Market Wrap

Excess Spread - a new dawn for CRE finance, do we need NoChu back, even more BNPLs

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

A new dawn for CRE finance?

The idea around here is not to do pure deal coverage — except when there’s something pretty special out there, and this week there very much is — Europe’s first Commercial Real Estate (CRE) CLO since 2008, potentially heralding a big step forward in CRE capital markets financing and mid-market CRE lending. 

Most CMBS in Europe these days is pretty uninspirational stuff — vanilla assets with low LTVs, often (but not always) sponsored by Blackstone. Last year was admittedly a particular low, but the giant PE shop’s buildout of its Mileway logistics platform was pretty much the only thing keeping the market on life support, instead of totally dead.

But Starz Mortgage Capital 2021-1, which Credit Suisse has been marketing this week,  is a different beast entirely. It’s a CRE CLO, the first seen in Europe since before 2008 (though it’s a vast market in the US), and could herald the emergence of an increasingly important new asset class (some five or six other deals are said to be ramping).

The loans in the deal fills the gap between small balance CRE loans, provided in the normal course of business by bank branches (and a few specialists, like Finance Ireland and Together Money), and large institutional loans, of the sort which might be packaged into CMBS deals or leveraged privately using loan-on-loan structures.

The largest loan in the Starz deal is £38m, for example — a big cheque for a commercial banking business but too small for many investment banks or institutional CRE debt funds to bother with. A loan-on-loan financing would be even smaller, of course, perhaps too small to get on the radar of an investment bank.

Collecting nine loans together, however, as in the Starz deal, gives a transaction large enough to fund in the capital markets, opening the door to cheaper leverage for specialist debt originators, like Starz, serving the mid-market — where spreads are juicier than in prime large ticket lending.

In the US, where the market is on course for a $40bn year, according to JP Morgan research, most CRE CLOs are actively managed, often with a revolving period where loans can be added or removed from the pool.

Starz Mortgage Capital 2021-1 is static, cutting down on the learning curve for the European investor base, but the deal still gives Starz more flexibility in managing loans if they go bad than is typical with a standard CMBS — where powers are often limited before loans are transferred to special servicing. 

Capital markets CRE financing in Europe has been so dead not because there’s not a lot of CRE financing to do, but because of the confluence of regulation and culture. An awful lot of CRE lending is still handled by commercial bank balance sheets, and never touches the market, but even where large CRE loans are sold into institutions, this is often in whole loan or club format, since that’s more appealing than the capital treatment of securitized tranches. These institutional lenders may then raise further leverage in loan-on-loan financing, rather than pooling loans, securitizing and selling bonds.

That’s harder to do for smaller loans, and a capital markets solution may also give better terms — let’s see where CS lands with this.

It won’t be easy though. The Starz deal is heavy on the credit work and complexity, with nine different loans in two currencies secured by 17 properties, all with their own idiosyncratic business plans, prospects, and sponsors. The deal also spans sub-asset classes, with retail, hotels, offices, industrials and multifamily all represented in a deal that only totals £186m. Even the securitisation element isn’t simple, with two separate waterfalls for the publicly offered sterling portion and the smaller preplaced euros, coming together in the junior mezz and sub notes Starz will retain.

Put all this together, and it seems unlikely that the deal will find a huge audience in Europe — the already limited sterling CMBS buyer base may be further trimmed by the newness of the CRE CLO format in Europe, and the difficulty of the credit work, though offering it publicly plants a flag in a way that a club deal never could.

The deal does, however, come with 144A docs, so may prove attractive to US buyers familiar with the asset class and seeking a bit of pickup to their home market.

Starz itself is a bit of an unknown — it has only been running since 2018 — but comes with heavyweight backing. It’s a portfolio company of Sightway Capital (contributing the ST to the name) itself the private equity arm of giant quant hedge fund Two Sigma. The “Arz” comes from chief executive David Arzi, the former head of Marathon Asset Management’s European CRE efforts, and working alongside him are two former senior members of Deutsche Bank’s European CRE team.

Starz Mortgage Capital 2021-1 is also of particular interest to your correspondent because it finances Brixton Market, an old stomping ground, which Kroll described in its presale as “below-average condition overall but in line with the condition of other retail properties in the area”. My south London pride was slightly irked but it’s not wrong, exactly, despite the increasing bougie set which patronise the market. 

Some years ago a few locals protested the gentrification of Brixton Market, chanting “Yuppies Out” and targeting boutique “Champagne + Fromage” with a protest movement eating Dairy Lea and drinking White Lightning cider (a favourite tipple of the down-at-heel). Angry locals were not mentioned as a risk factor for the Angelo Gordon-owned property, so presumably the battle against gentrification is now lost in the area, clearing the way for a smooth execution. No doubt the Brixton locals would be delighted to know they’re part of a landmark capital markets transaction.

NoChu’s comeback

Bloomberg reports that Norinchukin Bank is BACK in CLO land. Well. Not exactly. The news is that NoChu has rolled into a reset for Octagon Investment Partners, rather than allowing its holdings to roll off, as with much of the reset flow on both sides of the Atlantic this year.

That’s not quite the same as coming back in all guns blazing, willing to anchor most of the market’s triple A tranches, but, as the article says, perhaps it signals a slowing of the pace at which the Japanese bank is running down its holdings.

The bigger question is whether the market actually needs or wants the Japanese anchors back in size. 

Although anchoring a deal at the triple-A level does provide more execution certainty, particularly for European deals, where the buyer base is smaller than for the US, syndicated deals can certainly get done and real money is said to be playing more actively in senior tranches than in the past. This is thanks to the exceptional relative value in CLOs compared to other high-grade fixed income products, and because the risks perceived in the product last year have receded.

At “peak NoChu” in early 2019, the market was recovering from the sell-off in the winter of 2018, which shut Lev loan and CLO markets alike — and meant that managers and arrangers were desperate to de-risk their new issues.

But the stipulations the Japanese bank demanded were notoriously harsh and inconvenient — managers were asked, for example, to ensure someone senior was always available during Japanese hours to pick up the phone if NoChu had questions. The economic terms, too, were tough, with NoChu insisting on particularly senior-friendly deal structures.

Part of the reason for resetting deals from this era, apart from the obvious spread improvements, is the chance to redocument to get away from restrictive stips, adding in the post-Covid flexibilities around workout obligations and making other manager and equity-friendly changes.

So while NoChu might want to run down its book less quickly than in the past, it’s not obvious that managers and arrangers will be rushing back to sell it new primary. There’s a price for everything, no doubt, but unless it wants to buy substantially inside where seniors trade elsewhere, it may find the market has grown up and moved on.

Primary CLOs have gone nowhere special this week, with a new issue print from Bain Capital Credit landing at 102 bps on the senior tranche (seemingly the standard for the last few weeks), while Covid-era resets of Blackstone Credit’s Deer Park Funding and Fair Oaks III came at 101 bps and 100 bps respectively. 

Even at the bottom of the stack, dispersion remained fairly modest, with Bain’s single B note at 915 bps, Blackstone’s at 883 bps and Fair Oaks at 865 bps.

Good news doesn’t sell papers, but stable spreads and continued supply signals a basically healthy market — enough demand up and down the stack to do deals, a healthy equity arbitrage, and an encouraging pipeline of loans large and small, mostly structured to a more CLO-friendly B2 level, and concentrated in new issue rather than more aggressive use of proceeds such as divi recap.

BNPL redux

Last week I wrote about the booming BNPL market — and the opportunities securitization professionals were spotting in the sector. 

One M&A example I missed was Davidson Kempner taking a stake in the UK’s DivideBuy (with a board seat for European structured credit head Otaso Osayimwese), as well as refinancing the company’s existing borrowing with a new £300m facility. Given DK’s capital costs, it will be leveraging this line with senior bank money.

BNPL deals, all private so far in Europe, get around the problem of the headline 0% rate by combining a commission bonus from the retail with the principal amount of the loan. This allows the loans to be sold into the vehicle below par, topped up by the commission, with a single principal and interest waterfall structure.

The crucial role of the retailer, though, gives the sector different and challenging origination dynamics, compared to other forms of consumer credit.

The explosive growth of the sector has come partly because it is so tightly integrated with the existing experience of online retail. The idea is that a customer can choose to defer the cost of a purchase at the point of sale, with minimal friction and in the minimum time possible — something only made possible by a good tech infrastructure which minimizes the pain points and click-throughs necessary to take the loan.

But this means that retailers want the experience to be seamless - and as few of their customers rejected as possible, encouraging originators of these products to be as accommodating as possible in their credit scoring. The lenders are competing mainly on ease of use and accommodating criteria, rather than primarily on price.

That means writing loans well into subprime territory (though there’s an argument that few customers want to be without, say, a smartphone or a washing machine, so defaults on loans to purchase “essential” items might be lower than expected). That’s all fine, so long as there’s enough spread in the deal to cover losses — which works if the retailer kicks in a large enough commission.

This, in turn, means the sweet spot for using BNPL lending is in high margin purchase which can be bought on impulse — leading right back to the regulatory concerns about the sector we discussed last it a useful new financing technique or just encouraging people who can’t afford it to buy stuff they don’t need? And how does it fit with the ever-increasing march of ESG?

It’s also worth taking a look at the FT’s Alphaville blog, which covered an interesting report from Redburn Research looking at the sector — and concluding that the economics for the BNPL firms don’t stack up.

Thanks for reading Excess Spread — any feedback or comments, please get in touch on or

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