Market Wrap

Excess Spread — Solar sunrise, DK decency, shrinking CLOs

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

Everybody loves the sunshine

We’ve been excited about the potential for a solar ABS market in Europe for some time — it seems to be an asset class that attracts true believers, and, frankly, it’s a great opportunity for securitisation to really move the needle on green assets. There’s nothing wrong with a nice green RMBS, the teams at Obvion and UCI are doing decent work but… ABS is a real way to connect the firehouse of money coming out of the capital markets to real decarbonising of the European economy. Plus it could be €150bn!

But so far, it’s been long on hype and short on deals. Now, Perfecta Consumer Finance has announced the first solar ABS in Spain, a €133m securitisation fund, with a warehouse from Barclays, and equity from Spanish impact investing firm Q-IMPACT.

The senior facility isn’t huge, at €50m with an option to extend to €100m….but it’s still a major step in the right direction. Spain, for obvious meteorological reason, is a pretty good market in which to kick off the potential for a solar ABS market — the returns to homeowners from taking on a solar installation are better the sunnier the conditions.

Rather larger is the debt funding raised last year by Germany’s Enpal, a €275m senior debt piece from BlackRockPricoa Private Capital and UniCredit. There’s a €70m mezz loan too, with the debt being used to refinance more than 15k new solar plants and energy storage systems.

The basic problem, according to bankers working on the space, is that the firehose of institutional capital is still too large for the small scale of solar installers/financiers. Unlike the US market, where consolidated players quickly emerged which could handle institutional volumes of ABS financing, most European players have simply proved too small to do anything useful with €100m+ chunks of capital…..and hence too small to sponsor securitisations.

Right now, in much of Europe, sheer volume of qualified installers is acting as a bottleneck for the solar rollout — the installation firms exist, they can raise financing, and even procure panels, but still need someone to physically connect them to rooftops and to household energy supplies.

If you’re wondering about the collateral for this transaction….Perfecta Energia has you covered, with a handy FAQ. In short, the terms are a 7% loan for up to 20 years. If the term is shorter than 20 years, there’s a balloon payment to cover the outstanding cost of the system. Householders own the solar panels themselves — allowing them to potentially benefit from local tax benefits designed to encourage solar installation — but can choose to pay an additional fee to Perfecta to cover maintenance. Stop paying your loan, and Perfecta takes back the panels, and tries to claim any outstanding difference between panel value and loan…but it’s not secured like a mortgage.

Perfecta also says it is available to help finance other solar installation firms on this basis — at this point, origination volume is the name of the game. But congrats, again, to Barclays, who, as we saw last week, are doing pretty cool stuff in the energy space.

Relatedly, one reader alerted me to a interesting speech from Bank of England advisor Michael Sheren, delivered in sunny Barcelona. I missed all the keynotes at Global ABS this year, a personal record, but IMN kindly makes them available for viewing afterwards, and I’d recommend this one.

He argues that securitisation has a big role to play not just in solar (where the UK is a less natural geography than Spain), but in financing other bits of green retrofitting, such as heat pumps and insulation.

Sheren said “All our homes are extraordinarily expensive tents. They’re leaky, they’re draughty, they’re ridiculous. The UK has the most energy inefficient housing stock in Europe by far. It doesn’t just need heat pumps, it needs insulation, it means a variety of other things as well. The challenges for how to get that financed are going to be huge, and securitisation will be part of the solution.”

As someone who bought a freezing Victorian house for the high ceilings and the nice brickwork, can confirm — from October onwards, it is indeed basically a tent.

It’s the same concept as solar — a high upfront cost which saves huge amounts of energy, but which plausibly pays back over a period of more than a decade. But we need that energy saved, and there’s scope for clever financing to fit in the middle, the faster the better.

Keep moving to stay afloat

One problem with the slow-moving and shockingly wide CLO market at present is that without a route to refi and reset, the market starting slowly shrinking, as transactions slated for reset in H1 this year tick over out of their reinvestment period.

In recent weeks we’ve seen BNPP IP Euro CLO 2015-1Anchorage Capital Europe CLO 1, and BlackRock European CLO 1 exit reinvestment, and there are others coming up….an economically viable reset for Euro-Galaxy VI (seniors at 71 bps) seems unlikely before the end of reinvestment in October.

It wasn’t so long ago that old CLOs basically never died, but could be extended pretty much forever — 2021 was the best year ever for reset and refi activity in Europe.

If anything, the pendulum had probably ticked too far towards resets and refis — a market where deals are called and portfolios sold is probably a healthier market, with more trading activity and liquidity in the underlying loans, and less hoarding of AUM.

But now, equity and managers are pretty much stuck with their amortizing transactions. Nobody in their right mind is going to be calling deals and sticking the portfolio out on BWIC, crystallising the horrific equity NAVs prevailing at the moment. That leaves “do nothing and wait” as the only viable strategy, but that’s not very appealing either.

Even if we assume most of the average CLO portfolio is money good in the long run, it’s not a great environment for refinancing leveraged loans either, so these positions are going to be hanging around for a while. A few deals will be taken out (Fedrigoni, for example, thanks to the new facility backing BC Partners’ investment in the Italian paper manufacturer), but in general, these deals are going to be amortizing slowly, dwindling into an inefficient twilight as the triple-A shrinks.

That feeds into the problems of loan market liquidity (of which more later). It’s only a handful of deals which have exited reinvestment so far this year, but every deal which enters amortization is another €400m of assets that cannot be actively traded in the European leveraged loan market.

It could also cause a few interesting wrinkles down the road as some loans get into trouble. Default expectations are all over the map at the moment, but let’s assume that we’re going to get a few — there are some well-known deep distress situations like PlusServer and NSO Group, well-flagged stressed credits like Holland & BarrettCineworld and Hurtigruten….but there will be other emerging widely held credits that need to fix their capital structure in a recessionary environment. Genesis Care, for example, trading in the low 60s, is certainly pricing to restructuring.

Nearly all the recently issued or recently reset CLO transactions have “workout language” or “loss mitigation language”, easing the path to deploying new money into restructuring situations. But the deals exiting reinvestment now are mainly 2018 vintage (either new issue or most recent reset), well before this date.

That will mean a given investment manager has contrary incentives across their different CLO holdings — some of their CLOs will be able and willing to participate in new money situations, others prohibited by their deal docs.

In practice, that probably means the traditional CLO investor remedy of selling out to a distressed shop….but that’s a further drag on returns for these post-reinvestment transactions.

Beating the bid-offer

There’s a bunch of CLO managers with portfolios they don’t really want (or can’t economically finance), and a bunch of CLO managers wanting to do deals, but without much confidence that they can source a portfolio.

But these two facts about the world remain disconnected.

Unlike in the post-Covid period, when there were a few portfolios trading (one of the first post-Covid CLOs was a book purchased from a liquidating warehouse), everyone is pretty much hanging in there hoping to get their CLO executed, even if it means accepting a deal that’s going to deliver lousy equity returns.

There’s no great mystery here — the bid-offer is massive.

Most pre-invasion portfolios were probably bought around 98-99, as in typical in normalish loan market times, and depending on the exact asset mix, they’d be lucky to get a 9-handle price at all these days. There’s not enough juice in warehouse equity to just eat a 10 point loss across the portfolio, so most funds are likely hoping to salvage something by terming out and trading through the troubles.

But this is bad news for the broader market, especially liquidity in the loan market — it’s better for trading volumes, for financing, for eventual term CLO transactions, if managers own assets they want to own at prices which are realistic. Gravity cannot be defied indefinitely, but the slow meltdown this spring and summer has allowed managers and equity to keep hoping instead taking the pain.

Trading is not totally dead — there’s a €48m loan BWIC lined up for Friday, but the fact that we’re even discussing a sub-€50m portfolio tells its own story. Largest position is dialysis group Diaverum at €2.45m (let’s hope they don’t take the piss on pricing) but mostly we’re talking €1m clips or below. There’s even a €44k piece of Keter, and a number of other odd lots in the mix.

This doesn’t smell like disgorgement from a CLO warehouse — everything is much too small to have been acquired with a CLO in mind — and colour we’re hearing is that it’s a loan fund covering some outflows, so we may have to keep waiting for assets to change hands.

Lousy liquidity is a big part of the issue keeping the European print-and-sprint market in its present parlous state.

Pretty much every manager with equity available has looked at it, but with loan market liquidity at a low ebb, and very little primary activity, being a forced buyer isn’t a pleasant place to be. Carlyle worked closely with arranger JP Morgan’s loan trading desk to get a line of sight to its preferred portfolio for its print-and-sprint but even the mighty JPM isn’t immune from the liquidity issue.

A near-dead primary market means no portfolio churn and no refinancing. Crystallising losses is no fun when many credits are likely money good; there’s no catalyst for many loan market participants to sell, and no desire from potential buyers to bid up assets when the backdrop remains weak.

Up the capital structure

For managers without equity available….the options remain limited. Equity providers have different views and differing incentives, but most players in equity are also active at the bottom of the capital structure, and right now, the risk-return on offer for doing single-B rather than equity look pretty fantastic.

Blackstone Credit’s Clonmore Park deal last week, for example, saw a single-B note issued at 80.73, and paying 1102 bps, and with more than 9% of par sub. As we discussed, it’s possible this bond was placed close to home (it’s a lot of money to give up), but it’s in line with secondary levels

We like to keep an eye on some of the listed funds which play low in the CLO cap stack, and that’s what they’re saying.

Axa Investment Management’s Volta Fund, for example, said in its last investor update that “Capturing the bottom in loan and CLO markets is always challenging when considering…the time to market in pricing a new CLO Equity tranche. So, after accumulating cash for already several months, Volta will seek to reinvest, considering buying mezzanine CLO debts at significant discounts and/or opening new CLO warehouses to be able to purchase loans at even deeper prices if some others are forced to capitulate.”

For Fair Oaks Capital, too, single Bs are the new equity…”The recent market volatility has allowed us to invest in attractive single B-rated CLO notes, generating very high returns to maturity, with potential for further upside should markets normalise, and resilient enough to withstand stress tests based on the conditions of the 2000, 2008 and Eurozone crisis periods”.

Volta’s reporting also underlines the still-impressive strength of the risk transfer market, with “bank balance sheet transactions” in the fund marked at 86.1, vs 43% for European CLO equity and 58% for US CLO equity.

The asset classes aren’t identical, even when we’re talking about the large corporate SRT deals which make up the bulk of the market — the typical assets in a large corporate SRT deal are higher-rated than in a leveraged loan CLO, and comprise relationship lending exposures, rather than purely financing for the PE community. But they’re still first loss pieces in corporate credit….and often SRTs are thinner.

It’s the technicals of the market, though, that probably make the real difference in supporting SRT pricing. There’s a very active public sector participant, the European Investment Fund, plus a real whale of an investor in the shape of PGGM / Alecta. Funds raised for risk transfer are often forced to stay in risk transfer, and we’ve heard of a couple of new allocations this year (M&G and Chenavari were the names mentioned) which are doubtless keen to deploy.

Steak out

So Davidson Kempner is doing the decent thing, and (probably) calling Hawksmoor when it comes up to First Optional Redemption Date (FORD) this August.

We’d previously noted the presence of the promising-sounding SPV “Stratton Hawksmoor 2022-1”, incorporated in April, but with the step-up margin in the Hawksmoor 2019 deal at 158 bps, we thought it was close to the danger zone….the folks at Deutsche Bank research put generic non-conform senior spreads at 160 bps in their update last week, while the mezz, which had a step-up capped at 100 bps, will definitely be more expensive in any new deal.

But nonetheless, sole arranger Bank of America has popped the deal on screen, with pricing slated for next week.

That’s been followed by an announcement saying that “the Issuer understands from the Mortgage Pool Option Holder that its current expectation is that it will exercise the Mortgage Pool Option in August 2022..the Issuer understands that the Mortgage Pool Option Holder’s present expectations are subject to change and that it has not given notice to exercise any rights in respect of such Mortgage Pool Option. Any such notice may or may not be given.”

In other words…..DK will call the deal, except it might not. But it probably will. But it can’t say so properly just yet, for Legal Reasons.

Any old idiot can figure out that “Stratton Hawksmoor” is going to be the Hawksmoor refi, but the new deal is actually going to wrap together several other DK-controlled transactions, including Stratton Mortgage Funding 2019 (a portfolio previously in Moorgate Funding 2014-1 and RMS 25), and Clavis 2006-1 and 2007-1.

Had I been a little more diligent, I might have noticed that the Stratton 2019-1 call date and Hawksmoor call date were identical, suggesting a combination was always planned, but at least we know now.

The Clavis deals are, as the names suggest, pre-GFC non-conforming transactions, originated by Basinghall Finance, about which I know little — other than that they were targets for Rizwan Hussain’s activities, generating the usual flurry of suit and counter-suit.

Rizwan also had a pop at Stratton 2019-1, as it happens…a couple of financings before, this is one of the few portfolios in which he had a semi-legit interest, with Kilimanjaro Asset Management, a vehicle set up while he worked at StormHarbour, holding the “risk retention” in Moorgate Funding 2014-1, acting as beneficial title seller, and receiving the Revenue Residual Certificates.

I say legit, but this was pretty sketchy — it was the early wild west days of risk retention, and let’s just say there wasn’t a huge amount of economic exposure staying with Kilimanjaro. But that’s enough Rizwan for today. DK has suffered enough.

The deal announcement from Bank of America is interesting for other reasons too — including what it doesn’t say. There’s no explicit mention of “preplacement”….it simply informs the market that “a transaction may follow subject to market conditions”.

Presumably market conditions aren’t going to be “good” exactly and it’s a lot of wood to chop without some anchor accounts in place — there’s £1.6bn outstanding in Hawksmoor alone, and just shy of £300m more in Stratton 2019-1.

We’d expect some kind of derisking to have been done prior to announcement…many of the previous large legacy books come out with seniors already spoken for, generally from the kinds of accounts that like their bonds in £100m+ size. Mezz placement has been hard lately, but Bank of America trading desk has done some hard backstops in the past, most notably with the Granite refinancing, which came to market while the UK government was having one of its frequent Brexit-related meltdowns in 2019.

Private sounding for a fully preplaced deal is an easier proposition for deals like the recent NewDay and Together transactions, which aren’t funding calls of existing public securities — it’s not exactly a secret that NewDay and Together periodically issue securitisations, and hard to argue that knowledge of a new issue should move the price of the existing.

But knowledge of a transaction that could refi an existing trade is harder. If the refi doesn’t happen, and you’re still locked up, then that closes off an exit route from a bond with a lot of extension risk. But Hawksmoor was pretty well flagged, and pretty well known — investors could have shared their colour and price thoughts without the need for a formal wallcrossing, simply on the basis that a deal was surely in the works.

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