Contents

Structured Finance

Questions remain over insurer participation

The European Commission recently published the Delegated Act on Solvency 2, which improves the capital treatment for certain ABS exposures, as of 1 January 2019. However, market participants suggest that STS securitisations deserve fairer capital treatment and, as a result, insurance firms remain unlikely to return to the securitisation market in great number.

Rabobank credit analysts take a bullish approach to the amendments and comment that so far it is the “most significant change [to] the regulatory push to revive the European ABS market”. The analysts suggest that the move offers insurance companies incentives to increase their allocations to the asset class.

Egbert Bronsema, senior portfolio manager at Aegon Asset Management, isn’t so upbeat. “Capital treatment has certainly improved, but it’s not going to lure back insurers – particularly not smaller ones and especially not in non-STS asset classes like CLOs, CMBS and post-Brexit UK deals that will no longer be STS compliant,” he comments.

He concedes however that capital treatment has improved to a large degree for STS securitisations. For a triple-A rated senior tranche, capital charges will fall from the current 2.1% to 1%. The treatment has also improved on non-seniors, says Bronsema, with treatment on a triple-B non-senior over four years falling from 80%-32% - which, he adds, is a “a big improvement.”

While Aegon has historically been a big investor in ABS, it reduced its ABS holdings in recent years, but remains invested in certain pockets. Bronsema points out that Aegon is only able to invest in these because it has the size - and therefore the ability - to develop and employ an internal capital model, which is regulated on a local level.

Bronsema adds: “Smaller insurers do not have this ability and…are now largely absent from investing in ABS as a result of Solvency 2.” He agrees, however, that a big positive of the amendment is that it has reclassified Type 1 and 2 securitisations to STS and non-STS and, while Type 1 used to only relate to senior tranches, STS now covers whole transactions.

Brexit also raises additional risks, because certain UK deals will no longer fall under STS if the UK leaves the EU, affecting capital charges. As an example, the capital charge for a five-year triple-A rated UK STS transaction will increase from 10.5% to 62% after the UK leaves the EU.

Another deterrent for insurers is that other asset classes may offer better value. In particular, whole loans can offer around 50%-60% return on capital over 4-5 years on average, while five-year triple-A ABS tranches backed by the same collateral may only offer a 2% return.

An open letter signed by AFME, the Deutsche Securitisation Association, Eurofinas, the European Banking Federation, the International Capital Market Association, Leaseeurope and the TSI takes a similar view to Bronsema. The industry bodies comment that they support the common framework and the framework for STS securitisations, but that EU legislation needs to create the right conditions to support the recovery of STS. They add that the new framework will change “very little”, if it is not recognised appropriately in other related legislation.

On the one hand, the associations welcome the proposed improvements in relation to senior tranches of STS securitisations, as they will result in a closer alignment with corporate and covered bonds. This should make it more attractive for insurers to invest in European securitisation and level the playing field with whole loan investment, while not incentivising investment in the same underlying assets in an unsecuritised and illiquid format.

On the other hand, the associations are clear that the proposed Solvency 2 risk factors remain “too high for the mezzanine and junior tranches of STS securitisations and for all non-STS securitisations.” This is important because of the vital role insurance investors play at the mezzanine and junior level, as these notes match their risk-return needs and transfer risk in the financial system.

They say that it is therefore “crucial” that revised calibrations under Solvency 2 be further adjusted at the non-senior STS level. This is especially true, as capital charges for non-senior STS securitisations remain “disproportionately high.”

The associations add that the same is true for non-STS securitisations, which should continue to play a role in the future market. Additionally, several “tough” new regulatory requirements in the Common Framework apply to all securitisations, not just STS.

They go on to criticise current liquidity coverage ratio (LCR) provisions and state that the senior tranches of STS term securitisations be recognised as Level 2A assets, or Level 2B assets with a haircut of 15% under the LCR. They note that all securitisations currently fall under the category of Level 2B.

The associations comment: “Many types of securitisations have demonstrated good levels of liquidity performance through and since the crisis. Supporting the eligibility of senior tranches of STS securitisations under the LCR will be a crucial opportunity to send a strong signal regarding the prudential strength of the STS framework.”

They continue: “It will create an incentive for bank investors to invest in the senior tranches of the highest quality securitisations and will redress to some extent the continuing very uneven playing field with other fixed income instruments.”

The associations also recommend that senior tranches – and only these – of all STS term securitisations should be classified as Level 2A assets, with maximum allocations and minimum haircuts equivalent to current treatment of covered bonds of CQS 2.

Bronsema says that there needs also to be an adjustment to the imbalance between banks and insurers. He says that banks have capital charges of 2% to invest in STS securitisation, while for insurers it is typically 10%, which he says isn’t fair or economically viable for most insurers.

“It is especially frustrating because ABS is certainly an attractive asset class, especially now. It currently makes a lot of sense to invest in ABS, with one reason being it is a floating rate product and so really appeals in a rising interest rate environment,” he says.

He continues: “It also has a long history of solid performance - particularly in Europe. Generally speaking, in Europe, securitisation works and has limited risks relative to other asset classes.”

Currently, Bronsema adds that Aegon is investing in shorter duration European paper because capital charges are per year and the yield curve is relatively flat. He says that the firm is “invested from triple-A down to triple-B in short duration, Type 2/non-STS transactions like European CLOs and UK consumer ABS.”

He adds that the firm is also investing in first-time US managers launching European CLOs, as they tend to offer higher yields. Outside ABS, Bromsema comments that the firm is looking at whole loans and the alternative credit space, including government and corporate debt, infrastructure and consumer debt.

More broadly, Bronsema is supportive of the STS classification, stating that it can help regulators become more comfortable with ABS and so help to level the playing field between ABS and other asset classes in the long term. He concludes that with regulatory backing, investor confidence in the asset class may therefore be boosted further and bring back investors deterred after the crisis, particularly pension funds.

RB

Capital Relief Trades

PRA's tough stance continues

Banks have been reviewing the PRA’s significant risk transfer (SRT) consultation, which proposes a full capital charge for excess spread in SRT securitisations and is expected to reduce the capital relief that can be achieved by UK issuers. The paper also introduces uncertainty over the hierarchy of approaches and is another indication that, going forward, the UK regulator’s stance on capital relief trades will remain far stricter, compared to the position of the EBA.  

According to the paper, banks that intend to include synthetic excess spread (SES) in an SRT transaction should count it as an “off-balance sheet securitisation position” for the purposes of calculating capital requirements. In particular, banks shall apply a 1250% risk weight, amounting to a 100% capital charge and a deduction from CET1 ratios.

“Excess spread is broadly understood as expected future income, which is why it is not treated as an on-balance sheet asset; this is why it doesn’t make much sense to hold capital against it. The PRA’s proposal will significantly reduce the amount of capital relief that we can get,” says a structurer at a large European bank.  

SES has been used as credit enhancement in SRT transactions to absorb losses before an investor takes on losses. However, regulators including the PRA and the EBA have raised objections on its usage - which is why it is not that common in transactions.

Nevertheless, the EBA only recommends requiring a capital deduction for excess spread if it’s structured as a trapped mechanism. The mechanism allows the amount of excess spread not absorbed by losses during a given year to remain trapped in the transaction in the form of a funded reserve account, available to absorb losses in future years.

The ‘use it or lose it’ mechanism, on other hand, stipulates that excess spread may be used to cover credit losses during each payment period. Excess spread not used for that purpose during the payment period is returned to the originator (SCI 23 March).

This stance contrasts with the position of the PRA, which requires a capital deduction for any excess spread used in an SRT deal - whether trapped or on a use it or lose it basis - as well as a full capital charge, despite the fact that SES is not recognised as an on-balance sheet item.

Another point of contention for banks is uncertainty over the capital treatment of an SRT transaction. The consultation proposes that the PRA should use its discretions on the hierarchy of approaches, if the UK regulator determines that the standardised approach (SA) or the internal ratings-based approach (IRBA) doesn’t cover additional risks, such as non-credit risks.

As one issuer explains: “If the PRA determines that the SA and the IRBA doesn’t capture all the risks, they can force us into the external ratings-based approach (ERBA). The problem with this is that the PRA opines on this after the deals have been executed, creating a lot of uncertainty over the capital treatment of our trades. It’s also unclear whether investors will agree post-closing to amend the documentation in order to include a rating.”

Robert Bradbury, md at StormHarbour, notes: “What may happen with regards to the hierarchy of approaches remains unclear. There could be a wide adoption of transactions into the SEC-IRBA, having the majority of transactions rated under SEC-ERBA or a hybrid of the two, determined on a case-by-case basis.”

He continues: “Among other factors, part of the driver behind the use of ratings in UK transactions was due to the ‘cliff effect’ and the resulting rapid changes in risk weights which can occur in the current framework. Given that the revised securitisation framework updates the approach for a number of such factors, it will be interesting to see how this develops.”

The PRA’s stance is not expected to change soon. Looking forward, the paper notes that the UK regulator will review SS9/13 following a delegated regulation from the European Commission. SS9/13 is a supervisory statement by the PRA - first released in December 2013 - that outlines its expectations on SRT transactions. The Commission on its part may adopt a delegated regulation following a report by the EBA on its SRT consultation in January 2021.  

The consultation paper adds though that, generally, the PRA will keep its approach as set out in SS9/13 under review. If it ultimately keeps the same approach as in SS9/13, this would effectively mean no pro-rata amortisation and no SRT if an issuer retains the first-loss tranche, as well as a continuation of the rating requirement.

The consultation closes on 22 August 2018.

SP

Capital Relief Trades

Mortgage SRT booster voted down

MEP Caroline Nagtegaal’s amendment 596 to Article 234 of the CRR was rejected by the European Parliament in a vote this week, in order to prevent the establishment of an unwanted precedent. The amendment had been expected to boost significant risk transfer (SRT) transactions of mortgages (SCI 20 April).

According to Article 234 of the CRR, loan-level insurance protection for synthetic securitisations that is tranched first-loss protection must apply Chapter Five of the securitisation framework, which is designed for portfolios rather than individual loans. This approach is very complicated and to date there is no known case of capital relief being achieved through this route.

If passed, the amendment would have allowed banks to treat first-loss protection as proportional protection (or partial protection) for the purpose of calculating capital relief and thus avoid having to go through the securitisation framework. This is accomplished by integrating the new Basel 3 rules into the CRR, which is expected to be introduced in 2022. However, the amendment itself would have become immediately effective, had it been legitimised by the European Parliament.

Brussels sources observe that the two biggest political groups in the European Parliament - the European People’s Party (EPP) and the Progressive Alliance of Socialists and Democrats (S&D) - agreed on a compromise package on mortgage risk weights that eventually left out amendment 596. “Initially, there was some support within the EPP over the amendment, but the party decided to toe the line in order to prevent a split in the alliance between the EPP and the Socialists,” says a source close to the discussions.

Tradition turned out to be the main cause behind the fallout. According to the same sources, EU practices stipulate an integration of the whole Basel package into the CRR. Furthermore, policymakers were said to be concerned that the introduction of an amendment to the CRR without integrating the whole framework could create an unwanted precedent.

Negotiators in favour of Nagtegaal’s amendment argued that it could help banks in member states with a high volume of mortgages - such as the Netherlands - to adapt to higher risk weights, following the integration of Basel 4 into the CRR.

Uncertainty currently clouds decisions over the next steps, although it is clear that the topic will not be a priority in the Trilogue discussions, which will start in two weeks’ time. This pushes the goal posts to 2019-2020 at the next review of the CRR, rendering the implementation of the amendment ever more important because that is when the integration of the Basel capital floors will be discussed. If the amendment is not integrated by then, cliff effects or abrupt increases in mortgage risk weights could be introduced, subsequent to the introduction of the capital floor proposals.

As another Brussels source concludes: “It should be at the negotiating table; why wait until 2022 when Basel 4 comes into effect? The amendment would have made it easier for banks to protect the first loss of each mortgage loan, typically with high loan-to-value ratios, and would have avoided any complication introduced by caps and floors.”

SP

Structured Finance

SCI Start the Week - 18 June

A look at the major activity in structured finance over the past seven days

Pipeline
A mixed bag of securitisations remained in the pipeline at the end of last week. ABS once again accounted for the majority of deals, but a number of CMBS and RMBS were also marketing.

The newly announced auto ABS comprised: US$1.11bn Ally Auto Receivables Trust 2018-3, US$399.32m California Republic Auto Receivables Trust 2018-1, Ford Auto Securitization Trust 2018-B, US$1.24bn GM Financial Automobile Leasing Trust series 2018-2, US$154m Hertz Vehicle Financing II Series 2018-2, US$154m Hertz Vehicle Financing II Series 2018-3 and US$1.11bn Santander Drive Auto Receivables Trust 2018-3. The non-auto related ABS consisted of US$821.5m Business Jet Securities 2018-2, US$699.33m Golden State Tobacco Securitization Corp series 2018A-1, US$350m MVW Owner Trust 2018-1 and US$746m Navient Student Loan Trust 2018-3.

US$466.93m Flagstar Mortgage Trust 2018-4, FT RMBS Prado VI, US$1.1bn Invitation Homes 2018-SFR3, CNY9.96bn Jianyuan 2018-11, £317.5m Malt Hill No. 2, US$437.94m Mill City Mortgage Loan Trust 2018-2, TIAA Bank Mortgage Loan Trust 2018-2 and £273.7m Trinidad Mortgage Securities 2018-1 made up the RMBS in the pipeline. The CMBS were US$1.22bn FREMF 2018-K77, US$400m JPMCC 2018-AON, €247.8m Kantoor Finance 2018 and €282.5m Libra (European Loan Conduit No. 31). The US$278.3m RCMF 2018-FL2 CRE CLO rounds out the newly announced deals.

Pricings
Last week’s pricings spanned a range of asset classes, from esoteric ABS to NPLs. A rare New Zealand RMBS also printed.

The non-auto ABS new issues included: US$130.14m Accelerated Assets 2018-1, €586.35m Aragon NPL 2018, US$279.68m CLUB 2018-P1, US$100m Coinstar Funding Series 2018-1, US$199.29m College Ave Student Loans 2018-A, US$991.78m DEFT 2018-1, US$256.35m FREED ABS Trust 2018-1, US$450m Golden Credit Card Trust series 2018-3, US$147.34m Renew 2018-1, US$686.5m SMB Private Education Loan Trust 2018-B, US$482.5m Trinity Rail Leasing 2018, US$368m Triton Container Finance VI Series 2018-2 and €652m Volta VI. The auto pricings were US$248m American Credit Acceptance Receivables Trust 2018-2, US$299.39m GLS Auto Receivables Issuer Trust 2018-2, €804m BBVA Consumer Auto 2018-1 and €600m SC Germany Auto 2018-1.

The RMBS prints were NZ$150m Avanti RMBS 2018-1 Trust, A$1bn Firstmac Mortgage Funding Trust No. 4 Series 2-2018, €827m 2018 Popolare Bari RMBS and US$1.05bn STACR 2018-DNA2. A handful of CLOs (US$511.65m Mariner CLO 6, US$516.5m Octagon Investment Partners XVI (refinancing) and US$509.6m Trinitas CLO VIII) and CMBS (US$603m Atrium Hotel Portfolio Trust 2018-ATRM and US$166m WFCM 2018-1745) were also issued.

Editor’s picks
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…
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…

Deal news

• 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.

Capital Relief Trades

Risk transfer round-up - 22 June

Intesa Sanpaolo is rumoured to be prepping a capital relief trade referencing corporate assets, with the transaction currently believed to be in the portfolio selection process. The Italian lender is a frequent issuer of synthetic SME securitisations, but it has been less active in the corporate space (see SCI’s capital relief trades database).

Structured Finance

PE players driving growth

Australian ABS and RMBS issuance saw record volumes of over A$8bn and A$37bn respectively in 2017, according to SCI data. The rise of fintech platforms, non-bank financial institutions and private equity-backed lenders in the country - combined with the global hunt for yield - is set to support continued growth of its securitisation market.

Private equity involvement in the Australian securitisation market began in 2015 when Deutsche Bank, KKR and Varde Partners acquired GE Capital’s Australian and New Zealand consumer finance business, renaming it Latitude Financial Services. The first public ABS issuance from that platform - a credit card deal - came in March 2017. Since then, RMBS issuers Pepper Homeloans, La Trobe Financial and Bluestone have received investment from or been bought out by KKR, Blackstone and Cerberus respectively.

Panellists at IMN’s recent Global ABS conference highlighted how the Australian securitisation market has benefitted from the injection of capital and experience by these private equity players. Indeed, multiple issuances are expected from their programmes over the next couple of years, along with the potential expansion of product types. Warehouse lines are also being extended to fintech companies in the personal loan and SME spaces, which could result in securitisation exits.

Jordan Batchelor, director, structured capital markets at ANZ Bank, said that the strength of the Australian securitisation market is attracting both domestic and offshore investors. “We’re seeing issuance right down the capital structure in RMBS, as the yield is attractive and worth doing the work.”

Fitch figures show that Australian 30+ day mortgage arrears increased by 12bp to 1.13% in 1Q18 from the previous quarter, although this is consistent with the seasonal increase in spending during the year-end holiday period and the rate remains 9bp lower than in 1Q17. Meanwhile, the conditional prepayment rate recorded five consecutive quarters at below 20%, reflecting increased refinancing difficulties due to a combination of tighter underwriting standards and regulatory restrictions on annual interest-only and investment-loan growth.

Batchelor noted that while there is a focus on whether there is a bubble in Australian housing, most observers don’t give enough credit to the fact that different regions have been performing differently in recent times. “For example, Tasmanian house prices have risen materially, whereas there has been some slow-down in Sydney and Melbourne – although increasing population and limited supply is likely to support demand for property in the long term within these cities. At the same time, stress in Western Australia from the mining downturn is flowing through, with this market potentially at a turning point,” he observed.

A stress test of Australian RMBS that Fitch conducted last month demonstrates the resilience of triple-A ratings across the segment. The agency ran a stress scenario similar to the Irish housing downturn in 2008, applying a default rate of 13% and a market value decline of 43% to its Australian RMBS portfolio over a three-year period. It also applied credit to lenders' mortgage insurance recoveries in line with criteria during the three-year stress period, but assumed that all RMBS ratings post the stress period reflected the LMI providers' being downgraded to triple-B.

Under the stress scenario, 78% of triple-A Australian RMBS ratings remained unchanged, with less than 1% downgraded to below investment grade. The downgrade of the LMI providers accounts for just under half of the triple-A downgrades, as Fitch does not apply credit to LMI for triple-A ratings when the providers are rated triple-B. The most resilient triple-A tranches were those from older vintages, which benefit from extra credit enhancement due to deleveraging since closing.

Looking ahead, the panellists noted that the market is awaiting the findings of the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. The commission - which was established in December 2017 - is due to publish an interim report by 30 September and a final report by 1 February 2019. The evidence presented by the commission so far points to the importance of strong compliance, reporting and governance frameworks for bank and non-bank financial institutions, as well as appropriate incentive structures to minimise potential moral hazard and conduct risks.

CS

Structured Finance

Market moves - 22 June

Europe

Axa Investment Managers has hired Hans Stoter to global head of fixed income and interim head of multi asset client solutions. He was previously cio at NN Investment Partners.

DBRS has hired Edward Dittmer to its CMBS team as svp and will be based in New York. He was previously svp in the CMBS team at Morningstar.

BlueBay has appointed Sid Chhabra to the newly created role of structured credit and CLOs, based in London. He will be leading a new drive to manage a range of BlueBay global structured credit and ABS strategies. He was previously at Anchorage Capital.

Octopus Property has hired Matthew Pritchard as head of structuring, based in London. He was previously a portfolio manager at Man Group and head of structured products Europe for Deutsche Pfandbriefbank.

Fund launches

Janus Henderson is planning to launch a mortgage-backed securities ETF. The firm has filed a preliminary registration statement with the SEC and it will be called the Janus Henderson Mortgage-Backed Securities ETF (JMBS) and will be co-managed by John Kerschner and Nick Childs.

Neuberger Berman is preparing to launch a CLO Income Fund pending approval at the end of July. It is aimed at investors looking for floating rate strategies in a rising interest rate environment.

North America

Two Harbors, a hybrid mortgage real estate investment trust, today appointed William Greenberg and Matthew Koeppen as co-deputy Chief Investment Officers, effective 1 July 2018. Prior to joining Two Harbors in 2012, Greenberg was an md at UBS AG. Most recently, Koeppen served as an md of business development, where he was responsible for a variety of initiatives to diversify and grow assets under management.

Secured crypto-token in the works

Artificial intelligence firm Blockchain Assets AI has launched with the aim of creating a US-compliant securitised and asset-backed crypto-token, called the Numeum. Unlike other cryptocurrencies that have limited or no intrinsic value, the Numeum - which will be issued by the Numeum Wealth Fund – is designed to have an intrinsic value, as its price will be supported by an actively managed asset pool backing the token. Further, the structure of the ‘Numeum System’ should allow the public to invest into a fund structure operating on the blockchain that was previously limited to accredited investors. The firm is currently seeking new directors/officers and is conducting a seed round via a private placement.

Sub-advisor motion due

An emergency motion to approve break-up fee, expense reimbursement and replacement sub-advisory requirements in the bankruptcy case of Highland Capital Management affiliate Acis Capital will be heard in the Texas Northern Bankruptcy Court on 6 July. The motion seeks an order granting an allowed administrative expense claim to Oaktree Capital Management and authorisation for the firm to replace Highland as sub-advisor to the ACIS CLO 2013-1, 2014-3, 2014-4, 2014-5 and 2015-6 deals. The bankruptcy petition was brought by ousted Acis portfolio manager Josh Terry and was converted from a chapter 7 case to a chapter 11 case in May, with Robin Phelan subsequently being appointed chapter 11 trustee for the debtors.