Market Wrap

Excess Spread — Sprint!, bank treasuries inbound, hold up

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

Excess Spread will be off next week. Enjoy the long weekend for our UK readers, and congrats to Her Maj — she was retirement age before all of this even started.

Need for speed

CLO primary continues to land — but of a very particular kind, with Carlyle (newly-crowned Largest CLO manager since acquiring CBAM) issuing a true “print and sprint” transaction, Carlyle Euro CLO 2022-3, via JP Morgan on Tuesday.

The idea is simple (and common in the liquid US loan market)…instead of warehousing before issuing a CLO, then finishing off the ramp process afterwards, issue a CLO structure with no collateral purchased, and buy as fast as possible in secondary.

For obvious reasons, it tends to work in periods when loans are trading cheap, dealers are looking to dump inventory, and bargains can snapped up in size — but true print and sprints have been rare in Europe. Only Fair Oaks Capital has got a “real” print and sprint away, in 2020, though plenty of managers this year have tried their best to boost deal sizes at issue, cutting their ramped percentage and making room for cheaper assets (we’ve been calling this “print more and jog”, though it’s yet to catch on).

Carlyle, among others, first set its sights on a print and sprint in February, but CLO formation continued at a strong pace after loan primary shut, and loan prices bounced back quickly, shutting off the economics of the trade and prompting the general arb complaints that characterised CLO events in April and May.

Even more than usual, print and sprints rely on supportive anchor money in the liability stack, and that probably favours larger managers who are on everyone’s list….or managers like Apollo / Redding Ridge (also working on a European print and sprint) which can subscribe for large parts of their own debt stack.

Expect to see more of these keeping the CLO market lights on — if there’s no loan rally, managers which can would rather do a new print and sprint than issue an uneconomic pre-invasion warehouse at current levels.

The strategy of bargain hunting means equity can tolerate a wider debt stack — it’s not about eking out some semblance of arbitrage on a pre-crisis portfolio, so much as getting a deal out there. If you’re buying the whole portfolio at 95 instead of 99, that’s a lot of performance and a lot of par build baked in.

So it’s a record-breaking deal (in a bad way) when it comes to single-B levels…this tranche was placed at 90 with a 1062 bps coupon, for a claimed DM of 1250 bps (to end of reinvestment, though worse if called shortly after the 1.5 NC is up). This is a piece of debt that’s yielding like ordinary equity….though it’s still cheaper than the modelled equity return for this deal, and presumably accretive to returns, otherwise equity would have kept it.

I think we’re also in record-breaking territory on the double-Bs as well, with a quoted DM of 975 bps, well into territory formerly reserved for the class below, but same applies — getting out there and ready to buy loans is the name of the game.

The fixed rate structuring is also worth a look — generally deals have either been opting for capped triple-A (the 2.5% Euribor cap solves for rating agency stresses on the fixed rate bucket) or the more traditional fixed rate double-A tranche, with, reportedly, a diminishing investor base that’s now charging a premium.

Carlyle, however, has gone for both, hedging 12.4% of the €337m deal size through a €25m capped triple A and €16.8m fixed rate double-A. This may have been encouraged by strong execution levels — the double-A piece came at 3.15%, vs 3.5% and 3.45% in Redding Ridge 12 and Invesco VIII. This was however, in line with Angelo Gordon’s Northwoods 26.

This reflects a bigger fixed rate bucket, at 15%, as this is where the best bargain hunting is to be done…but also, represents a much bigger hedged percentage than in previous trades — Carlyle had a 12.5% fixed bucket in its 2021-3 deal, its last European new issue, with just 2% of the capital structure fixed rate.

Carlyle seems to mostly use its fixed rate flexibility, running with pretty modest headroom to the max fixed rate bucket (if you’re going to pay for it on the structuring side, you might as well), so expect this to be almost maxed out.

As the designation “2022-3” suggests, Carlyle still has a couple of trades which had been slated for this year on the shelf, probably with rather more challenging economics. The warehouse for 2022-1 was opened at the back end of last year, with 2022-2 opened in mid-February, so the first one, at least, is probably underwater at this point.

The cavalry are coming?

We wondered when the rates-ravaged securitisation markets would switch back to pre-placement — and wondered why on earth it hadn’t happened sooner. Thankfully we held off from loudly declaiming about this trend, since no sooner had I filed last week’s Excess Spread then joint leads BNP ParibasCiti, Lloyds and Natixis announced Together’s second charge deal would be fully preplaced and pricing shortly.

The deal’s been expected for a while — it’s the natural complement to Together’s inaugural first lien only deal last autumn. If you’re expecting better executions from carving out distinct asset pools from a previously mixed programme, then you need a second lien shelf and a first lien.

Sterling second charge is a particularly suitable asset class for a spot of preplacement, as the already-narrow sterling RMBS investor base gets even smaller, as a couple of accounts simply don’t play here. West One’s Elstree No. 2, featuring £109m of second charge and priced against the balmy January backdrop, saw only 12 accounts allocated.

The relative absence of preplacements might be explained by the fact that the big real money anchor accounts have also been suffering outflows — it’s not as simple as slapping on some extra spread and executing in private. We talked last week about the €13bn leaving Pimco’s Income Fund in Q1, per Bloomberg, as one example. We’ve not seen outflow data for the other real money big beasts in ABS, but it doesn’t take many funds to be out for preplacement to look like less of a slam-dunk.

But as also discussed last week…the other big beasts that could anchor the market are the bank treasuries, which aren’t subject to quite the same outflow dynamics as the asset managers.

That’s what helped the Together deal over the line — the levels on offer in senior RMBS are now attractive enough to generate substantial, rapid and high conviction interest from major bank investors, two of whom anchored the senior at the outset, for a spread of 125 bps over Sonia. Prytania Solutions pegs UK non-conforming seniors at 114 bps for last week, probably a significant understatement of where a primary deal would clear. Add to that a premium for second charge in considerable size (£350m) and this looks like a pretty good level in the circumstances.

We understand there’s a certain amount of reverse enquiry taking place behind the scenes, with bank treasuries sniffing around looking for attractively priced anchor positions to take down.

Structuring the triple-A as a loan note is a clear signal of what’s going on. This is pretty rare in European RMBS, but we saw a rash of triple-A loan notes in CLOs in early 2021, which generally reflected the involvement of Bank of America or State Street treasury in anchoring the deal — loan notes apparently work better for US GAAP in some way (please write in with an explanation if you understand it) and if they’re a buy-and-hold position, the extra liquidity from issuing a fixed income security doesn’t matter much.

With the senior squared away, there was a deal to be done, but the mezz levels were always going to be painful. Together indicated to potential investors that it would walk away and retain down the stack if too much urine was extracted in pricing discussions (as PSA Spain and Santander Consumer Finland also flagged in recent ABS transactions) but market levels are market levels.

Let’s have a look at where we are down the stack — Together’s deal is 125/265/315/415/575/700, while Elstree Funding No. 2 in January (not a perfect comp, with less than half the deal second lien) was at 72/100/130/170 down to triple-B level.

Placing a class ‘F’ at Sonia+700 bps and 96.692 has got to hurt….though, from Together’s perspective, it’s still tighter than the (slightly better rated) HoldCo PIK notes, seen at around 8.7% yield.

As I argued last week…..securitisation is still pretty efficient, even when the market’s rubbish. Together quoted the financing cost of the deal at 1.96%, vs weighted average loan margin of 6%. Together would doubtless prefer to have financed the pool at 1.5% if possible, but borrowing below 2% and lending at 6% is still a pretty functional business model.

Terming out some assets from Together’s conduit facilities also helps ensure plenty of firepower left to lend more. Underlying mortgage origination is still running at a good clip for specialist lenders (though pockets of BTL may be verging on the uneconomic). Lenders with sufficiently robust funding structure are in a good position to take share.

The Together deal terms out some of the loans financed in the private Charles Street ABS conduit, itself refinanced as a pure resi facility in March 2022, stripping out the bridging loans to be financed instead in a facility called Lakeside ABS.

According to UK Companies House, Charles Street is provided by NatWest Markets, Natixis, HSBC, Lloyds, Barclays, and BNP Paribas (Natixis, Barclays and Lloyds using conduit vehicles).

That’s pretty much the previous banking group, though Barclays appears to have brought in the Sunderland conduit, while HSBC and BNP Paribas switched out their Regency and Matchpoint vehicles in the refi.

Arguably that leaves Citi as the odd one out in the arranger group for the second lien deal, though it is part of Together’s bank group, running the last HY outing for example. Perhaps more importantly, it does have quite a substantial treasury arm….

The Charles Street class B and C notes were placed with asset managers Insight Investment and TwentyFour, with both of them in the class B and TwentyFour only in the class C. One might expect that these funds would be among the first calls for the term mezz as well — if you like the assets in private form, why not public too?

While we’re grubbing around in Companies House, we might as well mention that Santander appears to have joined the financing group for Lakeside ABS, the bridging loan facility, when that was refinanced in March — an early fruit of new(ish) securitisation boss Matt Cooke’s drive to bank more third party financial institutions perhaps?

Hold up

For lenders that can’t stomach current conditions, their friendly local investment bank may have a solution.

We hear that some lenders are flipping from their longstanding portfolio-building warehouses into “hold warehouses” — essentially just a private facility that can hold a full portfolio, and give more runway in current conditions. The investment bank gets the carry, at more or less market levels, the lender can time the market (hopefully) better, and reload origination capacity in its main warehouse so it doesn’t lose share while its waiting for term capital markets access.

It’s conceptually similar to just selling it all to a trading desk, as Oodle did when bringing its 2020 deal to market via Citi in the teeth of the pandemic, but it gives more flexibility on structuring.

Rating agencies stress deals based on likely market coupons plus post-call step up, so if better times might be ahead, it might be worth waiting to get an efficient structure in place. As such, we’d expect to find this in lower yielding mortgage assets (where the interest rate stress is most important), rather than high yielding unsecured loans, where there’s plenty of spread in the deal.

This might also be the preferred option where sponsors want to call outstanding deals, rather than swallow the step-up and investor opprobrium that comes with extending beyond the FORD. There was precedent during 2020 for a skipped call (TwentyFour with Oat Hill for example) — but in 2020 there was also a clear line of sight to exercising the call at the next IPD, which is harder to see in current markets.

M&G called Dublin Bay in March into a privately-financed facility in March (the Dublin Bay 2022 SPV remains on the shelf), while the recent notice for Pepper Money’s Polaris 2019-1 (FORD in July) could go the same way if markets stay this bad.

It could also read as a good sign for the medium term health of markets — if the banks were pulling in their horns and closing down lending, then we’d have a real problem. Hold warehouses (and the activity of the bank treasuries) signals there’s appetite for what the securitisation market is selling, it’s just a question of price.

Leaving legacy

In the past several years, a pretty good trade was buying old mortgages, originated before the financial crisis, and financing them with securitisations. Sometimes the trade was about capital appreciation — the mortgages would perform over time, with careful servicing and economic recovery, and you could own a book with only 5% down — and sometimes it was about spread, with some old loan portfolios stuck on high reversionary rates, while prevailing financing rates were an invisible Libor plus a small credit spread. Sometimes both!

But with rising rates and spiralling credit spreads, the trade looks a little trickier.

At the February interest payment date, Towd Point-Auburn 14, a Cerberus-sponsored RMBS backed by buy-to-let mortgages from Capital Home Loans, announced it wouldn’t be able to pay interest on class ‘XA’. Now it’s also deferring interest on classes ‘D’ and ‘E’. All the classes up to class ‘B’ in the transaction can defer, a way to manage the extremely low (2.03% weighted average according to S&P) interest in the portfolio when the deal was closed in February 2020.

That’s all well and good — investors at the time were presumably getting paid for the possibility of deferral — but will come back to bite Cerberus come refi time. Deferred interest has to be paid at the call, and the mortgage portfolio will be worth less. Underlying mortgages are linked to Bank of England Base Rate, so payments will improve following the March and May hikes but….swap rates have gone up much faster. Prepayments have been running at 5%, per the last investor report, but that’s surely heading down as reasonably-priced BTL refis recede.

The call isn’t until February 2023, so it’s possible markets will have improved by then….but I wouldn’t bet on it.

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