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KKR’s landmark deal and will CLO managers mix BSL with private credit?

Transcript

SPEAKER_02 0:07

Hello, and welcome to number 20 minutes. I'm Drew Smith, Global Capital Security Decision Editor, and I'm joined by Tom Hall, our ABS reporter, and Thomas Hopkins, our CEO reporter. Hello. Hello. We'll start with with you, Tom, given the enthusiasm with which you've just greeted me. Your weekly from last week, which was about how the sterling market is sort of underperforming relative to the Euro market in primary, has proved to be prescient.

SPEAKER_00 0:32

Yeah, it's been quite interesting this week. I mean it's it's been another uh sort of pack week. We we've had kind of 11 deals in the pipeline throughout the week. Um I think one one of the the most notable ones um has been the permanent deal from Lloyd, so it is from its um prime sterling prime RBS Master Trust. And that that was quite an interesting outcome because it it priced uh uh 55 basis points, which is a little bit sort of wider than we we've kind of seen, you know, most RMBS deals from you know a major bank and issuing through master trust have sort of been pricing over the last kind of year or so.

SPEAKER_02 1:10

But in spite of that, um your sources close to the deal thought it was a pretty good outcome?

SPEAKER_00 1:17

Yeah, I think it was a good outcome in a lot of ways. I mean, if you if you just look at the you know, it was a very sort of uh granular, diverse book, and you know, it was a a three-day execution for the deal. Um and it it sounded like this this was kind of entirely expected, and it and it was you know, before the the deal had been announced, they they were kind of thinking, you know, 55 basis points is probably the the best case scenario just given where the market is. And also, you know, it it does feel like um outside of any kind of you know supply and demand dynamics that are going on in the selling market, which has probably you know played a factor in UK by Telette spreads sort of pushing quite a bit wider uh than the start of the year. It's it's felt like I mean definitely since the the end of last year I've I've spoken to bankers who have been saying it, it does feel like UK prime RMBS has been due uh a little bit of a repricing. So maybe you know I think the the headline for the article I wrote was Lloyd's kind of sets a new level for the market. You know, I I don't think this is is going to necessarily be an outlier trade. I I think this this will be uh the sort of trade that the next you know sort of prime issuers will will be looking at and thinking uh maybe these are the the kind of new sort of pricing expectations.

SPEAKER_02 2:34

Yeah, well I guess if if we're and you know you you said as well last week, you know, UK by to let is is a bit wider and and and so forth, but one issue of backing the trend um was was Lander Ball making its its debut this week.

SPEAKER_00 2:49

Yeah, and that was uh you know that was that was a very impressive trade, I think, you know, from a pricing perspective in general, just how the deal went. I mean, I think um yeah, the the seniors priced uh 84 basis points, which is you know pretty solid levels for a uh debut UK unsecured consumer deal. I think it tightened from I think it was low 90s um seniors, which is obviously looks like uh you know quite quite an appealing sort of prospect for for any kind of uh triple A rated paper. So yeah, I think that that looked like um a pretty successful outcome. Maybe the sort of sterling spread widening has has been uh kind of isolated into the the RBS asset class, perhaps.

SPEAKER_02 3:31

Mortgage sector. Yeah, well you were saying when you that like a lot of the buy-to-let sluggishness is down to oversupply. The same probably can't be set of prime, but no.

SPEAKER_00 3:40

I mean I I suppose there there might be more of an overlap uh between that investor base compared to you know a a UK unsecured consumer is gonna be you know mostly real money accounts versus you know there there will be sort of more bank treasuries getting involved in uh you know UK buy-to-play deals, especially if they're they're STS. So there there might be a little bit uh more overlap between UK buy to play and UK Prime necessarily than you know, UK unsecured consumer.

SPEAKER_02 4:08

Yeah, and then I mean the other the other consumer deal this week is also performing pretty well, isn't it, in the UK? The one from Bug Please and Admiral. Not sure has has it priced as as we record on Friday.

SPEAKER_00 4:19

No, it hasn't priced yet.

SPEAKER_02 4:21

But it's well on the way.

SPEAKER_00 4:22

Yeah, well on the way. It's another interesting one because it's the first time uh it's got an STS stamp. It feels like every deal in the market is now getting an STS label, and that that obviously you know does help. I think I think it definitely I mean, one of the things is is especially useful in a really busy market, um, because it helps sort of differentiate uh deals if you know you're quite a small sort of investment team and you're looking across sort of you know 11 deals or something if if we have I mean it it it didn't necessarily apply this week because um Lendable's deal is also STS. But that you know there will be times in the future, I'm sure, where you'll have two bicolet deals marketing and one will be STS and one won't, and you know that that might sort of be be making the difference if if you're you have a very you know stretched uh ABS analytics team who are who are just kind of considering you know which deal uh looks the best.

SPEAKER_02 5:14

Yeah, yeah, indeed. Well, I think um we should now cut the chase, uh what everybody's been waiting for, I'm sure, is us to discuss the KKR and and PayPal deal.

SPEAKER_00 5:26

Yeah, so this is a really interesting deal, and you know, there's by now feel it is an ethic class that's really been talked about for for ages. I I did a big story on it last year, but it I mean way before then it's been talked about. And you know, this this sort of KKR uh deal, I mean it goes back to uh sort of 2023, I think, and that that was the original Ford Flow agreement was agreed between KKR and PayPal for financing its Why Now payway to loans. Um and then that was majorly sort of increased uh at the end of 2025 to it it was sort of a six billion line, and because the the loans sort of pay down so quickly, it it could uh you know expand to I think it was about sixty-five billion financing over the the lifetime of the deal. And so yeah, that that's um been transitioned into the the public market now this week, uh with a deal called I think Alps Partners Germany, ABS 2026-1.

SPEAKER_02 6:26

Well, I think so yeah, I mean I think that makes it probably the biggest forward flow in Europe, maybe by like v number of assets purchased or at a facility size maybe maybe smaller.

SPEAKER_00 6:39

Yes, it can it can be a little bit misleading, I think, uh call calling it, you know, uh a sixty-five billion uh sort of facility because the these loans, you know, they they turn over very quickly. So yeah, they're they're not like a standard sort of unsecured consumer loan.

SPEAKER_02 6:53

It's not sixty-five billion of simultaneously committed capsule. But anyway, tell us about the structure then. I I mean I guess people have always been anxious about the short-dated nature of buy now pay later, how you'd have to have a revolving period, um, you know, all all these considerations about how you'd work with those short-date receivables, whether the portfolio could kind of migrate towards lower quality across the life of the deal. They must have come up with some solutions if they're confident they can get a public deal away.

SPEAKER_00 7:21

Yeah, absolutely. And you know, as you say, th there's plenty of you know triggers and uh different sort of standards within the the structure that sort of prevent the characteristics of the portfolio changing uh during the revolving period. So I mean the this deal is a much longer uh revolving period than it than is typical uh with most sort of you know German consumer deals. So it's got a 24-month uh period where the issuer can buy additional receivables. And and that you know would be much more efficient funding, I think, for for KKR than just using you know what's typical with German unsecured or you know, the kind of 12 to 18 months or or even a static deal, because otherwise, you know, you you have so many super short dated loans that it it would you know pay down very quickly and it wouldn't uh provide you with super strong funding for for a very long period. So that that's quite an interesting aspect with the deal and and yeah, there are uh there's sort of limits with with different loans that can be purchased uh by the issuer during the revolving period. So it it's broken out all all the loans, uh they paid monthly interest instalments, and they're either a three-month, six-month, twelve-month, or twenty-four-month uh loan. And I think that there's limits on I mean naturally, I think the the longer uh the duration of the loan, there there's more risk that it it could um perform worse. So there's a limit on the the 24-month uh loans can't make up more than 55% of the pool and the 12-month loans can't make up more than 35%, then there's no limit on the uh the six and three-month loans uh during the revolving period as as the issuer purchases more receivables.

SPEAKER_02 9:04

Yes, indeed. Um and you wrote a little bit about the hedging. Um hedging's always questioning these kind of portfolios, like how how you put in place exactly what what sort of hedge you want to use, how does it work in in this transaction?

SPEAKER_00 9:20

Yeah, so I think in in most transactions you you'd agree uh you'd obviously agree a swap uh with banker closing, and that and that's just because you know they they pay a fixed rate interest, but um the securitization deals make floating rate payments to the bondholders, so you need a swap to sort of account for that. Um and the the difference with this deal is that during the uh revolving period, so KKR has an agreement with uh BP Paraba that it will uh purchase uh additional uh swaps for at each um receivable purchase date during the revolving period of the transaction to kind of you know account for the fact that there's gonna be a a longer revolving period than usual, and also uh these loans are gonna be paying down much quicker than sort of typical of these deals. So you don't want to have a case where you you have you know just one swap at the at closing and then you're purchasing you know lots of receivables that have been originated at possibly you know an interest rate that's no longer economical for the transaction and starts um sort of you know taking away from the the deal's excess spread.

SPEAKER_02 10:32

Yeah, indeed. Well, I guess the last question and the question everybody will be wondering is this the start of a of an enormous new asset class in Europe?

SPEAKER_00 10:41

Yeah, I think it it it's definitely very interesting. I mean, you know, I I had a section in the article over whether this is you know a pure buy now pay later trade, because the these are ultimately um you know the fixed instalment interest uh loans, so which is you know sort of more more typical with what you just see in a standard uh German unsecured ABS. But I mean the the difference is that these are uh much shorter, much shorter term loans than than you'd see, you know, with with a deal that that might have, you know, I don't know, several years sort of term loans. But again, we we can see you know some of these are are only three months. Um so it it does sort of provide a template for for you know any issuers that do want to uh securitize the these super short-term loans, uh that it it doesn't look like it it's possible. I think the the question sort of changes, you know, you're asking how how would you securitize what people consider to be a kind of buy now pay later in its truest form, which is you know interest-free payments uh super short duration, like um PayPal as is uh pay in 30 days product, which you you just defer a payment for 30 days basically, and you pay no interest uh when you pay them back. So it has the the sort of pay later element of it, you're you're not just take out a kind of standard loan where they'll you know they'll they'll make money through the interest, it will be you know the the money for those is made through uh merchant fees agree to sort of use the platform. But yeah, so I I think it's it's answered sort of maybe half half of the questions uh uh around how uh by now pay later can be securitized. Uh so there's definitely room for for more transactions and and definitely you know not looking at the the funding side but looking at the the kind of underlying product. I mean it's it's super fast growing. Um there's plenty of lenders. I suppose one of the differences with um PayPal is that it's definitely considered a very high quality uh lender with with super high quality collateral. So maybe that would be an interesting issue of you know when when we see other deals, it would be the question of do they have uh long enough historical data to really uh to get the rating agencies comfortable with rating a deal and you know, it's is the collateral uh you know a really strong sort of you know portfolio of of loans.

SPEAKER_02 13:12

Okay. Well, thank you, Tom. Uh the story, if you want to read all the details, is called KKL's debut lays foundation for buy now, pay later, ABS Asset Class in Europe. Um and I think we should move on to CLOs. Thomas, have you had any deal action to keep me busy?

SPEAKER_01 13:28

I have, yes, George. Um yes, good to be on the podcast as as usual. So after a rather slow week last week, um, we do seem to have been pretty busy this week. So, you know, quite a few deals going ahead. So there was Carlisle uh 2026 One new issue deal. Uh there was a refinancing from Soundpoint, you know, KKR had its um Evoka new issue deal. Uh there was a sort of one tranche refi from Golden Tree, Diameter notably priced its second ever Euro CLO. And then sort of just last night we had ReFi from Anchorage Capital. Um, and uh there was also a new issue from you know Harvest, the latest Harvest CLO, and then uh finally a reset for Henley CLO1. So things do seem to be ramping up um considerably at at the moment. Uh it's sort of more deal flow, frankly, than we've seen in um quite a number of weeks.

SPEAKER_02 14:31

Okay, well, it's good news, despite the uh the escalation and um at least conflict again.

SPEAKER_01 14:37

Yes, I I think basically, you know, we we had a something of a slowdown for you know several months following the Iran war because um you know, with the sort of closure of the Strait of Hummus, there was just this persistent sense in the CLO market that borrowers might be sort of affected um negatively. But the the market does just seem to have accepted the sort of risks that the higher energy costs and inflation are potentially posing to borrowers and are just kind of going ahead anyway. And we're actually seeing spreads tightening at the moment. So it's clear that eventually investors have just sort of accepted a kind of new status quo, uh yet another fracture uh in the sort of you know geopolitical landscape that we have, and uh just sort of you know still buying CLO paper uh and as a consequence, I think issuance has ramped up. But also you have to remember that, you know, um my favorite subject, captive equity funds, you know, with with CLO managers, it's often, you know, they have these captive equity funds and they almost have something of a mandate to print like a certain number of deals, because obviously there's there's a window in which you can sort of deploy this capital, and so it gets to a point where you actually just kind of need to print. And so there might be a bit of that as well, that they just have to sort of accept whatever the risks are and go ahead uh in order to sort of deploy the capital they've got in their captive equity funds.

SPEAKER_02 16:00

Yes, indeed. Wow. We'll move on to sort of slightly removed from the immediate primary market weekly story, but still nonetheless forward looking to what could be to come. And this was about well, I I actually changed the headline to hybrid CLOs floated to solve arbitrage puzzle. But it was about these kind of the option to mix private credit loans into BSLs or mix BSL loans into private credit CLOs. Like, why would you want to do that? Surely uh putting in uh one or the other, like keeping under set pressure gives you the most efficient capital structure I would have thought.

SPEAKER_01 16:36

Well, that depends, George. And so I should point out with with hybrid deals, they're not something that we have very directly seen yet in Europe. I mean, there are current structures that we look at, that we can look at the sort of gesture towards the the you know the hybrid structure, but we haven't yet seen broadly syndicated loan collateral and private credit collateral very directly and intentionally blended in a CLO. There are several advantages, basically, to you know going ahead with the with a hybrid deal, and this is why there's quite a lot of sort of market interest in this at the moment. KBRA put out some research a couple of weeks ago indicating in some ways that you know market participants are viewing this as kind of the next step in the evolution of uh say private credit CLOs and things in in in Europe. Now, if you are a manager who is sort of looking to launch a private credit CLO, there is a certain advantage in some ways to incorporating some BSL collateral. The reason for this is that ramping a private credit CLO can take a while because you basically have to fill the CLO portfolio with private credit loans that you've sort of been originating. So depending on how many loans you actually have available at any given time to sort of securitize and put into this CLO, can take a while. You don't have a kind of secondary market where you can just buy up collateral to fill your CLO. So there's a suggestion that you could actually use the BSL collateral to sort of help ramp your deal and sort of speed up the ramp. Secondly, you might actually also be able to crowd in more investors that you might not otherwise have been able to do to sort of get to back your private credit deal. Because obviously, in there are some investors who have concerns about the sort of the you know the credit quality of private credit assets, their illiquidity, and you know, but they're comfortable with BSL. And if you can show that your CLO actually has a blend of the two, you might actually be able to get investors who wouldn't back a pure private credit CLO to come on board with your hybrid CLO. So certainly, George, you were talking, obviously, you can, you know, you you can sort of be blending BSL with private credit, or you can blend private credit with BSL, but certainly um for for those doing private credit CLOs, um, you know, the there's certainly that advantage.

SPEAKER_02 19:03

So in theory, then I guess you're hoping that like what like the the senior investors price it like a BSL CLO and the med the junior investors price it like uh um the private credit CLO, and overall your cost of capital comes out a bit lower, like you only pay a small premium over what you would have paid versus uh a pure BSL, but you get all the benefits of private credit.

SPEAKER_01 19:25

That is kind of the the crucial thing, and I think that's probably the greatest area of uncertainty, I think, about these deals is that it's not yet known if investors would just kind of go, well, we don't care that this is actually a mix of BSL and private credit, it's got private credit collateral in it, so we're gonna price it exactly as we would price a pure private credit CLO. Because if you do that, if that happens, then the CLO makes no sense whatsoever on the basis that you will have the higher spreads that come along with a private credit CLO, and you'll be trying to fund sort of servicing that uh you know that those notes with sort of lower priced BSL collateral at least forming part of your of your deal. So the arbitrage doesn't work at all. The arbitrage only works in this sort of deal if it's somewhere between where a BSL deal price is and where a pure private credit CLO price is. So there's there's certainly, you know, there's a bit of execution risk, and I think it will take a brave manager to do the first deal. But I think any manager would probably have done sort of substantial engagement with investors before launching a deal like this just to kind of you know have some kind of sense of um you know where pricing could potentially land, but it would still be a brave manager to take that first step.

SPEAKER_02 20:50

Yeah, you run the risk of ending up basically with the kind of worst of of both. If you were eyeing kind of having the best of both.

SPEAKER_01 20:59

Exactly. Yeah, I think you do. I mean, this is also it it it could it could help managers, though, uh who sort of are currently would generally do a sort of pure BSL deal. You know, this is if they can achieve the pricing and get the best of both worlds rather than the worst of both worlds, as you were saying, George. But at the moment, and you know, again, this is another theme I return to quite quite often, the arbitrage for CLOs is just, you know, for BSL CLOs anyway, it's very difficult to make it work. Um, captive equity funds can accept a sort of slight slightly lower arb, but fundamentally the arbitrage is really compressed at the moment for BSL CLOs. Now, if you have say a 20% sleeve of private credit assets that you uh sort of sneak uh into your into your CLO and create a hybrid deal, well the arbitrage is going to be considerably better, at least in theory, because you know you've you you'll have spreads of sort of 400, 500 on the underlying loans from the private credit deals. And I mean, if you think about it, I mean the BSL CLO market and the private credit market kind of share many of the same borrowers. A lot of the managers have CLO businesses, private credit businesses. It serves them quite well to be able to securitize their sort of private credit debt, and they could potentially boost the arbitrage on their BSL CLOs at the same time. So, you know, it seems like this could be something that would be really popular for for managers. It really is just this uncertainty around how investors are going to price a hybrid deal.

SPEAKER_02 22:38

So when will someone actually kind of go ahead and do one of these things?

SPEAKER_01 22:42

Well, that's a little bit uh uncertain, although I have had, you know, when when sort of you know researching this story, I've had quite a lot of interest expressed by managers in sort of in doing these deals, uh, from investors in you know, potentially looking at at the CLO paper. So the important thing to remember though is with the private credit, some of the private credit CLOs that we've seen in Europe at the moment, you know, all so far, they've actually included a like a certain bucket for BSL collateral. So, for example, I think on the recent Golub private credit deal, there was a 20% BSL bucket. This doesn't quite make it a hybrid CLO or like a true hybrid CLO in you know in sort of how the way in which we're discussing it, because that bucket's only really intended to be used if, say, you know, a private credit asset in the CLO prepays, and it can be it can take a while to replace that asset, and so you get cash drag. Whereas if you can buy up some BSL assets at least temporarily, you can sort of mitigate that cash drag. But in some ways, that is actually a kind of an illustration of using a kind of hybrid collateral structure in a CLO. So we we've already taken the first steps, it's just about whether or not somebody actually kind of takes that further and and prices a sort of true hybrid deal.

SPEAKER_02 24:03

Wonderful. Well, if you want to read about all the applications, as I said earlier, the story has called Hybrid CLOs floating the silver arbitrage puzzle. And otherwise I think that's probably all we've got time for. So thank you for listening and goodbye. Goodbye.

SPEAKER_03 24:18

Goodbye.