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Owen Sanderson

The fourth quarter has dawned and now fear stalks the land. September saw a strong tone and a wave of primary across credit markets; now there’s grim macro news and volatility wherever you look, sell offs in equities, bonds, chaos in US politics.

But as ever, asset-backed markets in Europe are (somewhat) sheltered, with primary deals continuing to progress to completion. CLOs from Palmer Square and CVC Credit were priced this week, with CVC on Thursday somewhat softer down the stack than Palmer Square — 540bps rather than 525bps on the triple-B, 850bps rather than 825bps on the double-B — though Palmer Square had 10.5% par sub at double-B level, vs 9.41% on CVC Cordatus XXIX.

Books looked strong on Qander Consumer Finance’s Aurorus 2023 — it’s been rare to see a deal twice done on the seniors — and Auto ABS French Leases 2023 is settling down, even managing a small upsize from €400m to €450m.

After a big September, investors don’t need to buy, they’re well invested and not keen to chase bonds.

“It’s still possible to get things done, there’s just not a great degree of pricing tension, some bonds are coming wider than they should,” as one syndicate banker put it. Ticket sizes are down, and chasing tighter is off the table.

There’s no obvious catalyst for an immediate return to “risk on” — so that throws up the question of go/no-go for the October deals. Last year, LDI pretty much blew up the Q4 execution window, never the strongest season for primary supply; issuers that delayed in the wake of Liz Truss found themselves delayed, delaying again, and then running into the springtime bank collapses. 

There’s an argument that a deal which exists trumps a hypothetical transaction that could have been 5bps tighter but is never actually executed. The lesson of last year is that windows do reemerge, but it’s essential to move fast and seize opportunities.

We also wonder about certain idiosyncratic risks. This time last year, Gilts were spiking and LDI funds were puking, with something like €8bn disgorged across securitised products. A major counterparty sitting on the other side of the RMBS sales was Metro Bank, which acquired more than £1bn of RMBS last year from a standing start.

This, however, is the same Metro Bank whose stock is down 30% on Thursday, following an FT report that it’s looking to raise £600m in capital (reported to be £250m in equity and £350m in debt). Given the current £62m market cap, this is kind of a whole new bank?

Anyway, having taken advantage of the UK real money funds in their hour of need, I think if I were at Metro Bank I might be looking to take profits on some of this RMBS?

My growing team of CLO colleagues have been hard at work, publishing CLO Outlooks for the fourth quarter in the US and in Europe. There are plenty of warehouses open (70 from 50 managers, according to Maples & Calder), and they’re mostly fairly recent.

Two comments in the piece, however, tell the basic story:

One anonymous manager said “Some managers want to come to market by October/November but are at only €50m [ramped]. I would tell them to pack their stuff and wait for next year.”

Loic Prevot at Polus Capital Management, meanwhile, said: “Recently we have seen two types of situations play out — one with new deals like WorldPay and Infra Group, in a context where managers want new paper,” he said. “Those started reasonably wide at launch but tightened significantly. Despite their tight pricing, demand has been very strong for these deals and allocations have been small.”

“On the other hand, existing issuers such as VMED or Altice International have also used the current window of strength to opportunistically tap the market. These deals have been upsized, and almost sized to demand, resulting in large allocations for some investors who were generally already existing lenders.”

I won’t lift anything else from the Outlook (it’s worth a read) but here we still are — not enough new money loans, it’s hard to fill a warehouse, and there’s still a ton of potential CLOs out there (plus the deals out there now and ramping).

So there’s a technical tailwind behind the loan market, even as the macro headwinds blow in. 

Before the sell-off, the ELLI was making post-invasion highs, loans in primary were a furious bunfight, OIDs were tightened and deals were upsized. 

There’s still primary supply in market this week (bottle topper Guala Closures most definitely did not screw up its FRN issue, landing at the tight end). There’s a divi deal for Exact Software, a big add-on for INEOS Enterprises, a €350m LBO for Palex Medical, an A&E for Zoopla and an add-on for Circet. Not a bad haul, if they all come off, but there are hints that the wider worries are spilling into loans — Circet priced its €175m add-on at at 98 from the 98-98.5 guidance, something you wouldn’t have seen in the balmy days of two weeks ago.

The primary calendar is supplemented by fairly heavy BWIC flows in loans — some €880m last week, and further lists this week — which were clearly an attempt to sell into the technical strength. This week featured more BWIC supply, with one list said to be the liquidation of an old CLO warehouse.

Anchorage, however, provided a little confusion. Investors notices for Anchorage Capital Europe CLO 6 had been published signalling that the deal would be reset, which was scheduled to occur on October 20.

However, on Tuesday this week, the redemption notice was cancelled with a further notice. Several sources said that a BWIC which was scheduled for the following day was the portfolio from this CLO, but this BWIC in turn was cancelled.

A loan trader described the planned BWIC as an “opportunistic liquidation” which had run into a softening market.

UK whole business securitisations seemed like a good idea at the time. Who wouldn’t want an extra turn or more of investment-grade leverage? 

But once they’re out there, you’re kind of stuck with them, and UK capital markets have plenty of lumbering WBS dinosaurs structured a decade or more ago, too costly and too complex to wind up, but no longer the preferred capital structure for the businesses they finance. By running the business for the benefit of bondholders (or at least, guarding their interests with a punchy package of cash traps and covenants) you do create a cheaper financing structure, but one which can be notably inflexible when it comes to selling assets, selling businesses, extracting cash and the like.

Picking them apart means obtaining bondholder consents, and bondholder consent would basically require paying off bondholders. Lots of the outstanding WBS deals have long-dated bonds including make-whole clauses, and there’s simply no incentive for bondholders to accept less than getting paid out in full. Covid was a special case; pubcos, airports and the like generally got the waivers they needed

Stonegate (a HY borrower owned by TDR Capital) became the proud controller of EI Group (Enterprise Inns) in 2019, a move which also brought it control of the Unique Pub Finance Co WBS, a structure which first accessed the market in 1999. 

Unique holds the tenanted pubs (i.e. landlords are basically independent of the pubco), which Stonegate’s pubs are mostly managed, including the “Slug and Lettuce” brand. In recent years, these have tended to be more profitable than tenanted pubs.

Anyway, Unique is arguably a bit of an albatross around the Stonegate neck. Not only is it not kicking off any cash, but Stonegate, with its own bonds trading north of 12%, had to dribble in some cash (£6m in Q3). 

The reserve fund is depleted, even the class A notes are now rated double-B, and the structure staggers on. Per S&P, “The issuer's liquidity position will start improving once the class M notes fully repay, but it will take time. The liquidity facility and the reserve fund are expected to be replenished to their target levels within two to three years after the class M notes expected repayment in March 2024. During this period, the is suer's liquidity position will remain materially weakened.”

So it is with considerable excitement that we saw that Stonegate is looking at options to raise new debt against 1000 pubs, with a planned sale of the pubs proving unsuccessful. 

According to Bloomberg, the proposal involves “splitting off the group of about 1,000 outlets into a special-purpose vehicle and using it to raise debt from outside parties”. This would be a large enough transaction to support another Unique (currently 1761 pubs), though it would surely need a less oxymoronic name?

There are no details on the possible structuring of such a deal, but it would probably need a little more complexity than a standard sale-and-leaseback. Flexibility to move individual pubs in and out of the estate is important, as is the degree of delinkage built in to the structure. B3-rated Stonegate is facing a 2025 maturity (going current in the middle of next year), so you’ll want to avoid having strong, supermarket-style credit linkage in the structure (though the Stonegate pubs are managed, so it’s going to be there regardless). 

Clearly it will be backed by actual hard property assets, in the shape of the pubs in question, but given that Stonegate has apparently struggled to sell these on the open market and is turning to a secured debt structure as second-best, it’d be wise to haircut the supposed value of these.

So maybe this does point to a structure with some securitisation-style bells and whistles — credit enhancement, reserve funds, liquidity facilities, cash traps and so forth. 1000 pubs gives a granular pool, which means underwriting any debt on essentially pooled characteristics. It’s not like anyone is likely to go line-by-line through this.

Time, then, to dust over the WBS structuring playbook and see what a contemporary reboot looks like.

Insurance regulation is actually very cool

Solvency II, as Winston Churchill once said, is a mystery wrapped up in an enigma. Whole careers have been made interpreting, advising and most importantly, arbitraging the European insurance rules, legendary for their complexity.

For securitisation, this has mainly involved complex internal structuring within insurance companies. The “Matching Adjustment” concept within Solvency II gives a big benefit to assets with fixed cashflows, proportionally increasing when these assets have a lot of duration.

This has encouraged life insurance firms, whose basically liabilities are annuity payments, to create their own long-dated assets, carving MA-eligible pieces out of whole loan portfolios. UK lifers have a particular fondness for equity release portfolios, whose payment profile, like that of annuity liabilities, is correlated to mortality. There have also been a few public Matching Adjustment securitisations, mostly equity release (Towd Point Hasting1, ERM Funding 2021-1, SME Equity Release 2018-1 and 2023) as well as MA tranches in Dublin Bay and in the student loan deals.

Anyway, the UK regulator is planning a major overhaul of Matching Adjustment rules (a Brexit dividend, at last!)

The shakeup will basically allow prepayable assets and callable assets to be included in Matching Adjustment portfolios, making them massively more attractive to life insurance investors. There will also be more flexibility to include sub-investment grade bonds in an MA portfolio.

The new proposals were only published last week, so sector specialists are still working through which assets are most likely to be attractive under the new rules, but some early candidates including regular mortgage portfolios (which could be held without creating burdensome internal securitisations), commercial mortgages, callable fixed income, bonds with features such as cash traps/sweeps and prepayability, ground rent portfolios, infrastructure loans, and construction loans.

Life insurers will still want long-dated assets where possible, so they’re unlikely be keen for consumer credit or SME loans, but there’s a ton of real asset financings that currently don’t work for the Matching Adjustment, but which could become much more attractive under the new rules.

I dig into this in some detail in a piece here (let me know if you’d like a copy), with particular help from Vladimir Zdorovenin, head of insurance solutions EMEA & Japan at PineBridge Investments, who wrote an excellent paper on the changes. An investment bank which has to remain nameless at this time was also very helpful, you know who you are and I very much appreciate it.

The changes are fairly technical, and my piece only scratches the surface, but the numbers involved are very large indeed. According to the Bank of England’s study on the subject, there’s £350bn im Matching Adjustment assets backing annuity liabilities, split as follows — re-allocate a percentage point here and there and you are talking about some very large tickets. Leaving aside the organic growth in the sector, UK lifers are also on a tear in the Bulk Purchase market (buying out pension fund liabilities), with this activity running at record levels of >£50bn per year. A little dribble of allocation out of that firehouse of capital is very very material.

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