Your Ultimate Guide to Astrea V (Part 2)

After discussing about Astrea V’s key credit features in Part 1 of this article (“Your Ultimate Guide to Astrea V (Part I)”), here we look at the important terms and conditions of the three classes of bonds and illustrate the transaction’s priority of payments. We will also touch on the results of a few simulation studies and cash flow analysis on Astrea V, and provide our guesstimates on the bond pricings.

Summary of Astrea V and the bonds

Figure 1: Astrea V offers three classes of investment-grade bonds

Class A-1 bonds

• Most senior class; rank pari passu with the class A-2 bonds
• Expected ratings of ‘Asf’ and ‘A+ (sf)’ by Fitch and S&P respectively
• No prepayment risk prior to scheduled call date; expected five-year tenor with a ten-year legal final maturity
• Coupon step-up of 1 percentage point (“ppt”) on the fifth anniversary of issuance
• Astrea V will reserve USD46m every six months for principal repayment of the class A bonds

If you are familiar with Astrea IV, you can basically skip this section as we see no practical difference between the terms and conditions of Astrea V’s class A-1 notes and their predecessor. The class A-1 bonds will be denominated in SGD, and sized to be equivalent to USD230m (~S$315m). Fitch and S&P rate the notes at ‘Asf’ and ‘A+ (sf)’ respectively, which represents a strong capacity to satisfy financial obligations.

Astrea V will offer the class A-1 notes across two tranches; a placement tranche to institutional and other investors, and a public offer tranche to retail investors in Singapore. The allocation between the public offer bonds and placement bonds has yet to be decided, but if Astrea IV is anything to go by, we can expect an equal split between the two tranches—i.e. a public offering of approximately S$157.5m.

Together with the A-2s, the class A-1 notes will constitute the most senior class of bonds in Astrea V’s structure. This means that in the event of liquidation, class-A bondholders are paid first before class B bondholders and equity (after settlement of senior expenses and any credit facility loans).

The A-1 notes have a legal final maturity of ten years, with a scheduled call date of five years (same as the class A-2 notes). During the five-year non-call period, Astrea V cannot redeem the class A bonds.

Astrea V will deposit USD46m every six months into reserves accounts for the repayment of the class A bonds. If and after Astrea V meets its performance threshold¹, instead of the sponsor retaining all of the cash flow remaining after payment of expenses and amounts ranking ahead of the sponsor in Astrea V’s priority of payments, the issuer has to allocate 50% of such cash flow to the reserves accounts. This sponsor sharing feature will cease after the scheduled call date.

On the scheduled call date in June 2024, if the total balance in the reserves accounts is sufficient to pay off the class A-1 bonds, the issuer must fully redeem the notes. In the event that the class A bonds remain outstanding after five years, their coupon rate will increase by one ppt per annum.

Finally, if Astrea V meets its performance threshold on or before the scheduled call date, the issuer will pay a bonus redemption premium of up to 0.5% of the principal amount of the class A-1 bonds. The bonus redemption premium is payable to the class A-1 bondholders only upon repayment of the notes.

Class A-2 bonds

• Along with the class A-1 SGD bonds, the USD-denominated class A-2 bonds rank senior to the class B bonds and equity investments, and subordinate to the credit facility
• Expected rating of ‘Asf’ by Fitch
• No prepayment risk prior to scheduled call date; expected five-year tenor with a ten-year legal final maturity
• Coupon step-up of 1 ppt on the fifth anniversary of issuance
• Astrea V will reserve USD46m every six months for principal repayment of the class A bonds
• No bonus payout applicable

Astrea V’s class A-2 bonds are also almost identical to their Astrea IV counterpart, with one notable difference in their redemption mechanisms. In Astrea IV’s case, if monies in the reserves accounts are insufficient to redeem the class A-2 bonds in full on their scheduled call date, all of the A-2 notes would remain outstanding until a later distribution date, when the issuer has accumulated enough funds in the reserves accounts. The issuer will then fully repay the class A-2 bonds.

The same scenario would entail different actions for Astrea V. If after Astrea V redeems the class A-1 bonds in full there are still reserves monies remaining, but which are less than the total principal amount of the class A-2 bonds, the issuer has to use this remaining balance to redeem part of the class A-2 bonds on a pro-rata basis. The remaining outstanding class A-2 bonds are repayable on subsequent distribution dates using available cash flows, in accordance with the priority of payments.

Other than the currency and coupon rate, the class A-1 and A-2 bonds have very few differences between them. Similar to Astrea IV, Astrea V’s bonus payout feature is only applicable to the class A-1 bonds. A second, and more important, difference between the two classes, is their sequence of redemption.

The reserves accounts and scheduled reserve payments are earmarked for both the class A-1 and A-2 bonds, and the two classes have equal claim on the reserves monies in a default scenario. However, if the balance of the reserves accounts is insufficient to redeem both classes of bonds simultaneously on the scheduled call date, the issuer will first use the reserves amount to redeem the A-1 notes, then partially repay the A-2 notes with any remaining reserve funds.

We think under most circumstances (see the section on scenario analysis), this factor is inconsequential as we expect Astrea V to pay off the class A-1 and A-2 bonds at the same time. Nonetheless, should Astrea V’s fund investments perform very poorly due to weak economic conditions, there is a possibility that the class A-1 bonds may be repaid before the class A-2 bonds. Consequently, the A-2 bonds are in effect subordinated to the A-1 bonds on a time factor, although we note that Fitch has deemed the level of credit enhancement sufficient to support rating equalization between the two classes.

Class B bonds

• Subordinated to the class A notes
• USD-denominated; expected rating of ‘BBBsf’ by Fitch
• Legal final maturity: ten years, with no scheduled call date
• Repayment starts after full redemption of the Class A notes; 90% cash flow sweep after application of clause 1 through clause 8 of the priority of payments

At the risk of boring even ourselves with repetition, the class B notes of Astrea IV and V are very much alike. Astrea V’s USD140m class B bonds are subordinated to the class A bonds and have a ten-year legal final maturity. The class B bonds do not have a scheduled call date, and repayment of the bonds will start only after Astrea V has fully paid off class A.

The full redemption of the class A bonds will trigger a 90% cash flow sweep for the repayment of the class B bonds, subject to Astrea V’s priority of payments. This means that the principal payback period of the class B bonds is expected to start on their 5.5-year anniversary, and ends on their full redemption.

There are a couple of potentialities that could accelerate the repayment of the class B bonds. First, Astrea V has the ability to sell its fund investments, up to 15% of the initial portfolio NAV. Should Astrea V exercise this disposal option, it has to pay the disposal proceeds to the reserves accounts. If the reserves accounts have already reached their cap of USD460m, Astrea V will have to apply the disposal option proceeds to principal repayment of the class B bonds instead.

Second, if Astrea V fails its maximum loan-to-value test—the threshold is 50%--it has to deleverage by directing cash distributions (from its fund investments) to the reserves accounts. Again, if the reserves accounts cap is already reached, Astrea V will use its cash flows to pay down the class B bonds, until the maximum LTV ratio is no longer in breach.

The lack of a hard repayment schedule makes it difficult to pin down the maturity of the class B bonds. Nonetheless, we can refer to the results of some simulation studies, described later in this article, for estimates of the time to maturity of the class B bonds.

Priority of payments

Figure 2: Astrea V’s priority of payments

Astrea V’s cash-flow waterfall (see Figure 2) is pretty much the same as Astrea IV’s. The only difference we observe is that Astrea V has thirteen clauses (one fewer than Astrea IV), as it has combined the liquidity facility and capital call facility of its predecessor into one “credit facility”.

After receiving cash distributions from its fund investments, Astrea V will apply those cash semiannually in accordance with its priority of payments. The numbering of the clauses in Figure 2 dictates the payment order, with available cash flowing from clause 1 to clause 13.

To give a simplified description of Figure 2, collateral cash-flow is first applied to senior expenses and payments (e.g. taxes and expenses, hedge payments, management fees), then to interest on the Astrea V bonds. Subsequent to interest payments, Astrea V will pay the reserves amount for the class A bonds (or repay the class B bonds) and apply the maximum LTV test. After satisfying the maximum LTV ratio provision, the issuer will use the remaining cash flow for administrative expenses in excess of the clause 1 cap (USD900,000) and any hedge unwind costs. Finally, the sponsor gets whatever is left after all the aforementioned payments have been made.

Illustrative scenario analysis

Given that Astrea V’s transaction portfolio comprises of 862, mostly privately held, investee companies, we could not hope to assess the collateralized fund obligation’s (“CFO”) credit strength by studying the financials of these investee companies. What we can do instead is to refer to a few analytical studies that examine the ability of Astrea V to meet its obligations under various scenarios of portfolio performance. In this section, we discuss the results of simulation studies conducted by the issuer and Bella Research Group (“Bella”)—both of which are included in Astrea V’s preliminary prospectus—as well as model scenarios of Fitch and S&P.

We won’t get into the technical details, but essentially these studies share a common approach of simulating investment portfolios that mimic Astrea V’s portfolio characteristics, such as the types of funds and the ages of the funds. The researchers than examined how these simulated portfolios performed over different economic cycles and market conditions, and the ability of Astrea V to make timely interest and principal payments under various performance scenarios.

The issuer’s own study (see Figure 3) shows that Astrea V is able to generate sufficient cash flows to repay all the bonds by their legal final maturity of 2029, in all four hypothetical cases examined. Under the most severe downside scenario—in which the issuer simulated a prolonged period of poor market conditions, combined with the lowest quartile of fund performance—the class A-1 bonds were called in year 5.5, while the principal payback period of the class A-2 and class B bonds ranged between 7.0-7.5 years and 9.0-9.5 years respectively.

Figure 3: Hypothetical lives of the Astrea V bonds

Bella’s study shows similar positive results (see Figure 4), as the majority of their simulations saw Astrea V being able to meet the principal repayment obligations of the bonds by their scheduled call date or final maturity date. Their downside scenarios generally show slower time to repayment and higher risk of extension for the class A bonds. Nevertheless, the research consultant concluded that the ability of the simulated portfolios to repay their liabilities by the end of year 10 in the downside scenarios is comparable to their base case scenario.

Figure 4: Percentage of simulated portfolios in which principal repayment obligations are met

Fitch’s cash flow scenario analysis finds that Astrea V’s class A bonds are able to withstand fourth quartile level performance in the underlying funds, while the class B bonds can weather third quartile fund performance scenarios. These results indicate a high resilience to stress in our view, considering that more than half (~53%) of Astrea V’s portfolio comprises of PE funds in the top two performance quartiles. Even assuming the most punitive scenario combined with fourth quartile performance projections, Fitch’s model suggests that Astrea V would be able to redeem the class A-1 and A-2 bonds by 5 and 6.5 years respectively.

Last but not least, S&P’s cash flow modeling simulation shows a default probability of 0.054% for the class A-1 notes. To put this number into perspective, according to S&P, the default probability for a five-year triple-A corporate bond is 0.150%.

Conclusion and bond pricing thoughts

Astrea IV, with its high similarity to Astrea V, provides a good pricing benchmark for the transaction. As of this writing, the ASTLC 4.350% 14JUN2028 CORP (SGD) - CLASS A-1 - RETAIL is indicating at yields of around 3.08%. We think strong retail demand on the exchange contributed to the high prices of the Astrea IV class A-1 notes, which look expensive compared to the over-the-counter traded ASTLC 5.500% 14Jun2028 Corp (USD) - Class A-2 (yield to next call: 4.74%) and ASTLC 6.750% 14Jun2028 Corp (USD) - Class B (5.76%).

As such, we will take reference instead from the pricing of Astrea IV at issuance, which provides a fairer reference point in our view. From that baseline, we will make adjustments for movements in interest rates and credit spreads during the past one year to arrive at our pricing estimates for Astrea V.

Since the issuance of Astrea IV in June 2018, interest rates have dropped substantially (see Figure 5), reflecting the escalating trade tensions between major economies and slowing global growth outlook. Meanwhile, credit spreads in the investment-grade sector have remained largely unchanged.

Adjusting for interest rate and spread movements, we see fair value for the Astrea V class A-1 SGD notes at about 3.8%. Swapped to USD, and incorporating some return premium to account for time subordination of the A-2 notes, we think this should translate to approximately 4.7% for the class A-2 USD notes. Finally, based on the price differentials between the A-2 and B bonds of previous Astrea transactions, and taking into account Astrea V’s younger portfolio (which benefits the class B bonds), we think the Astrea V class B bonds should price at around 5.7%.

Figure 5: Interest rates have moved lower amid political and economic concerns

As the old saying goes, if it ain't broke, don't fix it. This mantra seems to be behind Azalea’s approach in structuring Astrea V, making only minor tweaks to the latest Astrea product such as adding the mandatory partial redemption provision to the class A-2 bonds.

Azalea’s sticking to their tried-and-true formula is certainly understandable in view of the stellar track record of earlier Astrea transactions. Taking Astrea III and IV as examples, Fitch just last month upgraded its ratings on the bonds², saying that the two CFOs have been performing in line with expectations, and significantly better than its stress scenarios.

We should warn here that a slavish devotion to history makes little sense, and an overreliance on perceived similarities can be dangerous, especially in the context of asset-backed securities where each transaction is unique. However, having examined Astrea V in detail, we think the transaction is backed by a mature and well-diversified portfolio of private equity funds. The deal also shares many of the same merits that support the credit quality of previous Astrea transactions, particularly the strong alignment of interests between Azalea and bondholders. Should Astrea V be priced at or above our fair value estimates, we would think the bonds are a good investment alternative that serves unique diversification benefits and attractive return premiums over corporate bonds of the same rating tier.

¹ The performance threshold is met when the sponsor receives USD407m—being the amount equal to 50% of the issuer’s total equity of USD813m—prior to the class A scheduled call date.

² Fitch raised the ratings on Astrea III’s class A-2 and B bonds to ‘A+sf’ (from ‘Asf’) and ‘BBB+sf’ (from ‘BBBsf’) respectively. The rating agency also upgraded the rating on Astrea IV’s class A-1 bonds to ‘A+sf’ (from ‘Asf’).

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.