Excess Spread — The bank of the future, big in Japan, not dead just resting
- Owen Sanderson
Banking but better
Would you rather be a managing director in an investment bank, or a partner at an alternative asset manager like Blackstone or Apollo? It’s not a theoretical question, and plenty of senior securitisation people have made the switch — to take three at random, Dan Pietrzak used to run Deutsche’s securitised products business, and now heads private credit for KKR. Jesus Rio Cortes used to be a senior structurer at Bank of America, and now runs European resi mortgage activities at Apollo. Michael Dryden, formerly boss of Credit Suisse’s global securitised products biz, now heads structured products at Sixth Street. I could go on but you get the idea.
But the rest of Dryden’s old team could also be on the verge of a wholesale switch out of the investment banking business, with the announcement as part of Credit Suisse’s latest results that the bank is now looking for third party investment in its securitisation business.
Securitisation and leveraged finance were jewels in the crown of Credit Suisse’s investment bank, a legacy of the DLJ (Donaldson Lufkin & Jenrette, for the youth) DNA. But they’re capital-intensive spots to play, and CS has struggled for years to explain to its investors exactly why a Swiss commercial and retail bank, global wealth manager, and a credit powerhouse investment bank belong under the same roof.
Turns out, maybe they don’t. An investment bank’s securitisation business is basically a financing business, writing loans secured on assets. Zoom out far enough, and it’s just….secured lending. A big pile of senior-ish facilities backing consumer loans, commercial real estate, leveraged loan investing, sports and media rights, litigation funding, mortgage origination and anything else you can imagine, adding up to perhaps $70bn or so globally in the case of Credit Suisse. That would be a lot to sell at once, and the people managing them don’t come cheap. But it’s not a million miles away from the kind of assets that have been piling up inside the alternative asset managers’ tame insurance firms — the likes of Athene are already competing with the investment banks to finance asset portfolios of various kinds. If they can succeed in pooling capital, why not Credit Suisse?
The lines between what banks do and what “investors” do is getting blurrier all the time — the credit funds are now underwriting deals, financing receivables, and even managing capital markets syndication….so why not travel the other way, and turn part of your bank into a big alternative credit fund?
The bank’s management stayed pretty tight-lipped about the process on the investor call, though they unveiled a slate of investment banking luminaries who’ve been given board seats to work on the “strategic options” involved. I’d expect sovereign wealth money would be the first port of call — best option is probably a big strategic permanent investment from a deep pocketed long term buyer.
A big question for the market is what this does to Credit Suisse’s securitisation placement activities.
As a relatively pureplay investment bank with a small balance sheet compared to its commercial bank rivals, Credit Suisse was encouraged to turn over its balance sheet and term out its financing in the market. There aren’t a lot of European public deals (other than CLOs) with CS’s name attached, but discerning securitisation investors appreciate the flow of interesting assets coming out of the CS business.
If the third party capital raising goes well, though, does the flow disappear? The origination activities of Credit Suisse should be enhanced by a big slug of new external capital, but the assets will feed the balance sheet of the as-yet-undetermined third party investor (as well as the LP interest the bank will presumably maintain)….meaning less for the regular securitisation investors out there.
CLO primary is still staggering along, with more managers taking the hit last week to price deals mostly below par. Last week saw Alcentra, with Jubilee CLO 2022 XXVI, its first deal since agreeing the takeover from Franklin Templeton, CSAM, with Madison Park Euro Funding XX, and Bain Capital Credit, with Bain Euro CLO 2022-2. The Alcentra transaction is a portfolio that’s very long in the tooth, with the vehicle established almost a year before and a warehouse in place from October 2021, while the CSAM trade is somewhat fresher, dating from March this year.
Alcentra had Standard Chartered on board with arranger Jefferies as “co-placement agent”, a signal that the UK-headquartered bank is once again doing anchor tickets, but unlike the Japanese players lately active, they seem to be buying pretty much on-market — 212 bps with some OID, not too far from CSAM’s 210 bps senior print.
Getting to par for any tranche today seems impressive, with the 7% B-2 fixed rate note the only par print in the CSAM deal, and all the Alcentra tranches issued at a discount. That’s all very well if the portfolios are full of loans purchased at a chunky discount, as with any recently ramped deal, but expensive if not the case.
Still, it does at least create a capital structure with a little more excess spread in down the road. The pull to par on the loans should cover the OID that has to be offered, and give managers a more viable capital structure with at least a little arb left in.
This week, Tikehau successfully pushed out Tikehau VII via BNP Paribas, also pricing everything below par. The deal was helped over the line with “sizeable lead interest” in the class A. One might presume that the €122m class A loan note is the more appealing piece for a bank to hold, with the €118m triple-A bond class placed elsewhere. This strategy was also on display in BNPP’s last deal, Clonmore Park CLO, with a €60m bond and €148m loan at a senior level, and makes a lot of sense if a given institution can join the dots between its underwriting arm and its investment / buy-and-hold arm.
We’re seeing analogous moves in the leveraged loan market, where some underwriting groups are recutting their LBOs to feature more term loan A (amortising bank debt) and less institutionally placed TLB or bonds — see this Bloomberg piece on the Citrix deal, one of the biggest and toughest underwrites still on banks’ books, for example.
The Tikehau trade also illustrates the blurry distinction between marketing a deal and not marketing a deal….placement discussions were definitely underway on this one as early as April, but you wouldn’t say it’s had a three month bookbuild, even if some of the investors that were keen in the spring stayed in place. The cap structure has definitely been recut — no deals in April had a 2-handle on the seniors — but fundamentally it’s the same CLO that’s been ticking along for months.
Still, there are some encouraging signs — along with the stabilisation in broader credit markets, bankers report accounts returning to CLO primary up and down the capital structure, touching wood and hoping that these are the wides.
CVC Credit has scored what might loosely be called a print-and-sprint with CVC Cordatus Loan Fund XXIV, arranged by Goldman Sachs. It’s a bit of a hybrid vehicle, with the SPV set up back in February and a warehouse established in March (but without much in, freeing the firm to fill up on low priced loans).
The 120 bps senior coupon is spectacularly low by current standards, but exactly in line with Carlyle’s 2022-3 print-and-sprint in late May. Goldman thoughtfully left any actual pricing off the publicly circulated termsheet, drawing a veil over any OID ugliness, so we may have to wait for more info on where these bonds cleared.
But the deal differs from the Carlyle trade in the extreme shortness of the transaction — it’s a 1RP/1NC transaction — as soon as the deal becomes callable, it also starts amortising. It’s a pure and simple attempt to bet that the loan market bounces back by next September.
In the case of Carlyle, the term structure was basically normal, at 1.5/4.5 — so the deal’s economics rested not only on buying the assets at a discount, but also continuing to trade and invest for the life of the portfolio.
If the loan market has indeed bounced back by next year, then it’s a fair bet that CVC will also be in a position to get a reset away, terming out the deal and returning it to an “ordinary” transaction — while flushing out the returns of the loan price appreciation.
We don’t have any insight into how the portfolio was acquired, and liquidity in loans has certainly been stretched. But we’d suspect Goldman’s trading desk may have helped things along, just as JP Morgan did with Carlyle — it’s a lot easier to “sprint” if a friendly counterparty has already located a lot of the collateral.
With credit markets stabilising, pricing in the better loan names has popped — there’s a flight to quality, with every investor looking for non-cyclical businesses with limited energy exposure and large liquid capital structures.
That’s going to make any future “print and sprint” particularly tricky to execute, with some of the crucial building blocks of a classic CLO portfolio too expensive to source. Print and sprint is a lot less workable if it means a portfolio full of unlovely recession-exposed rubbish.
Separately, we’ve been doing a bit of work on possible CLO manager consolidation — a perennial topic for the European market, which has around half the number of managers of the US, serving a market around a fifth the size. We talked through the issues in this piece (for 9fin subscribers, but give me a shout if you’re interested) and screened for subscale managers which seem to have paused their European activities.
We’ve been out of the bank capital game for a long time now — there’s enough acronyms in the day job — but occasionally a few interesting nuggets emerge.
The big US banks have been strong, verging on the over-capitalised, for years but from this year, they’ve had to adopt the “Standard Approach Counterparty Credit Risk” (SACCR for the acronym fans), which basically makes their derivatives books much more capital-intensive. US banks will also see their “G-SIB” (another good one) surcharge increase next year, and a tough test on the stress capital buffer (SCB) tests.
Per Morgan Stanley’s banks analyst Betsy Graseck, “Betsy notes that they will need to keep dividends flat, eliminate buybacks, and reduce their RWAs to generate a capital ratio above their new required minimums. She further estimates that the three largest banks (JP Morgan, Bank of America and Citigroup) alone will need to lower their RWAs by more than $150bn in aggregate by the end of the year if they maintain a 100 bps management buffer on top of their regulatory minimums”.
The note continues: “Banks have been substantial buyers of senior tranches of securitized products, thus playing a crucial role in enabling credit formation across a wide range of assets by providing senior leverage. While such senior tranches are risk-remote by constructions, they carry higher risk weights and thus are capital intensive. If banks step back from such assets, the cost of financing would increase, affecting the cost and availability of credit across the system. Spreads of Fannie/Freddie MBS and CLO AAA tranches, trading near post-GFC wides, suggest that pressures from RWA optimisation are already at play.”
Anyway, TLDR — US banks are short on capital, making CLO triple-A investments less attractive to them. The big US institutions aren’t always a major presence in the European market, but CLOs is pretty global, with plenty of accounts looking at the relative value between US and EU. Wide US CLOs means wide European CLOs, directly or otherwise.
Just to throw a few numbers around here…JP Morgan discloses $49.57bn of CLOs in the held-to-maturity book, plus $10.5bn available for sale. Citi and Bank of America’s SEC disclosures don’t line up exactly the same way, making it hard to pull out CLOs as an asset class, but we’re certainly in whale investor territory here — and bank capital rules could be adding a further overlay to the already challenging market.
Big in Japan
It doesn’t take a genius to figure out that, prior to announcing a £2bn+ refinancing, you get a bit of work done behind the scenes.
So it is with Stratton Hawksmoor 2022-1, we understand, where the relevant deal parties have been making the trek out to Tokyo to ensure that the senior tranches can be locked away in safe hands that can do serious size. As in the CLO market, it is a royal pain to get large Japanese accounts in place — it’s not down to conservatism exactly, but there’s a long list of stipulations and diligence, plus the in-person meetings on the other side of the world to get done.
But once they’re in, they’re reliable, and might well roll into the refi, and the refi after that as well. Locking in £1.7bn of funding, as in Hawksmoor, is well worth the brain damage and the travel time.
That might help explain sponsor Davidson Kempner’s decision to wrap together the Hawksmoor refi, Stratton 2019, and two Clavis deals in the new transaction — once you’ve got the Japanese senior anchor in, better to finance as much as possible. Stratton Hawksmoor 2022-1, I believe, is also a record-holder for financing some of the oldest originations in the post-GFC securitisation market, with collateral going back to 1987, when I was a literal embryo.
Pricing, too, is clearly a benefit, with the anchored senior notes placed at par and 122 bps over Sonia — or, to put it another way, an absolute mile inside the market. Pepper Money’s front book non-conforming deal Polaris 2022-2 came at 130 bps on June 1, by way of comparison, so we reckon this level was probably agreed a while back, much like Investcorp’s Harvest XXIX CLO, which priced some 50 bps inside the market in early July.
Last week’s musings about whether DK’s step up to 158 bps, was inside the market level for non-conform seemed like a valid concern at the time, but presumably provoked a chuckle from those in the know about the anchor level.
The well-anchored senior also translates to more generous call treatment. The senior investors get a 1.5x step-up, capped at 100 bps increase (exactly as in the 2019 Hawksmoor deal, though off a higher coupon baseline).
But in this incarnation of the deal, the mezz gets an uncapped 2x coupon increase, restricted only by a Sonia cap at 8%, compared with the same 1.5x, 100 bps cap that the senior got in the 2019 deal. The baseline coupons, however, have actually been cut since the 2019 issue, with the current challenging market levels reached by discounting the bonds — so the 2x uplift doesn’t mean quite as much as you’d think. But there’s turbo amortisation as well, for extra reassurance.
It’s also worth pondering the curious decision to split the triple-A — not in the usual fast pay / slow pay fashion, where senior notes are tranched in time but not in credit enhancement, but in carving out a second-ranked A2 note.
Triple A mezz doesn’t really exist as an asset class, so it’s an open question who actually wants this kind of bond, and there was a not-inconsiderable £63m to place. The levels here are much more on market, at 150 bps coupon and 98.27, so perhaps the real question is who didn’t want it? If the Japanese were in for the A1, perhaps they had limits on size or credit enhancement that meant this A2 note has to land elsewhere?
Anyway, the deal is done, congrats to sole arranger Bank of America. The old deals will be called, and, whisper it, but just maybe this is a crisis where everyone honours their call schedules?
We spoke to someone involved in the delicate business of leveraging real estate funds the other day, who said that conditions in the bank market were pretty tough — counterparties were demanding more control, better security, more recourse to funds, and better economics. That’s what you’d expect, given the broader market conditions, and the likely impact of recession on commercial real estate….but potentially it offers some encouragement to the mostly absent European CRE CLO market.
Since Starz did its debut static deal last autumn, there have been a grand total of zero follow-on transactions, despite the four or five big names that were said to be waiting in the wings.
Some of these have switched back into private bank facilities as the capital markets have deteriorated — unlike newbie Starz, the likes of Blackstone and Brookfield are very well placed to browbeat the investment banking community into giving them the financing they want.
Just as classical European CMBS is always in competition with bank or private CRE debt, CRE CLOs were always a contingent product, dependent on the pull of pricing, and the push of difficulty executing in other formats. If CRE CLOs can’t deliver better terms than loan-on-loan repo, TRS leverage or straight warehouse facilities, they’re not going to happen.
But what you might call “manager tiering” is much more extreme in CRE funds than in leveraged loans (there’s a lot more diversity of collateral). While Blackstone Real Estate can expect the triple-platinum treatment from its banks, there’s a long tail of relatively new entrants, with limited track records, who might find the level playing field of the capital markets more congenial for sourcing leverage.
That’s a long way of saying….we think CRE CLOs aren’t dead, just resting.