In public markets, there’s no question that the former is most important; most well-established asset managers get shown more or less everything, and covered by every big dealer. These relationships are worth cultivating, but it’s a fairly efficient market (though you wouldn’t know it, for all the complaints about allocations and playing favourites).

Go private, though, and the balance tips towards deal sourcing. “Proprietary dealflow” is the holy grail of private capital, and there’s a very real adverse selection problem; if you’re not on the front foot to source transactions, you run the risk of only being shown deals already passed by your competitors.

In private markets perhaps origination is the dominant skill, and investment banks are historically the best training ground for originating new deals. Hence a lot of specialty finance/asset-backed private credit investors out there have a banking background; consider Rob Scott at M&G, or Bob Paterson at CQS, Masashi Washida at Sixth Street, Vaibhav Piplapure at KKR, Claus Skrumsager at MSIM, or indeed the entire Jefferies EMEA securitisation origination business.

The other side of the argument is that optimising for origination basically means optimising for capital deployment, rather than returns — it’s the classic argument against investing in a megafund, under pressure to deploy its billions rather than a smaller more nimble operation.

The primacy of origination is softened by the role of the advisory firms, which can run a semi-public NDA-bound process contacting most of the relevant firms, thus cutting out some of the potential returns to origination-led skills.

There’s a lot of change afoot in this market though, with the “Big Four” firms on the losing side — several members of the EY team have recently joined Interpath, while senior figures in Deloitte’s portfolio advisory operation have headed to RBC Capital Markets (Arun Sharma is now head of FIG Advisory) or Teneo (where Alok Gahrota is launching a Credit Solutions Group). Much of the KPMG loan portfolio group formed the core of Alantra’s FIG advisory unit when they joined in 2019. PwC would thus appear to be the most raidable big four operation still in place.

Anyway, we think Pimco’s appointment of Jason O’Brien to its private asset-backed operations is a big move. O’Brien previously ran Atlas SP Partners in Europe, the Apollo-backed spin-out of Credit Suisse’s securitised products unit.

Atlas was far bigger in the US (as was Credit Suisse SPG), with the Shard-based London office initially staffed with seven, all ex-CS. Ben Barrett joined from Atrato in 2023, but Anastasia Traberg-Christensen left this year following the Barcelona conference.

It remains a fairly unusual proposition, though, offering financing in sizes more associated with investment banks without the constraints of being a bank, but requiring higher returns than the likes of a Citi or a BNP Paribas.

This was more or less the Credit Suisse approach. With a higher cost of capital than its competitors, it made a virtue of hunting down the newest, most niche opportunities in asset-backed credit, and rarely disturbed the public markets with its offerings. Two of its disclosed trades included senior financings against real estate portfolios for Castlelake; what made these more difficult to do was the complex corporate situation of original owner SBB, which was battling to deleverage and stave off distress.

Anyway, O’Brien’s departure will probably slow or stop new origination activities, pending support from the larger US business, a replacement hire, or assistance from parent group Apollo. Atlas’s loss, though, is Pimco’s gain.

What we can discern of Pimco in recent years is it is very, very good at winning portfolios. You can guarantee it will be there or thereabouts in any large portfolio sale process, and more often than not it will win.

Just in the last couple of years there’s the Kensington and RNHB back books and the three Lloyds disposals (Bridgegate, Performer and Barrow), for north of €10bn equivalent. Add to that various residual note sales Pimco has won, including LendInvest and Charter Court recently, plus Irish RPLs in Jamestown… run it further back and consider Optimum from Co-op (Warwick Finance), Chester and Jupiter from UK bad bank NRAM, Slate (also ex-NRAM) and dozens of other smaller transactions.

These deals are all, however, carefully managed auction processes with all plausible buyers invited.

Pimco has an advantage in this area because, although it securitises the books it wins, it generally retains the full capital structure. The trade doesn’t depend on the cost of securitised financing to deliver a return — the point is the mortgages have better risk-return characteristics than many of the other Income Fund assets, and there’s enough money coming off the Income Funds to bid for absolutely anything that comes out.

That’s a different business from getting in front of new lenders and providing them with strategic capital, be that in forward flow, equity, mezz or senior format. Find the special situations before they come out in public processes and returns should be much better — that was the Credit Suisse approach, the Atlas approach, and now Pimco wants to make it work as well.

In contrast to most asset-backed private credit strategies though, which focus on junior or mezzanine risk, Pimco has more pockets and more ability to offer senior financing as well. It hasn’t just been buying portfolios (or occasionally whole deals), but will regularly show up as anchor senior tickets, or do bespoke senior financings like B2 Holdings’ RPL securitisation.

Turning round the Haus

In the aftermath of the Elizabeth Finance 2018 senior loss, Fitch flagged Haus (EloC 39) as another potential basket case.

Fitch gives it both barrels: “Were it not for recurrent sponsor subsidy, the multifamily housing securing Haus would be producing negative net operating income due to its high rate of vacancy. The financing is facing an interest rate shock, and without a swift turnaround in operating performance, including a capex programme mired in delays and cost overruns, we believe all classes of notes will incur losses.”

…with a swipe at the competition (”both deals’ class A notes are still rated in the AAsf category by other agencies”).

Actually, at the time, DBRS had the A1 notes still at triple-A!

But in Fitch’s comments “were it not for recurrent sponsor subsidy” is doing a lot of work. There has indeed been a lot of sponsor subsidy, and it looks like it’s continuing; sure, investors in a securitisation should consider the asset pool in isolation, but the facts on the ground and the cash in the deal suggest Brookfield wants to hang onto this one.

There is, as of last year, an equity commitment letter from Brookfield, guaranteeing finance payments to the end of the year, plus an escrowed capex account funded by the sponsor. It’s not just an empty assumption it wants to hang onto these assets until the refurb thesis plays out.

Haus was a strange deal — it’s a German multifamily CMBS, which used to be considered a cut above regular CRE financings, being halfway to residential, and indeed it priced with a 65bps senior margin in 2021, well into specialist RMBS territory.

But it funded a portfolio of transitional assets, with high vacancy rates and high capex requirements — TwentyFour Asset Management had a good rundown when it priced. At the time, one of TwentyFour’s concerns was that Brookfield had a “free option to refinance on cheaper terms after two years”, but this has not come to pass, and performance has not turned around.

Instead, vacancies have crept up, from a 40% rate at the first investor report in 2021 to 47.5% most recently. Somewhat alarmingly, according to the latest investor report “vacancy has increased this quarter as physical inspections revealed some units (271) marked as occupied were vacant”.

To me this conjures images of an intrepid valuation agent creeping through the dingy corridors of 1970s apartment blocks knocking on doors with clipboards… but surely this metric should be generally trustworthy? What else needs a re-underwrite?

The property valuation has gone up (assessed at 18% increase as of December 2023, a distinct rarity in CMBS) so the LTV is now a healthy 63.7%… but the debt yield is an abysmal 1.9%, and interest coverage on the loan is just 0.49x.

I haven’t seen the valuation report, but I have trouble believing investors are clamouring to put down €500m to earn €18m — Euribor-flat, more or less. Much less, if you assume financing comes at a meaningful Euribor spread, and a new debt facility on market terms would surely be more expensive than the Haus (Project Zinc) loan.

Obviously there’s a lot of upside if the empty units can be let, but why would a new owner be that much better than Brookfield at managing or turning around the portfolio? Real estate sponsors don’t get much more experienced and blue-chip than Brookfield. Savills, in a December 2023 report on German resi, points out that “prices on the residential investment market have fallen sharply. This is the sharpest price correction in recent history”.

That doesn’t spell “18% increase” to me, although admittedly this is from an October 2022 valuation.

This week, more implicit support from Brookfield. With interest cover already minimal, there’s simply no room to replace hedging on market terms. According to the investor report, unhedged interest cover would have been just 0.33x, while hedged ICR for the previous quarter was 0.78x.

Clearly a cap at or above Euribor would be unsupportable under these conditions — so instead it has obtained a cap in line with the old hedging, with a strike at 2% and running until July 2025. I haven’t got the tools at my fingertips to value it, but it’s got to be a few million, and hints Brookfield wants to run the position for a bit, rather than run away.

In a call with investors in August last year, the headline was very much “Brookfield will stick around”. I mean, they would say that, and if you have to announce it that tells you something, but “Note-holders can be assured that the Brookfield Sponsor remains fully committed to bringing this investment to stabilisation… Brookfield’s conviction on the investment remains strong, as occupier fundamentals are as favourable as ever”.

Fitch’s dire predictions do seem a bit much. Even if we’re sceptical about the €500m valuation, there are only €213m of senior notes outstanding; a worst case enforcement and fire sale should still see these covered.

More debt more fun

We enjoyed the Financial Times graphical explainer on “How private equity tangled banks in a web of debt” — some very cool graphical technology walks through the multiple angles of PE leverage, taking in leveraged finance, private credit, back leverage, secondaries leverage, NAV lending and subscription finance. If one wanted to tangle the web further, you could consider CLO warehousing, TRS leverage for loan investing, and all manner of bespoke repo as well!

The headline I’m not sure about — I don’t think “private equity tangled banks” so much as banks willingly and enthusiastically pitched more and more ways to lend money to some of their best clients. They’re in the business of “lending money”, so tangled themselves, for profit!

Where there’s money to be lent, there’s securitisation to do, and we’re hearing securitisation lawyers and securitisation groups spending more and more of their time on various forms of fund financing. It was clearly a big theme at the latest Fund Finance Association event — see a write-up from Maples here — securitisation part below.

It’s essentially about capital — even if industry lobbyists grumble about the capital treatment for securitisations, it can more advantageous for banks to hold a senior financing position in a NAV-type facility in securitisation format than straight debt (and the implied rating can be higher).

It’s easiest to port over public structures when a bank is leveraging a private credit fund; this is just a private credit CLO, and this market has been large and growing for years. They’re loans, they have cashflows and security, it’s not a huge leap.

Applying this to private equity is more complicated, because the cashflows are less predictable. Portfolio companies don’t produce reliable money unless they’re paying dividends or unless there are realisations from the fund.

While bank lenders often appreciated a securitised NAV structure, it doesn’t work everywhere — levering funds involved in asset-backed finance or SRT transactions runs into the rules against re-securitisation, requiring careful structuring and the deliberate avoidance of a securitisation regulation treatment.

Where fund leverage is itself being provided by a fund, securitisation is also usually a negative, tangling said credit fund up in more regulation than it wants — there’s no capital incentive for a non-bank institution.

But even non-securitisations still require securitisation expertise — payment waterfalls, trigger levels, rating methodologies and more. Putting the fun back in fund finance!

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