Contents

NPLs

NPL relief

ECB extends provisioning calendar

The ECB is set to align its supervisory expectations regarding the provisioning of new non-performing loans with an April 2019 amendment to the CRR that outlines Pillar 1 requirements for the assets. The alignment offers banks more time to provision for recently classified NPLs, but is expected to have a minimal impact on NPL securitisations, given that the bulk of such deals are backed by seasoned portfolios.

Marco Troiano, executive director at Scope Ratings, notes: “The fact that the regulation applies to loans originated after 26 April means that the existing stock of NPLs won’t be affected by this change. I don’t think securitisations will be affected, since what gets securitised tends to be more seasoned.” 

The April 2019 amendment to the CRR regarding the minimum loss coverage for NPLs established legally-binding provisioning requirements under Pillar 1 for NPLs originated after 26 April 2019. Banks failing to meet provisioning requirements on loans originated after that date will be forced to make mandatory deductions from CET1 capital. At the same time, though, the amendment gave banks more time to comply.

The pathway to achieving 100% coverage for secured NPLs was updated to take into account the longer CRR timeframe and hence stipulates: 25% coverage in the fourth year following NPL classification, 35% in year five, 55% in year six, 70% in year seven for loans secured by immovable property, 80% in year seven for other secured NPLs, 80% in year eight for exposures secured by immovable property, 100% for other secured NPEs by the first day of year eight, 85% for exposures secured by immovable property in year nine and 100% by the first day of year 10.

The timeline for achieving full coverage for unsecured exposures was extended from two years under the addendum to three years. Banks will be required to achieve 35% coverage by the end of the third year and 100% from the first day of year four.

When the ECB’s addendum was published it caused a rift with the European Parliament, since the supervisor was perceived to be overstepping its mandate. The ECB responded by saying that the addendum was simply a Pillar 2 measure or an expectation and consequently doesn’t constitute a ‘regulation’. The CRR amendment, by contrast, is a mandatory Pillar 1 regulation.

Hence, lenders that don’t comply with the calendar as set out in the CRR amendment will face capital deductions. But banks that violate the ECB’s expectations on coverage may receive a higher capital requirement under Pillar 2, although this will depend on the supervisory dialogue between the banks and the ECB.

Troiano states: “Under the amended CRR, a capital deduction would be made for any provisioning shortfall. Moreover, different supervisory expectation under Pillar 2 may still apply on a bank-by-bank basis and in certain situations on a loan-by-loan basis.”

The extra breathing space that banks now have as a result of the CRR amendments can be seen as a somewhat more liberal approach. “The addendum schedule was tighter than the new Pillar 1 requirements, so this is a minor loosening of the supervisory screws for banks going forward,” says Troiano.

However, the ECB stresses that its addendum will remain important for some time to come. According to the accompanying ECB document that was published last week: “For several years, the provisioning inadequacy related to the NPEs will not be addressed by Pillar 1 NPE treatment. Instead, the supervisory expectations for prudential provisioning for NPEs under the ECB’s Pillar 2 approach will remain the key tool for several years to bridge the gap to a state where the majority of exposures become subject to the CRR Pillar 1 NPE treatment.”

Stelios Papadopoulos

Capital Relief Trades

Regulatory boost

Italian SRT issuance picks up

Italian capital relief trades are experiencing a strong pick-up in issuance this year as regulatory changes enable more standardised banks to execute risk transfer transactions and open up the market to private investors. However, these banks will need time to adapt their IT and reporting systems, while risk-sharing transactions involving both SSAs and private investors are a more promising prospect.

Italian standardised banks including Banca Popolare di Bari have already completed transactions with private investors this year (SCI 2 August) and others, such as Banca Popolare dell'Alto Adige, are believed to be readying trades for 4Q19. According to Gregorio Consoli, partner at Chiomenti: “Before the new securitisation regulation, banks using the standardised approach suffered a more punitive treatment for the unrated tranches of their synthetic securitisations. Until then, all such banks had to consider a rating, but if you couldn’t get ratings on a retained tranche, they had to apply a 1250% risk weight and a corresponding deduction from capital.”

He continues: “This was the main issue with the old regime; you needed a rating if you weren’t using the IRB approach. However, by ditching the rating requirement through the application of the SEC-SA formula, non-IRB banks can now do more deals and broaden their investor base.”

The rating requirement was punitive for Italian standardised banks, given the country rating ceiling. If they wanted to avoid the rating option, their only alternative was the EIF. Under the old framework, EIF transactions were the most cost-effective deals, given that the SSA guaranteed close to the whole capital stack for a small spread.

The new securitisation regulation, on the other hand, permits standardised banks to use the SEC-SA formula. The formula allows them to assign risk weights to unrated tranches and it reduces risk weights for retained tranches.

Robert Bradbury, head of structuring and advisory at StormHarbour, notes: “Under the previous securitisation regime, the options available to standardised banks were more limited, since it was difficult to get a securitised rating structure that was cost-effective - unless the loans were of very high quality and were not bound by lower country rating ceilings.”

He continues: “For example, even if a southern European bank could protect a ‘standard’ tranche for a risk transfer transaction, the bank would still have to deal with the remainder of the capital structure that was junior to the most senior tranche, which which would generally be retained and accompanied by higher risk weights. The new securitisation framework changes a lot of these dynamics.”

Second, the willingness to use synthetic securitisation technology for these banks was arguably not as present as it is now. “Furthermore, there was a perception that the complexity was a significant barrier to entry, both operationally and because of the potential reaction to the absence of internal models from various market participants. The enhanced standardisation of these transactions has aided the normalisation of the technology,” says Bradbury.

Another factor driving rising issuance is current market conditions in southern Europe. In particular, raising equity isn’t always an option for many southern European banks.

“The rating of Italian standardised banks makes it hard to raise equity, while synthetics offer a non-dilutive option,” says an md at a large European bank.

The changes in the regulations enable Italian standardised banks to broaden their investor base beyond the EIF, although the fund is expected to continue its involvement with these lenders, given that private investors are less interested in mezzanine tranches. “The SEC-SA requires thicker tranches that combine both mezzanine and junior pieces in order to achieve a certain RWA floor. This means that private investors can offer more competitive pricing for anything up to 10%, but anything above that won’t satisfy their return requirements,” notes the md.

However, it’s clear that the new regulations and the EIF’s capacity constraints open up the standardised bank market to private investors, especially since the latter are in a position to reap a number of benefits from these transactions. Bradbury explains: “Such transactions may provide some investors with more flexibility over portfolio eligibility, less competition and diversification of underlying exposures. However, there may be challenges around size materiality for large investors and data quality, among other factors, so portfolio selection and underwriting are likely to remain key considerations.”

Hence, going forward, Italian standardised banks will need time to adapt their IT and reporting systems in order to satisfy data quality concerns. Transactions such as BCC Cajamar’s risk transfer trade offer an example of how the investor base could evolve and the promising prospect of risk-sharing deals. The standardised lender’s SRT attracted both private and SSA investors (SCI 9 January).

Stelios Papadopoulos

ABS

Strong performance

Refi PSL ABS upgraded

Moody's has lowered its expected default rate for typical unseasoned refinancing private student loan (PSL) ABS to 1.5% from 2.5%, in light of the sector’s strong performance, borrower characteristics and underwriting criteria. Concurrently, the rating agency has upgraded a raft of 2015-2017 vintage bonds issued by CommonBond, Laurel Road and SoFi.

In a recent analysis, Moody's compared borrower characteristics, underwriting criteria and performance of refi PSL ABS to high-FICO non-refi PSL and high-FICO prime auto loans that have experienced a full credit cycle. On average, the agency found that PSL ABS have lower annualised default rates than high-FICO non-refi PSL and high-FICO prime auto loans. Outstanding refi PSL ABS that have benefited from very high prepayment rates also typically have lower cumulative defaults than high-FICO prime auto loan ABS.

"Refi PSL ABS have a large proportion of obligors with advanced degrees, providing job security throughout the business cycle," says Moody's analyst Selven Veeraragoo. "Furthermore, refi PSL ABS have lower exposure to borrowers with credit scores below 700. Lastly, refinancing lenders typically require 100% income verification and use affordability checks in their underwriting process."

The agency consequently lowered its expected default rate and downwardly revised the volatility around its stressed default rates for refi PSL ABS deals.

Totalling approximately US$416m, SoFi bonds accounted for the largest proportion of upgrades due to Moody’s revised assumptions for refi private student loans. Of the 15 tranches from across 12 SoFi Professional Loan Program transactions that were affected by the rating actions, 11 class B notes have been upgraded to Aaa.

The agency has revised its base-case remaining cumulative net loss expectations as a percentage of the current pool balance to 0.90%-1.35% for these deals. As of 31 July 2019, the cumulative default rate to date for the deals has ranged between 0.36% to 0.85%, with pool factors at 19% to 63%.

Meanwhile, five tranches accounting for approximately US$55m securities issued by DRB Prime Student Loan Trust 2015-D, 2016-A and 2017-A and Laurel Road Prime Student Loan Trust 2017-B were also upgraded, four of which were to Aaa. For the pools backing these deals, Moody’s has revised its base-case remaining cumulative net loss expectations to 0.45%-1.35%. As of 31 July 2019, the cumulative default rate has ranged between 0.13% to 0.22%, with pool factors at 28% to 65% for the deals.

Finally, the CommonBond Student Loan Trust 2015-A class A notes were upgraded to A1 and the 2017-B-GS class B and C notes upgraded to Aa2 and Aa3 respectively, with approximately US$39m of securities affected. Moody’s revised its base-case remaining cumulative net loss expectations to 0.90% for Commonbond 2015-A and to 1.35% for Commonbond 2017-B-GS. As of 31 July 2019, the cumulative default rate to date is 0.55% for Commonbond 2015-A with a pool factor of 15% and 0.25% for Commonbond 2017-B-GS with a pool factor of 65%.

In all three cases, Moody’s revised downwards its net loss rate assumptions to recognise the collateral pools' low defaults and high prepayments, leading to a shorter remaining life.

Corinne Smith

Structured Finance

Esoteric opportunities

Structured solutions to address corporate risk transfer needs

The newly-formed CAC Specialty (SCI 21 August) is seeking to capitalise on the convergence of the insurance and capital markets on a broader basis than that represented by the ILS market. Indeed, the firm aims to transfer the more esoteric risks via insurance and place them in a structured format.

“Insurance brokerage and investment banking have a lot in common in that both ultimately are in the risk transfer business,” explains Jack Leventhal, senior md at CAC Specialty. “We generally think about structured solutions in two ways: using insurance to transfer risk (often to satisfy a regulatory or capital requirement) and creating efficiencies via traditional capital market structures with highly rated counterparties (typically involving SPVs).”

The firm’s clients tend to be financial sponsors that are seeking transactional products; for example, around corporate events (transaction liability insurance and solutions for letter of credit exposures), residual value guarantees or litigation risk. Whether the risk is placed in a structured format or via a traditional capital markets instrument depends on investor appetite and how the client prefers to transact.

“We are agnostic about the instrument, as the placement decision is driven by what provides the greatest efficiencies. For instance, we recently used a TRS to hedge delinquencies in a pool of mortgages with exposure to hurricanes. CAC Specialty is unique in that we can place in either the insurance market or capital markets because our offering combines insurance brokerage with investment banking,” says Leventhal.

In comparison to the ILS market - which Leventhal suggests has “become commoditised, albeit will continue growing” - there appears to be more opportunity in structured solutions specifically addressing corporate risk transfer needs. “While ILS is a public market, we’re focusing on private bespoke financings, as the private market is more efficient and has plenty of capacity. We anticipate seeing an acceleration of acceptance of such structures from financial sponsors – they tend to move up the curve quickly and corporates will then follow,” he observes.

Equally, given that the economic cycle is poised for a downturn, distressed opportunities are set to become more relevant for CAC Specialty. “For instance, we can help trustees address issues in connection with company reorganisations – it is possible to release or defease legacy liabilities and trapped collateral using portfolio risk transfer. Indeed, optimising, restructuring and distressed opportunities are likely to increase going forward – it’s a natural evolution of the risk transfer market. Eventually, the market will expand to the point where risk transfer technology is common, but its use remains largely bespoke,” Leventhal concludes.

Corinne Smith

Capital Relief Trades

Risk transfer round-up - 28 August

CRT sector developments and deal news

Credit Suisse has called two transactions from its Magnolia Finance V programme. The transactions were issued in 2013 and 2014 and both risk transfer trades referenced US and Swiss corporate loans. The exercise of the calls concerned the underlying US loans.

One transaction, dubbed Magnolia Finance V series 2013-1, was an eight-year US$75m CLN that printed in August 2013. The other deal, called Magnolia Finance V series 2014-1, was an eight-year US$210m CLN that completed in March 2014 (see SCI’s capital relief trades database).

CLOs

Euro CLOs strong

Market maintaining positive path

The European CLO market has had a strong 2019 so far. That strength looks set to continue in the months ahead.

Figures from JPMorgan CLO research published last Friday note that in Europe, the primary market is up 5% from last year’s record post-crisis year. Indeed, 60 Euro CLOs have priced totalling €24.2bn – comprising €19.7bn across 47 new issues and €4.5bn in 13 refinancings, resets and re-issues.

So far this year, the market has seen five first-time managers from a total of 36 European managers that have brought a new CLO to market, the research reports. This compares to 40 managers last year and three first-time managers.

At the same time, the JPMorgan research notes that European secondary CLO trading activity has marginally increased year-over-year (by around 4%), despite fewer triple-A BWICs, which are significantly down – around 55% from the same time last year. Nevertheless, most BWIC activity was in investment grade tranches (61%) versus non-investment grade (28%) and equity (11%).

Rob Ford, partner and portfolio manager at TwentyFour Asset Management, is unsurprised by the figures. “These days triple-As all head off to the usual suspects for buy-and-hold strategies. But there’s plenty of liquidity in the investment grade mezzanine tranches, particularly at the triple-B level, which makes them very attractive instruments to us and, of course, many others.”

Further, Ford expects that strong interest to continue in the sector. “CLOs are the only space where there is regular full stack issuance, aside from UK non-conforming RMBS. So, investors who trade in euros or want to avoid any Brexit-specific implications have only one place to go.”

Overall, the JPMorgan CLO research notes that notable increases in activity year-over-year were seen in double-A tranches (+108%) and double-Bs (+84%), which is also the most active tranche this year with €780m in for the bid so far. DNTs account for 12% of all BWIC activity, mostly in triple-B, double-B and equity tranches.

Mark Pelham

CMBS

Multifamily delinquencies ticking up

Growing student housing vacancies major factor

Delinquencies among multifamily loans in CMBS have recently increased and are expected to grow further. A Morningstar report adds that the increase to 0.40%, from a post-crisis low of 0.30% in June last year, is likely to continue, tempered by a lack of affordable options.

Furthermore, Morningstar suggests that multifamily demand is slowing, with a major reason being a shrinking working-age population in the US leading to slowing rent growth, which is already lagging 2014-2017 growth rates. At the same time, CBRE has forecast that national vacancy rates will begin inching up at around 10bp per quarter, as high inventory growth persists and employment growth remains positive, but starts to soften.

Furthermore, Morningstar suggests there are certain pockets of risk, such as underperforming student housing, to which lenders have shifted more of their multifamily funds, with the annual volume of student housing loans in CMBS rising to more than US$2bn in 2018, from US$100m in 2010. The delinquency rate for student housing loans has now more than doubled to 7% in June, from 3.1% at the beginning of 2018, and have posted a decline in NCF by 10% from underwriting.

The rising delinquency rate is attributable to a decline in student-housing occupancy, partly driven by a decrease in international student enrolment. This is due to greater obstacles for foreign students studying in the US, as a result of the current political climate, which has led to student visa issuance falling 39% since year-end 2014.

Furthermore, Morningstar notes that across 318 CMBS deals since 2010, the weighted average occupancy rate for student housing from the securitisation date, to the most recent occupancy date, decreased 3.67% across all 50 states. However, the agency also finds that occupancy rates have declined much more – by 4.20% - in noncoastal states, compared with a decline of only 0.65% in coastal states.

Morningstar adds that the decline in international student enrollment is disproportionately affecting student-housing properties in noncoastal states, resulting in a sharper increase in vacancy rates than those in coastal states. As a result of this, and the increasing negative risk perceptions surrounding student-housing loans, they have already been gradually appearing less often in total loan pools.

Morningstar notes, however, that multifamily loans are the most common in CMBS, representing US$400bn and multifamily has been the best-performing property type over the last seven years, having recovered from delinquency rates of 10.2% during the last recession. Driven by healthy fundamentals, most multifamily loans are stable with less than 3% experiencing a net cash flow (NCF) decline for the most recent 12-month period of more than 10% from underwriting.

Somewhat contrastingly, Shroders’ securitised credit analysts note that lower interest rates in the US are likely to support commercial real estate and residential property values. The 10-year US Treasury yield, often used as a benchmark for interest rates on mortgage loans, is at 1.7% and the Federal Reserve is lowering short term rates which could lead to a “sustained period of appreciation for real estate assets” and reduced credit risk in real estate loans.

In simple terms, a drop in the mortgage rate will mean that borrowers may be able to support a larger loan without increasing their monthly payments, while homeowners will also be able to refinance existing mortgages to a new rate and so see their monthly payments drop. This increased affordability could push up home valuations, while also boosting consumer spending power more broadly and improve the health of the US consumer.

The securitised credit analysts also suggest that lower rates will translate into higher commercial property values, because of the direct relationship between capitalisaton (cap) rates and US Treasury rates, with cap rates historically at a premium to Treasuries.

The difference between the cap rate and the US 10-year Treasury rate represents the risk premium of a commercial real estate investment. If risk premiums remain constant, declining US Treasury rates will result in declining cap rates and, at the same level of operating income, this would cause CRE values to appreciate.  

Finally, the analysts expect cap rates to decline with lower US 10-year Treasury rates, which should provide continued support to CRE valuations. In turn, this will provide greater support for private CRE whole loans and CMBS.

Richard Budden

Structured Finance

Ceo replaced

Sector developments and company hires

New ceo appointed

Oaktree Specialty Lending has announced that ceo and cio Edgar Lee has resigned from the company for personal reasons, effective 30 September 2019. He is to be replaced by Armen Panossian who will take over both roles. Panossian is currently md and head of Oaktree’s Performing Credit organisation and has spent 12 years at the firm.

Partnership

Satori Capital has announced an investment and acceleration partnership with Cicero Capital Partners. Satori, a multi-strategy firm with more than US$1bn in AUM completed the US$20 million investment on April 1, 2019, and through August 1, 2019, has increased the allocation to approximately US$30m. Cicero actively manages a portfolio of CMBS and other commercial real estate structured opportunities.

Structured Finance

Structured credit head steps down

Company hires and sector developments

BUMF 6 claim filed

Business Mortgage Finance 6 has issued a claim against Roundstone Technologies (RTL) in the London High Court of Justice stating, among other things, that the purported sale and purchase agreement between the issuer and RTL is void and that RTL has acquired no right to act for or on behalf of the issuer pursuant to a Power of Attorney (SCI 16 August). The issuer is also seeking a final injunction restraining RTL from acting as if it has acquired any interest in any of the issuer's property or authority to act on its behalf. Additionally, it has made a Court application seeking an order expediting the trial of the claim, while considering whether it is necessary to apply for interim relief pending the outcome of the claim.

CMBS trends to negative

DBRS has changed the trend on the class B, C, D and E notes issued by Elizabeth Finance 2018 to negative from stable. DRBS notes that the change is a result of the further deterioration of the UK retail sector, which could affect the performance of the Maroon loan by increasing: (1) the re-letting risk for the upcoming lease break options of some of the largest tenants in the portfolio and (2) the number of retailers entering into company voluntary arrangements or deciding to consolidate their space across the country.

DBRS comments further that the current challenging UK retail environment coupled with an increased possibility of a hard Brexit are expected to maintain a strong downward pressure on the loan’s performance, hence the negative trends. Conversely, the upcoming opening of an H&M at the Vancouver Shopping Centre (the asset registering the highest value decline since origination at -22%) as well as a weighted-average unexpired-lease-term-to-break of over four years as at 2Q19 are expected to stabilise the performance of the portfolio and reduce the cash flow volatility in the near future.

GSO co-founder to depart

Bennett Goodman, co-founder of GSO Capital Partners, intends to step down from his full-time role with Blackstone and its board of directors at the end of the year. He will remain chairman of GSO’s BDC, however, and serve as a senior advisor to the firm. Dwight Scott, who was appointed president of GSO in 2017, will continue to oversee the management of the business. Separate from his role with Blackstone, Goodman plans to establish a new Goodman family office.

Market value study

A new Fitch study shows that there is a wide range in trustee reported market values for defaulted loans held by US middle market CLOs, highlighting the illiquidity of the sector. For example, term loans of Dimensional Dental Management are held in eight MM CLOs of four managers, with reported marks for the same loan varying from 70 to 97. Another example is Hollander Sleep Products term loans, which are held in six CLOs of two managers with marks in the range of 75-98. Further, the rating agency notes that MM CLOs managed by Bain and Guggenheim have the highest percent of obligors with an IHS Markit bid depth, due to greater exposure to broadly syndicated loan assets than peers, while Deerpath MM CLO has the least coverage - reflective of the smaller issuers in the portfolio. Nevertheless, Fitch points out that substitution provisions are observed in most MM CLOs it rates, enabling managers to provide a backstop to illiquid distressed or defaulted assets and work out a resolution outside of the CLO structure with fewer limitations.

Positive outlook

In its recent report on funding plans, the EBA predicts that activity in the securitisation market should pick up in 2020 and 2021. The largest issuance volumes in 2019 are expected in the Netherlands, amounting to close to €7bn. Banks in France, Spain, the United Kingdom and Italy plan to substantially increase issuance volumes in 2020 and 2021.

Issuance volumes in those four countries are expected to increase in 2020 to more than double the volume reported for 2019. Plans for ABS issuance volumes were also adjusted significantly compared with those reported in December 2017. Planned issuances for 2019 were adjusted to 64% of what banks had planned the previous year. Planned issuances for 2020 were reported as €37bn, an increase of 30% compared with plans reported in December 2017.

Structured credit head steps down

The head of the structured credit and CLO team at Barings, Matthew Natcharian, is stepping down. Following that, Taryn Leonard and Melissa Ricco have been named as co-heads of the structured credit investments group.

Structured Finance

Portuguese ABS framework updated

Sector developments and company hires

Portuguese ABS framework updated

A new regulation has been introduced in Portugal providing for the execution of regulation 2017/2402 of the European Parliament and of the Council, which lays down a general framework for securitisation. It also creates a specific framework for STS securitisation. Along with modifications to the Portuguese Legal Framework, the new regulation impacts: the definition of securitisation, securitisation types - including synthetic and STS/non-STS securitisations - transferability of underlying exposures, real estate holdings, early redemption, sanctions and supervision requirements.

The Law enters into force on 29 August 2019, but securitisations dated prior to its entry into force remain subject to the previous framework.

Quantum portfolio optimisation delivered

Fujitsu has successfully concluded a loan portfolio management proof of concept (PoC) with Commerzbank’s research and development unit, main incubator, leveraging the Fujitsu quantum computing-inspired Digital Annealer. Focusing on receivables from vehicle leasing contracts, the PoC optimised the selection process for a loan portfolio. The Digital Annealer optimised the bundling of receivables, giving customers the ability to fully leverage the potential of securities issued by them. 

The PoC focused on the selection optimisation of several thousand vehicle leasing assets for a securitisation portfolio. Critical factors taken into simultaneous consideration included regulatory requirements, absolute volume limits and percentage limits for specific asset characteristics needed to achieve greater risk diversification. 

The Fujitsu Digital Annealer provides simultaneous calculation of combinatorial optimisation challenges by leveraging quantum characteristics in a digital architecture, making the PoC possible for main incubator in a business context.