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Cheesed off

Enron may enjoy the glamour, courtesy of an excellent book, and take the credit for the wholesale reworking of US corporate disclosure law which followed its spectacular collapse in 2001 (the company’s former website is now a bizarre semi-satirical art project, featuring an at-home nuclear reactor called ‘The Egg’).

But Parmalat is the connoisseur’s choice of early 2000s corporate scandal — a $14bn balance sheet hole, a bank account which supposedly contained $4bn (but didn’t exist), a massive, sustained and complex fraud which gummed up the Italian courts for years.

At the heart of it, though, was double-pledging invoices for cash. Parmalat sold its products twice: once to an off-balance sheet entity, and once to the actual customer, raising funding on the security of both. This process quickly spiralled, and was uncovered only when a new CFO started asking questions about the monstrous interest payments going out to service apparently modest debts.

Anyway, good thing we all learned our lesson and nothing like that could happen again!

Just kidding. More than 20 years down the road, we have been treated to a double helping of sketchy financings, with the abrupt collapse of subprime auto lender Tricolor and auto parts supplier First Brands. There’s been plenty of mainstream coverage of both, but 9fin has been all over both stories; subscribers can follow our coverage here and here, and even pore over the dockets (both are now in court-supervised insolvency processes).

In both situations, there are questions about the integrity of the receivables pledged to raise finance. As the FT reported, the Justice Department is probing allegations at Tricolor, and Fifth Third, a warehouse lender to Tricolor, said it would write down the bulk of a $200m loan at one of its clients (unspecified) due to fraudulent activity.

At First Brands, the factoring and leasing entities are considerably more complex and less transparent, but one of the first moves after it fell into bankruptcy was the appointment of a special committee to investigate ‘factoring irregularities’. The firm’s factoring arrangements were also a factor in Apollo opening its short position.

As always in contemporary America, there’s a political angle. First Brands was hit hard by tariffs, recording wild gyrations in inventory as it tried to navigate the on-off regime. Tricolor lent to subprime customers, specifically undocumented immigrants, which is either an illustration of the follies of a DEI business model, or a business model blown up by the unconstitutional terror unleashed by ICE, depending on your political affiliation.

But really, this is a tide going out/who is swimming naked type situation. Companies which have stretched their working capital arrangements as far as possible have no ability to absorb shocks, and companies which are frauds are more likely to be found out against a background of broader stress. Credit deterioration makes lenders ask awkward questions.

Given the subprime nature of the Tricolor lending, there’s a renewed nervousness that we’re on the brink of an ‘07 situation. Worries about the balance sheet health of US consumers have been swirling, and some commentators are keen to cry wolf with every added basis point of delinquencies. There are tremors elsewhere. High-yield bonds issued by consumer lender Pagaya have slid around five points this week, and the stock is down 32% from its high of 18 September (though still up 169% on the past six months, so, y’know, the crisis seems contained).

So we can potentially add these to an ever-growing pile of cautionary tales that includes Stenn, Prax (irregularities in the securitisation), Petra Management, Gedesco… what is it with these receivables?

They could be linked — not through a global cabal of receivables fraudsters, but because lenders who saw losses in one situation (or had a near miss) might respond with a detailed review of their other lending and spot red flags which were previously missed, prompting yet another house of cards to fall.

In the details, all of these are idiosyncratic situations, but, fundamentally, trade receivables deals — whether on-balance-sheet factoring, off-balance-sheet securitisation, or private credit — involve swapping PDF documents for cash.

This has obvious attractions for the maliciously-inclined.

Double-pledging other types of collateral, such as auto loans, should be harder; there’s a comprehensive register of vehicle liens and registrations in the US, which should be the kind of tool which stops this behaviour in its tracks. But there’s always a business advantage, for a while, in skipping a few steps. Want to make underwriting consumer debt click-button-seamless? Simply ignore all the verification procedures!

Invoice finance moves too fast for any kind of comprehensive verification (spot checks and due diligence at inception are standard).

The theoretical sweet spot for this kind of lending is, well, First Brands. Auto parts companies which sell to large-cap OEMs are often more smaller, more highly levered firms. They should be able to raise cheap funding by pledging invoices drawn on Ford, VW or GM, effectively renting the credit quality of the larger firm, to borrow at much lower rates than they could in their own right.

However, the fragments of disclosure which have emerged in the case of First Brands show rates in the teens, raising, with the benefit of hindsight, an obvious question about adverse selection. Why should auto parts invoices yield this much, and why are they being financed in private credit rather than through a vanilla bank line?

First Brands’ largest single creditor is Onset Financial, with about $1.8bn out, and this is a chapter that’s yet to be written.

The firm’s website proclaims that it had financed about $5bn in leases prior to its acquisition this year of Channel Partners Capital, and it is a “dominant force and leader in the equipment lease and finance industry”.

If First Brands represents more than a third of its entire book of business, this state of affairs may not persist for long.

But as a privately held, single shareholder/founder company, it has left few marks of any kind on the public record.

A fast-growing equipment lessor is a capital-hungry beast, and will almost always finance itself through some kind of securitisation. Poring over conference lists, it seems CEO Justin Nielsen and CFO Remington Atwood have found reasons to hang out with securitisation bankers, even if they haven’t done public trades. Channel Partners Capital, which Onset bought earlier this year, used a public ABS shelf called CPC Asset Securitization, and continued to issue refinancings after the acquisition.

But Onset itself still needed to find funding for its $5bn of leasing. The most likely explanation is a large private facility, in which the providers of said facility are asking some quite urgent questions about Onset’s First Brands exposure.

Keystone Private Income Fund, which directly subscribed some of the Carnaby inventory notes from First Brands, also discloses holdings in some Onset Financial notes, offering a partial explanation, but it’s still an unusual capital structure for such a large lessor — and a capital structure suffering a severe shock.

Tree hugging

Oaktree Capital needs no introduction. Biggest distressed debt investor in the world, the memos from founder/chairman Howard Marks are required reading across credit, centre stage in some of the biggest distressed situations in history (its role in the bankruptcy and restructuring of Caesar’s Palace is entertainingly dissected by 9fin’s Max Frumes here).

It’s been a familiar name in European asset-backed markets largely through distressed-type trades — packages of NPLs or RPLs and opportunistic real estate portfolios — though it’s been quieter in recent years. The big NPL disposals are over, the juiciest opportunities are closed off, and the opportunities to make a quick turn through a securitisation exit are limited.

Investing in legacy assets is now about the carry, not about a quick buck.

Oaktree has also changed since the glory days of the NPL market, with similarly pastorally-themed Brookfield buying a controlling stake in 2019, and the two firms now offering “wealth solutions” together.

Anyway, no self-respecting alternative asset management giant can be seen these days without an asset-based finance strategy. SEC filings show the launch of the Oaktree Asset-Backed Finance Fund in January followed by the Oaktree Asset-Backed Income Fund and the Oaktree Asset-Backed Income Private Fund in February. Positions so far include some residential solar mezz, a combo equipment leasing deal with warrants and debt, and another equipment lease position.

But the strategy is also heading to this side of the Atlantic, with the first London hire now locked in. The spoilsports have taken the job ad down now that the position has been filled, though it is preserved on Glassdoor here (I’d ignore the estimated salary range of £58k-£80k).

The firm sought: “An experienced ABF investor to lead all phases of the private ABF investment process in Europe, supervising more junior analysts and to serve as a subject matter expert in a number of ABF verticals and competencies. This professional would be the first ABF team member to join Oaktree’s existing London office”.

Other requirements:

• Source ABF investment opportunities which fit the targeted risk-return parameters of Oaktree’s ABF strategy. Recognizing that Oaktree sources opportunities and leads through a variety of internal and external channels, the ABF Senior Vice President will follow up on introductions and inquiries of potential relevance to the ABF strategy in Europe.
• For those opportunities determined to be potentially attractive for Oaktree funds and clients, the candidate will lead diligence, negotiation of terms and documentation, building models and preparing investment memoranda for consideration by the ABF investment committee.
• Supervise more junior analysts in the monitoring, surveillance and valuation of existing investments.
• Partner with various Oaktree colleagues to arrange financing or issue securitizations.
• Present information about investments, both actual and considered, to partners such as clients, prospects, financing providers and co-investors.
• Contribute to the evaluation of traded European ABS opportunities.

Anyway, the lucky man taking the Oaktree job is Lloyd Morrish-Thomas, formerly of Morgan Stanley.

As we discussed last week, MS has made a ton of money doing principal deals, but also has a keen eye on distribution and a big market network of originators.

One of the preferred attributes for the Oaktree gig is “experience executing private asset backed investments (without relying on an arranging bank to structure the investment)” — what better preparation than working at an arranging bank that spends a lot of time acting as an investor?

Oaktree’s last public securitization outing in Europe was an MS-arranged transaction, an aggregation of Spanish NPL and REO portfolios called Retiro Mortgage Securities DAC. It was… not a straightforward transaction, stitching together Spanish propcos and loancos, Lux holdcos and multiple Irish DACs.

No deposit no problem

We attended DealCatalyst’s UK Mortgage Finance conference on Monday, always a good event!

The most interesting takeaway for us came late in the day, in a session looking at innovative forms of mortgage lending — including high LTV products and equity options.

April Mortgages launched in the UK earlier this year, offering 100% loans. The product is a long-term fix for 10 or 15 years, with a high ERC charge (waived on house move). If that sounds like something tailored for longer-term institutional funding, you’d not be wrong; April was launched by DMFCO, which also started MUNT Hypotheken in the Netherlands, an originator which primarily sells its loans into pension fund and insurance money.

The 100% LTVs dovetail nicely with the long-term fixed model. The higher the LTV gets, the more a credit assessment relies on the borrower’s debt service capacity rather than the property value. Take off some variability in debt service, and that helps!

In the UK, April has a traditional warehouse funding model for the moment, with ABN Amro providing the facility. The Dutch love a high LTV, and ABN has supported other long-term fixed products, providing the first warehouse for Perenna, for example.

This summer it was joined by Gable Group, which is offering a five year 100% LTV product, and again, leaning on cashflows to ensure creditworthiness. The pitch from both of these lenders is, understandably, not about lending to those with no money and hoping for the best; the idea is that a 100% mortgage can allow borrowers to keep their savings intact and preserve a prudent nest egg while getting on the property ladder. A few years of amortisation later and they can be refi’d out in the considerably more liquid (but still constrained) 95% LTV market.

Neither has much track record to go on, but there has to be interesting funding to do here — a UK mortgage paying nearly 6% is a very juicy product indeed with the right leverage attached.

Other variants are possible — Generation Home (Gen H to its friends) doesn’t do a 100% product, but has just launched a part-and-part deal going up to 95%, where up to 80% of the loan can be interest-only.

These products are most useful to first-time buyers, but there’s later-life innovation too. Dutch firm Nestflow allows homeowners to cash in a part of their equity, in exchange for a percentage of the future sale value of the home. This isn’t totally dissimilar to the US home equity investments market, which have already made their way into securitized format.

This is basically a long-dated options contract, and definitely solves a customer problem — but the lenders offering these structures have a big information advantage over those customers, and that creates scope for putting a lot of juice in the option.

The payoff is long-dated — like equity release — with no cashflows along the way, making it harder to squeeze into conventional securitisation format. But insurers that really want duration (and high spreads) should lap these up.

Excess Spread is our weekly newsletter, covering trends, deals and more in structured credit and ABS — subscribe to this newsletter here.