News Analysis
CLOs
New wave?
Could ESG CLOs be the start of a trend?
Fair Oaks Capital is set to issue a debut European CLO in 2Q19 and, notably, it has been structured according to strict ESG criteria. It follows hot-on-the-heels of similar transactions from Permira Debt Managers last year and it may be the start of things to come in terms of greater adoption of ESG-aligned investment strategies in the US and Europe.
Tyler Wallace, pm at Fair Oaks, says that his firm has signed the UN’s Principles for Responsible Investing (PRI) and so it is committed to incorporating responsible investing at a firm level. This then filters through the whole company strategy, including investing in and managing, CLOs.
In terms of why the firm is driven by an ESG investment strategy, he says that this is largely down to the ethical and philosophical stance of the founders, but adds that “we do think we are getting ahead of the curve.” In line with this, he predicts that in five years the vast majority of investment firms will have a strong ESG mandate.
Wallace adds that this impacts two areas of the firm’s strategy in terms of investing at the CLO equity level and the mezzanine level. When investing at the CLO control equity level, says Wallace, the firm has more influence on ESG strategy and what the CLO invests in - at the mezzanine level, it is harder to have the same level of control.
“I know of instances” he says, “where Fair Oaks has ensured that the CLO manager switch out of a particular exposure because it breaches ESG agreements. For example, we have pushed managers in some instances to move out of exposure linked to defence and this has been unrelated to the credit quality of the firm but simply because it doesn’t fit our ESG principles.”
In line with this, the CLO will have Fair Oaks’ ESG language embedded in it and the CLO ESG documentation, says, Wallace, is modelled off of other European CLOs with ESG language. Permira Debt Managers (PDM), has issued two CLOs to date from its Providus platform (see SCI new issuance database), following ESG investment criteria.
Ariadna Stefanescu, co-pm at PDM, says that ESG has been a focus for her company since it started, initially implemented on the direct lending side and then through to its Providus CLO 2.0 platform. She adds that she “understands” that the firm is the first to write ESG criteria into the fund documentation and then both the Providus CLOs.
She says that ESG is “emphasised internally, externally and is something we feel investors want.” In terms of investor reception to the CLOs, Stefanescu says that the feedback has been positive and that more institutions – especially in Europe – are taking ESG into account.
Wallace seconds this and says: “In Europe at least there has been a growing number of end investors, pension and insurance firms, that have been pushing for more ESG compliant investments and this will likely drive things further toward ESG investing. Feedback is therefore positive in this regard.”
Stefanescu does highlight, however, that an ESG-aligned investment approach is not without its challenges. “At the moment” she says, “it is still a relatively recent focus and there are certainly some people in the market that don’t know how to interpret it or make it relevant to their strategies.”
She continues: “We believe we can keep improving our ESG commitments and are always looking to fine tune-it deal by deal, doc by doc– for now, though, we are delighted to have made a significant first step for the sector by including explicit ESG criteria in the fund docs.”
It terms of challenges involved in putting together an ESG CLO, Stefanescu says that PDM incorporates ESG commitments throughout the ethos of the business, so that the “inclusion of negative screening in the docs” hasn’t presented major challenges, as it focuses away from these contentious investment areas anyway. She adds: “Reputational risk searches for ESG ‘red flags’ such as human rights, environmental issues or governance issues also help us consider potential risks for investments.”
This mentality was echoed by Wallace, who says that it doesn’t make it harder to launch a CLO in line with ESG criteria because the ESG approach is embedded at a firm wide level. This is aided by an investment team of analysts weighing up all the potential exposures against a number of ESG criteria, before including in the CLO portfolio.
He adds, however: “There are sometimes quite clear guidelines, but the process can be trickier. For example, if a firm is tied to defence we would avoid that but there are some grey areas - some firms may produce palm oil but in an ethical way, so that would have to be taken in to account.”
In terms of pricing, Wallace doesn’t think tiering is likely to appear until the ESG CLO market is much larger than it is currently. Stefanescu agrees, to an extent, and says that she doesn’t think the ESG focus has affected the pricing of her firms’ CLOs, but, she notes: “We believe there is a link between ESG criteria and credit risk and that companies we are screening out are also likely to have a higher credit risk in the medium to long term.”
With regard to whether ESG CLOs, are likely to be the start of a trend, Stefanescu thinks so. “We have certainly seen more of our peers follow suit. We understand that ESG screening requirements have been used for some time in the CLO market but that it’s unusual to have included these in the fund documentation.”
She continues: “ESG and responsible investment is becoming increasingly mainstream across asset classes and that trend will likely become more pervasive in the CLO markets too.”
Likewise, she doesn’t think it is a big leap for a company to commit to ESG but says it is a “careful and slow process” as a firm has to be completely committed to the value of the ESG approach. She says that some hurdles still may remain for the investor community, however, such as “further interest from investors on including ESG considerations in CLO markets and demonstrating that the approach benefits returns and investment outcomes. I think that is an area that the sector could do better in quantifying and we are keen to undertake more analysis of the benefits.”
For Wallace, his firm is also contending with the challenges associated with being a first time issuer although he thinks his firm can allay these worries. He says: “There is some concern that debut issuers won’t have the same infrastructure as existing managers. Fair Oaks has its headquarters in London and invested upfront in a dedicated European CLO management team.”
He concludes: “There is also sometimes a concern where firms might be involved in say distressed debt and move into CLOs. We have always been a specialist corporate credit investment firm, so issuing a CLO is an extension of what we do.”
Richard Budden
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Market Reports
RMBS
Sonia success
European ABS market update
The first UK STS RMBS – Nationwide’s Silverstone Master Issuer 2019-1 – priced yesterday, with substantial demand seen for both the sterling and US dollar tranches. The transaction is also the debut deal to publicly place a floating coupon referencing Sonia.
Silverstone 2019-1’s US$350m triple-A rated 1.95-year class 1A notes printed at three-month Libor plus 57bp (compared to initial price thoughts of plus 65bp area), while the £750m triple-A rated 2.94-year class 2A notes came at Sonia plus 75bp (compared to IPTs of low-80s). Coverage levels were 4.9x and 1.9x respectively.
One trader points to the “small premium” paid for the sterling notes. “There is currently a 10bp differential between Libor and Sonia, which means there was around a 5bp pick-up for the class 2A notes.”
However, TwentyFour Asset Management partner and portfolio manager Douglas Charleston suggests that the strength of the book did not necessarily warrant a material premium. He notes that the sterling tranche was upsized twice from the initial £250m target.
“While it is hard to extrapolate any incremental demand compared to that for Libor paper, we understand that bank treasury buyers were early adopters of Sonia-linked deals and are likely to have supported this inaugural deal,” he adds.
Similarly, the trader says it is difficult to judge whether STS compliancy is resulting in better deal execution, given that only three deals with the label have been publicly placed so far. He indicates that the focus is more about “making progress down the STS road”, which will hopefully enable more accounts to participate in the European ABS market.
Looking ahead, the trader notes that the heavy pipeline over the last few weeks has been absorbed well but hasn’t quite cleared yet. “I expect new issuance to be a bit lighter over the Easter period and then start building ahead of the Global ABS conference. Secondary market activity has been quiet while the primary supply has been dealt with, but the focus is likely to be on secondary opportunities for the rest of this month.”
Corinne Smith
News
Structured Finance
SCI Start the Week - 15 April
A review of securitisation activity over the past seven days
SCI seminars
- SCI's 2nd Annual NPL Securitisation Seminar will be held on 13 May in Milan. For more information or to register, click here.
- SCI's 1st Annual Middle Market CLO Seminar will be held on 26 June in New York. For more information or to register, click here.
Transaction of the week
DLA Piper bulked up its securitisation capabilities to 20 lawyers for Stack Infrastructure's inaugural and innovative ABS from February, due to structuring challenges (SCI 12 April). The potential for rendering the deal risk retention-compliant means that similar deals could be seen in Europe in the future.
Dubbed Stack Infrastructure Issuer series 2019-1, the deal is a securitisation of real estate and tenant lease payments for space and electrical capacity in Stack Infrastructure's six completed and operating wholesale data centres located across five states. Stack plans to use the proceeds to repay existing debt and for other purposes, including further development of data centres. Indeed, securitisation proved an attractive tool for refinancing the data centres, due to the cheaper cost of financing.
The structure of the securitisation had to reflect the firm's business model, which involves numerous expenses, many reserve requirements and different leases. As such, DLA Piper reviewed every lease and addressed various state-level real estate matters, including transfer tax issues. Hence requiring a team of 18-20 attorneys across the US.
Rated by S&P, the transaction comprises US$125m single-A minus rated class A1 and US$725m single-A minus class A2 notes (which priced with a 4.540% coupon) (see SCI's primary issuance database). Among the strengths of the transaction are the current tenants' high average credit quality, leases that are important to the tenants' core businesses - with the majority of leased capacity supporting revenue-generating services - and geographic diversity, with sites in Oregon, Georgia, Illinois, Texas and California. Weaknesses include limited industry diversity - with the majority of tenants in various subsectors of the technology industry - and limited historical sector performance data.
The deal is structured as a master trust, allowing for the addition of new collateral and the issuance of additional series of notes. David Ridenour, partner at DLA Piper, notes: "The master trust structure is an efficient way of adding new collateral to an existing pool of assets and reduces the cost of future financings. Given the asset class, the overcollateralisation of the pool and the various credit enhancement mechanisms, investors see this structure as a relatively low risk."
Other deal-related news
- The first seasoned non-qualified mortgage RMBS issued by a private fund managed by PIMCO is marketing. The US$382.45m transaction, dubbed BRAVO Residential Funding Trust 2019-1, is backed by 1,311 loans originated by Capital One and acquired by a PIMCO-run fund in a bulk sale (SCI 12 April).
- The One Stamford Forum loan, securitised in the MSBAM 2016-C31 and WFCM 2016-BNK1 CMBS, transferred to special servicing due to imminent monetary default. The property's top tenant Purdue Pharma is understood to be preparing a bankruptcy filing to mitigate its liability from lawsuits alleging its role in the opioid epidemic. For more CRE-related news, see SCI's CMBS loan events database.
- The World Bank Group is seeking to hire a modeling agent to work on the development of the next phase of its Pandemic Emergency Financing Facility (PEF 2.0), an insurance-based financing mechanism supporting efforts to tackle rare, high-severity disease outbreaks, with the aim of preventing such outbreaks from becoming pandemics (SCI 30 June 2017). In advance of the scheduled maturity of the PEF 1.0 parametric insurance coverage in July 2020, the World Bank - with the help of selected re/insurance brokers - is reviewing all aspects of the structure in order to improve the programme, where necessary, for the anticipated commencement of marketing the PEF 2.0 risk transfer mechanism in May 2020 (SCI 11 April).
Regulatory round-up
- The European Council has adopted new rules for the provisioning of non-performing loans, which stipulate loss coverage for future NPLs with different coverage requirements depending on different NPL classifications. The text is a relief for Italian banks, given the application of the rules to newly created NPLs - both secured and unsecured (SCI 10 April).
- The European Court of Justice's (ECJ) 26 March judgement on early-termination clauses in Spanish consumer mortgage contracts could result in the use of quicker mortgage foreclosure proceedings in Spanish non-performing loan transactions. The final outcome rests with the Spanish courts, however, prolonging existing uncertainty over the course and length of Spanish foreclosure proceedings (SCI 12 April).
Data
Pricings
US ABS issuance roared back into life last week, with 13 transactions pricing, including seven auto deals. Meanwhile, five international RMBS also printed.
The auto-related securitisations were: US$1.37bn CarMax Auto Owner Trust 2019-2, US$228.28m CPS Auto Receivables Trust 2019-B, US$998.04m Daimler Trucks Retail Trust 2019-1, US$1.25bn GM Financial Consumer Automobile Receivables Trust 2019-2, US$1.25bn Nissan Auto Lease Trust 2019-A, US$1.23bn Santander Retail Auto Lease Trust 2019-A and US$270m US Auto Funding Trust 2019-1. The other ABS pricings comprised: US$374.89m Ascentium Equipment Receivables 2019-1, US$867.57m Castlelake Aircraft Structured Trust 2019-1, US$302.7m CCG Receivables Trust 2019-1, US$914.69m Dell Equipment Finance Trust 2019-1, US$746.6m Navient Student Loan Trust 2019-2 and US$300m PFS Financing Corp Series 2019-A.
Last week's RMBS issuance consisted of €219.2m Cartesian Residential Mortgages Blue, US$857.33m CAS 2019-R03, €215m Dilosk RMBS No. 3, A$750m La Trobe Financial Capital Markets Trust 2019-1, €358m Mulcair Securities and A$750m-equivalent Pepper I-Prime 2019-1. The US$634m Apidos XXXI, US$405m Barings 2019-III, US$438m Benefit Street Partners IV (refinancing), US$614.8m Carlyle CLO 2012-4 (refinancing), US$656m Magnetite XXII and US$503.31m Nassau 2019-I deals were among the CLOs that priced. Finally, the US$1.6bn FREMF 2019-K734 CMBS was also issued.
BWIC volume
Podcast
Episode six of SCI's podcast is now available. In this edition, we discuss European CLO structural innovations, the difficulties involved in securitising unlikely-to-pay loans and the evolving CRE CLO landscape.
News
Capital Relief Trades
Risk transfer round-up - 18 April
CRT sector developments and deal news
Credit Suisse is believed to be readying a corporate capital relief trade from its Elvetia programme that is expected to close in June. The Swiss lender’s previous Elvetia trade closed in November last year (SCI 30 November 2018).
Another risk transfer transaction that is reportedly in the pipeline for this year is a commercial real estate deal from Raiffeisen. Two CRE CRT waves have hit the market over the last two years, with all six deals referencing UK commercial real estate (see SCI’s capital relief trades database).
Market Moves
Structured Finance
ILS restructuring agreed
Sector developments and company hires
ILS restructuring agreed
Ballantyne Re has entered into a lock-up support agreement with Ambac Assurance UK, Assured Guaranty, approximately 82% by value of the class A noteholders, Security Life of Denver Insurance Company (SLD) and Swiss Re Life and Health America (SRLHA) in connection with a proposed restructuring transaction in respect of its obligations under the ILS notes. The key features of the restructuring include: novation of the indemnity reinsurance agreement between Ballantyne and SLD to SRLHA; disbursement of the assets from Ballantyne's reinsurance trust account to effectuate the novation and pay class A noteholders; commute the financial guarantees provided by Ambac; and preserve claims under the financial guarantees provided by Assured Guaranty. The restructuring will be implemented through a scheme of arrangement under Part 9 of the Irish Companies Act 2014, requiring the consent of a majority of class A noteholders, following which Ballantyne will be wound-up by way of a solvent liquidation. The transaction experienced around US$1bn of losses between May 2006 and October 2008 - as approximately 95% of its proceeds was invested in subprime and Alt-A RMBS – and its class C notes were contractually written-down as a result, while there is no economic value attributable to the class B notes (SCI 30 July 2013). Class A noteholders are expected to be paid approximately 51% of par, with an additional cash payment of 17.4% to each class A2a noteholder and 14.5% to each class A3 noteholder, plus a deferred consideration of up to 1%. The lock-up fee is 1.25% of the par value of the notes held by each consenting noteholder.
Law firm bulks up
Allen & Overy has promoted Suril Patel to partner within its CLO practice in London.
Partnerships
Moody’s Analytics and European DataWarehouse are partnering to help originators and sponsors of ABS comply with select transparency requirements under the Securitisation Regulation (EU) 2017/2402 (The Regulation). The Regulation requires originators and sponsors to meet disclosure requirements for public securitisations to be eligible for the STS designation through notification to securitisation repositories. Originators and sponsors will now be able manage their STS disclosure requirements through the joint effort of European DataWarehouse and Moody’s Analytics.
Sub-prime penalty levied
General Electric has been ordered to pay a civil penalty of US$1.5bn to resolve claims involving subprime residential mortgage loans originated by WMC Mortgage (WMC), a GE subsidiary, after WMC was acquired by GE in 2004. WMC, GE, and their affiliates allegedly misrepresented the quality of WMC’s loans and the extent of WMC’s internal quality and fraud controls in connection with the marketing and sale of residential mortgage-backed securities (RMBS).
Market Moves
Structured Finance
BMF administration order filed
Sector developments and company hires
BMF 6 tender
An application for an administration order in respect of Business Mortgage Finance 6 was presented in the London High Court of Justice last week, with a return date of 18 April. The application was presented by Greencoat Investments, which is understood to be in the process of carrying out a tender process for the acquisition of certain notes, but is not presently a noteholder of the securitisation. The application has been made by Greencoat in its purported capacity as a contingent or prospective creditor of the issuer, but the issuer intends to oppose the application on the basis that Greencoat does not have standing to file it.
CMBS losses
KBRA has examined US conduit CMBS issued between 2005 and 2008 to determine historical losses by vintage, certificate class and original rating. As of the February 2019 remittance period, 23 of the transactions were retired, leaving 168 active deals secured by 1,333 loans comprising an aggregate unpaid balance of US$17.6bn. The total original balance for the 191 legacy conduits in this cohort was US$498bn and these transactions experienced aggregate realised losses totalling US$43.6bn (equating to an 8.74% severity), according to the study.
Debt service change
A proposed law (Bill 87) introduced in Canada last month would require the Province of Ontario to pay all debt-service costs associated with Fair Hydro Trust Series 2018-1 and 2018-2 notes, instead of only providing a contingent guarantee. Moody’s suggests that the rules are credit neutral, given that the change only alters the nature of governmental support and not the underlying risk of the debt. The proposal would end FHT's reliance on future consumer charges to fund the note payments.
Market Moves
Structured Finance
CLO manager denied incentive fee
Sector developments and company hires
Incentive fee ruling
The High Court in London has ruled that Barings (UK), as collateral manager, was not entitled to an incentive fee at the expense of junior bondholders following the optional redemption of the Duchess VI CLO. Part 8 proceedings were brought by Deutsche Trustee Company, to determine the correct interpretation of the bond documentation in which Barings (UK) claimed to be entitled to over €15m in the form of an incentive collateral management fee, following the redemption of the structure by the class F noteholders. Collyer Bristow acted for Napier Park European Credit Opportunities Fund as representative of the class F noteholders, which are now entitled to funds that had been reserved during the dispute. The collateral manager has permission to appeal the ruling.
North America
Capsicum Re has hired Stephen Mathews to lead the global analytics capability of its mortgage indemnity reinsurance division, based in New York. He reports to Steven Rance, managing partner of mortgage indemnity reinsurance. Mathews was previously md of Guy Carpenter and a co-founder of its mortgage credit specialty reinsurance practice. Before that, he was with Willis Capital Markets & Advisory, Bank of America Merrill Lynch and Goldman Sachs.
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