Contents

Capital Relief Trades

Risk transfer round-up - 26 April

CRT sector developments and deal news

The second quarter of this year is expected to be more active in terms of capital relief trade issuance, compared to previous years, as banks adapt to ESMA’s securitisation disclosure requirements and many uncompleted deals slated for 4Q18 move to this year. Among these transactions are said to be four SME and two leveraged loan risk transfer trades targeted for June.

CDO

Opportunities eyed

Trups CDO manager targets Europe

EJF Capital is eyeing opportunities in Europe, as bank consolidation pressures grow and rates continue to rise. However, the firm’s plans remain at an early stage, given that European consolidation lags behind that of US banks.

According to Omer Ijaz, md at EJF Capital: “We have set eyes on Europe, where we are seeing opportunities emerge in light of recent regulatory and market developments. However, opportunities are in their nascent stages, given that Europe lags behind the US in terms of consolidation. Regulatory pressures for consolidation and rising rates are catalysts for these opportunities going forward.”

Scope Ratings suggests that a major obstacle to further banking consolidation in Europe has been the lack of a supervisory level playing field, despite evolutionary improvements. Banks remain concerned about the regulatory and political treatment of cross-border mergers, including uncertainties about resolution structures or the possibility of capital and liquidity ring-fencing across jurisdictions, within or outside the EU.

EFJ’s shift to Trups CDOs began in 2011, but it became the firm’s core focus in 2015. Driving the shift has been the deregulation in the US community bank sector.

“We believe the regulatory costs for these banks are high and consolidation allows them access to the capital markets and a consequent cheaper cost of capital,” says Ijaz. Examples of such consolidation include the recent merger between SunTrust and BB&T.

Stelios Papadopoulos

NPLs

Global opportunities

Cerberus completes first dedicated NPL fund

Cerberus has closed a US$5.1bn dedicated non-performing loan fund. Dubbed Global NPL Fund, it targets NPL opportunities across the globe, as concerns regarding the late stages of the credit cycle continue to grow.

According to Massimo Famularo, board member at Frontis NPL: “Cerberus is clearly recognising that the NPL market is a global opportunity, with a convenient risk/reward profile that could become even more attractive as we approach the late stages of the cycle.”

Indeed, along with significant opportunities in Europe, Cerberus is eyeing NPL investments in China, India and Brazil. The private equity firm initially targeted US$3.5bn in commitments and closed approximately US$4.1bn from existing and new limited partners. In addition to the Global NPL Fund, the firm raised over US$1bn of commitments in separately managed accounts (SMAs) for its global NPL strategy.

Cerberus’ NPL platform is supported by 46 investment professionals that work in concert with its proprietary servicing platforms, including Cerberus European Servicing, along with third-party servicing partners in local jurisdictions.

Over the past 20 years, Cerberus has executed more than 215 NPL transactions across 17 countries globally, with a total transaction size in excess of US$65bn. Since 2013, the firm has been one of the major purchasers of European NPL portfolios, investing approximately US$15bn in equity.

Stelios Papadopoulos

CDO

Value investing

Tim Gramatovich, cio of Gateway Credit Partners, answers SCI's questions

Q: How and when did Gateway Credit Partners become involved in the securitisation market?
A: Gateway Credit Partners is the credit platform of B Riley Financial’s investment advisor subsidiary B Riley Capital Management and was established in March (SCI 26 March). Our strategy is to identify and acquire undervalued non-investment grade corporate credit securities and implement our portfolio management services through actively managed CDO structures. We are value investors in the credit market.

I have over 33 years of experience in leveraged finance and was formerly co-founder and cio of Peritus Asset Management, which issued two cashflow high yield bond CDOs - one in 2003 and a follow-up in 2005 (Peritus I CDO). I brought with me a four-person team to B Riley: we’ve been working together for over 15 years now.

The common thread in today’s environment is that it is necessary to have scale and stability, from compliance resources all the way through to capital. B Riley has the opportunity to co-invest in all of our deals.

Q: What are your key areas of focus today?
A: We see interesting opportunities in the secondary loan market at present. We have seen retail outflows from ETFs and mutual funds for 20 straight weeks and this has caused some downward pricing pressure, which presents a good entry point to many secondary loans.

Given the length of the credit cycle, we are highly cognisant of risk, particularly as it relates to what we see as insanely aggressive addbacks to increase reported cashflow numbers. Today we have pushed the boundaries of sanity with what is called “pro-forma further adjusted EBITDA.”  So many reported levels of leverage are dramatically understated, which is why an active approach to credit risk is key.

Our focus is on matching the opportunity set with the correct structure, credit selection and active management. We aim to create value by building a portfolio that has around half the leverage metrics of the broader market (at around 3x), yet significantly exceeds the yield of the market.

As we develop the portfolio – including both high yield bonds and leveraged loans - we’ll let the market dictate the optimal structure and timing of issuance. Employing CDO technology is interesting and appropriate, given the lack of mark-to-market risk and liquidity constraints involved. We’re open to other vehicles, as long as they have rational liquidity constraints.

Another thing we have done historically is to protect our structures from rating migration. Rating agencies tend to issue blanket downgrades when the tide goes out. As such, a large triple-C bucket (north of 20%-25% historically) is also crucial for deals to be protected in the current and future environment.

Q: How do you differentiate yourself from your competitors?
A: Our focus is on the asset side of the ledger. We consider ourselves adept at managing bond and loan portfolios.

We are not structured credit investors, but use structured credit vehicles to term finance our portfolios appropriately. The portfolio will determine the appropriate capital structure, not the other way around.

We include both bonds and loans in our structures to both reduce risk and increase the opportunity set. We are somewhat agnostic on the security, as our focus is on the spread and yield per turn of leverage – whether that is represented by a bond or loan is secondary.

Importantly, we believe size is something we can continue to arbitrage. Rating agency models favour size and longevity, so punish companies (with poor ratings) who are deemed smaller (sub US$1bn in revenues).

We expect our average tranche size to remain under US$500m. This would be considered a hybrid between a traditional broadly syndicated loan CLO and a middle market deal.

We typically look to allocate US$5m-US$10m per name. At that level, we’re not being disruptive, but still have enough stroke to negotiate good execution. This is the sweet spot for us, as that range is too small for most CLO managers.

Q: What is your strategy going forward?
A: We expect that over 90% of our investments are likely to be sourced in the secondary market, but we’d like to keep access to the primary market open when markets become challenged. The team has a long history of being able to execute trades in the secondary market – it is highly reputational and good relationships are crucial to success.

Corinne Smith

Insurance-linked securities

Landmark involvement

Michael Bennett, head of derivatives and structured finance for the World Bank Treasury, answers SCI's questions

Q: How and when did the World Bank Treasury become involved in the risk transfer market?
A: We became involved in insurance risk transfer in 2007 when we began to intermediate drought and other natural catastrophe swaps for member countries and regional facilities. We extended that work to the capital markets beginning in 2009 with the creation of our MultiCat programme, a platform our member countries can use to issue catastrophe bonds to cover themselves against the risk of natural disasters. Since then, we’ve issued roughly US$2.7bn outstanding of cat bonds, including several landmark transactions for the market.

The other way the World Bank is involved in the risk transfer market is by issuing puttable bonds that can be used by other cat bond issuers as liquid, high-quality collateral, given the post-crisis requirement for sources of conservative collateral. The bonds are triple-A rated and floating rate, with periodic puts that enable a sponsor to call the bond and sell the collateral to pay noteholders, should a covered event occur. We’ve issued 60 of these bonds so far, totalling US$13bn.

Q: Which landmark transactions has the World Bank been involved with?
A: The MultiCat programme was first used by the Mexican government in 2009 to issue the US$290m three-year MultiCat Mexico 2009 deal, which provided parametric insurance coverage against earthquake risk in three regions around Mexico City and hurricanes on the Atlantic and Pacific coasts (see SCI’s primary issuance database). The Mexican government tapped the capital markets again in 2012, with the US$315m three-year MultiCat Mexico series 2012-I, which provided parametric insurance coverage against earthquake risk in five geographic regions and hurricane risk in three regions along the Atlantic and Pacific coasts. Goldman Sachs and Swiss Re acted as co-lead managers on both deals.

For the MultiCat Mexico deals, a separate SPV was set up for each issuance. However, we decided to simplify the process in 2014 by issuing cat bonds off our own balance sheet, thereby avoiding the need to establish SPVs and maintain collateral.

World Bank cat bonds are issued off a supplement to our regular triple-A rated Global Debt Issuance Facility (called the Capital At Risk (CAR) notes supplement) and are similar to other World Bank bonds, except that (due to the risk of loss of principal) they may not be assigned a credit rating or may be assigned a lower rating than the Facility. The aim was to make our issuance more flexible, in terms of including new perils and regions, and to potentially enhance yield for investors.

In 2014, we issued a US$30m three-year parametric cat bond covering earthquake and hurricane for the 16 countries participating in the Caribbean Catastrophe Risk Insurance Facility via the IBRD (SCI 3 July 2014). GC Securities served as sole placement agent and co-structuring agent with Munich Re on this deal.

Three years later, the World Bank launched the first pandemic cat bonds – the US$320m IBRD CAR 111 and 112 notes (SCI 30 June 2017). The issuance supported the Pandemic Emergency Financing Facility (PEF), which is our mechanism for channelling surge funding to developing countries facing the risk of a pandemic.

Swiss Re was sole book runner for the bond placement and joint structuring agent with Munich Re. Munich Re and GC Securities were co-managers.

The Mexican government also returned to the cat bond market in 2017, with three tranches of Capital At Risk notes – CAR 113, 114 and 115 – issued via the IBRD for a total of US$360m. The transactions provided parametric coverage for earthquakes and named storms, with GC Securities acting as sole bookrunner and joint structuring agent/co-manager alongside Munich Re.

Finally, last year we printed the second-largest cat bond ever and the largest sovereign risk transfer transaction (SCI 8 February 2018). Sized at US$1.36bn, the deal covers earthquake risk in the four Pacific Alliance countries of Mexico, Chile, Columbia and Peru – marking the first time the latter three jurisdictions have accessed the capital markets to obtain insurance for natural disasters. The issuance comprised five classes of bonds – CAR notes 116 to 120.

Q: The PEF Facility is notable for having a cash window and an insurance window. What was the World Bank trying to achieve with this structure?
A: The PEF was informed by the Ebola outbreak in West Africa that began in 2013. We were trying to solve the issue of relief cash not being made available fast enough to stamp out outbreaks of the virus.

The idea was to use risk transfer to expand risk takers to the private sector and to access the cash quickly once certain parametric triggers were hit. Since this was a very novel transaction, it took a long time to work out with our partners in the international community - most notably the World Health Organization, the donor governments and our private sector partners - which viruses to cover, the proper risk modelling and the parameters of the events we wanted to cover. Ultimately, the facility covered six of the viruses most likely to cause pandemics: flu, coronavirus, filovirus, lassa fever virus, rift valley fever virus and Crimean Congo hemorrhagic fever virus.

The structure involved the establishment of a trust fund that receives donations from Australia, Germany and Japan, which was split into two windows. The cash window is a pool of donations that can be deployed without specific parameters and at the will of the donors. The insurance window employs risk transfer to provide US$425m of pandemic coverage over three years.

Because it was a new risk to the market, we weren’t sure where we’d achieve the best capacity and price – with traditional insurers or via the capital markets. Consequently, we decided on a highly innovative approach: simultaneously placing the risk in the two markets through one joint book - ultimately placing US$105m with insurers and US$320m in cat bond form with investors across Asia, Europe, the US and Bermuda.

The PEF matures next year and so we’re currently exploring how we can possibly improve the coverage with the next iteration of the facility (SCI 11 April). The original parameter was to cover regional outbreaks; the next version could potentially comprise single-country coverage and/or cover more or different viruses. Another possibility we’re considering is whether it’s possible to tie the cash and insurance windows even closer together to reduce costs.

Q: What is your strategy going forward?
A: We have only scratched the surface of the member countries exposed to natural catastrophes. Thus far, only four of our 189 member countries and two facilities have tapped the cat bond market through our intermediation.

In theory, the World Bank can issue cat bonds covering any type of risk, but so far we’ve concentrated on natural catastrophes and pandemics.

Generally, we continue to look at the insurability of other risks. For instance, we are actively investigating whether the risk of famine could be insured in a manner possibly similar to the way we have insured pandemics. Another risk we are looking at are losses for governments related to cyber attacks.

Corinne Smith

Structured Finance

Lender charged for overstating returns

Sector developments and company hires

CRT analytics
dv01 has launched a credit risk transfer market surveillance offering, which adds US$1.8trn of Freddie Mac STACR and Fannie Mae CAS securitisations to its loan-level data analytics platform. The service allows investors to analyse historical performance of CRT deals individually or combined, perform whole market analysis and run cashflow scenarios.

MPL platform charged
The US SEC has ordered Prosper Funding to pay a US$3m penalty for miscalculating and materially overstating annualised net returns to more than 30,000 investors on individual account pages on its website and in emails soliciting additional investments. According to the order, from approximately July 2015 until May 2017, the marketplace lending platform excluded certain non-performing charged-off loans from its calculation of annualised net returns – resulting in many investors deciding to make additional investments. The order also finds that Prosper failed to identify and correct the error, despite its knowledge that it no longer understood how annualised net returns were calculated and despite investor complaints about the calculation.

Platinum HECMs
Investors in Ginnie Mae securities backed by HECMs can now take advantage of a new form of execution - the Home Equity Conversion Mortgages Backed Security (HMBS) Platinum securitisation channel. The platform is designed to ease the administrative costs of holding multiple HMBS securities and enhance market liquidity. Platinum products can be created using fixed-rate MBS (15- and 30-year mortgages), WAC ARM and jumbo-only fixed mortgages.

Structured Finance

Rating agency names managing director

Sector developments and company hires

EMEA
Scope has named Guillaume Jolivet as md. He joins the firm’s management board, alongside Torsten Hinrichs, coo of the Scope Group. With more than 18 years of experience in credit analysis and ratings, Jolivet joined Scope in 2013 and held several senior positions at Moody’s and UBS before that.

New York University’s Stern School of Business finance professor Edward Altman and former head of risk appetite portfolio decisioning at RBS Gabriele Sabato have co-founded Wiserfunding. The platform assesses the creditworthiness of SMEs across Europe and uses a proprietary Bond Rating Equivalent method to enable risk assessments to be comparable across industries and markets. Building on the Z-Score model, Wiserfunding uses artificial intelligence to assess intangible factors, such as corporate governance, management capacity and macroeconomic outlook. The aim is to empower businesses to obtain finance and lenders and insurers to assess the risk of business applicants by providing more accurate data.