By design, they’re hard to call, since regulators want the credit protection in place for good times and bad, so you’re stuck with a deal and a counterparty for the long term. Hence, goes the argument, it’s best to keep the market private and clubby, so these negotiations can be conducted between long term counterparties in a repeated relationship game.

But this is not an insurmountable problem. If there are more investors deploying more capital into the space, SRT docs will probably get looser (and more standardised). Issuers won’t need to ask for as many amendments if they already have very issuer-friendly terms!

That’s not necessarily what the investors raising money for the space would want to see, and absolutely not what SRT investors of long standing want to see, but plenty of capital markets function quite happily on more or less these terms. In more liquid, syndicated markets, structuring desks can predict with some accuracy how much given terms are worth. In leveraged loans, HY bonds, US CMBS, RMBS, there’s a menu of features and flexibilities which might add or subtract cost, and generally these have converged towards flexibility in times of strong market conditions. It’s more art than science, but it’s a manageable problem.

US capital markets in general trend towards standardisation and liquidity, but the peculiarities of the US regulatory regime for SRTs probably give it a further push. Structuring the deals via a credit-linked note runs up against a size limit ($20bn in total), and it is somewhat annoying to manage (requiring regulatory “reservation of authority”, and reducing protection where there are maturity mismatches), but SPV structures sponsored by banks are worse, requiring careful navigation around tax issues, Volcker Rule ‘covered funds’, and CFTC commodity pool rules and exemptions.

Investors have increasingly been setting up their own SPVs, taking care of the legal pain. This is a competitive advantage in originating deals, especially from regional banks early in their SRT journey, but also puts these investors firmly in charge of any further risk distribution, retranching and relevering. If issuers appreciate the convenience of facing an investor-sponsored SPV, this comes at the cost of giving up some control of what happens to the risk later on.

The very fact that the US SRT regime requires such thick tranches (12.5% standard) also points in this direction. SRT investors from the hedge fund and opportunistic credit worlds don’t want a fat slice of IG-equivalent mezz risk, so they’re going to lever these up, or look to retranche and pass on the IG mezz to a more suitable capital provider like an insurer.

Using trading desk leverage sends risk right back into the banking system where it came from, and it also brings trading desks into much closer contact with the SRT product. Traders also generally like trading, and the natural extension of being a financing counterparty across a lot of SRT transactions is to look to find a way to move bonds from time to time. The European market did see a spate of trading in spring 2020, when a fund was blown out by margin calls and liquidated its SRT positions, but that’s more a desperate attempt to cope with crisis conditions (the bonds were absorbed very well!) than a foundation for market liquidity.

There was also a certain amount of discussion about using cash risk transfer structures more in the US, which have none of the structural and regulatory issues associated with synthetics. In a way this is odd; the US major banks have massive ongoing shelves packaging up and distributing mortgage portfolios and CRE loans. It’s no doubt skilled and interesting business in the details, but it’s absolutely routine.

JP Morgan this summer, though, issued a cash deal packaging Chase-originated home loans, keeping the senior tranche in loan format and distributing the junior to achieve said “risk transfer”.

This was heralded in certain quarters as “a new type of mortgage credit risk transfer”, but honestly I’m not so sure; this looks more or less the same as all of the Lloyds disposal deals, Barclays Italy, Gemgarto 2023-1….or even tiny Tandem Bank just last week. It’s a new type of mortgage credit risk transfer, known otherwise as “selling mortgages”?

Still, the format works well, and probably emerges from a different place within the JPM empire, with a different rationale from its regular RMBS repackagings. To the extent that the major banks follow suit, it still fits the megatheme of banks recycling their own risk into the asset-backed world, and adds to the menu of choice available.

Masterful

Maybe I just miss home, but it’s nice to see Capital on Tap’s London-themed financing plans take a step forwards. Following two standalone issues, London Cards No. 1 and 2, the SME credit card provider is putting together London Cards Master Issuer, as a longer term platform for capital markets and bank funding.

Traditional mortgage master trusts might be a dwindling market (does Lanark get mothballed now the Virgin / Nationwide merger is done?) but it’s a compelling format for credit cards, the best way yet developed to turn revolving debt balances into fixed term bonds.

Actually, I may be exaggerating the decline of the mortgage trust. Coventry Building Society launched Economic Master Issuer in 2020, adopting a new and structurally simplified approach cooked up by Clifford Chance’s Chris Walsh. Barclays has a prospectus for such a shelf, so far unused. IFR reported earlier this year that Yorkshire was in the process of picking up the structure; we assume this is White Rose Master Issuer (the white rose was the emblem of the Yorkists during the Wars of the Roses). Still unaccounted for by my tally is Prosperity Master Issuer, for which an SPV was incorporated in March this year.

That said, there still aren’t a huge number of active UK credit cards programmes. Gracechurch and Penarth, for Barclays and Lloyds respectively, have been distinctly quiet in recent years (Penarth might be getting a refurb), reflecting in part the generally quiet market for securitised funding from major banks. Bank of England liquidity might be rolling off, but the credit card trusts are not going to be the cheapest-to-deliver secured platforms. They need to be comped against covered bonds and RMBS (and Barclays doesn’t even do RMBS, the dormant master trust doc notwithstanding).

The only other prime trust is Tesco Bank’s Delamare Cards, from which the last issue came in October last year (an unconvincing 1x book 5bps back of IPTs)….but since then, Barclays has bought Tesco Bank, including its credit card balances, and presumably the funding is due for a rethink.

The obvious comparable, especially considering that Capital on Tap will want to be fully levered, is NewDay, which has two active and frequently issuing trusts, funding its regular and partnership-branded cards respectively.

We hear however that the Capital on Tap structure represents a further evolution on the NewDay approach, rather than a straight structural imitation, though with the first capital markets deal landing in mid-2025 at least, it’ll be a while before we get a look.

When senior secured isn’t

Some unpleasant noise is starting to emerge around Zenith. The UK leasing firm announced a new chief executive on Wednesday, Richard Jones, formerly head of Lloyds’ Black Horse unit. I’m sure he’s a fine hire, but top of his in-tray is probably going to be figuring out how to juggle the company’s financing.

The “senior secured” bonds were down as low as 65 earlier this year (now quoted around 73), and last week saw S&P downgrade the £475m 2026 notes from B+ to B. That’s a perfectly respectable rating for a private equity owned business, and Zenith has more private equity history than most. Even in 2014, it was on its fifth buyout, and that was before Bridgepoint, the current owner, notched up a sixth in 2017. That investment is already a bit long in the tooth, can we make it seven?

S&P’s recovery analysis, though, should give pause for thought (it estimates 35%). That’s clearly a different animal from the kind of “senior secured” debt that sits anywhere near the top of a corporate capital structure.

Zenith, like a variety of other financial businesses (NewDay, Together, The Very Group) layers in its corporate debt below a massive securitisation facility, Exhibition Finance (there’s a smaller one called Forge Funding too), so it’s quite distinctly junior debt, despite the name.

The thesis around Zenith (and a concern raised by S&P), is what happens when the securitisation matures (November 2025). The company increased the size of its securitisation facilities in July, but didn’t push out maturities.

Per S&P, “In our base-case scenario, we assume that the company will be able to extend its securitization facilities next year, but further significant decline in car prices and Zenith's weaker performance could make new securitized funding less attractive, making it more expensive and putting pressure on the company's business growth. Zenith's liquidity may also face additional pressure if materially lower car prices lead it to post additional cash collateral into securitization, as was the case in August, when the company had to post an extra £8.7m with another £12m to be posted over the next 12 months.”

Indeed, the increase in size came alongside some minor tweaks, with the prices paid for selling collateral into the securitisation adjusted to reflect the new residual value curves. In plain English, the cars are worth less, so the leases are too.

“The cars are worth less” is the basic problem for Zenith all over; it seems to be a well-run efficient business with a good customer franchise. It’s just unfortunate that its business involves owning a lot of cars at a time when car prices were slumping.

Senior funders are Citi, Bank of America and RBC, with Elliott in the mezz (incidentally, the Elliott position is owned through the same Kaluga Investments vehicle which owned the massive student loan positions we talked about a couple of weeks ago; Elliott had levered them via Morgan Stanley, which may explain why MS got the sale business).

Like S&P, it seems overwhelmingly likely to us that the securitisation gets rolled. It’s also likely that intelligent conversations about the roll, terms, advance rates and so forth were had while negotiating the upsize. You don’t just lay out another £300m of funding without considering the future!

But that doesn’t necessarily mean there’s enough value in the rest of the business to let the bondholders sleep easy. After six PE owners, there aren’t a whole lot of debt levers left to pull that don’t leave the “secured” debt even less secured than before. That said, there may well be a price for derisking the residual value (or for selling the car risk wholesale), which could flush cash into the business in an emergency.

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