A new Frontier

Bank of America securitises more Santander mortgages, the loan market is back above par, and Another Fine Mezz Live in Barcelona!

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Hello and welcome to another function. I'm George Smith, Global Capital Securitization Editor, and I'm joined by our European ABS reporter Tom O and our European CLO reporter Thomas Hopkins. Hello. Hello, George. How are you doing? I'm very well indeed. Uh the sun's shining, but it's not quite as hot on Friday as it has been this week, which is a relief to me and and presumably to everyone else. It's been diabolically hot this week. I I don't do very well in the hot weather, so I've been uh basically in a rather bad mood all week, I think, George. Yeah. Yeah, I think a lot of people have been. Hazel, my daughter, certainly among the people who've been less than impressed by the weather. But we should talk about the securitisation market, which I think has weathered the weather and continued in a healthy fashion, has it not? Yeah, it's actually it's been a a very uh busy week in terms of primary market. It I wasn't really too sure exactly what was going to happen kind of following on from last week, because we had kind of four or five deals, which was a bit lighter than I think what uh I was kind of hearing, but it sounded like it's sort of all been pushed into this week, which makes sense because I I was speaking to someone this week and they were saying, you know, given it it normally takes longer than a week to execute a deal unless you're working with you know a super you know regular prime R and BS issuer, uh, you know, this week you really need to announce a deal towards the end of the week, and then you can execute it uh next week. Otherwise, you know, if you wait till next week, you probably won't be able to execute it, and then you've got Barcelona the week after, and everyone's you know gonna be there, so there'll be less sort of investor engagement. So you you could, if you don't get a deal out now, sort of essentially be waiting three weeks to get a deal done. So we we've seen you know quite a few interesting deals go on screen. So I guess the the most interesting one is um we've got a a debut UK credit card ABS from Fanquist Bank. So that's uh you know, that's always uh a very interesting thing to see, and it it seems like credit card ABS is uh kind of having a really phenomenal year so far with with two Master Trust uh debuts, the other one being from Advancia Bank. Yes, indeed. And and you've covered that and the and the rest of the pipeline in depth for the for the subscribers. Um but your your big story of the week was on a different deal from well, was it from Bank of America or was it from Santander? Yeah, so that that's the interesting thing about this deal. So it's it's the second time Bank of America has done this. It's it's sponsoring the deal, but it's backed by mortgages originated by Santander, and these are kind of you know slightly more seasoned uh mortgages. They kind of you know have higher arrears and delinquencies than you'd see in kind of a a tick typical uh sort of prime portfolio. Um so it's it's quite an interesting sort of deal. And yeah, it's I think the most interesting really is that it's it's the second time they're doing this because I I covered it back in September when they they did uh the debut from the the Frontier Shelf, which is the the program which Bank of America is using to securitize these Santander UK uh residential mortgages. And it it seemed like you know it could potentially be just a one-off transaction because it wasn't necessarily clear whether they'd bought the loans directly from Santander or they'd you know managed to buy them off of the secondary market. But now, you know, it it looks like it's it's sort of going to be a a more regular uh program. So Bank of America's when you say sponsoring, that means they're holding risk retention, right? Yeah, that's exactly right. So I mean they're they're kind of taking the the long-term risk on the deal, and uh, you know, Santander is is able to deconsolidate the assets off this balance sheet. And you know, they they both sort of have you know different reasons for for why they're you know kind of doing it. I mean, but Bank of America, I suppose, is trying to make the the profit from the difference between you know buying the portfolio straight from Santander and then securitizing it and selling it to investors, and then um you know it it's taking on that execution risk and the uh uh risk retention. But I think also I mean part one of the things that's interesting within the structure is also it it uses a um VR which is kind of proportional to just doing like a vertical risk retention where you retain five percent of each tranch. But because this is you know a really big deal with lots of different tranches, uh it looks like it'll be kind of more efficient just using the loan note. Um and then Bank of America doesn't have to do the kind of sort of accounting and reporting work on each individual tranche and working out the different you know kind of average lives uh for the tranches. I see, yeah, yeah. So some interesting structuring um as well as I guess what appears to be a kind of I suppose an a slightly novel playbook for for these banks. Um the second deal, is this something you kind of like how does this fit into into the market more broadly? Might others copy or might we see more frontier transactions? Yeah, it's interesting so far. I mean it seems like it's mostly sort of the domain of sort of big US banks. I guess the two kind of big players uh certainly for this year and last has been Bank of America, obviously, through its frontier shelf with Santander, and also Morgan Stanley has been pretty active. It did a uh deconsolidation trade of uh Santander UK mortgages uh called Hazel Residential back last year, and then it also did a Spanish one, I think uh the transaction was called Torres, and that was more you know, sort of legacy uh Santander mortgages. So I I don't know whether that's the case of you just need to be a really big sort of US-based bank to be willing to take on uh the risk of such a big uh kind of portfolio acquisition. So that that would you know suggest that maybe uh there's not going to be you know loads of other players trying to get in on these kind of you know transactions. So it it seems like the the frontier shelf at least uh you know could be continuing. Yeah, I mean Santander though is itself a an active issue of securitizations. Could they not have run this through their own um their own sort of desk? Yeah, I mean they uh obviously it's possible. I think it's I mean the thing about Santander is it's you know very, very active. I think I I was looking through uh SEBAM monitor and re-recorded about you know 15 transactions that Santander issued last year, and it's also obviously super active in the uh SRT market, uh, which is you know a bit more private. But um you you could understand why it would make more sense from Santander's perspective to focus on you know structuring its many transactions that are you know certainly more simple to structure than doing the work on you know the this mortgage portfolio, which is going to be having much higher than normal arrears, delinquencies, uh a lot of interest-only loans than you know your typical prime uh mortgage pool. Um so I I think from from Santa's perspective, it it definitely does make sense to you know just take the the much simpler route of selling the portfolio to someone else who's willing to securitize it and then just getting the lines off your balance sheet. Well, thank you, Tom. That story, if you want to read it, is called B of A Make Securitizing Center Day UK Mortgages into a program. And the story is for subscribers, contains a few extra details of the structure and and how they how that fits into the call incentives. Um so I'd definitely recommend checking it out on the website. But moving on to the CLO market, has there been much to to talk about this week, Thomas? Um oddly enough, at this point, recording on a Friday morning, obviously as we always do, um not an enormous amount of enormous amount of activity or number of deals priced over the course of this week, although again that that will probably change by by the end of today. Um but what we are certainly seeing is quite a large pipeline of deals. The sort of sentiment I'm getting from you know market participants is that um primarily because investors have become more comfortable with say the risks of like the Iran War and things, we've got sort of spreads tightening, and this is prompting quite a lot of um sort of deal activity. So, I mean, you know, some research from PNG alternative investments that sort of came out this week listed kind of 20 deals um sort of in the pipeline across new issues, refinancing, resets. So um, you know, for example, with new issues, I mean, um, you know, we've got sort of CQS, Blackstone, Guggenheim Invest Investgo, Alcentra, EAM loan management, King Street, 1988 asset management, they've all got sort of pipeline deals at the moment. Um, so you know, things are definitely, I think, set to pick up from the kind of two or three deals we were having a week for many weeks after the Iran War started. Um, but as of this moment, right now, this week, not been the busiest week in terms of primary deals, you know, pricing. Can they all get done before Barcelona, or is this going to be a like mid-Barcelona and post-Barcelona pipeline as well? I mean, one banker this week that I spoke to did say to me that um, you know, he felt that people would desperately be trying to get their deals done before Barcelona. So um, you know, we may see a surge today, but also I imagine next week there'll be uh it could be a reasonably busy week next week as people come and get their deals done before Barcelona. Because I think it would be unlikely that you know managers would sort of want their deals kind of hanging over Barcelona and things when the whole market is is a way that would uh uh you know, I think be not exactly ideal conditions for for sort of trying to price a deal. And yeah, certainly what market sources have told me is that people would probably rush to get things finalized before Barcelona. I see, yes. Uh well let's talk about the weekly story then, which is back on the load market, and you know, we we've talked in recent weeks about how kind of load prices had fallen a bit, and there was an opportunity to sort of pick some things up below power, but the window has slammed shut. It has indeed, George. Yes, we've gone back to well not quite back to, but almost back to the situation that we had sort of at the start of this year and also for several months before that, where you have a large portion of the loan market sort of trading above par. It's around half the market now is is above par. But you rightly point out, George, that you know, there was a moment sort of again following the Iran War, kind of through sort of March and into early April, where loans did trade down quite a lot, and we saw the share of loans trading above par actually go below 10%, which was quite notable. And um, you know, despite the fact that deals were emerging quite slowly because managers were quite cautious at that point, um, what managers were saying to me is that, you know, it was quite a good time to be buying loans because, you know, for once you could simply buy loans that might otherwise be at 101 that were say at 99, um, just because the entire market sort of you know traded down basically because of risks associated with the war. But basically what's happened now is that the leverage loan market is very much kind of priced in a scenario in which uh the Iran war is resolved before the US midterm elections, because that would be politically expedient for you know the uh present occupant of the White House. And um, you know, I think the thought is then that if this does get resolved, the straight upon those opens, you know, by the by the US midterms. The the long-term consequences for borrowers are probably not that severe. It's not that the war will have no effect, but it probably won't have an extraordinarily severe effect. And so, you know, I think people are more comfortable and loans have sort of risen above par again. I mean, it's also a a function of the standard dynamic of the leveraged loan market that we've seen for months on end as well, in which ultimately demand from CLOs massively outstrips kind of primary loan issuance, and at that point what you get is you know inflated secondary prices, uh, and so everything kind of moves above par. Um, so that's the situation managers are are facing again at the moment. Yeah, so I mean in January, right, there was a pretty horrible situation for managers because like you had this enormous wave of repricing, so at the same time, there was like not really much they could buy that was not below par or that was in fact not above par. Is it quite as bad this time? Like are they are they in the same kind of bind again now? I mean, I did see some interesting research from Bank of America to this week sort of indicating that with so much of the loan market drifting above par again, repricings are now sort of back on the back on the agenda, back on the menu, as it were, um, which uh will will not be pleasing to you know managers and CLO equity investors. So that's certainly a possibility. Um I think you know, certainly in terms of how it's going to affect new issue CLOs, certainly what you know, I think the the primary effect is that it's going to slow the ramp up of new issue CLOs so much in the loan market being above par because you know what what happens is that prior to pricing a CLO, but when managers are ramping, they're going to have to sort of concentrate more on primary loan issuance than secondary, because primary loans tend to be issued at a bit of a discount to secondary. So if secondary is a bit north of par, well then you know primary might be at par. And I think particularly when you've sort of got the flexibility in terms of timelines before you price a deal, you want to be trying to sort of fill up with you know uh as much primary loan issuance as you can if a lot of secondary is above par because there's no real upside um to you know buying a whole lot of loans in secondary that are above par because ultimately those loans, if they prepay, they'll prepay at par. Um and you, you know, this they don't tend to trade very far above par because of the threat of repricings. So you're unlikely to be able to sell them at much of a higher price. So if you can get primary at a discount, um, you're going to want to. But at the same time, the flow of primary leverage loans is notably, well, continues to be slow. And so your ability to fill up your warehouse with primary loan issuance is, you know, well, it's it's limited and it's going to take you a while. You know, we've had a couple of big sporadic deals like the electronic arts deal a couple of months ago, but they've not been enough for managers to just kind of fill a lot of their, you know, uh warehouses with primary deals. I mean, the calculus changes a bit after you price a deal and you have to sort of complete the remaining ramp ahead of closing because you do have a pretty, you know, you have a that deadline of closing when you draw down your liabilities and you've got to carry the cost of those liabilities. And at that point, you really do need to have your CLO portfolio sort of almost fully ramped. So, you know, at that point, you might be forced to buy some assets in secondary even if unattractive. But it's this sort of thing where you're gonna have to ramp your CLO more slowly before pricing, and then you know, you're gonna have to buy expensive assets in secondary, you know, between pricing and closing, because you might not have many other options just given that so much of the high quality credits are at or above power. Yeah, so perhaps this 20-deal pipeline might be a temporary, uh temporary phenomenon. Let's talk a bit more about reinvestment then. It's a tricky environment, isn't it, to to be trading. Um you're at quite at risk of of burning some power if you have a uh uh kind of prepayment of any sort. Like how do you play this, the these conditions at this moment? Yes, I mean it's it's it's difficult for for managers, and there's the there's a reason for this, and that's just sort of primarily because general reinvestment conditions in most CLOs will prevent you from replacing an asset that you sell or that is prepaid um with an asset that has a sort of you know a lesser kind of par balance. You know, you have to sort of replace an asset that that is you know prepaid or being sold with an asset that has an equal or greater par balance or sort of notional balance. And you know, the difficulty is that say you have a loan that you know prepays at par, as they all do, and then most of the loan market, most of the loans you could conceivably access, you know, that that are of a decent quality or above par, well, you have a difficulty funding that replacement um of that asset. And so, yeah, that that that is the primary difficulty for managers. I mean, there there are several solutions, and uh, you know, there's some of them are perfectly viable, but they all do come with certain risks and certain disadvantages. So, for example, you could replace an asset, you know, that's sort of prepaid at par with an asset that's trading below par uh that has a you know the same sort of par balance. But at that point, you know, you you you do have to wonder how far you're looking below par because there are credit risks attached to doing so. There's a reason that, you know, loans are trading, if they're trading much below par, there tends to be a credit reason for that. You can also sort of avoid the requirement to sort of have the kind of equal or greater par balance if you've sort of built par in your portfolio already. But again, with so much of the loan market above par, it's quite difficult to build par at the moment. One of the most common solutions is a trading plan where you sort of, you know, you don't replace one asset with one asset, you sort of aggregate multiple sales and purchases together to sort of offset any above par purchases with discounted purchases. But again, you know, you do still have to have some viable assets that are trading below par. And again, there's something of a shortage of those at the moment, so that's a bit difficult. The final thing, which is quite a newer sort of technique that we've seen used, is managers are starting to use excess interest proceeds to sort of fund the above par premium, as it were, when you, you know, when you're sort of purchasing an asset that's above par with the same par balance as a as a loan that prepaid or sold at say par. And you know, that comes with its own risks, you know, in terms of the amount of cash flow in a CLO. Um, so there are ways around it, but this is it's not really an ideal situation for reinvestment for managers, you know, when they have to replace assets, if so much of the loan market is about par. I see. So I suppose investors have views on this. Do they uh what what are they like? Um how do they think that managers should uh should approach this? I mean it's sort of it can be difficult for equity investors and liability investors. I mean, you know, the just the the very fact of it being difficult to build par in a CLO is not great for equity, particularly when you know your arbitrage remains pretty compressed um by tight loan spreads, although granted the arbitrage has improved slightly recently because loans liability spreads have tightened slightly. But that's not good for equity investors. And then, you know, similarly, if to do things, you know, if managers are having to look to assets that are trading below par in order to continue reinvesting, be that through you know trying to build par or uh through the trading plans or through just replacing assets that they're uh prepaid with assets that are below par. You know, in all of those scenarios, again, you are you do risk amount just buying assets that have sort of lower credit quality purely because they need to do that to keep reinvesting. So that's not great either for equity or liability investors because it raises sort of default risk. And then certainly in terms of the excess interest point, you know, I mean, SP sort of produced some research that mentioned this. And um, you know, they've certainly indicated um that they'll kind of include, you know, they said sort of where present, the sort of diversion of excess interest proceeds. They said where present, we will typically reflect an additional stress in our cash flow analysis, because ultimately, you know, this cash flow, and they're really thinking about the liability investors, but if you use this technique very widely, it is kind of limiting the amount of spare cash you have in a in the CLO to sort of you know repay your liabilities. Obviously, equity investors also don't like it because you know ultimately if you're using that excessed interest that might otherwise be tipped down the waterfall to equity, um, you know, it's going to just keep the asset reinvesting. So that's not great. And I suppose then the final point really that I think investors will be concerned about is, you know, that there have been some proposals that have been put to rating agencies. Well, you know, SP sort of acknowledges this directly, that have been asking, you know, for them to be able to sort of reinvest in above, you know, make these above-par purchases without any mitigants. Now, SP has said quite directly in their research that they've pushed back against such proposals, but there's clearly some appetite there to tweak the rules. And obviously, if you were, you know, these rules about reinvestment are not actively destroying par in CLO portfolios. They exist for the explicit protection of investors. So it would certainly change investors' calculus if these rules were to be tweaked or weakened. Again, I mean SP said quite directly that they pushed back, but there's appetite there, and I think investors will certainly be mindful of that. Well, thank you, Thomas. The the story which is extremely well sourced and and packed with news from market participants, can be read by subscribers on the website. And it is called Embarrassment of Riches. Loan price surge puts CLA managers in a bite. And we have one final very exciting thing to say, which is that another fine mez is returning to the stage in global ABS this year. We will be on stage on the spotlight stage, which is in the exhibition hall of of the conference um on Tuesday the 9th at ten forty five for half an hour. Uh we'll be talking about all the big trends and our our features and and special reports we've done for the conference. And we would very, very much appreciate if you if you like the show, if you were to come and watch us live, it would be tremendous. And with that, we shall say thank you very much for listening and and goodbye. Goodbye. Goodbye.