CLO summer party

CLO mezz pricing tight but seniors stuck, another specialist lender collapses

Transcript

SPEAKER_01 0:07

Hello, welcome to another five minutes. I'm Tom Hall, Global Capital's senior securitization reporter, and I'm joined only this week by Thomas Hopkins, our uh European CLI reporter. Hi Thomas, how are you doing?

SPEAKER_00 0:21

I'm doing very well, thanks, Tom. Yes, we don't have George with us. Um we've gone from me doing a sort of solo interview last week to the two of us this week, but I think normal service should be resumed next week when uh George will return from his two-week holiday, of which I am very, very jealous.

SPEAKER_01 0:38

Yes, it it often happens in financial journalism where you you have odd things happening in uh the month of late July and August in terms of who's around. But yeah, and other things that kind of happen that are you know odd in in terms of the financial markets in these these quieter months. We we normally don't get much happening on primary market. I know for ABS we haven't had any updates on I think there's only one or two sort of outstanding deals uh this week. But I I think the the market is essentially shut almost for the summer. But it it's been quite the opposite story with the the CLO primary market. I mean, what what's been happening over the last kind of week or so?

SPEAKER_00 1:15

Yes, you're exactly right, Tom. It's quite a strange situation in a way, because where I've got lots of colleagues at Global Capital who are you know sort of needing to write lots of different stories and not, you know, they don't have any sort of deals that are coming through to cover at the moment, uh, just because the primary pipeline, as usual, is sort of slowing down in the markets they cover you know over the course of the summer. That that just absolutely does not seem to have applied to CLOs at this stage. Um, so it's uh you know, my my desk has been really quite busy over the last week or so because obviously we record these podcasts typically on a Friday morning, but you know, sort of Friday evening last week was absolutely mad. I think we had sort of you know around six deals coming through, sort of all at that time, and that's that included new issues, resets, and refines. So it's the full range of of sort of uh CLO transaction types are sort of coming through. And um then this week so far, and again, I I think we will get probably uh you know another couple of deals this evening, but um so far this week we've had a couple of deals. We've seen LGT print their fourth CLO in the space of 12 months, and they only entered the CLO market sort of for the first time in July last year. So four CLOs in in in sort of 12 months, and then also there was a sort of refinancing of Egon Asset Manager Management's Northwesterly 8 CLO, which is quite interesting because it was the uh sort of first CLO that Egon had done sort of since the uh announcement of one of their major sort of portfolio managers, Herman Giuliani was um was announced. He's retiring today, actually, as we as we record this on this Friday. And additionally, if you sort of look at the pipeline kind of going into August, it's still you know, there's still quite a few deals sort of teed up, and some quite a few market sources that I've spoken to think that the pipeline is actually going to be reasonably strong in August. There will be a modest slowdown, people do still go on holiday, you know. Uh CLO bankers and managers and investors do take time off. Uh, but there's not really an expectation that we will see a complete halt to deals. Uh, we will just maybe see very slightly slower deal flows. So it's quite interesting that the CLO market does seem to operate in this way, you know, and and apparently sort of investor holiday patterns have kind of changed over the years. It's not quite so concentrated in August, so CLOs do seem to continue to print through the summer. But Tom, moving on to a very important story that you have written about this week, Tom. You know, you've you've written your weekly about the collapse of Amplify as a UK specialist lender. It's a very, very interesting story. So could you start off just sort of telling us kind of what Amplify was and what did it do and sort of what happened basically?

SPEAKER_01 4:00

Yeah, I mean they're they're quite an interesting uh sort of name. They they weren't like a huge player in the market. So essentially Amplify Capital was a credit union broker and also a near-prime unsecured consumer lender. It operated through sort of two lending channels or or brand names. But the company went into administration on June 9th after uh it had sort of a continuous decrease in revenue. This was from constrained origination volumes and credit losses. I think it this was you know, it seems like it was primarily in the uh the credit union loan books, but there they were also struggling parts of the uh consumer loans business. But um it it's quite an interesting thing for you know, in terms of news. I mean, the the reason why I've only written about it this week, despite you know, I've it went into administration now almost two months ago, is because it it's sort of been revealed, you know, how how much kind of access it it had to the capital markets. It you know, it had a uh a big funding line for its uh unsecured consumer loans. Uh it was a warehouse called Castor Financing that had NatOS as the senior funder and MG as a uh methane funder. So it had the the backing of some some pretty major players in the market. So I I thought it would be you know quite quite an interesting uh story to do a little bit of a uh analysis and see how its collapse would kind of impact the market.

SPEAKER_00 5:22

Why do the banks and you know other lenders who sort of fund these specialist lenders do it through say ABF over other sort of forms of funding?

SPEAKER_01 5:31

Yeah, I mean it it's quite interesting. So in terms of why a bank would want to enter into a securitisation warehouse with like a near prime specialist lender over, say, you know, issuing those kind of loans itself or just buying a portfolio. I think the the primary reason is because it's structurally much better to be involved in a securitisation warehouse. You could have a mezzanine funder and then or someone holding the equity, so that will protect you from any sort of first losses, and you'll you'll probably have you know some excess spread within the deal. So you you get additional kind of protections and and as a result you you're probably gonna be having a much lower uh capital charge. So you can still it's essentially a way of still getting access uh to you know some of these high yielding assets, but you you don't necessarily have to pay you know as as high a capital charge to get exposure to these assets. So I think that's definitely a big sort of impetus for getting involved in the the AB ABF market. It seems like the rewards are pretty high, but when when you've had you know a couple sort of uh big lenders collapsing over the last uh couple months, is is that kind of you know changing the the question of the the kind of risk reward balance? Is it looking like the the risks are kind of getting you know too high?

SPEAKER_00 6:49

And of course, Tom, this is not the first time we've seen the collapse of a UK specialist lender this year. Of course, we saw MFS go under earlier in the year. Do you want to sort of tell us a little bit about some of some of the differences uh between the sort of collapses of Amplify and MFS?

SPEAKER_01 7:09

Yeah, so I mean I think it's important to say that these are like, you know, completely different situations. I mean, partly in terms of size, I think Amplify was quite a bit smaller uh than MFS, even though I I don't think either of those players were considered, you know, super big names in their respective markets, you know, for for MFS in the the bridging market and Amplify for the uh unsecure consumer lending market. But you know, I I think the the fall of Amplify is really you know it's sad, but it it is just a result of uh you know the the originations weren't as strong as they they were hoping they would be, and it was just around credit losses and you know perfectly normal stuff that that unfortunately just happens to some businesses. Um and and they were all you know very honest about what was happening and you know there were attempted restructurings over the last kind of couple years, um, but but ultimately uh they you know obviously did have to go into administration. I think you know when you look at the case of MFS, it's obviously a very different situation because there are so many allegations of uh frauds and double sledging, which we should say MFS uh denies all those allegations. So say in the case you're funding someone and uh it turns out that they were fraudulent, you know, that that can cause a huge issue because you you know you thought you were funding a business where that you thought was performing very well, and then out of nowhere it turns out you've got big exposures to a business, and if there's double pledge involved, you may not be sure around uh you know if you're gonna be able to recover any of the cash that you've you know put into this business. Uh that's gonna be a very different situation than you know a business that's uh being completely honest about financial position and that is deteriorating because you know you you can try and work with uh lender to see what you can do. You can try and you know refinance your warehouse position, you can do all sorts of things and you you'll have a lot more time to kind of react to the situation. Uh so they're highly different situations, and as a result, I think you know Amplify is is definitely uh you know it it's obviously sad when when any business fails, but I I'm not sure it's gonna have as large an impact on the market as uh MFS.

SPEAKER_00 9:17

And what are the likely consequences of this collapse for ADF and sort of specialist lenders in general?

SPEAKER_01 9:23

Yeah, I mean this is the the kind of big question. I think the market's been pretty sanguine, to be honest. You know, in at the start of the week I I was asking a few people, it seems like the responses were you know they either hadn't really heard of it or you know they were sort of tangentially aware of this lender and uh you know they they heard that it had it been having uh some troubles. But I mean I I think you know I mean there's a few reasons why I I don't think it's necessarily going to have uh this this big kind of impact in the market. I mean, I I think it seemed like you know their business model was quite different than what you see with some of the more mature, you know, fintech sort of standard uh consumer, especially if lenders, you know, because it they obviously have you know the credit union brokerage channel, and and that that was really the the main part of his business, you know, that was that had been around since 2017. The Revo Money uh brand, which did it the you know, standards unsecured consumer lending, that was only really started in 2022. And you know, that that that side is probably the more uh securitization specific side of the story because the cash financing warehouse was fully backed by uh its Revo Money loans. But you know, equally, I I think it's you know it was quite a unique actor in the market. So, you know, when whenever you get a lent like this falling, there's always going to be questions of is this uh canary in the coal mine for potential problems in the the wider sector. But equally, you know, I think Amplify had probably been struggling for at least kind of two years, just based on from its accounts up to uh March 31st, 2024, it had already recorded a £100,000 loss uh that year compared to you know like 5.5 million profits in the year before. So I mean, you know, there there were signs that it was um beginning to struggle. And equally, you know, if if there was a lot of read across to the wider market, I would have thought two years on you should certainly see, you know, at least signs if other lenders are struggling. And you know, it's very interesting also that if you look at this year in terms of the the public ABS markets, unsecured consumer ABS has been doing really well in the UK. We we've had you know a debut deal from uh City, which is backed by bound loans. We've had a debut uh from Lendable and Barclays has returns with his Avall back deal, and and they've all performed uh you know extremely well. So I think you know, certainly on the public side, it doesn't look like there are any concerns from investors. I think two of those deals also, Lendable and Barclays, were issued after um June 9th. So it you know that that was after Amplify had um gone into administration. So I I think on the whole, yeah, it seems like the the market has has taken uh the news pretty well. And it it doesn't look like this is going to be you know another big disruptive event that's gonna lead to uh you know more expensive uh warehousing or forward flow arrangements from you know banks uh sort of withdrawing from the sector. I think I I'd be surprised if you see sort of anyone withdrawing because of this. You know, it might be used in conjunction with something else. But I I think this alone isn't isn't big enough to really justify a massive uh change in ADF market practices.

SPEAKER_00 12:39

Thank you very much, Tom. I mean, certainly this story is very, very interesting, and I commend it to listeners. Um, it is called Amplify Collapse, unlikely to cause major disruption to ADF market, and that is available for global capital subscribers on our website. Great.

SPEAKER_01 12:57

So if we turn over to what you've been writing about this week, I think we've got one of my favorite types of stories, a classic pricing dynamic story. I guess I'll I'll start with the question of you know, how are triple A spreads comparing uh spreads across the rest of the CLO capital stack at the moment?

SPEAKER_00 13:14

Yes, so it's quite interesting in the way in which CLO liability spreads have been moving if you look at these different parts of the capital stack as you say, Tom, because going right down from AA to double B, now that's quite a few tranches there, because you've obviously got double A, single A, triple B, double B. You know, so that's most of the mezzanine stack uh in a CLO. Pricing there is historically tight. I mean, I had some estimates from Barclays this week, and uh, you know, from double A to A B, yeah, they're sort of nearing kind of the the tights of the sort of pricing ranges for those tranches, sort of on a five-year basis. But triple A's are not really behaving in the same way. So again, these but the Barclays figures would say that for triple A's we're on the 22nd percentile. So where mezzanine tranches have got almost as tight as they have been in the last five years, triple A's really are still quite wide of their tightest levels uh over that time. Triple A pricing has just kind of, I mean, this is a this is a favorite topic actually of this podcast about CLO AAA pricing not moving. But it it it is remarkable. I mean, it sort of sat in kind of the sort of mid-120s since about May. But I mean, if you sort of go back to the beginning of the year, it was around the the low 130s and then tightened very quickly to the low 120s, then sort of widened back to the low 130s after the Iran War, and then kind of just sort of settled into the mid to high 120s. But if you go back for the for the 18 months sort of prior to the start of this year, it was also sitting around 130. So what's quite clear is that while you've got significant spread tightening in MES, and that's with the exclusion of single B's, which have been a bit volatile, I should say, but over most of the MES, you've got significant spread tightening, triple A's have just really just stickily just priced in the same kind of area month after month. So they really are behaving incredibly differently, I'd say, at the moment.

SPEAKER_01 15:16

Yeah, I mean it's kind of interesting. I I think certainly in the the ABS world, we we've had a thing where you know Mes has been pricing very tight, but a big factor has just been supply and demand dynamics of we've had plenty of uh AAA supply and often in ABS deals, you know, the MES tranches will be pretty slim, so you won't get as much access. But I mean, what you know, what's sort of going on in the the CLO market in terms of why do you think MES in that market is uh you know so tight?

SPEAKER_00 15:43

Well, I think it's partly to do with the fact that I think CLO mezzanine tranches have sort of considerable kind of relative value at the moment, and this is lead spreads to tight. And so I mean you can get you know I think CLOs, it's sort of they're notorious for you know having quite high credit ratings and yet still quite high spreads in relation to those credit ratings, because you can get some investment grade CLO notes that are pricing similarly to sort of high-yield bonds, which is really remarkable. So um, if you look at, for example, uh CLO Triple Bs, so the the sort of junior most investment grade tranche in a CLO, some of some of them have got spreads kind of in the region of 295 basis points at the moment, so sort of just inside 300 basis points. Um, but you know, what sort of one investor sort of told me that about 75% of the European high yield benchmark is currently inside 300 basis points. So if you're uh you know an investor who's sort of looking to build out a high yield portfolio, you can actually buy investment grade paper that's you know it's in the CLO market and get a similar spread to what you'd have to, you know, you get from like lower-rated bonds. So it it's it can be very attractive, basically. And so I think that really has driven you know spreads tighter. I think uh the fact that their floating rate is also quite attractive just because there's a bit of uncertainty around interest rates at the moment. So the fact that you know that whatever does happen with rates, you know, your CLO notes that you hold will sort of you know adjust as rates move. Uh, I think that's quite attractive as well. So I think that's certainly a factor behind why the mezzanine spreads are are so tight, which as I say is sort of notably different from triple A's at the moment. Yeah. And then so why aren't the AAA's tightening as much? Yeah, well, there's a number of factors here, Tom. So the one thing that is important to note is that you know, on CLO notes, your eyeball is flawed at zero. Um, and that obviously made AAA's very attractive when in when rates were negative, you know, because that obviously has significant sort of optionality and value if you know if if interest rates are generally negative, um, if you know if you know that this the the that the benchmark on a you know CLO note won't go negative, and that allowed issuers to offer sort of tighter spreads, but there's absolutely at the moment no prospect uh of a return to low rates. I think it's fair to say, just you know, given that central banks are largely holding rates and just you've got the Iran and the Ukraine wars just with a sort of persistent inflationary effect from that, and obviously, you know, the higher rates have to kind of combat that. So incentive to tighten spreads has been removed. So that's one important factor. And I think the other sort of important factors, it's just we've had a lot of CLO issuance. I mean, you know, I was talking about this earlier, but I mean, last week alone there were 11 deals, and you know, but we're in the summer. Um, there's at least another 12 in the immediate pipeline. Barclays has just raised its forecast for new CLO issuance, you know, this year from 55 billion to 60 billion. So that's an extra 5 billion Barclays is now expecting. And so, you know, it's just basic supply and demand with a large supply of uh of CLOs. Um, you're just sort of unlikely to tighten spreads much further. However, you would think that that would cause mes spreads to widen as well. But that's I think the difference here really is that you know, CLO mezzanine tranches have a very broad investor base. It's a global investor base. As I said earlier, these these tranches have a lot of value for those doing sort of high yield portfolios, whereas European CLOAA investors are sort of heavily concentrated in Europe and Japan, and banks make up sort of 40% of the investor base. So, you know, you've got this highly concentrated base of investors that inv invest in CLO AAA's, and and also you must remember that some CLOs make up CLO AAAs make up 60% of the capital stack, so it's a lot of capital that you require from quite a narrow band of investors relative to, say, the MES tranches. And so this means that even with higher issuance, MES can still tighten, but triple A's really do struggle to tighten uh under these circumstances.

SPEAKER_01 19:54

And then, yeah, how are investors obviously feeling about the wider AAA spreads?

SPEAKER_00 19:59

Well, it depends which investors you've talked to here, Tom, because obviously AAA investors are over the moon about it, I think, you know, because again, if you we had some sort of figures um from BlackRock, but you know, if you if you look at the spreads that you get on new issue AAA's, which are around sort of 125 basis points in primary at the moment, you know, triple A's, these AAA's have higher spreads than roughly 75% of the European investment grade and 27% of the sort of high yield indices. Now that's remarkable. So, you know, I think this will keep AAA investors like, you know, very, very happy. However, if you sort of go right down to the other end of the CLO capital stack and you look at CLO equity investors, they're going to be much, much less happy about this because the arbitrage is very, very weak at the moment. You know, we've had over 80 billion euros of leverage loan repricing so far this year, which has lowered the sort of median weighted average spread for CLOs within reinvestment to less than 360 basis points, according to Bank of America. The arbitrage, as I say, is very weak, and sort of median cash on cash distributions to equity investors have fallen to their lowest level in the sort of CLO 2.0 era over the course of July. And what happens with the arbitrage is obviously if you if you have very tight loan spreads, that weakens the arbitrage. And if there's not much prospect of improving the loan spreads at the moment, then the only thing that you can really do to improve the arbitrage, you know, as a CLO manager is to tighten your liability spreads. Now, Mes spreads are about as tight as they can conceivably go because they're the tightest levels they've been at for sort of five years, and AAA seem to be stuck fast in this position in the mid-twen mid-120s. So I think if you're an equity investor, uh you know the picture is much less favorable. And I think CLO equity and indeed you know managers are often the same, often but not always the same thing, or at least not the same thing in terms of having a majority of the equity in a CLO. I think both managers and and equity investors would like AAAs to tighten further. The one real prospect, I think, of CLOAA spreads tightening is I think with the changes to solvency two that's sort of due to come in at the start of next year, uh, because this will just make it a lot easier in terms of the sort of capital treatment applied to CLO AAA's, you know, for insurers, and we're expecting you know a lot of insurer capital to kind of potentially flow into AAAs. And obviously, if you have more investors in that space, a broader investor base, you are potentially able to tighten spreads a bit further. But at the moment, I think you know it's quite likely for AAA spreads to remain a bit sticky. I mean, banks do get some new budgets sometimes in September, so there might be a slight tightening there, you know, obviously because it is quite linked to sort of bank budgets that they have to invest in CLOs. Uh, you know, I I think as I say, pricing is sort of likely to remain quite sticky uh in you know, it's sort of near to medium term for CLO AAAs.

SPEAKER_01 22:57

Okay, well, excellent. Well, uh, if anyone wants to read that story, it's called CLO Triple A spreads stay sticky as Issuance Surges, and that's what they're able to read on the uh Global Capital website. I think it's been a uh another pretty successful week getting through the the typically slower summer months, but um I think we we've both been quite lucky actually over the last couple weeks that we've had plenty to write about. You you with the uh you've had plenty of you know new deals, and uh I I've been quite lucky that there's been a lot going on in uh private markets to write about. But um, yeah, I guess all that's left to say now is thanks so much for listening and uh goodbye.

SPEAKER_00 23:36

Thanks and goodbye.