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Excess Spread is our weekly newsletter, covering trends, deals and more in structured credit and ABS. Find out more about 9fin for structured credit.

As the year draws in, so is the latest Lloyds disposal process, the £1bn Project Frankie, a portfolio of reperforming loans, which is in second round bids and heading towards the finish line. Like the other transactions in the latest disposal programme, it's pre-structured into a securitisation.

In most of the other Lloyds sales, the UK bank has held onto the senior notes through various entities (Bank of Scotland plc in Bridgegate, Lloyds Bank plc in Performer, Black Horse in Cardiff Auto Receivables Securitisation 2024-1), though not in Barrowby.

That was the initial plan for Frankie, though in the second round the senior’s up for grabs as well — likely the preferred structure for a certain west coast asset manager, based not in Hollywood but about 50 miles away in Newport Beach, which has been very prominent in the Lloyds sales so far.

There's a virtue in scale and simplicity of execution. In other Lloyds deals, the UK bank has invited investors to bid whatever they wanted, but clearly in practice a single account taking everything is easiest to execute. If you go down the Pimco route, that implies going all the way. It's unlikely that any investor really wants to be 50% of the F notes in a deal which is otherwise 100% Pimco.

Now, though, Pimco’s competitors for portfolios are also increasingly happy to buy full structures, even if they ultimately want the levered return available on the junior pieces. If the deal is basically on market terms, surplus senior and IG mezz can be straightforwardly financed or sold on. Pimco might even buy them!

“Basically on market terms” is doing a lot of work here, because the presence or absence of Pimco is sufficient to move the market, and sometimes it effectively is the market. Lloyds held onto the senior notes in Bridgegate but what’s market for a £2.3bn senior tranche? It’s too big for a real syndication, so if it were to be placed, it would probably be placed with… Pimco.

While Pimco winning a lot can be dispiriting, the Frankie process is still competitive, with One William Street and a joint GoldenTree/Morgan Stanley bid in the mix.

Morgan Stanley has been sellside on most recent Lloyds processes, though this time it’s Alantra’s portfolio group working alongside Lloyds itself to manage the sale. GoldenTree also represents a new partner for MS.

Historically it’s had a close and active partnership with Ellington, bidding, winning and securitising Irish and Spanish RPL portfolios. A co-investment structure means Morgan Stanley doesn’t have to consolidate these principal trades, and from a lightly staffed fund’s perspective, having an investment bank on board means many more warm bodies to help work on a bid, and structure a subsequent takeout.

Pimco might have bought a lot of Lloyds loans so far, but GoldenTree has notched a couple of other wins this year, beating Pimco to Project Peninsula, the Barclays Italy mortgage book, and Project Titan, the Bank of Ireland UK unsecured consumer loan book. GoldenTree clearly fits into the “levered buyer” camp, while Pimco can and does buy unlevered, but that’s not necessarily a handicap, especially as leverage conditions are pretty good right now.

We hear the package attached to Project Titan was particularly pleasing, with a spread below 90bps and Bank of America, Lloyds and Morgan Stanley lending. Without an advance rate it’s hard to backsolve public comps, but it’s a short term position (c. 1.5 years) and a prime, clean book — with NewDay’s “near prime” (YMMV) triple As at 90bps in late October and a cleaner collateral pool, it makes sense.

This is not typical MS territory though — the US bank offered a staple as part of its sellside role on Titan, but presumably at wider levels, before rolling into the winner’s financing.

For Lloyds, this represents a nice win. It’s not necessarily the first bank you’d expect to partner with a hedge fund on a portfolio bidding process (though Lloyds did plenty of work around the UKAR sales), but a build-out of the UK bank’s sponsor and hedge fund client base has been a key priority for Miray Muminoglu’s post-2021 reboot of the securitisation platform.

The water has been almost too quiet in UK auto ABS following the Court of Appeal’s ruling at the end of October on payment of commissions. This ascertains a fiduciary duty between a broker of a credit product (such as a car dealership) and their customers, and requires full disclosure of any commission payments, a huge change from existing market practice.

If this means essentially every auto finance agreement in the country was missold, the damage could be huge — a report from Moody’s this week put the bid-offer at £8bn-£21bn in total redress, with a downside case of up to £30bn. If this judgment stands and compensation payments come in at these kind of levels (it’s being appealed to the Supreme Court), this will be very painful for the big clearing banks with motor finance arms (Lloyds, Barclays and Santander), a life-changing injury for smaller lenders (Aldermore, Close Brothers), and likely fatal for thinly capitalised non-bank lenders like Oodle, Startline and Blue Motor Finance, all securitisation issuers.

For securitisation investors and the securitisation-funded lenders, much depends on what kind of redress scheme ultimately emerges. Cash compensation from the originator lands differently to a reduction in loan balance; the details of any transaction mechanisms to manage “set-off risk” also matter.

Part of the reason for the relative price stability in UK autos is the binary nature of the risk; sure, it’s not a good time to add new bonds, but there’s a decent chance that the judgment is reversed, it’s business as usual, and anyone fire-selling their auto ABS book will feel silly.

But now there’s a real test coming, as the junior bonds and residual certificates in Blue Motor Finance’s Azure No. 3 are out for BWIC next week. Azure No. 3 priced last year, and according to the offering circular, the residual was placed to “potentially Morgan Stanley, pursuant to arrangements to acquire certain residual certificates from Blue [Motor Finance]”.

Evidently Morgan Stanley has sold it on, since the BWIC seller is a hedge fund — class E and F notes are on offer, plus a majority residual position. If the motor commission settlement ends up trimming loan balances, not just smacking the originators, these bonds are absolute toast; if the Supreme Court reverses the decision, they’re decent (the deal is deleveraging nicely).

So potentially this is a fishing exercise. If the eerie market complacency holds, the seller can cheerfully report that it’s well out of a highly exposed position. If the offers come in at insulting levels (or levels reflecting a meaningful risk of a zero), no need to sell, just hang tight and hope the court comes good. But a fishing expedition probably points to DNT, since anyone rolling the dice on a court decision will need to be well compensated.

Europe’s largest debt purchaser, Stockholm-headquartered Intrum AB, is conducting its first and possibly last piece of US business, filing in the Southern District of Texas for a prepackaged Chapter 11 process. 9fin’s distressed debt team have done a great job covering Intrum’s descent, and the fight between the majority creditors supporting the current Chapter 11 plan, with its very modest deleveraging content (the 10% debt-for-equity swap still leaves Intrum’s debt miles above NAV), and holdout funds in the shorter bonds.

Anyway, you can read some of our coverage here, here and here on the 9fin platform, but the interesting thing, we think, is what the Intrum business looks like in future.

All of the corporate debt purchasers have been adjusting their business models. Intrum itself was supposed to be pivoting to a “capital light” model, it just didn’t turn quickly enough for its monster debt stack.

One could loosely call this “doing an Arrow”, given that Arrow Global was early in turning itself into something like a fund manager. It has third party funds with regular LPs, joint ventures, securitisations, private debt management, real estate, bridging lending; there’s a lot of Arrow assets that don’t sit on the corporate balance sheet but which are part-controlled by Arrow and drive servicing revenues. A lot of the legacy debt purchasing assets are still hanging about, but there’s a clear story to tell. One might even consider that owner TDR Capital is rare among big PE shops in having no credit arm. It has a productive relationship with AlbaCore Capital Management, which is active in large cap corporate credit, but for its granular private credit and NPL investing, perhaps portco Arrow is a better vehicle that setting up “TDR Credit”.

Anyway, this transition basically amounts to using different routes to bring in outside capital. A capital light structure still needs someone to actually fund the purchases of the assets.

After Chapter 11, though, Intrum’s freedom of manoeuvre will be constrained. Corporate creditors understandably, want to preserve their collateral and control. Signing a ton of co-investment deals with assetco debt, or leveraging/monetising existing portfolios effectively primes them. Intrum already sold a big portfolio to Cerberus and signed a forward flow with Cerberus. Bondholders don’t want the rest of the company to become a Cerberus sub-division by degrees.

Thus the conditions under which Intrum can sign minority or majority co-investments, in levered or unlevered format, are severely constrained. There’s a return target to hit, prescriptions on servicing arrangements, leverage limits, and an overall cap. None of this really constrained Intrum in the past; it had wide latitude for Qualified Receivables Finance, and unconsolidated, non-recourse securitisation debt was treated generously. Deals can probably be struck on the new terms, but the more restrictions Intrum must abide by, the less attractive it is as a potential partner. Large NPL sales are generally offered to a broad range of funds and debt purchasers; even if the restrictions only bite at the margins, why partner with Intrum when easier counterparties are available?

The one major piece of wiggle room is “synthetic sales”, a provision inserted first into Intrum’s bond docs in 2017. Synthetic sales were a way to solve for Norway’s lack of a securitisation law and restrictive rules on holding loans on balance sheet; the intention was not to derisk NPL books through a SRT-like structure, but to sell the economic exposure for cash and leave the loans in place.

Post-Chapter 11, though, Intrum’s greatest flexibility will be in this area. If the company wants to get back on the front foot and be more than a run-off business, it’s going to have to be clever about co-investment.

The big reveal in the UK Chancellor's Mansion House Speech this year was a proposal to require local government pension schemes to be pooled by 2026. It's been a long journey to this point, with Chancellor George Osborne promoting pooling back in 2015, but various governmental distractions intervened in the past decade, and maybe this time it’s real?

Here’s a nice rundown from NatWest. The model is quite explicitly Australia and Canada — Rachel Reeves described the reform as: “our plans to create Canadian and Australian style-“megafunds” to power growth in our economy” — and why not?

The Australian "super" (superannuation) funds and the Canadian pension funds are globe-trotting colossi of the investment industry, sought-after LPs and co-investors in everything from infrastructure to LBOs to SRTs.

In principle there's no reason at all that the UK funds can't end up in positions like this. There'll be £1.3trn in assets in UK local government schemes by the end of the decade, according to the release announcing the changes, and the government’s research suggests that the benefits below kick in at scales of £25bn-£50bn. These are said to include:

Greater expertise and increased ability to hire skilled staff

Ability to make meaningful investment in productive finance

If a fund’s 5% alternatives bucket comes to £50m, that doesn't pay for much staff time, and ends up as a few small tickets in co-mingled funds; if the alternatives bucket is £10bn, you can build out an internal PE and private credit team, pursue co-investment and low-fee sweetheart deals with all kinds of asset managers. With that kind of money, when you say jump, the GPs will call you right away to ask "how high".

Whether this money all flows into the UK is a different question, let alone whether it goes into “productive finance”. Whatever that is, we’re more interested in baroque financial engineering here anyway.

I'd have thought the first agenda item of any newly created megafund is to consider whether it's overallocated to the UK, rather than go looking for previously neglected UK opportunities to finance. After all, the UK is already the stomping ground for the big Canadians and Aussies. "Do the deals that CDPQ, Macquarie and Teachers all passed" is not a great pitch to any newly hired infrastructure investor looking to make their mark.

The UK is also a favoured playground for large pockets of long-dated lifer money, shortly to be shaken up further by the UK Solvency reforms, which improves the treatment for assets with “highly predictable” (but not fixed) cashflows. Later life mortgage lending, commercial real estate, agriculture, infrastructure, student housing, ground rents, private debt all attract plenty of insurance capital, and these sorts of investments likely top of the list for pension funds that have recently got bigger and more specialised.

One could consider USS, the Universities Superannuation Scheme, as a potential precedent for the behaviour of a new crop of UK local government super funds.

There’s a big private assets business, which has done deals including buying shared ownership properties from Sage, the Blackstone-owned housing association, signing a partnership with Credit Suisse (later Morgan Stanley) to derisk a middle market fund finance portfolio, buying second charge mortgages from Equifinance and more besides. USS can offer bespoke fund finances and leverage complex junior securitisation risk.

But USS also has a relatively new ABS fund management function, led by Janet Oram, who joined from BlackRock in 2021. This account is able to buy ABS and CLOs, co-invest, and is generally active in more liquid securitised products.

If the UK super funds all replicate these elements that’s like, a 50% boost to the sterling ABS investor base right there? Bring it on.

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