Astrea 8 bonds: Riding on strong track record and improving PE landscape

ASTREA 8, the latest offering of private equity-backed bonds by Azalea Investment Management, has quite a few things going for it.

There is the evergreen appetite for yield among Singapore savers, and an improving environment for private equity (PE) as an asset class, which bodes well for the bond’s coupon and principal repayment.

But I would argue the biggest plus is the track record Azalea has set in its previous issuances.

We know the standard caveat by heart: The past isn’t an indication of the future. Yet in the case of the Astrea series, there is a lot to be said for the sponsor’s parentage; the structural safeguards in each issuance; and the fact that the intent of the bond issuance isn’t to acquire leverage, but to broaden PE access among retail investors in a risk-controlled manner.

This means the interests of holders of these retail bonds – in this case, Class A-1 bonds with a mandatory call feature at the end of five years, and Class A-2 bonds with one at the end of six years – take precedence over the interests of equity holders. All the equity is held by Azalea 8, the sponsor.

As for the priority of interest and the ability to repay bond obligations, almost nothing is left to chance, thanks to the bond structure. Fitch has issued a tentative rating of “A+sf” for Class A-1 bonds and “Asf” for Class A-2 bonds.

The issuer, Astrea 8, is part of Azalea Asset Management, which in turn is part of the Temasek group.

For those who may be unfamiliar, the Astrea series comprises bonds collateralised by a portfolio of PE funds. As a bond investor, you receive regular coupons and the return of your capital on maturity.

Cash flows from the underlying PE funds are used to fund coupon payouts. But there is no capital upside of the sort that you would typically expect from direct investments in PE funds.

Here are the relevant details for the latest issuance: Retail investors may apply for Class A-1 bonds with an annual coupon rate of 4.35 per cent in Singapore dollars, or Class A-2 bonds in US dollars with a coupon rate of 6.35 per cent. Applications close at noon on Jul 17. Trading on the Singapore Exchange will begin on Jul 22.

Astrea 8’s total issuance size is U$$585 million. The retail offer comprises S$260 million of Class A-1 bonds and US$50 million of Class A-2 bonds.

The coupon rate was determined through a competitive bookbuilding process for institutions, which were invited to submit bids. The rates set by the institutions are the same rates for the retail tranches. As for asset coverage, the portfolio net asset value (NAV) of about US$1.5 billion is 2.5 times the bond issuance.

Bondsupermart analyst Wong Di Ming said Astrea 8’s Class A-1 bonds appear more attractive than most other investment-grade (IG) corporate bonds, “especially with most IG non-financial Singdollar debt offering below 4 per cent yield levels”.

He added: “Interest payments and principal repayments will come from the cash flow of the PE portfolio, which is considerably different from the revenue and profits of individual companies. While we do like the Astrea 8 issuance, investors will need to be aware of the risks arising from the PE portfolio and monitor Astrea 8’s performance regularly.”

Here are some things to note.

Priority of payments

Like the previous series, Astrea 8’s cash flows have a prescribed sequence of priorities. The first payment goes to “senior” expenses such as payments to the fund auditor and administrator.

This is followed by interest for classes A-1 and A-2, then payments to the reserve account, which ensures sufficient funds for the future repayment of the principal.

Payments to equity holders are last in line. If the loan-to-value (LTV) ratio exceeds the cap of 40 per cent, payments must go to the reserve account first, in order to reduce this ratio.

Strong track record

In earlier issuances, structural safeguards have resulted in a steady reduction of the LTV. All issuances, from Astrea III to Astrea 7, have had rating upgrades from Fitch, which are testament to credit quality.

All issuances have a credit facility which can be drawn upon for certain expenses, including capital calls. To date, none of the issuances have had to draw upon the credit facility.

Resilience in Covid-19 crisis

It’s worth noting that when the pandemic hit in 2020, business and divestment activities came to a halt, raising uncertainty over the underlying PE funds’ cash flows. While cash flows were sufficient for distributions by Astrea IV and V, the sponsor took the extra step of waiving distributions to itself in order to accelerate payments into the reserve account.

All classes of Astrea IV bonds have since been fully redeemed as scheduled. For Astrea V, Class-A bonds were fully redeemed in June.

Historically, portfolio cash distributions were in excess of the initial portfolios’ NAV.

In its analysis of Astrea 8, Fitch said: “Previously, the sponsor took voluntary actions beyond what was required by transaction documentation of certain other Astrea deals to support senior bonds during periods of market volatility. While Fitch does not rely on such support in its analytical assumptions, it is viewed as a positive.”

Brightening outlook for PE

Astrea portfolios’ greatest PE exposure is to the buyout strategy, which has historically outperformed the S&P 500. PE assets, however, suffered between 2022 and 2023, when aggressive rate hikes caused a steep decline in the stock and bond markets.

But conditions have since reversed. As Azalea chief investment officer Chue En Yaw said: “From (July 2023) onwards, the stock markets recovered. That increased divestment activities and generated a lot of distributions back to the portfolio. The financing market also came back; credit funds are willing to lend. You now see more M&A activities… All that benefits the Astrea portfolios.”

Some differences in features

Those who are repeat investors in Astrea issuances will note some differences in the Astrea 8 offering.

There are now only Class A-1 and A-2 bonds; earlier issuances had more subordinated offerings such as Class B. The absence of Class B in this round is understood to be part of efforts to “streamline” the offering.

Astrea 8’s maturity is now 15 years, unlike earlier offerings at 10 years. This is to facilitate comparisons with other PE-backed bonds in the market that mostly have 15-year maturities, “and better demonstrate the relative quality of the Astrea 8”, said the prospectus.

There is still a step-up interest rate of 1 per cent per annum if the bonds are not called as scheduled. But for Class A-1, there is no 0.5 per cent bonus interest component to be paid when the principal is redeemed. Astrea V and VI had this bonus interest, but not Astrea 7.

Chue said the bonus interest was part of market development efforts then. “We put the feature as we (had) hoped to create enough interest (among retail investors) to better understand our issuance and performance.”

Investors in the US dollar Class A-2 bonds receive a higher coupon of 6.35 per cent. But they should note that even though classes A-1 and A-2 rank equally in the capital structure in the event of a default, A-2 bonds have a longer tenor of six years. There is also time subordination relative to A-1 bonds, which would be redeemed ahead of A-2 bonds.

Curating PE funds

One of the biggest challenges in PE investments – as well as other private market assets – is that due diligence and choice of fund manager are key to returns. As Astrea 8’s prospectus pointed out, for buyout funds between the vintage years of 2008 and 2023, there was a difference of 14 per cent between upper and lower quartile funds in terms of the internal rate of return.

This is where Azalea’s Temasek parentage matters. Temasek itself is a seasoned PE investor, and its clout gives it access to coveted high-performing fund managers.

Said Chue: “We’re very fortunate that we are able to curate portfolios from Temasek… As in all things, quality matters and helps you tide through the weaker, more tumultuous times.”

All Astrea portfolios are backed by mature PE funds, which are more cash-generative. The weighted average age of the Astrea 8 portfolio is 6.1 years. The greater exposures are to the older vintages between 2015 and 2018. This suggests that most funds are already in the process of divestment.