Excess Spread — Where house, point and shoot, breaking barriers

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Excess Spread — Where house, point and shoot, breaking barriers

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

Weighing anchor

Last week, we were heads down in a monster piece about CLO docs and A&E requests, though it’s written more for the levfin dilettante than the hardcore structured credit heads that read Excess Spread.

That meant we’re only just catching up to the news about the BirchLane Capital CLO warehouses. I believe this was first broken by CapitalStructure and followed by Bloomberg, so credit where it’s due, though both are ungoogleable.

Basically, BirchLane Capital was a hedge fund set up by Fajr Bouguettaya, of former JP Morgan fame (he ran ABS/CLO trading, as well as correlation trading), in 2020, with seed capital from CPPIB (reportedly $300m).

Shortly afterwards, it appears to have gone hard into the CLO warehouse equity game.

According to recent reporting, it had five slices of warehouse equity, plus also equity in HPS’s latest deal Aqueduct 2022-7. So six warehouse equity positions, call it €40m+ a time…assuming no fund-level leverage, that’s a pretty big piece of the $300m seed.

Warehouse equity is quite a specialist gig. As one former practitioner put it, “done right, it’s free money”, but “done right” is doing quite a lot of work in that sentence. It’s shorter WAL and less levered than term CLO equity, with exposure to better quality portfolios (managers tend to fill their warehouses with the decent stuff, as it’s their shop window when it comes to execution). But it can also create a lot of cash drag, and you are more exposed to execution conditions in the CLO market and the loan market backdrop. Warehouses have shorter terms and step-ups, so you can’t just sit tight indefinitely if the market’s not there for a takeout.

Anyway, it’s not clear whether BirchLane had intended to run an exclusively warehouse strategy, or roll over into the term deals it had staked, but funding 2021 warehouses for 2022 takeouts was not a particularly successful strategy. According to Bloomberg, the fund “gained about 5% annually although suffered a low single-digit loss this year”, which is not great on a risk-adjusted basis.

As of October 2022, it was over — CPPIB pulled out, leaving the CLOs where BirchLane funded the warehouse stranded. This week, it emerged that Anchorage Capital will be taking over five of the positions, seemingly at the behest of CPPIB itself, which is also an LP in Anchorage.

That is, rather than auction off either the assets in the warehouse, or a package of warehouse equity to go, CPPIB seems to have orchestrated a direct takeover.

One might wonder on what terms this was agreed; Anchorage is not known for being an especially cuddly counterparty when faced with a motivated seller. One might also wonder whether other CPPIB-linked funds were shown the assets; AlbaCore, to name just one, has a lot of money (and a senior leadership team) from CPPIB, plus an active and high-performing European CLO franchise.

We’ve heard Anchorage has quickly turned around to sell some of these assets off…

There were a couple of small loan BWICs at the back end of last week, with a CLO-esque scent to them (newish collateral in round lots of fairly even size, high quality names). The amounts seem small to us, however, with one list of €67m and one of €29m — more like a recent vintage low-ramped warehouse than something that’s been hanging around since 2021 and probably ramped in the good times.

Perhaps this was always the plan, and CPPIB was simply enlisting Anchorage to manage the unwinds?

Managers and warehouse equity should be a partnership based on mutual trust and aligned interests, but being stuck thanks to the difficulties of a fund should be a salutary lesson for those trying to pick a partner — it’s not enough to look at individual credentials, you need to be sure that your warehouse equity provider will exist a year or two hence. You need to understand their LPs, their motivations, and overall fund performance.

The deals in question were for RBC (BlueBay)Angelo Gordon, Cairn Capital (now Polus), Sculptor Capital, and Acer Tree Investment Management. These may not be giant Blackstone and Carlyle-type shops, but they’re pretty serious players with a track record, and some ability to bring their own equity. Acer Tree, admittedly, is a new manager with only one term deal under its belt, but the fund’s management team launched and ran the CVC Cordatus platform, so they’re not exactly neophytes.

So did BirchLane elbow its way in through price or terms? The experience of these managers will make it harder for startup funds to get into the warehouse equity game at all. If you’re a manager doing a deal every nine months or so, why would you blow up your year’s primary activities partnering with a newcomer fund that might not be there when the time comes?

HPS Investment Partners’ Aqueduct 2022-7 we think is worth returning to, because it’s a deal that’s been on a few adventures.

It was originally a deal done with BirchLane equity, though as we saw last June, it dropped out of RP in the middle of the year.

By the time it resurfaced in 2023, manager HPS was in the equity, and, more mysteriously, the average purchase price of the portfolio had dropped from the somewhat off-market levels suggestive of a 2021 warehouse to the more plausible low-90s levels of newly ramped portfolio.

The sub notes are listed on the Vienna Stock Exchange, and a notice emerged there which might shed some light on what happened to the eight points or so that went missing.

Pursuant to the terms of an amendment deed entered into between, among others, HPS Investment Partners CLO (UK) LLP and the Issuer dated 13 January 2023, certain amendments have been made to the warehouse deed dated 16 September 2021 to adjust the allocation and calculation of realised and unrealised gains and losses

It’s silent on what kind of adjustments, but it could plausibly be a way to push those losses back to the original warehouse equity (i.e. BirchLane) rather than carry them forwards.

Breaking barriers

The year’s strong opening in credit has had several salutary effects on CLO primary, of which the most significant is triple-A prints absolutely smashing through the 200 bps barrier. GoldenTree and Partners Group, issuing at the back end of last week, both managed 185 bps at the senior level. That’s formed the new starting level for the deals announced this week, so we may be heading tighter still.

Unfortunately, CLO markets are chronically behind everything else in credit, particularly actual CLO collateral. High yield has been on a tear in January, as have leveraged loans.

My colleague Chris Haffenden thinks this is overdone, but as an old restructuring hand, there’s always a bear market around the corner…

Anyway, the point remains that CLOs being rather slow to follow the everything rally mean that arbitrage is still not necessarily in a healthy place.

For much of last year, as spreads went wider, the chicken-and-egg dance between CLOs and loan spreads pointed towards doing low-ramped deals; better to buy cheaper loans later after locking the liabilities. In a rally, the calculation reverses, but the actual warehouses in a position to come to market are only around 20% ramped. As we flagged a couple of weeks back, all the conditions are in place for a technical squeeze on the more savoury parts of the loan market as these CLO vehicles step on the gas between pricing and settlement.

But most encouraging is the fact that the deals coming through the market have decent room to run — they’re full fat 1.5 non-call / 4.5 reinvestment period structures which give the manager some opportunity to navigate the cycle ahead, and, y’know, actually do active portfolio management.

As such, let’s not get too hung up on the purchase price / ramped % situation. That sets the tone for the first IPD or two but by the time 2027 rolls around, these deals will still be well in RP and will look very different.

The shortening of primary deals in the back end of last year was driven in large part from the senior part of the cap stack — the few senior buyers that could be found had already the rest of their portfolios extended beyond their expectations at pricing, so perhaps were in no mood to give lengthy runways at new issue.

As we discussed last week, courtesy of Michael Schweitz’s excellent piece, senior buyers have arguably given away an option which may not be priced properly; maybe last year was when they were in a position to assert themselves.

To follow up on the discussion of equity call options though — an erudite reader points out that CLO seniors have consistently traded wider than every other triple-A product

Govvies, covered bonds etc tend not to have any optionality baked in, and trade the tightest. RMBS and ABS do have calls in place, but strong incentives, both economic and social, to hit the first call. CLO seniors trade wider than both, but it’s not an issue of credit risk, so perhaps it is just the option value given to equity. That’s exactly what senior investors are harvesting buying cheap triple-A!

Anyway, as underscored by the rapid tightening on triple-A, the pendulum has swung back the other way, and it may no longer be practical for anchor investors to insist on getting their money back fast. Longer deals ahoy!

Point and shoot

We didn’t give Goldman’s Parkmore Point RMBS 2022-1 the airtime it deserved over in the autumn, perhaps because the first part of the sale closed pretty much as Kwasi Kwarteng was dropping his mini-Budget bomb on the market.

But it’s a pretty interesting trade, consisting as it does of some of the UK’s more complex mortgage credits. The portfolio originates in a packaged sale from Kensington, called Project Hammer which closed in August 2021.

Goldman teamed up with an undisclosed challenger bank and won the bidding for the book, which consisted of loans previously securitized in RMS 29, 30 and 31 (all called in 2021).

The pair then split the portfolio, with the challenger taking the cleaner end and Goldman taking loans which didn’t suit regulated bank criteria.

Our top picks for acquisitive challengers would be OneSavings Bank or Starling, both of which have been active portfolio buyers in the time period, though we’re not sure anything they’ve disclosed quite matches the size and profile of these assets.

OSB disclosed that it bought a £55m portfolio of UK residential mortgages in 2021 “at a discount to current balances”. Starling didn’t recognise anything this large in 2021, but did announce (on p172 of its annual report) that it spent £514.2m on “a closed portfolio of mortgage loans” in April 2022.

That’s quite a decent ticket, though the timing doesn’t really fit with the Koala portfolio. Perhaps the mystery will remain mysterious.

Anyway, this left Goldman with a fairly credit intensive portfolio to exit — 77% IOs, 62% in 3m+ arrears, 30% >1 county court judgement, that kind of vibe.

On the other hand, at least most of the portfolio is on floating rate! Front book lenders with lots of fixed rate found the interaction between 2021 origination rates and 2022 exit levels somewhat painful; this portfolio is somewhat protected, though wider credit spreads still make for a less efficient structure.

The exit strategy here has certainly been buffeted by market conditions. The equity marketing process through August and September held together, despite the sharp deterioration at the end of the month. But the market was far from ideal for placing the debt tranches — even Yorkshire Building Society’s super-clean prime RMBS Brass No. 11 decided discretion was the better part of valour in the autumn.

But things are looking firmer now, and the debt placement is pushing ahead. This deal is some way off generic non-conforming levels, with IPTs at mid-200s/mid-300s/mid-high 400s / 600 bps down the stack for A/B/C/D.

When poking around Parkmore Point, we also came across a Koala-themed financing, Eucalyptus Mortgages 2022. The sale processes for Kensington last year (and in 2014!) were both dubbed Project Koala, so evidently someone there appreciates a cuddly marsupial.

Eucalyptus looks very much like an unrated securitisation, with some £235m of 144A/Reg S class A notes listed on TISE. Goldman appears to be a “consultant” to it, based on Companies House disclosure.

Tracing it back through the Kensington Group disclosures, Eucalyptus bought everything that was in “Koala Warehouse Limited”, some time in March 2022. At that point, this included residual notes in Gemgarto 2018-1, Finsbury Square 2019-2, Finsbury Square 2019-3 and Finsbury Square 2020-1.

The first two deals have already been called, and the latter two are up for call this year, in March and September respectively. Pimco was definitely down to take the Kensington back book — perhaps Eucalyptus is one of the vehicles through which it’s happening.

Barbell

Consolidation in CLO managers appears to be ramping up, though admittedly led mostly by the US.

Sound Point’s takeover of Assured Investment Management, itself having absorbed BlueMountain Investment Management, has transatlantic implications; Blackstone’s takeover of AIG Credit Management and Investcorp’s acquisition of Marble Point rather less so.

Exercise for the reader — given the US leveraged finance markets / CLO outstanding are roughly 4.5x Europe, but the number of managers is 2x, how much more M&A activity should you expect to see in US vs European CLO markets?

The basic costs for a CLO manager are paying credit analysts (and giving them helpful things like 9fin subscriptions), so this should scale with the size of the leveraged finance markets, raising the breakeven deal count. If you need four or so deals to pay your European analysts, then 15+ is the sweet spot for the US. Perhaps that’s sufficient to explain the manager count / size disparity alone.

It’s striking that this acquisition activity is once again focused on established large cap platforms. CLO manager M&A is not sweeping up the long tail of smaller managers; it is making the market’s monsters larger still.

According to Bank of America, the top 10 managers now account for 41% of CLO assets under management in Europe.

Larger platforms may not be as nimble as the small shops; especially in Europe, the loan market simply isn’t large enough to diversify much if you’re running >10bn.

But you can be more relevant to sponsors, get more early-birds, better allocations, and so forth. Size helps redress the power imbalance between the giant sponsors with fingers in every alternative asset pie and their lenders (though in many cases, the lenders are just arms of those same sponsors…).

More activity of this kind will tend to hollow out the mid-tier of CLO management. There’ll be a few giant players at the top of the tree, and startups at the bottom (consider the huge list of debuts slated for the European market in 2023) and really not very much in the middle.

Perhaps a synthesis, though, is medium-sized shops backed up by serious capital and embedded into larger organizations. Sharing organizational costs across a large investing operation should lower the break-even deal count, and raise profitability for the mid-tier; firm relationships with committed equity providers that won’t pack up overnight means more runway for the midcaps.

Green Shoots

The most interesting and lucrative parts of consumer securitisation over the last few years have tending to be in fintech or alternative lending platforms, and growth in this sector tends to be a good forward indicator of revenues in securitised products divisions and issuance volumes and diversity down the road.

With that in mind, a recent flowering of press releases bodes very well!

First up we’ve got a payroll lending facility for Salary Finance, with Atalaya Capital Management and JP Morganfor a very healthy and securitisable £300m. Then we have LiveMore Capital, a later life mortgage lending offering retirement interest-only mortgages, a relatively spicy product, doing £250m with Citi. Let us not forget tech subscriptions platform Rayloraising £110m from Quilam Capital and NatWest. It’s described as a debt facility, so perhaps this is mezz and senior respectively. We’ve also had Channel Capital doing mezz for Swiss SME receivables-backed platform TP24. Unfortunately it’s not clear which facility this sits underneath. Apparently it raised a $200m-equivalent debt package at some point prior to 2022, and given that it’s Credit Suisse-backed at an equity level, CS might be a plausible place to start.

Volume of press releases <> volume of securitisation financing, but there’s some exciting stuff in here which should help fuel the market down the road. Apologies for the brevity; short week as I’m off to the Alps.

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