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Talking about a revolution

Most fintechs do not change the world, and most don’t set out to do so. They do existing things better, faster, smoother, more pleasantly, or serve hitherto untapped niches in credit, data, or payments. They work within the system, not seek to overturn it.

Perenna is different. It’s a mortgage lender, but a mortgage lender which sought root-and-branch reform of the UK mortgage market. The plan was to bring the benefits of the Danish system, and particularly the benefits of fixed-for-life mortgages, to the UK market.

The question of who bears the interest rate risk in home lending is absolutely fundamental. A home loan is the largest piece of borrowing most households undertake, and residential lending is the largest debt market in most advanced economies.

Radically different models exist. In the UK, interest rate risk is borne mainly by the borrower, who will fix their interest rate for two or five years, refinancing on market terms thereafter, repeating the process over perhaps 20 years.

In the US, bondholders of agency RMBS largely bear this risk, and borrowers can obtain a 30-year fixed rate mortgage prepayable at the borrower’s option. In Denmark, too, bondholders bear the risk, via a deep and liquid mortgage covered bond market which matches maturities and coupons with the underlying home loans.

Pushing interest rate risk to bondholders has two major advantages — borrowers benefit from greater certainty over payments, and the ability to borrow more, because they are insulated from possible interest rate increases. Potential bondholders have a deep pool of risk-free liquid assets manufactured for them.

But however compelling the pitch, it’s hard to flip an entire system. In the 30 years between 1992 and 2022, allowing borrowers to be long interest rate risk in the UK was generally a benefit, as rates mostly trended down. The large and concentrated UK banking sector finds existing arrangements congenial, raking in product fees for each refinancing (and sitting on a pile of assets whose interest payments adjust to market conditions).

So Perenna has been on a long journey. Founder and chief executive Arjan Verbeek started working on the project after leaving BNP Paribas, where he had structured and originated covered bonds and ABS, in 2013.

He has worked tirelessly to explain the benefits of the new model, the benefits of fixed-for-life mortgages, the problems of LTI caps and existing stress tests, the benefits to pension funds and more, across conference panels, blog posts, regulatory submissions, think pieces and, crucially, investor pitches.

The Perenna dream caught the imagination of a few securitisation professionals. Kevin Flaherty, who ran Deutsche Bank’s European securitisation syndicate desk for more than a decade to 2012, is an investor. Angela Clist, a veteran securitisation partner at A&O (latterly AO Shearman) is an investor, and interim chair of the board. Kris Gozra, former treasurer at Coventry Building Society and Paratus AMC, is an investor.

But the biggest backer is SilverStripe Investment Management, a family office-backed financial services investor, which provided $30m in 2022 and a further $52m in 2023.

2023 was a turning point. Perenna obtained a banking licence, and could start lending from October, flush with its new capital injection. In early 2024, it obtained a £200m warehouse line from ABN Amro, giving a more efficient funding source for the loans (prior to covered bond issuance of course).

By this time, the operation was getting sizeable; records from Companies House show 47 employees in 2022, before the company had written a single loan, and 65 at the end of 2023. Getting a banking licence is a heavy lift, costly in management time, compliance staff, bureaucracy and approvals, and the 2023 accounts show £10m in staffing costs and a £15m loss overall for the year.

This was, admittedly, a year when the firm was mostly not lending, and the balance sheet showed £2.8m of commitments (mortgage offers which haven’t yet funded), presumably originated since Perenna opened its lending doors in October.

For a point of comparison, in 2023 Enra Specialist Finance had 101 employees, while Belmont Green (now Vida Bank) had 180 — a heavier staffing burden, but these institutions had £1bn+ mortgage books at the time.

Anyway, a year into Perenna’s journey as a bank, it looks like it’s going to be hard to achieve the dream.

Verbeek is off the board, according to Companies House, and out as CEO, according to the FCA register. Perenna will doubtless keep originating, but without the visionary that spotted a chance to change the whole mortgage market.

Whether that means a wholesale strategy pivot is harder to say — the company is keeping schtum.

Pending any revolution, it’s hard to write business at the long end. Several lenders have tried to introduced longer-tenor mortgages or long fixed periods (though without Perenna’s grand ambitions), and struggled to crank up origination.

Habito was one example, writing its Habito One product, funded through a forward flow with CarVal. The startup shut its door to new lending, but the portfolio found its way to market in Bletchley Park Funding 2024-1…. and was just £15m at the time. Figures from uswitch show 63% of UK mortgage quotes are for two-year deals, with 27% for five years. 10 years clocked in at just 0.6%.

Perhaps a less ambitious middle way could have worked — get the mortgage licence first, and start originating loans into a forward flow, instead of running up costs and headaches to get a banking licence.

Still, a banking licence is a valuable piece of property, and it’s certainly possible for Perenna to pivot at this point. The work of taking in deposits and lending out mortgages might not add up to a revolution, but it should keep the lights on longer.

Deutsche’s deal

Press releases about partnerships are all the rage, but hide a multitude of structures. We talked a lot a couple of weeks back about JP Morgan’s JV with Quilam Capital, a genuine partnership benefitting both sides, as well as a trade — it’s given concrete form through a large securitisation structure.

But this week another partnership breaks cover, this time Deutsche Bank and DWS, which are announcing: “A strategic cooperation to develop private credit origination and investment opportunities for DWS clients across the private credit space. As part of the cooperation, DWS will have preferred access to certain asset-based finance, direct lending and other private credit asset opportunities originated by Deutsche Bank.”

This is a different animal again. There are deep links between Deutsche Bank and DWS, which were literally under the same roof seven years ago, and even now, following a listing of a minority stake, remains majority-controlled by Deutsche Bank. The chief executive is Stefan Hoops, formerly head of the corporate bank at DB, and heading over to DWS to lead its private credit effort is longtime DB structured finance banker Pat Connors.

Unkind folk in the past sometimes questioned Deutsche Bank’s ability to cooperate with itself, but that’s all water under the bridge. The bank is now thoroughly prepared to cooperate with its own investment management subsidiary — though being wound down at the same time is DB Investment Partners, a private credit unit fully within the Deutsche Bank perimeter.

The DWS-DB cooperation deal is opposite in a number of ways to the JPM-Quilam setup. In that deal, Quilam brings the origination and JP Morgan brings the money.

In the Deutsche-DWS cooperation, Deutsche Bank brings the origination, and DWS brings the money (though some reporting, for example this from Bloomberg, suggests DWS has been struggling to raise).

At least in the release (the companies involved are staying quiet), there’s nothing about picking spots in the capital structure, or Deutsche Bank levering DWS assets; it appears that the “preferred access” to origination is the heart of the cooperation arrangement.

So here are some questions about “preferred access”:

Preferred access could mean DWS gets first look at Deutsche Bank origination. Would that mean all origination through the asset-backed and private credit teams, or only those parts Deutsche was planning to sell anyway?

Deutsche Bank has an active principal finance business within its asset-backed group; will this group switch to originate-to-distribute-to-DWS? That would be less lucrative, so presumably the bankers involved wouldn’t like it. Structured finance has been a quiet but important engine of profitabilty within the Deutsche Bank credit business, in part because Deutsche has been willing to take significant principal swings, rather than just clipping senior coupons.

The most important question is “preferred access at what price”.

If preferred access means that DWS gets to buy Deutsche-originated assets at below-market prices, that will prove very controversial inside Deutsche.

All else being equal, the best price will be achieved by selling assets through a competitive process. Deutsche Bank has great distribution and great connectivity to the funds active in private credit and asset-based finance; what are the odds that DWS will always be best bid for every asset? And if you put loan portfolios, warehouse mezz, unitranche loans, fund finance or whatever else out to a general bid, what’s “preferred” about the DWS access?

There’s a significant cost involved in private credit or asset-based origination. For smaller deals it shows up as search costs and structuring, for larger deals shown more widely it’s more about bidding on transactions you don’t win. If Deutsche Bank is doing this for DWS, how will Deutsche’s bankers or their profit centres be compensated? Does “preferred access” mean selling assets to DWS above market to compensate DB’s bankers for their origination efforts?

So it looks like Deutsche Bank is bringing the most to the table for this partnership. It’s bringing origination, talent (Connors is transferring), and a more compelling fundraising pitch (DWS can cite ‘proprietary dealflow’ from the partnership). DWS can derisk certain position for Deutsche Bank, but I’d wager the DB team, if they had the choice, would want to deploy more capital into asset-based opportunities rather than share the bounty.

DWS is not yet a huge asset-based finance shop in its own right. It’s done some interesting deals (examples include financing for Enpal and a chunky £100m ticket for UK adtech financier Revving) on its own, but it’s not a top tier player in either asset-based credit or corporate private credit. It’s been starting a CLO platform, but one of the PMs who joined to launch it has already left, and is heading to Silver Point.

Connors, who’s coming in as global head of private credit at DWS and reporting to the CEO, has been running one of the Street’s biggest asset-based finance principal shops for years; with or without the cooperation agreement, you wouldn’t want to bet against his ability to ramp up DWS. If bankers do indeed do it better, he’s one of the most senior and best-connected in the space.

Whatever the partnership entails, it comes alongside the shuttering of Deutsche’s internal private credit unit DB Investment Partners. This venture was launched in 2023, and “established to give institutional and high net worth clients access to private credit investment opportunities”. Now it is being wound down, with some of the bankers involved placed at risk; chief executive Raheman Meghji and portfolio manager Appu Mundassery already appear to be starting a new fund, Double Black Partners, according to their LinkedIn profiles and Companies House filings.

We dig the name: does it refer to skiing, gambling, or Johnny Walker Double Black, all of which can play important roles in the life of an enterprising private credit fund manager? It shortens to DB, of course, or perhaps it’s a nod to the Blackstone/BlackRock double act. Twice as black as those guys, twice as good?

Getting Closer

Much of the UK finance industry will be crossing fingers for the Supreme Court hearing on 1 April, when Hopcraft and another v Close Brothers Limited will be heard. The case was called Hopcroft when it was in the Court of Appeal but presumably this and any other wrinkles will have been ironed out.

This is, of course, the case concerning commissions in motor finance, which caused chaos following the Court of Appeal judgment in October, and has already wracked up some chunky provisions from the UK’s largest lenders. Lloyds has reserved £1.2bn, Santander UK £295m, Barclays £90m. Of the smaller lenders, FirstRand (Aldermore) has reserved £140m and Close Brothers £165m.

There is, in short, a lot of money riding on the Court’s ruling, and any subsequent redress scheme. Although potential damage has already been chewed over, Close Brothers’ shares took another 20% dive on Tuesday (18 March), as the chunky provision took it to a £100m loss for the half year period, while other capital actions such as the cancellation of the dividend also took their toll on shareholders.

Most intriguingly, Close Brothers flagged that it had an SRT ready to go referencing the Motor Finance book, with other SRTs potentially in the works as capital demands require it.

An SRT deal referencing the very book at the heart of the problems is going to be a complex deal indeed. If Close Brothers means a cash deal (it’s an active securitisation issuer through the Orbita shelf, though the last deal was retained) then careful handling will be required to ensure investors bear credit risk, and not redress risk. If any redress takes the form of, for example, loan principal writedowns, then separating that out would be painful indeed.

A synthetic transaction might be easier, because it doesn’t require segregating the assets to the same extent — just tight drafting of the credit event conditions to ensure that redress-related restructurings don’t creep in.

It would still be a complex deal for investors to get comfortable with, but it’s not unprecedented — Santander UK issued Motor Securities 2024-1, a synthetic deal referencing an auto loan book, late last year, once the Court of Appeal chaos was well under way.

The way this transaction handled the judgment was basically through robust buyback commitments.

“If any of the Reference Obligations are found to be unenforceable as a result of the Court of Appeal judgment, such Reference Obligations would constitute Non-Compliant Obligations and will be removed from the Reference Portfolio”

and

“In the event that Santander UK reduces the outstanding principal amount of a Reference Obligation following a complaint from the Reference Borrower, or as a result of the operation of law, by way of the operation of any set-off, or in response to any guidance, instruction of rules issued by the FCA or any court judgment, the Reference Obligation Notional Amount will also be reduced accordingly. Any such reduction would not constitute a failure to pay the relevant amount by the Reference Borrower, and thus would not of itself constitute a Credit Event.”

In other words, the deal could end up unwinding rapidly, if any post-Court redress scheme proves sizeable and comprehensive, but investors are insulated from bearing these redress risks.

Counterparty risk remains (and Santander is more able to take its £295m provision on the chin than Close Brothers with its £165m) but it looks like the technology works — and the fact that Close Brothers is contemplating this move shows the flexibility of the SRT product today.

It’s not just about loan hedging and capital optimisation; it’s now a viable tool for a bank that might need to shore up capital in fairly short order.

Me IRL

Big conference week coming up. Sadly I’m not at the Dutch Securitisation Event in Amsterdam on Tuesday, but I’m moderating a session at Invisso’s Private Credit Connect event on Wednesday (26 March).

We’re looking at “ABF and SRT as a tool for bank capital relief”, and I’ve got a great panel featuring Frank Benhamou at Cheyne Capital, Matt Jones at GoldenTree, Jiri Krol of AIMA, and Pascale Olivié, who runs Société Générale's risk transfer programme. To be honest I’ll probably just sit back and let them do the talking, but do come along!

If you’re keen for much much more SRT content, then Thursday is the day for you, with Invisso’s SRT Symposium. I’ll be there all day, and my colleague Celeste is moderating the investor session, featuring Charis Edwards at Orchard, Benedetto Fiorillo at Bayview, Kaikobad Kakalia at Chorus, and James Parsons at PAG.

Hope to see you all soon!

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