What You Should Know About the Upcoming Astrea III Notes - Part 2

A Temasek Holdings unit is looking to issue notes backed by the cashflows from a portfolio of private equity (PE) funds. In this article, we look at the different classes of notes from the upcoming Astrea III note issuance, and highlight the features that investors should be aware of.

iFAST Research Team June 13, 2016

Summary of note classes:

Class A-1:

  • Part of the most senior note class, SGD-denominated
  • Expected rating of A(sf) by Fitch and S&P
  • No prepayment risk prior to scheduled maturity; expected 3Y tenor (10Y maximum)
  • Coupon step-up applies if tenor exceeds 3 years
  • Bonus payout applicable subjected to sponsor meeting specified return conditions, but only up to 0.3% of principal

Class A-2:

  • Part of most senior note class, USD-denominated
  • Expected rating of A(sf) by Fitch
  • No prepayment risk prior to scheduled maturity; expected 5Y tenor (10Y maximum)
  • Coupon step-up applies if tenor exceeds 5 years
  • No bonus payout applicable

Class B:

  • Subordinated to Class A notes; will provide regular interest payments in cash
  • USD-denominated; expected rating of BBB(sf) by Fitch
  • No scheduled maturity (10Y maximum); notes start to amortise after full provisions for Class A note redemptions are made
  • May even be redeemed in full prior to A2s if cash generation is strong

Class C:

  • Subordinated to Class B notes, not expected to be rated; USD-denominated
  • No scheduled maturity (10Y maximum); will amortise after Class Bs redeemed in full
  • Payment-in-kind feature means no cash coupons; coupons are reinvested as additional bond principal
  • Equity participation; participates via 5% of residual cash after sponsor achieves a 15% IRR

Taking a closer look at the individual note classes of Astrea III

After looking at the proposed structure of Astrea III notes in What You Should Know About the Upcoming Astrea III Notes - Part 1, investors may wish to know more about the 4 different classes of notes expected to be launched under the upcoming Astrea III programme. In this update, we elaborate more on the differences in the terms of the various classes, and offer our comments on potential pricing.

Class A-1 (expected S$234m, the equivalent of USD170m; 3Y expected tenor)

Most senior note obligations, SGD denominated

The A-1 notes (alongside the A-2s) constitute the most senior note obligations under the Astrea III programme. S$234m of notes are expected to be issued (the equivalent of USD170m), and this will be the first issuance of SGD-denominated notes collateralised by PE fund investments in Singapore. While the underlying investments are primarily denominated in USD and EUR, the issuer has catered for a currency hedging mechanism to facilitate the SGD-denomination of the Class A-1 notes. The A-1 notes are rated by both Fitch and S&P – the rating agencies have accorded the notes a preliminary "A (structured finance)" rating, representing a fairly strong investment-grade rating.

Expected tenor is just 3 years

Like the other classes of notes, the A-1 notes have a maximum tenor of 10 years, although the scheduled maturity is 3 years after issue; unlike what is common for most asset-backed securities, there will not be pre-payment risk for the Class A-1 notes – the A-1s will not be redeemed prior to the scheduled 3-year maturity. Simply put, if things go to plan, an investment in the A-1 notes will be similar to 3-year bullet bond paying semi-annual coupons.

Coupon step-up applies if tenor crosses 3Y

But what if things don't go to plan? In the unlikely event that the underlying investments cannot provide sufficient cashflow to redeem the Class A-1 notes at the scheduled maturity date, a coupon step-up will apply on interest payments after the first 3 years to compensate investors for the additional tenor. Holders of the Class A-1 notes will continue to receive interest payments until sufficient funds are accumulated to redeem the Class A-1 notes in full (at a future interest payment date).

Bonus payout possible, but capped at 0.3% of principal

For the Class A-1 notes, there is a bit of participation (in the underlying PE investments) for noteholders if a "bonus redemption" threshold is met. Transaction documents suggest that this requires the sponsor to receive payouts of more than 50% of the initial equity investments made (as of end-May 16) over the first three years (on or before the scheduled maturity date of the A-1s). We would suggest that investors worry less about the possibility of the bonus redemption threshold being met, since this possible bonus is capped at a mere 0.3% of bond principal.

Class A-2 (expected USD170m; 5Y expected tenor)

Most senior note obligations, USD denominated

Ranked pari passu with the A-1s, the A-2 notes are part of the most senior note obligations under the Astrea III programme. Denominated in USD, USD170m of these notes are expected to be issued, and while the maximum life is 10 years, the A-2 notes have a scheduled maturity 5 years after issue. The notes have been accorded a preliminary rating of "A (structured finance)" by Fitch, representing a fairly strong investment-grade rating.

Expected tenor of 5 years

Similar to the Class A-1s, the A-2s will not have pre-payment risk since they will not be redeemed prior to the scheduled 5-year maturity date. Again, these notes may be seen as being structurally similar to a bullet 5-year bond, if the issuer is able to meet the scheduled 5-year maturity.

Coupon step-up if tenor crosses 5 years; no "bonus" payout applicable

If things don't go to plan, the maturity of the Class A-2s will extend beyond the 5-year mark, and an interest rate step-up will apply. Like in the case of the Class A-1s, the notes will be redeemed once sufficient funds have been accumulated to pay off the entire Class A-2 notes in full. Investors may wish to note that there is no "bonus" payout feature for the Class A-2 notes.

Class B (expected USD100m)

USD-denominated subordinated notes; amortisation will apply

Subordinated to the Class A notes, the Class B notes (USD-denominated, USD100m size expected) will have a 10-year final maturity date, with no scheduled maturity. Class B noteholders will receive ongoing interest payments, but amortisation of principal will apply – that is, after sufficient funds for the redemption of both the Class A-1s and Class A-2s in full have been set aside, the Class B notes will start to amortise. This means that various portions of the bond principal may be returned over the life of the bond, up until the eventual maturity in full.

No maturity "floor", so Class B notes may be redeemed in full prior to Class A-2s

An important implication of this is that the Class B notes may actually be redeemed in full prior to the Class A-2s if the underlying PE funds generate sufficiently strong cash payouts. Since there is a maturity "floor" for both Class A-1s and A-2s (3 years and 5 years respectively; the notes cannot be redeemed prior to those tenors), a successful provision for both A-1s and A-2s in full will then see the Class B notes being amortised; it is worth mentioning that the transaction documents include three hypothetical cases where the underlying PE funds deliver 1) average returns, 2) 4th quartile returns, and 3) no distributions over the first 3 years, before delivering 4th quartile returns thereafter. Under such cases, the hypothetical life of the Class B notes ranges from 4.5 years to 6 years, which may provide a reasonable estimate of the expected maturity of the Class B notes in full.

Class C (expected USD70m)

USD-denominated, deeply subordinated notes; amortisation applies

The Class Cs are the most subordinated tranche of notes in the upcoming Astrea III series, and are senior only to equity. Like its peers, the Class C notes will have a maximum life of 10 years, and amortisation applies, like in the case of the Class Bs – the Class C notes will start to amortise only after the Class Bs have been redeemed in full.

Most direct form of private equity participation

However, the Class C notes have the most direct participation in the returns from the underlying PE fund portfolio – after the sponsor has achieved a 15% IRR (internal rate of return) and there is remaining cash in the operating account of the issuer on each distribution date, Class C noteholders will be entitled to 5% of the residual cash balance, which could provide for a more "equity-like" return on the notes.

Payment-in-kind means no cash coupons

Investors should also note that unlike the Class As and Class B notes, the Class C notes are structured with a "payment-in-kind" (PIK) feature – that is, no actual cash interest will be paid. Instead, investors in the Class C notes will receive interest in the form of additional bond principal, which will add to the investor's holdings of Class C notes.

Our take: 

As previously discussed, the loan-to-value (<40% at the point of transaction) appears fairly conservative, providing for a rather wide margin of safety for investors participating in the notes; the underlying portfolio also appears to be well-diversified across managers (GPs), sectors, vintages and even geographical regions – it must be highlighted also that the funds are invested with some of the best-known PE managers in the business, sporting long track records.

The proposed structure of the Astrea III notes means that there is something for everyone; investors looking for lower-risk instruments or those seeking equity-like (or even private equity-like) returns may find something suitable amongst the 4 proposed classes of Astrea III notes. While the low initial LTV and maximum LTV clause applicable throughout the life of the notes mean that the risk of impairment is not substantial, investors will have to note the possibility of illiquidity of their investments in the various classes of Astrea III notes – investors who buy all 4 classes of the notes should invest with a view of holding them to maturity.

Class A-1 and Class A-2 notes are viable alternatives to plain vanilla bonds

For the Class A notes (A1s and A2s), we think that investors can view them as alternatives to more "plain vanilla" 3Y SGD and 5Y USD bonds available in the market; we think that both notes are unlikely to exceed their scheduled maturities, while the coupon step-up should provide some compensation in the unlikely event that the scheduled redemption dates cannot be met.

Pricing is an important consideration here; while there is clearly no peer comparable for the Class A-1 notes at present, we may draw some parallels with subordinated securities issued by some of the larger rated (financial) issuers. For example, recently-launched BPCEGP 4.500% 03Jun2026 Corp (SGD)s are Tier 2 securities (A- by Fitch, BBB by S&P, Ba3 by Moody's) with a maximum tenor of 10Y, although market expectations are for the notes to be called after 5 years – this is similar to the Astrea III Class A-1 and A-2 notes which are expected to be called in 3Y and 5Y respectively, but have a maximum tenor of 10Y. The BPCE notes are currently quoted at around 240bps over swaps (~5Y to call), which (admittedly a poor surrogate for pricing the new notes) suggests that a yield in the 4% to 4.1% range may be viewed as a possibility for the Class A-1s, also considering that the notes are unlikely to be as liquid as their peers.

Similarly, looking at subordinated T2s for higher-rated financial institutions in the USD space suggests a 200-300bps spread would be fair; the low 5Y Treasury yields (1.138% at the time of writing) implies a low 4% yield for the Class A-2s – we think pricing will eventually be dictated by the Class A-1s (on a currency-agnostic basis), with the Class A-2s likely to be indicated at a decent yield premium (50-100bps?) to the Class A-1s, which could place yield guidance for the A-2s in the high 4% to low 5% range.

Class B and Class C notes for more aggressive investors

We admittedly don't have a good sense in terms of pricing for the Class B and Class C notes, having little experience with amortising structures. Needless to say, the Class B will have to be offered at a higher yield compared to the Class A-2s; investors should note that the Class Bs, while subordinated to the Class A notes, could actually be redeemed in full earlier than the Class A-2 notes.

The Class C notes are perhaps the most interesting tranche, offering investors the potential to participate in some of the upside potential from the underlying PE portfolio. The PIK feature means investors should be prepared to be "locked in" without seeing any actual income for the first few years – this is similar to the experience of private equity investors where cash flows only materialise in the later stages of the fund's investment life. Investors who are looking at equity or PE-type returns from an investment which also attempts to limit downside may thus find the upcoming Class C notes interesting owing to their higher-return possibility. We will hazard a guess at a possible double-digit coupon rate (PIK), which would offer individual investors a means of participating in the sphere of private equity investments, where investors trade liquidity for higher returns.

 

This article was provided courtesy of iFAST. iFAST Corporation operates in Singapore, Hong Kong and Malaysia as iFAST Financial Pte Ltd (Singapore), iFAST Financial (Hong Kong) Ltd and iFAST Capital Sdn Bhd (Malaysia) respectively and is licensed by the local financial market regulator in each respective jurisdiction .