SPEAKER_02 0:07

Hello and welcome to another finding. I'm George Smith, Global Capital's Securitization Editor. And I'm joined by Thomas Hopkins, our CO reporter, and Tom Hall, our ABS reporter.

SPEAKER_01 0:19

Hello. Hello. How are you doing, George?

SPEAKER_02 0:21

I'm very well. I'm very well. We'll be talking to Thomas shortly about um tiering in the in the CLO market. But before we do that, Tom, um let's start with you and talk about the ABS market this week. People have sort of gave me the impression, at least this was like nearing the end of the kind of pre-summer supply now and things might start to taper off. Is that your impression?

SPEAKER_01 0:45

Yeah, I think that's the case. We we only had one new announcement uh this week for a deal that's set to price next week. Um that's from uh Waterfall. It's sponsoring a deal backed by Pepper originated second lean mortgages. Um so that's quite an interesting deal. But yeah, apart from that, I mean we we've had a lot that have been sort of pricing this week. I think about seven deals. A lot of those were announced um, you know, at the the start of last week's where we're recording this on Friday the 17th. So a lot of these deals have sort of been marketing for uh, you know, sort of eight or nine working days, uh, which is you know a little bit longer uh than you'd expect for for some ABS deals. And I think that's uh partly just because supply has been so heavy and it's also mixed with a lot of these deals are uh quite esoteric. So as you mentioned, we we've got the Belgian deal, but there's also the uh the KKR by now pay later deal, which went on screens last week. So, you know, they they obviously are gonna you know require a little bit more time for investors to to really look at those deals. So naturally you you can sort of expect uh longer execution times. But yeah, I I think it's interesting in terms of I mean last year we we basically had I was looking, I think it was around sort of July 17th was the last deal to price, and then we just didn't have any deals uh on the public market until around the the August bank holiday. I think this year it sounds like we you know we we might get a few more, maybe like one or two publicly marketed in the summer period. But it it's you know it's obviously will be uh much lighter supply in it, and quite a few bankers I've been speaking to this week have been saying that they've uh they've reached the end of their pre-summer pipelines and uh are now just you know going to be preparing for when the market restarts in September.

SPEAKER_02 2:38

Heading to the beach, maybe.

SPEAKER_01 2:40

Yeah, possibly.

SPEAKER_02 2:41

Well, let's move on to talk about your weekly story for the week, which was about an extremely rare sort of country and collateral combination, and that was Belgian RBS.

SPEAKER_01 2:52

Yeah, so yeah, definitely as you say, Belgian RBS is very rare. I think the the last deal that most people said is the last sort of public deal was this uh deal from Belphius, which was a prime deal back in 2015, and even then I I think it didn't seem like you know it was a a super regular programme. I think that deal may have just been uh sort of a a one-off. But yeah, so it's it's definitely uh a very rare thing in the market. There there used to be a few kind of prime RMBS deals, but yeah, it had a uh a big revival this week with um a specialist lender uh called Crafin. Uh it issued a 300 million euro uh deal. And yeah, it's uh it's a little bit different than uh some of the um you know, I mean not that there were many kind of RMBS, Belgium RMBS deals, even to the the prior ten years uh when there were a few, but those all look very kind of prime and bank led. This is uh especially a slender in Crafin. And uh the the vast majority are sort of regulated conforming loans, but it does have uh some non-conforming, so that does sort of uh differentiate it a bit. There's also a mix of uh owner-occupied and buy-to-et. So it's it's slightly different collateral um than what you know the the majority of the the Belgian market uh is. So it's probably more comparable to uh maybe like a Dutch Bytolette trade or maybe some of the uh you know, in the the UK we obviously mix uh collateral a lot a lot more often of uh you get these these an arch guided and buy to let mixed deals.

SPEAKER_02 4:35

So it's priced as we record. Did it go down well with investors?

SPEAKER_01 4:38

Yeah, I think it looks quite well. I mean it it you know, they they issued uh uh the maximum size and the the scene is priced uh eighty spaces points, over three months, Eurobar. So I think you know I'd I it's hard to say we we haven't seen like a Dutch Baytolette in a while. I think at the start of the year they were pricing sort of in the the mid to low 70s, but that was um you know an especially tight period. I think in in more kind of normal times it would probably be maybe kind of low 70s is what what I was hearing. So yeah, if it's only uh a sort of 10 basis point premium, and that's accounting for, you know, obviously there should be a liquidity premium because we we don't really see any uh building trades. And there's uh a new issue, new issuer premium, uh, and then uh a new sort of region premium. So there there's lots of different possible premiums, but if if that only looks like uh sort of around 10 basis points for the first deal, I'd say that that looks like uh a pretty solid outcome. And um, you know, Craven has said that uh it plants on issuing twice a year, uh so you you'd expect uh you know though those premiums to sort of start diminishing uh as they're more active in the market.

SPEAKER_02 5:47

But there's no there's no rarity value to matter at the premiums. The diversification perhaps. Anyway, I think I mean pro probably some some listeners will be less familiar with the with the Belgian mortgage market, having obviously not had too many opportunities to look at Belgian mortgage collateral. What is kind of Belgian mortgages beginner, crash course? How do they work? Um what's the structure?

SPEAKER_01 6:13

Yeah, so in terms of you know, the largest part of the market is very I think it's very similar to the French market, uh, if anyone's familiar with that. So I mean you you've got uh you know Belgium's, I think, four largest banks are leading the market, and it has a size of about fifty billion uh originations a year, and they're you know almost all gonna be uh fixed rate mortgages to prime borrowers, so very similar to France. The difference being that obviously France is a much bigger market, but there there is you know some room in terms of specialist lenders. I'd say Crafin is is very much um you know it has quite a unique offering because I I think it's the only specialist lender that is fully regulated, and they also are very active in the uh mortgage broker space, um, which is very small in Belgium. So that you know that obviously has sort of some benefits of you you can get a bit of a spread pickup because there's there's just very low supply in that that market, sort of uh a little bit of a a lesser tap market. I think only about sort of 15 to 20% of uh mortgages are originated through a broker in the Belgian market that compares more to like 60% in the Netherlands, or like I think the number for the UK I found was 87%. So uh that that's one quite interesting uh difference between the the those markets.

SPEAKER_02 7:37

And how does the um interest rate structure work? Getting down to the the securitization nitty-gritty.

SPEAKER_01 7:44

Yeah, exactly. So with the you know, the the majority of bank loans, they're all gonna be a fixed interest, but when you go into the broker market, you can get uh you know slightly more niche interest rate structures. Uh and the structure that Crafin uses is you know, I I think it's fairly unique. I mean, uh I haven't really seen anything similar to it. I I think they call it the the 555 rate for its uh regulated mortgages. So that's basically it has a fixed margin margin at origination, uh, and that's benchmarked to the uh five-year Belgian government bond, and then five years' time that fixed margin will be reapplied to whatever the new rate on the the five-year Belgian government bond is uh for another five-year period. Um, and that's subject to a few uh sort of caps and flaws. But yeah, on the whole, I think uh so it it's sort of you know it's it's not like the the UK market where you you get a two to five year fix and then it refers to floating, you know, a fixed rate that reverts to a new fixed rate uh for five years. So again, it's it is you know a little bit uh sort of different than either the UK market or the the French market or you know the majority of the Belgian market, even when it's just uh fix the entire length of uh the term. And then obviously when it when it comes to securitization, uh I can already see you're about to ask the question, how how does this uh impact in terms of hedging? But yeah, you you obviously, you know, if it if you were just dealing with a fixed rate deal for for the length of the term, you you could just have one interest rate swap. But when it comes to this deal, uh they they use two uh swaps, which is quite interesting. So the the first swap is for you know the that's just to hedge the the interest rate risk before the the mortgages reset at the new Belgian government bond rate. So that sort of lasts for around uh kind of four-ish years based on you know when the loans were originated. Um and that's a swap with uh NatWest over one month uh Eurobore. And that that's just you know hedging until the first reset. And then they have a second swap with Deutsche Bank, um, and that's a three-month Eurobord plus uh 275 basis points, uh, and that is going to be mitigating the interest rate risk and the additional risk from the the new I think it's called the the OLO rate, which is the the five-year Belgian government bond, uh, and that applies to basically all consecutive resets. Uh so they only need two swaps.

SPEAKER_02 10:19

Okay, yeah, yeah. And I think uh you happy to leave it there, and then we'll leave a few a few juicy details for the reader.

SPEAKER_01 10:26

Yeah, yeah, exactly.

SPEAKER_02 10:27

Okay, well thank you, Tom. That is a very interesting story, and there is actually a lot more in the story about the Belgian mortgage market and you know how the banks are competing and and the old question of R and BS be covered bonds. So if you want to get all those details, um it's on the website for subscribers and it's called Belgian RMBS Returns After a Decade's gap. And with that, we will move on to CLOs. Thomas, are you on a summer break yet?

SPEAKER_00 10:53

Um well partly, George, partly. Um we sort of deal flow seems to be a bit kind of erratic. You know, last week was an absolutely enormously busy week. Um, you know, I think we had sort of seven or eight deals in the in the same week, but then uh over the course of this week, and granted we're only on Friday morning, but we've only had, I think, just the one deal from Blue Bay Asset Management. However, um I did put out a story this week noting that there were sort of around 12 deals potentially in the pipeline. And uh the sort of consensus that I'm getting from the market is that managers are kind of rushing to sort of price um deals ahead of August, basically, when I think the market will sort of typically slow down a bit. So not quite on holiday yet, George, but uh yes, certainly a holiday seems like a you know distant prospect.

SPEAKER_02 11:43

Yes, yes. And what you've written about for the weekly story is is quite interesting this week. It's about CLO manager tearing, as I said at the start. And manager tearing is is something you know that people talk a lot about and how it's um you know it's it's only ever kind of seems to be increasing. So so how big are the tiers these days?

SPEAKER_00 12:04

Well, the thing is, yeah, this is a topic that comes up at just about every CLO conference. People constantly talk about expecting it, you know. I think um it's sort of brought up because everyone, I think, perhaps believes that they're going to be in the top tier. But yeah, essentially what tiering is, it basically is if you sort of think about um kind of a great big flight of of stairs, or you know, if you look at a stadium with the sort of tiers going up in the stands, and apply that to sort of how liabilities price for CLOs. Basically, the idea is that really excellent managers with really strong records, really long experience in the market would be sort of tier one managers, top-tier managers, and they would get the tightest liability pricing, and you'd move down several tiers according to managers' track records and as I say, kind of level of experience in in the market. Um, now in the US, this is really quite pronounced. Um you you you can even refer to like tier one, two, and three managers. You know, that that's a common sort of um terminology used um to you know it to refer to the US market, and you'll get tiering of, you know, well, some market participants say sort of 10 to 12 basis points, some even go as high as 20 basis points in terms of how much tiering you will see on the triple A notes in US CLOs. Um and obviously the AAA's are not the only notes in a CLO, but they're often the most relevant consideration when you think about a CLO's cost of funds, because they make up about sort of 60% of any given CLO. In Europe, it's much closer to sort of four to six basis points, and six is kind of pushing it often for how much tiering we see on the triple A's. And so I I suppose the point I'm really making that's really central to the article I wrote is that tiering hasn't really materialized yet in European CLOs, because if you're talking about a new manager premium of sort of four or five basis points, that really doesn't suggest an awful lot of kind of gradation in liability pricing at this stage.

SPEAKER_02 14:11

Yes, indeed. Well, that is a bit surprising considering how much everyone likes to uh likes to proclaim the rise of tiering. Why is it only four or five basis points?

SPEAKER_00 14:23

Well, I think this actually has a lot to do with certainly kind of the the extent to which CLOs in Europe all kind of hold the same collateral. Because, you know, at least in theory, you know, you you'd think that tiering should be something that you'd be seeing more of, because you know, we've had all the risks um of sort of software-leveraged loans and you know the the threat, potential threat that artificial intelligence you know poses to software companies' revenues. We've had the Iran war and the risks um you know sort of defaults because of high energy prices. We've had the bifurcated loan market where you have a lot of loans pricing around par until suddenly they drop in value with a ratings downgrade. So you'd think that credit selection would be something that's truly, truly crucial, and that you know, investors would be sort of looking at each individual manager, looking at how they select credits and going, yes, I'm going to reward this manager and I'm going to penalize this manager. And yet, you know, if you look at last week, I mean the KKR Evoker deal had triple A's of 124, and you know, the the Diameter deal had triple A's of 128. Now, KKR is a very established manager. The Diameter deal was only Diameter Capital Partners' second ever European CLO. So there's just the the tiering that you might expect given the environment that we're seeing with leverage loans just sort of isn't appearing. And the reason for this, I think, and you know, certainly this seems to be a common view amongst market participants, is just the extent of the collateral overlap in European CLOs. So SP estimates that, you know, as of June this year, the kind of average collateral overlap between any two sort of random CLOs in you know that across the universe that acted European CLOs is about 50.2%. Now, in basic terms, if you think about it, you know, obviously managers' skill and credit selection is relevant, but if managers CLOs all end up holding very, very similar collateral, uh well then ultimately, even if different managers have different styles or different levels of experience or skill, if you're holding the same loans, the risks become much more closely correlated than they might otherwise. And if the risks are very closely correlated, well then spreads are probably going to follow suit.

SPEAKER_02 16:45

Yes, indeed. Yeah. So what we need then is uh is a surge in in loan issuance to get the tearing going, after all.

SPEAKER_00 16:53

Yes, we we return to to our favorite topic on this podcast, George, which is the the mismatch between leverage loan issuance and CLO issuance. But ultimately, you know, a big part of this does relate to that. I mean the reason that you have European CLOs all holding the same thing is principally because uh there's you know the the private equity market in Europe remains soft, LBO activity is uh sort of reasonably limited, uh particularly in relation to the large volume of CLO issuance, which, you know, despite the sort of continually sort of weak arbitrage and as Bank of America pointed out in some research recently, some quite significant par loss over the last three years for CLOs. CLOs continue to print using sort of captive equity funds. And so you'll you'll if you've got very, very strong CLO issuance and quite weak leverage loan issuance, well then it's very likely that CLOs are going to end up holding the same thing. It's different in the US, where you have a much larger leverage loan market and you have a wider base of investors. So you've got kind of leverage loan mutual funds, which sort of compete alongside CLOs to sort of hold different pieces of particular loans. And uh this just makes it less likely that CLOs are all going to be holding similar collateral, and so collateral overlap is lower in the US, and so tiering is more pronounced, you know, whereas in Europe it's just sort of you know CLOs are the primary buyer of leveraged loans and the market is small. And so at this point, you you know you you you you just simply don't you get a lot of collateral overlap and you don't get very much tiering. And I think, I mean, in some ways, this isn't really the most efficient way of the market running, because in some ways you'd want the sort of most experienced CLO managers to be able to sort of be rewarded for that experience and for sort of steering their their CLOs kind of successfully over a number of years. But at the moment, all of that experience is only really worth, well, three or four basis points at this point. Do you get a bit more on the MES? You do, you do. So it's important to point out that tiering does appear a little bit more, particularly on junior MES, where you know investors are a little bit more sensitive to sort of credit selection. But again, it's not that vast. I mean, if I return to the two deals I pointed out earlier, you know, the KKR's Evoka deal and uh the diameter capital deal. I mean, you know, Evoka did a sort of double B print of um 500 basis points over, and you know, I think double the diameter's double B's were only sort of 20 basis points wide of that. So, yes, that there was sort of a greater difference. I mean, you've got maybe 20 basis points of tiering there between the two deals, but it's not this kind of vast gulf where you sort of think that you know differences in sort of just manager experience and track record are really actively being you know considered and included in the way in which liabilities price in you know in in sort of clear tiers.

SPEAKER_02 20:01

Yes. Well, if you want to read that story, it's also on the website for subscribers. And it is called CLO Investors Put Low Value on European Managers Experience. Otherwise, I think that's all we've got time for today. So thank you very much for listening and goodbye.

SPEAKER_01 20:19

Goodbye.

SPEAKER_00 20:19

Goodbye.