Hitting the high LTVs

How securitization can help high LTV mortgage lending and why is the CLO market so busy

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SPEAKER_01 0:06

Hello and welcome to another five minutes. I'm your host, Tom Paul, Global Capital's senior European securitisation reporter, and I am joined this week by Thomas Hopkins, our European CLO reporter. How are you doing, Thomas?

SPEAKER_00 0:20

I'm doing very well, thanks, Tom. Yeah, uh I'm very much looking forward to a long weekend that I've got coming off, uh coming up, sort of uh because uh Global Capital very generously gives us a day off for our birthdays. It's my birthday on Sunday, so that means I get a day off on Monday, and this is absolutely fabulous news. So I'm in a pretty good mood, Tom.

SPEAKER_01 0:39

Excellent. How old are you, turning?

SPEAKER_00 0:41

Is it 31 if I remember? Yes, and very sad. I'm turning 31. I'm now heading deeper into my 30s. I could not be more distressed about that, Tom. But uh but yes, turning turning to more important matters than than my aging. Um, I should ask you, what's been going on in the ABS market? I mean, obviously, I know it's been a little bit quiet the last couple of weeks. Has there been any kind of pickup over this week?

SPEAKER_01 1:05

There has, but it's been a pretty subdued pickup. It was interesting. We so we had SockGen be announced an Italian auto on Monday, and I was kind of thinking, you know, my my expectation was oh, we'll probably see, you know, at least two more announcements this week, uh, you know, kind of taking their place at the front of the queue, ready to to price for next week. But uh we're recording, you know, kind of late on Friday, about you know, 3 p.m. ish, and we haven't seen any other new issues. So uh it looks like you know, if there there is going to be any sort of flurry of issuers, you you'd expect them all to be uh you know sort of coming on the Monday with with an idea of uh pricing on on the Friday, uh especially because we'll have the the bank holiday the uh the week after. So uh yeah, some interesting dynamics going on in uh in ABS world. Uh what's been happening in uh on the CLO primary?

SPEAKER_00 1:55

Well, CLO primary has continued to be a little bit busy. This has been a slightly slower week so far than the previous two weeks, but let's be honest, the previous two weeks have been really busy. I mean, we had 17 deals in the first two weeks of August. You know, the European CLO market just really does not shut down, you know, over the sort of August period. Um, but yes, we've seen a number of deals. Um we had on Monday we had a new issue from Macquarie, who's obviously taken over um the Spire CLO platform because they acquired Spire this year, but we had so that was their Aureum CLO, and then we had a sort of a rare kind of post-pricing upsize. Um, that was the aqueduct European CLO 18. Upsize being a technical term there, we don't tend to use it in our copy, so it was increased in size after pricing, I should say. And then we had a a refi um yesterday, it was Trinitas, and then um also yesterday we've actually seen Sona has done a private credit CLO, and then today we've had a um a recess from Carlisle. So yeah, I mean still a still a reasonably busy week, sort of you know, issuance-wise, but it's very slightly slower than last week at this stage. But you know, even though it's sort of 20 past three on a Friday afternoon, um, we uh we might yet see a couple more deals. So yeah, CLO market very much remaining open over the course of August.

SPEAKER_01 3:19

Yeah, very interesting. Well, I mean you're you're saying it sounds like a slow week, and I I guess it is for CLOs, but I think any other uh you know one in in DCM would be would be absolutely thrilled to have that many deals uh in you know the what is it, the the third week of August.

SPEAKER_00 3:35

Yeah, exactly. You know, I mean, you know, I think they CLOs have been providing some quite good relative value for investors actually because of that. But uh more of that later. I think um first though, I think we should have a look at your weekly for this week. Um so as I understand it, Tom, you've been looking at the kind of high LTV mortgage market. Does high LTV mortgage lending, is it sort of starting to have a bit of a revival, do you think?

SPEAKER_01 3:59

Yeah, very interesting. So I mean these were you know pretty popular products before the financial crash. Uh I had some figures in the story, but I think in 2007, you know, mortgages with an LTV over 90% basically made up 14% of total mortgage originations uh for that year, and 5% of total lending was uh mortgages with an LTV over 95%. So that's you know pretty huge to compare to 2009, where post-financial crash they they had a big drop-off and there were very few lenders offering these products and you know, pre-financial crash. I mean, what one of the the kind of famous uh products I think was uh now now obviously a collapsed bank, Northern Rock, but it it uh offered you know up to I think 125% mortgages under uh one of its um lending programs. So uh we're we're quite a distance uh from from that sort of lending. But we we have been sort of having a revival. We it kind of started in 2023 and has only really been increasing. And you know, the the emphasis for really this story was we we had uh you know Gable Group announced a 250 million funding line, you know, I guess uh it might be a couple weeks ago as as this uh podcast comes out. But that really made me uh sort of yeah look into it a little bit more. And it, you know, it seems like I mean some of the the figures I saw, I think the last week I saw was mortgages with announced even over 90% made up about 8.3% of you know gross mortgage advances. That was at the end of 2025. So, you know, that it's obviously a bit of a come down from the the 14% in 2007, but it's still you know it's the uh the highest amount since since 2008. So the these products are you know steadily uh growing.

SPEAKER_00 5:51

And how burdensome are the capital charges on high LTV mortgages?

SPEAKER_01 5:56

Yeah, I mean that's that's really the the kind of interesting and kind of the deepest question on this. I mean, I suppose one thing before I sort of get into that is I should say that you know modern high LTV mortgages are they're a lot less risky, I'd say, than the pre-GFC ones. You you have a lot stronger uh affordability and income checks, you you have rental payment history requirements, often you'll need a guarantor uh if you want to get one of these mortgages. And you know, also you know, the these things come down to underwriting. You know, it's entirely possible there could be you know an 80% LTV mortgage that's been underwritten worse and is therefore more risky than you know uh a 90% LTV mortgage that you know has a has a much stronger underwriting criteria. I mean I I think there you know there there's obviously going to be inherent risks when you get to the higher LTVs, because you know, if you think about it, if you have a zero deposit uh mortgage, the the borrower's no equity in the home. That means if there's any you know drop in house prices, that's going to immediately put the borrower to a negative equity and the the bank is going to be taking on more risk. And and that's sort of you know what links it to the the increased capital charge. The the there is an inherent sort of risk when you're doing higher LTV lending. So I mean, you know, generally speaking, residential mortgages up to about 55% LTV. This is under you know the capital requirements regulation. We have a slightly different uh sort of set of regs in the UK, but it's it broadly follows the same framework. Uh you get a very low risk weight for those uh mortgages. I think it's around 20% if you're using the standardised approach. Obviously, you know, some of the other banks will will be using a uh internal ratings-based approach. But um, you know, and one once you get out to higher LTVs, uh, it's you're you're essentially treating these mortgages as if they're any sort of form of you know unsecured consumer lending. And you know, you you get a an increased risk weight as you go uh higher up in the LTV.

SPEAKER_00 8:00

And what options do banks and specialist lenders have for getting capital relief on these loans with high risk weights?

SPEAKER_01 8:08

Yeah, so I mean part of the answer to that question is is going to be based around size. So a lot of the momentum in the sector is coming from specialist lenders and kind of small building societies. So I mentioned Gable Group. I think Melton Building Society also began launching its products uh in January this year, where you know, I I think these kind of mortgage loans probably aren't going to have a large enough book where it's economic for them to do uh significant risk transfer. So they're gonna be looking at sort of credit risk mitigation strategies, like you know, possibly getting an insurer to provide protection against the first loss in the lines, uh, which that's gonna effectively cap the LTV of the pool and should therefore lower the risk weights. But if we're talking about you know larger banks or challenger banks, they're probably going to be looking at doing an SRT or a deconsolidation RMBS. So for an SRT, you're you're transferring the risk from uh the pool of assets to an investor, but you're still keeping the assets on your balance sheet. That's sort of the synthetic uh aspect of the significant risk transfer. So that's one way you're you're freeing up capital. But in a in a deconsolidation trade, or or also they're kind of called a cash SRT, but that you're you're structuring it much more like a sort of typical RMBS where you're gonna have you know sort of slimmer mes tranches, you're you're gonna have rated notes, and the idea is that you're you're selling the capital-intensive uh mes notes to investors while you're gonna be retaining the senior notes, and that way you know you can sort of say you've taken the assets off your balance sheet, uh, so you don't need to hold capital against them anymore.

SPEAKER_00 9:46

And um do you think there's gonna be investor appetite for buying these sort of high LTV mortgage securitizations?

SPEAKER_01 9:52

Yeah, I mean that's that's obviously the most interesting uh kind of aspect because it is a pretty new sort of element to the market. I'd say a big part of the kind of you know the deconsolidation RMBS trades is that you know you're saying you've derecognized the assets from your balance sheet. So part of that is you know usually going to involve selling the equity and the call rights to the deal, you know, as a way of essentially saying to the regulator you you don't really control the securitization anymore. And that can be a problem for some RMBS investors. As you know, I think a third-party asset manager doesn't necessarily have the same incentives to call a deal on time, uh, that regular RMBS issuer who's gonna want to keep investors coming uh whenever they you know issue a new deal. I think there's always gonna be incentives. Obviously, no one wants to have a reputation of you know being a an issuer or someone who holds the cool race to a deal that never calls their deals um vehicle. There's just gonna be slightly different incentives when you're dealing with um a mortgage lender who is selling you know two R and BS transactions a year versus you know just an asset manager who buys the the cool race to uh you know some deconsolidation deal. And then on the SRT side, there's probably gonna be a little bit of a learning curve as you know, residential mortgages are a pretty esoteric asset class for SRT. You you typically see you know more consumer loans or SME loans uh getting securitized because they have you know much higher risk weights, so it's a lot more economic for banks to uh suddenly at least start with doing SRTs on those uh loan pools. You know, you typically get very low risk weights for uh residential mortgages. It it sort of only changes when once you start you know moving up the uh LTV ladder. So I think one interesting thing is that you know we we might see sort of a mix of high and low LTV mortgages in the early deals. So you know the the issue of that is you you unlock less uh capital relief from a deal like this, but you you also have to pay less of a premium. So it could end up being you know sort of more efficient in in terms of cost per unit.

SPEAKER_00 12:02

Of course. Um well I thank you very much, Tom. And I very much commend Tom's weekly to listeners. His weekly is called More Capital Relief Securitizations on the Horizon for higher LTV mortgage lenders that is available on the global capital website for global capital subscribers.

SPEAKER_01 12:20

Yes, and we should move on to uh CLO Weekly. Uh it's a weekly that I've been looking forward to for a while because it's something that we've uh kind of been frequently talking about, how the kind of CLO market kind of operates a little bit differently to uh what's certainly the ABS market. And really, I think it seems like most uh DCM markets where we we don't really see that many deals uh coming out throughout the majority of the summer. I mean, I I guess my first question with this story is you know, why have CLO managers continued to print new issue deals over the summer?

SPEAKER_00 12:56

Well, that's a very good question, Tom. And yes, you're right. We've been talking about this for a while, and you know, I've sort of seen um the kind of workload and sort of deal flow sort of slow a little bit for you know colleagues in other parts of the publication. I've sort of go been going, sort of, why are there still so many CLOs printing? But yeah, it's uh it's a very it's a very interesting topic to to dive into because we have seen new issue deals in August, which historically, you know, was really just you know a much quieter time for the CLO market. It's not always been this way. Um and I think you know the the rationale for why there tends to be you know sort of slightly fewer new issue deals in August tends to be well that new issue deals when they're ramping up their portfolios, they depend more on sort of new like primary loan supply from the leveraged loan market than resets do. And so, you know, the leveraged loan market tends to be a bit quieter in August, and if you can't fill up your portfolio, you don't really want to sort of bring a new issue deal to market in August. Now, there's some sort of remnants of that trend still there because if you look at the deals that are priced, um, there are many more resets than there are new issues, but nonetheless, we have still seen, I think, currently six new issues, and that's sort of five BSL, one private credit over the course of this month. So managers are still able to print, they are still bringing deals. Why? Well, I suppose um in terms of sourcing sufficient loans, yes, it's more difficult in August, but there are kind of ways that you can manage it. So, for example, you can sort of structure deals with slightly longer kind of price to close windows, which you know might give you more time to kind of fill up portfolios. You can purchase loans in the secondary market as part of your ramp. And additionally, managers that already maybe had deals that were at a kind of advanced stage of the ramp-up process, you know, they could sort of bring deals to market sort of in August, having already ramped them quite a lot at another point in the summer, and that was sort of viable for them. But I think the other really important thing to consider here is captive equity funds, you know, something again that I've I've spoken about quite a lot recently. But with captive equity funds, I think they've sort of changed the issuance patterns of CLOs because when CLOs were dependent on, you know, sort of third-party equity to print deals, they had to kind of wait until there were kind of optimal market conditions for equity returns. And you know, that that those tend not to be the case in August, because obviously if the supply of loans shrinks, well then this sort of supply and demand imbalance that you already have with CLOs and leverage loans, but there are too few leverage loans relative to CLO demand, that kind of worsens. So, you know, spreads are tighter, loans go closer to par. It's not always a great time for equity because you just have fewer loans. But I think when you've got a captive equity fund, you don't mind quite as much about what the conditions are for equity on day one. So, you know, you're thinking over the long term, you will be including multiple CLOs in your captive equity fund and you hope that the average overall equity return is good, even if you know there are a couple of deals that didn't perform as well. And I think what managers tend to do now is just sort of print when they have the ability to do so and kind of then work to improve the equity over time, because you don't really know when there are going to be moments of market dislocation when suddenly you know the it becomes a better environment for equity. So best just to print deals when you have the ability to do so uh and kind of move in that way. And so because managers now think in those terms, even though equity, you know, conditions for CLO equity are really not particularly good in terms of a day one arbitrage at the moment, I think managers are still just able to bring deals to market just because they think about maybe m just printing on a more regular basis and not sort of trying to kind of time the market for optimal conditions as they might have done in the past. So I think those are some of the reasons why certainly managers have continued to do new issue deals, I think, uh over August.

SPEAKER_01 17:09

And then why do you think there's been more resets than new issue deals?

SPEAKER_00 17:13

Well, certainly with resets, um, as I was sort of partly mentioned earlier, they don't they don't depend as much on kind of new leverage loan issuance, you know, in the in the kind of primary leverage loan market. Because while you will have to buy up some loans in a reset as part of like cleaning your portfolio, um, you don't need to sort of build a whole portfolio from scratch. So you don't need as much loan supply you can buy in the secondary market. So there's that aspect to it. Um, but then the other aspect is actually market conditions have you know been really quite good in August if you're thinking about doing a reset. And the reason for this is that mezzanine spreads, certainly if you're talking kind of double A to double B, are very, very tight for CLOs at the moment. In fact, sort of double A to double B, they're in the kind of like tightest 5% of spreads over like the the last five years at the moment. So in for MES, you have not really seen spreads this tight in a long time. Now, triple A's and single B's are a little bit different. Single Bs are quite volatile at the moment because there's a lot of still geopolitical risk with the Iran War. Managers are still concerned about software and AI. Um, but then again, single Bs make up a very small part of the capital stack, and they're not that, so they're not they don't have an enormous impact on your cost of capital. Triple A's, they're a bit wider than their sort of historical tights, you know, if you know, they're in the sort of mid-120s now versus sort of you know 80, 90, you know, in sort of 2021. So they're a bit wider, but they're still quite a lot tighter than the spreads that you might have got, you know, in uh in large parts of 2022, 2023, 2024, even parts of 2025. So it's quite a good moment in time. And you know, managers resets are kind of always a function of whether or not you can tighten spreads. That's the biggest motivator for whether or not you reset a deal. Obviously, there's the other question, which is prolonging the life of a deal, extending its reinvestment period. That's another consideration. But you typically want to do that at a moment when spreads are as tight as they can be. And, you know, I think certainly for 2021 deals, it might be particularly attractive because quite a few managers have kept 2021 deals running for a while, you know, out of reinvestment, even because they have these really tight AAA spreads and they didn't want to sort of you know widen the spreads on those AAAs, you know, on those deals. Now they have this moment where, well, mes spreads are as tight as they're gonna be, and triple A spreads are not that bad. So yes, they will still widen on triple A if they reset right now, but the blow of that is softened a little bit by having these very, very tight mes spreads. So it's actually, you know, it's a reasonably good environment to reset, oddly enough, in August.

SPEAKER_01 19:59

Yeah, and I guess you know, the the last of the question, I mean, when you look at other markets, I mean to be blunt, you know, the the demand basically falls because investors are on holiday and there's just fewer investors at desks, and you know, especially in ABS world when it you know it takes a long time to sort of look at these deals and really kind of digest them and exactly you know what it takes to invest in them, it's it's just not really you just don't have that capacity in August. So the the market really has to take some time off. I mean, why why do you think investor demand for CLOs has remained so strong throughout August?

SPEAKER_00 20:32

Well, it's definitely an interesting point, Tom, because you would think, well, you know, all the investors are presumably on the beach somewhere, and so, you know, not wanting to, you know, uh invest in in CLOs. But I think there's there's a couple of factors. The one factor is the increasing presence of US investors in the market. Now, the US market doesn't really close in the same way over the summer that Europe does. And so because you've got this strong base of US investors, you do actually still have enough of a kind of investor base that you can sort of tap into at the moment over the over the summer. I mean, that doesn't mean that the market is necessarily busy every summer because there are US investors, but you know, if managers want to print deals, you know, there's certainly like it, you know, is some demand there from the US. And granted, managers wouldn't bring deals if they thought they were going to get incredibly wide spreads. Um, and so part of that, I mean, it becomes a bit of a chicken and egg thing as to, you know, is investor demand there because managers are bringing deals, or are managers bringing deals because there's investor demand? But nonetheless, you can see how the two things are kind of certainly always related. You know, managers are kind of willing to bring deals, but there is demand there from the US investors. But the other side of this, I think, also is that while there are kind of investor absences and things over the summer, you know, people do go on holiday and they're not around quite as much. I think with the investors that are still kind of active over the course of the summer, CLO paper actually starts to look quite attractive. Because, as you say, Tom, large parts of the debt capital markets do shut down. And so if you're kind of searching, you know, if you're for an investor and you're wondering where to allocate capital, and you do do CLOs over the summer, well, there is CLO paper available, managers are using captive equity funds to bring deals more on a regular basis, you know, and so you might really quite conceivably think it was a good idea just because there's not so much other paper around. But also actually, if you want to compare you know spreads on CLO paper to sort of equivalently rated or even lower-rated corporate bonds, there's a very attractive spread premium that you get if you invest in CLO liabilities. Now, obviously, that spread premium does exist because CLOs are arguably, you know, inherently a little bit more complicated than corporate bonds, but nonetheless, you do get a big spread premium and there's paper available all through August. Um, and so you know that's very attractive to investors. And so I think that's why, you know, we've seen kind of strong demand, and and sort of I think the thing that indicates just how strong demand has been is well, both the number of deals, but also there's been a large number of deals pricing at extremely tight spread. So it does just show you that you've got US investors and then you've got the remaining contingent of European investors all reasonably keen uh to invest in CLO liabilities over August for the reasons I mentioned.

SPEAKER_01 23:23

Yeah, well, this really excellent story and goes into a lot of detail about you know an element of the CLO market which really does make it unique compared to you know a lot of other DCM markets. Uh and if anyone wants to read it, it's called uh CLO managers print deals all summer as investor appetite endures. Uh I think that's uh that's all we've really got time for this week. Uh we we've covered plenty of stuff, but uh I guess uh all that's uh left to say is uh goodbye. Bye.