Market Wrap

Excess Spread — Will you buy what Apollo is selling?, Primetime, stuttering

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

Will you buy what Apollo’s selling?

Congratulations to the bankers in Credit Suisse’s securitised products group, shortly to become unmoored from the doofuses who lent billions to Bill Hwang and Lex Greensill. The Swiss bank announced on Thursday morning that it had agreed the sale of the unit to a consortium of Apollo and Pimco, who beat Centerbridge / Martello Re in the final round. We understand that the contest went down to the wire, with both parties in the running as of COB on Wednesday.

But Apollo and Pimco it is!

Both firms need no introduction, and we’ve written a fair bit about their activities here (mostly it simplifies down to “they’re buying EVERYTHING”). Credit Suisse SPG (I don’t think the bidders have gotten around to renaming the unit yet) has a good amount of everything that can be financed in securitised or secured format, so the purchase is a great way to bump up those AUM numbers.

AUM, though, is unlikely to be the only play. Credit Suisse’s release doesn’t give much detail on the pricing of the sale (or the balance sheet of SPG), but no matter….the basic point is that if Apollo or Pimco just wanted the assets in the business, they could have quite readily called CS and asked them. Credit Suisse was very much in the business of selling assets to the likes of Apollo and Pimco. But Apollo and Pimco are not just buying the assets, they’re buying the teams and the systems too, all of which are set up basically to do intermediation.

So the buyers either embark on a massively value-destroying conversion from intermediary to asset gathering….or they’re going to be in much the same business of profitable recycling of risk that Credit Suisse was in.

Sounds good right? But how much does it matter who’s selling you something?

Obviously we don’t have access to Credit Suisse’s securitisation client list, but quite a few of them are direct competitors to Apollo, Pimco or both.

Apollo has lately been pitching itself more as a financing partner than a PE shop, trumpeting the giant cheques it has written to the likes of SoftBank during its investor calls. But….it’s still very much a PE shop too. Both institutions are sufficiently large and diversified that they’ve got pockets in almost every part of the capital market…..sponsors, financing partners, distressed funds, real estate funds, leverage providers, NPL buyers, credit opps, loan funds, you name it. The only part of the value chain yet to be covered is…the investment banks that sit in the middle of it all, and that’s what’s changing now.

The worry for the existing CS clients is likely to be the mother of all negative selection issues - the risk that ApoLimco Securities LLC does decide to sell on, is the risk that neither mothership wants to buy itself. Clients may be concerned that the dealflow left to the rest of the market is whatever’s left after some epic cherrypicking from some of the deepest pockets out there.

Hopefully the CS team will find a way to offer reassurance on the way to their new home….but either way it’s an epic experiment in reshaping the securitised products industry. Good luck!

Capital when you need it

We hadn’t clocked until this week that Klarna, the poster child for the Buy Now Pay Later revolution in Europe, has been active in the SRT market, placing what must be the first and almost certainly the only trade referencing this asset class.

Credit where it’s due to Structured Credit Investor, which reported on this deal back in June — and sure enough, you can discern the footprints of securitisation in Klarna Bank AB’s June 2022 disclosures.

There is, for example, SEK1bn of standardized approach securitisation exposure, requiring minimum capital of SEK82m, newly added to the firm’s balance sheet in the past six months. That doesn’t signal a huge deal, but it’s not nothing.

In some ways BNPL is the perfect SRT asset class — relatively high risk (high capital intensity) assets, which may not incorporate any excess spread, because they are often 0% loans.

The BNPL platform makes its money on the retailer fees charged, which give a separate income stream — so for cash BNPL ABS, the way to inject some spread into the deal is to sell the assets at a discount. Most unsecured consumer credit products work best as a cash deal, because the credit support from the excess spread protects the residual notes from losses.

SRT deals, though, face severe limitations on the use of “synthetic excess spread” (the regulation is complex and evolving, but PCS has a pretty lucid look at recent developments), so if there’s a cash transaction to be had in high interest products, the economics generally look better. That does not necessarily work where the loans pay 0% but have similar credit risk….and hence the benefit for SRT.

BNPL originations are also generally short-dated, limiting their utility in term ABS transactions - bank lines can be much more flexible about revolving and replenishment than rated term structures…..but SRT can be just as flexible (look at the StanChart trade finance deals!).

For Klarna, there’s a particularly important angle — the firm’s access to capital. In July 2022 it closed a new $800m capital raise…healthy enough market access, one might think — but at a valuation of $6.7bn post-money. This was a “down round” on an epic scale. The company’s previous funding round in June 2021 valued it at $45.6bn, a truly stupendous figure reflecting the exuberance of 2021 “tech”. That means access to non-dilutive capital is exactly the sort of thing the firm needs.

Of course, this only really works because Klarna is a bank — SRT transactions are a function of bank capital regulation — so it’s unlikely to herald the birth of a giant new asset class. Most of the BNPL platforms are still non-banks, so more likely to use cash ABS or sell on their portfolios.

BNPL or point of sale financing is, however, an area of expansion for the big banks. Barclays, for example, has been ramping up its “Barclays Partner Finance” division, which already gave us one cash securitisation this year, Pavillion Point of Sale 2021-1A (held over from late last year).

The more that BNPL sits with banks, especially big shops with pre-existing SRT programmes…..the more this asset class might come out in SRT form.

Nobody has any money

The primary leveraged credit market hasn’t exactly been running hot, but the few transactions which have come out contain some interesting hints about the state of the CLO market, now we’re the best part of a year out from the last round of refinancings.

First up, Fedrigoni, which priced last week — the deal was a partial secondary LBO, financing BC Partners’ investment into the Italian paper and label manufacturer alongside existing sponsor Bain. As such, there was a big capital structure in place, with a ton of CLOs in the outstanding floating rate tranche (Italian borrowers can’t really do TLBs for tax reasons).

The unusual part was a “cashless roll” from the old FRNs into the new issue, which may have had a dual purpose. First off, it means no lag in settlement at the expense of the investors (CLOs have to block out the new bonds once priced, prior to settlement and prior to repayment of the old bonds).

Perhaps more importantly, it may have allowed some CLOs which were out of reinvestment period to play the new issue. It’s not a slam dunk — reinvestment language does pretty explicitly bar new investments, for obvious reasons, so the cashless roll may have been threading a tight needle — but if it helps any incremental demand to come in at the cost of an extra documentary tweak, it’s probably worth it.

It underlines the difficulties in a leveraged finance market that’s largely dependent on outstanding transactions, rather than new issue CLOs. The nature of the CLO structure encourages managers to stay fully invested (they have liability stacks to support and cash doesn’t help). Coupons flow straight through the structure, and there aren’t very many loan refinancings at the moment. Add to that the increasing numbers of deals passing reinvestment, and there’s simply not much wiggle room in the CLO universe.

The second notable item is the Ineos refinancing transaction, announced this week. The UK-based chemicals group is a big capital structure with a big following. By numbers, it has €3.8bn in Ebitda and €8.2bn in net debt, and Fitch data suggests nearly 80% of European CLOs have some. Other Ineos complex credits are also well represented, with Quattro at 71% and Enterprises 55%.

The new deal is to push out its 2024 maturities to 2027, through a €1.15bn dollar and euro loan, handily timed to market off the Q3 Ineos numbers this week.

Doubtless it will be well supported, but the illustrative part, we think, is that the borrower is not going for a fully fledged seven year TLB refi, as it has in happier times. Seven years is pretty much the leveraged loan standard unless you have a good reason to do otherwise.

One good reason might be the increasing number of its existing lenders falling out of reinvestment periods and eyeing up WAL test constraints. Fine to do a longer deal for a CLO with a path to reset; not so much in the present condition.

Five years rather than seven probably isn’t a huge give for Ineos; it’s a double-B with a commanding market position, not some desperately clinging on B3 trying to justify its existence, so it can probably roll its debt pretty much whenever. But it does illustrate the difficulties of doing deals against a backdrop of no cash.

That said, there are new issue CLO transactions stuttering their way to market — we didn’t discuss the Axa Investment Management static deal (Adagio X) last week, but this week of greater stability has also brought Barings 2022-1 to market via Goldman Sachs (the discount margins modestly veiled), and could finish off with further transactions…..Oaktree and CQS are also in market, perhaps closing as soon as this week.

These represent several species of CLO new issue — Adagio X was a static deal, though probably, like Sound Point IX, not originally conceived as such. The vehicle dates from November 2021, so presumably started life as a fully fledged longer WAL deal. Switching to static cuts the equity cheque, though there’s an unusual structure in place here…€14.7m of true sub, with €13.85m of “deferrable FRN” class Z sitting underneath the class ‘F’.

Barings is also a well-seasoned portfolio (a vehicle created in December 2021, and as the name suggests, the first transaction this year from one of the market’s largest managers). It’s another ultra-short deal, with a one year non-call and one year reinvestment period, just like Cross Ocean’s Bosphorus VII a couple of weeks ago, and supported, like many recent trades, with a hefty loan note in the senior.

There’s an unusual approach to the fixed rate hedging in the portfolio, with fixed tranches in the triple A and double A. The “CLO classic” structure generally includes only a double A fixed tranche, though this has been a slightly orphaned tranche of late, with a small and dwindling buyer base. If there’s incremental demand for fixed seniors, though, that’s got to help other trades over the line….the Barings A-2 note is only €15m, but every little helps.

A hefty slug of bonds is also perhaps more appealing than ever in a CLO portfolio, as so much more of the duration risk is now priced in. The loan-bond switches many managers were putting on in March and April aren’t looking quite so hot right now; bonds have stubbornly not bounced back. So perhaps right about now is a better entry point.

We understand that, despite the hard times, interest in opening warehouses remains strong, with equity investors getting plenty of inbound. The attitude of banks is said to be more mixed….some institutions are happy to quote, but also happy not to be chosen, while others are still in fully fledged competition mode.

That’s not necessarily because managers see a clear path to a lucrative exit….but if they can find some equity capital, this gives them optionality. An empty warehouse and a ready arranger makes a “print and jog” deal possible, if the market supports it; some spare capacity means managers can selectively lift assets where they see value, even if most of their vehicles are fully invested.

We need to do some more work on just how many facilities are being opened at the moment…..perhaps the issue is not “nobody has any money”, but more that the CLO money which has been raised (in warehouse form) is being highly selective and price sensitive.


Times have been hard in RMBS, with extension risk back on the table, and the massive overhang from the LDI selloff still weighing on pricing in the UK market. But that doesn’t mean deals are all off the table — arranger Bank of America steered Clydesdale/Virgin Money’s Lanark 2022-2 across the line early this week.

This is not a slamdunk signal that everything is right in the world — the placed size of £400m is not large, it’s a prime master trust STS deal with no mezz on offer, and it was announced 1.3x done, so a certain amount of derisking had clearly happened before Monday’s announcement.

But look closer, and there are some genuinely encouraging signals. Bank treasuries, a capital pool unafflicted by the LDI unwind, took 69% of the book — but that means 31% went to asset managers. Given the limited pool of sterling senior investors, this almost certainly means some of funds seen dumping their LDI portfolios have been back in the game here.

That doesn’t mean the LDI fallout is over — large UK real money firms like Insight, Schroders, or M&G have multiple pockets to buy bonds, and shortish STS eligible prime is a decent place for parking a bit of cash. If anything, the scale of the selloff is likely to have scared some of the ultimate capital providers, with ABS once again being a victim of its own success….high cash price bonds are the first positions to dump at a time like this.

The Lanark deal was also increased from an original deal size of £300m to £400m in placed notes (£400m retained), and was still 2.1x done at £400m. Spreads came in nicely from the 85 bps area guidance to price at 82 — that’s a signal that the anchor+public approach worked rather nicely, with the basic trade de-risked but some extra price tension from going public.

Not so Brass No. 11, announced on September 22 (the day before the mini-budget), pulled September 28, and priced as a fully retained issue on October 13. The A1 coupon was 75 bps for a three year bond, a level which is still slightly through the market had it been placed — Brass, as a standalone deal should price wider than Lanark’s master trust issue.

The trouble with prime is simply that there’s not very much of it. UK banks and builders do want to do some funding (preferably longer dated to smooth out the withdrawal of central bank support), but don’t have a huge liquidity need, and mostly ample access to covered bonds or other funding tools. Perhaps there’s another trade before year end, a smattering in January…..but the industry can’t live on prime alone.

Diversity training

Diversity metrics in CLOs are an illustration of the basic tension in CLO investing.

They’re kind of the heart of the product — a big part of the reason why CLO structures deliver efficient leverage is because the collateral comes from different industries with different drivers, and is unlikely to default all at once. When CLO market participants bristle at the comparison to pre-GFC CDOs of ABS, diversity of collateral is what fuels the righteous anger. It’s not just levered exposure to the same stuff over and over again, it’s levered exposure to pretty much the whole real economy.

But in practice, the diversity constraints can be very annoying!

Here’s some CLO boilerplate from a Bain Capital deal: “Although the resulting diversification of Collateral may reduce the risk described above, the diversification requirements applicable to the Issuer may cause the Issuer to invest in obligors or industries that suffer more defaults than if the Issuer were not required to invest in a diversified portfolio.”

The need to keep up the diversity means managers buy loans they don’t want from companies they don’t believe in. They might be monitoring more names than they have bandwidth for, or lending to second tier credits to plump up the score. Equity investors generally prefer managers to play to their strengths and invest with conviction rather than scattergun the whole market for expensive levered loan index beta.

Debt investors might care slightly less, but still focus heavily on manager style and differentiation. The European loan market remains small, CLO holdings overlap is high, and almost everyone has a piece of the biggest capital structures. Diversity scoring isn’t the only reason behind the overlap, but it doesn’t help either.

The situation is also getting worse — more restrictive — as leveraged loan primary has more or less dried up. New money LBO financings, such as there are, are going to relationship banks and to private credit instead of into the CLO universe.

According to the BofA research team, almost 5% of deals are now breaching their Moody’s diversity score tests. This is below last year’s level, but has been increasing quite sharply….and pre-pandemic, less than 1% of deals were failing this test.

Per the team “in times of market stress, CLO managers have to be highly selective in what loans they purchase. Considerations like credit quality, outlook, liquidity, rating, etc. are considered more important than industry usually. As a result, collateral pool diversity can decline.

Second, regarding test failures this year only, leveraged loan supply has been weak in 2022, so CLO managers have a small range only of deals in the primary to choose from.”

Ready for Rishi (to securitise)

UK politics has felt like a torrent of headlines aimed directly into your brain these past few weeks. Now, with the third prime minister in 50 days, there’s a chance of some stability. That’s helped UK assets, be it currency, rates, or the aforementioned Lanark 2022-2 RMBS.

Perhaps it also means there’s a chance to use securitisation to get smart about the problems faced by the country. One of the few policies passed by the late and unlamented Truss government was the consumer energy price cap, limiting the costs of consumer bills to £2.5k per year. As has been abundantly noted since then, this open-ended commitment could be stunningly expensive, and provides little incentive for actually curbing energy use. It was, in short, a big dumb panic response from a government that left it all much too late.

Securitisation potentially lets government be much smarter about energy bills. As we’ve noted in these pages before, “tariff deficit” schemes like Spain’s FADE or Portugal’s Volta allow extreme energy costs to be spread across future consumer bills, taking the pain off the government balance sheet (and out of the forecast Gilts issuance). That might clear some fiscal headroom to support actual demand mitigation…household insulation, double-glazing, efficient boilers and the rest. The best way to deal with demand issues is make British homes warmer, not just hope that everyone feels too poor or too guilty to heat them.

But all this requires thinking more than one move ahead — and a government with some direction, purpose and stability. No point pitching this to a Chancellor that’s not going to last out the month.

New Chancellor Jeremy Hunt has pushed back the “Halloween plan” and upgraded it to an autumn statement (mini-budgets being presumably too toxic)….nothing has leaked about it at the time of writing, but the energy price cap is a big fat line item that’s ripe for a rethink.

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