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Fiber in the diet

Figuring out which asset classes come to Europe next is sometimes just a case of looking across the pond, and it looks, right now, like fiber ABS is pretty hot. Zayo, a DigitalBridge/EQT portfolio company with a $9bn levfin debt stack, is marketing its first fiber ABS, a $1.46bn deal, which will raise much-needed funds to help address the rest of the capital structure (some coverage here).

We’re a proudly securitisation-loving publication here, but as you’d expect, the ABS basically delivers far better terms — leverage of 9.1x through the class Cs, on the company’s numbers, 10.8x and 11.6x by the rating agencies. Corporate leverage last year, to a B- rating, was 7.8x by S&P’s figures.

The deal is marketing, but Uniti Group recently priced a fiber ABS with a 6.5% weighted average cost of capital, so I guess we’re talking 200bps or so back of Treasuries? Cheaper money, way more leverage, what’s not to like?

As with data centers (or centres), the ABS magic is partly driven by improved asset security, but also because customers drive the credit quality, not the provider. Zayo’s deal is backed by contracts with its customers, more than 40% of which are investment-grade — lots of big stable telcos and financial institutions in the mix.

Face these credits, instead of a thoroughly leveraged PE-owned infra company, and watch the ratings climb!

As ever, the difficulty in Europe isn’t so much getting a deal together. There will be wrinkles, challenges, tax and security issuers to solve, but there are plenty of clever people to solve them.

One problem in the Zayo deal is that you can’t easily mortgage the actual networks and the permits and licences associated with them, so asset security comes through equity interests in these instead. Different European jurisdictions will have different treatments for these assets and different mechanics around charges and liens but… that’s what you pay the lawyers for. Any number of firms would be delighted to advise on a debut European fibre ABS transaction.

The economic problem is the banks, as it is for other CRE and infrastructure assets.

If we take, for argument’s sake, CityFibre, a UK fibre infrastructure provider that has been growing rapidly, then we can see it raised a chunky £4.9bn (£3.9bn drawn) debt package in 2022, paying 5%, subsequently ratcheted up to 6%. That’s more than enough to carve out an ABS piece if needed. But this has been thoroughly supported by a solid banking group, with M&G the only non-bank listed on the initial release (though the loan may have been syndicated down to various infra funds in the back end).

It’s reportedly coming back for yet more debt, on the back of revenue of just £99.7m. It’s hard to unpick this to give a like-for-like leverage number (the Zayo bonds have the benefit of public ratings), but there is plenty of cash at decent levels available for this kind of infrastructure investment. Perhaps an ABS would give better leverage terms, perhaps even better pricing, but it’s hard to know without printing a deal, and a heavy lift to get to the first one. It’s not so much a question of unclogging the fiber ABS market (if you build it they will come) as it is of competition and economic logic.

Gorilla warfare

There has been a long-running fight over Silverback Finance, a CMBS backed by a sale-and-leaseback of Santander’s Spanish branch network, which was finally settled, to the tune of €86m, this week. The final payout is far lower than the €250m originally claimed when the court case was filed, but it’s not pocket change either.

The original €1.34bn deal was struck in 2015, and involved Santander selling the branches to Uro Properties, a vehicle with a special tax exempt SOCIMI status, and leasing them back again. Santander had second thoughts, buying Uro in 2020 and bringing it back on balance sheet.

This meant Uro lost its tax treatment, which allowed a special mandatory redemption on the deal, a right Santander exercised, paying off the principal in the deal. But should it have also paid the make-whole cost of the bonds? The documents provided it should, when the loss of SOCIMI status was through act or omission of the borrower… so does the buyout of Uro count? Is it an act to allow oneself to be bought? What’s the right way to construe the documents and the right way to calculate said make-whole?

One can see how this could quickly spiral, especially with €250m at stake (the bonds were very long and the rates curve was very flat when the redemption was exercised). The trustee, BNP Paribas, declined to release the security on the assets until the make-whole was paid, so the whole unwind procedure was stalled.

For all the details, see the 2022 judgment, which was followed by further procedural challenges last year, but both are fairly hard going.

Last year, a more consensual approach moved ahead, with an ad hoc group of bondholders striking a deal to clean-up the situation, and accept a lower payment in exchange for amending the deal and allowing it to be wound up.

These bondholders represented around 70% of the A1 bonds and 70% of the A2, although disregarding Santander’s holdings of the bonds, these figures rise to 83% and 74%.

This year, the deal was finally consummated, delivering a final A1 payment of €39.284 for every €1,000 bonds, while class A2 gets €109.39178 for €1,000. Both classes get early bird fees of 1.5% of the make-whole amount and voting fees of 1.5% of make-whole amount. The total available for class A1 is €34.09m, and total available for class A2 is €52.17m.

Ad hoc group members will also receive a ‘work fee’ equivalent to 3% of the make-whole amounts, and €16.8m towards professional fees incurred.

The deal will include an end to the court case, amendments to the deal documents (to strike out the ‘act or omission’ language, redeem the deal, and close off any further possibilities for action).

Meetings were held on Friday (17 January) to vote on the deal, with the extraordinary resolution passed, and bondholders due to receive payment on Tuesday (21 January).

A ‘make-whole’ is supposed to be what it says on the tin — bondholders receive everything they would have got, and are compensated for the time value of money. The call was clearly triggered through an act of the ultimate beneficiary, Santander, even if it wasn’t obviously an act of the borrower, so it seems fairly justified bondholders fought it.

It’s also quite reasonable, in 2024, to take a big haircut to the original claim to close it out and get a deal. Risk free rates have shot up, there are profitable alternative places for money to be invested, the drama has been considerable (as noted above, the deal includes €16.8m of professional fees!) and a bird in the hand etc etc. We don’t have much colour on the trading activity, but it’s quite possible the regular-way bond investors in the deal from day-one traded out, over time, to funds with the stomach for robust litigation; this is a lot of brain damage for a bond PM with other things on their mind.

A lender’s journey

European consumer lender Younited, the largest instant credit provider in Europe (according to its website) has made it to fintech nirvana — a public listing!

From a Series A in 2012 to Series H in 2022, taking it to a valuation of €1.1bn, with €5.5bn of loans originated along the way, the still-unprofitable firm has been on a journey — which underlines some of the complex issues around how to build a modern lending business.

A public listing is a major event, but hasn’t always been kind to innovative lenders.

Funding Circle in the UK, a pioneer in the original ‘marketplace lending’ wave, has almost never traded over its 440p IPO price of 2018, and opened at 132p on Tuesday. UK mortgage platform LendInvest went public at 186p, but has traded below 30bp since the end of 2023.

Younited is pivoting alongside its listing.

It intends to spend the proceeds on boosting its capital base. It’s already an ECB-regulated credit institution, registered in Italy, Spain, Portugal and Germany, and this capital will be of the regulatory kind, CET1 in the banking jargon. This capital base in turn will also allow Younited to shift from ‘originate to distribute’ towards ‘originate to hold’.

It’s already been holding a lot. Most of Younited’s funding comes through German deposit marketplace Raisin, although it notes in its offering circular this is expensive. This is Capital Markets Union in action! Younited borrows excess deposits in Germany and lends them out at better interest rates in Italy and France, without the long intermediation chain of traditional banking or the bond market.

But there’s institutional funding too. M&G’s specialty finance fund bought a €180m book of Italian loans in Italy, and committed a €120m forward flow. Citi stepped in as principal in XXXX, buying Italian assets and eventually taking them out in Youni Italy 2024-1. This deal went through the two-step process now on display with Citi’s Jubilee Place 7 Dutch RMBS; lock up the equity first and then bookbuild the rest of the stack.

There’s also a Younited-managed fund (technically a securitisation, as it sits inside a French FCT wrapper), allowing institutional and retail funding, similar to the UK products offered by Zopa, or the mortgage funds of LendInvest and Ratesetter.

But as interest rates rose in 2022, investors stopped buying the loans (9fin emphasis)

Per the listing prospectus, “due to an increase in European Central Bank (“ECB”) base rates, certain investors postponed their investments into Younited’s funds resulting in one large institutional investor representing the majority of loan purchases. Such concentration exposes the Company disproportionately to any of those investors choosing to cease participation on the Company’s platform or choosing to deploy their capital elsewhere”.

This likely hit the forward flow as well. Investors like M&G always have price requirements, expressed in terms of swap spread, but borrower expectations lagged the rise in the risk-free rate, and the platform couldn’t write much at the kind of spreads that worked for the institutions.

French origination (M&G and Citi were buying Italian loans) was also hampered by the Banque de France’s usury rate, which is based on the average rate over the previous three months, so max rates on lending lagged the rising swaps rates in early 2022.

The process took a while to play through — Younited’s average effective interest rate on origination went from 6.6% in 2022 to 9.8% — and resulted in some losses.

“During FY23, a large Italian backbook comprising mostly 2022 and early 2023 origination was sold below par.”

The pivot and the listing are also unusual. The listing will be achieved not through IPO, but through combination with acquisition shell Iris Financial, a vehicle sponsored by Ripplewood Holdings. This was a new name to me, but it’s a meaningful player; a previous listed acquisition vehicle bought the UK’s Friends Provident, much of Axa’s UK life insurance business, and private healthcare provider Bupa’s assurance business. The group also owned Citadele, a Baltics-based banking group.

Combinations are neat, and there’s some real cash coming in, but the assumptions are punchy. Having never made a profit, the business plan in the prospectus anticipates positive return on equity by the end of this year, 10% return on equity in 2026, and more than 25% return on equity in 2027.

As the prospectus notes, “The Company believes a high growth, 25%+ ROE business will be a very attractive equity security for French and other European investors.”

They are not wrong about that! It is, in the view of this author, more questionable whether good tech for a lender, which is pivoting to a very classic business model called ‘being a bank’ necessarily translates to rapidly expanding margins of the sort contemplated here.

Younited, like many fintech lenders, has thoughtfully remixed various parts of financial intermediation. What if funding came from a tech platform, or from a fund, or from asset managers, or from securitisation? What if lending could be embedded at the point of sale and underwriting could be cheap and seamless? What if it could bundle other financial products (we note with some pleasure a partnership with a guarantee firm named 'Owen')?

But remixing legal forms and capital sources doesn’t get away from the iron constraints of the business. Fund at low rates, lend at high rates, optimise the capital required to do so. It’s a fine thing to do, but it’s a hard journey to 25% ROE.

Blackstone keeps it coming

I have joked that European CMBS is now a subsidiary of Blackstone Inc but it’s honestly hard to see a counter-argument. A market that used to be a diverse tool financing offices, shopping centres in and out of town, hotels, science parks, service stations and more is now a one-trick pony, expanding the funding sources for Blackstone’s monstrous logistics binge.

Four out of five CMBS deals in Europe last year were for Blackstone, of which three were for logistics assets. Yet this was a sideshow to the largest European CRE financing in history, a refinancing for… Blackstone logistics assets. We hear talk of other CMBS deals waiting in the wings, of office buildings with cap rates reattached to reality, of digital infrastructure that must diversify, but for now, there is Blackstone logistics.

None of this should take away from the fact that Mileway, Blackstone’s ‘last mile’ logistics platform, is a force of nature. Last mile, since the pandemic, has been the hottest sector of logistics (that’s the part that directly supplies the vans seen plying every residential street in every major city all day).

Scale matters, and Blackstone absolutely delivered it; being a last-mile player with only a couple of facilities is like being a conductor with only a couple of tubas — the pitch to potential tenants is that space is available near all of the major European markets, and there’s a one-stop shop to get it.

So we come to Sequoia Logistics 2025-1. Unlike several of the CMBS deals over the past three years, the economics clearly work in a conventional fashion. Based on the marketed NOI and valuation figures, the portfolio is returning 6.6%. The debt yields are healthy. The sponsor is not, day-one, paying the entire rental income into the structure, but instead is optimising leverage to achieve a more attractive return.

Read the docs carefully; there are some curious hedging structures in there, including a 4% Euribor cap if the original deal hedging doesn’t work out. That doesn’t mean an investment bank covers the cost of any rise in Euribor above that level, it means the deal will pretend Euribor is 4% even if the rate is higher, with any excess payments subordinated in the waterfall.

One might point out 2.67% is not all that far from actual Euribor at 2.67%, and you’d be right, but it’s not totally without precedent. Blackstone baked a similar provision into a CMBS-like deal for its UK housing association, Sage, capping Sonia at 4% once hedging fell away, with excess amounts subordinated.

We discussed it here, but if you push back on it and Blackstone says “it’s the market”… they’re not wrong. They are literally the European CMBS market right now!

The pension fund that could

We had a very enjoyable discussion with Ben Levenstein, head of private markets at the UK’s largest pension fund USS.

The USS private markets operation runs a lot more like one of the Canadian megafunds than the average UK corporate defined benefit scheme, with big direct equity tickets and an adventurous appetite in credit, fund finance and more.

If you're looking for more structured credit content, make sure you read the full discussion with Ben Levenstein here.