The old adage that bigger is not always better undoubtedly applies in investment banking. Natixis has shown that smaller and more nimble players are sometimes able to innovate in ways that eclipse the best efforts of their bigger rivals.
A $500-million collateralised loan obligation Natixis placed for a top-tier US CLO manager earlier this year is one such example, says Christophe Bridoux, head of financial engineering, fixed income, Asia-Pacific at Natixis in Hong Kong.
The French bank distributed a significant amount of the hard-to-sell equity tranche to investors in Taiwan in an innovative special purpose vehicle (SPV) repack format embedding a principal protection feature.
“The CLO equity repack in principal-protected note format shows we continue to be extremely innovative and ahead of all our competitors in the market,” he says. “Although we are smaller than our peers, that helps us to be the most disruptive house in the region today.”
The bank used a similar technique to place a CLO using a Natixis note as a wrapper in 2017. For this deal there was a further innovation, however. Instead of using a Natixis note, a long-dated zero-coupon bond issued by a US bank was used in an SPV repack format in order to enhance the internal rate of return.
Due to internal constraints, institutional investors are often limited to invest in principal-protected products. But the return from such assets often falls short of their yield targets.
“You have an appetite in the US for the middle-rated CLO tranches,” Bridoux says. “It’s the triple-A and the equity tranche where we struggle to find investor appetite for. On the other hand, in Asia, we managed to distribute the entire triple-A tranche to investors in Japan, and we placed over 70% of the equity tranche in principal-protected notes format to Taiwanese investors.”
To boost investors’ internal rate of return, Natixis cleverly set the maturity of the repack note and its underlying zero-coupon bond to 30 years, rather than matching it more closely to the 12-year legal maturity of the CLO equity tranche. The longer tenor meant principal protection could be achieved relatively cheaply, thereby boosting allocation to the equity tranche and, consequently, the internal rate of return that can be achieved with the product. This is the result of the long-term compounding effect in zero-coupon bonds, he explains.
The CLO equity repack in principal-protected note format shows we continue to be extremely innovative and ahead of all our competitors in the market. Although we are smaller than our peers, that helps us to be the most disruptive house in the region today
Christophe Bridoux, Natixis
“If you do a $100 10-year principal-protected investment, you need to spend $70 on the zero-coupon part – so you only get $30 allocated to the CLO equity tranche,” says Bridoux. “For a 30-year investment however, it’s the other way around; you only need to spend $30 on the zero-coupon part, and you can achieve $70 allocation to the CLO equity tranche, so you have much more allocation to high yielding asset.”
Although the 30-year zero-coupon bond delivers a more efficient allocation to the CLO equity tranche than a shorter-dated investment, its use creates a maturity mismatch with the equity tranche, which has a much shorter lifespan.
To tackle the maturity mismatch of the repack note and the equity tranche, the note was structured such that upon redemption the noteholder can reinvest the proceeds for new CLO assets or redeem the note early by physical delivery of the underlying zero-coupon bond.
“Now that you have a 30-year investment tenor versus a usual range of 10–12 years for the CLO equity, additionally we give the investors the ability, every time the CLO matures, to take the proceeds and invest into a new CLO equity tranche within the existing repack,” Bridoux says. “As a result, from the client’s perspective, the repack becomes a long-term CLO investing facility.”
In order to meet clients’ regulatory requirements, the repack note was also rated by S&P Global Ratings, adding an extra layer of complexity. The structure of the transaction had to be analysed closely in order to ensure the notes could receive the same credit rating as the zero-coupon bond. The rating agency also needed to be confident that all the SPV fees that could be incurred over the life of the investment had been accounted for.
Bringing all of the various elements of the transaction together was made possible by teamwork across departments and geographies, explains Bridoux, with the debt capital markets team in New York working closely with its Hong Kong-based financial structuring team.
He is convinced the close collaboration required to execute such a complex transaction would have been very difficult to achieve for a larger, less well-integrated institution.
“When Natixis goes to see a CLO manager in the US, the fact we have this integrated investor reach across geographies, with US and Asia distribution in parallel, is a big plus,” Bridoux says. “This is helped by our relatively small size, which allows us to communicate better and react quickly for this type of opportunities. I think the deal is quite illustrative of our focus on innovative, solutions-based approach.”