News Analysis
CLOs
CLO trends ring alarm bells
Ever loosening loan documentation and manager drift are giving CLO investors pause for thought, particularly those higher in the structure. While certain managers may be benefiting now, there are worries that those pursuing a less conservative strategy may fall short when the credit cycle turns.
Michael Schewitz, co-portfolio manager of credit trading and investment at Investec, suggests that the trend of looser loan documentation is overall not a positive for the sector. However, he points out that this can depend on where you invest in the capital stack and that exceptions can be made depending on the experience and track record of the CLO manager.
“Generally I would disagree with the concept that loosening constraints might be a good thing but it can depend on where you are investing. If you are investing in equity you want flexibility in the documentation,” he says.
Schewitz continues: “Higher up the capital stack, such as in triple-A, you want stability and to get your money back. Triple-A investors do not want uncertainty.”
Greg Branch, partner and cio at SCIO Capital, says that while loosening loan covenants might be concerning, it is typical to see higher loan covenants at the start of a credit cycle, easing off towards the end. He says: “My view has always been that you look at the underlying quality of the credit. As such I would always take a strong credit with few covenants over a weak credit with lots of covenants.”
In fact, the impact of a turn in the credit cycle - which Branch thinks is looking more and more likely - concerns him more than trends in loan documentation. “During a period of growth, certain CLO managers have been willing to strap on risk, run the beta and are being rewarded for doing so. However, I do think when the cycle turns these managers will be exposed. In the past, managers that took a more prudent and conservative stance have tended to fare better during downturns,” he says.
Concurrently, there is a trend of managers shifting investment strategy to less familiar ground. Particularly alarming, for example, is where managers which are well-versed in broadly syndicated loans start moving into the middle market space.
Schewitz comments: “One of the concerns with this issue is that of the manager. For larger managers like Cerberus or Golub, they have the knowledge and expertise to work through middle market loans, but ultimately if they need to, they will take the keys when the time comes.”
He continues: “For a smaller manager, they may not have the expertise or infrastructure to take the keys. I think smaller broadly-syndicated loan managers moving into the middle market space … is a big concern.”
In line with this, Branch adds that there is sometimes a tendency for CLO managers to think that success in one area will bring the same in another. He suggests that it may often be better “to stick to your knitting” and develop expertise in one area and so form a competitive advantage.
Schewitz also highlights another trend wherein CLO structures are tipping in favour of equity investors, particularly in terms of influence and optionality. He suggests that debt investors are not adequately pricing this in and that this is at odds with other asset classes.
He says: “For example, you might get less nominal return on a non-conforming RMBS triple- or double-A but this is not necessarily a worse deal, because if you have purchased it a discount, there is not the threat of getting taken out of your position prematurely in two years, as there is a with a CLO position which, in the current market, is invariably bought very close to par.”
S&P has also recognised this trend and says it has observed a shift in the market dynamics between CLO senior noteholders and equity holders. The agency says that this is demonstrated in recent new issue CLO indentures which show that senior investors have been “trying to hold the line against changes in document provisions that they view in a negative light”.
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News Analysis
NPLs
NPL recovery boost expected
Greek systemic banks are teaming up to create a platform that will manage and settle mortgage and retail non-performing loans to borrowers who have filed for protection under a much-abused law providing favourable restructuring terms (SCI 8 December 2016). Greek lenders have used this procedure for corporate loans, but not for mortgages, consumer and SME loans.
The arrangement is expected to improve Greek NPL recoveries. The “Katselis law” allows a borrower, during the interim period from application to final court hearing, to pay each month only 10% of their original instalment.
“It can take up to 10 years to reach a legal decision. We hope for an enhancement of the law, by having debtors that do not meet the monthly payments that the court has ordered automatically exempted from the protection of the law,” says one Greek bank source.
The law has been abused in a number of ways. For instance, although it is not applicable to commercial debt, these borrowers can apply to the courts and avoid a restructuring solution.
This is why joint arrangements are important. Since 4Q17, Greek banks have been approaching borrowers with pending court cases to offer them favourable terms in an effort to escape the courts.
The same source notes: “The goal is to offer protection only to those borrowers who fall under the protection of the law, using eligibility criteria that will be cross-referenced with the provisions of the law.”
The collective approach becomes necessary given the fact that the majority of borrowers have loans with more than one bank. “If you do not approach them collectively, the likelihood of recovery success becomes low,” observes the source.
The arrangement has been used in the past but irregularly. George Kofinakos, md at Stormharbour notes: “It happens sporadically for big corporate loans but the ECB and bank balance sheets are forcing them into collective ventures.”
He continues: “It offers a quick solution, particularly for mortgages. For the latter, banks are faced with a situation where the collateral does not cover the value of the loan. By writing off the value of the loan down to the value of the collateral, they can then take the latter and auction it on electronic platforms.”
However, there are caveats. He continues: “It would involve restructuring or transfer of assets to banks but it is not an easy solution. Greek banks, as with Italian banks, are not flexible, since until now they have not really considered the mass solutions that their UK and Irish counterparts have. We will have to wait and see how this goes.”
According to official data, the percentage of non-performing exposure (NPE) debtors that have applied for legal protection remains significant. On aggregate, 13.9% of NPE debtors have applied for legal protection, with the highest level of protection observed in the mortgage portfolio, where the percentage exceeds 30%.
The same data show total NPE volumes of €93.6bn, which is broken down into mortgages (€27.5bn), business loans including both corporates and SMEs (€55.8bn), and consumer loans (€10.4bn). The reduction of NPEs over the past quarter was the highest quarterly reduction since the beginning of the crisis.
Compared to March 2016, when the stock of NPEs reached its peak, the reduction is 12% or €13bn. NPE reductions over the past quarter are driven by write-offs which amounted to €2.1bn and sales which amounted to €1.8bn.
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News Analysis
CLOs
Widespread risk retention sell-off unlikely
After the recent repeal of risk retention for open-market CLO managers in the US, a widespread sell-off of risk retention capital is thought to be unlikely as managers will still keep some skin in the game. Furthermore, while there is agreement that the repeal has lowered barriers to entry, opinion is divided as to whether it will lead to an influx of new CLO managers.
“I do not think there will be a widespread trend of managers selling their risk retention pieces. Perhaps managers who are capital constrained will feel compelled to sell, but generally people will be economically rational, particularly given the widening markets,” says Joyce DeLucca, portfolio manager in the US for Hayfin Capital Management’s high-yield and syndicated loans strategy.
DeLucca adds that some compliant CLOs will have incorporated risk retention into the documentation and, along with structural restrictions, it cannot be easily sold off. She also suggests that the underlying investment thesis for capital in CLO equity will still hold after the ruling and so it will still make sense to keep the holdings.
David Quirolo, partner at Cadwalader, also highlights the fact that several managers have a lot of stored capital as a result of risk retention allowing them to take equity positions in their CLOs, or they may maintain it to optimise warehouse facilities.
DeLucca seconds this point and adds that the rollback of risk retention provides CLO managers a degree of flexibility in that it allows them to access this capital more opportunistically than before the repeal.
In terms of the impact on supply, DeLucca thinks that there is a “very real” impact whereby there are a number of deals coming to market to reset or refi that might not otherwise have been done. She adds: “This should dissipate as we move through the heavy April and July payment dates, and many deals are building in flexibility to reset or refi on any business day rather than only on a payment date.”
In terms of the management landscape, Quirolo suggests that the ruling lowers the barriers for entry, which could bring new players and greater diversification into the market. DeLucca is less bullish however and says that, while there may be new entrants, it is unlikely to be overwhelming.
DeLucca says: “Small managers without balance sheet or some other capital source will still face an uphill climb. The reversal of risk retention is only part of the story and does not change the larger trend toward size and scale.”
“Without access to capital,” DeLucca continues, “managers remain subject to the cost of the marginal dollar which generally puts pressure on management fees. That is a much tougher business model in a market that has evolved towards the institutional player, and all of the infrastructure requirements that entails. A capital constrained manager is simply at a competitive disadvantage on so many fronts.”
Despite the ruling, it seems likely that managers will maintain some risk retention capital as it puts them in a stronger position relative to other managers and Quirolo adds that, while true, it will not be to the same extent as the previous 5% requirement. This is a sentiment echoed by DeLucca, who adds that where managers maintain involvement it will likely be in the equity and mezz tranches.
On the investment front, European firms will be negatively impacted by the much smaller number of US CLOs that they can invest in, as they will not meet EU risk retention rules. Additionally, the number of dual-complaint CLOs being issued will see a drop-off, although Quirolo suggests that “if you look to the issuance landscape when European risk retention was in place but did not apply to the US, US managers still issued some European compliant CLOs”.
He continues: “They will therefore most likely continue to issue some deals that meet European risk retention rules, should the economics makes sense. The number of such deals issued may shrink, however.”
DeLucca adds a positive slant on the diminishment of dual-compliant CLOs and the shrinking investable universe for European investors, suggesting it could be a technical positive for euro liability spreads. Additionally, she concludes that US managers will still consider issuing European-compliant transactions and that it could be a differentiator for US managers in terms of appealing to European firms looking to invest in the US dollar market.
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News
Structured Finance
SCI Start the Week - 30 April
A look at the major activity in structured finance over the past seven days.
Upcoming event
SCI NPL Securitisation Seminar – 9 May, London
SCI’s NPL Securitisation Seminar provides an opportunity for investors and issuers to come together to add depth to discussions around European non-performing loan activity, the regulatory treatment of NPL securitisations and the benefits of this technology as an exit mechanism. Panels cover deal structuring, servicing, regulations, investment trends and rating considerations. Click here for more information.
Pipeline
ABS were dominant this week although a number of CMBS and RMBS also hit the pipeline, along with a single CRE CLO.
The ABS in the pipeline at the start of the week are: US$212.6m ACC Trust 2018-1, C$590m BMW Canada Auto Trust 2018-1, US$824m DLL 2018-1, US$36.7m MSRP 2018-SC1, $635.66m PSNH Funding 3, £206.6m SBOLT 2018-1, US$248.2m STEAM 2018-1. CMBS include: US$782.7m Ashford Hospitality Trust 2018-ASHF, US$510.5m BX Trust 2018-GW, US$500m DBWF 2018-AMXP Mortgage Trust, US$579.8m WFCM 2018-C44 and the one CRE CLO is US$826.6m GPMT 2018-FL1. Following that, the RMBS in the pipeline are: US$1.245bn Arroyo Mortgage Trust 2018-1, US$1.2.bn CAS 2018-C03, US$380m CIM Trust 2018-J1, US$736.5m JP Morgan Mortgage Trust 2018-4, US$425.956m New Residential Mortgage Loan Trust 2018-2.
Pricings
ABS made up the bulk of pricings last week with RMBS not far behind.
The ABS that priced were: €379m A-Best 13 (Re-offer), US$400m AESOP Funding 2018-1, US$1.1bn Ally Auto Receivables Trust 2018-2, €1.075bn Bavarian Sky German Auto Loans 8, US$379.6m CLI Funding VI series 2018-1, C$390m CNH Capital Canada Receivables Trust Series 2018-1, C$785m Fair Hydro Trust Series 2018-2, €395.7m Golden Bar Securitisation, US$340.47m GoodGreen 2018-1, $482m Hertz Fleet Lease Funding Series 2018-1, €1bn IM BCC Cajamar PYME 2, US$278.15m Laurel Road Prime Student Loan Trust 2018-B, $610.5m MAPS 2018-1, C$532m MBARC Credit Canada 2018-A, US$379.60m Seacube Container 2018-1, US$500m Securitized Term Auto Receivables Trust 2018-1.
The RMBS that priced were: A$1.25bn Apollo Series Trust 2018-1, US$704.07m Flagstar Mortgage Trust 2018-2, A$687.4m Liberty Series 2018-1 Trust, US$381.65m Mill City Mortgage Loan Trust 2018-1, A$141.9m MTG Ariera Trust Repo Series 1, US$450m PMT Issuer Trust - FMSR Series 2018-FT1, $380.09m Sequoia Mortgage Trust 2018-5, £308.7m Tower Bridge Funding No. 2. A single CMBS also priced: US$688.2m BANK 2018-1 BNK11.
Editor’s picks
SRT features incorporated: The EIF has granted BBVA a €90m guarantee on a mezzanine tranche of a €1.95bn portfolio which will enable the provision of up to €600m financing of new investment projects to Spanish SMEs. The transaction incorporates structural features from the EBA’s significant risk transfer discussion paper and is part of a wave of agreements supporting SMEs across Europe.
CRT issuance boost expected: Total capital relief trade issuance this year should exceed 2017, believes alternative asset manager PAG Asia, one of the sector’s major investors. Issuance is expected to be accelerated by an end to accommodative central bank monetary policies, underlining the importance of investing experience and expertise.
Regulatory news
The European Commission has launched a consultation on its proposed new risk-sensitive treatment of securitisations under Solvency 2. The proposal – which seeks to harmonise existing legislation with the STS framework - has been welcomed for its potential to attract insurers back into the ABS market.
News
Capital Relief Trades
Risk transfer round-up - 4 May
The Royal Bank of Scotland is rumoured to be marketing a commercial real estate transaction dubbed “project Dragonstone”. The deal is expected to close in the summer when overall issuance is expected to pick up.
The market is undergoing a quiet period, following some unusual activity for 1Q18. Sources point to three transactions during this period from Deutsche Bank, Credit Suisse and a “UK bank with a non-standard portfolio” (SCI 20 April).
Among other trades rumoured to be in the pipeline is an SME transaction by one of the large Spanish banks.
The Structured Credit Interview
ABS
Investor-led start-up targets capital market niches
Travis Miller, co-founder and joint md of iPartners, answers SCI’s questions
Q: How did iPartners become involved in the market?
A: We were observing a broad range of fintech firms launching with a technology and product focus which struck us as a “build it and they will come” approach; it was not obvious that any were investor focused.
The driver for launching iPartners was to give a broader universe of investors access to direct alternative investment opportunities on an aligned basis. Our approach is first to consider whether we would personally invest, who are our investment partners and where is the market undersupplied, then back-solving for technology and product given investor requirements. It is never the other way around.
Q: What are the key areas that you are focusing on in the near to medium term?
A: We are focused on three key business areas: boutique direct property across various levels of the capital structure, market exposure through derivatives and emerging/niche asset-backed exposures.
If it is a mainstream asset for large institutions it is typically not on our radar due to the ease of access from incumbents and/or saturation of product providers.
Q: How does your firm set itself apart from your competitors and traditional lenders?
A: The main difference is that we are not focused on lending, we are focused on the provision of good investment opportunities and structuring of investment products in favour of our investors. Those sourcing capital are typically comfortable with our approach, as through overlaying our views on what is driving investors they are more likely to obtain their funding objectives and obtain a more loyal repeat funder.
Q: What challenges do you see your firm facing in the next 12 months? Are these the same for all new lenders in the sector or are they specific to a non-bank/fintech firm, and how do you hope to meet them?
A: Being a nimble start-up business we like challenges as they bring opportunities.
One of the more immediate challenges is the education of investors on the merits of investing in different styles of credit opportunity; in non-scale, non-brand name asset-backed businesses for example. In this case the challenge was to highlight the power of ring-fencing the start-up operating business away from security taken for investors over the actual assets.
Q: What opportunities do you hope will open up for your firm in the next 12 months?
A: We see some opportunities in alternative property strategies, such as positive cash flow land banking opportunities on Sydney’s growing suburban footprint. These could be funded over time via rural tourism/agriculture based businesses centred around a long term buy/hold strategy.
Creating a scalable method for investors to access traditionally non-scale asset backed securitisations in new asset classes and/or new start-up providers.
Q: What motivated you to move into asset classes such as student loans to parents and do you envisage yourself as fulfilling a niche role that traditional firms in Australia do not fill? Do you intend to open up to more asset classes?
A: We specifically went after the student loan opportunity as the loans were not like the more traditional US student loan cohort. The underlying loans are to the parents of private school students, so there is no exposure to the actual student. We saw the underlying credit as a high-quality credit and a way to deliver an attractive risk/return profile for our investors and in turn solve a funding gap for an emerging education lender.
Q: What motivated you to tap the securitisation market for the student loan transaction and do you intend to utilise securitisation across a broader range of asset classes?
A: iPartners has a broad database of investors with different risk/return objectives. After establishing that we liked the underlying credit, a tranched offer was a logical way to offer an outcome to suit different types of investors. We built a scalable template for future deals and while the opportunity exists to create attractive risk/return outcomes, these types of transaction will remain a core focus of the business.
Q: What is your growth strategy looking ahead? Do you hope to remain in Australia, for example?
A: Our business and growth strategy is focused on scalability, whether it is the technology, documentation or operations, as this gives us a distinct competitive advantage over the larger traditional incumbents. We are in a position to be able to do a capital raise of A$5m or A$500m largely without leaking the economics for the investor due to the low cost structure of transaction execution.
We expect organic growth from an increased allocation to alternatives investments, combined with iPartners providing investment opportunities that the investors historically have found difficult to source. Short term the focus is on Australia, although as the primary enabler of the business is technology, transferring to other regions over time is expected to be a relatively seamless transition.
- iPartners recently launched its debut securitisation comprising loans to the parents of private school children. It was a private, unrated deal with a two tranche structure with a junior tranche paying 12% and a senior tranche paying 7%.
- iPartners was the arranger, originator and structurer on the deal, while investors were mainly HNWs, family offices and small funds. iPartners is a fintech firm offering direct alternative investments, with three core business lines: property, markets and ABS.
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Market Moves
Structured Finance
Market moves - 4 May
Acquisitions
Five Oaks Investment Corporation has acquired 100% of the equity interests of Hunt CMT Equity from hunt Mortgage Group for US$68m. Assets of Hunt CMT Equity include the junior retained notes and preferred shares of a commercial real estate CLO, a licensed commercial mortgage lender and eight loan participations. The assets of the CLO consist of performing transitional floating rate commercial mortgage loans with a portfolio balance of US$346.3m, collateralized by a diverse mix of property types, including multifamily, retail, office, mixed-use, industrial and student housing.
Bank of Montreal is to acquire KGS-Alpha Capital Markets, a New York-based fixed-income broker specialising in US mortgage and asset-backed securities. The transaction is subject to receipt of the required regulatory approvals and is expected to close in BMO’s fourth fiscal quarter. On closing, KGS-Alpha will be rebranded as BMO Capital Markets. The KGS management team, sales and trading professionals will become part of BMO Capital Markets' trading products group led by Kelsey Gunderson. Corporate support area professionals will report to their respective areas within BMO. The acquisition complements BMO Capital Markets' existing MBS trading business and immediately makes BMO a top tier dealer in securitised products with special emphasis on agency-backed residential and commercial MBS products.
Europe
Intertrust, Jersey, has made three senior promotions across capital markets, real estate and private wealth. In capital markets, Cheryl Heslop has been promoted to associate director and has 17 years’ experience in capital markets and structured finance. Heslop currently sits on a number of boards, mostly for SPVs across multiple jurisdictions, as well as managing a team of administrators. Will Turner has been promoted to client director in the real estate team, while Lucy Blampied has been promoted to client director in private wealth.
Fund close
Alcentra has completed the final close for Clareant Structured Credit Opportunities Fund III at US$513m, as compared to a fundraising target of US$300m. This fundraising brings assets under management for Alcentra’s structured credit platform to over US$4.5bn across a combination of open and closed end funds and separately managed accounts, and firm AUM to US$37.4bn. The fund’s objective is to generate attractive absolute and risk-adjusted returns through opportunistic investing in structured credit debt and equity securities in the US and Europe. The Fund’s investors include leading sovereign wealth, public, and corporate pension funds from Asia, Europe, the US and the Middle East.
Fund employs SF strategy
Ranger Direct Lending (RDL) has appointed Ares as its new manager after the departure of Oaktree. Under Ares’ proposal, RDL’s investments will now consist primarily of private, asset-backed loans sourced and structured by Ares. The portfolio would continue to have a significant majority of its assets in US$ denominated and US based loans, but there would also be some exposure to Canadian and Eurozone loans. Keith Ashton and Jeffrey Kramer, each a partner and co-Head of structured credit, would serve as the designated portfolio managers for RDL.
Litigation
Four former Wilmington Trust executives have been found guilty by a federal jury in Wilmington, Delaware of concealing from regulators the amount of troubled loans on the bank’s books after the financial crisis. The four executives are the former executives are president Robert Harra, cfo David Gibson, controller Kevyn Rakowski and cco William North and were found guilty by a jury on all counts faced including securities fraud, conspiracy and making false statements to federal regulators. A date has not yet been set for sentencing.
Former Jeffries’ trader Jesse Litvak’s conviction for RMBS fraud (SCI 28 April) has been overturned by the US Second Circuit Court of Appeals in Manhattan. The court stated that the district court that previously found Litvak guilty for allowing the use of certain evidence that should have been inadmissible. More specifically the “the district court materially erred in admitting evidence that 5 the counterparty representative in the sole transaction underlying the count of 6 conviction mistakenly believed that appellant was his agent.”
North America
Dechert has hired Matthew Hays to its global finance practice as partner, based in Chicago. Hays was previously a partner at Kirkland & Ellis and he has experience across a range of structured finance activities.
Portfolio acquisition
Highbrook has completed an acquisition of the Mesdag Delta portfolio. HighBrook secured the transaction on an off-market basis through partnering with the existing owner Breevast to structure a portfolio recapitalisation. The deal was structured and closed within approximately 30 days. As a result of the transaction, Breevast has now repaid the existing €615m loan in full. The planned foreclosure sale on 15 May 2018 will not take place and Breevast has withdrawn its appeal that was placed on the agenda for 26 April 2018. The portfolio consists of 56 assets spread throughout the Netherlands totalling 456,000 square meters. Included are a number of monumental trophy buildings in the city centre of Amsterdam as well as light-industrial properties and large grocery anchored retail centres. Over 50% of the portfolio is located in Amsterdam and nearly 70% is located within the greater Randstad area. Breevast retains full responsibility for the property, asset & development management of the portfolio. HighBrook Investors and Breevast have drawn up a proactive value-add asset management strategy and business plan for the portfolio. This transaction marks HighBrook’s 12th investment on the Dutch market within the last 18 months. The firm has now acquired nearly 100 properties throughout the Netherlands and is actively working on multiple pending transactions, including but not limited to the acquisition of the iconic Groothandelsgebouwen in Rotterdam. Loyens & Loeff and Bryan Cave Leighton Paisner acted as advisors for HighBrook Investors in this transaction. Breevast was advised by Dentons Boekel and CMS. BNP Paribas Real Estate was deal advisor to both HighBrook Investors and Breevast.
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