Contents

ABS

RRBs on the rise?

Signs of an uptick in the US rate reduction bond (RRB) market are emerging, albeit the sector remains a relatively small segment of the securitisation landscape. More states are putting frameworks in place to enable them to issue RRBs and there are indications of innovative transactions on the horizon.

Deborah Newman, director at S&P, says that while the RRB market is still fairly small, there are around 42 outstanding deals that the agency rates, totalling US$14bn. The senior notes in all of the deals are rated triple-A.

The market started gaining traction in the late 1990s-early 2000s, after the deregulation of wholesale power supply markets. Growing competition between utility companies then led to a growth in uneconomical stranded assets.

Utility firms in the US then turned to securitisation and issuing RRBs as an innovative way to combat the costs of these stranded assets, with minimal customer impact. Jay Srivats, director at S&P, adds: “By issuing RRBs, utility companies can generate a large amount of funding upfront, while also reducing the costs to customers.”

While RRBs are usually issued by utility firms, there have been some quirks in the market, such as the structure being “used more recently by companies looking to fund recovery after severe storms, like Hurricane Katrina,” says Srivats. She adds that the firms are securitising similar payment streams, but the motivation is slightly different.

From an investor perspective, RRBs provide an appealing form of protection through the true-up mechanism, which is unique to such bonds. Srivats comments: “It’s a very useful cover-all to ensure that the charge is applied to customers’ bills, regardless of customer circumstance, such as employment.”

She continues: “It is also one of the key reasons why some RRB deals may achieve a triple-A rating at the senior tranche level.”

Newman adds that investors are provided further comfort through the financing order. “Additionally, one of the things that is appealing about RRBs is that financing orders generally provide that the charge is non-bypassable. Cashflows are typically stable for the lifetime of the transaction, which can be attractive to investors.”

A positive for utility firms too is that issuance doesn’t negatively affect the company in the sense that repayment of the bonds is not a financial obligation. A downside for the issuing firm, however, is the time it can take to put the legislation in place to approve the charge on utility customers’ bills.

Additionally, utility firms may need to grapple with a complex, unfamiliar process. “Also from the utility firms’ perspective, they may not be familiar with securitisation as a funding method, so a degree of education is required for these firms to get comfortable prior to execution,” says Srivats.

Transactions are typically fairly similar, although the odd exception can emerge, such as the US$369.75m Utility Debt Securitisation Authority 2017, issued by Long Island Lighting Co and rated triple-A by S&P across all the notes. Newman comments that it recently issued multiple series of debt between 2013 and 2017, used in a “slightly novel way, which was to refinance existing debt”.

Looking ahead, growth in issuance could be on the cards and Newman says that while a number of states have yet to issue RRBs, more states are adopting legislation to allow RRBs to be executed by utility firms. She concludes: “This could lead to more transactions. There has also been interest in water- and sewer-related transactions, so that’s a potential new development in the market.”

RB

Capital Relief Trades

Consultant activity surveyed

Investment consultants for long-term investors such as pension funds haven’t been as active in capital relief trades as other investors, typically hedge funds - although this is expected to change, as corporate defaults pick up over the next two to three years (SCI 25 April). The trades are attractive to consultants’ clients, as they provide exposure to higher quality corporate collateral, control over underwriting standards and structural protections.

According to Raelan Lambert, md at Pavilion: “Most of our clients are looking for something sustainable when the debt cycle turns. Risk-sharing transactions, executed by managers on a proactive basis, provide investors with exposure to high quality collateral held by tier one European banks, control over underwriting standards, structural protections and an ability to re-underwrite the assets without having to rely on the bank’s underwriting standards.”

Although not as involved in risk transfer as other participants, investment consultants have developed a track record in the sector over the last seven to eight years. “We started investing in these trades seven or eight years ago and, over this period, it’s clear that spreads have tightened. Yet there are tactical opportunities and, considering other opportunities, there’s still yield to be made,” says Neil Sheth, partner and director of alternative assets research at NEPC.

NEPC evaluates trades from both an IRR and a return on invested capital perspective, using locked-up facilities similar to private equity funds. Sheth explains: “Both are important. On a levered basis, you can generate IRRs in the low-teens. However, the lock-up period is seven years, which means that the money isn’t called up for seven years - I will return the capital plus gains or losses after seven years.”

He adds: “From a risk-reward perspective, this is interesting, but you don’t know what’s going to happen in seven years. If the capital is going to be locked up for that long, you need a 1.4-1.6 multiple to justify that.”

Investor motivations vary by investor type, although the attractive yield remains a common factor. Sheth continues: “If we are talking about pension funds, such as public pension funds, they have liquidity constraints, so they seek a high enough multiple to justify an illiquid investment. On the other hand, we don’t see as many corporate plans, since many are well funded and the complexity premium for these investments often does not fit well for their portfolios.”

He adds: “Any further expansion of the investor base across the spectrum would involve higher premiums.”

Similarities across the investor base can also be discerned in terms of the structural features that are sought after. Sheth notes: “We have clients investing in both first loss and non-first loss positions, with pro-rata being preferable to sequential. If you have a senior investor getting paid first, then rates of return are higher for the investors lower in the capital structure.”

Asset classes that have attracted the most interest remain for the most part corporates, although there has been some minor interest in other asset classes, such as infrastructure. NEPC, for one, hasn’t found most infrastructure-related funds overly impressive, since they feature long lock-up periods and the return on an unlevered basis is in the single- to mid-digits. Indeed, the firm remains an active investor in mid-market corporate loans.  

Regarding corporate defaults, Moody’s notes that corporate leverage is higher than its peak before the 2008-2009 financial crisis. Median debt/EBITDA is about 30% higher than in 2007 across the population of global non-financial investment grade companies and is about 10% higher across the population of speculative grade companies. The rating agency states that this has set the stage for a large wave of defaults when the next period of broad economic stress eventually arrives.

SP

CLOs

Managers set out stalls post-repeal

Of open-market CLO managers that have issued a risk retention-compliant CLO, 61% are seeking to sell some or all of the risk retention interest, according to a recent survey from Maples and Calder. Indeed, a number of risk retention pieces have been put up for sale on the secondary market in recent weeks, following the official repeal of the ruling for CLOs earlier this year (SCI passim).

Exactly 5% vertical strips from five CLOs - CRMN 2013-1A, CRMN 2014-1A, BLUEM 2013-2A, MVEW 2013-1A and MVEW 2017-2A - were seen on bid lists recently. Furthermore, 5% of double-B and single-B rated tranches of a number of PGIM’s Dryden CLOs have appeared on bid lists over the last two weeks.

As shown in SCI’s PriceABS archive, a US$8.2m single-B rated piece of DRYD 2015-44X covered at 101.04 on 22 May. A US$500,000 double-B piece of DRYD 2017-52X E did not trade, however, after appearing on bid lists on 23 May. DRYD 2015-39X ER covered at 100.25 on the same day.

Despite the number of managers looking to sell their risk retention interests, 58% of managers polled by Maples and Calder plan to keep some risk retention in place. According to the survey, around 35% of managers intend to keep the full 5% or more.

Under one-fifth of managers intend to have less than 5% risk retention. The largest percentage, at around 45%, said they had no fixed amount yet in mind.

Equally, the survey suggests that some managers would be willing to hold a large portion of equity, should it be required by a particular investor. Despite this, the survey reports that over half of investors will not tier managers based on whether or not they retain risk or make significant investments in equity.

In terms of cross-border activity, 59% of managers asked would still consider issuing an EU risk retention-compliant CLO in order to attract EU investors. Of this segment, 86% said they would comply with EU compliancy rules through the originator route.

Maples and Calder suggests that an ongoing concern for managers is whether the EU manager-originator approach will lead to a CLO falling outside the definition of the open-market CLO exemption. Partner at the firm, Stephen McLoughlin, says: "Under the existing European risk retention regime, US managers have to opt for the originator route, as the MiFID authorisation requirements mean the 'sponsor' approach is restricted to EU based managers.”

“However,” he continues, “this looks set to change next year under the new European Securitisation Regulation, as the definition of 'sponsor' has been opened up to include credit institutions whether inside the EU or not, as well as 'investment firms' whose regular business is the provision of one or more investment services to third parties. The de-coupling of the definition of sponsor from MiFID authorisation looks to have opened up the sponsor approach to non-EU managers."

With regards to the shape of the market, it’s reported that nearly all respondents expect the number of managers to increase. There is also a very strong belief that manager diversity will increase in terms of the types of firms entering the market.

A small number, only around 20%, believe that manager diversity will remain the same. Views diverge somewhat in terms of new investors entering the CLO market, with around 40% seeing an increase in investors but most - at 60% - see no change.

While a number of respondents anticipate that the sale of risk retention funds is set to increase, around two-thirds do not expect risk retention funds to disappear. Instead, over half believe that risk retention capital funds might evolve and, finally, 74% of managers reckon that issuance will increase on the back of the ruling.

RB

Structured Finance

Euro mortgage market heating up

A thriving European mortgage market is attracting foreign investors seeking to capitalise on the low-risk returns on offer, particularly in the UK and the Netherlands. New firms such as Fortrum (SCI 18 May) are being established, offering innovative products and services to help smooth the path for those venturing into the European structured finance sector.

Simon Collingridge, co-founder of Fortrum, comments: “We are essentially looking to provide a combination of insurance and structured finance techniques to create more efficient securitisations and to help companies make more efficient use of capital.”

Part of this effort involves partnering with Lime Risk to engage in activities where insurance and securitisation cross over. For example, the venture will provide insurance through a rep and warranty on the originator penalty incurred on the SPV, resulting from securitisation.

The firm is also looking to offer mortgage indemnity insurance to help with capital protection on mortgages. Collingridge suggests this is particularly needed in the Netherlands and is something that can help protect investors in securitisations backed by property.

Although the Dutch government’s NHG insurance is useful for certain properties, it falls short when it comes to more expensive ones. As a result, Fortrum has structured an additional insurance policy to cover a broader range of properties, “which makes sense from a capital perspective”.

In terms of the firm’s client base, it is hoping to attract first-time investors, largely coming into the Dutch and UK mortgage market. These will likely be insurers, pension funds and some banks that want to match long-term assets with liabilities.

The Dutch government has a clear strategy in supporting the country’s mortgage market, as well as aiming to bring down LTV ratios, complemented by a strong political and economic environment. As a result, significant projected growth in the Dutch mortgage market of €600bn-€850bn is expected over the next few years, potentially fuelled by foreign investment.

Collingridge believes that his firm will be able to fill a gap in the market, where investors may need due diligence and local expertise to help them get a foothold - whether this be securitisation, whole loan sales or originate-to-manage strategies (SCI 10 April). “We can assess a mortgage portfolio for an investor and review it on an ongoing basis, particularly if they are securitising it. An investor will need a third party to oversee a transaction,” he says.

He continues: “Additionally, from a compliance point of view, ongoing surveillance can help to ensure investors have a fully compliant book, which is important under IFRS 9. We are especially able to help investors with origination or underwriting expertise at a local level.”

The non-performing loan sector is also a target area for Fortrum, whether in the UK, Spain, Italy or other jurisdictions with high NPL exposures - particularly in terms of “plugging the data gap.” Collingridge says that one of the most shocking things in Italy, for example, is “the absolute absence of data in many instances” - which makes it particularly difficult to bring a securitisation. He hopes that his firm will be able to help, particularly in “the area of data collation and helping banks to judge which loans to keep or dispose of.”

He suggests that the ECB’s attempts to push ahead with resolving the NPL data consistency issues should be applauded. Such issues need to be resolved, especially if banks are to comply with IFRS 9 and, to do this, they need a clear recovery strategy.

Collingridge adds that Fortrum will step in where banks need guidance on strategy, by helping to weigh up which portfolios to keep and which to sell, and also help with surveillance and underwriting.

More broadly, he says securitisation is a suitable tool for managing risk and raising capital and it has lost a degree of stigma in Europe, boosting its prospects. Work still needs to be done, however, in terms of aligning it with other asset classes in Europe.

Collingridge concludes: “Regulations are still not completely set, however, and [securitisation] is still treated punitively compared to corporate bonds, which receive preferable capital treatment. That may change in time. But otherwise it is still a more optimistic outlook than previously, especially with stabilising factors like STS coming into place.”

RB

Structured Finance

Market moves - 1 June

BTL RMBS planned
UK Mortgages and TwentyFour Asset Management have acquired a high-quality pool of approximately £350m buy-to-let non-member mortgages originated by The Coventry Building Society Group through its Godiva brand. The portfolio comprises 2,077 recently-originated loans with an average balance of approximately £169,000 and an average LTV of 60.8%. The loans have approximately five years until the current fixed rate period is due to end, thereby helping the subsequent term securitisation to maintain leverage – and therefore the investment return - for longer. TwentyFour is moving forward with the financing phase of the transaction, with The Coventry continuing to service the mortgage holders.

Documentation issues resolved
Laurentian Bank Financial Group says it has successfully resolved issues related to mortgages purchased by an unnamed third-party purchaser and has agreed an action plan with CMHC regarding its securitisation programme, after a 4Q17 audit identified that certain loans were inadvertently portfolio insured while they did not meet CMHC portfolio insurance eligibility criteria. Under the agreement, Laurentian Bank will repurchase an additional C$115m of branch-originated ineligible mortgages during 3Q18 and provide a C$55m cash reserve deposit to the third-party purchaser as additional credit enhancement to the programme, which will be remitted to the bank over time as the branch-originated mortgage loans amortise. The bank is also reviewing all B2B bank and branch-originated mortgage loans portfolio insured by CMHC and has provided CMHC with a C$20m cash reserve deposit, pending the conclusion of the review, which CMHC will assess. The bank says it has implemented improved quality control and origination processes since November 2017.

EMEA
Ashurst has hired Jonathan Walsh as a securitisation partner at its London global markets practice. Walsh joins from Baker McKenzie where he was senior partner in the finance group and global head of securitisation.

Aviva Investors has formed a new real assets business, bringing together direct real estate, infrastructure, structured finance and private debt under a single leadership and operating structure. Mark Versey has been appointed cio, real assets, overseeing around 300 professionals in five locations – London, Norwich, Paris, Frankfurt and Toronto - working across fund management, asset management, asset origination, underwriting, research and business management. The real assets leadership team also includes: Barry Fowler, md, alternative income; Daniel McHugh, md, real estate investments; David Skinner, md, real estate strategy and fund management; and Chris Urwin, director of research, real assets. The firm has also agreed to sell its real estate multi-manager business and its interest in Encore+ to LaSalle Investment Management. The deal will see approximately £6bn of assets transferring on completion, with Aviva’s global real estate ceo Ed Casal joining LaSalle as part of the transaction.

Hovnanian dispute settled
Solus Alternative Asset Management has decided to settle its dispute over the recent refinancing transaction involving GSO Capital Partners and Hovnanian Enterprises (SCI passim). The terms of the settlement reached by Solus and GSO included an agreement by GSO to consent to the indenture amendments necessary to allow Hovnanian to make the interest payment that it did not make to its own subsidiary on 1 May 2018 prior to the expiration of the grace period, which Hovnanian has now done. GSO has also agreed not to support any future failure to pay events affecting Hovnanian. Other terms of the agreement were not disclosed.

ILS
Hamilton Insurance Group has appointed Brenton Slade as svp of Hamilton Capital Partners, a new business unit that will be tasked with the further development of the firm’s capital management capabilities. Slade will join Hamilton on 19 June and report to group cfo Jonathan Reiss. He was previously coo at The Horseshoe Group and before that was chief marketing and capital markets officer for Flagstone Reinsurance, where his responsibilities included ILS, cat bonds and sidecars, and evp and principal of West End Capital Management.

North America
Credit Agricole has strengthened its US credit platform with three new hires. Among them is Beth Starr, who will be based in New York and joins the bank as head of ABS syndicate for the Americas, reporting to Nicolas Leopardi, head of debt syndicate Americas. Starr was previously head of loan capital markets at Spruce Finance and has also worked at Merrill Lynch, Lehman Brothers, Jefferies and CommonBond.

Peoples Group has appointed three new members to its board, including Laura Rubino. Rubino has over 24 years' experience in the Canadian financial services sector, spanning wholesale banking and independent brokerage operations. She brings expertise in debt capital markets and has held leadership roles in origination, marketing, trading, risk management, structuring and securitisation activities.

NPL securitisation underway
Banco BPM has approved the assignment of a €5.1bn gross nominal value portfolio of non-performing loans to the Red Sea SPV. In relation to the planned securitisation, the bank intends to put in place a GACS guarantee for the senior notes. Banco BPM will subscribe to the senior, mezzanine and junior tranches, the latter two of which will be subsequently transferred to third-party investors. The transaction is part of a €13bn disposal plan dubbed Project Exodus.

RFC on Volcker amendments
The US Fed has asked for comment on a proposal to simplify and streamline compliance requirements relating to the Volcker rule, in light of compliance uncertainty created by the complexity of the rule. The proposed changes would: tailor the rule's compliance requirements based on the size of a firm's trading assets and liabilities; provide more clarity by revising the definition of ‘trading account’ in the rule, in part by relying on commonly used accounting definitions; clarify that firms that trade within appropriately developed internal risk limits are engaged in permissible market making or underwriting activity; streamline the criteria that apply when a banking entity seeks to rely on the hedging exemption from the proprietary trading prohibition; limit the impact of the Volcker rule on the foreign activity of foreign banks; and simplify the trading activity information that banking entities are required to provide to the agencies. Comment will be accepted for 60 days after the proposal's publication in the Federal Register.

Sole adviser approved
The board of THL Credit Senior Loan Fund has approved THL Credit Advisors, the fund's current sub-adviser, to serve as its sole investment adviser. The fund's current advisory agreement with Four Wood Capital Advisors will terminate on 21 June, along with the its investor support services agreement with FWCA's affiliate Four Wood Capital Partners. Under the new agreement with THL Credit, the annual fee payable by the fund has been reduced from 1.05% to 0.80% of the value of its average daily managed assets and certain non-management expenses borne by the fund will not exceed 0.25% per year. In connection with the new advisory relationship, the board has appointed THL Credit senior md Brian Good as an interested trustee. Steven Baffico, a managing partner and ceo of FWCP, will remain on the board.