Astrea III Pte. Ltd, an entity which owns interests in 34 private equity (PE) funds, is looking to issue a series of notes which are backed by the cashflows of the underlying PE funds. The issuer is currently in the midst of meeting prospective investors, and the notes are expected to be announced thereafter. In this update, we identify some things investors should know about the upcoming Astrea III notes.
Understanding the structure
For the upcoming Astrea III notes, the issue is structured as a collateralised obligation backed by a portfolio of PE fund investments. As shown in Chart 1, the underlying collateral consists of 34 PE funds with an NAV of USD1.1416 billion (as of 31 Mar 16), with an additional USD201.4m in undrawn capital – the eventual underlying portfolio will have an exposure size of around USD1.3 billion. This PE fund portfolio will back the borrowings made via 4 classes of notes (Class A-1, Class A-2, Class B and Class C), with the residual equity tranche to be held in its entirety by Astrea Capital Pte Ltd, an indirect wholly-owned subsidiary of Temasek Holdings.
Chart 1: Proposed structure
Source: Transaction documents; figures are indicative
In such a securitised transaction, investors should look at three key points: 1) the quality of the underlying collateral, 2) the leverage or loan-to-value of the transaction, and 3) the seniority or subordination involved.
Quality of underlying collateral
For notes issued under a collateralised structure, the quality of the underlying collateral is paramount, since this ultimately determines whether noteholders will be repaid. For this upcoming issue, the PE portfolio entails investments in 34 private equity funds managed by 26 General Partners (GPs). Total commitments amount to USD1.557 billion (as of end-Mar 16), with investments spread across 592 companies in the US (66.5%), Asia (21.2%) and Europe (12.3%, as of end-Dec 15). Based on information contained in the transaction documents, we note that the portfolio is fairly diversified, with the three largest GP exposures at only 8.9%, 7.9% and 7.6% (to KKR & Co. L.P., EQT Partners and TPG Capital respectively, as of end-Mar 16), while the largest individual fund investment was 6.7% to the Warburg Pincus Private Equity XI, L.P, representing a USD76.1m investment. Sector exposure is relatively diversified, although we observe that the more growth-centric Consumer Discretionary and Information Technology sectors represented 23.4% and 22% of total portfolio NAV (as of 31 Dec 15) – this is likely a function of the sector-specific opportunities in the PE space rather than a conscious effort on the part of the GPs to focus on these sectors.
In terms of cash-flow risks, investors should note that the underlying PE funds are spread across "vintages" from 2004-2013 (weighted average vintage of 2009); USD458.1m of underlying PE fund investments would have crossed the 10-year mark (2008 vintage or older) by 2019 (when the Class A-1 notes are expected to mature). These older vintages are expected to be in the distribution phase (rather than in the process of calling capital), which should provide the necessary liquidity to redeem the most senior tranches of bonds.
While an investor may be comfortable with the underlying collateral, the extent of leverage employed also an important consideration. Intuitively, the more borrowings secured by the same pool of assets, the more risky the investment. For the upcoming Astrea III notes, we observe that the structure is fairly conservative from the perspective of noteholders: approximately USD510m of notes will be issued (in 4 classes) against approximately USD1.3 billion of PE fund assets (including undrawn capital), representing an expected loan-to-value (LTV) of less than 40% for the entire transaction. This provides a strong buffer against the risk of things going wrong; investors should note that the notes will come with a "maximum loan-to-value" clause (45% initially, declining to 20% after the tenth distribution date) – failure to conform to this maximum LTV will result in principal payments for notes to be accelerated until the breach is rectified.
Seniority of notes
For such a collateralised structure, investors should be aware of the seniority or subordinated involved in the various traches of notes – this becomes very relevant in the (unlikely) event of a default. When things go wrong, the following principal holds: senior noteholders get paid before subordinated noteholders, and holders of equity are the last in line to be paid.
The upcoming Astrea III notes will come in 4 classes, representing 3 levels of seniority/subordination. The Class A-1s and A-2s are pari passu (around USD340m of senior obligations), and represent the most senior noteholder obligations in the event of a default. The Class B notes (USD100m expected) are subordinated to the Class As, while the Class Cs (USD70m expected) are the most subordinated tranche of the Astrea III notes, sitting just above the equity tranche.
The notes are not "Temasek-backed"!
While Temasek Holdings is intricately involved in the deal (the equity investor, sponsor, issuer and manager are all wholly-owned indirect subsidiaries of Temasek Holdings), investors should note that the notes are not "Temasek-backed". The Astrea III notes are structured as collateralised obligations – cashflows for interest and principal payments will come from this underlying pool of PE fund assets, while in the event that something goes wrong, investor recourse will be to this same pool of assets backing the transaction.
Nevertheless, investors may wish to know that this upcoming transaction will be the third time Temasek Holdings has embarked on a securitisation of its PE fund assets: Astrea I (backed by 46 PE funds) was launched in 2006, with a Temasek entity remaining as the single largest investor in the unrated (subordinated) tranches of notes – the rated senior notes have since been successfully redeemed. In 2014, Astrea II notes (backed by investments in 36 PE funds) were launched, with an entity of Temasek Holdings being the single largest investor.
Are the upcoming notes suitable for me?
While the collateralised structure of the upcoming Astrea III notes may not be familiar to many investors, we think that the various note classes may actually appeal to different groups of investors. Having a better understanding of the overall structure is just the first step to discovering the potential opportunities brought about by the upcoming Astrea III issue. In What You Should Know About the Upcoming Astrea III Notes - Part 2, we explore the differences between the various note classes and offer our take on potential pricing.