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Private Credit 

Owen Sanderson

Molo Finance is the poster child for the challenges faced by UK non-bank lenders over the last couple of years.

Many lenders shrank their origination, as rising rates made writing loans a money-losing proposition for the securitisation-funded community. Deposit-funded banks kept mortgage rates lower for longer and took share; lenders which sold their loans into forward flows had no coupons to clip to keep the lights on, and had to rely on product fees from origination which wasn’t happening.

Anyway, Molo stopped lending early, suspending BTL origination in April 2022; it became impossible to write loans for its forward flow on acceptable terms. A hard stop like this is bad news for a specialist lender, since it lands badly with the broker networks on which many depend. Pull product without warning and it taints the lender’s brand.

But much water has passed under the bridge since then. Australian lender ColCap Financial signed a partnership in July 2022, “a broader strategic alliance between the two lenders that will allow ColCap to expand into the UK market”. Basically, it bought the equity in Molo, exercising a call option to upgrade the investment to a majority stake in March 2023, and bought the back book as well in July 2023 (Patron Capital owned the portfolio, with funding from Macquarie).

ColCap is a monster, in a good way. The company’s results are private, but it had a A$12.4bn loan portfolio as of December 2022, wrote A$5.5bn in the year, and had printed A$17.7bn of RMBS deals. These are Kensington-like numbers in a market only a third of the size.

The point is, this is a very serious entrant to be turning up in UK non-bank lending. Molo has also changed personnel since the troubled times. Chief executive and co-founder Francesca Carlesi stepped down in October last year, and is now chief executive of Revolut UK (as the FT writes, “Will Reovlut ever get a British banking licence?”). Capital markets head Qasim Jafri now looks after Enra’s funding through the Elstree programme.

Two weeks back, Molo appointed experienced mortgage executive Matt Kimber, who formerly headed up CHL’s front book origination, as chief executive — so now it’s ready to look to the capital markets, it seems.

One might object that UK BTL volumes have crashed hard over the last year, and even the most entrenched incumbents are having a hard time. The UK market is very well served across BTL products, highly competitive and diverse, and there aren’t that many niches which remain unexplored. But still, if anyone can make it work it’s probably ColCap, and presumably it’s more of a strategic plan than a short term trade; never bet against the British propensity for property speculation.

Molo, we understand, has been on the road talking to securitisation investors, with a view to a possible BTL deal down the road.

Delving into the depths of the UK companies registry, it appears New Molo has two main vehicles, Victoria Mortgage RMBS No. 1 and No. 2, with the first funded by Standard Chartered and Macquarie in the senior and Waterfall Asset Management in the mezz. The second appears to have Citi in the senior and ColCap (and related vehicles) down the stack. Keeping it royal, there seem to be vehicles called Elizabeth RR No. 1 and No. 2, which presumably have something to do with the risk retentions in the warehouses, or planned risk retentions for a public exit.

Undoubtedly these are Top Queens of the UK (and Australia), but nothing for poor old Charles III? Maybe he doesn’t yet merit lending his name to a prime BTL facility; he’ll probably pop up on the unregulated bridging vehicle down the road.

Big picture, it’s undoubtedly healthy for securitisation to have another very serious player (re)enter the UK non-bank mortgage market. Deposit-funded banks have been having it all their own way over the last couple of years, and consolidation (Kensington, Fleet, Bluestone etc) has been cutting the number of players.

Here’s a very cautious prediction: The way the European NPL market looked from 2015 to 2020 is not the way it will look from 2024 going forwards. The high yield-funded debt purchasing firms are pivoting, and in some cases struggling. The laggards, such as Lowell and Intrum, need to figure out their place in the new world (and figure out how to refinance their bonds in the meantime), but they’re unlikely to be the players they were in the pre-pandemic glory days.

The other big pivot is in the role of the state-backed securitisation schemes. Italy’s GACS and Greece’s HAPS(Hercules), similarly structured guarantees for the senior tranches of NPL securitisations, were successful schemes at encouraging the banks to rapidly offload giant portfolios of NPLs and clean up their balance sheets.

State-subsidised leverage allowed bidders to pay more for portfolios, reducing the cash hit banks took on the sales. For banks which were already thinly capitalised (Greek bank balance sheets were mostly goodwill at the time HAPS was introduced, and a single quarter of JP Morgan’s profits could have bought the entire banking system) minimising the capital hit was vital.

Southern European states in the wake of the sovereign crisis couldn’t afford to support their banking systems directly, and the European Union wouldn’t really allow it. State securitisation guarantees kicked the problem down the road (the state guarantees wouldn’t be called until losses were realised) and a hand-waving pricing mechanism meant these didn’t count as “state aid” subsidies.

Now the contradictions and distortions of the state support schemes are all coming out in the wash. Most of the state-supported NPL securitisations are underperforming business plans, sometimes to a massive extent. This isn’t an accident; the schemes incentivised aggressive plans to maximise the benefit of the state-guaranteed leverage. One bidder we know of had a shadow “real” business plan in the background when they were bidding state-supported deals, and I imagine this was common.

This underperformance has flowed through the transaction hedging. Hedging an NPL deal with an all-singing all-dancing balance-guaranteed swap would be amazingly expensive, so most of the deal hedged with a cap referencing a notional amount based on the (optimistic) business plan. With interest rates shooting up and deals underperforming, many deals are now very seriously underhedged, so the Euribor cap is only covering a fraction of the outstanding note size, and more and more of the deal payments are sucked up covering Euribor at 3.9% instead of 0%.

When a servicer fails to deliver, deal investors might think of replacing the servicer with one who can perform! It’s an extreme remedy, but perhaps justified in the circumstances?

That’s not generally what’s happening in the GACS / HAPS deals, however. The business plans were so aggressive out of the gate that owning the servicer is the best way to get at some cashflow. Underperforming the business plan will switch off cashflows to the junior notes in most cases, but the servicer will still be paid a percentage of collections.

Still, NPL portfolio buyers do like money in all flavours and would rather have more of it than less, so they’d prefer to keep the junior cashflows going.

Some deals don’t have this trouble. Elrond SPV 2017, a GACS deal with a portfolio from Credito Valtellinese, is one of the worst deals out there in terms of actual performance. We wrote about it last year, following a Moody’s downgrade to Caa2 and Ca for the class A and B respectively. The collection performance was poor, and the hedging followed the same pattern outlined above; the Euribor cap amortised well ahead of the actual note amortisation.

But crucially, it’s one of the few deals where there’s still cash leakage out to the mezz. Per Scope “unlike most Italian GACS NPL transactions, there is no class B interest subordination feature that is triggered by either low collections or low profitability on closed positions”.

It’s probably not a coincidence, then, that this is one of the deals where the equity has traded, with Waterfall selling to Phoenix Asset Management in 2020.

Still, most of the state-guaranteed deals do have such triggers, and that’s what’s driven the most active part of the NPL market in the last year — secondary sales.

The Greek HAPS deals were massive portfolios featuring a grab-bag of non-performing assets of all stripes. They were mostly secured (banks get a lot more bang for their buck selling a secured portfolio, since the writedown is usually less aggressive and the euro amounts are much larger). But that covers everything from a small ticket residential mortgage to a medium-sized business. The banks were focused on chopping a lot of wood very quickly, and they weren’t in a mood to slice and dice their exposures to optimise them for fund investors.

Take Project Mexico, a €3.2bn gross book value portfolio from Eurobank for example (one of the few deals with decent reporting available). It features exposures in four different currencies, with 10 different asset classes, ranging from consumer to CRE, SME and “not applicable”. Loans were originated any time between 2000 and 2021 (the deal traded in 2022). There’s clearly a ton of scope for more tailored asset sales.

So the megafunds which own the HAPS deals, and the servicers they often bought as part of the transfer, can deliver part of their return by working through these deals and carving out more bespoke portfolios. Some funds specialise in court-related workouts; others like corporate credit and working out midcap exposures, others like real estate plays. Maybe a small book of residential mortgages concentrated in Athens is easier to handle and easier to extract high returns from than a giant and diverse book.

Most importantly, selling mini-portfolios out of existing HAPS transactions allows a potentially underperforming transaction to stay ahead of its business plan (and hence maintain cashflows to the junior note). Greek court processes might be slow, but just selling slugs of assets out of HAPS deals still counts as a collection.

A bigger structural issue for the old wave of NPL securitisations is the possibility of New Money. In standard corporate credit distressed investing this is one of the main ways that a fund gets paid; offer debt with better security or economics than the existing capital structure.

In NPLs the focus has been more on collecting what you can from existing debts, either by enforcing security or restructuring payment terms such that a loan becomes reperforming. The lowest hanging fruit of this kind, however, has already been collected or is in process, either in a legal situation or with security already enforced and the investor owning some real estate.

But there’s a bunch of loans, especially the secured portfolios, which do require new money to fix. If there’s value in a piece of real estate or a company, sometimes all that’s needed is a bit of capex to get an asset working again.

As one of the panellists at DDC’s Global Investor Summit on Tuesday said: “if you have a baker’s factory somewhere in rural Spain, there aren’t a ton of other potential occupants. If you seize the real estate, only the original sponsor will really want to occupy it. So you need to figure out how to refinance them”.

Maybe this is a lick of paint for a tired office building, maybe it’s environmental clean-up, maybe it’s finishing a development that’s only part-complete, maybe it’s a full refit for a property that’s been empty for years, maybe it’s a new working capital line to get an SME back on its feet. The possibilities are as diverse as the borrowing, but it all requires capital.

Of course, this capital can come from elsewhere — a business ready to stand on its own two feet again should be able to obtain new credit lines — but in practice this is unlikely. Banks don’t necessarily want to jump back in to lend to borrowers which have been struggling for years. The Greek banks, having cleaned up their balance sheets, aren’t queuing up to lend money to the “NPL” borrowers of their peers, and frankly, they aren’t set up for it. Small cap lending in Greece or elsewhere is often fairly low touch; the banks aren’t going to be building DCF models to project the EBITDA of every one man band plumbing business into the future.

The institution with the best understanding of a given SME / small balance CRE exposure is probably, at this point, the servicer of the NPL portfolio, which is paid handsomely to understand the credits in question and extract the maximum value from them. If new money is needed, the existing servicer is best placed to know how to deploy it and on what terms.

This has implications for the kinds of institutions which are involved in the NPL business. Some of the high yield-funded debt purchasers, as we noted above, are having a tough time. Their own capital raising via high yield is looking challenging (Lowell’s bonds are yielding more than 26%, and Intrum’s long bonds are over 20%).

Intrum has been trying to pivot to a capital-lite business model, and may focus more on its core granular consumer business. At the same time, though, it has done a lot of big HAPS deals, often with partners (seven transactions with Piraeus Bank alone). If what’s really needed to make these deals perform is capital…where does this come from?

Capital-lite, to be fair to the debt purchasers, refers partly to the firm’s own capital. As Arrow Global shows, it’s possibly to raise third party cash for NPL investing, and leverage the servicing capabilities of the institution to deploy someone else’s money. But it’s time for the cash to go both ways now.

It’s Basel’s world, we just live in it

UK prime minister Harold Wilson memorably blamed the “gnomes of Zurich” for speculating against the pound, a convenient way of shifting the blame for his own government’s twin devaluations of the currency and an acknowledgement, in a way, that London in the 60s had become a financial backwater and all the action was to be found offshore and lakeside (for more trenchant commentary lifted from my dissertation please do write in).

London has had its mojo back for a few decades now, but it’s still true that the (central) bankers meeting in Switzerland can fill or kill entire business models with a stroke of the pen.

The Basel “Endgame” is supposedly what’s juicing the upswing in the US SRT market; the Basel IV output floor is arguably driving the growth in asset-based lending and private credit.

But down among the weeds of the Basel 3.1 rules is another major shift for the European securitisation market, specifically adjustments to the risk weighting for buy-to-let mortgages.

These account for a disproportionate amount of securitisation supply, especially in the UK, the most active market. Most prime, vanilla, owner-occupied mortgages live on bank balance sheets, sometimes supporting covered bonds and very occasionally, a prime RMBS or two.

The non-bank specialist lenders, however, who require warehousing, forward flows, HoldCo leverage, and term securitisation takeouts, are among the best clients for the securitisation industry. Kensington, prior to being folded into Barclays, was the most regular RMBS issuer in the market (congratulations to Kensington’s funding boss Alex Maddox on his new role as head of principal funding and securitisation at Barclays!).

But for the past couple of years at least, the market has been favouring the deposit-funded lenders. Former securitisation stalwarts like Paragon switched over to deposit funding; OneSavings Bank kept up its market presence, but is mostly doing funding deals rather than the fully levered transactions of the past.

Basel 3.1, though, could render much of the complex BTL market a challenge for regulated credit institutions, since under the UK proposals (due to be implemented from July 2025), risk weights jump sharply for “repayments which are materially dependent on the cash low generated by the property”. So portfolio landlords, or limited company BTL, holiday let, or HMO (houses in multiple occupation) loans could be caught by this — the regulatory intuition is that these loans look a bit more like a CRE exposure than an owner-occupied resi mortgage, so they must be riskier.

To borrow a nice chart from PwC’s rundown….as you see, quite a few of the asset classes which show up in securitisation are hit hard by this.

Also worth noting is the presence of prime residential mortgages under the standardised approach in the green section, and prime residential mortgage under the internal ratings-based approach in the red.

So the incentives will be to give the challenger banks (most of which have been racing for IRB approvals) a fairer playing field to compete with the High Street in the prime, vanilla space, but handicap them vs the non-banks when it comes to complex BTL, second charge, high LTV and so on.

This isn’t entirely set in stone (the PRA has published “near-final” rules), but it’s likely, despite the heavy lobbying that’s brought to bear, that it will look similar.

The challengers are well capitalised, and have been reassuring investors that they can handle the changes with no more than a modest hit. But it may still affect the pricing of products and the overall structure of the industry — if you’ve got a cheeky bid for a complex BTL book, maybe it’s time to get out there!

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