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Owen Sanderson

Excess Spread is our weekly newsletter, covering trends, deals and more in structured credit and ABS. Find out more about 9fin for structured credit here.

Now that I have children of my own, I would never allow the Argos catalogue to enter my house. Journalism doesn't pay nearly enough to satisfy the boundless acquisitive desire of a five-year old girl.

But I remember it fondly, and, under the protective umbrella of Sainsbury's, the business has carried on successfully, pivoting to online sales collected within Sainsbury’s stores, when most of the British high street brands of my youth have restructured or imploded entirely.

What, then, to make of the sale of a large portfolio of Argos co-branded credit cards to NewDay? The portfolio is £800m of receivables, bought for £720m, and funded in part by a £60m vendor loan note. We've seen no loan tapes and modelled no collateral, but hear the process was highly competitive, suggesting seller Sainsbury's Bank scored a good result.

One could infer that, if the portfolio was fully valued in a competitive process, and still traded at 90% of the receivables balance, that the credit quality is somewhat mixed (but in the NewDay sweet spot).

It’s also a strategic addition. NewDay has been partnered with Argos since 2019, when it launched the Argos Classic credit card to Argos customers who didn’t qualify for Argos’ own store card — bringing the rest of the Argos-branded book over slots in very nicely.

NewDay’s overall charge-off rate is over 9%, but it’s very different across the book. Fitch models a steady state charge-off rate of 17% for the near-prime cards in NewDay Funding Master Issuer, and around 7.9% for NewDay Partnership Master Issuer, which houses the merchant partnership offerings.

As well as the Argos relationship, the firm has done several other partnership deals, notably launching the John Lewis partnership card in August 2022.

For those less familiar with the UK’s retail landscape, John Lewis is the quintessential middle class department store offering — it’s often the voucher of choice for wedding lists, allowing newlyweds to furnish their homes with good quality toasters and cushions.

John Lewis partnership card holders are therefore prime borrowers, something of a departure for NewDay. These card balances were placed in a separate facility, and it’s actually these middle-class skinflints that have caused trouble for NewDay. Merchant partnership cards often include deals to buy items from a given store interest-free, and cards don’t charge interest if they’re paid in full. The hope, for NewDay and other credit card lenders, is that the cards get used for interest-bearing purchases as well.

Per the firm’s Q1 results, “excess spread on other NewDay Partnership Funding facilities c.2% lower in Q1 2024 than Partnership Funding ABS facilities in part owing to lower yield from John Lewis receivables”.

CEO John Hourican said in the annual report: “The John Lewis & Partners programme, whilst seeing good customer adoption and spend, has been commercially challenging due to the prime nature of the portfolio and the higher funding cost environment”.

Further down, you get the problem — “Although spend increased significantly due to the John Lewis & Partners programme, these customers tend to pay down in full and therefore do not generate higher gross receivables”.

NewDay is working with John Lewis to figure out a solution, but the firm’s business remains very much geared to lending money at interest — and the things it is best at are risk-managing and funding unsecured credit. It’s not helpful if the customers are too well-heeled to borrow and pay interest!

Argos serves a different segment, and its customer base could be juicier. Unsecured credit can be highly seasonal; as Christmas approaches, customers will be able to raid their NewDay-provided Asda store card for presents and stack the fridge at Sainsbury’s besides.

We should also note Mark Kleinman’s latest story on NewDay — apparently the sale is back on.

I’m old enough to remember the last Sky NewDay IPO story (which was going to be £2.5bn rather than the £1.7bn talk today) and of course the sale of Together (still unclosed but that doesn’t stop the bankers trying!). Kleinman must have got wind of something though, and CVC and Cinven have been in NewDay for a very long time, so surely they’ve been sizing up the market for a while.

We’re also interested in what this means for the other great catalogue-financing tie-up in the UK, The Very Group (Shop Direct). The secured bonds have been a target for distressed funds, thanks in part to poor operating performance, negative cashflow, and a ton of noise around the shareholders (see here for a 9fin analysis). Kleinman reports price talk is apparently £2.5bn, but I suspect the headlines are a little misleading, since the stories don’t specify what’s actually being valued.

Cashflow-negative and declining Very has £2.4bn of net debt, so the £2.5bn might make more sense as an enterprise value, while in the case NewDay, with more than £5bn of assets, the £1.7bn Kleinman talk has to mean equity — and on £219m of EBITDA that seems more than plausible.

2024 has seen two new hotly anticipated asset classes placed publicly in Europe, data centres and solar loans, from Vantage and Enpal respectively. But there’s far more weird and wonderful collateral financed in the private market, some of which we could see in public markets down the road — if arrangers and issuers can make it happen.

Because I think that’s interesting, I’m going to be talking about it in a webinar on 19 November, part of the build-up to DealCatalyst’s global asset-based/specialist finance event on 25 November.

I’ve got a superb panel, featuring Gordon Beck of Barclays, Tom Cochran of Latham & Watkins, and Matt Jones of S&P — more details here and free signup here.

Investment banking is sometimes considered a risky business to be in, but the possibilities for really wrecking yourself doing retail financial services are unparalleled.

The shock 25 October Court of Appeal decision in the UK offers an excellent example of the problem. One might think the question "should you trust used car dealers" has a straightforward answer, but seemingly not.

The UK's Court of Appeal has opined on a common law fiduciary duty between brokers of financial products and their customers, with a duty on lenders to ensure this is adhered to.

The most aggressive interpretation of the judgement appears to call into question all sales on the basis of undisclosed commissions. Even 9fin's excellent salespeople, you may be shocked to learn, do not sell subscriptions on a fiduciary basis, and do get paid a commission!

Reactions in the market ran the gamut from "that's insane" to "that's %!?£ing insane", and it caused absolute chaos in the UK motor finance industry.

Lenders who are particularly exposed include Lloyds, whose massive Black Horse business already provisioned £450m for claims relating to discretionary commission (we discussed it a bit here) and Close Brothers, which saw shares down 32% from before the ruling.

Lloyds reported Q3 numbers on 29 October, and despite the warning from CFO William Clamers that “there’s not terribly much I’m going to be able to say beyond the RNS”, every question but one on the call was about motor finance.

Several lenders paused activities entirely and have been redocumenting their disclosures in short order, hoping to get back to lending soon. Cars have sat idle on dealership forecourts waiting for customers who couldn't pick them up. Asset finance transactions have frozen.

For a more sober and scholarly rundown of how we got here and what it means, I recommend this note from Clifford Chance (other law firms are available).

Basically, it’s an outgrowth of the work the Financial Conduct Authority was already doing on discretionary commission in the sector.

This was banned in 2021, but there’s been an anarchic rush of ambulance-chasing claims management firms looking to extract cash from auto lenders, to which the FCA has been trying to bring some semblance of order. The regulator stayed the payment of compensation earlier this year as it tried to work out what a comprehensive redress scheme would look like, which pushed frustrated claimants to try their luck in the county courts instead. These then kicked cases up to the Court of Appeal, prompting the controversial ruling.

It's reasonably likely, to the extent that anyone can know the mind of judges, that this will be at least partly reversed. The implicated lenders, Aldermore Bank’s FirstRand (MotoNovo Finance) and Close Brothers appealed further to the Supreme Court, which is under some pressure from the FCA and others to take the case and provide a speedy ruling one way or the other.

The potential implications of the judgement are too large to really make sense. The customers in the test cases were arguably somewhat vulnerable, but so the rulings in these examples don’t necessary mean every consumer finance contract with an undisclosed commission is invalid. Even if that is the case, should redress mean voiding the contract, or simply compensating for any excess interest that could be demonstrated to have been paid as a result of the customer's alleged ignorance about a commission arrangement? How do you figure it out?

The high end of damage estimates is very high indeed. PPI cost UK financial institutions more than £40bn. It was a large enough compensation scheme that it had meaningful monetary policy effects, helping to counteract Osborne-era austerity with massive compensation payments to the public.

A high side estimate here is £16bn, with the clearers bearing the brunt. But even a mid-range estimate could be existential for a smaller, highly levered auto lender. If, like most sponsor-owned lenders, they've used securitisation, warehouses, forward flows and corporate debt to build a highly efficient capital structure, there's simply no money around to pay out consumer redress of the kind that some equity analysts are discussing.

But if it’s reversed, no problem. There’s a danger in binary outcomes. Splitting the difference between a thing that happens or doesn't is guaranteed to be wrong — so this decision doesn’t imply it’s wise to dump auto bonds.

For a start, there just isn’t a huge amount of UK paper issued by the levered non-banks — Oodle’s Dowson shelf is the largest, to which one could add Blue Motor Finance’s Azure and Startline’s Satus.

For another thing, there’s a good chance these thinly capitalised originators won’t be touched. While this decision is broader than the original discretionary commission probe, Oodle, for example, had no discretionary commission arrangements, according to the investor presentation for Dowson 2024-1, launched on 9 October.

There’s also a robust-seeming rep in the docs for the deal referencing commission disclosures — though this is not in Dowson 2022-1.

For what it’s worth, the last Azure deal, priced in April 2023, had a similar rep, while Satus from April this year reps that it has no discretionary commission, but doesn’t rep disclosed commission.

Pimco I consider an endlessly interesting institution, and I think the firm’s role as the whale par excellence in European asset-backed markets is under-appreciated in the world at large. All the ink spilled every time Monzo buys a new pot plant for the lobby, and very little on the fact that Pimco owns more UK consumer lending than any bank below ring-fence size.

One of the most distinctive Pimco behaviours is buying deals unlevered but securitising them anyway, which in turn is a function of the unusual fund structure through which it typically bids portfolios, using the retail cash held within the income fund complex.

This is quite distinct from the hedge fund or private equity closed-end institutional funds used by every Pimco competitor for portfolios. Cerberus, DK, KKR, GoldenTree, Blackstone, Apollo, M&G, Lone Star, Fortress, Elliott or whoever else use securitisation for the leverage, not because it creates securities. They care about advance rate and price; format is just a step on the way

But Pimco is now raising a Specialty Finance Income Fund, looking to capitalise on the regional bank retreat in the US, but also adding further private funds.

Surprisingly, this is the first private Pimco fund of its kind. There are ton of Pimco vehicles which touch the asset-backed universe, including not only the income funds but Pimco Tactical Opportunities Fund, Pimco Flexible Credit Income, Pimco Private Income Fund and Pimco Diversified Lending Fund.

The old Bravo funds and the credit opportunities fund have been known to dabble too. The first Bravo vintage hoovered up RMBS from motivated sellers in the immediate post-crisis period, though the strategy has strayed from the light a bit — the biggest trade in Bravo IV was the $4bn acquisition in 2021 of one of the US’s largest office reits, Columbia Property Trust, funded with floating rate CRE mortgages. You can probably run the lines forward yourself, but some of the CMBS was already defaulting in 2023, and to add insult to injury, the most valuable building in the portfolio was Twitter’s San Francisco office, on which Elon Musk decided to stop paying rent.

The first close of the new Specialty Finance Income Fund last year was at just $411m, most of which came from a single account, the New York State Common Retirement Fund, which committed $375m, according to its public records. Now it’s raised around $700m in the main fund, but around $2bn in another related sleeve — firepower more in line with the large asset-based offerings from its major competitors.

Of course, firepower has never been the Pimco problem, at least in Europe. It’s won a clear majority of the large performing portfolios up for sale in Europe for years, and sees scale as a clear strength — there’s only a few funds that can do sizes like the UKAR portfolios, so in theory at least, this counteracts the “winner’s curse” in a bidding war.

The Pimco presence has even encouraged more leverage-hungry institutions to head up into investment grade bonds and take down full capital structures in order to win portfolios — if you’re up against a bidder that will buy and hold everything, then one tactic is buy everything first and sell bonds on at your leisure.

It’s hard to imagine the new funds making Pimco even more hungry, but it would help the broader market if it gave Pimco more appetite for leverage — more bonds for everyone. Bring on the Specialty Finance Income.

Staying with vexed questions of motor finance, we've had a few discussions lately about rental company Europcar. It's facing two interlocking problems.

Number one, too many cars which aren't worth enough. This is a problem familiar to the creditors of electric car subscription platform Onto, and which has troubled levered lessors like Zenith. Used car prices surged thanks to the supply chain problems of 2022, to fall back with a bump in 2023, exacerbated by prices cuts on new vehicles as OEMs tried to get volumes moving again.

Number two, in the case of Europcar, is a lacklustre rental business. EBITDA dropped more than 100% at the last reporting date, prompting downgrades to the corporate bonds (now B3/B). See here for an excellent analysis from 9fin’s Ameeq Singh on the company’s performance and its bond refinancing prospects.

The fleet is too big, not valuable enough, and it isn't getting enough use. Europcar went hard on battery electric vehicles, and these are even worse; customers don't want to pay a premium to rent them, despite the lower fuel costs, as they're unwilling to trust the charging infrastructure in unfamiliar territory. It also tacked towards “at risk” vehicles in the last couple of years, rather than “buy-back” vehicles — meaning it’s been more exposed to residual value (buy-back means the OEM guarantees the value).

Europcar's fleet is funded mostly through private securitisation facilities. The main SPV funding the fleet in France, Germany, Italy and Spain is FCT Sinople, but there are others, including facilities for the UK, Australia and New Zealand, and a facility for the US fleet.

On the crucial question of “how many lines and boxes are there”, Europcar scores extremely high, as you’ll see below.

The fleet senior debt is mostly relationship banks — Credit Agricole CIB arranged it, but there’s a full suite of big French banks involved (BNP Paribas, Natixis and Société Générale) as well as Deutsche Bank, Lloyds, RBC, HSBC and ING. Bank of America stepped out in 2021.

What makes Europcar particularly interesting is that the bondholders do have some direct fleet security — and benefit from an easy-to-trip 95% LTV covenant on the fleet, broadly considered.

To that end, Europcar has been dripping cash back up to the securitisation. All fine while there's enough cash, but the company is facing some state-backed loan amortisations, a bond maturity in 2026, and has little RCF headroom.

The bull case for Europcar is a simple one. Volkswagen owns it, having bought it in 2022, trumpeting it as a key plank of its "Mobility Solutions" pivot. Car-as-a-service, and indeed VW itself are starting to look a lot less shiny these days, but the amount of money involved for a quick liquidity infusion would be small change for VW. On the other hand, if Europcar really needs to right-size its cap stack, what’s the point of chucking in more cash?

If Europcar just needs a quick liquidity infusion (or more implicit support through the fleet), VW can handle it, but what if it needs a smaller capital structure?

One thing VW probably doesn't want, which makes it different from a standard financial sponsor, is a disorderly outcome for the fleet.

VW's brands are stunningly valuable (it records intangible assets of €91bn). It doesn't want customers to rent tatty beaten-up VWs (or Audis or Skodas or Seats) from continuity Europcar when they go on holiday. It doesn't want a fire-sale of VW-branded ex-rentals depressing used car values and knocking the reputation for German quality that enables VW to command premium prices in the new car market. While bondholders are partly secured on the fleet, any outcome which actually enforces on the fleet security or comprises Europcar's maintenance and capex probably has knock-on impacts for VW.

PS: Owen Sanderson is hosting a webinar, in collaboration with DealCatalyst, on how to take esoteric assets out in public. For more information, and to sign up, click here.

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