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Owen Sanderson

Excess Spread is a day early this week and off next week, see you in August when markets are sure to be buzzing

Extension risk continues to stalk the land, sort of. The Towd Point deals that weren’t called remain uncalled, and now Trinidad Mortgage Securities 2018-1 has also missed its call on Monday.

The holder of the call option is an Irish SPV vehicle called Magellan Funding No. 2, which was part of Magellan Homeloans, which in turn was part of Mars Capital. This sort of looks like it rolls up into debt purchaser Arrow, but under the hood it’s Oaktree — Arrow struck a deal back in 2017 to manage Oaktree’s UK and Irish mortgage portfolios.

As of the last interest payment date in April, the class A notes had paid down from £238m at issue to £13.6m, while the rest of the deal structure remained fully outstanding. The original class A coupon was 80bps over Libor, stepping up to 135bps, while the class B steps up from 120bps to 195bps.

The deal contained a very mixed bag of mortgages — some pre-crisis loans written by Heritable Bank, an Icelandic institution which entered administration in 2008, some mixed residential, commercial and buy-to-let loans originated by Cyprus Popular Bank / Marfin, and some brand new mortgages newly originated by Magellan Home Loans.

Some of these loans were pretty spicy — the Heritable Bank loans were 72% to “Not Employed Borrower”, 93.3% interest-only or part and part, 33.9% self certified income. Even the new Magellan loans were 18.7% to borrowers with prior county court judgements against them, 22.9% to borrowers with past bankruptcy or IVA. Magellan stopped originating the year after the deal was issued, citing excessive competition, so I guess the “front book” mortgages pretty rapidly became a back book portfolio.

Though sterling base rates have shot up since the deal was issued — the class B notes were paying 5.245% in April, even before the coming 75bps step-up — the collateral is also paying far more than at origination.

£44m of the £50m remaining in the Heritable and Cyprus portfolios is paying more than 6.5%, while £17.8m of the £23.8m in the Magellan portfolio is paying more than 7%.

But nonetheless, a careful eye from a wise investor suggests the call is in the money, so why the delay?

Our best guess, on the digging we’ve done, is that Oaktree Opportunities IX, the fund which owns the HoldCo which owns the option holding SPV, is pretty near the end of its life — it was raising capital commitments in 2013 for a close in 2014. We couldn’t find a definite lifespan out there, but 10 years seems like a plausible number — and surely another rerack with a risk retention commitment would take it beyond any likely lifespan. It does seem like the fund in question is very all-inclusive — among the other assets appears to be a shipping finance company and a tanker fleet.

Perhaps it’s not yet the ideal time to sell a portfolio like this, perhaps there’s a process in play which is yet to finalise — so hopefully this is “extension for a couple of IPDs” not “full extension”.

In other Oaktree news, Opportunities Fund X is getting ahead of its realisation! Not sure what the other “Opportunities” were in this case, but it touches securitisation through its ownership of Retiro Mortgage Securities 2021-1, a Spanish NPL / REO transaction combining four sub-portfolios structured with typical artistry by Morgan Stanley.

Per the rating report, it features Spanish PropCos, Irish mortgage lenders, Lux HoldCos, all owned by a Cayman fund, so clearly something of a feast for the lawyers when it was put together.

Here’s the deal structure, which should clarify things!

Anyway, the important thing is, the portfolio(s) are up for sale, with Alantra running the process. 

The deal doesn’t feature a vanilla step-up, but there is an “additional note payment margin” (subordinated to the interest and principal on each relevant class) from April 2024. Presumably, given the complexities of the portfolio, any sale will take time, so it’s worth getting ahead of this date.

A further wrinkle, per the notice, is that servicer Redwood (which rolls up into Mars Capital) is apparently dealing with squatters, an occupational hazard I suppose in a large REO portfolio. Spanish hippies, the doyen of distressed debt, and an incredibly baroque securitisation — what’s not to like?

The European leveraged finance market, and by extension the European CLO market, is too concentrated. 

US managers launching in Europe raise their eyebrows when they survey the scene, and note that, say, one of the Altice France TLBs is in 308 deals from 50 managers (my colleague Dan Alderson has dug into these exposures with the help of Deutsche Bank).

A handful of other massive capital structures are also incredibly widely held. Patrick Drahi’s telco rival John Malone provides a ton of telco supply from the various Liberty Global companies; Jim Ratcliffe’s INEOS complex and the Issa Brothers’ EG Group weigh heavy. Throw in a couple of other billionaire-backed empires (Xavier Niel and Andrea Pignataro, with Iliad/Eir and the various ION silos) and you’ve already made a big dent in the top 15 European CLO exposures.

This has mostly been fine so far. No big blowups, heavy concentration in telcos, which is about as mainstream as leveraged finance gets. Everyone in the market will whinge about the various billionaires’ approach to corporate governance but will generally buy anyway.

But now credit worries are not just focused on rinky-dink overleveraged widget makers, but on some of the real leveraged finance giants. Altice, as we have covered extensively (see some news here, some excellent analysis here, and a look at the swaps book here) seems to be tottering, EG Group’s path to deleveraging remains obscure, and the business plan at BB-rated INEOS appears to have gone awry, with plunging EBITDA, awful numbers across the broader chemicals sector, and legal challenges to its brand new cracker plant in Antwerp.

These companies have grown enormous in the era of easy money, but much of the expansion has been debt-fuelled, on the promise they will grow into their capital structures. But lacklustre business performance has left these debt burdens hanging off the shoulders like a cheap suit, just as debt service costs tick up.

This is not to say that a wave of disaster is coming for the former market darlings of European LevFin. But these aren’t “sleep at night” credits, safe and liquid and sensible. Last week’s Altice news prompted a big slip in bond prices for the unsecureds (a favourite yield-enhancing exposure for some bond-heavy managers), and this appeared to be on meaningful volumes; how valid are the “market depth” measures for CLO exposures when everyone is rushing for the exit?

These worries could be perversely good for CLO diversity — if the market perception of Altice is problem child rather than market darling, new issue deals touting their clean portfolios will be Altice-free. The proportion of CLOs with heavy exposure to the large wobbly B3 structures of Altice and EG should trend down.

Both of the above completed massive amend-and-extend deals earlier this year, which will have had a meaningful effect on the market. We’re becoming increasingly familiar with the statistics on deals leaving their reinvestment periods and butting up against WAL test constraints, but thinking about it on a market-wide level could be a useful lens.

Instead of saying X% of deals are failing their WAL Test (Deutsche Bank’s note last week said 81 deals in Europe vs 57 at the start of the year), what’s the total WAL-pushing capacity left in the CLO market? Whatever this figure is, the flood of A&E deals this year, and the giant size of some of the transactions, will have made a meaningful dent in the total ability of CLOs to agree maturity extensions.

With that in mind, the A&E deal launched this week for radiopharmaceutical group Curium is worth noting — it’s addressing euro and dollar maturities in July 2026 and December 2027, pushing both out to July 2029. 

Most of the A&Es so far have focused on 2025s, and clearly there’s an awful lot of runway to 2027….but if it is going to be increasingly difficult to actually execute an A&E as we roll into 2024, then smart borrowers will want to get even further ahead of the rest of the market. If you wait, the window might close

That said, CLO conditions seem good right now. Bain Capital Credit’s latest deal, its first of the year in Europe, scored a senior print of 175bps, then 280/360/535/850/1100 down the stack — well inside the Nassau III levels the previous week (195/325/425/610/880). 

Some of this is likely to be manager tiering — the Nassau track record in Europe is limited, this being deal #3, and some investors prefer the security of a large platform like Bain — but the market backdrop has also tightened. Senior spreads are the usual point of comparison, and the 20bps basis looks very wide, but this can often reflect placement strategy, and the extent to which anchor investors have been brought in early. The actual spread print, in other words, might be weeks out of date.

Unfortunately for Bain (and for all of the other managers lining up a pre-summer trade), once again the leveraged loan market has responded more rapidly to CLO conditions than CLO conditions have responded to levloans — it’s bid-only for the good CLO assets.

Pharmaceutical generics firm Zentiva’s A&E absolutely underlines the situation. The deal started as a €1.48bn A&E at 500bps and 97-97.5, and ended up as €1.825bn at 99. The second lien was going to be pushed to 2029 and the spread cranked up to 800; instead the first lien lenders are taking out the whole tranche.

Lenders we spoke to loved it, with one describing it as “Not a ‘Marmite’ credit but a Nutella credit that pleases everyone”, but the technical backdrop is also clearly extremely strong.

Last week brought new European regulation, but this time, strangely, it could be good for securitisation. 

Member states and the European Parliament struck a new deal on regulation for alternative investment managers (AIFMD II), after the usual months of wrangling and postponements. This is the European Council (member states) view.

Anyway, a particular focus for the new rules has been private credit, or “loan-originating AIFs” in the regulatory argot. Per the Council, “given the fast-growing private credit market, it is necessary to address the potential micro risks and macro prudential risks that loan originating AIFs could pose and spread to the broader financial system”.

It seems like this drafting would bring in CRE debt funds, infra funds, credit opportunities and much more besides the “vanilla” corporate private credit world.

Anyway, the tangible proposals include limits on leverage (300% for closed-end funds and 175% for open-ended), limits around liquidity risk, and adding a few bits to the regulatory toolbox.

The Council’s paper also includes some old favourites familiar from securitisation regulation (my emphasis):

To avert moral hazard and maintain the general credit quality of loans originated by AIF’s, such loans should be subject to risk retention requirements to avoid situations in which loans are originated with the sole purpose of selling them. Nevertheless, originate-to-distribute-loans should not be an investment strategy pursued by AIFs and AIFMs should therefore ensure that they only manage loan-originating AIFs whose investment strategy is not to originate loans with the objective to sell them.”

Given how fun the risk retention requirements have been for an entire generation of securitisation lawyers, it should be interesting to see how this gets ported over into fund structures, and how any limits on “originate-to-distribute” (won’t someone think of the children) actually get drafted.

Taken together, though, this should all be good for actual distributed public securitisation.

Competition at the bank-originated, securitisation-for-funding end of the market comes from covered bonds, but competition at the non-bank financing, alternative asset leverage space has basically come from fund structures. 

The non-emergence of the CRE CLO market in Europe is directly linked to the prevalence of fund-based back leverage; the non-emergence of distributed middle market CLOs in Europe is directly linked to the prevalence of bank-provided debt facility against private credit assets. 

Regulation on risk retention / originate-to-distribute would tend to level the playing field between securitisation-format financing and fund-format financing, depending on how the regulation evolves.

But securitisation can also come in at a considerably higher leverage point than the fund regs seem set to allow. Anecdotally, the bank facilities on private credit funds are not especially levered; 50%-60% attachments have been mentioned, though I’m sure these things get competed upwards over time. Clearly that wouldn’t trouble the proposed 300% limit for closed end funds. 

Looking over at the US though, we get leverage of more than 8x on the latest Ivy Hill MM CLO, or more than 5x on the Deerpath Capital reset. So there’s already the powerful pull of leverage to encourage European private credit funds to work up a rated deal; now there’s a push as well.

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