LevFin Insights: UK’s ThinCats explores quasi CLO options for private loan securitisation
UK SME lender ThinCats has ambitions to securitise a portfolio of private loans in a structure that will have similarities with a CLO, and is currently ramping a warehouse.
The firm focuses on mid-sized SMEs and typically lends £1mn-£15mn, focusing on a part of the market where, the company says, borrowers tend to be too small for traditional bank lending but aren’t well served by online-only lenders. It lent £302mn to businesses last year, lending up to 4x EBITDA on cashflow loans, and has AUM of ~ £675mn.
The firm’s managing director Ravi Anand thinks momentum for bringing CLO technology into Europe’s mid-market is growing. “There’s a lot more chat this year about mid-market CLOs than there ever has been,” he said. “We want to be a serial issuer in this space and our senior lending banks want us to be too.”
Mid-market CLO issuance is well-developed and still growing in the US, with a deep pool of investors. Analysts at Bank of America expect $10bn of gross issuance in 2023 from this segment of the market. But there is currently no equivalent in the smaller European market, following a series of false starts and an onerous regulatory landscape following the GFC.
Indeed, an investor said the history of this product was one of “continuing disappointment”. In 2020, DBRS said it had received an increase in requests to rate European warehouse funding facilities. These plans were then quietly dropped as focus shifted to managing existing facilities through the turbulence of the pandemic.
Rather than aiming for a structure that would be recognisable as a pure CLO, the type of transaction that ThinCats is considering is likely to occupy a loosely-defined gap between SME ABS and CLOs, carrying characteristics of both.
“It’s similar to a CLO in construct but different in underlying portfolio risk returns,” Anand explained. “Gross leverage among the assets sits at around 2x-3x, whereas in BSL [broadly syndicated loans] within a CLO it is closer to 5x.”
“The other thing to note is that CLOs tend to be exposed to a broadly similar set of credits, whereas private credit offers investors improved portfolio diversification,” he added.
To date, just one European deal that could be classed as “mid-market” has landed on investors’ desks. That is Be-Spoke Capital’s Alhambra SME Funding 2019-1, which is backed by a static portfolio of 52 Spanish SME loans.
Other lenders incorporate private loans granted to SMEs into structured vehicles, but these are backed by a much more granular profile of thousands of loans. One of these is Funding Circle, which recently pre-placed UK SME ABS SBOLT 2023-1.
Ratings question
A traditional BSL CLO is backed by a pool of assets which are – crucially – assigned a credit rating from at least two rating firms.
A major stumbling block to the development of a mid-market CLO product is rating the private loans, as well as absorbing the high cost of doing so.
“Unlike in a BSL CLO, none of the underlying loans are rated at this moment in time,” Anand said. “We’ve done exercises with ratings agencies and if we are unable to put a major agency in place on a cost-effective basis, that might constrain Triple A buyers with specific mandates.”
For the ratings firms, the process of rating a mid-market deal is not dissimilar from other CLOs. And while the timeline might be a bit more elongated as credit work is completed on private names, a set of portfolio tests familiar to European investors – WAL tests and OC cushions, to name but two – lays the foundations for their work.
While investors may scratch their heads about the difference between SME ABS and mid-market deals, Eric Hudson, senior managing director in the structured credit team at KBRA, sees a few key distinguishing features. “It’s fair to say there are some differences between mid-market and SME ABS deals, such as high granularity in ABS portfolios and varying structural features, like OC tests in MM CLOs. The size of the underlying borrower in the portfolio is also a point of distinction for a MM CLO.”
The label attached to a deal can however vary depending on its intended market. “Recurring revenue deals, for example, are typically tagged as an ABS, but we approach rating them in the same way we would a CLO – they are just structured differently with more of an ABS-style structure, which could influence the type of desk investing in it,” Hudson said.
