Motor finance blues

Credit quality diverges between CLOs and private credit, UK auto ABS thrives but FCA redress scheme hits Blue Motor Finance

Transcript

SPEAKER_02 0:07

Hello and welcome to Another Fine Mets. And this episode is once again sponsored by SP. So thank you very much to them. I'm George Smith, Global Capital Securitization Editor, and I'm joined by a full compliment. Tom Hall doing ABS and Thomas Hopkins doing CLOs. Hello.

SPEAKER_00 0:23

Hi George, how are you doing?

SPEAKER_02 0:25

I'm very well. And Thomas, we only have the pleasure of your company fleetingly today as you rush to to complete your week's work before the bank holiday. Although when you listen to this, it will be Tuesday, so the bank holiday will be will be history by then.

SPEAKER_01 0:39

Yes, alas, because frankly the bank holiday weekend can't come soon enough, George. But yes, as you point out, I'm rushing to get uh urgent news out to subscribers ahead of ahead of the break.

SPEAKER_02 0:50

Yeah, so we better start with um with CLOs and then but maybe we'll need to let you go and and then we've got an excellent story from Tom on the various kind of ways the motorfinance compensation scheme is is playing out in the ABS market. But but I can wait because as ever the CLO market is going head to head with private credit, to see who can get the the best borrowers.

SPEAKER_01 1:14

That it is. The two are sort of they have been viewed as rivals in the last few years. But I think my my point in this story is is is sort of that they're not necessarily rivals in the way one might imagine because they're increasingly attracting sort of slightly different types of borrowers. But you know, to set the scene a little bit, obviously you've got the broadly syndicated loan market and the private credit markets existing in the world of leverage finance, and some of the same borrowers do approach both markets. Now, um it's important to remember that approaching this from the perspective of CLOs, as I approach, you know, uh everything in life seemingly these days, I um, you know, CLOs own as much as 70% of European leveraged loans. So when you talk about the broadly syndicated loan market, you kind of also talk about the CLO market by proxy, although not entirely. But if you compare the two sizes, the sizes of the two markets in Europe now, you know, private credit grew from about $300 billion in Europe in late 2020 to roughly 500 billion in late 2025. So that's a huge increase in size over that time. Those are SP figures. And the European CLO market size is about 300 billion, and that's 300 billion euros, I should point out. So these two markets are definitely significant, they're large, and sort of some of the same borrowers might approach different markets, but because of sort of structural differences in the two markets and because of what we've seen in terms of geopolitical and economic uncertainty, increasingly borrowers that are in very different circumstances might be drawn towards or drift into either market.

SPEAKER_02 2:50

I guess if you're thinking it in kind of crude terms, the the stereotype is that sort of a distressed company that can't quite make it in the BSL market, might go to private credit, like work with a lender for six months, take on a very high interest rate, figure things out, and then go back to the BSL market. Am I right?

SPEAKER_01 3:11

Well, you're right that that is certainly the stereotype, George, and it does have merit to it. I will, you know, in the interests of sort of fairness to uh the private credit market, um, indicate that you know there are sometimes other very good reasons why you might go to private credit. For example, you know, private credit is set up to deal with only a small number of lenders, you get speed and certainty of execution. So if those things are paramount to you, you could approach private credit rather than the BSL market. Um you will pay a spread premium for that sort of speed and efficiency. But then also, George, you are right in the sense that private credit tends to have slightly, shall we say, more flexible underwriting criteria than the BSL market. Uh so for example, they'll allow higher levels of leverage, borrowers don't necessarily have to be rated, whereas in the BSL market, you know, borrowers definitely have to have credit ratings, and they're stricter about levels of leverage that are acceptable, but you of course you do get sort of tighter pricing in the BSL market. You don't get sort of certainty of execution because it's you know it's a public market. So essentially, there can be a division sometimes where those borrowers who sort of want the cheapest possible debt and who are sort of you know meet the BSL market's criteria for you know being eligible for finance might then sort of uh approach um the BSL market. Whereas those who have slightly more complicated credit stories, higher levels of leverage, who might sort of struggle in the BSL market can either go to private credit initially or indeed refinance their BSL debt in the private credit market. So I mean just in terms of the way in which the two markets are set up, they do sort of pull in borrowers from different areas of kind of the broader leverage finance market.

SPEAKER_02 4:57

I guess this perhaps fits in then quite nicely to your story from last week, which was about the looming maturity wall and how you know interest rates have have gone up since a lot of these loans which are are coming up for maturity in 2028 were made in 2021 in a very low rate environment, and then the various other kind of credit stories, I guess, that the market's thinking through, like the war in Iran at the moment and the and the software disruption from from AI. And we we sort of wondered, I think, last week a bit like how how this story was going to end and and where these borrowers were gonna go and whether it was all gonna be amend and extend. Is it the case that perhaps they could just all sort of go off into private credit?

SPEAKER_01 5:41

So, yes, George. So, yes, listeners who were listening, so I think very carefully last week might have, you know, we were talking about the various options for borrowers, and we talked about that really solely in the context of borrowers staying in the BSL market. And in that case, I think amend and extend provisions are very likely to be, or amend and extend kind of agreements are very likely to be the solution that borrowers have for this 2028 maturity wall. But there was an additional option really that we didn't sort of talk about last week, and that is these borrowers who are who've been struggling for years under the weight of sort of higher like interest rates that sort of jumped suddenly in 2022 and have stayed elevated since then with some ups and downs. Um they've been struggling under these sort of higher costs. They might sort of struggle to refinance in the BSL market, and rather that rather than doing an amend and extend, um, you know, they might actually be able to refinance in the private credit market because private credit lenders have a higher tolerance um for these sort of higher levels of leverage, more complicated kind of sort of credit stories, they might accept a couple of years of you know cash flows not being quite where you know the BSL market would like them. And that will push borrowers sort of towards the private credit market. But the other side of this, of course, is that with higher interest rates and with perhaps the Iran war, you know, the longer the Iran war goes on, the more likely it is that we're going to see rate hikes in the next couple of months. With that kind of looming large in borrowers' minds, any borrower that can approach the BSL market right now might want to do so in the sense that they'll get a lower spread in the BSL market and therefore an overall a lower overall cost of debt, which would help them if interest rates went up, sort of leverage loans being floating rate instruments. Um, because the the thing is what what quite a few market sources have sort of said to me is that you know the 150 to 200 basis point sort of spread premium that you pay in private credit versus BSL, that's not as meaningful if if negative like if interest rates are negative. But if interest rates start to go up, uh that suddenly becomes very, very important, you know. And so you could see borrowers like the current economic conditions shunting borrowers towards either market, actually, depending on their specific circumstances and needs. But really, what we're also going to be seeing, I think, is that you know, anyone who's sort of high performing enough will go to the BSL market, and you do have the risk that some of the more distressed borrowers just end up concentrating in the private credit market. That's not guaranteed, of course, and there will be a lot of variation between borrowers in private credit. I'm not trying to sort of paint them all in the same way, but there is, I think, that risk, and there's certainly definitely a sense of the gap widening between different types of borrowers. And George, the final point you made was really about software, and I think it's similarly, you know, a lot of you know a lot of those 2028 loans or loans maturing in 2028, I should say, are in the software sector, and there's a lot of concerns about the AI, uh, impact of AI on software companies' revenues, and so where these companies might struggle to refinance, you know, that in the BSL market, they might easily approach private credit. But then equally, the the interesting nuance there is perhaps there are not that many really, really high quality loans that are viewed to be very high quality in software at the moment. And so if you are actually a borrower that can demonstrate to the BSL market, you know, you're a software company, you can demonstrate you have strong fundamentals, you have strong resilience to AI, there might actually be some appetite for a refinancing there in the BSL market just because you know those credits are not that common at the moment. It would obviously depend on you know what investors in CLOs and things thought, but you know, that that there is that possibility for genuinely strong software credits. But yeah, I think certainly as you say, George, with sort of a lot of the geopolitical factors, the macroeconomic factors and uh and this kind of concern around software are definitely pushing different borrowers to the two different markets.

SPEAKER_02 9:43

So I guess you know, presumably some investors sort of look across the two or or think about CLOs in the context of other other opportunities. How does this dynamic impact upon the sort of relative attractiveness of allocating towards CLO funds or or the BSL market more broadly?

SPEAKER_01 10:04

Yeah, as you point out, George, there are investors that allocate capital both to sort of BSL CLOs, other areas of the BSL market, and to kind of private credit funds. So you might be an investor that is in simple terms deciding where to put your money. And certainly for investors concerned about software, BSL CLOs are definitely a better bet than private credit at the moment. There are differences in the sort of software credit held by private credit and BSL CLOs. The ones in private credit tend to sort of come from like high-growth company companies that were not yet profitable, but they were sort of growing their annually recurring revenues at around 30%, and sponsors and lenders were sort of willing to support those businesses. But now with risks from AI, there are now questions about whether these companies can continue to grow and service their debt. And those are sort of in private credit, whereas the software credits you do see in BSL CLOs tend to be slightly more mature companies in any case that are sort of a little bit more stable. And additionally, you know, software makes up about 8.2% of European CLO portfolios. Private nature of private credit means that we don't have a very, very precise estimate of exactly how much software exposure private credit lenders have, but market participants widely, widely think it that it is higher than in uh BSL CLOs. Um so if you're concerned about software, you will have both lower exposure in CLOs uh to software and probably exposure to better quality uh sort of software debt. So that's that's one point. And then I suppose if anxiety and rate, you know, if anxiety surrounding kind of interest rates and things is well founded, the Iran war continues, you know, there is this risk that there is this kind of concentration of slightly more distressed borrowers building up in private credit. And at that point, again, in terms of credit quality, investors might prefer the BSLC alone market. But of course, you know, ultimately, if some of these fears about AI's impact on software are a little bit overblown, you know, uh if the Iran war is resolved shortly, investors in private credit might fare better than some people might think they are, just to present the other side of the the argument here. There has been a lot of skepticism expressed about private credit, and a lot of it is very well founded. But of course, I'm just pointing out that with with it with the specific movement of borrowers right now, some of some of the risks here are actually contingent on fears around AI and the length of the war sort of materializing. Um, of course, that doesn't get away from private credit's sort of slightly looser attitude to levels of leverage. Uh that there's certainly no getting around that, and those risks kind of do remain regardless of what happens with software and the war in private credit. But yes, I I think certainly, particularly in a kind of tail risk scenario, if we get higher rates and stagflation, you know, BSL CLOs from a risk perspective probably quite a l quite a lot safer, I would argue, than than private credit. And uh yeah, several market participants I think uh would agree with me there.

SPEAKER_02 13:15

I see, yes. Well, perhaps it might be in their interests to do so. Dare I suggest. But if you want to read that extremely well researched story with with all the the fine details and and the views of various market participants um quoted, y you can find it on the Global Capital website. It is called Credit Quality Diverges, with CLOs getting better names, private credit, the rest. And for the rest of this podcast, I think we will be very sadly without Thomas, but thank you for your contribution today. And when we return, it shall be just me and Tom. And we're back. Thank you to our ABS listeners for staying patient. Uh it will be rewarded now, richly, I hope. First of all, Tom, do you want to give us a sort of high-level catch-up on the primary this week?

SPEAKER_00 14:07

Yeah, it's been kind of an interesting week. It's it's kind of been sort of a light to moderate pipeline. So we've had sort of three deals pricing this week, two sterling. So uh we had um AB Carvour sponsoring it, but it's a a quantum mortgages-originated deal. It's the the Bleshley Park deal. It's um the third deal from that shelf. Uh that priced on Thursday. Then Pepper pricing one of his Polaris deals, that's today. We're recording on a Friday. And uh Santander priced its German consumer deal on a Wednesday. So it it wasn't a super uh sort of busy week, but I think you know it did seem like there were some sort of minor uh kind of delays with the a few of the deals, so it does sound like investor engagement is kind of uh sort of an an interesting kind of place right now. Um I guess we'll we'll probably find out a bit more going into next week. I mean we we've got two deals on screens for for next week so far. Santander's got its um Portuguese uh consumer ABS and also uh Apollo's B Quip has has made a pretty quick return to the ABS market uh with uh with its second deal just sort of seven months after its debut. So uh and it's also uh you know it's another 500 million uh size, so it's it's quite a big deal as well. So uh they'll they'll both be you know quite interesting uh sort of tests for investor demand as we we kind of get closer global ABS.

SPEAKER_02 15:37

Yes, indeed. Well, rarely a week goes by without a sand and uh deal these days, but two issuers willing to navigate the UK bank holiday on the Monday, which we've talked about far too much in this episode. So now we're gonna move on to the the long-promised um UK motorfinance story you've done. So you know, we've we talked on a podcast quite a bit about how kind of motorfinance as an issue is kind of done and dusted as far as the primary market's concerned. Like Oodle's done deals at one end of the market, BMW and um Volkswagen have done deals, haven't they? So, you know, primaries primaries back up and running seems to be kind of firing well, investors are buying the paper. No one's really worried about any ABS deals particularly suffering um any losses or any set-off risk. So I have to wonder what brings you to write about the scandal this week.

SPEAKER_00 16:32

Yeah, so I mean it it's quite interesting, as you say. I mean, UK Auto ABS on the primary market has been having a phenomenal run. And, you know, I we've recorded sort of eight deals since last September, and that's compared to, you know, almost a year of no issuance while the sort of Supreme Court case uh around the auto finance scandal was ongoing, and as soon as we we got the ruling, it it felt like um you know the the market took that very well and really just opened straight back up. But we we've sort of you know we've had a few developments uh kind of since then. I mean the the big thing is the financial conduct authorities redress scheme for you know figuring out a way that you know consumers can get compensation payments if if they've been affected by these discretionary uh commission arrangements uh or rather uh sort of high, you know, very high commission uh loan agreements from sort of the period 2007 to 2021. And the you know, the the FCA uh opened its consultation uh towards the end of last year and it's you know finalized its process uh now. And the market reaction I think, you know, I did a story, you know, sort of last month when when it was first came out, it it seemed the initial reaction was quite mixed. And I think as as we've sort of had some time to sort of take it in, uh it seems like you know, for a lot of the market they they've taken it well, but you know, equally there there are some lenders, and and in this story I go into it uh with Blue Mite Finance uh seemingly being the main lender that has you know been really uh or seemingly you know really badly affected uh by the redress scheme. And you know, it it seems like they are sort of facing a bill of about 50 million in redress payments under the scheme.

SPEAKER_02 18:21

So let's talk a bit more about the case of Blue then. Um is that 50 million something they can afford to pay?

SPEAKER_00 18:28

It looks quite unlikely because they they've only sort of set aside 7.9 million to pay the redress. That's according to um some Bank of America research from this week. And you know, like like a lot of you know, special sort of finance lenders in this space, uh they operate a pretty uh sort of capital-like model. So it seems like it it would be difficult to make those payments. You know, I I think the case of Blue, yeah, it it does seem like it's in quite a difficult situation also with you know its its funding sources are sort of looking slimmer, as you know, Shawbrook Bank, uh, which you know had a a forward flow agreement uh with Blue since uh October 2023, decided not to renew its agreement back in February and sort of make clear it has it no longer has any uh lending exposure to uh Blue anymore. So it it seems like yeah, it could sort of be quite a big problem for that lender specifically.

SPEAKER_02 19:22

Yeah, well that's interesting. And then what's the broader read across then? It seems like you know, you you haven't heard of loads of kind of distress situations. I mean there's been a few there's been a few sort of uh reactions to it, like um we've written about first RAND putting Audemore Bank on the on the market, but uh as as we say, it doesn't seem like primary's affected. Like what what should we kind of take away from this situation?

SPEAKER_00 19:47

No, and it's interesting because I mean a lot of sort of lenders which will presumably have the the largest sort of bills uh for paying address, like you know, Lloyd's or Santander or you know, potentially Close Brothers, it it seems like I mean that none of them are have put challenges to the scheme so far. So it seems like a lot of you know players in the market are sort of accepting uh the scheme for for what it is. Um and then again on primary, if if you look at the the specialist lending space, a lot of lenders have probably I mean come out a lot stronger. Now they they have some certainty from the scheme. And you know, I think Udle is a really good example of a lender which is you know really kind of doing incredible, you know, certainly in terms of access to funding on the primary market. They they've managed to price uh sort of two deals since last September or last October. So that's you know, obviously really impressive. And I think the the scheme, when they brought out their deal uh from October, they assumed that they'd probably have a bill of about 13 million, which you know, like a lot of these lenders, they have uh majority owners um for private equity firms who are uh you know supporting them. And uh Udle's uh owner, KKR, provided a subordinated loan to uh cover that, which has had since uh July 2025. But I mean ultimately now that the scheme's been finalized, you know, with with Udo's most recent deal it put in the uh prospectus that it looks like it's now only gonna have about five million uh in redress payments. So that's you know less than half of what they originally uh were expecting. So I think it you know, a a lot of lenders have sort of come out of this you know quite a bit stronger. And you know, it it does feel like on the whole the the cloud has lifted. But it's just you know it's it seems sort of quite an isolated uh instant, the the case of Blue, where it it seems like you know, this this sort of finalized redress scheme has actually sort of made things worse for the lender.

SPEAKER_02 21:45

Yeah. I mean, there is actually one deal outstanding, isn't there, from Blue. Should noteholders be getting nervous about that?

SPEAKER_00 21:53

No, I I think it's unlikely because you know, as as you say with this this deal from its um it's a zero finite shelf. um the last deal price back in April 2023. So um you know the the notes outstanding are about eleven point five percent of the initial pool size. So we're we're getting close to the 10% hurdle for the the cleanup call. And again I I think the the Bank of America research said that's probably going to be reached uh either this month or next. The only sort of I guess danger would be if if BMF you know were to collapse in in a matter of days or something. You know, that that could mean that you know the the cleanup call uh wouldn't be exercised um which you know could could be a a slight issue for investors. But it it doesn't seem like I mean it again we're we're so close to you know the the end of this deal that you know it it doesn't seem like a big sort of issue for the market. Good.

SPEAKER_02 22:47

Well thank you Tom if you want to read the story it's called best selling re-risk scheme costs shadow over UK Auto ABS revival. And we've gone on long enough so with that we shall say thank you very much for listening and goodbye. Goodbye