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Private Credit 

Owen Sanderson

Bridgegate Funding (Project Typhoon), priced just over a year ago, was a remarkable deal — a £2.8bn portfolio of some of the worst mortgages ever seen outside the NPL / RPL universe, a broad marketing process to deconsolidate these from the Lloyds balance sheet and take them out of the stress-testing perimeter, and a big cheque written by Pimco to win the deal. It was also the first investment bank risk retention for the Lloyds asset-backed investment banking business, which also held the triple-A note, as it did in Performer Funding, the Pimco-deconsolidation trade at the end of last year.

Anyway, the ratings were also remarkable in their own right, though I didn’t pay much attention at the time. Fitchassigned a “CC” rating to the X note, indicating “default of some kind seems probable” (excess spread was just 0.11%). For S&P, however, a bright and breezy BBB- on the same tranche.

Up the stack same story. Class F was split-rated (S&P/Fitch) BB+/CCC, E at BBB+/BB, D at A/BBB, C at AA-/A.

Split ratings in complex portfolios aren’t unheard of — given thin, sensitive tranches, weird optionality and deferral structures, different agencies have different assumptions — but this is… not that.

From S&P’s rather red-faced update on Tuesday — “Following our periodic review of the performance of the transaction, we discovered that at the time of assigning our ratings on the notes, we had incorrectly calculated the interest payment on the rated notes.”

By quite a lot! Class C drops from AA- to BBB+, D from A to BB+, E from BBB+ to B-, F from BB+ to CCC, and X from BBB- to CCC-.

This is exacerbated by the very low excess spread in the deal and, as S&P notes, “With rising interest rates resulting in an increase in loan arrears, undercollateralization has further reduced the excess spread available on the notes.”

I suspect this week was probably a very bad one for the S&P analyst on the deal.

Also: “Currently, the reserve fund is completely drawn (following a drawing made in March 2023 to pay the senior expenses, which was a one-time senior servicing fee).”

So… the reserve fund for the notes disappeared on the first IPD to cover a completely predictable deal cost. Cool. I’m sure the agencies appreciated the credit support.

Anyway, in a sense, none of this matters much economically — Pimco owns the whole thing aside from the risk retention and triple-A (which S&P affirmed) and presumably bought the portfolio at a level that works. But the theoretical bond liquidity Pimco gains by owning securitisation bonds is presumably somewhat impaired! 

Not sure how Lloyds marks its risk retention position; given that it owned the loans for the best part of two decades the rating shouldn’t be material, but… if it is, it’s worse now!

You’d be a fool to bet against the British propensity for property speculation. This is a nation where “Homes Under the Hammer”, now in its 28th season, pulls in 1.5m viewers in its 10am weekday slot. But, as we’ve discussed, mortgage volumes in the specialist universe have fallen off a cliff lately, with BTL origination for home purchase down more than 50% last year.

Low volumes are bad news for thinly capitalised specialist lenders. If they’re selling their origination straight into a forward flow, the product fees are all that’s keeping the lights on, and there’s precious little of that.

Borrower affordability is a big constraint — complex credit owner occupiers and BTL landlords might not be underwritable at current rates levels — but the behaviour of the lenders also matters. Rather than write unprofitable business over the last couple of years, lots of them pulled their horns in and raised prices.

But the capital markets have turned, rates expectations are for cuts, and we are once again cooking on gasoline!

You only have to look at West One’s latest Elstree Funding transaction. The collateral is a mixed BTL and second charge portfolio, with rather more of the latter (£204m of £344m). Second charge has historically been awkward to finance; it’s not that nobody will buy it, there are several active specialist lenders securitising these (most recently Together, with TABS X). It’s that not quite enough people want to buy it, and they’ll ask for a premium. 

The already concentrated sterling RMBS investor base shrinks still further once you’re in this zone, with the builder treasuries reluctant to touch it. Real money and hedge funds are happy to play down the stack, at a price; it’s getting the triple-A away that’s the challenge.

At the time of writing, though, West One is 1.9x done on the triple-A at 112bps, from a start of 120bps. The class B was 3.1x done at 155bps-165bps, but landeed 1x done at 145bps — which puts it tighter than the triple-A in Together’s all-second-charge TABS X three weeks prior.

Together opted for a loan note to derisk the triple-A placement, locking it away with banks, and you can’t really criticise the choice, given the difficulties in sourcing good senior bids over the last two years. But now it’s clearly viable, and extremely compelling to go the syndicated route.

This matters because if the route to the exit is clear, you can start putting a lot more origination through the entrance. Affordability will still be a problem, and the product switch issue won’t go away. But securitisation-funded originators can now survey the scene with a little more confidence, and start to turn on their taps.

That’s going to be particularly useful for originators that have avoided the market as much as possible in the past two years, whose warehouse providers are probably getting very keen to see some takeouts happen. Lenders will always roll (not necessarily at attractive levels), but it’s much better to get a capital markets deal out when the window is there.

I was at DealCatalyst’s European private credit and middle market finance conference on Monday, helping to bring out the benefits of asset backed credit with a panel including Andrew Bloom, Zhu Gong, Dennis Stone and Paul Watts. Some pictures here, our broader conference writeup here, and some interviews from our private editor Josie here.

There’s something in the air about asset backed credit — while a cynic would argue it’s just a whizzy rebrand of securitisation, it’s broader and more ambitious in scope, and it’s driven by nothing less than the wholesale reworking of the financial industry. 

Maybe I’m a true believer but I’d argue we should properly see most of the “corporate private credit” universe as a subset of asset-backed private credit, rather than the other way around.

To plagarise myself and borrow the words of Man Group’s Matthew Moniot:

““The increase in regulatory capital requirements following the financial crisis made it clear that regulators don't want banks to take credit risk, and, and even more importantly, that banks are not competitive in high credit risk markets,” said Moniot. “Banks need other capital to stand between them and credit risky borrowers, so you have specialty finance companies in shipping and aircraft, leveraged finance, consumer credit and everything else. Unlike 20 years ago, the banks lend to these companies, but don't own them. They're in the senior financing position. SRT just recreates the same structure for assets that specialty finance companies are not well suited to address.””

With [Basel 3.1/IV/End-Game], bank capital requirements go up pretty much across the board — the output floor limits the ability of banks to optimise and manage their risk-based capital down. 

For the big longstanding banks with large portfolios on the internal ratings-based approach, this is bad news — they’ve put huge amounts of effort over the years into carefully tweaking portfolio perimeters and crunching performance data to manage their capital down, and now their requirements will be anchored to the standardised one-size-fits-all regulatory framework.

This will create some weird wrinkles around some portfolios and asset types, but big picture it’s just going to mean higher capital everywhere. Banks will be incentivised to stick to senior financing, where the return on risk-based capital is still attractive, and let others take the junior risk.

From there, you can remix it however you want. Maybe it’s a hedge fund agreeing a forward flow for salary sacrifice loans, with senior bank funding. Maybe it’s an infra fund anchoring portfolios of solar rooftop loans (of which more later). Maybe it’s a well-capitalised originator looking for a warehouse? Maybe it’s a private equity fund swooping in to derisk a regional bank’s CRE book, with senior finance from an investment bank. 

SRT, as Moniot notes, offers the same structure, just flipped around and with the initiative from the other side. Instead of the junior capital provider lining up their bank counterparties for the best possible terms, you have a bank lining up junior capital providers for the best possible terms (and on a much wider range of assets).

Corporate private credit is no exception — the direct lenders often pitch themselves as disintermediating banks, or doing deals that banks don’t want to do or can’t afford to do. That’s sort of right, but not quite. The banks have just moved up the capital structure, to provide senior back leverage against private credit fund structures. They haven’t retreated from the asset class, they’ve just headed up the capital structure, letting others do the origination and hold the junior risk.

Securitisation sceptics (perhaps they’d be more comfortable in a different newsletter?) would say, sure, but the volumes for European securitisation are still pretty lousy. That’s true of the public markets. Barclays predicted around €75bn in volume for this year back in November. That puts it above European leveraged loans or high yield (but behind both together), but roughly where a decently active fortnight in US investment grade would land.

It’s worth distinguishing the “turning into securities” part of securitisation from the tranching pools of risk part. The first part, the natural and original meaning of securitisation, is languishing a bit, in line with the bigger trend away from all kinds of securities markets into private debt and equity finance. But the second part, using securitisation technology for tranching and leverage, has never been healthier — and looks set to keep eating the world.

We flagged some questions about the future of Capital Home Loans just before Christmas — the venerable mortgage lender is only a touch younger than me, having formed first as a joint venture between Credit Foncier and Societe Generale. Permanent TSB bought it in 1996, but since 2016 it’s been sat with Cerberus, part of the US private equity giant’s big bet on UK and European mortgage markets.

In 2021 it made a much heralded return to BTL origination, and opened a couple of warehouses. This would have been around the time of the Fleet-Starling acquisition, when having a BTL originator seemed a most excellent thing, but it seems to have walked away from the product at the back end of 2023, and the autumn saw a sale process to clear out the warehouses (a challenger bank is the most likely winner).

Just before Christmas, CHL filings at Companies House show a major capital reduction. The last capital change was in 2018, and gave the entity £79m of capital. This was trimmed to £5m in December 2023.

This is particularly significant as Cerberus held its positions in Towd Point Mortgage Funding-Auburn 12, 13, and 14 through the CHL vehicle, rather than one of its Promotoria SPVs, so that suggests some sort of disposal in mind.

These deals are all well past call, and despite some vaguely encouraging RNS statements, show no signs of catching up. Auburn 12 was retained and financed on repo, but 13 and 14 were placed — admittedly with structures that weren’t terribly reassuring in terms of actual timely call exercise.

On a pure triple-A spread basis, the 135bps step-up margin is now outside the likely market level for a new deal. But redeeming the whole stack to refi might entail paying more than the portfolio is actually worth. Just looking at principal balances you’ve got £594m of notes in Auburn 14 supported by £581m of mortgages by this point, and this is not a par portfolio.

Still, a notice on all three deals last week suggests something is moving. 

“It is the current expectation of the Mortgage Portfolio Purchase Option Holder is that it will exercise the Mortgage Portfolio Purchase Option on the Interest Payment Date falling in May 2024… the Issuer understands that it is the current expectation of the Mortgage Portfolio Purchase Option Holder that the Mortgage Portfolio may be repurchased following the next quarterly Interest Payment Date falling in February 2024, but before the Interest Payment Date falling in May 2024, and potentially combined into a single new securitisation financing in April 2024.”

This frees Cerberus to run a wall-crossed marketing process for the portfolio, if that’s the plan — now it just needs to find a very juicy bid.

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