This is a healthy-looking and diverse pipeline we can all enjoy — capital relief, prime funding, STS, non-STS, loans, leases, prime mortgages, non-conforming mortgages, sterling, euros. There’s something for everyone, and we’ve seen enough updates and pricings so far to get a sense of market conditions.

We can say for sure that mezz is hot. 

Many of the deals above are senior-only, but the TABS mezz was 6.5x / 6x / 7.4x for class B/C/D at update #3, Red & Black Germany was 4.2x / 8.6x / 5.9x for B/C/D, while Autonoria Spain was 3x / 2.6x / 3.3x / 2x for B/C/D/E at update #1.

Mezz tranches are small and the asset managers that play in ABS are large, so the coverage multiples don’t necessarily mean much. A monster coverage level on a £5.5m class D might just mean that half a dozen UK real money funds all liked the level and bid for the whole tranche.

But equally, if half a dozen UK real money funds are flush and axed to buy some RMBS, then it’s happy days.

The senior picture is more mixed, and deals are coming with some derisking elements, the need for which has already being demonstrated. 

Autonoria has €100m of protected orders in class A and B, while Principality Building Society launched Friary No. 8 with the option to retain part of the class A (not required in the end).

Together, as a non-bank, is not in the business of keeping lots of senior bonds around, but opted to for certainty through a £225m pre-placed senior loan note, of which two thirds went to MUFG conduit Albion Capital Corporation and the remainder to JLM Wells Fargo (a coming force in the European securitisation market, which will come all the quicker if it keeps buying £70m clips).

As I was writing this, the announcement for a fully preplaced RMAC No. 3 RMBS for Paratus also came through, perhaps the most cautious execution of all.

SG shows why this is prudent — the mezz placement in Red & Black might have been a bunfight, but at the senior level, it limped over the line just covered thanks to a €30m order from SG itself. Bumper NL 2023-1 (also, in effect, an SG deal, since SG sub ALD Leasing bought LeasePlan last year) had €400m of orders at the first update for a tranche that should be €500m based on the provisional pool.

It’s probably no coincidence that the somewhat challenged Red & Black Germany was one of the tightest deals on offer from the plethora of supply out there; if there’s a limited bid for euro seniors, why not wait and buy something juicier?

Placement strategies were a subject of some debate at S&P’s European Structured Finance conference on Thursday, though views broke down along perhaps-predictable lines. 

Investors don’t like to see locked away loan notes, or preplacement to accounts which aren’t them — they’re fundamentally in the business of buying bonds, and less bonds to buy is bad. 

They’d rather see originators retain some senior bonds, which might come out later in response to an attractive reverse enquiry, rather than loan notes, which typically stay with a bank buyer for life and can’t be bought by many funds. This, however, isn’t really an option for the specialist lender / non-bank community.

They also have concerns about levels — not out of an altruistic desire to see sponsors get the best possible execution, but because it’s frustrating to not be able to buy a deal which they would have bid tighter than the preplacement counterparty.

But the view from the issuer side is that caution wins. Don’t try to be a hero and chase the last 5bps. Good market windows have been hard to find these past 18 months, and when they come around you want to hit them hard with a deal that works. If you’re going to do one or two securitisations a year, make sure they’re a success.

WACI Races

CLO managers in Europe have been eager to parade their ESG credentials for years now, spurred partly by sustainability-mind LPs and investors, but also carried along in the broader capital markets push in this direction. We’re now at a point where pretty much every deal in Europe has at least “negative exclusion” ESG approach — though these are often carefully drafted to exclude very few of the companies actually active in European leveraged loans. 

Here’s the state of the art as of early 2022, a look at the global picture this year, and a detailed look this week at ESG reporting from Sam Robinson, who has recently joined 9fin’s growing structured credit effort.

Debut managers (or relaunching managers) have been particularly keen to distinguish themselves by raising the bar still further. Fidelity made a splash when the former MeDirect team relaunched the shelf in 2021, adding an ESG score test with maintain or improve language when it is failing.

From Sam’s piece: “Fidelity International manages over 100 Article 8 funds, and its CLOs follow the same framework. In order to demonstrate how vehicles promote, among other characteristics, environmental or social characteristics, the majority of its portfolio must be rated good or better according to Fidelity’s ESG scores, and this test is included in the reports.

If the test is failed then future trades must maintain or improve this score much like a warf test, as “it’s important there’s an actual test in the portfolio that has teeth”, says portfolio manager Camille Mcleod-Salmon.

The reports also show carbon reporting for each issuer, with scope 1-3 emissions detailed and a figure for the number of estimated figures included in the report.”

M&G also went hard on sustainability in its 2.0 era return with Margay CLO 1. M&G was already running the largest sustainable loan fund in the market, and earmarked £5bn for “sustainable private assets” in 2021.

From Sam again: “The CLO deliberately used an ESG focused investment framework, and was designed to be Article 8-aligned, alongside other products properly caught within SFDR’s framework, such as its M&G Sustainable Loan Fund.

M&G is publishing KPIs in yearly prospectuses and plans to start producing quarterly RTS reports. The CLO also commits to a percentage of sustainable investments in its portfolio.”

Anyway, the debut manager ESG arms race continues, with Pemberton marketing Indigo Credit Management 1through JP Morgan. Pemberton, an investment shop best known for private debt, has been working on the debut since hiring Spire’s Rob Reynolds in March 2022.

We think naming your CLO shelf after the colour of your corporate branding is kind of lame (here’s looking at you, Natixis Investment Managers!) though I suppose it’s more creative than [name of fund manager] Loan Funding.

But the ESG elements are genuinely cool — Pemberton is adding a “Weighted Average Carbon Intensity” calculation across the portfolio. This is a fairly common approach in the broader sustainable investing universe, and looks at carbon emissions proportional to sales/revenues, in an attempt to normalise carbon emissions and understand how much a given investment portfolio might be contributing.

Loan market sustainability data might not be quite at the point where this is a watertight and rigorous calculation, and Pemberton says it will use its own proprietary methodology to do the calculation.

As with ESG scoring, the “WACI” test doesn’t have the same bite as WAS or WARF. But Pemberton does caution investors in the CLO that ESG might not be best for returns — “As a result of the failure by individual Collateral Debt Obligations to comply with the ESG Eligibility Criteria and/or the disclosure of an ESG Score or WACI, the Collateral Manager may be incentivised to manage ESG Compliant Obligations in a manner that may focus not only on the monetary value thereof.”

The real test of ESG investing is surely that — are you ESG-compliant even if it costs you money?

The other ESG innovation in the Pemberton deal is the inclusion of Sustainability Bonds as a defined term, included in the provisions for reinvesting management fees.

“The Collateral Manager may direct the Issuer to acquire Sustainability Bonds with a view to, amongst other things, improving the WACI of the Portfolio, including by designating Collateral Management Fees for reinvestment in accordance with the Conditions and the Transaction Documents.”

“The Collateral Manager may, in its sole discretion, designate all or part of its Collateral Management Fee(s) towards the acquisition of or reinvestment in Collateral Debt Obligations (including without limitation, Sustainability Bonds) and/or Loss Mitigation Obligations”.

The definition of Sustainability Bonds is fairly broad, but it does mean labelled debt!

On my read of this, it doesn’t look like it applies to sustainability-linked loans with KPI-type ratchets — by far the most common type of explicitly ESG instrument in the CLO management universe. 

There’s a fair bit of sustainability-linked or green high yield out there which would be eligible (9fin’s quarterly Sustainable Junk publication tracks the trends), but Pemberton is coming out with a super-tight 5% fixed rate bucket, so it doesn’t look like this will be much of a theme.

I talk about mortgages

I’ve been collaborating with events company DealCatalyst ahead of their UK Mortgage Finance conference next Tuesday — it was a great event on its debut last year (marred only slightly by my moderating) and I hope to see many of you there this year.

Here is a great chat I had with Hugo Davies, chief capital officer at LendInvest. Hugo’s hair is a lot sharper than mine and his mortgage takes are even sharper. We touched on the tension between the Mortgage Charter and Consumer Duty, the funding environment, pipeline hedging, distribution for whole loans and equity, the surprisingly resilient bridging market and more.

Deposit-takers have been the dominant force in funding UK mortgages this year and last, offering the best rates to borrowers, funding the most advantageous forward flows, and being the best bid for whole loan portfolios. This is basically because deposit rates, even in the ultra-competitive fixed term market, have lagged swap rate increases through the hiking cycle (and some banks may be choosing to go unhedged to win share).

What happens on the way down again though? Is it a symmetrical process? 

Deposit rates lag swaps because it’s a less liquid market, but most important to market dynamics is total funding cost, not point in time price comparisons. 

In English — it takes deposit-takers time to turn over their books, especially if they have relied heavily on fixed term or brokered deposits rather than current accounts. Capital markets funders, however, pay Sonia+ on all of their funding and might be able to cut rates quicker once the cycle turns...so will this flip the script when it comes and put securitisation-funded lenders on the front foot again?

Anyway, for all this and more, check out the video, and see you next week!

Silver lining

Commercial real estate valuations are quite a topic these days — as we discussed the other day in relation to The Year’s Only CMBS, asset yields in some parts of the market are materially inside not only debt yields, but also Bank Rate. 

If cap rates adjust to levels that situate CRE somewhere sensible in the investment universe (like, above the risk free rate?) then there has to be a substantial revaluation across huge swathes of commercial property.

That’s on top of the pandemic legacy. Partial WFH is here to stay, and tenants fundamentally don’t need as much office space as they used to. Walk through the City on a Friday and it’s a ghost town.

So we want to figure out how this plays out, who it hurts, and who lent them money on what terms.

In the meantime, we heard some heroic optimism at the S&P Conference. 

A big shakeout in valuations could actually be good for CMBS, goes the argument, because this will bring market values more closely into line with the heavily haircut rating agency valuations.

That takes away one of the major downsides of doing a rated capital markets transaction, rather than relying on bank balance sheet funding or unrated whole loan distribution. No drag from rating agency haircuts means a more efficient tranching structure, lower overall cost of funds, and a CMBS market that’s competitive again.

Turn that frown upside down.