This is one aspect of the dispute between the US parties related to JZI Investments and former European partners of JZI Miguel Hernando Rueda and Ole Groth — specifically, who owes whom what payments from JZI’s European funds. This is intrinsically bound up in the claims and counterclaims over improper conduct in the management of Gedesco and other portfolio companies, with both sides accusing the other of various forms of self-dealing.

The other structured financing that’s been implicated in the process is the privately placed Castilla Finance, originally issued in 2018.

This finances receivables originated by Toro Finance SLU, an entity historically linked to Gedesco — but whose shareholder base was historically a different JZI fund.

There were other linkages as well. Toro originated some of the collateral within Gedesco Trade Receivables 2020-1, specifically the promissory notes or pagarés (essentially the only collateral in the portfolio which had not defaulted at the December investor update).

It also shared some core functions, such as HR, with Gedesco, several members of the management team has roles in both organisations, and in Castilla Finance, it originally had a servicing agreement with Gedesco for the portfolio.

We incorrectly identified Toro as an “arm of Gedesco” in a previous piece covering the situation — but the separate shareholder base is crucial.

Limited partners in the fund which owns Toro appointed Alvarez & Marsal in early 2022 to fix the problems with the portfolio, and the advisory firm moved rapidly to start the process of severing ties with Gedesco.

This did not prevent Toro being named in one of JZI’s New York complaints (now withdrawn). Here’s a small sample:

“The typical pattern was for Toro, at Fund-B’s expense, to fund investments by Defendants’ companies, exposing Fund-B to the downside risk of these investments while appropriating for themselves the upside opportunity of the investments in violation of their fiduciary duties. The majority of those “loans” were paid to Stator Management and its affiliates. To execute and hide their fraudulent schemes, Defendants repeatedly lied to Fund-B’s representatives and their investors.”

A&M is mandated to maximise value from the former JZI fund, and doing that required setting Toro on a stable footing where it could carry on its existing business originating promissory note financings separately from Gedesco.

This meant, among other things, extending the Castilla Finance vehicle further (it had already had four previous extensions).

In October last year, noteholders were presented with a further restructuring proposition, which would see the coupon cranked up from 2.65% fixed to 175bps over six month Euribor from April 2024, a €1.5m restructuring fee, and a revised amortisation schedule: €20m in January 2024, €25m in April 2024, and then a step-up to €67.5m in October 2024, April 2025 and October 2025.

The deal also included a €12m servicer incentive fee, a limit of originating receivables from entities which aren’t already in the portfolio, and, crucially, a new servicing agreement which appoints Toro instead of Gedesco.

The point of doing this deal is to give some breathing room to sell Toro itself, hopefully too much noise from the ongoing legal troubles around Gedesco. The originator had its best-ever year last year, despite the adjacent turmoil, and has now maxed out its financing capacity in Castilla, so it’s marketed against a compelling backdrop (if you can get past the flurry of headlines).

A sale process started last year, and is now going into the second round, while the Castilla restructuring was finalised at the end of January, with more than 75% of the senior and 100% of the mezz voting in favour.

Noteholders could surely see the value in getting Toro into more stable hands, but as the senior paydown in Gedesco Trade Receivables 2020-1 shows, senior noteholders usually get their money back even when the portfolio is absolute carnage, so if they’re going to extend, they need to get paid.

A new owner of Toro is surely likely to want their own financing in place (and to replace Castilla), which raises intriguing possibilities.

Other than Gedesco Trade Receivables 2020-1, the other well-known Spanish SME financing deal was Be-Spoke Capital’s Alhambra SME 2019-1. I think I gave this one an award (don’t @me), but it’s fair to say that distribution proved challenging. Let’s just say it was originally called Alhambra SME 2018-1, and didn’t price until November 2019.

Lots of the senior team at Be-Spoke have subsequently left, and Be-Spoke itself has renamed itself to Aptimus Capital Partners (and taken over administrative roles so that yours truly can’t see the latest investor report).

But as of September last year, according to DBRS, 21 of the 52 loans had defaulted, for a cumulative defaulted balance of €105.5m, or 38% of the initial portfolio, though the agency said that €19m was now reperforming.

In short, it’s not a deal that anyone is likely to want to replicate any time soon. The Toro portfolio is different to Alhambra and the pagarés contracts have some real strengths — banks will honour them if a company has cash in the bank, like a cheque, and they cross-default other corporate debt — but two out of two Spanish midcap securitisations have been among the market’s biggest dogs of recent years.

Whichever bank wants to fund the Toro bidders will therefore have an uphill struggle in getting a distributed deal together — it’s severed from its former sister company, but it may still be in the shadow of the poorly performing deals in the past.

The risk nobody wants?

Most of finance, and certainly structured finance, involves figuring out the right entity to bear certain kinds of risk — it’s like water flowing down a hill, to whichever capital source is best placed to own an exposure and will charge the least for doing so.

Residual value in auto leases is a particularly knotty problem. This is basically the exposure to the value of a car once a lease term has expired. There are lots of capital providers who like exposure to bundles of consumer payments, like lease contracts, but generally they don’t really want exposure to used car values. Auto lease securitisations including residual value therefore price wide of those with the lease contracts only — but the captive finance providers which bring lease deals without residual value then have to do something else with their exposure to residual value.

As arms of vehicle manufacturers, which have extensive networks of dealerships, customer service and repair capabilities, arguably they’re well-placed to bear this risk. But ability may not match desire. The purpose of the captive finance arms is to sell new cars for the OEM car manufacturers; that’s a different proposition to owning exposure to lots of used cars.

New business models and technologies have made the problem more acute. Car subscription services are basically just thin-slicing lease contracts into a slick, customer-friendly tech-enabled package. This requires newer cars, with shorter leases in which to embed depreciation curves.

By the time a new car has been leased out for three or four years, it’s already done a lot of its depreciating, but the six months or year-long contracts from a car subscription leave a lot more value embedded in the vehicle. Get this wrong and risk a blow-up, as in the case of Onto, an EV-only subscription service which span off the road last year.

Stelios over at RTRA Intelligence reports that there might be an SRT solution. Some auto lenders are “looking at potential transactions backed by pure residual value risk or concentrated dealer exposures” — head over to his site if you’re interested.

This would be quite a step from the usual mainstream of corporate SRT transactions. The general idea in SRT, as in securitisation more generally, is that you’re exposed to a lot of different uncorrelated exposures. If you get, say, Atos missing a payment in a corporate portfolio, no worries, you’ve got 200 other obligors and a healthy coupon. Macro trends push household finances around so mortgages and so forth are correlated…. but not directly related.

If you’re taking on the residual value exposure for a big auto maker, though, you have general correlations — used car prices across different models are related — but also very specific, lumpy exposures.

Mass market car brands sell most of their volume across just a few models. If we take, say, Volkswagen Financial Services’ Driver UK 8, which priced this week (and contained 58.7% residual value exposure), there’s £156m of VWexposure in there, of which £31m is the Polo, £28m is the Golf, £27m is the Tiguan and £24m is the T-Roc. £12m of the £37m Porsche exposure is the 911. Four models make up more than £100m of the £190m Audi portfolio. You get the idea. If you write a pure RV contract, it’s not going to be very granular price risk.

Structured finance people can price the risk (basically you’re looking at a couple of databases for your residual value curves, adding a haircut and making sure you get paid), but would they price it at the right level?

Based on the VW trade, at 135bps on the class B, it looks fairly compelling — but that’s only because VW commits to buying back the lease receivables at the end. The deal is funding the RV exposures, but not really bearing the economic risk. Only in the event of VW Financial Services going insolvent is the deal properly exposed.

VWFS more broadly does have pure residual value securitisations — VCL Master Residual Value, a private bank-funded deal — but this is also a funding transaction, which, again includes a repurchase obligation, and basically stems from the different structure of German auto finance contracts, which allow VW to present its public German VCL ABS deals free of RV. The actual, real, vehicle price risk still stays with the originator.

You can be a little bit cleverer than that, if you’re really looking to transfer RV risk in a lease deal.

It gets a bit complicated because achieving Simple Transparent & Standardised (STS) designation requires that “repayment of a securitisation position should not be predominantly dependent on the sale of the assets collateralising the underlying exposures”. If you have a lease contract which expires, the vehicle is handed back and sold, then you’ve securitised the RV exposure, but this is clearly not STS-eligible.

Lloyds, in its Cardiff Auto Receivables Securitisation 2019-1 (CARS, ho ho), included a “residual value top-up reserve fund”, totalling a massive £79.6m (on a £610m portfolio). This, however, was basically a contingent loan that would kick in if sales proceeds were below a certain threshold. As DBRS puts it “the reserve is not designed to fully cover investors for RV losses — its sole purpose is to meet STS requirements”.

This mechanic was dropped from CARS 2022-1, which saw Black Horse, the Lloyds car lessor, retained a fixed rate senior piece as well as an unrated class S sub note.

Lloyds placed the mezz, totalling £149.5m, and Black Horse claimed some £106.585m of residual value protection the following year. Bank lessors also have to deal with regulator-imposed stress above the actual residual value exposure, so presumably this relief does double duty.

Other, non-securitised options exist. Insurers will provide residual value cover, though this is more usual for large ticket leases like aircraft, or oil exploration kit. Retail car buyers can purchase their own RV cover, in the form of GAP (Guaranteed Asset Protection) insurance; at least they could until two weeks ago, when the FCA got 80% of the insurers in the market to pause sales of these policies.

Best of all is finding just the right risk owner. One of the funds involved in the car subscription space described an agreement with used car dealers to take year-old cars off their hands. This works for the dealers, who get ready access to a flow of quality high value used cars with good maintenance histories, and works for the fund, which gets to offer capital to the platform, and the portfolio of contract, but caps its auto price-related downside. Car risk is best borne by car people?

One million dollars

To derisk or not has been the great debate in RMBS execution these past couple of years. Does the prudent issuer sell the whole stack to Pimco, preplace the seniors to a couple of banks, pre-sound, wall-cross and protect some orders, or just go full send and hit the market with a proper public transaction with no special favours in place?

Some of this is about balancing the risks of a failed deal with the possible benefits of real public price tension, while some of it relates to the warehousing arrangements which are transitioning to public markets.

Warehouse banks which like the risk might like senior positions in a public deal just as much these days; with base rates up and triple-A bonds giving decent return on risk-based capital, originate-to-distribute is becoming originate-to-distribute-mezz. Warehouse mezz providers may also have negotiated preferential access to public market mezz, with a right of first refusal on bonds which might be 5x done in syndication.

The preplacement vs public balance is a function of market conditions, but TABS X and Elstree No. 4 illustrate the issue. Together opted, reasonably, for derisking, with BNP Paribas and Citi taking down the senior note at 150bps. Wind forward a few weeks in a hot market though, and Enra managed to place its class B note inside this level through a full public process (taking the B note book from 5x to 1x at the final spread).

Pepper Money is opting for a middle ground on Polaris 2024-1, with £92.5m of protected orders, including from JLM affiliates, in the class A note, pre-chopping some of the wood in getting an 85.5% senior tranche away on a £500m pool, decently large for sterling.

More unusually, it is “derisking” the £7.5m class F note with a protected order for 12.7% of the tranche, not quite a cool £1m ticket.

This is not usual execution practice; the list of funds that habitually play deep mezz, residuals, X notes etc is not a long one, but if the level is right, all of them are capable of doing full tranche orders. There’s often an auction style process to get the deep mezz done; this results in more satisfying allocations than pro-rata slicing a £5m tranche five ways.

So what’s going on here? Who’s sitting pretty on a guaranteed allocation of nearly a million pounds?

The red offers a clue — it describes selling the class F (retention aside) to a single third party investor. Presumably at some point in the structuring process, markets were relatively weaker and a backstop at the bottom of the cap stack was worth having — likely from the existing warehouse provider.

Now there’s better execution to be had just offering the deal out, but this is a little unfortunate for the fund which did the work and took the wall-cross ahead of announcement, so the least the sponsor can do is save a teeny tiny ticket.