Astrea IV PE-backed bonds: Looking after retail investors' interests

Singapore

PRIVATE equity, which invests in private companies, is typically classed as a high-risk investment - for good reasons. It is illiquid, requires a high minimum investment, and the risk of picking a poor-performing manager is high.

Retail investors are usually unable to invest in private equity, not only due to regulations but also because the best managers shun retail monies.

Hence Astrea IV, which structured a portfolio of PE funds into a retail bond, is truly innovative in many respects. First, PE funds typically do not pay an income, but the retail tranche (Class A-1 bonds) will pay 4.35 per cent per annum over a period of five years.

There is a bonus interest of 0.5 per cent if the sponsor - Astrea Capital IV - receives 50 per cent of its equity investment of US$313 million on or before the scheduled call date. If the issuer is unable to redeem the bonds in full on the scheduled call date, a "step-up'' interest of 1 per cent per annum will apply.

Two, the bonds will be listed on the stock exchange, which provides an avenue for investors to trade. And, the structure offers robust safeguards designed to ensure that for A-1 bonds in particular, investors should receive coupons and principal as scheduled.

Astrea IV is the fourth in a series of PE-backed securities by Temasek-linked Azalea group. The public offer for S$121 million of A-1 bonds will close on June 12. Retail investors may subscribe via ATM with a S$2000 minimum.

Investors hungry for yield will find the annual coupon of 4.35 per cent attractive. It exceeds the CPF Special Account rate of 4 per cent, and deposit rates remain paltry. The latest Singapore Savings Bond pays an average interest of 2.63 per cent a year if held for 10 years. The A-1 bonds are expected to be rated A by Fitch and S&P.

Clifford Lee, DBS Bank head of fixed income, says a good starting point to suss out value is to compare the yield with other A-rated Singapore dollar paper. In this respect, a coupon rate of 4.35 per cent is rare, he says. The average yield of five-year A-rated Singapore bonds is about 3.1 per cent, and 3.65 per cent for 10-year bonds.

"Investors will also have to assess the risk and return of this bond themselves and compare it to the other investments they have at hand, and consider how this bond stacks up,'' he said. He cautions, however, that as the instrument is new, it may take some time for a secondary market in PE-backed bonds to develop.

Samuel Chan, Standard Chartered Bank capital markets head, says a key comparison for an indication of fair value may be Azalea's outstanding Astrea III Class A-1 bonds. These are trading at 3.5 per cent and have a scheduled maturity in July 2019. This, he said, implies that "the 85bps pick-up for four years of tenor extension is fair, but at the same time attractive for bond investors''. He expects strong interest among retail investors for the new issue.

Azalea III's A-1 bonds were launched in 2016 with a coupon of 3.9 per cent.

How much confidence can investors have that they will receive their coupons and principal as indicated? There is after all no guarantee.

There are, however, a number of factors that should boost confidence. One is that the portfolio comprises 36 fairly mature funds, with a weighted average age of seven years. This suggests that a number of the underlying funds are already making distributions.

A second factor is the safeguards within the bond structure, which have several components. One is a reserve account, which requires cash to be set aside to redeem the bonds.

There is also a liquidity facility to fund expenses including unpaid accrued interest on the bonds. There is a capital call facility should there be insufficient cash to fund capital calls. The structure is over-collateralised with a loan-to-value ratio at 45.6 per cent.

The track record of Astrea III is reassuring. For the fiscal year ended in March 2018, Astrea III reported strong distributions by its underlying funds of US$415 million. The portfolio NAV stood at US$904 million at end-March after net distributions. Compared to March 2016, total portfolio returns have increased 28.7 per cent.

Based on the FY17/18 annual report, the reserve account held US$224 million. Last year Astrea III A-1 notes were upgraded by Fitch and S&P to A+. Fitch cited Astrea III's well-diversified portfolio, over-collateralisation, ability to pass loan-to-value tests and the close alignment of interest between the sponsor and noteholders. S&P deemed that Astrea III's reserve account balance of over US$180 million at the time should be sufficient to fully repay A-1 notes.

But what if there is a dire crisis? In 2008, PE funds weathered a "drought'', as public markets tanked and PE funds were unable to exit investments via initial public offers. The first Astrea series launched in 2006 was a securitised portfolio of 46 PE funds. Astrea I was understood to have fared well through the crisis, despite the drought. Principal was repaid. Said Margaret Lui, Azalea Investment Management chief executive: "It goes back to the underlying portfolio assembled at that time; it was high quality and the structure was robust.''

It is understood that Astrea IV's liquidity facility is able to help the structure withstand a dry spell of three years.

For Astrea IV, the issuer has also run simulations of a hypothetical portfolio through four scenarios, three of which incorporate "severe downside'' conditions. The vast majority of the simulated portfolios generated sufficient cash flows to meet principal repayment by the scheduled call date and by the maturity date. Of course, this exercise was theoretical and used historical data. As the prospectus says, "future conditions may differ in ways that would have a meaningful impact''.

In the bad days of the 2008 crisis, structured debt justifiably earned a bad name. Few would forget Lehman Minibonds where so-called bondholders were actually the unwitting parties in a credit default swap and were left holding the bag when Lehman failed.

Astrea IV thankfully isn't a synthetic structure built on air. It isn't guaranteed. But it has taken pains to look after the interests of retail investors. Most would wish the issue size was larger.