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Owen Sanderson

The race to print a data centre ABS in Europe is very much on, and early whispers suggest Deutsche Bank is likely to win it — the deal was being shown in private around the Barcelona conference, so it’s been on the cards for a while, just waiting for the right window.

September was hectic, October has been volatile — new asset classes probably need a few weeks of clear stability, with balanced supply and a bit of investor bandwidth.

European data centre (center?) finance is subject to similar dynamics to other commercial financings — namely, there’s a lot of bank money around, and so there have to be compelling reasons to opt for capital markets distribution rather than bank balance sheet money. Banks can be more flexible on rating and credit assessment, the structuring is less painful, and frankly, pricing can be more attractive.

The established US issuers of data center ABS, however, clearly see some value in the structures, just as a very select group of sponsors (sometimes just Blackstone) in Europe appreciate financing through CMBS. Capital markets funding might mean less onerous covenants, more flexibility, or higher leverage points, and if they’ve already established a US programme, there’s less of a learning curve involved in replicating this in Europe.

The asset class is particularly interesting because there are multiple approaches to thinking through the credit — data centres can be considered infrastructure, or commercial real estate, or financed through security on the receivables. 

S&P rates data centre deals through the 'Methodology and Assumptions For Rating North American Single-Tenant Real Estate Triple-Net Lease-Backed Securitisations', though presumably there’s some European version which would apply to the potential deals coming out here. S&P is, however, reviewing its approach this year, and considering something more data centre-specific.

The 'lease' element refers to the leasing of virtual space or data capacity, rather than the leasing of a physical object, and the 'tenants' in this case are the users. That’s the key credit complexity for the data centre business — a data centre with a 20-year lease to triple-A rated Microsoft should be a superb proposition. It’s Microsoft risk, with a recourse not just to the most credit-worthy company in North America, but to hard assets as well. A data centre primarily supporting B3-rated Altice France, meanwhile, is a very different animal.

Established US issuers are also in a prime position to tap their existing investors for a European transaction. We’d expect the market to be a 144A market for the foreseeable future, allowing experienced US bond buyers to cross the pond.

Barely a fortnight after HSBC’s hire of Nikunj Gupta to run European CLO origination, there’s a mandate in the bag — Blackstone’s Wilton Park, priced last week via arranger Morgan Stanley, with HSBC as co-placement agent. 

This is a time-honoured approach to winning a slice of the CLO market. Standard Chartered and NatWest Marketshave done plenty of these in the past, and Société Générale is taking a similar approach, taking down some bonds in the new Ares deal. SG also bought some of Blackstone’s Glenbrook Park, as well participating in deals for Tikehauand CVC last year.

Sometimes these arrangements work as a backstop, rather than an anchor — an investment bank with capacity to buy CLO triple-A will put in its order, take the placement fee, but may be happy enough to see some of the position syndicated out. This is preferable to taking the whole senior tranche, since it validates the market price paid, but it also leaves more ammo left for deals in future.

Co-placement agent can mean something different in each deal. Arrangers will typically hint that they were doing all the work, with co-placement just along for the ride, but most of the banks adopting this strategy have at least some trading and distribution capability of their own. Standard Chartered, for example, has been building its CLO trading capabilities, hiring Tyron Eng as global head of CLO/CDO trading in 2021, and John Parker to run global securitised products trading earlier this year. Société Générale brought in Erik Parker on trading this year, while Alex Harrison’s team at HSBC were already active in market-making. Perhaps these firms don’t have the reach of a Goldman Sachs or a Citi, but they can surely add something.

Much depends on the motivations for banks getting involved in the CLO business. Buying CLO senior makes sense as an outright investment; they’re still by some way the cheapest triple-A assets in the market. But arranging CLOs also helping loan trading, leveraged loan primary distribution, and it pays some fees outright.

More senior investors is good for the market, but what we really need is price-insensitive buyers ready to yolo triple-A spreads down below 150bps. The market volatility this October sent CLO senior bonds wider, with proportionally more weakness than other securitised product triple-A. There’s clearly some softness in loans, with deals clearing at the wide end of IPTs. One example is Exact Software coming at 450bps, and dropping half a point of OID, but it’s worth considering that this was a divi recap, never the easiest transaction to pull off, and there’s still clearly enough market confidence to see another divi deal launch this week (online travel platform Etraveli), two A&Es from Delachaux and Minimax Viking, and an add-on from Aggreko.

The visible CLO pipeline has slowed a bit, but that doesn’t mean the tight technicals are behind us. CLOs priced in September are still scrambling to fill their target portfolios, ideally before the bonds settle, and the loan pipeline is still bitty. 

Blink and you could have almost missed the Metro Bank flame-out and rescue. There were red flags for years — flying your dog around on a private jet paid for by the company does not bespeak sober prudence and risk management. There was the accounting error in 2019, the complicated business of buying portfolios from Cerberus, and subsequently selling a portfolio of mortgages to Cerberus, following aforementioned accounting issues. It’s always struggled to find subordinated capital at a manageable price; now the T2 is facing a haircut under the proposed rescue terms, so that was justified!

Judging by the weekend’s headlines, Metro was shopped around pretty extensively — the clearers were approached, HSBC, JP Morgan were mentioned — but there seems to be limited appetite to push in the branch-heavy direction that Metro has made its own. JP Morgan has already sunk massive sums into building its own enormous Chase UK balance sheet, on the back of a digital first model, so why on earth would it want to acquire a big book of retail branches and some dog biscuits to go with it?

Part of the rescue package will be a sale of a £3bn mortgage book, being handled by Morgan Stanley’s loan solutions group. Metro hasn’t specified exactly what’s in the portfolio, but guided that it was consuming £1bn or so in RWAs. That suggests it’s on the riskier end of the mortgage spectrum. The proximate cause of the Metro debacle, though, was the PRA’s refusal to validate its mortgage risk models, so perhaps the whole book is up there at 33%, even the good low LTV owner-occupied stuff. 

Metro said that it would “reinvest the proceeds into cash at a higher yield”, so we can assume, for the sake of argument, that this means everything yields below Bank Rate (5.25%), and that Metro is also going to take a P&L hit selling the portfolio. Metro, though, needs CET1 more than it needs to maximise accounting profits, so that doesn’t matter too much.

We hear the funds are not exactly champing at the bit to get a hold of Metro’s book (though Cerberus may well have enjoyed its previous role as Metro counterparty), so that probably points to a bank buyer. 

Starling, OSB and Chetwood would seem plausible candidates, but the most obvious name in the frame is Shawbrook. Of all the institutions apparently asked to look at Metro over the past week, Shawbrook appears to be the only one which actually wants it, and it’s clearly on the acquisition trail, apparently bidding again for Co-Op Bank. Owners BC Partners and Pollen Street looked at an IPO last year, but the market wasn’t really there, and presumably have pivoted towards bulking up before any realisation of their investments.

There can’t be that much value in the brand name of Metro at this point — people don’t like keeping their money in banks which nearly fall over — so if there’s no deal to be done for the whole bank, why not buy the mortgage book? 

Shawbrook is on the standardised approach, and discloses no particular plans to seek IRB authorisation in its latest reporting, so there isn’t an obvious cap arb to be done here. On the other hand, it’s a prudent and profitable bank with decent capital ratios, a track record, and supportive shareholders.

While we’re discussing challengers, we did note an SPV incorporated recently dubbed Chetwood Funding 2023-1. 

This might not be linked to Chetwood Financial, though it would be pretty weird for it to be linked to anyone else, so we’ll proceed on that basis. 

Per the latest accounts, Chetwood more than doubled its assets in the course of the year to March 2023, up to £683m — this included a discounted portfolio bought from LendInvest, but the lender also discloses three forward flow arrangements (one with LendInvest). If we had to guess, we’d guess the deal would be the LendInvest portfolio. It’s familiar collateral to the market, available in securitisable size.

But it may not even be marketed. Chetwood doesn’t need the funding; per the latest balance sheet, it had £1.3bn of customer deposits, with some £680m parked at the Bank of England. However, it might want cheaper funding, or there might be some benefit in manufacturing marketable securities. It seems unlikely that it was want to fund through central bank repo, though — right now, on its SmartSave Bank website, I can park one-year money at 5.94%. Level C collateral (senior bonds from mixed BTL pools) minimum bid for the Bank’s ITLR operations (six months) is at 30bps over Bank Rate, or 5.55%.

Incidentally, Chetwood also disclosed its RMBS holdings for the year — £125m, up from £4.8m the year before. This suggests selective bargain-hunting post LDI; not quite on the scale of Metro’s £1bn+ trade.

As Stonegate proceeds with the marketing of its secured pub debt, as we discussed last week, there’s a broader question about the future of the UK whole business securitisation sector. 

Some of the deals have been outstanding more or less forever (Unique, part of Stonegate’s balance sheet today, first issued in 1999 to fund the brief period when Nomura was the largest pub landlord in Britain). CFOs which inherited these structures may be less than enamoured with them in a vastly changed environment — the initial attractions of a higher leverage point and more investment grade debt have soured, and now WBS structures operate as structures which lock up cash, and even require periodic support to stay in compliance with onerous covenant packages, and stop bondholders from whisking companies out from under the noses of shareholders.

There’s no easy way to break up these structures without paying through the nose; bondholders have few reasons to accept less cash than they are scheduled to get, so unless there’s a cast-iron case that granting waivers or more flexibility is a credit positive, they’ll probably pass.

Dignity Finance, the funeral home operator, gives an example of a cast-iron credit positive — recent consent solicitations since last year’s take-private have basically allowed the shareholders to inject more money as an equity cure, and loosened up the company’s ability to sell funeral homes from the group (subject to appropriate application of the proceeds). Bondholders are the clear beneficiaries; they don’t want to have a structure breaching its triggers, they’d rather have the equity injection (they’ve already had £32m). 

If you do want to break a structure, the easy way is simply to pay the make-whole and collapse the structure, which costs money. Unique has an outstanding 2032 bond. Imagine structuring an LBO today with a 33-year bond in the capital structure.

But the surge in Gilt yields over the past couple of years gives finance teams in UK plc a golden opportunity to get the monkey off their backs. WBS make-wholes generally refer to Gilts; bondholders must be paid an amount sufficient to get the price to be equivalent to the matched maturity Gilt. With Gilt yields at their highest level since the financial crisis, this is now cheaper, as a proportion of principal, than at any time in the last 15 years. 

Of course, this still represents the luxury option. Theoretically, it should be cheaper to buy back WBS bonds at a discount and collapse a structure that way — but it’s long, uncertain (there’s no guarantee long term bondholders will take less than par) and potentially painful.

Still, there’s a lot of value locked up — even if the business might not be performing brilliantly, there’s often a ton of property value, useful collateral for broader corporate strategy. Stonegate Group outside Unique is at an LTV somewhere above 100%, while Unique is somewhere in the mid-40s. Unlocking Unique would help get Stonegate into a more refinanceable condition (if it can find the cash to do so).

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