Grandmaster trusts

The rise of the European master trust and the CLO market nears shut down

Transcript

SPEAKER_01 0:06

Hello and welcome to another five minutes. I'm George Smith, Global Capital Securitization Editor, and we are back up to a full house. We have Tom Hall, our European ABS reporter, and back from South Africa, Thomas Hopkins, our CLO reporter.

SPEAKER_02 0:22

How was the break? It was great, George. In fact, I'm I'm quite disappointed to be back if I'm honest, but uh I uh this time last week I was sort of going swimming and you know uh having some some lovely wine with a view of of mountains and uh and yes, and now I'm uh back in the back in the UK and uh getting stuck into the CLO market once more. But I'm excited to be here and talking about CLOs again.

SPEAKER_01 0:45

Yes, yes. Well we we have a lack of CLOs for you to cover this week, but we'll come on to that later. Before that, Tom, it's been quite a lively week in the ABS market last year.

SPEAKER_00 0:55

Yeah, it's been been super busy. I mean the last two weeks have really been really busy. I think you know part of that is is just delays from Iran of you know a couple days of the market shutting down. So issuers are trying to, you know, get deals done. We and they've they've pretty much all been on screens. There's only really been one or two deals that normally you know go publicly that I think they made the decision that they might be willing to pay up a couple of basis points to get you know a solid, safe execution. But yeah, in terms of this week, we we've had quite a lot of diversity. We we've had I mean uh I think we've had eight deals. We've had you know, City has done its Montgomery Square, a consumer ABS debut, you know, New Day has done a partnership deal for its credit cards, Porsche has done an Austrian Auto ABS, Peff's done a secondly in UK R and BS.

SPEAKER_01 1:51

I mean the the list goes on, I could name them all, but yes, that's uh indeed plenty to keep you busy. But you've focused in on the weekly on the rise of Master Trust structures after the first European data center master trust.

SPEAKER_00 2:08

Uh was it did it price this week? Uh it's due to price this week. It we're recording early on Friday, and we haven't had any updates yet, but oftentimes that is how these things go. You will it just all does come at once uh at the end on a Friday. So we'll we'll see how that ends up going. It could get pushed into next week. But I mean the these things normally market over two weeks a data center trade, and they only announce this one, I think, late on Monday.

SPEAKER_01 2:33

So tell me about the deal then is uh Edge Connect.

SPEAKER_00 2:36

Yeah, it's Edge Connect, so it's their debut. It's the the first uh Dutch data center ABS, and yeah, as you said, it's the first one to use a master trust structure. So I think you know that that's quite an interesting element, because you would assume you know the first European master trust structure for the data center ABS would be quite a big deal, but it's only really you know, it's only really mentioned once in the term sheet, and from kind of you know, speaking to people sort of around the deal, it it sounds like you know, it's it's not sort of a huge thing that investors are kind of you know, it's not gonna help it price, you know, super, super tightly just because of the fact it's a master trust, which you know, we we sometimes do see, you know, tighter pricing on on more of the traditional kind of master trust structures in in the UK and Prime R and BS and uh you know credit card ABS. So I th I think you know data center master trusts are a quite different sort of kettle of fish than your traditional popular UK master trusts.

SPEAKER_01 3:41

Yes, right, yeah. This is still backed by specific data centers, right?

SPEAKER_00 3:46

Yeah, it's backed by two data centers uh near Amsterdam Airport. So as we always say, it's in that that prime Flappy uh region.

SPEAKER_01 3:55

Yes. That just gets uh more appealing as a phrase every time I hear it. So you know, you m you drew the comparison to RBS already. Um like kind of draw that out a bit more. I guess we had BPCE, right, doing a a first RBS master trust um in France quite recently. Um, you know, and as you said, these have been things that UK issuers in credit cards and mortgages have really dominated. Um is this kind of rise of the Euro Master Trust a fair like conclusion to draw from those two deals, or do you have to sort of split things up a bit more and think about it differently?

SPEAKER_00 4:35

Yeah, we probably have to split things up and say and think about it differently. Because I mean, you know, if you you look at the the reasons behind a kind of RMBS or credit card uh ABS master trust, is because you have you know homogenous and granular assets, so you know you can revolve them in quite a big master trust. And if you look at you know credit cards, I made the comparison with New Day of it it makes more sense if you're doing two to three trades a year that you're just working on you know one big pool, working on revolving that than having like you know ten transactions over time that you need to constantly sort of replenish because you know a lot of these receivables have quite short maturities, so it it can sort of make more sense to to go through the master trust structure in that way. I think it there seems to be quite different reasons for you know a data center master trust, because you know, I mean the the assets are never going to be granular, are they? You're you're always gonna be dealing with you know huge data centers. I think they they can be homogeneous. Uh you know, we talked about the flat D region. I mean, if you take you know different data centers, but they're all from sort of prime locations and have similar sort of makeups, then you could see some kind of you know homogeneity uh in the assets. But it it does seem like you know the main sort of desire is for more sort of structural tax reasons, uh, that it makes more sense to set up the master trust for your you know issuance program rather than setting up you know uh a different special purpose vehicle every time you want to do uh a new trade. But yeah, so I think I think it's gonna be different of whether we see you know other data center issuers following this. Because I mean Vantage and Yonder have both done trades and they they were both happy using you know standalone structures uh for those trades. But you know, who knows? I mean they they might end up you know going the the master trust route later if it's really successful for Edge Connects. But yeah, I think it's a a very different thought process if you're you know BPC doing uh a French RMBS master trust. I mean I think the the logic with that was it was definitely related to them stepping up the program because they they set up the trust in October and then I think February of this year they announced that they're now going to be doing you know two benchmark deals a year instead of the usual one. So it it you know you start getting that economy of scale and it it starts you know becoming more worthwhile getting the master trust.

SPEAKER_01 7:04

Yeah, I mean we talked about the kind of difference between bank and non-bank master trusts as well in the past. Um, you know, the the prime non-bank examples you mentioned is New Day, but we also had Capital and Tap um set one up. Do you think I guess these kind of data center master trusts can be seen as more comparable to those sort of non-bank ones, or do you still think like data centers themselves are just such a different asset from the kind of granular consumer ones, as you were saying, that um, you know, we just basically there there's little to be kind of compared and and contrasted here?

SPEAKER_00 7:43

Yeah, I think I'm slightly more subscribed to the latter. I think they it is very different, but also, you know, equally it's I mean it's interesting that the the first sort of must trust structure for data centers is in Europe rather than you know the UK because I mean that's you know you're under advantage of both done trades in the UK and the UK, you know, obviously you'd assume it it's got you know all the all the UK must trust there there's kind of legal frameworks existing and you know investors are kind of more familiar with must trust structures just on a you know kind of general basis. So I think it's still you know it's a really interesting thing that we've seen the first one in in kind of mainland Europe. But yeah, I I think when you're looking at credit card and R and BS mass trusts, they're they're sort of in quite a different field to a data center mass trust.

SPEAKER_01 8:37

Yeah. And then I guess final question, you know, this is obviously another step in the direction of the US market for the European data center market, yeah. Mass trusts are very prevalent in the US market. Do you think this is kind of a sign that what we've seen so far, which is very much that the European data central ABS market's model on the US, is likely to continue?

SPEAKER_00 9:00

Yeah, I mean it definitely looks like it. I mean, I think it it seemed like I mean, before we had this mass trust deal, it seemed like a lot of people were saying a mass trust seemed a bit less likely in Europe than the US. Because obviously in the US you have the advantage of you're all under basically the same kind of legal structure because it's all the same country. So it you can kind of you know add more uh data center assets into the trust uh without having to worry about, you know, if if you add you know a Dutch data center and a Spanish data centre, are they gonna have different legal frameworks and is that gonna add complications to the trust? But you know, I'm sure you know Edge Connects has I mean they they've not been you know super public about what sort of properties they're gonna be adding to the trust. Is it gonna be you know sort of more more Dutch properties or is it gonna be you know kind of quite different uh sort of regions? I mean we'll we'll sort of wait to see that. But uh yeah, I I think I mean it's definitely a strong sign that you know Europe is learning uh quite a lot still from the US and it it does seem like we we really are sort of copying that market just on a delay in a lot of ways.

SPEAKER_01 10:12

Yes. Well, if you want to read the story of all you need to know about European master trusts, it is called EdgeConnect lays ground for more European master trusts. And with that, I think we should move on to the CLO market where there has been less deal activity, Thomas.

SPEAKER_02 10:32

Yes, I think less is a notable term there, George, because we've had absolutely no deals priced so far this week. I think it is worth noting that we are recording this podcast, you know, on a Friday morning, and you know, when you do get a a lot of deals in the CLO market it in Europe, it tends to be sort of late Friday afternoon evening, with sometimes there's a glut of deals then. I would highly, highly doubt that there will be that this week. Uh, but just as a little caveat, just in case I uh sort of you know, uh just in case we see like you know one deal emerge, but I would I would think that that would be very unlikely.

SPEAKER_01 11:10

So when you went away last week, um I had to keep an on the CLO market for our uh newly launched asset-backed monitor, which you can find on the website, of course. But um I think I sent you a message saying, you know, there won't be any deals, will there? Like this is the there's war, like CLO market always shuts down when there's war. But uh initially, at least I was wrong. Um was kind of changed since then.

SPEAKER_02 11:34

Well, yes, so we we we have seen sort of seven deals price uh since the outbreak of the war, and uh and yes, you can you can see those seven deals on on asset back monitor, as you're as you're uh you know, as you're right to point out, George, we've launched the CLO component of it. So please do go and have a look. But yeah, so I think basically the seven deals that did price, it was largely because managers of those deals had already sort of really ramped up their warehouses. Uh these deals were kind of ready to launch to the market. And when you're at that stage as a manager, it's pretty difficult just to sort of delay indefinitely or you know, wait around. Uh, and it can actually be sort of counterproductive. You know, investors sort of expect that you're going to price, and if you wait for ages and ages, investors might raise questions about why. And you know, there's even then an opportunity for you know spreads to move kind of opportunistically sort of wider from from investors. So when the Iran war broke out, I think these managers were ready to price deals and just sort of had to move ahead, regardless of what the market conditions were. And some of them did quite well despite you know challenging market conditions, it's worth saying, you know, yes, spreads did move wider, yes, they probably did achieve wider levels than they'd you know expected to, but some did do really well despite the volatility. But yeah, so we saw five deals in the first week after the war, then two deals last week, and then we've seen nothing so far this week. And what market sources are basically telling me quite directly, really, is that it's pretty unlikely we're going to see very much deal activity, you know, this side of Easter. You know, obviously it all depends on what happens with the war, really, and that's proving to be very, very unpredictable. There is uh a notably unpredictable occupant of the of the of the White House, and uh and the decisions of said occupant uh could change the fortunes very quickly. But for as long as the current sort of Middle East crisis persists in its present form, uh managers, investors, you know, other market participants have been saying to me that it's gonna be quite difficult for deals of any type to price that be that new issue reset refinancing.

SPEAKER_00 13:48

I was gonna ask, I mean, what one of the deals you mentioned in the story was the the Bain deal where the AAA is priced uh uh 127 basis points. And you mentioned that, you know, sort of so it sounded like it would be more in the the low kind of 120s. But in terms of you know the the last sort of year or so, I mean it it felt like kind of you know last last sort of summer you you'd be lucky to see one sort of breaking through, you know, one 130 basis points at the AAA. Why do you think people are kind of unhappy at you know bringing out a CLO at the current levels?

SPEAKER_02 14:21

Well, I suppose you we had seen sort of significant liability tightening earlier in the year. So you know, triple A's had gone to sort of you know the the low 120s, you know, even a couple of deals even slightly below 120. And I think because you know, because the triple A's make up such a large portion of the CLO capital stack, essentially even a few basis points on your AAAs can make quite a big difference. So, you know, you're right to point out with the Bain deal, Tom, you know, it's sort of moved from kind of what the manager have expected to be sort of the low 120s to sort of you know 127. And that doesn't seem like an enormous difference, particularly given the severity of you know, sort of the conflict and what's going on. I think that's probably a testament to quite a well-executed deal. Um, but it's also even a few basis points of movement like that on your triple A's can have a big effect on your weighted average cost of capital. The other side of it is also that the AAAs are sort of the, you know, almost you know, the the sort of the tip of the iceberg. I mean, if you move further down the capital stack, you know, down into say your junior mes notes, pricing is moving much, much wider. I mean, on single B's, you're talking discount margins of, you know, upwards of a thousand basis points. And, you know, obviously single B's make up a smaller portion of the capital stack, but that will have a very notable effect uh on pricing and uh you know on the weighted average cost of capital, and also with the arbitrage as sort of compressed as it has been, a move like that in liability spreads can be quite punitive for a CLO.

SPEAKER_01 15:56

So if we're thinking the market's more or less close to Easter, which isn't actually that far away now, um that's kind of Easter's been in my mind as a sort of destin, destined thing for a long time, but it's actually only two weeks as we as we record, then at what point is this gonna is this gonna reopen? What are people kind of expecting now? I guess this the situation in the Middle East is kind of unpredictable, but what what does pricing imply or or that sort of thing?

SPEAKER_02 16:24

Well, basically what market sources are telling me is that the market is currently pricing in a scenario where the Middle East conflict is sort of at least partially resolved by mid-April, so you know, other side of Easter. And then in this scenario, sort of energy commodities kind of resume a kind of normal sort of flow into kind of around June, and then that you know gradually means that the CLO market can kind of unlock again and deals can sort of come to the market. Uh, we'd expect obviously that deals would come before June, but it would take probably until June for, you know, as I say, the flow of oil and gas to kind of resume to sort of you know pre-Middle East crisis levels. Okay. And and again, this is this is just a sort of scenario that is sort of being priced in by quite a few managers at the moment. It's not guaranteed that it'll happen. As you say, we are kind of to some extent crystal ballgazing here, uh, but that is certainly the the the market view currently um is that this is going to be resolved quickly. Because it's important to point out that the reason that we've seen such a slowdown in CLO activity had a lot to do with the flow of oil and gas um, you know, from the Gulf, basically, because one of Iran's responses to you know the US-Israeli missile strikes uh that took place in late February has been to kind of choke off the flow of oil and gas through the Strait of Homo's. You know, it's it's very, very difficult for oil and gas tankers um to get through there currently. And just to give you a a little idea, I mean, you know, the International Energy Agency sort of estimates that an average of 20 million barrels a day of crude oil and oil products were shipped through the strait last year. That's about 25% of the world's seaborne oil trade. Similarly, we can't currently export LNG from Qatar and the UAE, and those produce about, you know, those two countries alone produce about 20% of global LNG exports. And so you've seen oil and gas futures soaring, and this has huge consequences for energy prices in Europe, which have already been elevated in the last few years as you know, Europe has tried to kind of wean itself off Russian oil and gas, you know, following Russia's invasion of Ukraine. All of this leads into high electricity prices, which affect sectors like chemicals that are very energy intensive, that are held by CLOs. Uh, these sectors have already been stressed because of high electricity prices. They've already been less competitive. The default risk in these sectors has already been higher. And so investors are concerned about these sectors that exist in CLO portfolios, and they're offering much wider spreads as a consequence, and it makes it quite difficult to sort of bring a deal to market at the moment.

SPEAKER_01 19:07

Does this mean, like, you know, obviously this has taken a little while to feed through to the primary market, but does this mean that Iran is now the bigger worry than than software, which we've spent the last kind of three weeks talking about?

SPEAKER_02 19:21

It depends which manager you talk to, to be honest. You know, um, some managers are quite still remain quite optimistic about this sort of Middle East crisis being resolved. You know, they're saying, oh, well, it'll it'll it'll be wrapped up in a couple of weeks. And if it is wrapped up in a couple of weeks, there won't be too much damage done. There'll just have been a pause in issuance, and you know, defaults won't really meaningfully have increased. And ultimately, software is the big multi-year problem. You know, AI is posing a sort of threat to all sorts of software companies. We don't quite know how this is going to pan out, and this is going to be the long-term issue that we have to focus on. So some managers are saying that, and I think that is probably the more common view in the market right now. But obviously, there is an awareness, I think, in the market as well. But if this war carries on for, you know, much longer than is currently expected, it is going to be very difficult to continue to bring CLOs to the market. I mean, eventually over time, even if the war continues, probably, you know, because of some pent-up demand from CLO investors, managers might feel they can bring a deal to the market, you know, or deals to the market just because they might be able to achieve acceptable spreads because CLO investors haven't had any deals to deploy cash to. So they might feel comfortable with that. And additionally, if you get some leverage loan activity kind of coming through, as we've seen with the electronic arts deal that's sort of currently in the market, you know, those deals might have to come with slightly wider spreads, and so the arbitrage might sort of work a little bit better. But let's be very clear, if the crisis continues in its current form, you know, conditions for CLO managers are going to be materially worse.

SPEAKER_01 21:07

Yes, indeed. Well, that um electronic arts deal is one sort of self-aligning, I suppose, wasn't it? Because we've all been waiting for some for some loans to buy.

SPEAKER_02 21:17

Exactly, you know, and I think uh the sort of new kind of primary kind of leverage loan issuance is sort of yeah, kind of the the holy grail, really, of sort of solving some of the issues that CLOs have been facing with, you know, everything pricing at par. Um, of course, less is pricing at par now because of software in the Middle East, but you still kind of get a bit of market bifurcation at the moment because ultimately everything that's high quality and that isn't affected or is less affected by the Middle East or software is still pricing very close to par. So the problem has changed, but it hasn't really gone away. You know, and the only thing that really will change that is new loan activity. So the EA deal is, you know, obviously very exciting and it's come out at wider spread, you know, than than probably would have been the case if it had launched a couple of months ago. Because I think the pricing guidance is sort of 350 to 375. And they're I think it's expected to be issued at 98.5, whereas you know in January you probably could have got 325 to 350 at par. This is according to some market sources I spoke to. That's not my personal view. So yeah, it's it's certainly coming at a wider spread. And if there are other deals like EA that continue to come to the market even through this crisis, that that may be a little bit of a silver lining for for CLOs. And you know I would expect that even if the Middle East crisis continues, there may eventually be some deals. I think what at the moment what managers are doing is sort of thinking well if this crisis does abate quite quickly, then it might be sensible just to hold off for a couple of weeks because spreads might come in again. If it's clear it becomes a longer term issue, well then managers might have to rethink and find a way to print deals um through the crisis. But at the moment I think the thought is sort of more of a kind of wait and see holding pattern approach. I guess there must be like absolutely tons of partially ramped warehouses out there that at some point something is going to have to happen with exactly and I think this will become certainly if if market conditions make it really difficult for managers to bring deals to the market, then I mean certainly what a couple of managers have told me is that you could even see some warehouse liquidations in an extreme case. I think we're not there yet. I think at the moment any manager that doesn't have to price isn't pricing and is probably you know sort of being very careful about the ramp and choosing assets very carefully and is probably trying to ramp more slowly than they otherwise would. But yeah, if this does continue I think it's it's not implausible that we could have warehouse liquidations.

SPEAKER_01 23:56

Well yes I mean if you want to read more about the the challenges the CLO sector the story is called CLO issuance slows to a trickle as war costs threaten many sectors. And it's on the Global Capital website for subscribers. And the final thing that I need to say today is that I'm sure we'll be seeing many of you at our awards dinner this week so we'll we'll look forward keenly to that. If you've got an appetite for more awards then we've just opened the voting for the US process so this is in its final kind of stage now and you can find the link to vote on the website. Otherwise it's thank you very much for listening and goodbye from us. Goodbye goodbye