Market Wrap

Excess Spread — Mucky business, where’s WALy, welcome to winter

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

Winter is coming

How did you enjoy the September market reopening? Did you get the bonds you wanted? Did your deals sail through primary unimpeded? Because that might be it for a while. The UK’s self-inflicted crisis is pretty bad for the biggest securitisation market in Europe, but things aren’t exactly rosy elsewhere.

The UK moves have been particularly extreme. We’re not going to do the macro, the politics, the swaps or the Gilts piece (other publications are available) but will have a look at the action in mortgages and securitisation.

For most of the year specialist lenders, the mainstay of the UK RMBS market in good times, have been in a race to keep up with the rising rates cycle, keeping product rates competitive enough that they can actually write loans, but high enough that their loans are profitable. That’s been generally easier for lenders with deposit bases or insurance money behind them, rather than the securitisation-funded firms looking to a moving takeout target several months in the future. The High Street giants funding the prime end of the market have been insouciant about their rates, given their sticky ring-fenced current account liquidity, originating at levels tighter than swaps at certain points in 2022.

But last Friday’s “mini-Budget” was enough to blow that out the water. Maybe with judicious use of forward-starting swaps, specialist lenders can manage a 1% move in swaps in a month…how about in a couple of days?

The very biggest beasts, including Halifax (funders of my own highly levered London real estate exposure) pulled their products on Monday, along with essentially everyone else. There’s scarcely a mortgage to be had in the Kingdom until lenders feel they’ve a line of sight to some rates stability.

As TwentyFour Asset Management’s Doug Charleston points out, it’s not a crisis in the banking system….it’s simply that lenders do not know what rate to charge and cannot hedge. These sentiments were echoed by Hans Geberbauer of Foundation Home Loans (holding a reassuring chicken) and noting “there is no credit crisis and most lenders have ample liquidity and capital.”

That’s not a universal view…there are some very bearish takes out there about the consequences of widespread inability of borrowers to service their mortgages, and what the rates mean for house prices going forward….I’d think I’d incline to a view of stress but not crisis myself (though bear in mind this is from a guy who’s going to have to refi in June next year, send thoughts and prayers).

Historically, unemployment has been the thing that leads to mass mortgage defaults. The UK labour market is tight, with unemployment at historic lows…borrower behaviour suggests people will scrimp and save and cut more or less anything before they risk losing their homes. Better to default on energy bills (they can’t even cut you off!) or unsecured credit first.

There’s definitely a subset of borrowers that don’t have this flexibility, though — the “mortgage prisoners” from pre-GFC will be in a world of pain as the Bank Rate changes pass through to SVRs, for example, and there’s going to be pressure to ease the pain for these households.

Either way, the chaos is blowing up housing chains and borrowers are scared, so expect origination to take a pause while this mess is sorted out and products are reintroduced, and run lower run rates going forwards.

In the short term, the chaos might actually help to conceal the stresses in some specialist lender business models — pulling products at the same time as Halifax because of broader markets is indistinguishable, to the outsider, from pulling products because the lights are slowly going out on a particular funding model. For some of the struggling lenders, it could even offer a breathing space to rework their own funding structures and adjust to the new levels.

For the platforms, it’s the mortgage fee that pays the bills. The actual loans go straight off into a forward flow somewhere, where the rates, hedging, NIM and so forth are someone else’s problem, but the pure origination businesses need origination throughput to make the numbers work.

When lenders do bring products back, there might be a few differences. Keystone Property Finance (whose mortgages backed TwentyFour’s Hops Hills transaction the week before) launched a range of variable rate products on Thursday, priced at a spread over Bank Rate, with a “switch and fix” facility for borrowers who go variable to fix in the future. That solves the immediate swaps problem, and could in any case be appealing to customers… locking fixed rate at the highest level in two decades is a tough sell, even if the market is saying rates might rise further.


“LDI repositioning” used to mean something akin to “witches did it” — it was a smarter way to say “more sellers than buyers” and better than saying “I have no idea”.

But suddenly it’s top of the news cycle and markets have got intimately familiar with the effects of the strategy— see the FT and here also, Reuters, Risk, or, in very short words, the Guardian. My personal preference is M&G’s Bond Vigilantes blog (a name that’s suddenly no longer ironic).

Anyway, the TLDR is that a bunch of big UK pension funds were struggling to meet margin calls on their long dated swaps / levered gilt positions. The 2073 linker halved in price in a couple of days (I believe it might be the highest duration government bond in the world), so these margin calls were…..substantial.

Meeting the margin calls meant selling everything that wasn’t nailed down. That primarily meant other Gilts, exacerbating the broader panic in the market. But it flowed through to credit too. ABS isn’t the most liquid asset class to dump, but it is at least short duration and high cash price.

We hear one large UK asset manager put out around £2bn of securitisations for BWIC this week and last Friday, with sterling senior RMBS well represented, but enough mezz to be meaningful, with heavy CLO selling and some substantial euro lists emerging later in the week.

The involuntary nature of some of this selling can be divined from the presence of lines like Tommi 3Friary 7Pulse 2022-1, and Autonoria 2022 (the latter bonds hadn’t even settled). This was decidedly not a case of flipping for the new issue premium…these were positions which the seller fought for allocation in just two weeks ago, dumped in the market to cover redemptions.

Some lines were also in size — £50m of Finsbury Square Green 2021, £40m of Penarth 2018-1, £50m of Blitzen 2021-1 for example.

One source cited a four year UK master trust bond covered at 115 bps. Given Friary’s 67 bps print two weeks ago (which was back of master trust RMBS), we’re looking at a pretty savage move here. Weaker non-conform shelves that were in a 150 bps-160 bps context last week are well north of 200 bps; BTL mezz might be 75bps-100 bps wider.

This selling seems to have managed to be the worst of both worlds — one source said that these lists produced a huge number of DNTs, with only about a third of the bonds trading. In other words, the sellers tanked the market successfully, but without actually raising much of the cash they needed. The market coped poorly with this volume of disposals, with covers reportedly miles away from trading levels, no pricing consensus, and wide bid-offers.

If you had the dry powder and the guts to hang on, there were doubtless some bargains to be had — being a buyer when there are forced sellers is a nice place to be — but the big question is whether this capital pool comes back in.

The Bank of England’s intervention on Wednesday morning took some of the immediate margin call pressure off the table by stablising long end Gilts, but the witch hunt is now on for whoever allowed the UK’s pension system to get to this point. LDI funds themselves will want to see a period of market stability, and preferably some political and macro path out of the mess before they’re ready to jump back in….but it also seems possible that the near-death experience will lead to a fundamental rethink of UK pension rules which could change capital allocation in sterling forever.

Mucky business

All this proved rather disruptive for Brass No. 11, a prime RMBS from Yorkshire Building Society via arranger HSBC, plus Bank of America and Barclays as JLMs, which was announced last Thursday. Principality Building Society’s Friary 7 deal a couple of weeks back was a slam dunk, and Yorkshire is a stronger sponsor.

An ominous lack of updates was followed by the decision on Wednesday to pull the deal. Per the announcement “owing to exceptional volatility in the broader GBP markets following the announcement of this transaction, the issuer has decided not to proceed with a publicly placed transaction, and as such will be retaining the transaction in full”.

Prime RMBS is generally a nice-to-have for the banks and builders rather than mission-critical piece of strategic funding, and tends to switch off when the price isn’t right. Yorkshire isn’t desperate for liquidity, it was issuing to maintain a market presence and it doesn’t need this headache. Pushing ahead and printing would have signalled desperation, and Yorkshire wasn’t desperate.

Dollars, as originally featured in the Brass capital structure, is ordinarily a nice piece of diversification for UK prime issuers (and NewDay). The argument is simple enough; sure, it’s a pain to do the docs and the marketing (unless you like trips to Vegas and Miami for some reason?) but UK RMBS trades wide to prime US consumer assets and it should be a great way to get more price tension in your deal.

Not this week though. One suspects US structured product PMs aren’t very interested in the nuances of the political situation which got Britain here; they want a stable economy with no drama and an intelligible legal system. When the headlines are screaming that the UK’s becoming an emerging market (or a Kwasi emerging market, ho ho) they’re not interested. Not worth the brain damage.

In euros, BMW’s prime German auto deal Bavarian Sky Auto Leases 7 bucked the trend somewhat, moving from 55 bps IPTs to 50 bps final spread, and 2x done at the final level, but much of the book was likely in place before the crisis really took hold.

Still out in the market at the time of writing is Santander Consumer Germany 2022-1, a flagship shelf which has won awards in the past from uh, me. It offers some of the largest consumer mezz tranches in euros, big enough to be sold to a broader range of accounts with some reasonable expectation of liquidity. The first book update on Wednesday, however, did not make pretty reading, with the ‘B’ and ‘C’ notes less than 1x done, and class ‘D’ covered….50 bps outside IPTs.

If the class ‘D’ does indeed get done at the 550 bps level where there’s demand….that’s 130 bps back of AutoNoria priced on September 14, despite being German collateral rather than Spanish.

Bankers report decent primary pipelines for the autumn session, but not everything has to come to market if the levels aren’t right, and right now, that’s going to cut off a lot of transactions, especially from the UK specialist lender community.

But the market isn’t closed; indeed, Thursday saw a privately placed German auto deal, RevoCar 2022, and a French auto loan ABS from Credit Agricole announced. Despite the UK chaos, one source even suggested prime UK RMBS was available still — at a price — pointing out that the largest buyers these days are the bank treasuries, which are still active, even if the asset management community are hunkering down. Probably not the time to go far down the stack, but senior-only deals still seem possible.

Where’s WALy?

CLO structuring teams might be below budget this year, with no reset and refi flow to keep the lights on, but there’s certainly more creativity on display in 2022 than in 2021. The numbers remain perilously close to simply not working, so let a thousand flowers bloom, as managers and equity pull any levers they have available to eke out some arb from an unpromising market — and triple A investors exploit their dominant position to dictate the structures they want to see.

Cross Ocean Partners’ market debut in Europe (kind of; it’s the former Commerzbank shelf, with the same Bosphorus branding and the same portfolio management team) adds yet another twist.

Deals this year have generally been shorter, with 1 NC / 3 RP fairly common, and static transactions….well, not common, but there’s been one more than normal, thanks to Sound Point. Rumours are circulating of more to come as well.

Either way, full fat 1.5 / 4.5 structures, or the 2 / 5s of the pre-Covid market are now the exception not the norm.

The new Bosphorus deal not only has an unusual option structure, with the non-call period and the reinvestment period ending at the same time, but stiffens this already considerable call incentive with a weighted average life test that starts short and gets shorter. By the time of the non-call it will have amortised down to 4.25 years, and after that it will amortise down to nothing.

This means a deal that’s active, but much more curtailed in its activity than usual. New issue leveraged loans are usually seven-year facilities, so a six-year WAL test right out the gate signals Cross Ocean is not going to be doing a lot of primary. The modelled portfolio actually has a 5.5 year WAL, and it’s 80% ramped already so there’s a pretty good line of sight to the end state.

It’s basically halfway to becoming a static transaction — and in the glory days of pre-crisis CDO structuring, this might have meant another freshly minted acronym to brand the structure, perhaps “Bosphorus Active Leveraged Loan Security — Amortising Collateral” (sorry).

We understand this structure was driven from the triple-A end, with one particular anchor account strongly preferring short-dated transactions. Triple A buyers have been in short supply lately, with spreads stuck around the 200 bps mark. Bank treasuries have been active selectively (RBC, Standard Chartered, BNP Paribas, Deutsche Bank among others) but there’s no wholesale rush to anchor CLO transactions, and managers and equity must take what they can get.

The WAL straitjacket has also allowed Cross Ocean to call in Moody’s, for a change. Almost no new CLO issues have featured Moody’s up and down the stack since the Russian invasion, mostly because the agency’s WAL test assumptions are much more challenging than its rivals.

But the WAL limits, along with dropping S&P, does seem to allow a punchier structure than its freeWALing peers — par sub below 40% at the senior level, and lower through most of the stack than Five Arrows’ Contego X, priced on the same day. At double B level, for example, Bosphorus has par sub of 10% vs 13% in Contego, and 15% for GoldenTree’s new deal, in market at the moment with Bank of America.

Unfortunately, what was given through the leverage seems to have been taken away by execution. Bosphorus ‘B’ notes were more than 100 bps wide of Contego, with ‘C’ 75 bps wide, ‘D’ 55 bps and ‘E’ 60 bps.

Still, the deal is away, and the shelf is relaunched. Cross Ocean is willing to support the Bosphorus shelf with risk retention equity, meaning a faster pace of transactions than under Commerzbank’s ownership — and hopefully a more significant position in the broader leveraged finance universe going forward.

Whacked on GACS

Intrum announced late last Friday night (not exactly a sign of a relaxed IR operation) that it was taking a pretty big writedown on some Italian secured NPL portfolios, cutting estimated remaining collections by €138m-€156m.

It was clear from the hints in the release that this was the €10.8bn portfolio Intrum and CarVal bought from Intesa SanPaolo in 2018 — Project Savoy, subsequently securitised into Penelope SPV, which was itself restructured into GACS [Italian government senior guarantee] friendly format in late 2021.

From close until June this year, the last reporting date, Penelope is 5.8% behind business plan, not unusual in the broader GACS context but a pretty rapid slip behind.

The structural incentives of the GACS (get as much of a transaction as possible to BBB- rating by picking the servicer with the rosiest outlook) have left much of the market disappointing vs initial plans (have a look at Scope’s market review or DBRS) but something must have spooked Intrum’s finance team beyond the usual.

There’s a hint, too, that even more writedowns could occur once CarVal sells its stake in the portfolio: “Any sale to a third party of the stake in the Italian SPV currently held by Intrum’s co-investor would be considered as objective evidence and could potentially lead to a further adjustment of the book value.”

We don’t have any specific knowledge of whether CarVal is shopping its stake around (Intrum has an option to buy it out, which becomes active next year), but it seems plausible for a financial investor which has been in since 2018 to be scoping out the exits….

Intrum said in its release that it didn’t need to write down any other positions, but it’s fair to say the market was unconvinced, with shares down 20% on the news. Most of the other debt purchasers don’t have listed shares (though DoValue was down 10%), but bonds were ticking down for AnaCap, Arrow (despite the possibilities of a healthy UK NPL pipeline down the road).

Is this an early signal that Italian NPL marks are gonna have to come down a long way?

The Intesa book is very large, and pretty diverse (54% north, 21% central, 25% south and islands), with a mix of resi, industrial, retail and other collateral, some secured, some unsecured. Data quality, at least according to DBRS, was pretty good…’d probably expect a large national bank like Intesa to have better records and systems that the regional Populare banks.

What I’m getting at is, this ought to be a decent proxy for “Italian NPLs generally”, and Intrum is a pretty respectable buyer that knows the NPL trade well. Where Intrum marks, others will surely follow.

Taking the BIScuit

The distinguished wonks at the Bank for International Settlements raise the question “are CLO investors underestimating tail risk in European markets?”, (h/t David Altenhofen at PensionDanmark). The piece basically looks at whether the energy crisis in Europe will cause a wave of correlated defaults that cause credit issues in the CLO market — the basic proposition of the CLO structure, and the reason why it definitely definitely isn’t like pre-GFC CDOs, is diversification. If this diversification doesn’t work in practice or expectation, maybe the CLO structure doesn’t work either?

The BIS paper makes some fair points: “European CLO markets could be particularly exposed to correlated defaults. First, partly due to the smaller size of the European leveraged loan market relative to the US one, European CLOs have less diversified portfolios. Second, there is a higher overlap across the portfolio holdings of various European CLOs, which further limits investors' ability to diversify. Lastly, the European CLO market is relatively illiquid, which could amplify price swings in times of stress.”

Hard to argue with any of that. More questionable are assertations like “AAA-rated CLO tranches, which are very sensitive to broad-based disruptions”. Are they? Credit-wise you need a situation where we’re all buying baked beans and firearms before you’re likely to see losses on CLO triple A, and even on a spread basis…..there’s definitely been a sell-off, but CLO senior spreads roughly doubling while [gestures to entire financial system] is going on doesn’t seem that sensitive to me.

“Persistent issues with the supply of electricity or industrial inputs in Europe might worsen the outlook for many firms simultaneously, thus raising the risk of correlated defaults,” write the BIS. “Such a scenario could generate principal losses for AAA tranche investors, chiefly banks and insurers.”

I mean, it could, of course. You’ve got 40% credit enhancement, excess spread (ok, not so much of that today), plus recoveries of say, 50% on leveraged loans that do default. It’s going to be very, very hard to break these bonds.

Ignoring these asides, though, the BIS makes a reasonable point on correlation — basically arguing that credit markets are underpricing correlation vs equity markets.

Energy prices and currency moves do indeed tend to push everything in the same direction. European CLOs were sitting pretty in the energy selloff at the back end of 2015, as there are very few euro-denominated energy-linked loans, but right now, that would be a nice piece of diversification.

Whatever else they are, pretty much all the assets in a European CLO are consumers of energy; the only question is whether they consume a lot (paper, packaging, manfacturing) or not quite as much (healthcare, tech, retail).

The BIS might be wrong about breaking the triple-A, but it’s something to watch closely down the stack.

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