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Hedge Funds Start To Join Secret Lenders Clubs for Buyout Deals. So say our esteemed competitors at Bloomberg, citing the fact that Arini, Cross Ocean Partners and Sona are now on whitelists for new LBO lending.

This is, as the piece notes, driven by the fact that all three now have CLO management platforms in Europe — Cross Ocean’s is a little more established, as it bought the Commerzbank Bosphorus shelf in December 2021, while Arini and Sona have been starting greenfield operations.

Arini hired BNP Paribas’s Mehdi Kashani to build out the CLO operation in 2022, and hired Pinebridge’s Evangeline Lim in May this year, while Sona hired Rothschild’s Jacob Walton in January.

So of course these firms are now approved lenders. Just like any other CLO manager (though Arini and Sona are only at the warehouse stage).

The greater significance is not in these firms getting whitelist approval, but in what this says about credit investing.

These institutions are just the latest in a long line of funds which have broadened their initial focus, using the basic skills of credit analysis to drive different investment styles.

Not so very long ago, hearing that GSO and Apollo were buying into your TLB might send a shiver down sponsor spines. If Oaktree, Angelo Gordon, Anchorage, GoldenTree and Sculptor all showed up as well, that meant you’ve got a fight ahead. But today this is completely unremarkable; all of these firms have well-established CLO shelves and rank among the premier par loan-investing firms who’d support a primary transaction.

Elliott stands apart as the premier distressed firm without an in-house European CLO business, but it has Elmwood Asset Management in the US, and is a big equity investor in Europe, which you can bet keeps a close eye on how managers handle distressed situations.

Zooming right out, the broader trend of doing all kinds of investing in a single firm is clear. The big private equity firms are now big credit firms as well, and this credit approach encompasses private debt, asset-based lending, special situations, credit opportunities, capital solutions, par loans, bonds — really, just about everything. Apollo is now banging the drum for private investment grade opportunities, and possibly trying to look a bit nicer than in the past

The likes of Arini and Sona are clearly different (and considerably smaller) animals than a Carlyle or a KKR, but the direction of travel is similar — everything is blurring into “alternative asset management”. One could also consider the move of Albacore from a private credit base to CLO management, or Pemberton (another CLO debutant for this year), building on private credit roots but broadening into syndicated loans.

Corporate analysis is useful whether you’re lending super senior money to top quality businesses or structuring a warrants package in a troubled turnaround financing.

The basic game in distressed debt has also changed. There’s still a lot of legal tooling up to be done, but it’s harder to drive value by taking the keys or causing so much trouble that you get paid off. Looser documents make it harder to cause a stink or take over a business outright.

Instead, the basic play tends to involve providing new money on preferential terms; teaming up with sponsors to take value away from a group of existing lenders.

That requires a less adversarial relationship with sponsors than old-school distressed investing. It’s more important to get the first call for DIP financing than it is to squeeze the last basis point out in a courtroom battle — and if anything, having a big par loan operation is a benefit, giving credit firms the scale and sponsor relationships to help drive special situations/credit opportunities-style investments.

But there’s still a balance to be struck, particularly for a new CLO manager looking to establish itself in the market. Investors want to know that a CLO operation is not an afterthought; that it has independent longevity, and a place at the core of a business. Investors want to see a stable and experienced team, with expertise not just in corporate credit but in investing within the constraints of a CLO structure. Distressed debt expertise in-house is a plus, but not if it means the distressed team is in charge and par credit is a backwater.

Manager tiering is meaningful this year — Signal Capital Partners, known best for CRE investing and distressed debt, priced triple-A notes in its debut more than 15bps outside the market, and even Nassau, on its third transaction in Europe, paid a chunky premium over Bain in mid July.

That means market approach and institutional branding are going to be vital for the debuts still in the pipeline this year. There should be a nice window coming in September, good luck to all!

So Co-Op Bank has won the bidding for the Sainsbury’s Bank mortgage portfolio, a chunky £464m ticket. As far as one can discern from Sainsbury’s results past, the mortgages are pretty good — 97% of the portfolio is below 70% LTV.

There’s £1m of “impaired: over three months” from the £581m total at the beginning of March, and £6m of “credit impaired”. So it’s a prime-ish bunch of assets; an excellent match for the Co-Op Bank of today, which is pretty much all prime UK mortgages, following a long journey of restructuring and asset quality improvement since it collapsed into the arms of hedge funds in 2017. Let’s take a beat to remember Paul Flowers, the “Crystal Methodist”, former chair of the bank, and a more freewheeling high-living time in UK retail banking.

Anyway, Co-Op Bank constitutes a surprising winner for the portfolio sale, managed by Deloitte, on two grounds. The first is that it’s fairly publicly up for sale. A Reuters leak in April has the company hiring PJT Partners and Fenchurch Advisory for sale or IPO, while Sky’s Mark Kleinman had Shawbrook offering a stock-based merger this month.

That doesn’t preclude Co-Op from making tactical investments in the meantime, but it hasn’t exactly been a major consolidator over the last few years, preferring in general to sell assets rather than grow the balance sheet, and it’s unusual timing. Nick Slape, the CEO, said in the statement announcing the deal that it was Co-Op’s first acquisition in more than a decade.

The second noteworthy point is that it’s Co-Op Bank winning the portfolio and not someone else.

If the portfolio had been up for sale in 2021, we’d surely have seen securitisation-funded investors lead the way — the West Coast Asset Manager, M&G probably, maybe a Blackstone or Elliott — but deposit-funders are in charge today. More surprising is that it wasn’t one of the more active deposit-funded buyers.

Chetwood we have discussed extensively in these pages, as a buyer of BTL assets from LendInvest and of senior RMBS bonds, while Starling Bank has also been signing substantial portfolio acquisitions, and Shawbrook itself has been no slouch. OneSavings Bank, too, has been on the front foot.

Admittedly, most of these institutions have been purchasing somewhat juicier assets — buy-to-let and non-conforming, rather than prime — but surely this is mostly a question of price? Sainsbury’s said it sold the £479m gross value (£467m with hedging) book for £464m. We don’t know how effective the hedging actually is (and therefore how much of the discount is duration) but Sainsbury’s was a motivated seller; it was closing down the mortgage business, not hitting an opportunistic bid.

A few months back we were also interested in the balance sheet of the big daddy of challenger banks, JP Morgan’s Chase UK — and wondering if this would start down the path of sucking up assets to rescue some NIM from the headlong deposit competition. At the time we didn’t have any numbers, but since then the entity housing Chase has published December 2022 figures and…..well, get a load of this.

That’s £1.049bn of deposits at the end of 2021, £12.11bn at the end of 2022. Pretty much the entire deposit base is on-lent to other JP Morgan entities or placed in repo, and so the whole thing is still very much a money-losing proposition, but it’s become a balance sheet monster practically overnight.

A quick and unscientific poll of sellside syndicate suggests there’s a strong September in the works across securitisation asset classes, be that specialist mortgages, prime, euro consumer, CLOs, some off-the-run stuff — only CMBS is unlikely (of which more later). Some deals will be refis, others funding new origination, despite some lending weakness in the biggest UK market.

The US market has barely paused for the summer in any capital market, though there might be a dip around Labor Day, but this bodes well for the autumn session in Europe — spreads have ground in, and thus far it seems like ABS investors both sides of the Atlantic are expecting to be insulated from concerns over Chinese property companies.

UK Finance, which compiles mortgage figures across the industry, expected overall mortgage lending to fall 15% in 2023, with lending for house purchases expected to be down 23% and new lending to BTL down 27%.

We don’t have access to the latest figures, but this doesn’t necessarily translate to bad news for the specialists. One can think of the UK mortgage market like an iceberg, with the relatively transparent capital-markets funded specialist segment taking only those loans which surface from the vast, under-the-sea High Street lending.

UK Finance reckons on £275bn of gross first charge residential mortgage lending in 2023 — let’s do some cigarette pack maths and say an additional 1% of that figure gets pushed out of High Street banks and builders by cost-of-living pressures, complex incomes and tight credit metrics.

That’s £2.75bn, or maybe 10x £275m specialist lender RMBS transactions back by new origination? Quite a decent bit of dealflow, no?

Even in the prime UK space, where origination volume is less important than overall funding mix decisions, there are supportive trends — the big banks and builders want to get ahead of the roll-off of central bank liquidity support, as the four year money from the Bank of England’s Term Funding Scheme (TFSME) is due for repayment next year.

That means a shift to a more normalised wholesale funding mix across unsecured products and the various channels of secured funding (and prime master trust RMBS is relatively close to covered bond levels today). Lloyds chose to double-dip its relaunch of Permanent, raising an additional £750m with Permanent 2023-2 in mid-July — and part of the rationale for returning to market so quickly was the expectation of competing supply later on this year.

Expect the established master trust issuers — Nationwide, Virgin Money, and Santander UK plus the big builders at least, but there are still glaring holes in the issuer landscape. Barclays has had the documentation in place for a new-style master trust issue since the back end of 2019, but it hasn’t used it (yet), and HSBC has an active SRT shelf and covered bonds, but no RMBS.

Last September obviously started very well — BNP Paribas in particular did a good job in shipping out a lot of pipeline early on — but finished with the extraordinary scenes in the wake of the UK “mini-budget” and the massive disgorgement of senior securitisation bonds. There are no obvious political troubles brewing….but then, last year also came out of left field.

With holiday and general summer torpor I had given far too little attention to Blackstone’s Last Mile Logistics CMBS 2023-1, quite literally the only European CMBS for more than a year. I wrote a chunky piece for subscribers earlier this week, but the basic issue for this transaction, as for many formats of securitisation, is that it finances assets originated in one environment at rates dictated by the current environment.

Asset yields on logistics properties (the pandemic asset class of choice) were as low as the mid-3s in the glory days, and even the properties in this deal, mostly bought during 2022, were paying 4.73% based on the deal value and current rent roll.

The blended cost of debt (which passes straight through to the loan), however, would come in north of 8% (3.23% of margin+Sonia over 5%), were it not for a Sonia cap provided by HSBC. This brings the debt cost down to 5.88% — but financing an asset yielding 4.73% at 5.88% (55% LTV) is not an obviously lucrative or sensible activity.

It doesn’t necessarily mean that the investment thesis is broken; perhaps logistics assets will continue to appreciate, perhaps Blackstone can fix up this portfolio and flip it down the road (most of the deal’s financial restrictions kick in after two years).

But it’s going to be an uphill struggle. Commercial real estate has a quasi-mechanical link to prevailing interest rates, and it’s not clear that valuations have fully adjusted to the new environment. That certainly seems to be the case here — given the valuation baked into the deal, it appears that owning a bunch of scuzzy light industrial and logistics units gives a lower upfront return than placing cash on deposit with the Bank of England.

For the senior investors, including arranger Citi with a £30m loan note, and likely Standard Chartered as well, it looks like an excellent trade — low LTV, even if you apply a monster haircut, and a spread that’s a good 120bps back of even beaten-up resi.

But it’s unlikely to be a transaction sponsors are rushing to repeat.

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