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Depth charge

Excess Spread has been in Vegas this week, alongside with an increasingly large contingent from the European securitisation market, most of whom are in the Las Vegas airport lounge as I scribble this down.

We hear the UK issuers' dinner, once a small affair for the few Brits stranded 10 hours from home, has swollen to some 50 people. Together, Paratus, Coventry Building Society, NewDay and Funding Circle are among the issuers, plus Lloyds and Santander in force, combining investment banks and issuer teams.

Competitors (and left-behind colleagues) might hear tales of golfing, desert buggies and steak dinners and question the utility of it all, but behind the Vegas glitz is a serious question about the depth of the market, particularly in sterling securitisation.

It's easy to observe in distribution stats that the market isn't particularly wide. Santander’s Holmes in January had 35 investors, which is probably a maximum, Atom Bank’s Elvet had 27. Head into specialist lender territory, especially in second charge, and see it drop further. Together's 2024 2nds deal had 12 accounts in.

These accounts, however, clearly have a good deal of cash to put to work, as demonstrated by strong book coverage. Enra's latest Elstree transaction was 2.9x covered at guidance on the senior, generally the largest and hardest part to place, and an extremely robust 7.6x/8x/7.2x at guidance down the stack. Admittedly some of this fell away on the last push tighter, but seniors were still 2.7x covered at the final spread

But what are the limits to this? For a lender doing four deals a year, will that depth of demand remain? What about an issuer doing 10? Is there a maximum lender size which UK securitisation markets can support, and if so, how close are the big players to hitting that limit? What does the limit look like? Will banks that have big warehouse lines out to certain lenders play their bond deals as well?

These are unknowable questions, but important ones for any prudent funding team.

Securitisations shouldn't really be subject to the same concentration limits as you'd see in corporate finance, as each vehicle is its own delinked non-recourse pool of assets, but surely some concentration questions arise as lender capital structures growing into multi-billion territory.

We’ve got one data point in Kensington, now safely tucked in Barclays. This was the biggest of the bunch by a long way, and generally saw strong execution across its securitisation shelves. But this wasn't by accident; the substantial treasury team hustled hard and, generally, did Vegas. For Kensington, robust securitisation exits were existential, and it’s prudent to do the work when you can, rather than when you really need to.

Price-elasticity of demand, to get all economics on you, is the other bit of the picture, and my sense is that there isn't very much. If we say decent BTL seniors are now 70ish, with £750m or so of demand at this level (based on Enra's Elstree), how much demand would there be for a BTL deal at 140?

Everyone in the market that can buy specialist lender BTL would want to get their hands on such a screamingly cheap bond, but I don't think it would call forth a single new investor name. There aren't loads of funds allocating across asset classes, just waiting for RMBS to cheapen up a bit before plunging in. It's the same buyer base, chasing the same issuers, at whatever the market price happens to be.

But expanding distribution and tempting US accounts isn’t as simple as flying out and pressing the flesh.

The risk characteristics of UK mortgages are different from US product, and arguably better (full recourse to the borrower/no jingle mail), depending on where you draw the comparison. But that doesn’t mean that a hypothetical dollar deal from a UK issuer gets full credit for the quality of the collateral; US non-agency RMBS provides an argument to anchor UK deals wider. Given that UK mortgages have short fixed periods and prepay quickly, you can argue for anchoring price to auto ABS or credit cards instead, but it’s a reach.

While selling bonds is one possibility, there is, we hear, considerable interest from US accounts in buying the loans outright. Plenty of US-headquartered firms are deeply involved in offering forward flows to UK lenders, buying and trading their portfolios and all the activities we know and discuss in this newsletter. But if visiting the US can unearth yet more accounts, which anchor their pricing to the risk-reward characteristics of US non-agency mortgages instead of comping to other UK deals, that could be attractive.

Asset-backed securities without the assets

Las Vegas, a "moral cesspool" (according to one Uber driver) does make one think about the art of the possible. An enormous city devoted to gambling, surrounded by golf courses in the middle of the desert. It shouldn't exist but it does. If American capitalism can make this happen, what else can be done?

I want to highlight a couple of structures Europe might one day come around to, which are probably old news to those who follow US ABS closely but I find interesting.

In first place we have the 100% prefunded deal. This is basically an adaptation of CLO tech into consumer asset classes, and it's exactly what it sounds like.

The trade here is to issue a securitisation before any buying any actual assets. This shortcuts the traditional lifecycle of warehousing, private facilities and term takeout; just put in place the term deal straight away and sell assets into it when you have them.

Deal terms, just as in a CLO, specify a set of eligibility criteria, presumably carefully matched to the deal sponsor's origination flow. They've been around for a while in the US, and there’s no in-principle reason they wouldn't work elsewhere.

The biggest issuer of these structures is Pagaya, which has done $20bn in ABS issuance, and says this approach mitigates liquidity risk. It’s got a spicy origination model that hooks into other lenders’ systems and gives a second look to borrowers the more mainstream lenders would have turned down, which some commentators are sceptical about (here’s Iceberg Research)

But is it really worth it? If warehouse funding is reasonably plentiful and competitively priced, then why go to the effort of skipping it? If a lender wants to maximise leverage and retain no exposure to its own origination, a regular forward flow works fine.

A prefunded deal has cash drag before the assets are in place, and it prebakes origination parameters, while a warehouse with a single bank or club can be renegotiated if conditions change.

Rating agencies will rate to the worst end of the eligibility criteria, so a 100% prefunded deal loses efficiency, and investors will likewise be sceptical without an actual loan tape to look at… but then, a fully tranched deal can be more levered than a warehouse and a capital markets transaction should come tighter than a private one.

It gives sponsors more flexibility to time the market too, so sponsors should be able to hit the best windows for execution; they're less tied to a warehouse being full enough for a liquid takeout but not so full a lender is forced into the market.

The second product catching our attention was home equity options (or home equity agreements or shared appreciation agreements).

A homeowner can borrow money by selling off some equity in their home, payable only when they die or sell, and retains responsibility for upkeep and right of occupancy. Investors earn a capped return based on the value of the home, but receive no cashflow during the lifetime of the deal. In case that sounds a pure punt on house prices, it’s also worth noting the house price appraisal value is haircut heavily day-one, so the contract starts out well in the money.

Here’s one example, sponsored by Atalaya. It’s worth reading the presale in full, because it works through the maths and the payoff structure and explains the product; here’s a bit of extra blurb by Point, the originator, about the market.

Basically this process creates a house-price linked asset with a ton of duration, and that’s the kind of asset that’s often interesting to insurers. That’s why the life insurers love equity release mortgages so much! They share some elements in common (it’s a product to release equity!) but this is more flexible, can be offered to younger borrowers, and gives a more direct exposure to house prices.

But it’s also much more likely to be subordinated to existing mortgage debt (most of the Point pool is second or third lien) and therefore arguably much riskier, so insurer appetite for this kind of risk might be limited. US borrowers have always had more options to finance their equity.

HELOCs never really took off in Europe, not even in the UK. Selina Finance is the largest provider, but also does regular way second charge deals; it’s not clear how much of the £180m or so in mortgage assets it had at year-end 2023 were just ordinary seconds.

This is partly because the US first lien market is very different. Credit-worthy borrowers with a 30 year fixed rate deal struck in 2021 will want to keep this as long as possible, so have a strong incentive to use tools like HELOCs or second liens as and when required. UK borrowers refinance every two or five years; if they’re sitting on a ton of equity it’s a simple matter to relever the first lien as required.

But the home equity option product could still have legs in the UK market at least. An adventurous insurer would surely consider financing it!

One other little detail: the UK almost had a HPI-linked securitisation deal more than a decade ago. Unfortunately the sponsor was a vehicle linked to one Rizwan Hussain and aspects of the deal preparation proved challenging, with some critical components troublingly absent. Story for another time!

Private deals which aren’t private

Another big theme in Vegas (as apparently everywhere else) was the growth in private assets. In US ABS terms, that translates to doing deals under 4(a)2 private placement rules, instead of the 144A offering to qualified institutional buyers (realistically everyone in the securitization universe).

Private deals should in theory pay an illiquidity premium, but so much money has been raised for “private asset-based finance” strategies that there’s sdemand to render deals that were quite happily public partially private, with the addition of 4a2 notes into a hybrid structure. This doesn’t achieve discretion and doesn’t appear to make much difference to cost, but it fits an investment into a box. Other deals, meanwhile, are the other way around, 144A docs but placed so narrowly that in effect they are private transactions. It’s enough to make a mockery of the whole distinction.

You can think of this as a sort of fashion victim thing. Dumb money LPs, beguiled by a hundred think-pieces and Marc Rowan’s regular CNBC appearances, are allocating money to do private deals that are nothing of the kind. If public and private are merging and hybrid deal structures are on the rise, there’s not much excess return in doing only private deals (though perhaps the mark to market treatment is better).

I’m talking my book a bit here, because finding out about truly private deals is painful, but it’s not healthy for a market to swing too far to private structures.

Price discovery becomes difficult, power concentrates in the hands of a few big players (if you do a lot of deals you know what the price is), it’s harder for new players on buy or sell side to break in, it’s harder for anyone outside to assess risks or opportunities. If markets incorporate information through price and apply discipline the same way, having less transparency in pricing and terms is bad news.

At least the 4a2 / 144A debate concerns actual deals that are placed in some capacity. The other much-remarked trend was the ever-tighter synergy between originators and insurers. Every major alternative credit firm has either captive insurers or very tight relationships, and increasingly asset portfolios don’t even trouble the private placement market, simply going straight onto insurer balance sheets. This isn’t new, but it also narrows and squeezes the market.

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