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Private Credit 

Owen Sanderson

I’ve been out since before Easter, and there’s been a ton of news. Sifting through my post-break inbox it feels like I could have written about 10 Excess Spread columns on the back of the activity since April. Thanks to everyone who’s invited me to Barcelona drinks so far; your fine institutions are the true pillars of the securitisation market in Europe.

We’ve had debut issuers, top level departures, dealflow galore, a great test of the WBS market, a new asset class, some of the most oversubscribed bonds ever, the largest Italian RMBS ever, further developments on permacrisis lender Gedesco and perma-irritant Rizwan Hussain, another rating agency screwup, changes from the regulator of Europe’s biggest securitisation market, big things from the EU authorities, ART BONDS. A target-rich environment.

But there’s only one of me, and it’s a shortened week in the UK, so it’s just going to be a few highlights.

We have the first transaction in a brand new asset class on screen! A Barclays-arranged data center ABS/CMBS deal for veteran sponsor Vantage, backed by two assets near Cardiff in Wales. This has been a long time coming, and other banks are also readying transactions. These deals were under discussion last year, were marketed in Vegas, and now the Barclays trade is finally ready to be shown to the public; presumably there’s been a lot of legwork involved in getting it ready for full distribution.

The credit approach to financing data centres can vary. Are they more like a piece of commercial property, or a bundle of financial obligations?

It’s a moving target. A belt-and-braces approach to ratings has seen DBRS, Scope and S&P all mandated on the transaction, with S&P assigning A-, DBRS A (low), and Scope A to the single £600m tranche on offer.

S&P currently rates the deal under its “North American single-tenant real estate triple-net lease-backed securitizations” methodology, but is consulting on a data centre-specific methodology, which could change the game when it comes through. Other agencies, we understand, may also bring updated framework to handle the challenges of the asset class.

All the ratings have a structured finance tag, which can limit the audience for a deal of this kind. Regular corporate bond funds in the UK like a secured corporate paying a fixed-rate five-year coupon, but might not be mandated for structured finance. It’s not without precedent though; the Logicor bond or Westfield Stratford City deals are both single tranche secured corporate deals which nevertheless took the “sf” appendage.

Any methodology change will still be structured finance (even more so, if it’s looking at receivables rather than real estate). But if it can look through to the “tenants” (contracted users of the data centre capacity), that could be a big boost to the ratings here; 70% of the rent roll is paid by an (undisclosed) triple-A rated hyperscaler.

I don’t really know what a hyperscaler is (we all have a lot to learn about data centre financing), but the list of triple-A corporates is not long, and I think we can be confident that it’s Microsoft (Johnson & Johnson’s data centre usage is probably more limited).

So one compelling sales pitch for the deal is that you’re getting an exposure mostly backed by a triple-A Microsoft contract, at a coupon of 6.7%. Add to that Vantage as a sponsor (one of the top tier brand-name data centre operators).

That’s very compelling, but if you simply view it as a CRE deal, it’s a less obvious slam-dunk. Commenced leases are paying £74.2m annualised rent, a figure which should increase as the fitting out of the assets is completed. But the transaction contemplates paying £40m in coupon payments, and further fees on the committed class A1 variable funding note; enough DSCR to get by, but not the ample 2x cushion you might want on a new asset class.

Closing DSCR is 1.6x, which isn’t a lot of headroom to the trigger for scheduled amortisation at 1.5x, cash trap at 1.35x, and rapid amortisation at 1.2x.

There’s still some construction risk, and, apparently, a bunch of generators built without planning permission as well!

The data centre business is growing rapidly and there’s no reason to think this will stop; if anything, more and more computing power seems likely to be shovelled into AI. But the bonds are 15 years (five-year expected maturity with a tail period), and a lot can change in 15 years of tech…. Instagram’s $500k seed round was just under 15 years ago.

Keeping up with the pace of technological change also means lots of capex (though this mostly sits with the tenants). Leases in this deal are “modified gross”, which requires the tenants to reimburse the manager for electricity expenses. Tenants remain responsible for costs related to provision, installation and upkeep of equipment and network connectivity.

Given the long run up, I’m sure arranger Barclays will have done everything possible to make this deal a success, but whether the nascent market takes off depends on the alternatives. Owners of data centres can finance them through a broader corporate balance sheet, commercial mortgage, bank debt, or project finance-style debt. Major users of data centres (like the aforementioned Microsoft) can access plenty of capital in their own right and may prefer to bring some assets in house.

But the next deal, and the next and the next should be easier and faster to execute, opening up another tool in the treasury toolkit. That’s why it’s worth raising a glass to a market debut — the efforts of the deal team here genuinely make life easier for everyone else.

We also said it would be worth watching out for Molo, reborn and revitalised under the eye of Australia’s ColCap, a fearsomely competent and experienced mortgage lender and RMBS issuer in its native market. It was originating product into a warehouse, Victoria RMBS No. 1, funded by Standard Chartered and Macquarie at the senior level, and Waterfall Asset Management in the mezz, and had a further warehouse with Citi.

But it has now made its public markets debut with the superbly named “Molossus” programme. SPV names don’t always mean much, but this seems like a statement of intent; Molo, but a Colossus? It appears the name can also refer to an ancient Greek dog “famed throughout the ancient world for their size and ferocity”. Nice. ColCap has deep pockets; does it have the determination to join the top tier of UK BTL originators, with a securitisation shelf to match?

I say determination, but there are limited number of ways to win share while pricing new product profitably. Vanilla UK BTL is intensely competitive and well staffed with competent lenders with plentiful access to capital in different formats. There’s not a lot of market share lying around to be picked up for free.

ColCap does have an angle on international BTL origination. Aspirant BTL landlords in China, Dubai, Kuala Lumpur or Hong Kong might have touch points with ColCap already, and offer a (potentially less price sensitive) customer base.

The investor book declares that its “exploring appropriate forward flow opportunities avoiding channel conflicts”, so I guess if you have capital and want to buy some (hopefully off-market and juicy) BTL origination, give them a call.

This particular deal is 100% backed by UK origination though, and offers a firm base from which to expand. It’s been writing UK mortgages since December 2022 to amass this £300m portfolio; not bad from a standing start, though ColCap also bought Patron Capital’s original forward flow for Molo.

Deal execution, though, wasn’t quite the smooth debut ColCap might have hoped for. There’s been plenty of competing UK specialist lender supply in the last month, with Belmont Green, Together, Shawbrook, Equifinance, TwentyFour Asset Management and Bank of America bringing deals. Of these, Belmont Green and TwentyFour AM were truly toe-to-toe with Molo/ColCap, offering prime fully-levered BTL transactions, but fundamentally all UK specialist lenders are fishing in the same capital pool.

Anyway, Molossus started out with IPTs mh90s/lm100s/mh100s/m200s for class A/B/C/D, more or less around where Together’s non-conforming TABS XI landed (95/125/160/220).

A couple of days after the Molossus announcement, TwentyFour launched Hops Hills 4, backed by origination from Keystone Mortgages. This was partly a refinancing, but started with IPTs of 90-l90s/140a/180a/240a….roughly within the Molossus ranges but skewing to the wider side.

Investors who prefer a known quantity with a well-established shelf might have been tempted to stick with Hops rather than try out Molo, and Hops subsequently firmed guidance at this level, upsized the deal, and tested tighter to the final levels.

But Molossus was left high and dry with guidance coming outside Hops, at 97a/150a/200a, and deal coverage of 1.3x/1.2x/1.5x. The deal still works (and the seniors got down to 95bps) but it does suggest a meaningful debut issuer premium.

ColCap may feel this is a little unfair and even parochial — it’s issued $20bn of Australian RMBS — but against a backdrop of competing supply, investors will tend to use any excuse to demand some extra spread.

The good folk at ARC Ratings asked me to participate in the Spotlight interview series, so watch this space for the interview when it comes out. Among other things, we discussed the extent to which supply can create demand, and how the excitement around synthetic-format SRT transactions might read across to regular cash risk transfer deals.

There are structural differences switching from synthetic to funded format and back again, but the risk profile isn’t too different for deals with the same underlying asset classes. It’s not too much of a stretch to think that some of the money being raised to do SRT deals will end up deployed in good old fashioned cash transactions, rather than synthetics.

Junior risk in cash SRT has always suffered from limited size. Issuers that sell down the stack often offer tiny mezz tranches, perhaps €10m or €20m. If you’re an adventurous hedge fund you’d probably be levering those positions, so you’re deploying what, €5m at a time? If you’re allocated the whole tranche? Some funds make a good living in the space, but the public markets in Europe don’t offer much scale.

By contrast, synthetic SRT can get you slugs of junior risk up to €500m at a time (admittedly in corporate credit). Raising money for a market where you can deploy size is much easier, and now market participants are talking in the trillions.

Santander Consumer Bank’s German consumer ABS deals are therefore worth keeping an eye on, because they’re the largest providers of public mezzanine and junior supply out there — €84m in class B, €78m in class C…down to €18m in the class F. This is small by SRT standards, but still represents the largest and potentially most liquid deep mezz and junior paper in European structured finance.

It seems, from the recent deal execution of SC Germany Consumer 2024-1, that investors can’t get enough of more liquid mezz. By update three, the class F was 15x done at guidance — €270m of orders for a deeply subordinated sub-IG note.

Through the stack the coverage levels were 1.4/4.3/6.9/12.3/6.9/15 for classes A-F; that’s €424m of orders for the class D, the lowest IG tranche.

No doubt other factors were at play. In that class F, for example, IPTs of mid 600s and final pricing of 480bps shows, in the rear view mirror, that syndication started at generous levels.

Doing a deal that’s too large for a market can result in a flop, but there’s also a certain point where a larger deal creates its own demand. Investors want liquid mezz, and the size of the tranches means that it’s possible to run a more open syndication process right down the stack, instead of doing single investor or club allocation to sensitively handle a tiny tranche.

We’re probably too early to see if there is any read-across from the US-led synthetic SRT hype to other forms of securitisation, but it will surely happen eventually. Flicking through the last month’s research, we came across a deck from Barclays targeted at US ABS investors, working through the implications of more auto CLN supply.

This is the meat of the pitch (h/t Barclays)

If pitches along these lines can conjure up some unsatisfied demand for prime autos / consumer loan mezz and junior, it’s only a short skip from buying a Santander US CLN to buying a Santander Germany cash SRT?

While I was out, shareholders of Thames Water, the UK’s largest water company, threw in the towel; they’d got a preview of water regulator Ofwat’s plans for the next regulatory period, and were unwilling to keep chucking bags of money into the sewer.

Having decided to walk away, even the £190m maturity this April was throwing good money after bad, and so the holding company defaulted on this loan.

There’s a vast reservoir of coverage and think pieces, of which Rob Smith’s in the Financial Times is one of the best in the mainstream press, while I also commend my 9fin colleague Chris Haffenden’s work on it.

Following the holdco default, the market is now pricing impairment on the WBS bonds. But how would this impairment occur?

According to leaks to the Guardian, the state contingency plan is to renationalise it and use the ‘special administration’ regime to impair the bonds and recapitalise the opco. There’s lots of talk about special administration, and the regime has recently been strengthened. But the bar to pushing a company into it remains extremely high, and the lawsuits are going to be epic if there’s even a hint of uncertainty. How fun is discovery going to be? Can’t wait for all of the ministerial messages about Thames to be read out in open court! And if the government loses, the unwind of any impairment will be particularly painful.

Elliott has apparently been buying the WBS bonds, so I look forward to the spectacle of the hedge fund seizing one of the UK’s broken aircraft carriers to enforce payment. The position is apparently in the class A though, which is interesting — if the investment thesis is basically “WBS works”, then the class B should deliver better bang for the buck?

But does WBS work? That’s the £14bn question. As Steve Curtis at Latham, who worked on nine waterco WBS dealswrites…”A key objective of the structuring in the so-called ‘securitised’ financings is to reduce the risk that the UK government would have grounds for appointing a special administrator to the regulated entity on the basis of its insolvency (with financial covenant default ratios and liquidity maintenance requirements set at levels with a significant headroom to balance sheet and cashflow insolvency).”

Special administration is not a new risk which WBS structurers never contemplated; it’s a big part of the reason the structures exist. That doesn’t mean they’re 100% special admin-proof, and some ropey drafting has definitely come to light in pre-2007 asset financings. But it does mean that it’s not going to be trivial to push Thames over the edge, and bondholders don’t have much incentive to say anything beyond f-you pay you.

Various entities of the state can of course make it so that Thames breaches its licence conditions by moving the goalposts far enough at a time when the company has very little wiggle room and shareholders have already walked. But move them too far and the whole sector, not just Thames, will be found in breach.

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