Contents

Capital Relief Trades

Risk transfer reboot

Large corporate SRTs prepped

Capital relief trade issuance is set for a comeback in 2Q20 as a handful of banks are readying large corporate transactions. The reboot in issuance is largely driven by government and central bank programmes and the need to manage bank capital as companies draw down their revolvers.

According to one SRT investor: “Large corporate deals are easier to underwrite as you get significant information from public sources and you can also assess whether they will benefit from government stimulus and central bank funds. At the same time, corporate revolvers continue to be drawn, since not all of these firms can issue bonds to central banks. Banks therefore will see more capital consumption.”

JPMorgan notes that central bank funds have boosted the liquidity of investment grade large corporates, with European credit supply reaching a €40bn record on 2 April - although issuance is yet to pick up on the high yield side. At the same time, spreads have been retracing. IHS Markit’s iBoxx euro corporate benchmark spread for European investment grade firms declined by 22bp to 235bp over a two-week period ending on 8 April.

Banks can technically fund revolvers by accessing federal reserve programmes and therefore bypassing any need to manage capital via synthetic securitisations. Nevertheless, doing so means no risk transfer that provides capital relief. Consequently, synthetic securitisations remain a viable way to manage that capital.

Moreover, government support programmes are not expected to last long. “CRTs are likely to perform well and, with the hunt for yield continuing, it remains a good opportunity. Furthermore, other asset classes such as leveraged lending and direct lending may not benefit from government support, to the same extent. Government stimulus programmes though will not last long. At this point, we will likely see broad government support, but firms that do have a sustainable business model will struggle to refinance,” says the investor.

Similarly, another SRT investor notes: “Although relief measures including forbearance can help reduce the negative impact, it’s not going to stop the rating downgrades and overall increases in RWAs. Further measures such as payment holidays are also not going to do much for large syndicated corporate deals, although it might offer some relief for bilateral SME and consumer loans.”

Looking forward, the same SRT investor states: “Banks will be under greater pressure from a capital perspective for large corporate portfolios; corporate revolvers, for example, are subject to higher capital requirements once they are drawn. Additionally, as borrowers are downgraded, RWAs will increase significantly.”

The investor concludes: “However, SRT investors will have a better understanding of the potential impact from Covid-19 on large companies – where there is greater transparency in terms of disclosures and other traded debt. There is greater uncertainty related to the impact on SMEs and consumers and hence we would expect large corporate SRT transactions to return before SME and consumer transactions.”

Stelios Papadopoulos

CMBS

Forbearance foreseen

Euro CMBS cash-trap thresholds eyed

Three UK hotel CMBS and three Italian retail CMBS, representing just under £1bn and just over €1bn of securitised debt respectively, could become subject to cash-trapping if their LTV ratios are tested during the Covid-19 outbreak. However, should loan defaults occur, special servicers are likely to exercise forbearance while conditions improve.

The three hotel CMBS – Helios (ELoC 37), Magenta 2020 and Ribbon Finance – have LTVs of 62% or 63% and are subject to cash-trapping if the LTV exceeds 67% in the case of the first two transactions. BofA Global Research analysts suggest that the latter deal “has more headroom” to its cash trap LTV threshold of 71.5%, although they believe this could also be breached if the pandemic worsens in the UK.

“Cash trap covenants that reference debt yield could be more readily breached, in our view, as declines in revenue can be more immediately observed than LTVs and tested without requiring a new property valuation. In this case, Ribbon Finance looks most exposed, with almost no headroom between its latest reported debt yield of 10.4% and the cash trap threshold of 10.1%,” the BofA analysts add.

The 2021 maturity date of the Magenta loan may also raise concerns about refinancing risk, depending on the duration and depth of the outbreak. However, the analysts believe this is mitigated by the borrower's three options to extend the loan by one year each.

S&P last week placed on creditwatch negative its ratings on the class E notes of Helios and the class D and E notes of Magenta. The agency says the actions reflect the uncertainty surrounding the operational performance of the UK hotel properties securing the transactions over the short term due to the spread of Covid-19 and the potential negative effect this may have on their ability to pay timely interest on the affected notes.

Meanwhile, the Italian retail CMBS are Deco 2019-Vivaldi, Emerald Italy and Pietra Nero Uno. The BofA analysts note that Vivaldi has an LTV of 65% versus a cash trap LTV threshold of 75%, while the Franciacorta loan debt yield is 8.7% compared to a cash trap threshold of 7.6% and the Palmanova loan debt yield is 10.6% versus a cash trap threshold of 9.6%.

The Emerald Italy LTV is 62% compared to a cash trap LTV threshold of 70%, while the current debt yield is 12.9% versus a 11.3% cash trap threshold. Finally, the LTV cash trap thresholds for Pietra Nero Uno are set higher than in the other deals at 81% to 86%, while the debt yields also have more headroom, in the range of 1.2 to 1.8 percentage points.

However, the BofA analysts point out that refinancing the loans by their May 2020 maturity date may be difficult in the current environment and they expect that Blackstone (the borrower) will extend the loan. The maturity date is subject to three extension options of one year each.

Given that over the medium to longer term commercial real estate is likely to recover fully from the Coronavirus outbreak, the analysts foresee a short-term hit to tenant revenue as the biggest threat to European CMBS at present. “Tenant defaults tend to have an immediate and direct effect on loan performance. In the event of a default caused by tenant failure, we think the special servicer would take a long-term view towards supporting or replacing the tenant,” they suggest.

As such, existing borrowers could be granted forbearance and given time to stabilise the asset before any enforcement action is taken. “This strategy, hopefully, would restore the property value in time to refinance the loan or else recover par if the property had to be sold,” the analysts add. “Property disposals are highly unlikely to follow any Coronavirus-related loan defaults, in our view. The fire sale of distressed assets during times of market stress is not a good way to maximise recoveries for noteholders.”

The transactions most exposed to Covid-19 stresses have several years before they reach their legal final maturity dates, meaning that special servicers should have enough time to address any defaults and help minimise - if not avoid crystallising - losses caused by the outbreak. Indeed, S&P believes that special servicers would be more likely to provide loan extensions or enter into standstill agreements, provided that the borrowers are able to make interest payments in full.

“The spotlight will inevitably be on the hotel, retail and leisure, student housing and office co-working sectors. But there is the potential for other property sectors to experience some form of structural adjustment - whether it be through operational factors, such as how space is used, achievable rents, vacancy levels, flexibility of lease terms, or investment and financing sentiment driving capital values. At this point, however, it's too early to opine on with any conviction,” concludes Edward Twort, director, CMBS at S&P.

Jasleen Mann & Corinne Smith

Structured Finance

Bilateral activity

Opportunistic capital redeployment underway

The European ABS market appears poised to diverge between central bank-eligible issuance and opportunistic capital. Risk-off sentiment dominates, but pockets of bilateral activity are occurring.

“It's an interesting market at the moment. But quite different to the early global financial crisis in that because the central banks reacted so quickly and strongly, there is a sense that some opportunities from early March may have been missed already,” observes Robert Bradbury, head of structuring and advisory at StormHarbour.

On one hand, significant volumes of retained ABS are expected, in part due to the ECB’s launch of the Pandemic Emergency Purchase Programme (SCI 19 March). “There is already an increase in demand for retained transactions after the ECB dramatically increased access to liquidity through a range of facilities. Against the current market backdrop, no party wants to be short liquidity,” says Bradbury.

He continues: “One immediate impact is that bonds that aren’t eligible for central bank windows have in most cases not re-tightened the widening that was observed from the start of the current situation. In comparison, central bank-eligible paper is in many cases trading at the same levels it did before the current situation broke out.”

Central bank and governmental measures are also resulting in transactions being restructured to reflect the potential for debt moratoriums and consumer forbearance. “One example is that a failure to pay for a certain number of days might not be deemed a breach of contract in some jurisdictions if it relates to Covid-19 related stress. However, given that certain representations may have been made under any given transaction that don’t account for this, or certain tests and triggers may be linked to such metrics, the issuer and originator may need retrospective adjustments to be agreed in the documentation,” Bradbury explains.

On the other hand, there is a need for completely new types of transactions arising from the coronavirus-related business freeze and financial market volatility. An example is finding solutions for corporates in need of liquidity or bridging facilities, such as structuring sale and lease-back transactions secured by grounded aircraft to free up liquidity in the aviation sector.

Another opportunity is secured debt for companies that suddenly find their traditional access to financing – which, prior to the virus crisis, may have featured receivables, for example - being restricted. Examples could include using inventory to raise financing - something which in ‘normal’ markets would be more difficult and less attractive. However, Bradbury suggests that such transactions generally aren’t straightforward.

“Many traditional investors remain less willing to take on new risk. This leaves those capital providers which tend to target higher returns and more complex situations. Even high-quality issuers therefore are to some degree competing against the wide range of more distressed and higher yielding credit opportunities that such investors also see, which increases costs,” he explains.

Meanwhile, there has also been increased focus on capital relief trade secondary market trading. “The sellers aren’t forced sellers, but are seeing opportunities elsewhere and are trying to redeploy – if you’re seeing opportunities at high IRRs but holding paper at what are now lower yields, you may try to sell if you can get a price. Sellers are looking for liquidity but aren’t desperate – there are opportunities to be had on both sides. We are seeing interest from accounts that are interested in returning to the market after being absent for some time, as well as some looking to come in for the first time,” says Bradbury.

He concludes: “On the other hand, if a major fund holding this paper was to fail or needed to liquidate, that would test the market’s appetite, however.”

Corinne Smith

CLOs

Uncertain ratios

OC senior test failures accelerate, but options remain for some CLO managers to cure breaches

As the April reporting season gets underway in earnest, the number of US CLOs failing their OC tests is accelerating and breaches are now also moving up the capital stack. However, despite difficult market conditions, some managers still have some ability to cure breaches.

“Some deals have already started reporting late March/early April reports and some deals are failing not just the ID/junior OC test but in one case [JFINC152], even the triple-A/double-A OC test,” note BofA Global Research analysts in a new report. “This will likely be the first 2.0 deal failing the senior most OC test.”

For the deals that failed any one of the tests, the increase in triple-C assets has almost doubled over the past month. “The increased share of triple-C downgrades has caused many deals to have lower OC ratios as a result of triple-C excess and/or par burn as managers traded out of lower priced/lower rated loans,” the report explains.

The BofA analysts currently estimate around 17%-19% of loans in CLOs have been downgraded by both Moody's and S&P since February. At the same time, they estimate the share of triple-C plus and lower rated issuers is 10.5% and the share of Caa1/lower rated loans is around 8.5% across CLO portfolios. As a result of downgrades, they calculate that the S&P-implied WARF has increased by 250 points over the month on average.

The report considers current average loan prices across each rating cohort (after adjusting for downgrades). It found an increased dispersion between high and low quality names, with single-B plus and double-B issuers trading around US$90 and triple-C issuers at around US$60.

“As a result, to swap from a triple-C name into a single-B or higher rated asset still implies taking a US$25 hit to par,” it notes.

However, in some cases, the analysts suggest that managers can reduce the share of triple-C assets by selling higher priced triple-C names out of their portfolios into single-B or double-B rated assets without crystallising a lot of par. For instance, BMC Software and Riverbed Technologies, both of which are among the largest triple-C names in CLO portfolios, trade close to US$80 and can be swapped out for similar priced single-B rated credits.

“Based on updated triple-C concentrations, we estimate 20%-30% of deals are now potentially breaching their OC tests (assuming a US$40-US$50 price for excess triple-C assets and based off March portfolios). In some cases, we think the double-B bonds may PIK as well. With April determination dates beginning and around the corner, managers have very less room/time to trade out of loans and cure these breaches,” the BofA analysts warn.

Further, they note that a larger share of deals that are breaching their OC tests are already amortising (i.e. pre-2014 vintage deals) and managers have limited flexibility to cure such test failures. However, for deals potentially breaching junior OC tests in 2015 and later vintages, managers can still potentially swap out of triple-C buckets into single-B-minus or single-B rated issuers.

In addition, the analysts say: “Some deals only use the Moody's Caa1/lower facility to determine excess Caa haircuts. With the average Moody's Caa1 concentration at 8%, it provides a modest benefit to equity holders in the near term. Moreover, some deals also do not consider single-B minus loans with a negative watch as triple-C loans. Those deals too would benefit in the near term.”

Mark Pelham

RMBS

Price volatility

Liquidity constraints hit credit risk transfer

Acute losses have been suffered in the US credit risk transfer market over the last few weeks, as prices on many classes of bonds have executed a vertiginous descent. But the price action does not tell the whole story, and it is too early to say that investors will be cleaned out.

Covid-19 and the virtual cessation of most forms of economic activity throughout the US have rendered assets backed by mortgages particularly vulnerable. A scarcely credible 17 million people have registered as unemployed in two weeks, and is clear that many homeowners will struggle to meet their mortgage payments.

So, for example, the CAS 2015-C03 M2 bonds - which in February had been happily trading around 109 - went into a rapid nosedive and by 25 March had plummeted to around 82. Since then, there has been a recovery of sorts and these bonds have climbed back to around 96/97, yielding around 600bp over Treasuries. But this is still a long way off pre-Covid prices.

The newer vintages have been even worse hit. This is because the older bonds have enjoyed four or five years of home price appreciation and have consequently lower LTV ratios. So, over the last seven days, the average price of M2 bonds is a little over 80, while the B1s are around 55 and the B2s - the lowest rung in the capital stack, with minimum loss protection - are around 10/15.

B1 yields vary from around plus 1500bp to plus 4000bp, say sources. "At the worst level, the B1 2020s were at a dollar price of 14.5 and the B1 2019s were at 11 on 8 April. These are basically lottery tickets. The market is saying ‘hey, there is virtually little chance you’ll get your money on these.’ Prior to 9 March, these securities were trading at par,” says Joseph Sturtevant, co-founder and head of valuation at RiskSpan.

Even higher up the capital stack, the recent vintages are sagging on the ropes. The average price of the M2 2020s over the last seven days is around only 60.

But there are technical factors, as well as fundamental at play here. The better protected M1s and M2s have probably sunk in value as much due to liquidity constraints as much as due to expectation of loss, say sources. Market makers and investors have struggled to finance their positions as, for example, repo markets have seized up. Last week, only just over 50 trades in total were reportedly completed.

As JPMorgan notes in a research paper on the CRT market dated 27 March, the collapse of M2 prices is “more a deleveraging story than a credit fundamental story.”

Moreover, even fundamental assessments of asset value are composed of more than one consideration than the direction of home prices and ability to meet loan payments. There is still uncertainty about what action the GSEs and the FHA will take towards delinquency and forbearance, and this also drags prices down.

So, the bonds at the bottom of the capital stack - the B1s and the B2s - are probably depressed by the prospects of defaults and foreclosure. They typically possess a credit enhancement of only 25bp or 50bp, so a foreclosure rate of only 1%-2% would start to erode their value.

But higher up the capital stack, the M1s and the M2s, the constraint upon liquidity is probably the biggest factor. The M1s and M2s are also typically held by more leveraged investors. The JPMorgan note estimates that hedge funds and REITS make up 50%-60% of new issue demand for M2 paper, and both sets of investors have come under margin call stress lately, producing fire sale prices (SCI 2 April).

Despite the extraordinary dislocation and the prospect of a deep recession, sources in the securitised mortgage markets still seem to think that the M1 and M2 bonds are sufficiently protected.

“Depending on the deal, it will take a loss severity of between 40% and 60% and defaults in the 1%-4% range to hit the 2019 M2s. The M1s and the M2s have a greater probability of loss than they did before the uncertainty, but we’re probably still not in the expected loss scenario,” says Andrew Davidson, president and founder of Andrew Davidson & Co.

Moreover, the more recent vintages - those priced from mid-2015 onwards - are based on an actual loss structure, so that the investors are only in real danger when foreclosures begin; payment delinquency does not count as a credit event. The older bonds, from the earliest days of the CRT market, incorporated a so-called fixed severity formula which means they accrue losses with delinquency.

This difference is reflected in the fact that the CAS and STACR bonds that Moody’s this week placed on review for downgrade are all older vintage fixed severity structures. As it notes in the ratings rationale: “While a majority of CRT transactions allocate losses based on actual losses to mortgage loans in the reference pool, fixed severity deals will pass losses to investors when investors become 180 days delinquent.”

The CAS Series 2014-C04, 1M2 and 2M2 - previously upgraded to Aa1 and triple-A on 30 October last year - have been placed on review for downgrade, while four classes of notes from the STACR Series 2014-DN1 - all also upgraded to triple-A on the same date - have been put on review as well. These are all older notes and less than US$650m of outstanding principal is affected.

Nevertheless, the provisions of the recently enacted CARES bill and with the co-operation of the GSEs gives the actual loss deals further room for manoeuvre. Homeowners in financial difficulty can apply for 180 days of loan forbearance and, upon the expiry of that 180 days, can apply for a further 180 days. The monies are still due at the end of that period, but it gives an entire year before the possibility of foreclosure enters the picture.

Freddie Mac told SCI it has no plans to alter its CRT issuance for 2020, and it has priced three STACR deals in Q1 with another planned before the end of Q2. Fannie Mae, which priced a US$425m multifamily CAS deal at the beginning of March, was unavailable for comment.

Investors seem sanguine at the moment. Karlis Ulmanis, a portfolio manager at DuPont Capital, says he is not selling his CRT investments - all of which are investment grade, so above the B1 tranches - as he is confident that they will bounce back.

Investors also appear sure that the GSEs will not abandon the CRT market when the market returns to normality, whenever that may be. “The CRT sector is very important to the GSEs. I cannot see them getting rid of the market. They are more likely to offset is as an effective tool to offset risk,” says Ulmanis.

What is likely, however, is that even if a lot of CRT bonds are still standing where the Covid-19 fires become a smoulder, the entire sector may need to be repriced.

Simon Boughey

CLOs

Second wave

Widespread CLO rating downgrades add further uncertainty

Extensive CLO downgrades are expected to follow the widespread pandemic-driven negative rating actions already seen on underlying loans. Any such second wave is likely to hamper the market’s tentative early stage recovery and increase uncertainty and concerns over the future.

The second wave is inevitable, asserts one CLO trader. “You have to expect to see further downgrades of CLOs themselves, especially as triple-C buckets have been breached.”

However, the trader suggests that realisation has not yet been priced in effectively. “This week and at the end of last week, some offers struck me as quite ridiculous – we saw 175bp/180bp in triple-As, for example. Lower down the stack, it is even more of a case-by-case credit game and about knowing the manager – we are now most definitely in a world of manager tiering.”

He continues: “The impact of the downgrades could be significant deleveraging over the remainder of this year, though there will continue to be manager differentiation – those who have taken more risk would get hit quite hard. However, the size of the impact will also depend on the details of individual transactions.”

The likely extent of the CLO downgrades is also not yet clear, with the rating agencies understandably taking their time to work through the deluge. However, the move to rating watch negative appears to be well underway.

Matthias Neugebauer, md, structured credit at Fitch Ratings, says: “We placed a lot of EMEA CLOs and US CLOs on rating watch negative, primarily the sub-investment grade tranches. For Europe, we rate through the capital structure, from triple-A down to single-B-minus. In the US, of the 900-plus deals we rate, more than 850 are only rated triple-A by Fitch.”

He continues: “There is less concern on the triple-A, while double-B notes are most likely to be downgraded. The rating watch horizon is usually six months, but the crisis is unfolding fast and we do not know when it will be resolved.”

Overall, BofA Global Research analysts note that since March, S&P and Fitch have placed around 100 tranches on negative watch. “The vast majority of these deals were initially rated double-B and single-B and there are eight investment grade-rated tranches (mostly triple-B). Triple-B bonds continue to face a high risk of downgrade in the near term considering the increasing triple-C share and the recent uptick in defaults,” they say.

According to an analysis by S&P, should triple-Cs increase to 18%, defaults to 5% and there be OC declines of two points, around 46% of triple-B bonds could be downgraded to non-investment grade. “This has important ramifications for both bondholders and investors, as many deal documents initiate a restricted trading condition if any investment grade-rated CLO is downgraded,” the BofA analysts note.

The latter point is also highlighted by JPMorgan CLO research analysts. “Leveraged credit market participants should note downgrades trigger restricted trading periods, impacting flexibility for CLOs,” they suggest.

The JPM analysts go on to say: “There are many nuances to CLO downgrades, with different methodologies and subjectivity of rating agencies. CLOs have a management feature, unlike related structured products, which can make stress hard to predict as substitutions impact the portfolio.”

Beyond downgrades, there is, of course, the spectre of default, which the JPMorgan analysts argue cannot be dismissed entirely. “As the severity of the crisis impacts the economy, CLO event of default (EOD) may (re-)enter the lexicon. Language varies, but typically CLOs have multiple EOD triggers, including failure to pay interest and principal when due on non-PIKable bonds (triple-A and double-A) and a par coverage or OC EOD trigger, between 100%-105% (most commonly 102.5%, though it varies).”

The EOD OC ratio may only include the triple-A rated class or some both the triple-A and double-A rated classes, and again language will vary. There may also be triple-C ratings-based and discount obligation haircuts.

“Today’s average EOD OC cushion of 56% has plenty of headroom and EOD is unrealistic, but with the deepest recession expected in at least 50 years, one should at least consider this,” the JPMorgan analysts conclude.

Jasleen Mann & Mark Pelham

Capital Relief Trades

Discounted opportunities

Insurers target SRT secondary market

Insurers are now targeting the capital relief trades secondary market in search of discounted opportunities with an attractive risk profile following the coronavirus crisis. Secondary trades offer diversification and an existing track record of performance, although insurers are primarily eyeing mezzanine and senior tranches jointly with hedge funds, who will be in a position to gain junior exposure.

According to Thomas Oehl, director at Credit Risk Transfer Solutions (CRTS): “Despite the fact that there are other opportunities within capital markets at the moment, SRT is an asset class with enough diversification opportunities and a risk/return profile that is very suitable for the needs of our insurer clients. Secondary trades, in particular, offer a verifiable track record of performance and readily available documentation; asset onboarding is relatively straightforward compared to primary trades.”  

CRTS is an FCA authorised and regulated insurance broker, with a focus on the structuring and arranging of credit risk transfer - both primary and secondary participations - from banks to insurers, particularly in the context of SRT transactions. The firm has already gained experience in the primary market by tackling two issues that remain key challenges for insurer participation in the SRT market; namely, the nature of the contracts and ratings.

Andrew Garston, director at CRTS, explains: “When you talk about a fund writing cover, it’s a guarantee; but for insurers, it’s rarely a pure financial guarantee. The legal departments of underwriting firms generally want some insurance overlay, although there are some exceptions. Nevertheless, you can still write the contract in a way that complies with the CRR. If the conditions that come with an insurance policy are within the control of the beneficiary, then that is fine for CRR purposes.”

He continues: “The second issue is ratings. When an insurer writes a policy, it’s going to be through an operating company which doesn’t have a senior debt rating. Yet the CRR also allows for reliance on an Insurer Financial Strength Rating, which the insurer operating company does have and is provided by the top rating agencies, such as Moody’s and S&P.”

At the moment, CRTS has gone a step further and is in the process of putting together bank funding supported by an insurer guarantee. However, given that the risk is ultimately borne by insurers, the focus is on taking on mezzanine and senior exposure to a CLN. CRTS would work jointly with hedge funds that are in a position to acquire junior tranche exposure.

Garston concludes: “The hedge fund won’t have to finance the mezzanine and senior tranche, but can still access and earn the return on the junior tranche. Overall, our goal is to work jointly and in partnership with the funds.”

Stelios Papadopoulos

CMBS

Unified approach

Canadian CMBS servicing challenges surveyed

The Canadian CMBS market is expected to be more resilient to the coronavirus fallout than its US counterpart. Although tenant defaults and loan delinquencies are similarly likely to spike into 3Q20, to date Canadian servicers have seen relatively few borrower relief requests.

Unique to the Canadian CMBS market, borrower requests for relief are initially reviewed by the subservicer (typically the originator) before being passed on to the master servicer for approval. Fitch reports that during the first three weeks of the coronavirus pandemic, 22 CMBS borrowers representing C$231.9m of loans were referred to the master servicer for potential debt relief, representing approximately 5% of the Canadian CMBS market by balance.

In contrast to the US market, Fitch notes a surprisingly unified - though still evolving - approach to hardship and relief requests among Canadian servicers. The agency surveyed three active CMBS master servicers in Canada to assess tenant and borrower delinquencies, as well as the socioeconomic impact of the pandemic on primary property types, servicing processes and potential challenges.

These servicers expect borrowers to maintain interest-only payments for a few months followed by an approximately six- to 12-month period to pay back deferred principal. To protect borrowers' economic interests during the pandemic, Canadian master servicers have also largely agreed to waive processing fees for forbearance requests.

Of the relief requests, retail properties represent 59%, followed by multifamily (14%), office (9%) and hotels (5%). So far, no loans have transferred to special servicing.

“The limited number of relief requests for hotel properties reflect their relative representation in the market; only 3% of all outstanding loans are backed by hotel properties,” Fitch observes. “However, 37% of Canadian CMBS are backed by retail properties. Of the 236 loans backed by retail properties, 48% by count and 56% by balance have grocery and/or drug stores as the largest tenants.”

Retail maturities in 2020 and 2021 account for 46 loans totalling C$373.1m, of which 21 loans totalling C$229.4m have grocery and/or drug stores as the largest tenants. Of those 21 loans, 15 are backed by properties in the two most populous provinces - Ontario and Quebec.

Fitch notes that Canadian sponsor recourse incentivises borrowers to keep their loans current, although this benefit may be muted if sponsors face severe economic stress elsewhere in their portfolios, as guarantors are often not investment grade entities. Further, high levels of amortisation increase borrower equity, which also mitigates default behaviour.

Nevertheless, the agency suggests that investment in technology for disaster recovery, reporting and asset management, as well as the presence of experienced commercial real estate professionals means Canadian servicers are well situated to handle the potential increase in requests for borrower relief.

Fitch says its lower default expectations for Canadian CMBS reflect the expectation that borrowers pay interest during a forbearance period and the lower representation of ‘at-risk’ property types (hotel and retail), further supported by the degree of government support for businesses and consumers. The agency also points to the credit positive features of Canadian CMBS, including the country’s non-judicial enforcement regime.

In its most recent default and loss study covering 80 Canadian CMBS transactions issued from 1998-2018 with an original loan count of nearly 3,900 loans, Fitch observed a 1.7% cumulative default rate with cumulative losses of only 0.1%.

Corinne Smith

Insurance-linked securities

Coverage cleared

Debut programmatic ILW trade executed

Tremor last week executed what is believed to be the first programmatic ILW trade via an online auction. A US$50bn US wind and earthquake contract cleared at a rate on line (ROL) of 12.25% through the platform, having traded at a ROL of 12.5% before brokerage.

Tremor opened its weekly online ILW auctions on 2 April to provide an active marketplace to transact re/insurance coverage. Interested parties submit blind, sealed bids to buy and/or sell the posted ILWs; parties are not known to each other until a trade is successfully completed. Each structure has a fixed insurance form and ISDA form contract wording from which participants may choose.

Bidders can leverage complex constraints to transact the coverage that offers the best margins. An AM Best credit rating of single-A minus or better, or a fully collateralised commitment is required for protection sellers.

Upon the close of bidding, Tremor computes a market clearing price for each ILW and reports consequent trades. Anonymised aggregate supply, showing total supply available at various prices, is also made available to markets that bid on the Tremor platform.

PCS catastrophe loss estimates for the US, Canada, Japan and the Asia-Pacific region, as well as global cyber are used as the reference trigger on transactions cleared.

Capacity offered during the second weekly auction nearly tripled, with twice the number of bidders from the opening week of trade. Bidders offered US$87m of capacity equally across three structures, including a US$30bn Florida wind contract (with buy and sell ROLs of 12% and 12.50% respectively) and a US$15bn Japan wind contract (2.75% and 6.75% respectively).

US wind and earthquake perils were available on the platform initially, with the addition of other regions and perils to be rolled out subsequently. Tremor also plans to partner with brokers in innovative ways to bring trades to its ILW marketplace.

The platform comprises buyers and sellers of ILW protection and their brokers, including over 80 global reinsurers from all major markets, a number of reinsurance brokers, ILS funds and direct access to capacity at Lloyd’s.

Corinne Smith

RMBS

Forbearance risks

Pre-2015 GSE deals could suffer losses

As the coronavirus spreads and servicers offer mortgage forbearance plans to struggling obligors, certain pre-2015 credit risk transfer (CRT) fixed severity deals are set to sustain losses without action from Fannie Mae and Freddie Mac. In contrast, actual loss CRT deals do not automatically suffer losses from credit events, but are exposed to risks from rate reductions, permanent principal forbearance, defaults and delinquencies.

According to Moody’s, as struggling mortgage borrowers increasingly enter temporary forbearance plans, a number of fixed severity CRT deals will be exposed to losses from credit events such as a loan becoming 180 days delinquent. The deals include CAS 2013-C01, CAS 2014-C01, STACR 2013-DN1, STACR 2013-DN2, STACR 2014-DN1 and STACR 2014-DN2.

The rating agency notes that if a CRT fixed severity transaction has a natural disaster exception, the mechanics of how delinquencies are applied to the transaction differs between the GSEs. For Freddie Mac's STACR shelf, the natural disaster exception applies to the definition of credit event, providing a grace period of 1.5 years. During this period, affected forbearance loans would not be considered a credit event, shielding investors from automatic losses.

At the expiration of the grace period, any loans that are 180 days or more delinquent will be considered credit event obligations. Therefore, servicers have an incentive to modify loans within the grace period.

On the other hand, in certain Fannie Mae CAS shelf deals, a 180-day delinquent loan would be a credit event regardless of forbearance status. But the delinquent loan would become a reversed credit event obligation if the loan becomes current - including due to modification - at the end of the forbearance period or up to three months afterwards. Therefore, CAS deals will suffer tranche losses from a spike in delinquency, only to have the tranches written-up in future periods as loans are modified.

Transactions without a natural disaster exception will suffer losses from forbearance unless the GSEs issue a special exemption or amend the transactions' documentation. Losses are allocated to bondholders reverse sequentially and will eventually completely erode credit enhancement to the deals' most-subordinate mezzanine bond. The losses can be triggered only if the percentage of the current balance that would need to become 180-plus days delinquent ranges from 2.64% to 7.01%

Unlike fixed severity deals, actual loss CRT transactions do not automatically suffer losses from 180-day payment forbearance, but are still exposed to certain risks. CRT deals will incur losses if loans in forbearance undergo an interest rate modification or principal forbearance modification or subsequently default on a loan with a prior modification of principal forgiveness.

Actual loss CRT transactions - which have been issued since 2015 - allocate modification losses to bondholders reverse sequentially. The modification loss equals the reduced loan interest payment from an interest rate modification, the reduced interest payments from a principal forbearance modification that causes a portion of the loan's principal balance to become non-interest-bearing, or the amount of forgiven principal on a previously modified loan that ends up defaulting. High delinquencies also cut off some or all principal payments to subordinate bondholders in actual loss CRT.

Risks are expected to rise for fixed severity CRT deals as the economic deterioration from the coronavirus's spread drives a wave of mortgage delinquencies (SCI 15 April). Already, applications for unemployment benefits have surged and forbearance plans to support borrowers will continue to roll out as the recession deepens.

“The degree of impact from forbearance on CRT deals depends in part on how many of the borrowers receiving forbearance would have become delinquent anyway. Also, for actual loss deals, forbearance in the midst of economic dislocations could be a long-term positive,” Moody’s concludes.

Stelios Papadopoulos

Structured Finance

REMIC tax status clarified

Sector developments and company hires

REMIC revenue procedure
The US Internal Revenue Service has issued a revenue procedure that permits loans subject to certain forbearances and related modifications as a result of the Covid-19 pandemic to be contributed to, and held in, REMICs and grantor trusts without jeopardising the tax status of these vehicles. Cadwalader notes that under the revenue procedure: a mortgage loan’s LTV does not have to be retested as a result of a qualified forbearance to determine whether the loan is REMIC-eligible; a qualified forbearance before a loan is contributed to a REMIC does not restrict the vehicle from later foreclosing on the loan; and interest shortfalls and special servicing fees incurred as a result of a qualified forbearance do not cause a REMIC’s regular interests to fail to qualify as such. For these purposes, qualified forbearances are: forbearances granted under the Coronavirus Aid, Relief and Economic Security (CARES) Act; and forbearances of up to six months that are provided to borrowers experiencing financial hardship due to the Covid-19 emergency and are requested or agreed to between 27 March and 31 December 2020.

In other news…

DGO closes second ABS
Orrick has advised the noteholders in the third rated securitisation of oil and gas wellbore interests, this transaction being the second for Diversified Gas & Oil. Fitch has assigned a triple-B rating to the US$200m 5.25% notes issued by Diversified ABS Phase II. In November 2019, Orrick advised the noteholders on the first securitisation by Diversified Gas & Oil of its operated oil and gas wellbore interests (SCI 22 November 2019) and in September 2019, the firm advised the noteholders on the first rated securitisation of oil and gas on non-operated wellbore interests, issued by Raisa Energy.

Final PEFF trigger awaited
All conditions necessary to trigger the World Bank’s Pandemic Emergency Financing Facility catastrophe bonds have been met, except for a positive growth rate of Coronavirus cases in International Development Association and International Bank Reconstruction and Development countries. The third-party calculation agent for the pandemic bonds last week confirmed that the positive growth rate trigger had not been met, as of 23 March 2020. But DBRS Morningstar anticipates that this final condition can be met by late May, when the 12-week rolling period for the calculation (24 February to 18 May) will be mostly driven by the growth of cases in countries other than China. For instance, the slight growth in the number of cases in China during March contrasts with the rapid increases witnessed in Iran, Brazil, Turkey, Russia and Ecuador - all of which are IDA/IBRD countries.

PTAP expanded
Ginnie Mae has introduced a new version of the existing Pass-Through Assistance Program (PTAP) for use by issuers facing a temporary liquidity shortfall directly attributable to the Covid-19 national emergency (SCI 31 March). The programme allows issuers to apply for assistance in meeting their contractual obligation to make timely and in-full principal and interest payments due to MBS holders without being held in default under the Ginnie Mae guaranty agreement. Funds advanced by Ginnie Mae will bear a fixed rate of interest.

Structured Finance

Auto ABS rating withdrawn

Sector developments and company hires

Auto ABS rating withdrawn
Fitch has withdrawn the expected ratings of Swiss Car ABS 2020-1 (SCI 9 April). The rating agency notes that the debt issue is “no longer expected to proceed as previously envisaged”.

EMEA
Reed Smith has appointed Baptiste Gelpi as a partner in its financial industry group, based in Paris. Gelpi joins the firm from Hogan Lovells, where he led its French debt capital markets practice. He advises clients on a range of debt capital markets and structured finance products, including domestic and cross-border securitisations and derivatives.

Forbearance assumptions
Fitch reports that it is making assumptions for Covid-19 related payment holidays to test cashflow adequacy for timely payment of interest to the US RMBS triple-A and double-A notes it rates, using Hurricane Maria as a proxy for the potential spike in delinquencies. For prime jumbo RMBS, the agency is assuming 25% of the collateral will receive payment forbearance for six months before reverting to its standard liquidation timelines. For re-performing and non-QM, it is assuming 40% and 30% payment deferrals for six months respectively. Because prime jumbo and NQM RMBS have advancing mechanisms, Fitch believes payment disruption impact to the higher investment grade classes will be minimal.

Structured Finance

CMBS secured, unsecured sub debt weighed

Sector developments and company hires

CMBS secured, unsecured sub debt weighed
Senior US CMBS loans with unsecured subordinate debt (such as mezzanine or preferred equity) show significantly lower default rates than senior loans with secured subordinate debt (such as B-notes) at comparable leverage points, according to Fitch. The agency evaluated the performance of 1,001 senior CMBS conduit loans with subordinate debt in place, issued between 2003 and 2008, and found that for loans with mid-range leverage, the default rate for senior loans with unsecured subordinate debt is 25% lower than for loans with secured subordinate debt. Similarly, total realised loss rates for senior loans with unsecured subordinate debt were lower at each leverage category than for loans with secured subordinate debt. For loans with mid-range leverage (70%-80% total debt issuer LTV), realised losses on senior loans with unsecured subordinate debt totalled 1.8%, compared with 6.1% for loans with secured subordinate debt. The default rate on all senior loans with in-place subordinate debt was more than 55% higher than for loans without any subordinate debt.

North America
Kennedy Lewis Investment Management has hired Dik Blewitt as a partner and head of tactical opportunities. Blewitt was previously an md at GSO Capital Partners, focused on structured finance and credit investments. While at Blackstone, he was a senior portfolio manager for Carador Income Fund, as well as a member of the global structured credit investment committee for the firm's liquid credit business. Prior to joining Blackstone in 2014, he worked at Blackrock, R3 Capital, Lehman Brothers, Bank of America and JPMorgan.

RFC on RMBS approach
Fitch is requesting feedback on an exposure draft of its US RMBS coronavirus-related analytical assumptions criteria that will be used during the duration of the current economic crisis when rating US RMBS. Key changes proposed in the exposure draft include: a higher economic risk factor (ERF) floor in Fitch's loss model to better capture the projected economic disruption; minimum delinquency assumptions for new ratings during the first six months of the projection before reverting back to Fitch's model-derived projection; and a 20 point increase to the pool's current delinquency pipeline for outstanding transactions for a six month period before reverting back to Fitch's model-derived delinquency projection. If implemented as proposed, the agency expects the impact on mortgage pool loss projections to be relatively modest and concentrated in the non-investment grade rating categories. Comments on the approach are invited by 15 May.

Structured Finance

Interest rate mismatches eyed

Sector developments and company hires

Interest rate mismatches eyed
Moody’s suggests that loan repricing will increase interest rate mismatches for Chinese structured finance deals, posing a higher risk for RMBS than auto ABS, given the longer loan terms and the greater share of floating-rate loans. All Chinese financial institutions must reprice outstanding floating-rate loans to either loan prime rate (LPR)-indexed floating rates or fixed rates by August 2020. However, most outstanding securitisations have floating coupon rates. The move is also expected to reduce asset yields, as LPRs will likely continue to decline amid the coronavirus outbreak. Additionally, the repricing raises uncertainty for outstanding structured finance deals, as noteholders may need to consent to loan interest rate changes.

In other news…

Corporate services execs named
SANNE has promoted Jason Bingham to the role of chief strategy officer, based in London, and appointed Marta Ciemiega as business development director in New York. Bingham, who already serves on the group’s executive committee, had previously held the post of md of product development. He has been with SANNE since 2012, when he joined as head of real assets, focusing on strategy, business development and product operations. In her new role, Ciemiega will be responsible for building new relationships with fund managers that have investment strategies spanning private equity, real assets, infrastructure, private credit and hedge funds. She joins SANNE from RBC and prior to this held various senior roles at Bloomberg, Fitch Solutions and S&P.

Covid-19 guarantee fund backed
Following a recommendation by the Eurogroup on 9 April, the EIB has backed the creation of a €25bn European Covid-19 guarantee fund, which should enable the bank to increase its support for European companies up to an additional €200bn – with a focus on SMEs. The guarantee fund envisages a contribution from all 27 EU Member States and will also be open to contributions by third parties, for example from the EU budget. It will be established under the EIB’s structure of Partnership Platform for Funds (PPF), based on existing legal frameworks and standardised procedures. The fund will be formally established as soon as Member States accounting for at least 60% of EIB capital have made the necessary commitments.

Specialised lending RTS endorsed
The EBA has published an opinion responding to the European Commission’s intention to amend the EBA’s final draft RTS on assigning risk weights to specialised lending exposures before endorsing them. The EBA states that is of the view that the proposed changes - despite their substantive nature - do not alter the draft RTS in a significant manner, as they still maintain a good balance between the flexibility and risk sensitivity required for the IRB approach and the need for a harmonised regulatory framework. The substantive changes introduced by the Commission: introduce the possibility for institutions to consider a sub-factor as irrelevant for a certain type of specialised lending exposure; allows institutions to consider additional relevant information (an ‘additional risk driver’) for a type of specialised lending exposure, jointly with the sub-factor which most closely corresponds to that additional risk driver; and simplifies the rules on overlapping criteria at the level of the sub-factor.