Excess Spread — What’s a CLO manager worth, passports ready, backstops back

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Excess Spread — What’s a CLO manager worth, passports ready, backstops back

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

It’s time

After three years, the market’s finally heading back to Barcelona for IMN/Afme’s Global ABS conference. Despite the difficult conditions, there’s still 4000+ registered, and there’s a tangible anticipation about actually getting out there after all the Covid times. I’ll be there with my colleague Kat Hidalgo, we’ll be sniffing out the good goss and hitting all the good parties.

Say hello if you’re an Excess Spread reader — I look like this:

Owen Sanderson at IMN/Afme’s Global ABS conference

Fingers crossed for no flight trouble, see you next week!

What’s a CLO manager worth?

Last week the long-awaited sale of Alcentra to Franklin Templeton was announced — for a bargain-basement $350m of up-front cash. There’s a $350m earn-out, and a separate process to buy out Alcentra’s seed capital investments, expected to fetch around $305m, but for that low low $350m price, Franklin unit Benefit Street Partners gets 100% control of Alcentra, with its $38bn of AUM.

For a quick and dirty comp, consider Carlyle’s recent purchase of CBAM Partners for $812.9m ($614m in cash and the rest in stock). That brings in $15bn of new CLO assets.

At the time, we said it was tricky to unpick the price, since CBAM might well have owned a bunch of its own equity and debt, but Carlyle has been through a round of quarterly reporting since then, and it doesn’t look like this amounts to much. The acquisition came with $176m of CLO notes (some of it risk retention), with $157m of financing against them, so it doesn’t net out at a very material portion of the $812m deal.

In other words, it’s a pretty clean price for a bunch of CLO management contracts and accompanying platform.

T Rowe Price buying Oak Hill last year is also a valid data point, with a closer mix of assets to Alcentra — Oak Hill has $15bn in CLOs, $18bn in “liquid strategies” (loans, bonds, distressed and securitised products), and $20bn in private markets (private credit, securitisation, distressed, CRE, special sits).

That’s not a million miles away from Alcentra’s $11bn in CLOs, $9bn in private debt, $6.8bn in structured credit, and $11bn in various liquid strategies…..except that T Rowe Price paid $4.2bn to buy Oak Hill ($3.3bn up front+$900m earn-out), rather than $350m+$350m (maybe) for Alcentra.

Oak Hill did seem to have rather more people managing the business…..the investor deck for the acquisition cites 300+, with 100+ investment professionals, against Alcentra’s 180….but that’s not necessarily a good thing. The name of the game is surely managing assets (well) without spending too much on people. It’s also a very different market backdrop from when the Oak Hill deal was agreed, to be fair…shares in BlackRock, to take a listed asset management biz at random, are down 27% between the Oak Hill and Alcentra deals.

It’s probably a good thing for the actual Alcentra team, though — there’s not a huge overlap for Benefit Street, which doesn’t really have a European business. KKR and PGIM were floated as potential buyers earlier in the sale process, and both of these firms already have teams to cover many of the names Alcentra invests in, so job cuts cost synergies would have likely been larger.

Table of Private Debt, Structured Credit, CLOs and Commercial Real Estate

Alcentra is apparently bringing in $60m of operating income, which seems…unspectacular.

Previous owner BNY Mellon didn’t break out Alcentra’s performance in its reporting, but Alcentra had around £60m ($75m) in admin expenses in 2020, according to Companies House, of which most is presumably people.

$11bn in CLO assets ought to bring in $55m of fees, at full fat 15 bps+35 bps levels, $9bn of private debt could be another $70m+….and you’d hope the other $18bn of assets was doing at least 50 bps, for $90m in fees. This is probably an underestimate, if anything — Full fees for structured credit (18% of AUM) are 1.5% (1.25% for commitments over $10m), according to this document, a structured credit pitchbook to the San Bernandino pension fund.

For the old timey structured credit heads out there, this is the pension fund that contributed the equity for Cairn Capital’s Cairn CLO III, which started the CLO 2.0 era in Europe back in 2013, and earned a regulatory rebuke from MEP Sharon Bowles. But I digress.

Should you wish to see an Alcentra private debt pitchbook, here’s one, courtesy of Los Angeles City Employees’ Retirement System, though it doesn’t include a fee. There’s also a bonus Benefit Street pitchbook right after it for compare/contrast purposes.

Anyway, conservatively I make that $55m+$70m+$90m…Round it down to $200m or so for extra conservatism, round the expenses up to an even $100m to be conservative and…..you’re still a long way above $60m in operating income. So what’s going on?

My old shop and others have written a bit about the troubles at Alcentra, and others note the “baggage” — lots of high profile exits, failure to raise the megafunds which other private credit firms have managed — so there are certainly some issues baked into the price.

But we also wonder what it means for the long-heralded “consolidation” of CLO managers. The CBAM sale seemed to suggest more M&A to come, but the Alcentra valuation may serve to widen the potential bid-offer spread for these trades. The new entrants eyeing the market, of which there are plenty (Pemberton, Pimco, M&G, Canyon, Fortress, CQS, etc) may also have pause for thought — what’s the point in ploughing capital in, building a $10bn+ business over many years….and achieving a <6x multiple?

In markets, there’s a bit of general whinging about the lack of available triple-A buyers — but is there an actual lack of triple A demand, or just nobody willing to invest materially inside secondary levels? I’m sure if CLO managers start offering triple-A at 150-160 bps then any “demand” issues will clear themselves up pretty quick. But the dilemma remains the same…a term deal at these levels, with collateral bought in December/January/February is uneconomic.

Permira Credit and Barclays have finally pushed Providus CLO VII over the line. The deal’s been warehousing since late last year, and was marketed in late March. Best part of three months later and it’s finally priced…..a little wider than might have been expected at first.

The senior tranche at 140 bps is wider than any deal since the middle of 2020, though still well inside secondary — Prytania Solutions puts euro AAAs at 153 bps — and down the stack the levels were 240/385/570/875/1150. The double A note is roughly in line with March’s 240-250 IPTs, but the wide end of the March talk down the stack was 340/475/775 at 96 / call desk.

The press release announcing the deal quotes Permira liquid credit head Ariadna Stefanescu saying “this pricing is testament to the strength of the Providus platform and its ability to continue to perform throughout market cycles and volatility”, which I suppose is a positive spin to put on the situation, though any mention of the actual pricing was conspicuous by its absence.

One could argue (we have) that any actually existing deal is a good deal in the current environment— plenty of managers are still grappling with ways to push out their underwater warehouses — and keeping the triple-A anchor in place at a level tighter than secondary is definitely a strong result.

It’s smaller than originally planned, at €344m rather than €400m issue — perhaps a signal that the anchor was still there, but the incremental triple-A buyers doing €20m-€30m tickets were less interested at these levels. TwentyFour Asset Management’s Aza Teeuwen did an excellent blog last week pointing to the value in secondary CLO triple-As….and highlighting the 160 bps spread on Redding Ridge 7. As he says, “AAA CLOs are screaming value among euro denominated assets”…..but that doesn’t necessarily apply to the primary market.

Providus VIII will clearly have an uphill struggle for equity returns at first — unlike Carlyle’s recent print and sprint, this deal likely built up much of its collateral before the sell-off — but it’s a 2NC/5RP structure, so there is at least time for Permira to claw back some performance during the lifetime of the deal.

So should the other managers on the sidelines wait for better times, or go now? Investment grade markets seem to be firming up and supporting supply. The worst of the bleeding in Crossover has stopped, although there’s still plenty of volatility. Markets should, traditionally, reopen with quality and then broaden out to high beta product as recovery takes hold…..but RV is still tricky. Let’s see what Barca brings.

Backstops back alright

With Memorial Day in the US and the UK Platinum Jubilee, there weren’t many proper working days last week, but dealflow was surprisingly decent, with three UK mortgage deals all preplaced. Bank treasuries, as we discussed in the last Excess Spread, are back in force. Citi’s treasury arm is once again taking the 150 bps senior loan note in Together’s CRE deal — as it did in Together’s second lien RMBS the previous week (the latter alongside BNP Paribas). Standard Chartered was a joint lead on Brants Bridge 2022-1 (the name refers to a part of Bracknell) for Paratus and Polaris 2022-2 for Pepper Money, and hasn’t been averse to an anchor investment in the past….though it’s a longstanding member of the bank group for both Paratus and Pepper Money, so its role here probably stems from warehouse financing rather than bond buying.

So who’s next? The other US money center banks have form in European securitised products, but tend to dip in and out. JP Morgan CIO had its moments of greatest glory in the 2009-2011 period as the market reopened, buying prime master trust triple-A in the mid-100s, but it’s been selectively active since. BofA and State Street have done some CLO anchor investments in the recent past. Might we see Wells show up, to support its major buildout in European securitised products banking?

Relatedly, there’s still a few big name hires going through — Citi’s Mark Collier is joining Jefferies as head of European securitisation, adding a senior mortgage guy to the (ex-Citi) CLO operation, and replacing some of the Jefferies bankers that recently headed off to Wells.

Away from the senior tranches, times remain very tough — in the Together deal, 330 bps at 96.8 for a single-A piece of paper, 390 bps at 95.04 for a triple-B, and 600 bps at 96.46 for double-B. Small balance UK CRE is a pretty niche asset class (as is UK second charge), so the audience was never going to be huge, and the few investors could likely name their price — but the underlying loans are paying more than 7%. That means the trade should still work, and more importantly, allows Together to reload for new origination.

Reloading capacity is probably as important as locking in funding levels for some of the deals sneaking through the private market at the moment — originators with long-established warehouses are almost certainly getting better economics from these facilities than they would from a term deal today. But no treasurer wants to be tapped out on capacity and have to pull products, and prudent funding teams likely want to stay on the right side of their banks, who are unlikely to be enthusiastic about holding brimming warehouses at pre-sell off levels for the long term. I’m sure nobody is forced to come to market, but moves in that direction are likely much appreciated.

For the larger lenders, diverse funding avenues ought to be helpful in a time like this. A lender that can do prime, non-conforming, STS and social transactions should be able to pick products to print depending on the relative value and the extent of any pricing pressure.

Unfortunately, the only UK mortgage lender which really fits the bill is Kensington, which has been uncharacteristically absent from the market this year, after last year’s flurry of diverse labelled issuance. That’s probably because the sale process is still running on — and locking in funding at current unattractive levels may not be appreciated by any future owner, whose cost of capital might be well inside market levels.

Pre-placement in sterling RMBS markets is a bit of a curious beast — even a widely distributed public syndication might hit only 20 accounts, so pre-placing instead to the 10 most significant isn’t as much of a change as it might appear. It’s very different from what’s going on in leveraged credit, where a handful of private credit firms are competing to snaffle underwritten LBOs that might have once been sold to 100+ accounts.

But the advantages of execution certainty and face-saving are still present. Price thoughts can be shared bilaterally, and the momentum, or lack thereof, should not bog down execution too much. It’s an open question whether investors are getting paid for coming over the wall and giving issuers this certainty though….if there aren’t any public deals, is secondary a meaningful enough comparison?

Paratus’s Brants Bridge, is a new strategic milestone for the Apollo-owned lender — the first front-book owner-occupied RMBS, non-conforming collateral, but not the beaten-up legacy kind….this is pretty clean as non-conform goes, with no self-cert, no arrears, low CCJs and low LTVs, and this is reflected in the tranching, with 97.5% of the capital structure rated A or higher (88.5% triple-A).

As it was, most tranches were at par or close by, and the deal managed to fit in 3.25% of excess spread notes (the loans are paying 3.7%). Clearly this trade, even at its wider levels, still works too. If any deal is a good deal, perhaps this is better than most at the moment.

Bolt on

Funding Circle’s new agreement with Waterfall Asset Managementannounced in late May, should mean more runway for the UK SME lender’s SBOLT securitisation shelf, despite the substantial changes in the business model for Funding Circle over the past couple of years — there will likely be three or four deals off the back of the two year, £1bn partnership, all sponsored by Waterfall.

It stands as an endorsement for the collateral originated by Funding Circle, despite the tough times experienced by many UK SMEs following the Covid pandemic…the headline figures for defaulted loans look pretty terrifying — 40% of the pool in the defaulted bucket “unadjusted for Covid forbearance” in the case of SBOLT 2019-3.

That, however, reflects Funding Circle’s attempt to provide transparency around its forbearance and arrears process….and not necessarily a transaction that’s in deep trouble. Cashflow is key — all of the PDLs were cleared in 2019-3, including the class ‘Z’, and the X note switched back on again before the deal was called.

Even on the adjusted basis, there’s still a few defaults in the mix, but clearly Waterfall sees the loans as worth having — worth another £1bn commitment — though another pandemic is probably not in the business plan.

Last year and earlier this year, Funding Circle has changed its business model. In April it announced it was permanently closing to retail investment, following a two year Covid-driven pause on taking new money. The firm said that it had been funded by 90000 retail investors since launch in 2010, which was, originally, the core of the business model — in common with other early fintech movers, it was conceived as a loan marketplace, bringing savers and business borrowers together outside the banking system. By the end of last year though, retail was down to 5% of funding.

From relatively early on it was clear that institutional investment would be bigger and more important than the retail flows. KLS Diversified Asset Management, the sponsor of the first Funding Circle securitisation, set up its warehouse with Deutsche Bank in November 2014. Public deals with Pollen Street Capital and….Waterfall followed (the first £1bn deal with Waterfall was struck in 2018).

The shift in Funding Circle’s approach started in 2019, when, flush with cash from its 2018 IPO, it started sponsoring its own securitisations, rather than merely originating loans for third parties as in the past. This coincided with its launch in the US market, a deeper and more developed “marketplace lending” environment.

But now it’s pulled back again from sponsoring its own transactions — the new Waterfall deal will be sole Waterfall trades, rather than co-sponsored or Funding Circle deals. During the peak pandemic period, Funding Circle also pivoted successfully to become one of the largest originators of CBILS (UK government guaranteed) loans, working with funds including Chenavari and Sixth Street to write these loans. It’s also been writing government-backed loans under the Recovery Loan Scheme.

Both of these guarantee mechanisms are administered by the British Business Bank, which has its own particular rules to layer on top of standard securitisation legals. For one thing, public term deals are prohibited — securitisation must be in private. For another, Funding Circle has to keep 1% of the risk….as well as the equity investor keeping the usual 5% for securitisation risk retention. Public disclosure is also severely limited, forcing yours truly to go digging around in Companies House to trace the financings.

Also in the UK SME space, MarketFinance, which focuses more on invoice finance, said it had signed a £100m facility with Deutsche Bank. It’s not clear from the release whether there’s third party equity involved as well — a previous facility for MarketFinance seems to be sponsored by Varde Partners, with senior funding from Intesa’s conduit — nor whether this will eventually come out as a term deal. But securitisation people aren’t ever far away from the fintech lenders….MarketFinance’s capital markets head is former Morgan Stanley ABS syndicate banker Marion Delille.

Once more into the courtroom

I’m lucky enough, at this point, to get a fair bit of inbound Rizwan-related correspondence — and a delighted lawyer told me a month or so back that the officers of the law had finally caught up with Rizwan Hussain and put him away, per the judge’s order of a 24 month prison sentence for contempt of court relating to the Business Mortgage Finance transactions.

However, wires seem to be crossed somewhere — per the latest release from the BMF issuers, “the Issuer understands that Mr Hussain remains at large”.

He was sentenced in March, but one can assume that he’s a low priority target for a nationwide man-hunt…..he files a lot of lawsuits and annoys a lot of people, but he’s not actually much of a physical threat.

Anyway, he’s going back to court, somehow — appeals filed on his behalf shortly after the sanction will be heard in the Court of Appeal from July 5-7. We don’t pretend to be experts on the legal technicalities, but the judge in his contempt hearing took a pretty dim view of Rizwan’s failure to show up in person for that (leading to the issue of a “Bench Warrant” for his arrest”), and we think the court is unlikely to smile on another no-show in July.

The unfortunate BMF bondholders have also had to swallow the insult of a ratings downgrade, as well as the injury of the Rizwan case — Fitch downgraded five tranches at the end of May, as “the transactions’ senior expenses have increased considerably, mainly due to legal fees and Libor transition costs”.

The agency is, uh, cautiously optimistic on the end of the Rizwan saga, noting that “the other legal fees are related to a litigation that is unlikely to exposure the issuer to substantial costs in the long term. However there is no certainty about when this exceptional level of legal expenses will taper off”.

Assuming the appeal fails and the tipstaff eventually catches up with Rizwan, the BMF bondholders will have done the rest of the market a solid — there’s no real mechanism to share the burden more widely across securitisation investors, but buy them a beer at least.

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