Having provided an overview of the Astrea IV transaction in Part 1 of this article (“Astrea IV: What You Need to Know (Part 1) ”), we will take a closer look at the three tranches of bonds. We also describe Astrea IV’s cash-flow waterfall and discuss the bond pricing.
The offering and key terms of the bonds
Table 1: Summary of the Astrea IV transaction
Class A-1 Bonds
- Most senior note class; rank pari passu with the Class A-2 bonds
- Expected rating of ‘Asf’ and ‘A (sf)’ (Fitch and S&P)
- No prepayment risk prior to scheduled call date; expected five-year tenor (10 year maximum)
- Coupon step-up of 1% applies if tenor exceeds five years
- Astrea IV to pay USD40m and USD39m from the 1st to 5th and 6th to 10th distribution dates respectively to the reserves accounts as long as any Class A bonds remain outstanding
Together with the A-2s, the S$242m A-1 notes constitute the most senior note obligations under the Astrea IV transaction. The S$242m retail tranche of the A-1 notes is the first private equity bond in the world available to retail investors. The A-1 notes are expected to receive an ‘A’ rating (structured finance) from both Fitch and S&P, which represents strong capacity for payment of financial commitments.
Similar to the other Astrea IV bonds, the A-1 notes have a maturity date of 14 June 2028. The A-1s are scheduled to be called five years after issue, on 14 June 2023. Similar to Astrea III, Astrea IV’s Class A notes do not have prepayment risk—the issuer cannot redeem the bonds during the five-year non-call period.
Having considered Astrea IV’s structural safeguards and its cash-flow waterfall, we think it is highly likely that the issuer will redeem both Class A notes (A-1 and A-2) on their first call date. First, subject to its priority of payments (see the next section), Astrea IV has to pay USD40m and USD39m from the 1st to 5th and 6th to 10th distribution dates respectively (distribution dates occur semi-annually), whose purpose is to conserve capital for the repayment of the Class A notes.
Furthermore, Astrea IV has a sponsor sharing feature that is absent in its predecessor. Should the sponsor receive more than USD313m (50% of Astrea IV’s equity at inception) of distributions, Astrea IV would be deemed to have met its performance threshold. Subsequently, instead of the sponsor retaining all of the cash flow (that is remaining after settlement of all payments ahead of it in the cash-flow waterfall), Astrea IV will divert 50% of such cash flow to the reserves accounts. The sponsor sharing feature provides greater assurance that sufficient value will remain in the structure for the bondholders.
Finally, Astrea IV’s cash-flow waterfall has a coverage test that specifies its maximum loan-to-value (“LTV”) ratio must not exceed 50%. Should Astrea IV breach this covenant, it will have to divert the collateral cash-flow to the reserves accounts or toward the repayment of the Class B bonds, until its net debt-to-portfolio NAV ratio falls back below 50%.
Similar to Astrea III Class A-1s, there is a bonus payout to Astrea IV’s Class A-1 bondholders if the above-mentioned performance threshold is met on or before the scheduled call date. This time round, the bonus redemption premium is raised to 0.5% of the principal amount (from Astrea III’s 0.3%).
Class A-2 Bonds
- Most senior note class; rank pari passu with the Class A-1 bonds
- USD-denominated; expected rating of 'Asf' by Fitch
- No prepayment risk prior to scheduled call date; expected five-year tenor (10 year maximum)
- Coupon step-up of 1% applies if tenor exceeds five years
- Astrea IV to pay USD40m and USD39m from the 1st to 5th and 6th to 10th distribution dates respectively to reserves accounts as long as any Class A bonds remain outstanding
- No bonus payout applicable
Other than the currency and coupon rate, the USD210m Class A-2 notes have very few differences from the Class A-1s. The two Class A tranches rank pari passu with each other. Given the similar credit risk, the Class A-2s are expected to receive the same ‘Asf’ rating by Fitch. One notable difference between the two Class A tranches is that the Class A-2s do not have a bonus payout feature.
Class B Bonds
- Subordinated to the Class A notes; will provide regular interest payments in cash
- USD-denominated; expected rating of BBBsf by Fitch
- No scheduled call date (10-year maximum)
- Repayment starts after full redemption of the Class A notes; 90% cash flow sweep
The USD110m Class B notes are subordinated to the Class A notes and have a 10-year final maturity date. Unlike the Class A tranches, the Class B notes do not have a scheduled call date. Class B noteholders will receive ongoing interest payments, but amortization of principal will start only after Astrea IV has redeemed the Class A notes in full.
There are a couple of exceptions to the above rule. First, the bond documentation allows the issuer to sell up to 10% of the initial portfolio NAV. Should Astrea IV exercise this disposal option, it has to pay the disposal proceeds to the reserves accounts. If the reserves accounts have reached their cap of USD391m before the Class A notes’ scheduled call date, Astrea IV will use the disposal proceeds to pay off Class B notes instead.
Second, if Astrea IV fails its maximum LTV test, it has to divert the collateral cash-flow toward deleveraging. Again, if the reserves accounts are already maxed out before 14 June 2023, Astrea IV has to apply its cash flows toward the repayment of the Class B bonds, until it complies with the maximum LTV ratio covenant.
The full redemption of the Class A notes will trigger a 90% cash flow sweep for the repayment of the Class B bonds, subject to Astrea IV’s priority of payments. This means that Astrea IV will repay the Class B notes in various instalments after their fifth anniversary, until the eventual full redemption.
The lack of a hard repayment schedule makes it difficult to pin down the maturity of the Class B notes. Nonetheless, we may refer to the results of scenario analyses provided in the bond documentation for a better understanding of the bonds’ hypothetical lives.
The issuer ran simulations with four scenarios where the underlying PE funds delivered 1) average returns (based on historical data), 2) average returns with 25% reduction in distributions, 3) 4th quartile returns (the worst 25% of PE funds), and 4) 4th quartile returns with no distributions for the first three years. The simulations suggest the hypothetical life of the Class B notes ranges from 5.5 years in Case 1, to between 8.5-9.0 years in the most negative Case 4.
Priority of payments
Chart 1: Astrea IV’s priority of payments
Besides the quality of the underlying collateral (discussed in Part 1 of this article), the cash-flow structure of a collateralized fund obligation (“CFO”) such as Astrea IV is one of the most important credit considerations that investors need to understand. The cash-flow waterfall dictates the payment priority to different stakeholders in the structure, and therefore determines the risk-return profiles of the CFO tranches.
After receiving cash distributions from its underlying fund investments, Astrea IV pay out those cash through its priority of payments on a semi-annual basis. Such payments of available cash follow a defined payment order, flowing from the most senior to the most junior claims.
We have provided a conceptual illustration of Astrea IV’s priority of payments in Chart 1. To give a simplified description, collateral cash-flow is first applied to senior expenses and payments (taxes and expenses, hedge payments, management fee, liquidity facility payments). After that, Astrea IV will use its cash flow to pay the interest expense owed to bondholders.
Subsequent to interest payments, Astrea IV will fund the reserves accounts for the Class A notes and apply the maximum LTV test. After satisfying the maximum LTV ratio covenant, Astrea IV will apply remaining cash flows to any capital calls, excess expenses, and hedge unwind costs. Finally, it can distribute to the sponsor whatever is left.
Bond pricing and recommendation
The launch of Astrea III in June 2016 has provided a good benchmark for the pricing of Astrea IV. Due to their similar structure, we can look at the counterpart tranches of Astrea III for relative valuation. Besides its predecessor, we may also reference similar-rated issues in the bond market, albeit adjusting for Astrea IV’s securitization structure to allow some yield premium.
Being the first of its kind in the SGD bond market, and with its relatively high product complexity, Astrea III naturally had to offer sizeable new issue concessions to encourage investor interest. Spreads have also tightened noticeably in the two years since then. As such, we think the new issue premium should reasonably be less generous this time round as investors now have better familiarity with the asset class, and given the good performance of Astrea III.
On the other hand, we think Azalea has non-financial motivations in launching Astrea IV, due to its outspoken mission to broaden investor access to private equity. Given Azalea’s linkages with the Singapore government (through Temasek) and the highly-publicized transaction, we believe they have done the hard work of selecting the suitable PE funds that fit a more mainstream investor base, and making sure the deal rewards all stakeholders appropriately. Especially because Astrea IV involves mom-and-pop investors.
The ASTLC 3.900% 08Jul2019 Corp (SGD) - Class A-1 notes were issued at a spread of 218bps above the three-year SGD swap offer rate in 2016. Having considered the factors in the preceding paragraphs, we think the Astrea IV Class A-1s’ 4.35% price is less attractive than its predecessor. The pricing offers a spread of 200bps over the five-year SGD SOR.
Nevertheless, the 4.35% coupon rate compares favorably to the broader SGD corporate bond space. As a reference, the NAB 4.150% 19May2028 Corp (SGD) is trading at yield to worst (ask) of 3.511%, indicating a spread of 125bps above swaps. The NAB 4.15% ‘28s are also maturing in ten years (May 2028) with a five-year callable date (May 2023). It is rated Baa1, BBB, and A+ by Moody’s, S&P, and Fitch.
Similarly, we think the Astrea IV’s Class A-2 notes at 5.5% coupon rate are priced fairly relative to their Astrea III counterpart. At 5.5%, the Astrea IV Class A-2 notes are priced at a spread of 271bps above the five-year US Treasury yield. While that is tighter than the initial spread (354bps) of Astrea III’s Class A-2 notes, we think this is due to tightening spreads as explained earlier, and because the pricing is dictated mostly by the Class A-1s on a currency-agnostic basis.
Taking the 4.35% yield of the A-1 notes, the 5.5% yield on Astrea IV’s Class A-2 notes are fair on a post-swap basis. For reference, the five-year swap rate between the six-month SGD SOR and USD LIBOR is quoted at around negative 13bps. The gap between the 6M USD LIBOR (2.48%) and SGD SOR (1.68%) is about 80bps.
At 5.5% coupon rate, we think the Class A-2 notes offer a decent alternative to conventional corporate bonds in the USD space. For instance, ING Groep NV has a Tier 2 note outstanding that is maturing in March 2028 and first callable in March 2023. That security is indicating at a YTW (ask) of 4.748%, for a spread of 198bps above US Treasuries. It is rated Baa2, BBB, and A by Moody’s, S&P, and Fitch.
Regretfully, two year after the launch of Astrea III, we are still a long way from calling ourselves a pro in the valuation of securitized products. We still lack a good sense of what the Class B notes should price at, given its amortizing structure, except that it should offer a significantly higher yield than the Class A notes (obviously). Based on this admittedly opaque guideline and the pricing differentials between the Astrea III notes, we think the 6.75% coupon rate of the Astrea IV Class B notes is decent.
Overall, we like the Astrea IV transaction with its well-diversified PE investment portfolio, good structural credit protections to noteholders, and strong alignment of interest between sponsor and noteholders. The deal offers a good channel for investors to capture the illiquidity premia of private equity investments, access the value creation generated by a PE fund, and diversify their portfolio through a unique asset class.
Declaration:
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a principal position in ASTLC 3.900% 08Jul2019 Corp (SGD) - Class A-1,ASTLC Jun2028 Corp (SGD) - Class A-1 - Retail, ASTLC Jun2028 Corp (USD) - Class A-2 Classified as SIP and ASTLC Jun2028 Corp (USD) - Class B Classified as SIP. The analyst who produced this report holds a NIL position in the abovementioned securities