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Possibly the largest loan manager in Europe without an active CLO platform has just changed that, as M&G has printed Margay I, its long-heralded post-crisis return to CLO issuance. M&G had a shelf called “Leopard” before 2008, but a Margay, as it happens, is a smaller, gentler spotted cat (so we suspected this was an M&G deal when we clocked the filing).

We have been wondering what took M&G so long, to be honest — the public €3.5bn European Loan Fund has an initial fee of 2% and a max annual charge of 1.11%, according to its public disclosures. That’s a fair bit more than the CLO standard of 0.5%, across 15 bps senior and 35 bps subordinated fee, but a good deal less than the potential juice from outperforming the 12% equity IRR hurdle.

If you already have a big loan investing / credit analysis team, CLOs are basically a freebie. You need some time and expertise to handle the structuring and placement, but some shops still handle this via the PMs. Building out from an existing platform (M&G manages €9bn+ in leveraged finance, so 20+ CLO-equivalents) means not being subject to the same dash for AUM seen in brand new CLO shops — presumably the loans investing team is already washing its face so no need to rush to 3-4 deals to cover costs.

But part of the answer comes from ESG, we understand. There are aren’t many loan funds under the “light green” Article 8 of the Sustainable Finance Disclosure Regulation, with M&G’s Sustainable Loan Fund one of the largest (Invesco is the other big one, though others are launching; Robeco in March for example.)

The firm announced in 2021 that it was allocating £5bn into “sustainable private assets”, including private credit, real and financial assets and private equity, and later that year launched the Sustainable Loan Fund with a €175m seed from the Prudential With-Profits Fund and €26m from a Swedish pension fund.

The aim, on returning to the CLO market, was to do so in a maximally ESG fashion, and from this perspective, the timeline makes a lot of sense. Sustainable Loan Fund launched in October 2021, market was pretty lousy for much of 2022 (though M&G signed its warehouse in the middle of the year), and….that pretty much brings us up to date.

We haven’t been able to trace the equity investment beyond an anonymous Lux vehicle, but it’s also sustainability-orientated, so top notch ESG was always crucial.

Plenty of CLO managers are keen to bang the ESG drum, but the basic pitch is fairly compelling — it really is true that lenders to a private business have more direct engagement with management and sponsors than bondholders for a big listed company, for example. That doesn’t necessarily translate to power as such….if lenders cannot persuade sponsors not to market wildly inflated imaginary EBITDA figures and covenants you could drive a bus through, how can they stop them polluting? But it does give a seat at the table, and lots of sponsors are also pushing in a pro-ESG direction.

We’ve not seen the pitchbook for the new issue, but the Sustainable Loan Fund blurb says it “includes an explicit sustainability objective alongside its financial one. Achieving it involves a three-pronged approach, using screening, considered selection and M&G’s proprietary scoring methodology:

Exclusion – screening out companies who transgress behavioural norms or generate revenue from anti-sustainable and/or other specific business sectors, including thermal coal and oil and gas

Engagement – pursuit of a rigorous engagement strategy, involving both bilateral and collective action

Enhancement – tilting towards high-scoring companies and sustainable labelled instruments, including green, social, sustainability-linked loans and bonds, whose proceeds are either used for a specific purpose or are used for general corporate purposes, albeit linked to key performance indicators in keeping with a company’s stated sustainable performance targets.”

M&G’s existing loan fund returned 3.4% across the last year, which doesn’t seem terribly exciting — and doesn’t leave much to lever once the costs of a CLO debt stack are taken out. But it’s hard to unpick from the fund disclosures how much of this represents credit spread carry, how much is price decline across a rough 2022, and how much is Euribor.

The fund diverges from a classic CLO portfolio, based on the top 10 holdings disclosed — there are few crowd-pleasing telco classics like Ziggo, MassMovil, and Virgin Media, giant cap stacks like EG Group….but substantial positions in Parkdean (now refinanced by Ares) and software firm Visma, are not usually top 10 positions in European levfin.

CLO structures are, by design, constraining, and need high levels of diversity to achieve efficient tranching in the rated debt. That means M&G’s pitch to the CLO investor community cannot only be based on a strong track record investing in leveraged loans. 

Investors will want to know that not only can M&G do credit picking, but also that it can do credit picking within the confines of CLO investment parameters. Depending on where they sit in the capital structure, they will also want to know how M&G intends to use its powers. Picking loans (or bonds) that go up is a definite skill, but how will M&G, as CLO manager, handle its trading gains or excess par?

Conservatism is the institutional style, so expect Margay in the low WARF corner of the market, rather than reaching for yield with bonds or high triple-C allocations. In a sense, all par loan investing is conservative — you can’t make much of a principal gain on instruments that are infinitely callable, so not losing money is the name of the game — but some are more conservative than others.

That also extends to placement style and capital structure — we understand there was a fair bit of premarketing prior to launch (partly to make sure tranche investors are also ESG-friendly) and there’s no single-B tranche in sight. There’s also a €70m loan note in the class A, a feature which has been seen rather less this year than in the difficult days of 2023.

Speaking of loan notes, we’ve seen plenty issued, but not very many repaid. We note with considerable interest that Barings 2022-1 has done exactly that, substituting a €92.8m Loan note for an equivalent increase in the size of the class A bonds. This was contemplated under the original deal docs in what I’d assumed was boilerplate, but actually appears to be bespoke.

The transaction docs explicitly give the Class A-1 Lender a put option — it can “request the Issuer to repay the Class A-1 Loan (or any portion thereof) (the “Class A-1 Repayment Principal Amount”) to that Specified Lender and on such date, issue to one or more unrelated third parties (each a “New Noteholder”) Class A-1 Notes which shall be consolidated and form a single series with the existing Class A-1 Notes”.

We only checked one other loan note deal (Penta 12), but there was nothing like this in place. That suggests that the class A lender in Barings 2022-1 had a decent amount of leverage (nobody likes giving away options) and perhaps never intended to stick around. Perhaps it was arranger Goldman Sachs putting in a ticket to clear the deal?

With three recent debuts (Signal in market and M&G just priced; Canyon back in March), you might think that the environment is supportive for CLO issuance. But you would be wrong! CLO arbitrage remains, on paper, pretty weak. As the ever-cheerful team at Bloomberg put it, Collateralized Loan Obligations Face Lowest Profitability in Years.

Specialty chemicalss firm Nouryon (a nice big widely held capital structure) is offering 400 bps and 425-450 bps for the A&E of its dollar and euro facilities respectively, at 98.5-99 and 98 OID. Or you could look to Lottomatica, offering an FRN (Italian borrowers can’t really do loans) at 412.5 bps and 99. 

Slice off the margin you’d want to guarantee a healthy equity arb out of the gate and you need CLO debt to come in at 250 bps or below. With triple A hovering around 200, this is not gonna happen. 

But the CLO market is basically unkillable — there’s always an angle to be worked. 

Warehouse equity can be a nice trade if you’re getting a lot of OID in the door; warehouse terms are good, banks are still highly competitive, and there’s lots of money stuck in captive risk retention vehicles and looking for a home. There’s also an argument that it’s worth getting deals issued now and loans in the door to give you optionality for a reset down the road (as outlined in this Twitter thread). Think of CLO equity as an eight year trade not just the two years of non-call, and perhaps it looks more compelling.

Once upon a time when I started covering European securitisation, UK prime master trust RMBS was pretty much all there was in the market — but in truly fantastic size, with trades in the multi-billions. Master trusts and prime generally has been…less exciting since then, thanks mostly to the Bank of England. 

Various special liquidity support schemes left the UK majors with reduced market funding needs, which could be adequately served by cheapest-to-deliver covered bonds. Ring-fencing struck another blow against securitisation funding, essentially trapping pools of liquidity inside the UK clearers’ main mortgage lending arms. Just as optimistic observers were hoping for a prime revival in 2020, Covid struck, bringing yet another special liquidity support scheme to prop up the banks. 

So is this time different? Two master trust deals this week, and a 15G filing for Coventry Building Society suggests another in the works. Of these, the Lloyds Permanent shelf is the most significant — Clydesdale’s Lanark shelf has issued a regular keeping-in-touch trade each year, normally early on, while Coventry has been making use of its Economic Master Issuer vehicle each year since it was structured.

Permanent, however, has been absent since 2019, and Lloyds is larger by far than the others — it’s the UK’s biggest mortgage lender (and, full disclosure, a lender to me; no idea if my mortgage is in Perma). 

Lloyds used to have a smorgasbord of different mortgage issuance (master trusts from the Lloyds and the HBOS sides and a scatter of standalone), but now it has cut down (a bit). Perma for funding, Syon Securities for risk transfer on high LTV / first time buyers. I guess one could also count Bridgegate Funding, the regulatory deconsolidation of The Mortgage Business back book priced at the beginning of the year, though this was very much a one-off.

Permanent itself was heavily reworked prior to the latest issue, with the mezz stripped out for senior-only issuance going forward, swaps redone and old machinery related to the defunct Funding 1 vehicle removed.

This was a crucial window for Lloyds — the last external bonds had repaid, so there was a golden window to push through a master trust spring clean without running noteholder consent processes. The changes save some cash and streamline documents. No need to pay for ratings on the retained mezz notes, and the less crucial swaps will be uncollateralised, meaning a reduced contingent liquidity requirement for Lloyds. 

What Lloyds did not do, however, is adopt a single SPV structure, a la Coventry for Permanent. This would have streamlined documentation and issuance still further, cutting out an additional layer of SPV — read some old awards blurb by me here for an explanation. 

No issuers have yet followed Coventry down this road, though Barclays has an untouched shelf documented and ready to go. If Lloyds (or any of the other existing master trust issuers) does go down this route, it’s likely to launch it as a new offering, rather than trying to rework an existing trust.

Anyway, the books for the Permanent deal, priced on Wednesday, underline the demand picture (and the distinctive nature of master trust RMBS) — £1.6bn, allowing Lloyds to double the deal size from £500m to £1bn. Lanark books, at the time of writing, were £1.1bn for the £500m no-grow, so presumably there’s some unfilled appetite for Coventry when it follows.

Away from the master trust world, the challengers are also keen to print prime — Aldermore’s Oak No. 4 had a £480m book, and Charter Court just announced CMF 2023-1.

All of this supply gives abundant pricing data points, permitting some syndicate chin-stroking. 

What’s the basis between standalone and master trust RMBS? Funny you should ask. It’s 10 bps between Perma and Oak (though Oak is two years shorter). Lanark usually trades wide of the other master trust shelves, but by how much? Well, as of Thursday afternoon, it doesn’t any more, with Perma and Lanark both landing at 52 bps.

The size difference between books for master trusts and standalone transactions is striking. It’s ever been thus, but no prudent standalone issuer would want to be out there trying to print a billion in sterling.

The master trust investor base is definitely larger — Holmes 2023-1 saw 34 investors allocated bonds, compared with, say 23 on Bavarian Sky UK 5, or 15 on Azure Finance No. 3.

Scheduled amortisation gives predictable cashflows, which gives these some crossover appeal for regular bond funds as well as ABS specialists. If you like covered bonds you can probably handle scheduled amortisation RMBS? But these other funds would have to be showing up in serious size to get from books of £500m for a standalone to three times that.

The other big difference is secondary market liquidity, with master trust RMBS plus auto captives the most liquid end of the market. If you want to hold something that’s easy to trade in size, master trust RMBS is where it’s at. Any dealer will give you a Perma price in a heartbeat (when there are actual bonds outstanding).

Lots of non-performing loan securitisations, especially with a government guarantee, have been struggling for a while, and they’re struggling even harder now. The guarantee schemes, of which Italy’s GACS is by far the most extensively used, did their job of bridging buyer and seller expectations and getting loans out of the banking system….but structurally encouraged a certain optimism on collections and business plans.

Since then, performance has been disappointing across multiple transactions. Covid didn’t help, slowing down collections whether judicial or otherwise, but the targets were also ambitious. Per KPMG, “the underperformance is not only due to an underestimation of the onboarding process by the servicers…but also because of the servicers difficulty in respecting initial expectations”.

Across 15 Italian deals from 2018 rated by Scope, only three have escaped a senior downgrade.

Some, however, have proved worse than others, and some structural features don’t help.

Elrond SPV, a deal securitising a CreVal portfolio and originally sponsored by Waterfall Asset Management (since sold to Phoenix Asset Management) is one of the worst. Even by June 2021, collections were at 67% of business plan, and it had dropped further to 63% by the end of last year.

In Elrond’s case, the hedging is also something of a disaster. The original cap had a planned amortisation schedule, which has run well in advance of the actual repayment of the deal. So, per Moody’s, the cap now covers €150m (split equally between JP Morgan and Intesa Sanpaolo), which the class A balance is €229m and outstanding notes are €271m. 

The last payment date had a Euribor fix at 0.631% (so the 0.5% cap was already in the money), but now it’s very seriously in the money, with 6M at 3.658%. 

This is, not surprisingly, pretty bad news for a portfolio that’s already struggling to cover coupons, leading Moody’s to bust the class A down to Caa2 and class B to Ca.

Phoenix presumably bought the junior and mezz from Waterfall at a bargain basement level in 2020, so no tears there (though it may not have appreciated the damage that hedging would eventually do).

The complicated part, though, is how the class A troubles in Elrond (and other GACS deals) flow through, and who bears the pain. The standard trade for GACS deals, probably followed in Elrond, was for the originator to keep hold of the senior (it was structured with a wildly off-market 0.5% coupon so unlikely to be distributed).

Since it was government-guaranteed, and therefore 0% risk-weighted, the senior tranche could then be repo’d out, with the most likely counterparty the arranging bank or banks. Small NPL-ridden Italian banks didn’t have great access to private market-based funding at the time (still don’t,) so this was a useful route to liquidity.

Now, the bonds are still government guaranteed, but the government guarantee pays out at the back end, whenever that comes. Presumably the Italian state will be good for it, but it can’t be pleasant for the investment bank counterparties to sit there watching their collateral get crummier for years to come.

In the years since the transaction, CreVal has been acquired by Credit Agricole group, which presumably has less need of bespoke funding from JP Morgan and Intesa, so any repo arrangements might have been unwound. But much ugliness surely remains — any data on other underhedged deals much appreciated.

We at 9fin have been booking our flights and hotels for IMN/Afme’s Global ABS conference this week, and doubtless meetings are being furiously scheduled across the industry. Looking forward to catching up with many of you!

However, the drinks invites are coming in a little more slowly. Perhaps a problem with my email. Bank of the Year so far goes to Bank of America, and boutique of the year to Alantra, many thanks to them. No clash with Credit Suisse’s party this year I guess?

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