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Last Excess Spread of summer — see you all again 4 September for some more securitised action.

We’re heading into a traditionally quiet period for the primary market, and there’s always the chance of some low-liquidity jitter trading through August, but all eyes are turning to September.

Give your local syndicate professional lots of care and appreciation through August; all evidence indicates it’s going to be fast and furious come September. With a heavy primary slate coming, some issuers will be tempted to come early, hoping any residual holidays in the last week of August will be balanced by more attention and a less fatigued market.

September is also likely to fire the starting gun for any bank disposal processes that need to be squared away before year-end; any shorter than that and it’s a rush to get done before 31 December balance sheet.

We think this space will be particularly active. Banks have shed the assets that really drag the balance sheet, but there’s still lots of “optimisation” to go. Stage 2 assets (underperforming since origination) receive lifetime expected loss accounting treatment since the introduction of IFRS 9, rather than the previous one year expected loss treatment.

In plain English, that means higher provisions as soon as credit goes south — which means banks are more willing to sell these assets, having already taken the P&L impact of any deterioration. Regulatory stress tests are also unkind to these portfolios, so there are good reasons to ship them out to the buyside.

Of the UK institutions, Barclays has been selling non-core assets (Italy, Germany) and selling deconsolidation deals backed by some of its Kensington origination.

Lloyds has been feeding the Pimco beast with RPLs, consumer loans and car loans, Santander has been pushing out portfolios (the deal which became Hazel Residential in the UK, RPL portfolio Flamenco in Spain) as well as furiously executing front book SRTs in both cash and synthetic format.

But NatWest and HSBC have been quieter, at least with respect to UK deconsolidations. HSBC sold off its French mortgage portfolio (Rothesay won, as we thought it might) and is marketing Australia, and both banks are active users of synthetic SRTs.

But so far, they haven’t done as much as their peers when it comes to cash deconsolidations (in recent times; RBS’s journey from a £2.2trn balance sheet in 2008 to £708bn in 2024 obviously involved quite a lot of selling).

How should prospective sellers approach these transactions? One of the most obvious differences between sellers comes down to who does the structuring.

In the string of Lloyds disposals, the format has been essentially a prebaked securitisation structure, worked on by the Lloyds securitised products group (sometimes with sellside advice from Citi, Morgan Stanley or Alantra).

Santander has approached things differently. The SRT group has worked on the many, many synthetic SRTs out of the different Santander entities, the securitised products group has done the true sale SRTs on autos and consumer books, but Hazel and Flamenco were sold as whole loan books for someone else to structure (Morgan Stanley in the case of Hazel, yet to be structured for Flamenco but it’s going to be Goldman).

That’s not for lack of expertise within the broader bank (you don’t get to a place of doing an SRT every couple of weeks without a lot of that) but probably reflects Santander’s less centralised structure and approach.

It also depends on a certain view of the potential buyer base. A prebaked securitisation only really makes sense when all of the potential loan buyers are going to use securitisation — if there are bank buyers or insurers in the mix, they’d rather own whole loans or do their own internal structuring — but the argument in favour is that it levels the playing field to an extent; everyone has access to the same leverage.

Docs points can be more streamlined as well; there may still be room for negotiation, but there’s the starting point of a ready-made securitisation, rather than a blank sheet of paper. When the collateral is more complex, and servicing arrangements more delicate, as in RPL portfolios, documentation can be difficult too.

The in-house approach also keeps the fees in house as well. It might not worth this way in practice, but in theory, potential bidders ought to knock their own structuring and arranging fees off their bid price. So if you have the capabilities, why not get the better bid and recycle payments into the investment bank?

Happy Hopcraft day, we hope

The UK’s Supreme Court judges are heading off on their holidays too, but not before delivering one of the most consequential judgments in the history of UK consumer finance, the ruling on the Hopcraft appeal.

As a reminder, this is the case concerning commissions paid to brokers for auto loans.

The UK’s Court of Appeal briefly broke the whole auto finance market at the back end of October last year, with a judgment that suggested undisclosed commissions were unlawful, and that, in some cases, credit brokers owed a fiduciary duty to their customers.

The legal technicalities are a bit more subtle than that, and there are various resources available if you want to go deep (this is a good one), but despite the unanimous decision of three of the most learned judges in the country, there are some reasons to doubt whether their broader conclusions stand, and the judgment itself refers some matters to the Supreme Court.

But if the basic Court of Appeal approach stands, the gist is that most of the auto financing in the UK up to October 2024 could be open to challenge on grounds of misselling.

The Court of Appeal ordered the Hopcraft credit agreement unwound, held that lenders were accessories to the dealers’ breach of duty, and ordered the lenders to pay compensation equal to the commissions paid, interest on those amounts under the relevant financing agreements, plus interest on those combined amounts at an appropriate commercial rate from the date of the agreements.

This has prompted the biggest lenders to take massive provisions (£1.15bn for Lloyds) and activated trauma memories of the PPI misselling scandals among banks analysts and management teams.

Close Brothers has been in the eye of the storm, as one of the parties in the case and the appellant to the Supreme Court. It has proportionally one of the largest auto books among UK lenders, and shares were down 20% on the Court of Appeal’s judgment.

Close and FirstRand, the defendant in linked cases, appealed the judgment to the Supreme Court, in a case which was heard in April. This was moved up the Supreme Court’s agenda, because time is of the essence; with billions of provisions hanging in the balance and claims management sharks circling (you’ve probably got the spam calls or seen the ads) the industry desperately needs certainty.

That certainty is due to arrive on Friday, after market hours. Here’s a good summary from Clifford Chance of what to watch out for: the Court is expected to rule on the duties of credit brokers and what level of disclosure must brokers and lenders give their customers.

The judgment might be followed by a change in the law, with the Financial Times among others reporting that Chancellor Rachel Reeves is looking at contingency plans to shield lenders, and it is also likely to be followed by a proposed redress scheme from the FCA, which is desperate to cut off the chaos of ambulance-chasers around auto finance and restore some order to the market.

The regulator wants a fair scheme that’s open to everyone, rather than a situation where the sharp-elbowed exploit the lower courts and Financial Ombudsman Scheme to extract cash from the lenders — but it’s been unable to design such a scheme ahead of the Supreme Court’s decision.

Next week your law firm of choice will probably be on hand for guidance — Clifford Chance is doing a session on Tuesday, Hogan Lovells, and Simmons & Simmons are doing webinars on Monday, others are doubtless available — and apparently some optimism is creeping in among the analyst community ahead of the judgment.

We’ll be covering the fallout (if there is any) as it happens. A downside outcome could be existential for some smaller and more levered lenders, while the exact structure of any redress scheme matters, and the exact reps and warranties language could come into play.

Loans which are, in retrospect, missold might be eligible for buybacks by the originator, and the structure of any set-off arrangements could also trip up securitisation transactions.

If any compensation payments travel with the loan, and end up set off against future payments of principal and interest, that could hit some securitisations hard, but of course if the reverse is true, that’s especially bad for the originators — pay out when you’re no longer even receiving the benefits of the loan.

The largest exposures are from lenders with limited securitisation activity — the last Close Brothers auto ABS to be distributed, Orbita 2022-1, has seen the placed senior tranche amortised down from £298m to just £4m, while the 2023 edition was fully retained. Lloyds doesn’t use its Black Horse auto collateral for funding (though it sold a large book in Cardiff Auto Receivables Securitisation 2024-1 in August last year), while Santander UK has a programme of risk transfer deals, Motor Securities, referencing auto collateral.

Fingers crossed!

You know what’s cool? $20trn

KKR may be doing well at the fundraising, having procured a very healthy $6.5bn for its new asset-based finance fund ($5.6bn in KKR Asset-Based Finance Partners II and nearly $1bn in SMAs looking at the same opportunities).

But it needs to up its game in the arms race to say the biggest number for the asset-based finance market opportunity.

In the latest fundraising announcement, Dan Pietrzak, global head of private credit, puts it at $6trn, with projections to exceed $9trn by 2029.

Apollo, no slouch at the ABF fundraising either, puts the ABF opportunity at $20trn+ today. No disrespect to KKR but come on, allocate to Apollo there’s WAAAAY more addressable market there.

To be serious for a moment, this is a very wide bid-offer! Both institutions define asset-based finance broadly, looping in markets like aircraft leasing along with granular consumer assets, though they exclude commercial real estate and infra, which some firms do loop in to the asset-based box.

KKR says its figures come from: “Integer Advisors and KKR Credit research estimates based on latest available data as of March 31, 2024, sourced from country-specific official / trade bodies as well as company reports. Represents the private financial assets originated and held by non-banks based globally, related to household (including mortgages) and business credit. Excludes loans securitized or sold to government agencies and assets acquired in the capital markets or through other secondary/ syndicated channels”.

Integer is led by Ganesh Rajendra and Markus Schaber, whose judgement and analytical skills we rate very highly, so this does seem like the more credible figure — and it appears to be based on the actual facts on the ground, rather than Apollo’s more optimistic “What ABF could be if banks sold all of their assets” calculation.

In a European context, the interesting part is the relatively limited presence of these megafirms around the biggest portfolios, where Pimco overwhelmingly seems to win out. Pimco, eschewing external leverage, also puts far far more money to work.

KKR’s European trades include buying the consumer loans from Orange Bank, owning some large originators (Oodle and Pepper Money for example), and winning Project Danube, the PayPal Europe BNPL book. But even a megadeal like Danube doesn’t necessarily mean putting that much money to work.

The press release for Danube cited a €40bn arrangement (reflecting the rapid turnover of BNPL loans); the actual deal size was €2.94bn, but this was highly levered, with a senior tranche of €2.5bn and mezz of €170m. The junior notes held by KKR were €265m, a decent ticket to be sure, but it takes a lot to execute this kind of deal, and it’s pretty rare to get a portfolio of this size to look at.

Oodle and Pepper, rather than funnelling unlevered assets to KKR or its insurer Global Atlantic, still take plenty of external leverage through warehouses or term securitisation, as does Apollo’s UK mortgage business Foundation Home Loans, or its equipment lessor Haydock. The narrative of the alternative asset managers

Apollo is often around bidding processes (it bid Tampa, HSBC’s French mortgages, bid Sayara, BBVA’s Spanish RPLs and won Malbec, a recent CaixaBank’s NPL deal) but at least in performing assets, it seems to be looking for bargains, rather than putting on Pimco-beating pricing.

Of course, part of the private credit pitch (of which ABF forms a part for these alternatives firms) is that they originate off-market opportunities, so perhaps there’s a huge amount of deployment is going on below the radar. Certainly Apollo’s string of eyecatching private IG trades reinforces the message that if you need, say, $10bn in a hurry and have some assets to pledge, they’re probably the place to go.

But most sellers aren’t quite so desperate. Outside of a financial crisis, any prudent institution with billions of assets to dispose of will structure a process which is competitive and price-driven.

At the same time as KKR announced the new fundraise, it also announced a deal with Harley Davidson Financial Services, in which KKR and Pimco will take an originator stake, as well as buying more than $5bn of existing retail loan receivables and funding a five year forward flow arrangement, in which Harley Davison Financial Services will keep roughly a third of origination and the two funds will buy the rest.

We’re not close enough to the process to know much about the bidding, but Harley Davidson CEO Jochen Zeitz said on the latest earnings call that more than a dozen parties had bid over three rounds.

Assuming the portfolio has been efficiently levered, at least on KKR’s side, it also comes with the big book / small deployment problem — Harley’s last motorcycle loan ABS had triple-A notes with just 5% credit enhancement, so if KKR got leverage down to single-A or more, the actual cash deployment might be maybe 2-3% of its portion.

If it has half the initial $5bn, maybe it’s only actually putting down $75m of its own for the assets, plus whatever the equity stake cost. At this rate, KKR just needs to win the next 85 portfolio sales of $5bn or more, and the new fund should be fully deployed!

Double trouble

Summer is here and it’s time to do data stories. We crunched a few selected numbers from Lloyds reporting, to gauge the hard facts behind the reboot of the franchise over the last four years.

Honestly, it’s impressive stuff — the bank has roughly doubled its exposure to securitisation as an investor, a line item that includes public bonds bought as well as private warehouse lines committed, and excludes both the Cancara conduit and the retained piece from the deconsolidation deals such as Bridgegate and Performer.

To put hard numbers on it, that’s an increase from £10.87bn at the end of 2020 to £20.72bn at the end of 2024, a period where the bank also staffed up its securitisation operation (after a self-inflicted de-staffing driven by 2020’s donut payment). This came with a renewed focus on third party clients (as well as a lot of

Lloyds is far from alone is allocating more balance sheet to direct securitisation investments over the period — higher base rates have meant banks from the smallest challengers to the mightiest GSIBs have seen value in buying securitisation bonds. For a securitised products business, that can mean originating-to-distribute-to-themselves; the value is not just in lending money to get access to a capital markets takeout fee, it’s in lending money because it’s a good risk-reward in its own right.

The Lloyds disclosures don’t break out the asset classes in much detail, but it’s been a broad-based rise across STS and non-STS alike, with the largest line items in residential mortgages, “other retail exposures” and lease and receivables — pretty much what you’d expect if you’d followed the deals Lloyds has led and financed over the period.