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Excess Spread is our weekly newsletter, covering trends, deals and more in structured credit and ABS — subscribe to this newsletter here.

Excess Spread is off until the New Year. Happy holidays to all our readers, hope your 2024 has been excellent and see you on the other side! Normal service resuming 9 January.

ABS investing is often fintech investing. Other than banks, that’s generally where the loans are. We're a bit beyond the "mortgage lender with a website = fintech" stage, but for a startup with an asset financing angle, be it mortgages, credit cards, embedded finance, invoices, premium credit, equipment loans or anything else, securitisation in private form is often the answer.

Companies capitalised by VCs have no business using their expensive equity cheques to fund asset portfolios directly. You’d be daft to take cash looking for a 1,000% return and earn Euribor+400bps!

Often these companies end up with a kind of barbell capital structure, with the largest debt facility a senior securitisation tranche paying 150-250bps, and the (much smaller) operating business funded on VC cash to pay for coding, marketing and office space.

That brings into close contact different cultures of investing. Those who cut their teeth in securitisation will generally have little interest in lending to businesses whose plan is to keep defying gravity (or they’ll make damn sure they’re protected). Equity investors from the VC world may see debt as, frankly, a little boring — just something that needs to happen, that you can always raise if you need to, that doesn’t necessarily drive the business.

These are caricatures, but you get the idea. Is the value of the average fintech lender in its clever technology, AI-driven underwriting engine, lightning-fast decisioning, slick embedding, rapid growth? Or is it stable well-designed funding relationships that allow the lender to keep writing profitable business in size whatever the market backdrop?

You can sometimes see this cultural split inside a business too — the CEO can sell the sizzle to the VCs, but the treasury team makes sure the institutional funding is in place.

There is a very real tension here, though, as recent trade receivables shenanigans make clear. VCs generally want to see growth, lots of it, to prove out the business case for 10x their investment, and justify the CEO’s ambitious TAM claims. They want loans out the door pronto. This is not necessarily conducive to good quality underwriting, and not necessarily what funders want to see either! It’s good to have a warehouse utilised, but it’s not good if growth trumps credit quality.

From the investor side, the ideal synthesis is probably something like a deal with warrants to get a taste of that sweet VC upside, robust servicer replacement / servicer control language, and ability to pull the plug when they want. For investors in the middle of the stack, they need protection from senior lenders pulling the plug even faster.

But in the high noon of 2021, none of these things were required and fintechs were in no mood to give anything away. Valuations were soaring, bankers were falling over themselves to lend money, and the more innovative the business plan the better.

These deals were often struck with three to five-year terms, which means incoming maturities right about now. While 2025 is being teed up as a strong year in public markets, it’s also probably the year when all the dumb trades of 2021 come out of the woodwork. The tide is going out, who is swimming naked, etc etc.

The muppet Grover, in “Super Grover” guise. Property of Jim Henson, Sesame Street etc

Which brings us to Grover, the German tech rental / subscription firm, which scored some of 2021’s sweetest financings, in the form of a 100% advance rate, fixed rate facility to fund its tech inventory. The 100% advance rate is with respect to the wholesale price of the various tech goodies purchased and finance; the items were sold at retail price, on subscription contracts whose net present value was more than said retail price, so the economic advance rate was a different number, but it’s fair to say that accounts differ on what this actually is.

Most of this came from Fasanara Capital, a fintech-led fund with a finger in various alternative credit pies; receivables finance, alternative lending, and crypto. 2021 was a big growth year for Fasanara; according to the accounts for Fasanara Securitisation SA, the Lux vehicle through which it did much of its lending, assets grew from €173m to €958m over the course of the year.

Fasanara started funding the firm in 2019, starting with a €30m facility, upgraded to €250m (both fronted through Varengold), and upgraded massively in 2021 to €1bn (this was not the figure actually drawn), subsequently supplemented with a $250m deal to fund the now-shuttered US business.

M&G also got involved, providing a €270m facility, structured on somewhat less aggressive terms. It was still aggressive enough for the Specialty Finance Fund to pass on the deal, but Grover had good ‘impact’ credentials; it promised a circular economy proposition, with devices refurbished and resubscribed, cutting down on electronic waste, so M&G did it through Catalyst, an impact sleeve.

The financing was announced alongside a Series C equity round, for a total €330m package, valuing the firm at more than $1bn; one way the firm celebrated was minting a Grover Unicorn NFT for employees, current valuation unknown.

Under the hood, though, this is subprime lending. Customers don’t get a rental contract for their iPhone if they have the money and credit rating to get a real phone contract. Tech depreciates fast, and the economics rely on amortising the residual value through the life of a subscription.

The problem in 2024, and likely in 2025, is that the money ran out. One of Grover’s investors, listed fintech fund Augmentum, marked down its position 44% between March and September, despite kicking in money for a “bridge financing”, designed to get Grover to a more stable place.

One assumes the bridge hasn’t actually bridged to anywhere, as Bloomberg reports the firm is looking at a debt restructuring. As well as the asset-backed debt, Grover had a small slice of corporate venture debt from Kreos Capital.

But the underperformance in the asset-backed facilities has already been evident, we understand. As Grover has tightened its belt, closing its US operation and running a couple of RIF processes, origination has also slowed down, and that means fewer new loans into the asset-backed facilities, and more exposure to the realities of the credit. A fixed rate deal struck in 2021, as in the Fasanara facility, also creates its own obvious problems for the funder.

It’s possible Grover turns up something; Bloomberg says that ex-CEO Michael Cassau is pitching investors his own turnaround plan. But if it doesn’t, it means further bad news for the asset-based transactions.

These deals require specialist servicing. Finding the borrowers, deactivating their devices if they don’t pay, and managing the data is an unusual activity; it isn’t like a credit card deal where you can hot-swap the servicers for minimal interruption.

We’ve covered the situation more fulsomely behind the paywall, but it’s unlikely that Grover is the last tech company to have been forced to rein back its aspirations from the halcyon days of 2021 — and it’s not going to be the last asset-backed deal from the era to struggle.

Possibly the last deal of the year, and it’s one of the most interesting. Waterfall Asset Management, via Aira Force Capital Optimization LLC, is sponsoring an equity release RMBS, Lifetime Mortgage Funding 1, securitising older vintage lifetime mortgages originated by Aviva.

This is the second public RMBS which Waterfall has blessed us with this year, following Citadel 2024-1, a securitisation takeout of a Pepper Money second-charge forward flow. Waterfall are a smart bunch with no intrinsic interest in whether a given deal is public, private, bank or bond, so it might just be a coincidence… though I guess you could say the same of One William Street, which hasn’t sponsored any public deals for a while and managed two in 2024.

The smart money is back and ready to securitise, the market is reliable, and ready to take down more complex deals.

Incidentally, Aira Force is an exceptionally pretty waterfall in the UK’s Lake District, with “force” being a northern dialect word for “waterfall”.

We digress slightly. It’s an interesting deal because it marries up insurance capital, with a specific set of hard regulatory constraints, and Delaware-domiciled hedge fund capital, very much free of said constraints. Both sides can benefit.

The vast majority of all UK equity release product is originated by insurers, and remains held by insurers. Aviva itself has £9.8bn, which is “mostly internally securitised”. For a more detailed discussion of the trend, see this interview with Scott Robertson, head of mortgage solutions at Phoenix Group.

But sometimes certain portfolios might need derisking. This actually looks a little like two portfolios; most of the origination is from between 2008 and 2014, but there’s another big spike in origination date in 2023 (18% of the book).

Equity release mortgages are curious animals, which simply roll up interest indefinitely, with payments coming in when homeowners die or enter residential care. There are no upfront cashflows, so deals are super-long duration, require large reserve funds, and do not correlate to ordinary drivers of prepayment behaviour.

The natural thing to do, having bought a portfolio of this kind, is to sell a bunch of the capital structure back into the insurance market, which means structuring up some Solvency II (sorry, UK Solvency) friendly bonds. The class A notes all have scheduled amortisation, with particularly potent triggers for missing A1 payments, so these are “fixed cashflow” instruments and hence MA-eligible.

That creates a need for other bonds to soak up the payment volatility. This can be a senior bond, as in the A2 notes of Towd Point Mortgage Funding 2021-Hastings1 (though is it really senior, if the MA requirements of the A1 take priority?) or the class B notes, as in Lifetime Mortgage Funding, which are split, unusually, into a B0, B1, B2 and B3 (the last of which is retained).

These are all IG bonds, the B0 with a short 1.8 year WAL and the B1 and B2 with six year WALs. Probably best to treat these predictions with some caution, though, since these bonds contain the payment volatility, and making outsized profits on buying them requires being right about payments (they’re all zero coupon).

The B0 arguably behaves more like an excess spread note (short-dated, early in the cashflow waterfall), while the B1 and B2 are longer term; arranger Citi, which also did the Towd Point-Hastings deal and a number of private equity release deals, is refining the placement strategy for this kind of risk.

Who could object to a loveable rogue who funded a film about a shrimp taught to box by a pub landlord, and described securitisation as the crack cocaine of financial services?

Well, quite a lot of people over the years. I remember jubilation at Citigroup when Guy Hands dropped his EMI-related lawsuit in 2016, but the man has always been handy with a legal filing, suing the firm that advised him on said shrimp film, suing to keep control of Four Seasons Healthcare, suing the former chief executive of Terra Firma Capital Partners, and of course, suing the UK’s Ministry of Defence.

It is the last of these which concerns us, as one of the biggest property deals from the early days of UK secured funding and securitisation is no more. Annington Homes, which owned the Married Quarters Estate for the UK defence ministry, has had to sell this back to the UK government, prompting jubilation from said government.

Annington was arguably one of Hands’ best trades, concluded in 1996 when he was running Nomura’s Principal Finance Group, and subsequently sold to Hands’ PE shop Terra Firma in 2012.

Essentially it was levered exposure to the massive price increases in UK residential real estate over the past 30 years — Hands got in for £1.662bn and the properties are now worth £10bn — plus various contractual terms which worked to Hands’ benefit. The MOD was responsible for maintenance and upgrades, and it was required to hand back empty properties to Annington (the government says that the 18,000 properties where this applied would be worth £5.2bn at today’s valuations).

Various public bodies have been unimpressed. The National Audit Office estimated in 2018 that the MOD was £2.2bn to £4.2bn worse off over the first 21 years of the contract with Annington, and the Public Accounts Committee called it “disastrous”, with a former defence minister describing it a “shambles”.

Now, following the government’s victory in a lawsuit last year, Annington has had to hand back the Married Quarters Estate, which represents nearly all of its business (roughly 95%). It’s selling these properties back to the government for about £6bn, lower than the carrying value in Annington’s accounts, and much lower than the £10.1bn the government says they are worth, and the £230m annual rental bill will be eliminated. As a UK taxpayer I can only applaud this!

With 95% of the business disappearing, Annington is applying robust measures to its outstanding £3.7bn debt stack, redeeming two bond tranches and a loan, and opening a tender offer for the remaining bonds. The non-MQE properties will remain, and Annington says it will invest in other residential property in the UK (including MOD properties worth £55m), maintaining at LTV around 55%.

The figures aren’t exact, but plausibly this implies a debt stack of about £250m for Continuity Annington. Although some of the proceeds from the sale will be retained in the business, any surplus equity will be sent out as a dividend — this could be about £2.5bn.

So while the loss of the court case and the settlement with the MOD represent a loss for Hands, receiving a £2.5bn dividend should cushion the blow a little! 2022 saw £100m paid out, 2021 featured a £170m regular dividend and a £793.6m special dividend, after £100m in 2020. It’s been quite the lucrative ride for Hands; rather less good for soldiers stuck in mouldering poorly maintained housing.

…and if you wait long enough, you get some basic creditor rights as well! A judgement in the case of Banca Generali vs Sovereign Credit Opportunities SA is pretty interesting.

Added to the pile of trade receivables securitisation screwups should be three deals known as TFI, TFII, and TFIII, issued from Sovereign Credit Opportunities SA. These securitised receivables were originated by CFE (Suisse), a Geneva-based trade finance specialist. According to the court case, these deals all passed their redemption dates without being paid down.

The senior noteholders convened in late 2022, following this failure to pay, and sought to replace CFE as “fiscal agent”. This is a role which is not quite that of servicer, but can be directed by the noteholders. After a trigger notice under the docs (such as might follow a failure to pay), the fiscal agent gets an expanded role with more powers to act in the interests of noteholders.

Anyway, Banca Generali, as senior noteholder representative, sought to sue in order to enforce its decision to get CFE out as fiscal agent. It is reasonable to want the originator out, in a scenario when several deals are past maturity, and not ideal for them to dig their heels in.

Justice, however, finally prevailed. A judgment in 2023 found in favour of the noteholders, and this was confirmed late this year on appeal.

The legal significance of the judgment is quite technical, but it found that an event of default under the docs represented “a fundamental shift in the balance of power under the Schemes in favour of the Noteholders”.

According to Herbert Smith, “this change allowed the noteholders to rely on expansive post-default rights to effectively override the mechanisms for removing the fiscal agent that applied before a default had taken place. The Court of Appeal described this as making "perfect commercial sense", indicating that courts recognise the commercial implications of default and may accept arguments for significant changes in contractual operation following an event of default.”

This all seems very reasonable to me, and a sensible endorsement of how deals should work? But it’s a reminder that even in an apparently well-drafted deal, a determined party can always get to court and cause trouble.

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