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Owen Sanderson

We discussed electric vehicle financing a couple of weeks ago, in relation to the now-very-troubled Onto, which went into administration in September. How about a good news electric vehicle story instead?

Octopus Electric Vehicles announced this week it had done a £550m facility with Lloyds to fund its EV salary sacrifice scheme. This is a UK government-backed scheme allowing employees to lease an electric vehicle with payments coming out of their gross salary, giving a big tax benefit.

The new facility comes on top of a £150m forward flow agreed with Pollen Street (one of the Onto lenders) earlier this year, taking total funding for the company to £1.2bn, according to Octopus. There might be more in the pipeline too — the next part will be adding mezz to the facility.

The business has grown up rapidly — 3000 cars in late 2022, 13000 today, and a runway, with the new funding, to a target of 30000. Before Pollen Street and Lloyds, the business was largely funded through the asset finance specialists, with Close Brothers prominent among them. These deals initially involved the asset financiers providing the vehicles and Octopus broking the leases, but the business has moved on since then.

There’s something of a signal in the appointment of Michael Evans as chief financial officer of Octopus EV — Evans was most recently CFO at LendInvest, a firm that knows a thing or two about accessing securitisation markets and structured funding from banks and funds.

The Lloyds deal came out of a competitive process run by EY, seemingly involving every big securitisation bank and then some. It represents a genuinely new asset class with a genuine environment benefit — Octopus also has an energy arm, offering solar generation and battery storage as well as access to grid power. 

This part of the business is no stranger to structured finance either (see here for a writeup of the complex structured rescue financing provided by Barclays last year) but this integrated package allows UK customers to basically green their home and transport in one big hit with limited money down. Directing financing into this funnel really does make a difference. Lloyds already has a relationship with the energy side of Octopus, with Halifax mortgages working in collaboration to fund heat pump installation.

The price collapse in electric vehicles is slightly in the rear view mirror, which helps with the key risk in any lease-based structure — residual value. Octopus uses a data service called CAP to track residual values, haircutting these values and pricing RV into the contract with a quarterly residual value committee looking at this risk.

With new generations of electric vehicles coming online all of the time, and the prospects for price action to be driven by Elon Musk tweeting first and asking questions later, past performance may be no clear guide to future returns, but conservatism is the way to go — an appropriate haircut to manage the unpredictability.

Salary sacrifice is a little different from regular leasing, and from the hire purchase or PCP contracts that otherwise dominate UK auto finance. It’s very sticky, since the tax incentive means employees are unlikely to finance their vehicles any other way, and doesn’t have the same early termination structure as the PCP. It’s a scheme provided to employers, who then provide it to their employees and handle the salary sacrifice deduction. Employers bear some of the early termination risk.

An intriguing prospect is whether this kind of deal could come out in the public market. European securitisation has yet to see a purely EV-backed auto ABS, and Lloyds is likely to finance this exposure on balance sheet, but a warehouse is a natural prelude to securitisation, and if the growth stays stratospheric, then distributed funding surely has to follow. A first securitisation is a steep learning curve and a potentially painful process, but someone has to be the path-breaking debutant…

The execution window is still open after Kensington's storming return, allowing for the refinancing of Stratton Mortgage Funding 2021-2, which will be called around 20 January. The distribution for this transaction was somewhat concentrated at original issue, with separate Significant Investors disclosed (but not named) for the triple-A, the rated mezz, and the equity, and a quick google suggests a West Coast Asset Manager was involved. That’s probably going to make the refinancing a more straightforward exercise than a widely distributed deal, but still, the strong condition of the market at this time of year is impressive.

The Kensington deal, at 160/245/350/535 for class B/C/D/E, the only tranches on offer, was some of the tightest specialist lender mezz all year, though these prices represent a bit of a round trip — the whispers of mh100s/mh200s/md300s/mid 500s proved too tight as a starting point, with official IPTs at 200a/300a/400a/m500s more successful at pulling in the bond-starved Kensington buyer base… giving the scope to tighten down to, and through, the original levels.

The best comparable is probably Barclays’ own Pavillion deal from late last year, which also deconsolidated high LTV mortgages, though originated under Barclays, rather than the Kensington brand/underwriting. The distribution was… somewhat narrow, so it’s a little debatable how meaningful the levels on the bonds actually are, but it looks roughly in line.

Also debatable is whose deal Gemgarto 2023-1 actually is. Is it a deal for specialist lender Kensington, UK clearing bank Barclays, or the UK asset manager that actually owns the equity and the call option? Should a Barclays deal trade inside a specialist lender? Clearly the owner of the call rights matters most in determining when these bonds get paid back, but then Kensington’s origination and Barclays’ ability or desire to product switch is what covers you if it’s not called. 

We’re hearing next year should open with a bang. Securitisation markets are typically slow off the start line in January, with bank funding teams preferring to ship out covered bonds and senior deals, leaving ABS to catch up at a more sedate pace. But it’s likely syndicate desks have a heavy slate of supply to come across a broad range of asset classes.

A quick sample of SPV registrations suggests deals to come from Belmont Green, Enra and Premium Credit, but we hear there’s a decent slate of UK prime supply too, plus some more exotica down the round… at least one data centre CMBS, Sharia-compliant mortgages, among other things.

Securitisation markets in September might offer some guide to how (or how not to) direct the traffic. All the deals got done, largely without incident, although derisking senior execution proved the wise move. A large part of September’s supply came down to the issuance strategies adopted by the likes of BNP Paribas, Santander, and Société Générale, with various subsidiaries of these institutions often in the market almost together. A little more space between executions would allow investors more focus time and better execution, rather than everyone leaping for the same deal window.

Bigger picture, there’s bound to be a squeeze on specialist lender volumes, as origination volumes have been under pressure. In the second quarter, UK mortgage lending fell the most on the previous quarter since reporting began in 2007, with the lowest lending level since the pandemic. Q3 brought a meaningful bounce back, but the share of mortgage advances with rates less than 2% above Bank Rate was at its highest level since 2008 — suggesting the high spread, complex lending products that generally find their way into securitisations are simply not being written.

The big challenge for deal execution is likely to remain senior placement. The UK senior investor base in particular remains very narrow, especially once you step outside the assets favoured by the UK builders and bank treasuries. For euros it’s wider but hardly spectacular, as demonstrated by September’s supply. Watch the relative value closely; if covereds and corporates soften then the asset management community will start to get choosy about playing ABS.

We’ve been very complimentary about JP Morgan of late, describing its potentially path-breaking SRT shelf as “The Most Important Deal(s) in the World”, basically because it signals the handing on of the baton for core US corporate lending from the megabanks to the private credit / alternative asset management industry — these are now the capital providers of choice for the core activities in wholesale banking, as well as CRE lending, consumer credit, shipping, aviation and more.

We don’t play favourites, but another SRT executed by the JP Morgan team this year stands as maybe the coolest deal of the year? See what you think.

I’m going to have to cite another publication’s awards, specifically the Risk Awards 2024, in which the US giant won “Derivatives house of the year”, basically the top gong going.

One of the deals described in the writeup is a combination of a regional bank rescue financing and an SRT deal referencing private equity subscription lines.

From Risk’s writeup, which I’d encourage you to read: “Several US regional banks had built up large portfolios of revolving credit facilities to private equity funds, known as sub-lines. As their balance sheets came under pressure, bankers at JP Morgan quickly realised some of these portfolios would have to find new homes….

…..Word soon came back that a regional bank caught in the crosshairs of the crisis was seeking bidders for a multi-billion dollar portfolio of sub-lines. The equities team, which manages JP Morgan’s existing portfolio of private equity revolvers, began preparing a bid. 

At the same time, the credit business found a private investor to take the first loss on the portfolio via a synthetic securitisation. The credit risk transfer — thought to be the first involving sub-lines — made the deal far more attractive for JP Morgan from a capital perspective. The savings were shared with the regional bank, which was able to unlock much-needed liquidity at a lower cost than if it had to resort to senior secured funding.”

The case for “coolest deal in the world” rests on the fact that this wasn’t an ordinary course-of-business SRT to improve corporate capital treatment, but an integral part of one of 2023’s biggest themes; the pressure on US regional banks and the financing required to fix them.

According to JP Morgan, the deal, from first call with regional bank to sale of synthetic securitisation, took around four weeks, which must also put this high in the running for speediest SRT execution ever. 

I have doubts about this part: “thought to be the first involving sub-lines”, as this is an absolutely standard asset class in SRT. It’s not even the first in the US, as Western Alliance did one in 2021. 

JPM is also claiming to have kick-started the opening of the US SRT market via CLN structures with this deal, a gong which might be better shared with its peers.

From Risk: Since around 2020, US regulators have maintained that SRTs must include either a financial guarantee or a credit default swap (CDS) to qualify for capital relief. This effectively prevented banks from directly issuing credit-linked notes (CLNs) to investors – a common practice in Europe. 

JP Morgan’s solution was to document the transaction in a manner consistent with a derivative agreement. Sippel calls it “a test case” for industrialising credit risk transfers in the US.

The deal passed the test. On September 28, the Fed released a short FAQ effectively endorsing JP Morgan’s approach. The following day, regulators wrote to at least six banks confirming that direct CLN structures would qualify for capital relief, subject to certain conditions

I mean yes… but the bank actually named as receiving authorisation the following day by the Fed authorities was Morgan Stanley. I don’t doubt that the JP Morgan team have a full and active dialogue with the Fed, and I also don’t that they got the regulatory nod. But it surely can’t be random that the Fed named Morgan Stanley in late September?

In a sense, the JP Morgan-regional bank sub line SRT can be seen as a reversal of the normal order of things. 

Consider another transaction that’s fairly high up the “Coolest Deal” list for 2023 — Barclays financing Ares to buy a $3.5bn portfolio of warehousing lines from PacWest. This is the more traditional process. Equity bidder seeks assets, sources external leverage from investment bank, acquires assets.

But it fundamentally leaves things in the same economic position. Alternative asset management firm in the junior risk, bank in the senior. JP Morgan just did it backwards, buying the portfolio first and then selling the junior.

Sub lines / capital call facilities, though, are somewhat controversial targets for SRT. This isn’t because of the credit risk, which is often reckoned pretty good — these facilities bridge the gap between LP commitments and actual funding, so they’re credit risk to LPs. If these are big pension funds, sovereign wealth, insurance type institutions, they’re generally fairly credit-worthy. They have money, that’s why they’re acting as fund LPs! 

The difficulty comes from considerations of confidentiality and secrecy. If the unnamed regional bank had sub lines out to a bunch of mid-tier PE shops, these institutions might not be thrilled if, say, Blackstone or Ares did a SRT deal referencing these facilities. Their position as junior risk providers would open the kimono on utilisation, LP names, portfolio performance and more. Information barriers might help, but it’s unlikely to get these firms comfortable with a competitor looking over their shoulder.

We often use the phrase “SRT market” as a shorthand, but perhaps we shouldn’t! We’ve been longtime fans of Bank of America’s research team, run by Alex Batchvarov, and as he pointed out in October, “We avoid the use of the expression ‘synthetic securitisation market’ because we do not see the synthetic securitisation executed on what we consider to be the definition of a market: the deals are private, often with two participants only (the bank looking for protection and the entity providing protection, i.e. a protection buyer and a protection seller), it can be unfunded (i.e. guarantee or CDS) or funded (i.e. CLN cash collateralised), and even when funded the respective CLN does not trade, and the CLN may not even have an ISIN and be reported by Bloomberg.”

This is perhaps a little purist — surely the real estate market, art market, portfolio sale market or even the private credit market are uncontroversially markets? — but definitely gets at an important issue, specifically: why is SRT so private, could anything change this, and would that help?

SRT is on the cusp of a revolution, we think, with the opening of the US bank market, and even more importantly, the potential opening of the mainstream US investor base to the product. It will no longer be a niche European product but as American as apple pie (not actually American).

This raises the exciting possibility that it will become a tradeable, perhaps even a liquid asset class.

The longstanding Fannie Mae and Freddie Mac mortgage credit risk transfer shelves are enormous and eminently tradeable. According to the investor deck for the Fannie shelf, Connecticut Avenue Securities (CAS), there’s been $20.1bn of trading in the program(me) over the last 12 months, on a float of $21bn. Fannie has issued $63bn since 2013, transferring risk on $2.1trn notional… you get the idea. The deals are rated and syndicated, Fannie and Freddie publish their funding programmes in advance, offer standard structures and in every respect run a different model from the bespoke, NDA-garlanded and private SRT market. There might even be a tradeable index like, uh, ABX!

There’s everything to play for at the moment — to date, the Fed has disclosed waiver letters (allowing CLNs to count as synthetic securitisations) to only two banks, Morgan Stanley and US Bank.

Morgan Stanley’s deal appears to be a private transaction, while US Bank’s is rated and public (and, to be fair, follows in a well-established tradition of auto ABS credit risk securitisations). There are, to be fair, some real problems of privacy in making some of the more popular SRT asset classes more public and disclosed; banks are sensitive about disclosing their clients, their clients might be sensitive about the extent to which banks are hedging out their risk, and disclosure around exposures to other financial institutions (sub lines or capital calls) might be especially controversial.

These objections are partly cultural, though. Is it really such a secret that, say, BNP Paribas banks [any large French corporate]? Pre-GFC, synthetic corporate CDO featured rated capital structures, and active trading. Admittedly, many of these were arbitrage deals, and deal performance has been…mixed.

Or you could have a structure somewhat similar to leveraged loans — crucial information like corporate earnings and actions remains subject to NDA, but nonetheless trading desks make active markets and funds can trade in and out of transactions. To make a market you don’t need to make all information public, just broaden the pool of potential private investors.

Where SRT trading does occur, it tends to be on this kind of basis — investors in the more broadly syndicated programmes might add to existing positions if someone wants to exit. Certain trading desks still provide leverage against SRT tranches, so, apart from the horrible capital charge, would it be such a leap to active trade?

Against this is the idea that the illiquidity premium (or liquidity premium, depending where you sit) has basically disappeared. Private credit competes on a fairly level playing field with broadly syndicated loans; the cost to an issuer of using the less liquid product is basically the same, so there’s no real benefit to going through the disclosures and costs associated with trying to build a functioning actively tradeable public-ish market.

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