL reentered front book lending in 2021 to considerable fanfare, and has warehouses open with Barclays and BNP Paribas (Barossa is the SPV name). We have often wondered how you’d get a decent front book BTL takeout as an issuer with a well-established reputation for failing to call, and presumably it’s a question others have pondered too.

Indeed, it seems Cerberus itself is sceptical about the prospects. We understand CHL has been shopping the front book mortgages around, first bilaterally and latterly with EY… neither commented. Likely buyers for the front book are probably the deposit-takers — if we were running it, we’d probably talk to Starling, Chetwood, Shawbrook, and OSB as a first pass.

The back book may also be for sale, though it’s mostly in securitised format. Towd Point Mortgage Funding Auburn 12, 13 and 14 remain uncalled, so any sale process presumably involves offering the residuals around, so buyers would need to sit and wait for an opportune moment to rerack into a structure of their choosing. 

Matt Kimber, who led the CHL return to lending, recently moved on, joining Molo as chief operating officer. Molo was early in taking the pain hitting specialist lenders; maybe it’s going to be early to bounce back too?

We’ve been doing some work on the rather inventive football stadium financings emanating from Goldman Sachs lately — there’s a big piece here, which will go in front of the paywall in due course.

The two deals so far are a €1.5bn financing for FC Barcelona, which we discussed earlier this year, and a €305m deal for Olympique Lyonnais, closed last month. Both of these target the USPP investor base (essentially US lifers) with long-dated secured assets. The neat part, though, is the use of securitisation mechanics to get to a structure which is much more “covenant-lite” than a classic project or infra-style financing.

This basically gives the clubs more control over their own cash — instead of locking it up in an infra-style deal where operations, maintenance and everything else is inside (or packing the stadium as a whole business securitisation, like some of the ill-fated UK deals in the early 2000s) — the clubs keep control over much of their money. FC Barcelona gets to keep the first €100m of stadium revenue before the rest is funneled through the structure, while Olympique Lyonnais has a 50% split over certain categories of revenue. Operation and maintenance stay with the clubs, only the cash needed for each period of debt service gets trapped.

The big picture intuition is that stadiums themselves aren’t super-helpful collateral. There are some alternative uses, such as concerts, or occasional events like the Rugby World Cup and Olympic Games, but fundamentally the only club likely to regularly fill a stadium in Barcelona the size of Camp Nou (the fourth largest in the world) is FC Barcelona. If the club is in financial difficulties or can’t play for some reason, the stadium real estate doesn’t help you.

So these are really receivables financings, and the key credit part is getting a tight hold over the receivables — for which a securitisation structure suits admirably. A French law FCT, as in the Lyon deal, is exempted from the French banking monopoly, so it can grant a loan to the club, and issue USPP-format English law notes on the other side. Receivables in the FCT are also protected from a French law insolvency process, should this ever become an issue.

The Barcelona deal is considerably more baroque and complex, since it also funds a vast renovation project on Camp Nou costing nearly €1bn, so it has a series of construction risk and guarantee provisions, and the revenues securing the bonds are the future revenues for the completed stadium. But both are a neat example of securitisation problem-solving.

SRT has many benefits (we ran a 9fin Educational on the market this week) but the key thing is that it’s a way of raising bank capital without troubling the equity markets. None of the big banks want to do rights issues, but it’s even more important for the fintechs — for two reasons.

Klarna did its first deal in 2022, a SEK9.12bn-equivalent portfolio, according to the annual report (€812.6m). This saved SEK7.7bn of risk weighted assets, not bad on a total retail book of SEK57bn.

This is a firm that really doesn’t want to go around shaking the tin in the VC world. In July 2022 it closed a new $800m capital raise, at a valuation of $6.7bn post-money. This was a “down round” on an epic scale. The company’s previous funding round in June 2021 valued it at $45.6bn, a truly stupendous figure reflecting the exuberance of 2021 “tech”. 

This year, it seems to have geared up its programme, doing deals in March and just this week, and, bafflingly, deciding to list them. Only in the superlatively transparent Santander programme have we previously had the joy of poking around in SRT documentation.

Anyway, it looks like last summer’s deal was the big one, with €110m of placed notes — implying a pretty fat tranche of 13.5%, likely reflecting the riskiness of the collateral. Subsequent deals have been SEK512m in March, referencing a SEK5bn maximum portfolio (it looks to be revolving, again, sensible given the short-dated BNPL reference loans) with a 1225bps coupon.

This month we had €14.76m on a €144m portfolio at 960bps, and NOK348.5m on a NOK3.4bn portfolio, also at 960bps — 10.25% tranches. I think, given that it’s the same coupons and the tranche size on the same date, that these were two tranches of the same deal.

So it looks like Klarna has done SRT deals in Germany (2022), Sweden and in Norway, and apparently on improving terms. It’s also said to be working on a forward flow for the UK book — pulling all the capital levers it can.

Since the financial crisis, the issuer-pays ratings model has been controversial — the infamous scene in The Big Short basically sums up the popular perception, which is that agencies hand out the ratings that structurers and issuers want to achieve. The agencies have become massively more regulated since then, and the commercial-analytical line is as heavily policed as any institutional barrier in finance.

It’s clearly not true, in a trivial sense, that rating agencies hand out whatever rating their clients want; every structuring team is trying to maximise triple-A advance rates and lower the cost of capital, but they’re colouring within the lines, dealing with the constraints of rating agency methodologies as just part of life. 

But it is true in a fuzzier, larger sense. The agencies remain commercial enterprises, and do want to provide a service which is useful to their clients. Sometimes this might involve whipping up a new methodology when there’s a market opportunity, which is all fine and good and helpful; S&P’s exploration of a data center-specific approach would be an example, or ARC’s creation of an equity release approach. 

Structuring teams do pick and choose rating agencies according to what investors want, but also by which agency will give them the most attractive treatment. “Rating shopping” is the pejorative word for it, but I mean… how else would you choose a rating agency? Random chance? Rotation?

The safeguard against this in the post-crisis regulatory world was supposed to be the “unsolicited” rating; agencies were encouraged to publish unpaid ratings for deals they didn’t win, showing that they would have rated something lower than the mandated agency. 

At the time, everyone said this wouldn’t work, and it basically doesn’t! There’s zero incentive for the agencies to do a load of analytical work for free and to annoy their potential clients. Fitch published 25 unsolicited transaction commentaries globally in the 10 years between 2008 and 2018, and this is on the high side!

Some of these do redound to Fitch’s credit. Saying that the secondary shopping centre CMBS Elizabeth Finance 2018 couldn’t support a triple-A seems prescient; the one remaining loan entered special servicing in 2020 and receivers have been appointed. But it’s still a rare and controversial move.

In practice, the compromise approach for rating agencies is to do issuer-friendly things, but in a long term, consistent and compliant way instead of ad hoc deal by deal tweaks. 

Nowhere is this more obvious than in the CLO market, where the methodology change=market share dynamic has been so glaring as to attract the attention of the European Securities and Markets Authority. 

Last week, the regulator published the gripping page-turner “EU CLO credit ratings – risk of conflicts of interests relating to methodology changes”, which my CLO colleague Michelle wrote about here, in the teeth of post-Dana Point conference jetlag.

Anyway, this examines in some detail the very powerful effects CLO methodology shifts have had on rating mandates. Look at Fitch go!

The regulator, however, didn’t find any Big Short-style smoking guns. The best it could come up with was some stuff about “market outreach” meetings.

“ESMA observed that CLO rating analysts who have participated in market outreach activities may have been exposed to non-analytical information, such as the preferences of CLO related third parties in relation to credit ratings and rating methodologies, and the commercial perception of their methodologies… Non-analytical information could provide rating analysts, involved in the initiation and development of changes to a CLO rating methodology and rating process, with commercial information that results in a perception of or actual conflict of interests.”

I guess ESMA conceives of the agency analytical teams as ideally kept in a basement somewhere, fed only a thin gruel of offering memoranda and loan tapes, pure of heart and innocent of market practice? 

If you worked in the Moody’s CLO team, you’d have to be living under a rock not to notice that your market share has more than halved since the before the pandemic. You don’t need your colleague in business development to explain it to you. You see the dealflow, you notice you’re only being asked for triple-A ratings. The “commercial perception” is right there in the percentages!

But it does present Moody’s with a problem, and Fitch with a fait accompli. 

Following the ESMA report, it would be a bold agency indeed that decided to rework its CLO methodology in an issuer-friendly direction. You’d better have the most watertight and puritanical justification imaginable if you’re going to even try. Better to hunker down and hope the heat goes away.

If the ESMA report does freeze the methodologies in place, that’s a massive benefit to Fitch, at a historically record market share, and not so great for Moody’s, which moved slower to change its metholody, and is now at its lowest market share other than 2020. The publication of the report rewards precisely the issuer-friendly behaviour it is warning against.

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