Market Wrap

Excess Spread — Not another bank, better BTL, starting a CLO shop

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

From frying pan to fire

We wrote a bit about the planned sale of Credit Suisse’s securitised products business before, speculating that this might actually be pretty great for the bankers working in the business — they’d be doing the same sort of complex financing business, but as partners in an alternative asset management firm, rather than in the straitjacket of a megabank where they have to pay for the screwups of colleagues in prime brokerage, asset management, and wealth management.

Bloomberg, however, reports that the interested parties are Apollo and…..BNP Paribas.

This is not to cast aspersions on the BNP Paribas securitised products business — it’s been vaulting up the league tables in securitised products these past few years, winning multiple awards (including from me), handling massive amounts of client flow business, building an ever-expanding suite of securitisation shelves for the broader group, and pushing into more complex niches of the asset-backed universe. Buying a chunk of the Credit Suisse business would in some respects be a perfect complement to what’s been achieved so far at BNPP, deepening the French bank’s presence in the more esoteric end of securitised products. Credit Suisse is relatively stronger in the US, BNPP in Europe.

The CS bankers would get the massive firepower of the BNPP conduits and deposit funding to play with…but they’d keep big bank politics, big bank bureaucracy, big bank comp schemes, and one suspects there’d be quite a few overlapping positions once you matched the teams up.

That means brutal fights as the two sides duked it out for supremacy in the merged structure. It’s been a while since the post-crisis round of big bank mergers, but deals like, say, BofA and Merrill Lynch got pretty nasty internally.

The cliché about banking (or, really, any professional client service business), is that many of the most important assets walk out of the door each evening, and it’s not clear that a winning BNPP bid would encourage many of the CS assets to come back in the next day…..though it’s understandable that the French bank would enjoy a poke around the dataroom during the sales process.

Apollo is perhaps a better bet. It was very early in the permanent capital game with the establishment of Athene, and like its peers, has been broadening its activities out from the straight private equity game into providing all manner of strategic capital solutions. I kind of hate that phrase (it can mean anything from derivatives to project debt to mezz lending to bank hybrids), but here I’m talking about providing a lot of money very quickly to counterparties that won’t argue too much about price. Think five yards to SoftBank or four for Hertz. It’s clearly hungry for assets, Credit Suisse has a lot of high yielding structured financings, and conversion into newly minted Apollo partners is likely to sit better with the senior CS employees than a BNPP business card.

And yet….it still might not be right. From first principles, the best bid for the Credit Suisse business should be a buyer that values the assets, the existing integrated operations, and the banking capabilities of the existing employees. Securitisation businesses aren’t just a bunch of financings; there’s a lot of people skilled at turning the balance sheet and distributing risk as well. It’d be a shame to ditch the securities license entirely.

Maybe the end state looks something like Guggenheim, with a large investing arm sitting alongside a securities and advisory business that’s top of its game in its preferred niches. The ideal capital provider is not necessarily an established institution at all…..SWF or eccentric billionaire for preference.

London buses

You wait ages for one, then four come along at once. That’s buses, apparently, or new issue European CLOs last Friday. Actually, the cliché deserves a bit of reworking — London bus drivers are now tracked in real time, and have targets about regularising the service. Drivers that are behind can skip stops and try to catch up; those that are ahead might pause for a bit.

No such strategy is really possible in the CLO primary market though. As we saw in ABS, last week was a decent issuance window, with massive books seen on the skinny ABS mezz tranches.

Some of the four CLOs which priced on Friday (Palmer Square European Loan Funding 2022-3Trinitas Euro CLO IIIRRE 14 Loan ManagementCarlyle Euro CLO 2022-5) had been in market for three weeks or more; by last week, it was time to get them squared away. No point delaying in the hope of an empty market…. there’s enough CLO managers still wanting to get a print done that if there’s an empty window, it’s probably for a good reason.

None of these deals is exactly cookie-cutter. Palmer Square has carved out a niche of doing static deals by design (rather than static to solve for this year’s difficulties, as with Sound Point), while Redding Ridge, an Apollo unit, marches to its own beat, often issuing less levered deals with non-standard tranching. In this case, it structured down to the double-B level, but retained this tranche, so the market was only offered investment grade, and in short 1/3 non-call/reinvestment period format.

Redding Ridge also takes an unusual approach to getting its deals rated.

S&P and Fitch have had the market pretty much locked up this year, as a rating from Moody’s gets punishing for junior tranches. That only matters if you issue all the way down the stack, however, so Redding Ridge has more flexibility than most managers. In this case, Redding Ridge used S&P and Kroll Bond Rating Agency through the stack, topping and tailing with Moody’s (the methodology is fine for triple-A notes, and a string of US deals have done “senior Moody’s” trades, where the agency isn’t invited to offer opinions on the mezz).

Digging through the rating reports, though, underlines the scale of the broader problems facing the market — the new deal has 134 bps of “excess interest”, compared to between 208 bps and 219 bps for the last six European Redding Ridge deals.

The fee structure is also a little different, with Redding Ridge taking its fees through investing in “performance notes” (that’s subordinated management fee) and “preferred return notes” (incentive management fee). In theory this makes it harder for noteholders to insist on a change of manager….though in practice that’s not gonna happen anyway.

WhiteStar’s Trinitas Euro CLO III and Carlyle Euro CLO 2022-5 are more conventional, with 1.5/4.5 non-call/reinvestment periods, but still milestones — Trinitas Euro CLO III is the first true new issue since WhiteStar took over Mackay Shields Europe, and Carlyle Euro CLO 2022-5 is actually an old CBAM warehouse acquired as part of the takeover agreed earlier this year.

Certain conclusions can be inferred from deal structures — there’s a €74m loan note carved out of the Carlyle seniors, and a €40m loan note in Redding Ridge, which generally means a bank buyer.

Carlyle arranger BNP Paribas has in the past tipped its hand and disclosed that “Class A contains sizeable lead interest” (see Tikehau VII or Clonmore Park). This phrase, however, is absent from the Carlyle priced message. Absence of proof is not proof of absence, but perhaps it’s another bank doing the anchoring this time. Redding Ridge is more instructive, with RBC Europe joining as “placement agent” (and therefore prime suspect).

Standard Chartered’s co-placement role on the WhiteStar deal, arranged by Jefferies, is becoming a regular feature, with the bank’s treasury unit playing an important anchoring deals earlier this year as well (it’s been a regular feature in these pages).

The senior investor audience for Palmer Square’s static deals is generally narrower (a Large West Coast Asset Manager has traditionally been prominent in short WAL structures) but such sharp lines make less sense in today’s CLO market. The choice of product is not “Palmer Square static vs regular CLO”, but a bigger spectrum of different call and reinvestment periods. Senior investors that stick to their guns and want long WAL paper with plenty of time for active trading will have found their pool of primary deals shrinking sharply this year.

Unlike the consumer deals which came to market last week, it appears that the mezz was more of a struggle than the senior. That’s partly down to CLO market practice (most deals launch to general syndication with the triple-A anchored, perhaps with the banks mentioned above), and partly down to active secondary trading at mostly more attractive levels than where these managers wanted to print.

Don’t hang up the headset

We can’t ignore the brisk movement around the CLO market, either. Richard Metcalf at IFR has a nice rundown of some of the recent job switches among CLO and ABS traders (though he missed Medhi Kashani, whose departure from BNPP to set up the structured credit business at Arini helped precipitate the round of job moves). I doubt the headhunters are hanging up their headsets just yet…SG and Natixis still need to fill their market-making gaps, and there are several institutions still in build mode for their securitisation operations.

On the primary side, Mizuho formally announced the hiring of Hernan Quipildor to run CLO origination and syndicate. Per the release, he will be “supporting Mizuho’s EMEA growth story in developing a European CLO primary business — a market in which Japanese investors are very active”.

Well, perhaps not active enough for the tastes of some managers (can we have them active at <150 bps on the triple A pls), but sure.

It’s the second bite of the cherry for Mizuho, which had a go at building out European CLO primary in 2019 with the hire of Stefan Stefanov. At the time he was working for Juan-Carlos Martorell and Andrew Feachem, who ran risk transfer advisory, but all three have now departed, for Natixis, Munich Re and Guy Carpenter respectively.

As we saw in May, Mizuho had been doing some warehousing and risk retention financing on a Spire Partners CLO, and presumably it has been active elsewhere since then. But European CLOs is a pretty crowded space, and with zero reset volume since the Russian invasion, the fee pool isn’t what it was either. Other banks, such as Societe Generale, have also been dipping their toes in the water.

The missing part of the puzzle is the somewhat less transparent business of leveraging up private credit funds. In practice, you end up with something that looks basically like a CLO warehouse — a portfolio of sub-investment grade corporate credit, securing a bank-provided senior credit facility — but distribution is narrower (or absent entirely), tranching is simple, and the underlying cannot be easily traded or marked to market.

But there are an awful lot of private debt managers active today, and it’s a good route for banks looking to deploy some balance sheet in the sector. One broadly syndicated CLO a year is not going to keep the lights on for a new primary CLO shop, but if it can be supported with the private debt and fund financings as well, you have a much more viable proposition.

Bruised or broken?

A couple of weeks back, in the wake of DealCatalyst’s UK Mortgage Finance Conference, we wrote (because people were saying it), that the basic model of securitisation-funded specialist lending was broken. Yet here we are, several central bank rates decisions later, with two specialist finance BTL RMBS deals on screen, apparently going well — at the time of writing decently covered on the senior, 3x-7x done on the various mezz tranches.

These are respectively Hops Hills No. 2 for TwentyFour Asset Management (actually sponsored by the asset manager’s UK Mortgages vehicle), and Dutch Property Finance 2022-2 for CarVal-owned RNHB.

The former is perhaps the purer expression of the specialist lender model - the mortgages backing the deal were originated by Keystone Property Finance, funded through forward flow by TwentyFour with leverage from the arrangers, and now ready for term takeout.

It’s a deal which is financing collateral from the Before Times (seasoning is eight months), with a weighted average interest rate of 3.3% (actually slightly down on Hops Hill 1) at current rates, so this is theoretically exactly where the pain should bite.

And yet….we have triple A advance rates remarkably steady at 83% (83.75% vs 83.15% in Hops Hill 1). Step up structure is the same. It’s at the bottom of the stack that you see the strain, with the excess spread note gone, and a turbo post-step up date.

The switch to vertical risk retention could also be a sign of the times — this was present in Barley Hill No. 2, the last TwentyFour deal, and is generally seen as a punchier structure than horizontal (holding the first loss for the lifetime of the deal).

It gives more flexibility to sell portfolios in the life of the deal than a horizontal structure, but perhaps more importantly, it can be 100% financed by Nearwater Capital, eking out a bit more leverage on the same portfolio. There’s no disclosure in the deal docs on whether this is happening, beyond the standard boilerplate that the Retention Holder is allowed to raise financing…..but it’s a subtle way to get a more efficient structure in these troubled times.

So buy-to-let RMBS from specialist lenders can work in securitisation format….it just works less well. We’d note that the Keystone mortgages in Hops Hill are really very clean buy-to-let indeed— perhaps the specialist lenders with hairier collateral, or even just less yieldy collateral, won’t enjoy the same market access.

When we mentioned potential changes at Habito and Lendco after the conference, that was also not an entirely random stab in the dark — Habito was reportedly in discussions with mortgage broker London & Country during the summer for an old school / new school brokerage tie-up, but announced instead this month that it had raised £5m of funding from a consortium of existing investors.

The new round came along with a commitment to “refocusing on its core services: its award-winning mortgage brokerage and Plus, its innovative home-buying service that combines surveying, conveyancing, and mortgages under one roof.

That sounds to me like a lot less mortgage originating to come in future, one way or another — but this change in focus may be the right way for Habito to focus on its value as a tech play in the broking space, rather than a route to origination.

Habito used to sell some of its origination to Citi as part of the Canada Square shelf (we note the incorporation of “Canada Square Funding Holdings 7” at the beginning of the month so presumably the programme is still firing), and also originated long-dated fixed for CarVal. Presumably Citi is happy to go ahead and securitise any Habito assets it owns, while long-dated fixed is attracting a lot of interest.

Several panellists at the conference noted excellent appetite from the insurance community for long dated fixed (as well as equity release).

Difficulties with the buy-to-let arrangements at Molo (Patron Capital was the funding partner) caused it to suspend origination in April….but by then the lender had already struck a deal with Rothesay Life to do long term fixed owner-occupied. It’s not an exclusive partner (Rothesay already had a deal in place with Kensington for long term fixed), but expect to see much more of this kind of thing. Landbay partnered with Phoenix Group in July, for example.

This is kind of a long way of saying that….despite the changes at Habito, it’s unlikely to shake loose many mortgage portfolios to buy at a discount.

Yacht or not

It’s the strangest thing, but every time I talk to SRT investors there’s bafflement about how Credit Suisse got its notorious “yacht securitisation” away. Quite apart from the dubious honour of appearing in the Financial Times, the tranche was thin (4%), the portfolio was lumpy, and even the loans that weren’t oligarch yachts still had some, uh, complexity. Think margin loans to Chinese tycoons, that kind of thing.

Anyway, more sensible floating collateral is available, in the shape of a shipping SRT which Alantra executed for Piraeus Bank. We’ve not got much on it beyond the release, but Alantra says it is the first synthetic STS securitisation of performing shipping loans in Europe, and we’re in no position to disagree.

Shipping loans in general have appeared in the market before — NordLB’s vast Northvest 2 deal with Christofferson Robb in 2017 included some €1bn of shipping loans, alongside a grab bag of other lending (renewables, infra, aircraft, corporate) to the tune of €10.1bn — but seemingly not in this format.

But it looks pretty efficient for the banks with enough shipping loans to justify the effort. Alantra says the portfolio was €700m, and selling the mezz tranche frees up €400m-equivalent of risk weighted assets. That implies a pretty hefty risk density, exactly the sort of thing which should work well for SRT.

Other deal terms include a two year revolver and 4.8 year time call, though unfortunately nothing useful like coupon and attach/detach is included. Still, ship it in.

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