News Analysis
Capital Relief Trades
IFRS 9 benefit welcomed
The first-time adoption of IFRS 9 has had a muted impact on bank capital ratios and this has been reflected in existing capital relief trades through P&L gains (SCI 14 May). Indeed, the benefit can be acquired whether the first-loss tranche is sold or retained.
According to a structurer at a large European bank: “The silver lining in SRT deals is that if you sell the first-loss tranche and it’s properly structured, you may be able to offset provisions booked against the assets with an equal and opposite benefit for the SRT deal.”
He continues: “If a bank securitises assets and retains a first-loss tranche, it doesn’t have to recognise RWAs for the portion of first loss covered by provisions. In particular, the only capital that has to be recognised is the difference between the value of provisions and the tranche.”
This is important for the trades because the first-loss tranche is the most expensive one to sell due to its riskiness. Furthermore, most SRT trades are accrual accounted.
This means that the costs are amortised over the life of an instrument, which in turn implies that they don’t have to be accounted as marked to market - which introduces unnecessary volatility in the profit and loss statement. Any impact on provisioning is felt on the accounting side, so there is effectively no impact on the trade unless there is a typical credit event, such as bankruptcy or failure to pay.
“This is something to keep in mind, as a typical transaction is affected by actual defaults and not provisions,” says Robert Bradbury, md at StormHarbour. “For a typical diversified portfolio of ‘core’ assets with solid historical performance, the change of treatment to provisioning is unlikely to be a major driver behind a transaction.”
IFRS 9 introduces a forward-looking view of credit quality, under which banks are required to recognise impairment provisions and corresponding impairment losses before the occurrence of a loss event. This is reflected in the standard's three credit stages, with stage two requiring banks to provide for lifetime expected credit losses when there is a significant decline in creditworthiness but a loss event has not yet occurred.
Nevertheless, accountants have raised some challenges. If there is a maturity mismatch, for instance, between a portfolio’s maturity and the lifetime of the deal, there is a fear that credit risk may return onto the balance sheet - leading to a capital charge. If an asset matures within the lifetime of the deal, stage two mitigation can apply.
However, there are two things to consider. First, “although there are transactions referencing long-dated assets, such as mortgages and project finance, these represent a minority of deals when compared to corporate loans, for example. Furthermore, banks generally try to avoid maturity mismatches because it can have a significant impact on efficiency,” says Bradbury.
Second, from a structural perspective, long-dated assets do not necessarily present a problem. “Most of the deals have time calls, which - if structured only as an option of the originator – [means] the SRT deal will not be considered to have a maturity mismatch,” explains the structurer.
Yet there are other issues that should be taken into account. When assets are securitised, if the underlying assets are classified as SPPI (solely payments of principal and interest), then most tranches of a securitisation can also be classified as SPPI from an originator’s and investor’s point of view. SPPI is a test that assesses whether assets should be recognised as marked to market.
If the asset fails the test, then the originator and investor will have to start marking them as MTM. In order for the assets to be classified as SPPI, the bank has to determine whether there are any embedded derivatives or index-linked instruments that might introduce market risk.
However, the structurer observes: “There is an SPPI exemption, but it’s not available for tranches with a rating below the average rating of the underlying assets.”
Overall, IFRS 9 so far appears not to have changed much for capital relief trades, especially from a structural perspective. “Initially, we had discussions on the potential discrepancy between the regulatory LGD and the IFRS 9 LGD, but we have concluded that the two are closely matched. Expected losses should match stage three losses,” notes the same structurer.
He adds: “If a deal is structured with an adjustment mechanism that [ensures] that investors are only on the hook for actual losses incurred by the bank, you’ll be fine with IFRS 9.”
However, the credit cycle may turn, forcing a transition from stage two losses into stage three losses. This is where tranche thickness becomes important.
Another structurer observes: “The tranches are thick enough, given the new securitisation regulations (SCI 26 January), to absorb stage three losses as well as stage 1 and stage 2 impairments if they were to materialise. Most deals have a 7%-10% tranche thickness, while the EL of the portfolio is typically 5bp-15bp per annum on certain assets. Consequently, the base case here is that you should have significantly less than 1% cumulative loss on the portfolio.”
A market source concludes: “The thickness would be enough to cover expected and unexpected losses, unless you get some black swan event that is outside the stressed scenarios.”
SP
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News
Structured Finance
SCI Start the Week - 11 June
A look at the major activity in structured finance over the past seven days
Pipeline
Non-auto related ABS deals have dominated the pipeline recently. Indeed, transactions representing a broad mix of asset types and jurisdictions were announced last week.
The non-auto deals remaining in the pipeline by the end of the week were: US$130.14m Accelerated Assets 2018-1, US$100m AM Capital Funding Series 2018-1, US$294.4m CLUB 2018-P1, US$169.8m College Ave Student Loans 2018-A, US$991.78m DEFT 2018-1, US$147.34m Renew 2018-1, US$497.5m SMB Private Education Loan Trust 2018-B, US$586.9m START 2018-1, US$482.5m Trinity Rail Leasing 2018 and US$300m Triton Container Finance VI Series 2018-2. The auto ABS were: US$248m American Credit Acceptance Receivables Trust 2018-2, BBVA Consumer Auto 2018-1, US$299.39m GLS Auto Receivables Issuer Trust 2018-2 and A$300m Metro Finance 2018-1 Trust.
Additionally, a trio of RMBS (NZ$150m Avanti RMBS 2018-1 Trust, £10.25bn-equivalent Permanent Master Issuer Series 2018-1 and US$1.05bn STACR 2018-DNA2) and a trio of CMBS (US$635m Atrium Hotel Portfolio Trust 2018-ATRM, US$463m 5 Bryant Park 2018-5BP and US$521.55m GSMS 2018-SRP5) were announced.
Pricings
New issue activity was somewhat subdued last week. Pricings were spread across ABS, CLOs and RMBS.
The auto ABS pricings included US$900m BMW Floorplan Master Owner Trust Series 2018-1, US$486m DTAOT 2018-2 and US$671.46m HALST 2018-B, while the non-auto related pricings were US$845.6m Castlelake Aircraft Structured Trust 2018-1, US$466m Vivint Solar Financing V and €764.32m Voba Finance No. 7. The CLO prints included US$756m CBAM 2018-7 and US$514.2m XAN 2018-RSO6, while the US$1.59bn Seasoned Credit Risk Transfer Trust Series 2018-2 was the sole RMBS issuance.
Editor’s picks
Deal 'will happen' despite political risk: Banco BPM has announced the transferral of a €5.1bn gross nominal value (GNV) portfolio of NPLs to the Red Sea SPV, as part of Project Exodus (SCI 1 June). The Italian bank aims to sell the junior and mezzanine notes, although political uncertainty may lead to higher premiums, putting a strain on the transaction…
Chinese issuance growing strongly: Chinese securitisation issuance surged to a record high in 2017 but significant challenges remain. Overseas ABS market participants point to the need to develop the investor base and deepen market expertise, but are also showing increased willingness to dip their own toes in the water…
UTP loans raise AI prospects: Resolving unlikely to pay (UTP) loans is becoming more important for Italian banks, but the challenges involved can be particularly complex. As a result, special servicers are looking to create proprietary servicing platforms that utilise machine learning and artificial intelligence…
News
Capital Relief Trades
Risk transfer round-up - 15 June
Deutsche Bank is expected to execute two capital relief trades this month. One is a corporate deal from its CRAFT programme and the other is an SME deal from its GATE programme. The bank is also believed to be prepping a trade finance transaction from its TRAFIN programme for either end-3Q18 or 4Q18.
News
NPLs
Bankruptcy law brings transparency
India’s landmark Insolvency and Bankruptcy Code (IBC) has inflicted heavy losses on the nation’s banks this year. The law has nevertheless provided more transparency in the market and has reduced non-performing loan recovery periods.
Cumulative losses for state banks were large enough to wipe out almost all of the government's capital injections of US$13bn, while weak performance is likely to continue in the coming year. Sakate Khaitan, partner at Khaitan Legal Associates, comments: “The losses demonstrate that the law is working in terms of transparency. Furthermore, it has also worked from a resolution perspective.”
He continues: “Even small suppliers can take an entity to a court with resolution happening in a time-bound manner. Two landmark cases that demonstrate this are the Tata steel acquisition of Bhushan steel and Vedanta’s acquisition of Electro steel castings.”
The Bhushan deal, which was completed last month, enabled Tata to pay US$5.2bn to the insolvent firm’s creditors, a price that amounts to a 63% recovery rate. The law was introduced nearly a year ago and it has proved effective from a timing and resolution perspective, by tilting the balance of power towards lenders, while also introducing more transparency through bad loan recognition.
According to Fitch, the initial impact has been to raise credit costs, which reached 4.3% of loans on average at state banks from March 2017 to March 2018, compared with 2.5% as of financial year-end 2017. The sector’s NPL ratio rose to 12.1% from 9.3% from March 2017 to 2018 and slightly exceeded Fitch’s previous forecast of 11.5%.
The state banks' average NPL ratio was 14.5% - those of IDBI Bank, UCO Bank and Indian Overseas Bank were over 25%. Losses have been reported at 19 of the 21 state banks so far this year, including State Bank of India, while earnings at the large private banks also came under significant pressure, with Axis reporting its first-ever quarterly loss.
These losses have put further pressure on capital ratios. Six state-owned banks reported common equity Tier 1 (CET1) ratios that did not meet the regulatory minimum capital conservation buffer levels of 7.375% in March 2018.
The government has earmarked another US$11bn for recapitalisation in 2019, which should allow banks to avoid breaching regulatory triggers. However, more government capital is required to stabilise banks' balance sheets, meet regulatory requirements and support growth - there could be further (albeit lower) losses over the next few quarters.
More positively, official NPL ratios are now closer to what Fitch believes would be full recognition of legacy problems. Provision coverage has also improved, due in part to NPL ageing.
Improvements are also due to the regulatory push since August 2017 for banks to provide a minimum 50% on NCLT accounts. This minimum was brought down to 40% in April 2018, but most banks have opted to retain the higher coverage.
The rating agency concludes that regulatory efforts to speed up problem-loan resolution could release capital if recoveries prove higher than current provisions. Some of the 40 large NPL accounts currently in the insolvency courts - which constitute 40%-50% of the NPL stock - could be resolved in 2019, although the agency adds that there remains a risk of legal delays.
SP
News
NPLs
Creval completes second NPL deal
Credito Valtellinese (Creval) has completed a €586.35m non-performing loan securitisation with a gross book value equal to €1.67bn, as at the 31 December 2017 cut-off date. The senior notes of the deal – dubbed Aragorn NPL 2018 – are expected to benefit from the GACS guarantee.
Rated by DBRS and Scope, the transaction comprises a €509.52m BBB (low)/BBB- senior tranche (which priced at six-month Euribor plus 50bp), a €66.82m CCC/B mezzanine tranche and a €10m unrated junior tranche. The senior notes have been retained by Creval, while the majority (95%) of the mezzanine and junior tranches were placed with institutional investors.
The portfolio – which was acquired by the issuer at a 64.9% discount to GBV – comprises both secured (75.4%) and unsecured (24.6%) loans originated by Credito Valtellinese (84.5%) and Credito Siciliano (15.5%). The loans were extended to Italian companies (91.1%) and individuals (9.9%).
Secured loans are backed by residential (43.4% of indexed property valuations) and non-residential (56.6%) properties that are highly concentrated in the Lombardy region (46.6%). Indeed, Scope notes that the portfolio is concentrated because the 10 and 100 largest borrower exposures account for 8.2% and 39.4% of GBV respectively.
Almost 60% of the portfolio’s GBV corresponds to loans with no ongoing proceedings and about 23% of the loans are already in bankruptcy proceedings. The weighted average time since default is approximately 3.2 years for the unsecured portion of the portfolio.
Credito Fondiario will act as master servicer on the deal, operating jointly with Cerved Credit Management as special servicer, thereby limiting the transaction’s sensitivity to servicer disruption. Cerved Master Services is back-up servicer, while Securitisation Services is monitoring agent. In the event of servicer disruption, the monitoring agent will assist the issuer in finding a suitable replacement.
The senior noteholders are protected by relatively tight performance triggers, according to Scope. If the special servicers do not meet at least 90% of the business plan collections schedule, mezzanine tranche interest payments will be deferred below senior tranche principal.
Accounting deconsolidation of the Aragorn portfolio is expected to take place on 30 June 2018, while the prudential derecognition is subject to the obtainment of the GACS guarantee. Deconsolidation will improve Creval’s gross NPL ratio from 19.3%, as at 31 March 2018, to approximately 11.5% pro-forma. Aggregate sales carried out by the bank from 2015 amount to approximately €4bn, representing a reduction of the NPE gross amount by approximately 67%.
JPMorgan, Mediobanca and SG acted as co-arrangers of the Aragorn securitisation. Creval’s first NPL securitisation, Elrond NPL 2017, was launched in July 2017 (SCI 14 July 2017).
CS
News
RMBS
Innovative RMBS prepped
Mars Capital is in the market with a non-standard multi-lender £271.055m UK RMBS, dubbed Trinidad Mortgage Securities 2018-1. The transaction is backed by three individual portfolios of new and legacy first- and second-ranking mortgages, secured by residential or part-commercial properties in England and Wales.
DBRS and S&P have assigned provisional ratings to the transaction of AAA/AAA on the class A notes, AA (low)/AA on the class B notes, A (low)/A-plus on the class C notes, BBB (low)/A-minus on the class D notes, BB (low)/BBB on the class E notes and B (low)/BB on the class F notes. The notes are all tied to three-month Libor plus a margin.
The transaction is, unusually, backed by three different portfolios, each with atypical loan, borrower or property characteristics. For example, the seasoned portfolios that were originated prior to mortgage market reforms include loans that repay on an interest-only basis - without repayment vehicles - and borrowers who self-certified income at origination. The provisional portfolio includes both buy-to-let (BTL) and owner-occupied mortgages, with an average indexed LTV of 57% and 4.8 years of seasoning.
The largest subset of loans – accounting for 61% of the portfolio – was originated by Magellan Homeloans and Mars Capital, trading as Magellan Homeloans Limited (MHL), and is a collection of newly-originated owner-occupied loans. This includes credit repair mortgages - 19.4% of the subset - which were granted to borrowers with impaired credit histories.
A second subset is a mixed pool of BTL and owner-occupied mortgages from the Thrones 2013-1 (T13) RMBS, making up 30.4% of the portfolio. The collateral was originated between 2003 and 2008 by Heritable Bank, which was then purchased by Mars Capital in 2013 after Heritable Bank went into administration.
Thrones 2013-1 is close to its call date and is also subject to a tender offer by Clifden (SCI 8 June). The deal is expected to be redeemed on or around 20 July, after the closing of Trinidad Mortgage Securities 2018-1.
The remaining subset is the Camael portfolio - at 8.6% of the pool - which consists of legacy residential (both BTL and owner-occupied) and commercial mortgages originated by Cyprus Popular Bank, formerly Laiki Bank/Marfin Popular Bank. The originator of the portfolio collapsed in 2012 and was rescued by the Cypriot government, with Mars Capital subsequently acquiring the assets in 2014.
DBRS notes that the transaction’s structure envisages the issuer purchasing further mortgages. At closing, there will be an over-issuance of notes to fund a credit entry onto the pre-funding ledger and, at any time after the first calculation date, the issuer can purchase further Magellan loans.
DBRS notes that pre-funding in this manner can lead to negative carry, as the cash in the pre-funding reserve is likely to yield less than is due on the notes, as well as the possibility for deterioration in the credit quality. However, it suggests that risks associated with pre-funding are mitigated by pre-funding conditions, which constrain adverse credit features in the additional portfolio sold post-closing.
The mortgage sale agreement includes asset warranties that are in line with UK non-conforming market standards, although the remedial actions following a breach of asset warranties are substantially weaker than the agency normally observes. Furthermore, both the T13 and Camael pools contain single or multiple mortgages that are secured against a single property or multiple properties. If a borrower defaults under a particular debt, the servicer can enforce the other debt that is not directly pledged to the debt that has defaulted.
Deutsche Bank is arranger on the deal.
RB
Talking Point
Capital Relief Trades
CRI explained
Stephen Taylor, head of structured and capital solutions EMEA at Aon Risk Solutions, outlines the benefits of credit risk insurance for securitisations
Q: What is credit risk insurance?
A: Credit risk insurance (CRI) is used to transfer credit risk to insurers. One of the benefits of using CRI in securitisation structures is that this credit enhances the asset pool (subject to the legal/accounting treatment) and can make the portfolio more attractive to lenders.
Q: How does CRI help optimise a credit portfolio?
A: Our experience of working with securitisation transactions is normally where lenders use CRI across a portfolio of assets. The majority of the securitisation transactions that CRI markets support are where the underlying asset class is trade receivables. Alternative asset classes can be considered and we also have specialists at Aon that structure credit risk transfer solutions across consumer credit portfolios.
Q: Who uses CRI as a tool for credit portfolio optimisation?
A: Banks and lenders will be using CRI as a credit risk mitigant. Third parties that structure transactions and/or utilise their systems to support asset monitoring are also introducing credit insurance into the structuring process to improve the asset credit strength.
Q: Why use CRI over other tools to optimise a credit portfolio?
A: CRI is a flexible product, with growing insurance market capacity. The product is used widely by financial institutions to support lending.
The drivers for using CRI generally fall into three categories: risk management, credit concentration [and] capital optimisation. In securitisation structures, CRI often allows the percentage of eligible assets that are financed to be increased. For example, investors may not want to consider assets from certain geographical locations or may want to discount the value of the asset by a higher percentage without CRI.
If CRI is used across the portfolio, it effectively credit enhances the portfolio to investment grade (being the credit rating of the insurer). Some insurers also have specific securitisation teams that provide structuring advice and access to online systems that can be used to monitor the performance of the receivables.
Q: Has the use of CRI in securitisations become more prominent?
A: CRI has been used to support securitisation structures for a long time. Over the last 18 months, we have seen more securitisation enquiries and have started reviewing requests across a wider range of finance asset classes.
Q: What are the challenges in using CRI for portfolio optimisation?
A: Securitisation structures can be complex, so it is important to give the insurers sufficient time to properly review and understand the information package and to carry out their necessary due diligence. We would always recommend bringing an insurance partner(s) into the deal at an early stage to follow the deal journey and input into the credit protection structure, rather than being brought in at the last minute, where there is limited opportunity to adapt the underlying structure.
Q: Which developments will drive a broader adoption of CRI?
A: We believe that there will be continued growth in the use of CRI across all finance asset classes. The CRI markets were traditionally split between multi-debtor and single risk product offerings.
Multi-debtor insurers would traditionally cover short-term trade receivables and single risk insurers were more familiar with loan structures covering multiple asset classes. The trend that we are seeing is a convergence between the multi-debtor and single risk insurer product offering. We are starting to see single risk insurers consider loan portfolios and multi-debtor insurers consider wider asset classes.
While there are always other factors (for example, regulatory [and] economic trends) that could impact future growth, we believe that there will continue to be credit appetite from insurers and sufficient benefits for lenders to use credit protection to optimise securitisation deals.
SP
Market Moves
Structured Finance
Market moves - 15 June
CLO name change
The name of Babson Euro CLO 2014-1 has been changed to Barings Euro CLO 2014-1. The move is effective from 13 June.
Europe
MDB Group (MeDirect) has recruited Michael Curtis as cio, responsible for core credit activities and spearheading the bank’s diversification into new product areas. Based in London, he reports to ceo Mark Watson. Curtis was previously portfolio manager and md at ICG, leading the CLO and loans business, and before that worked at 3i Debt Management, Alpstar Capital and CIBC World Markets.
HSBC has hired Peter Mansbridge to the role of director within its structured finance group. Mansbridge was previously a vp in the structured finance group at RBS.
Fraud charge settled
Bank of America Merrill Lynch has agreed to pay US$10.5m to affected customers and to pay penalties of approximately US$5.2m to settle US SEC charges that its employees misled customers into overpaying for RMBS. In its order, the SEC found that Merrill Lynch traders and salespeople convinced the bank’s customers to overpay for RMBS by deceiving them about the price Merrill Lynch paid to acquire the securities. According to the order, the bank failed to have compliance and surveillance procedures in place that were reasonably designed to prevent and detect such misconduct.
ILS
Leadenhall Capital Partners has hired George Cooper as a non-life investment analyst. He was previously at Scor as a catastrophe risk analyst.
North America
Federman Steifman has appointed John Nastasi as partner in its New York office. Nastasi concentrates his legal practice in commercial real estate, structured finance and workouts. He previously founded Nastasi Law Group, served as in-house counsel for the real estate group of the Lehman Brothers estate and worked at Fried Frank.
Greystone has named George Kenny md, institutional sales for its lending operations based in New York. In this newly-created role, Kenny will drive increased debt origination among institutional clients, reporting to Chip Hudson, head of production for conventional and affordable agency loans at Greystone. He joins from Starwood Property Trust, where he served as head of new business development for real estate investing and servicing. Prior to Starwood, he was head of Americas mortgage and securitised product sales at UBS, and also worked at Bank of America Merrill Lynch, Braver Stern and Lord Abbett.
Katten Muchin Rosenman has hired Paul Kruger to the firm’s structured finance and securitisation practice in New York. Prior to joining Katten, Paul was based in New York, Abu Dhabi, Hong Kong and Tokyo. He is admitted in New York and England and Wales and he has represented some of the world's leading financial institutions, private equity investors, sovereign wealth funds and corporations on transactions across the United States, Asia, Europe and the Middle East.
Lowenstein Sandler has hired Ryan Wilson as a partner in the in its capital markets litigation and white collar criminal defense practices. Wilson was formerly an assistant US attorney for the Eastern District of New York and was a lead attorney in the prosecution of the world’s third-largest RMBS issuer/underwriter, resulting in a landmark settlement of over US$7bn.
NPL pool sold
MTGLQ Investors is the winning bidder in Fannie Mae’s latest non-performing loan sale, comprising approximately 9,800 loans totalling US$1.64bn in unpaid principal balance, divided among four pools. The cover bid was 81.48% of UPB (53.39% of BPO) for the four pools, which were purchased on an all-or-none basis. Meanwhile, bids are due for Fannie Mae's thirteenth community impact pool sale on 19 June and for its seventh reperforming loan sale on 10 July.
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