Your Ultimate Guide to Astrea V (Part 1)

One year after putting its name on the record books by issuing the first retail private equity bonds, the Azalea Group is back with Astrea V. Similar to Astrea IV (spoiler alert: we will be repeating this, a lot), the new collateralized fund obligation (“CFO”) will feature three classes of bonds, with a total expected principal amount of USD600m. The most senior tranche could have an issue size of S$315m, a portion of which will be available for subscription through ATMs for a minimum application amount of S$2,000.

We have already written at length about the CFO asset class, risks pertaining to private equity (“PE”) securitization transactions, and previous Astrea products and their performance. This time round, we will cut to the chase and focus on Astrea V, its key credit features, and its pertinent similarities and differences with Astrea IV.

Part two of this article examines the terms and conditions of the three classes of notes, illustrates Astrea V’s cash-flow waterfall, and describes the results of analytical studies on Astrea V’s capacity to meet its financial commitments. We will also hazard a guess at the coupon rates. Investors who wish to brush up on their understanding of CFOs, PE investments, and the earlier Astrea transactions can refer to the articles below.

Related articles:

• The Astrea III Bonds Today
• Astrea IV: What You Need to Know (Part 1)
• Astrea IV: What You Need to Know (Part 2)
• 5 Things to Know About Astrea IV's Performance in Its 1st Distribution Period

A quick glance of the Astrea products at launch

Having reviewed both Astrea IV and V, we think the two CFOs do share a lot of similarities in terms of their structure, features, and portfolio characteristics. So much so that if we were lazy, we could copy and paste most of the content from our Astrea IV articles (we didn’t) and just change the relevant details.

However, it is important for us to caution that each securitization transaction is unique and should be evaluated by itself in terms of the quality of its securitized assets, structure, and features. That is to say we should not rely wholesale on analogous reference to previous Astrea transactions and their performance. Having said that, for those of you who have invested in Astrea IV and are here just to have a quick idea of what is different about Astrea V, Figure 1 provides a brief comparison of Astrea III, IV, and V.

Figure 1: Comparison of the Astrea CFOs at launch¹

An introduction to Azalea Group and the Astrea platform

For those of you who are hearing the name Azalea or the Astrea platform for the first time, Azalea Investment Management Pte Ltd (“AIM”) is a wholly-owned subsidiary of Azalea Asset Management Pte Ltd ("Azalea"), which is in turn wholly-owned by Temasek Holdings (Private) Limited. Astrea V is a CFO backed by cash flows from a portfolio of PE funds, and managed by AIM. The deal sponsor is Astrea Capital V Pte Ltd, whose parent is Azalea.

Astrea V represents the fifth product from the Azalea Group’s Astrea platform, following the footsteps of its predecessors in 2006, 2014, 2016, and 2018. Investors may be curious as to the motivation behind Azalea launching a new deal just one year after Astrea IV. We raised this question in a recent meeting with management, and were told that Astrea V represents the group’s continuous effort to make private equity accessible to a broader group of investors.

 “The idea is to bring products based on private equity to investors who do not typically have access to them,” says Ms Margaret Lui-Chan, CEO and executive director of Azalea. “Astrea I shows that a securitized product, if structured well, can be a good investment to withstand financial market crisis.”

Ms Lui-Chan also stressed that the Azalea Group has a long-term objective to bring good PE products to retail investors. As PE is a novel concept to many investors here, Azalea is looking to launch an Astrea product every twelve to eighteen months, so as to familiarize investors with the asset class and give comfort to stakeholders and regulators.

“Hopefully one day, we can offer even equity exposure to retail investors,” says Ms Lui-Chan.

The Azalea team is filled with veterans having extensive experience and institutional knowledge in the PE sector. We also like Azalea’s connection with Temasek, which has been investing in PE funds globally for more than two decades. Given their deep experience in private equity and structuring multiple award-winning CFOs similar to Astrea V, we believe Azalea’s management quality provides strong support to the transaction.

Transaction overview

Astrea V is the sole shareholder of two asset-owning companies (“AOC”). The issuer’s portfolio comprises of 38 PE funds, held by AOC I and AOC II in a 36-2 split. We understand that two PE funds were housed under AOC II due to US tax reporting requirements.

The underlying funds will distribute cash to the AOCs as they generate income or sell their investments, and will demand additional capital contributions when they need cash for investments. The AOCs will transfer cash distributions from the funds to Astrea V, which then applies the distributions through its cash-flow waterfall, including principal and interest payments on the bonds.

Astrea V has a capital structure that mirrors Astrea IV, consisting of the class A-1, class A-2, and class B bonds, as well as an equity tranche (see Figure 2). The deal is bigger this round, with USD600m of debt (Astrea IV: USD501m) and a total portfolio net asset value (“NAV”) of USD1.32 billion (Astrea IV: USD1.10 billion) at launch. According to management, they have structured a larger deal in response to the overwhelming investor demand for Astrea III and IV, the latter of which received applications for its retail tranche that are more than seven times the public offering amount of S$121m.

Figure 2: Astrea V’s funding structure

Once again, Azalea (through the sponsor) retains the entire equity stake in Astrea V, which is subordinated to all the notes. The alphabetical order of Astrea V’s bond tranches indicates their seniority and relative safety, with the class A bonds being the most senior class of bonds and carrying the least risk.

All three classes of the Astrea V bonds are expected to receive investment-grade ratings (see Figure 3) and to be listed on the SGX. A portion of the class A-1 notes will be offered to Singapore retail investors.

Figure 3: Astrea V’s expected credit ratings

There are a few things to note about Astrea V’s credit ratings. First, the expected rating of A+ (sf) by S&P on the class A-1 notes is one notch higher than the equivalent class of Astrea IV—rated A (sf). Second, the credit ratings of Fitch and S&P address the likelihood of timely repayment of the bonds at their legal final maturities (June 2029), not the potential earlier redemption at their scheduled call dates (or earlier amortization of the class B notes).

Third, we understand that Fitch and S&P have a rating cap of ‘Asf’ and ‘AA (sf)’ respectively for PE CFOs, primarily because cash flows of PE funds are inherently less predictable, especially in volatile market conditions. This means that the two rating agencies have determined Astrea V’s class A-1 notes to have a credit quality that is at or close to their highest category of creditworthiness for the asset class.

The last point is assuring for investors, especially if we consider the conservative assumptions in the rating agencies’ analysis. For instance, S&P applied a 35% haircut to all future distributions from Astrea V’s Asian PE funds (22.3% of portfolio NAV) in their stress assumptions, to account for any potential mismatch between Asian PE fund performance and the non-Asian fund performance on which their methodology was based.³

Key credit features

PE CFOs come with many risks that are inherent to the PE asset class, which invests in illiquid assets with volatile cash flows. The use of leverage, which is common to many PE funds and their investee companies, magnifies both potential gains and losses. There is also a lack of consistency as well as substantial subjectivity in the NAV calculations of PE fund managers. Azalea seeks to mitigate these risks through the quality of Astrea V’s portfolio and structural safeguards in the deal, as elaborated in the following sections.

Well diversified transaction portfolio

In curating the Astrea V portfolio, the Azalea team has taken the same approach as that for its predecessors, with majority of the NAV in US funds and buyout funds (see Figure 4). In fact, we understand from management that comparing Astrea IV and V (at inception), the two CFOs have roughly 50% of portfolio overlap (in terms of NAV) in their fund investments. Azalea has also been consistent in portfolio diversification, ensuring that no single fund takes up more than 10% of portfolio NAV and no single fund manager or general partner (“GP”) constitutes more than 15%.

As of 31 Mar 19, Astrea V’s portfolio consists of 38 PE funds managed by 32 GPs with 862 underlying investee companies. Similar to Astrea IV, the portfolio is focused on buyout and growth equity strategies⁴, with 81% of the NAV in buyout funds and the remainder in growth equity funds. The management explained that their tilt toward buyout funds is driven by the higher control of GPs over the investee companies, which allows them to move fast during a financial crisis and effect changes (e.g. cut workforce, pivot business model) to increase the chances of survival.

Astrea V’s portfolio is diversified across a number of metrics, including vintage, geography, and sectors, as depicted in Figure 4 and Figure 5. We note that the transaction portfolio has superior single-name diversifications as compared to Astrea IV (at inception), with the largest individual fund investment being 5.4% of NAV in Silver Lake Partners IV (Astrea IV: 9.2% in Blackstone Capital Partners VI), largest GP exposure at 9.0% of NAV to KKR (Astrea IV: 10.6% to Blackstone Capital Partners), and largest investee company at 1.9% of NAV (Astrea IV: 2.6%).

Figure 4: Astrea V’s fund-level diversification (as at 31 Mar 19)

Figure 5: Astrea V’s investee company-level diversification (as at 31 Dec 18)

The diversification of Astrea V’s portfolio of funds is important to mitigate the idiosyncratic risks and volatile cash flows of individual PE funds. Just how important? Consider that based on a study included in Astrea V’s transaction documents (see Figure 6), 16.5% of individual PE funds lost money for their investors, compared to just 4.3% and 1.4% of primary fund of funds (“FoF”) and secondary FoFs respectively.⁵

Figure 6: A diversified portfolio of PE funds carries significantly lower risk of capital loss

In addition to the diversification characteristics described above, Astrea V’s transaction portfolio comprises of mature funds with low unfunded capital commitments totaling USD215m, or 16.2% of NAV. With the youngest fund having a vintage year of 2016, the need to divert cash flows toward the funding of additional capital contributions should be manageable throughout the life of the transaction.

We observe a couple of relative weaknesses in Astrea V’s transaction portfolio when compared to that of its predecessor. First, 14.6% of Astrea V’s NAV is invested in listed companies, which provide higher monetization and cash flow visibility. This is lower than Astrea IV’s 26.2% at launch.

Second, the Astrea V transaction portfolio has a weighted average fund age of 5.4 years, younger than Astrea IV’s seven years. Astrea V’s weighted average investee company holding period is 3.2 years, shorter than Astrea IV’s 4.3 years. Relative to Astrea IV’s more seasoned portfolio of PE funds, Astrea V’s funds may generate lesser cash flow in the first few years of the transaction. On the other hand, Astrea V’s younger transaction portfolio carries higher future value appreciation potential and may generate more cumulative cash flows over their remaining life.

There is another flip side to the second point mentioned above, which benefits the class B bonds. It is worth mentioning that Astrea V is allowed to make distributions to the sponsor while all the bonds are outstanding, as long as it has met the payments higher in the cash-flow waterfall. Therefore, a scenario where Astrea V generates very strong distributions in the first few years of the transaction, but then weakened substantially thereafter, is negative for the class B bonds.

In the scenario just described, total cash distributions may be high in the early years of the deal, but much of these cash flows would flow out of the structure to the sponsor. Investors of the class A bonds are protected from this value “leakage” by the semi-annual scheduled reserve payments, but class B bondholders are exposed to the risk of the remaining NAV being insufficient to pay off the bonds.

Astrea V’s younger portfolio should generate lesser excess distributions—cash remaining after the scheduled reserve payments—in the early years, leaving more distributions for its late years. This provides a better match between the CFO’s distribution patterns and its liabilities, which is credit positive for the class B bonds.

Finally, according to Fitch’s presale report on Astrea V, approximately 53% of Astrea V’s portfolio NAV belongs to funds in the top two performance quartiles. Only four funds, constituting 8% of portfolio NAV, fall in the bottom quartile of fund performance. The rating agency has a favorable view on Astrea V’s low exposure to weaker performing funds, and describes the portfolio as “relatively strong” compared to other CFOs they have rated.

All things considered, we like Astrea V’s portfolio composition and diversification. The well diversified portfolio has an overall quality that is as good as the earlier Astrea transactions, and should provide sufficient distributions to support the bonds over the life of the deal.

Over-collateralization with initial LTV at 45.3%

Astrea V has a conservative capital structure similar to its predecessors. At inception, the Astrea V bonds will constitute about 45.3% of the total portfolio NAV (see Figure 2). In other words, 54.7% of the transaction value sits below the bonds in Astrea V’s capital structure, providing a comfortable cushion against lower-than-expected cash realizations from the portfolio and other negative scenarios.

While Astrea V’s over-collateralized funding structure seems to serve as a rock solid credit enhancement, investors may be skeptical about whether reported fund NAVs are truly representative of what the funds are worth. We understand from management that most transactions (buying or selling of fund interests) on the secondary market take place between 95-105% of NAV. This give us some comfort that the NAVs reported by PE fund managers are a good indicator of the funds’ intrinsic value.

Similar to Astrea IV, the transaction documents stipulate a provision that prohibits the loan-to-value (“LTV”) ratio⁶ from exceeding 50%. The purpose of the LTV test is to ensure there is sufficient equity in the structure, protecting bondholders from the risk of a decline in portfolio value as well as the risk of too much fund distributions exiting the structure.

If Astrea V’s LTV ratio breaches the 50% trigger, it will have to reduce its leverage by diverting cash flows to the reserves accounts and, if necessary, redeem the Class B bonds. Although Astrea V is allowed to make distributions to equity subject to its priority of payments, it can only do so when the LTV ratio is below the 50% threshold.

Scheduled regular reserves

Just like Astrea III and IV, Astrea V features reserves accounts that will be funded on a straight-line basis. The issuer will reserve USD46m for principal repayment of the class A bonds, every six months, until the tenth distribution date (June 2024), when the reserves accounts hit their cap of USD460m—equivalent to the principal amount of the class A bonds—if everything goes according to schedule. On the tenth distribution date in June 2024, which is also the scheduled call date of the class A bonds, if the reserves amount is sufficient and no credit facility loans remain outstanding, Astrea V has to redeem the class A bonds with monies in the reserves accounts.

What if not everything goes as planned? If Astrea V has insufficient cash to satisfy the reserve amount of USD46m on any distribution date, the unpaid balance will carry forward to subsequent distribution dates until it is paid through the priority of payments.

Additionally, as and when the transaction portfolio has returned more than USD406.6m—50% of Astrea V’s total equity of USD813.2m—to the sponsor, the reserve payments will increase by half of the cash sweep to the sponsor thereafter. This sponsor sharing feature is valuable to the class A bondholders as it facilitates faster buildup of reserves for the redemption of the class A bonds.

Credit facility to plug cash flow shortfalls

We highlighted earlier that Astrea V has undrawn capital commitments—the agreed capital a GP can request from Astrea V—of USD215m as of March. The CFO will satisfy capital calls primarily with distributions from its portfolio of funds.

In the event of a failure to meet capital calls, Astrea V may be subject to severe penalties such as loss of its entitlement to distributions or income. To prevent such occurrences, Astrea V has put in place a credit facility (provided by DBS Bank and Standard Chartered Bank) to cover cash flow shortfalls on capital calls. Loans drawn from the credit facility can also be used to pay certain senior expenses (e.g. taxes, operating expenses, hedge payments, and management fees) and interest on the Astrea V bonds.

Astrea V has sized its credit facility to USD238m at the transaction’s inception. The total amount available under the credit facility, which is capped at USD300m, will be the sum of (i) a variable component that will step down from an initial USD130m over time; and (ii) 50% of the unfunded capital commitments. The credit facility terminates on the earlier of ten years from issuance or the date on which all classes of bonds have been fully redeemed.

We note that the relative amount of liquidity available under the credit facility is lower compared to previous Astrea transactions. For instance, Astrea V’s available credit is about 15.4% of its total exposure—portfolio NAV plus undrawn capital commitments—at launch, down from Astrea IV’s 21.2%. Nonetheless, we understand from management that the amount of readily available credit still reflects very conservative estimates of Astrea V’s liquidity needs.

The management’s assessment is consistent with that of Fitch, which said that the credit facility size is sufficient for its projected use and in line with other Fitch-rated PE CFOs. Under the rating agency’s most severe stress scenario, the maximum utilization of the facility was just USD96m, or about 41% of its total capacity.

Hedging

The Astrea V bonds are denominated in SGD (class A-1) and USD (class A-2 and class B), while the cash flows that the AOCs will receive from the fund investments will comprise mainly US dollars and euros. To mitigate this currency mismatch between its assets and liabilities, the issuer will be entering into a series of forward contracts to exchange USD-denominated asset cash flows for S$ and EUR-denominated cash flows for USD. As a result, we think currency risk in the structure is low.

Disposal option

Astrea V’s portfolio of PE fund investments will be essentially “static” through the course of the transaction, as the transaction manager is prohibited from altering the portfolio composition by investing in more funds. Changes in the fund investment schedule will mostly be driven by fund distributions, capital calls, and fair value gains and losses.

The issuer does have limited discretion to sell its fund investments, up to 15% of the initial portfolio NAV. Should Astrea V exercise this disposal option, all net proceeds from the sale of fund investments will be paid into the reserves accounts of the class A bonds (after settlement of higher clauses in the priority of payments). If the class A bonds are already fully reserved, Astrea V will use the sale proceeds to repay class B bondholders.

Although we note that disposal of fund investments has never occurred throughout the Astrea product history, Fitch has deemed this flexibility to dispose as a positive qualitative factor for the transaction. The disposal option allows Astrea V to accelerate monetization of the NAV, if needed, on the secondary market, albeit likely at a steep discount in a stressed environment.

Alignment of interests

Once again, Azalea (through the deal sponsor) will retain the entire equity stake of Astrea V, which constitutes 54.7% of NAV at inception. This serves to facilitate strong alignment of interests between the sponsor and bondholders, as the equity investor is the first in line to absorb losses of the structure and the last person to receive liquidation proceeds in an event of default. We understand that Azalea intends to maintain its equity position through Astrea V’s lifespan, just as it has done for Astrea III and IV.

Find out more about Astrea V

Now that you have a good understanding of Astrea V and its key credit features, hop on to Part 2 of this article to read about the three classes of bonds and our thoughts on pricing.

Endnotes:

¹ Information about Astrea V in this article (both Part 1 and Part 2) reflects the content of its preliminary prospectus dated 22 May 2019. Investors should be aware that the transaction has yet to be finalized and subsequent information may differ.

² In calculating the amount of liquidity available from credit facilities, we have included the sponsor's commitment to fund any shortfall in the operating account's ability to cover capital calls (in the case of Astrea III), and the amount available under a capital call facility (in the case of Astrea IV).

³ S&P actually applied a higher haircut of 45% to the Astrea IV portfolio. The rating agency reduced the haircut to 35% for Astrea V after comparing their data with external performance data on Asian PE funds.

⁴ Buyout strategies generally refer to the purchase of controlling stakes in companies, while growth equity refers to investments in fast-growing companies that are seeking funding for business expansions.

⁵ Primary FoFs invest in a portfolio of PE funds at their inception, while secondary FoFs acquire the interests of limited partners through secondary market purchases. Generally, as compared to primary FoFs, secondary FoFs provide investors with exposure to a significantly more seasoned and diversified portfolio of PE funds.

⁶ LTV is calculated as the aggregate outstanding amount of the Astrea V bonds and credit facility loans (net of the reserves balance) divided by total portfolio NAV.

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 and ASTLC 4.350% 14Jun2028 Corp (SGD) - Class A-1 - Retail. The analyst who produced this report holds a NIL position in the abovementioned securities.