Contents

NPLs

Questionable idea?

Central bad bank proposal raises concerns

The ECB is exploring the idea of a bad bank to relieve European bank balance sheets following expected asset-quality deterioration, due to the coronavirus fallout. Nevertheless, such a proposal would have to explain how purchase prices can be aligned with net book values, with some suggesting the move may be premature at this point.

Indeed, any Europe-wide bad bank proposal will have to answer a number of questions. Massimo Famularo, md at Distressed Technologies, explains: “Non-performing loans are currently booked on bank balance sheets. A bad bank is supposed to pay banks an amount close or similar to net book value. If expected collections are higher or equal to net book value, there is no gap to fill.”

An issue arises if expected recoveries are lower than current NBV because either the bank accepts an immediate loss or the bad bank pays the full NBV but will suffer a loss later. It is unclear what happens if expected recoveries do not match current accounting values of the NPL.

Debt collection processes and foreclosures also need to be initiated and monitored, and claims need to be submitted to bankruptcy receivers. “A bad bank may hire people to manage loans or outsource this activity to special servicers, but the recovery cost needs to be taken in account,” Famularo says. “So, a bad bank is supposed to pay a price higher than market players to acquire NPLs - that is the point in having a bad bank - and it is also supposed to collect enough cash on loans to cover the price paid and the operating costs. Yet again, what happens if expected collections are not enough to pay a price in line with book values?”

A bad bank proposal may also be premature. “Fiscal and monetary support measures have not had time to bed down and before any empirical data has emerged on how banks’ customers will respond once measures such as moratoriums and government-backed loan or grant schemes have ended and the extent of corporate, SME and household defaults becomes clearer,” comments Dierk Brandenburg, head of the financial institutions team at Scope Ratings.

Banks are in much better shape compared to 2008, when a raft of national bad banks emerged following the financial crisis. The NPL ratio for EU banks declined to 2.7% by the end of 2019, according to EBA data.

One of the contradictions for the banking sector contained in official guidance and Covid-19 monetary stimulus lies in the pressure authorities are piling on banks to continue lending in order to cushion economic impacts. “The motivations behind continued bank lending are clear on paper but adding to corporate indebtedness at a time when customers are less likely in aggregate to be in a position to stay current on their bank facilities,” says Brandenburg.

Indeed, in Europe, offering TLTRO 3 as low as minus 75bp for eligible counterparties, keeping liquidity taps open via standard LTRO facilities, easing collateral standards and offering sovereign loan guarantees shows how determined governments are to push banks to lend. “If NPLs across the euro area have in aggregate ceased to be systemically dangerous, pressuring banks to continue lending into a recessionary environment will with a reasonable degree of certainty reverse the multi-year downtrend, albeit with a time-lag,” states Scope.

State aid challenges are another obstacle to the ECB proposal, albeit they may open doors for more NPL ABS issuance. Burkhard Heppe, cto at NPL Markets, notes: “If there is a problem in the long term, then you might need a bad bank. We don’t think this is a short-term blip only, but most countries should manage without a central bad bank.”

He continues: “Nevertheless, they are useful and necessary rescue vehicles for failed institutions and there will be a need for those in the future. A bad bank remains a good option in actual resolutions and it’s not difficult to imagine it co-existing with the private market, as happened in Ireland and Spain. Selling the loans of a bank that is about to fail via the private market isn’t feasible on very short notice; it takes weeks due to the analysis and the due diligence, so in these situations a bad bank rescue vehicle can be useful.”

The option to use a bad bank as a resolution vehicle is not desirable for a viable institution, as it may lead to bail-ins or hefty write-downs for the bank’s AT1 bonds and equity. “In the long term, banks will have to deduct unsecured NPLs that will be expensive to have on their balance sheets; hence, they will be more incentivised to sell. Yet another option is NPL securitisations. If government guarantees on securitisation tranches became available in more countries other than Italy and Greece, then this could be the preferred political solution, given that NPLs aren’t transferred fully to the public at potentially inflated prices and the taxpayer would assume less risk.”

Stelios Papadopoulos

Structured Finance

Unknown unknowns

Covid-19 modelling challenges persist

Banks are running simulations in an effort to address the credit risk modelling challenges of the coronavirus crisis (SCI 8 April). However, this is yet to clarify whether lenders can use both through-the-cycle (TTC) and point-in-time (PIT) modelling or merely point in time.   

According to Martin Zorn, president and coo at Kamakura: “Stochastic modelling and stress testing is the only way forward at this point. The virus is an unknown unknown; we don’t know much about it and there’s no vaccine, so ultimately you have to think of scenarios that could be tail events and assess their negative outcomes for expected losses and capital.”

Historical information isn’t the best guide at this point, so banks will have to find a way to assess a potential loss or a stress scenario easily and quickly and this is where the main challenge lies. Most banks utilise TTC models as internal ratings and for capital, but also have variations of PIT models for IFRS 9 and stress testing.

For most banks, PIT models rely on macroeconomic indicators such as quarterly GDP figures, which can take a while to update. TTC modelling persists for some objectives like regulatory capital, despite the advent of IFRS 9 (SCI 23 June 2017).

According to a McKinsey report: “Most bank models draw on historical data, without the access to high-frequency data that would enable recalibration. [W]hile access to the needed alternative data is theoretically possible, models would not be able to integrate the new information in an agile manner, because the systems and infrastructure on which they are built lack the necessary flexibility.”

The alternative to TTC modelling is PIT, but this raises the question of where to draw from the data that will allow lenders to construct the models. Scott Aguais, md at Z-Risk Engine (ZRE) says that accurate loss estimations in PIT models can only be captured more dynamically through public-firm default models, such as Moody’s expected default frequencies (EDFs). EDFs are a measure of the probability that a firm will default over a specified period of time - typically one year - and they are driven by equity values, equity volatility and liability structures.

The point remains though that banks find it hard to shift to PIT modelling and this is obvious in the variability of PIT converted ECL estimates. Global Credit Data’s IFRS 9 benchmark study shows that variability between banks’ PIT converted estimates is observed for all segments defined by ECL drivers, such as obligor type, geography, industry, rating and PD, facility type, guarantees and collateralisation. Measuring variability meant introducing a multiplier that stood on average at a level of at least four.

Aguais states: “The Basel regulations have been always though-the-cycle because you need those stable PDs to estimate the capital requirements, but the corona crisis calls for full PIT credit modelling. This is not to say that banks haven’t tried to move into a PIT direction, but the modifications are still basically hybrid models. If you look at the PIT-TTC literature, they talk about looking across the cycle.”

However, not everyone agrees with such root and branch changes. Zorn remarks: “Banks should use both through-the-cycle and point-in-time. Through-the-cycle uses historical information, but nothing stops you from using a stressed PD if this cycle is different from the last one.”

Joe Breeden, ceo at Prescient Models, concurs: “You have to use both; if you do a loan rewrite, forget about loss reserves - it’s only about cashflow analysis for an account and this is where the point-in-time aspect comes in. Once you do that, you can then revert back to through-the-cycle.”

He continues: “Loan by loan analysis will become crucial. The impact of this recession will be broad, but not all businesses in a vulnerable industry will disappear. Takeout pizza places are all right, but that is obviously not the case for high-rent fine dining.”

Prescient Models has been running simulations for banks since January and by February, it had already produced forecasts. “If we are talking about expected credit losses, then it’s easily a factor of two - which sounds bad, but you have to consider the offsetting effects of government programmes. Furthermore, there could be a second wave that could adversely affect consumer behaviour.”

Indeed, government programmes can simply mask losses and therefore raise further challenges for loss estimations. Breeden comments: “SMEs can claim support, even though a business would have failed anyway. Restaurants normally run on low margins and can fail if rents are too high. That, in turn, can lead to CRE loan defaults by the property owners.”

Another question is about the impact for different asset classes. “You can be as severe as you want with your stresses, but the impact will differ between sectors. Due to this, management overlays have been added in banks to capture the uncertainty and sensitivity to different sectors,” says Fernando de la Mora, md at Alvarez & Marsal.

He notes that the main difference is between consumer and corporate and SME loans. Consumer portfolios tend to have better predicting models. Covid-19 has led to higher provisions on them, but the correlation between unemployment and losses is clear.

“This cannot be said for corporates and SMEs, where ratings typically lag economic performance and don’t reflect the credit risk of the firm. Nevertheless, there will undoubtedly be a broad-based rise in expected losses,” de la Mora says.

He concludes: “Our simulations estimate an increase by a factor of three, compared to 2019. This can be absorbed by well capitalised European banks.”

Stelios Papadopoulos

Structured Finance

Tortuous TALF 2.0

Markets question TALF usage

The Federal Reserve this Tuesday (May 12) published more details about the terms of its $100bn new emergency lending facility generally referred to as TALF 2, and while these details were welcomed there are a still a lot of questions in the market about how useful this programme will be.

The first of those questions revolves around relative value. The cost of a TALF loan is benchmarks plus 125bp (150bp in the case of CLOs), which is 25bp more than the original TALF programme over a decade ago. This elevated cost of funding makes relative value often difficult to realise, particularly in the light of recent spread compression.

“TALF 1.0 provided below market rates for financing and that was what made it so attractive. Is plus 125bp or plus 150bp a rate at which anyone will utilise TALF with the restrictions that it imposes? The problem we’re seeing is that the price is high enough to have a chilling effect on the market,” says Gregg Jubin, a managing partner in the securitization practice at Cadwalader, Wickersham & Taft in Washington, DC.

For example, this week Volkswagen priced a $4bn four tranche ABS deal, of which the longest dated tranche, the A4s, paid Libor plus 100bp. The other three tranches were considerably tighter (the A1s came in at Libor minor 8bp). It makes no sense to buy notes and borrow under TALF at levels such as these.

“I’m a lawyer not a banker, but even I can see that if you’re borrowing at plus 125bp and investing at plus 100bp, you’re probably not going to make any money,” says Stuart Litwin, co-head of the securitization practice at Mayer Brown in Chicago.

As CLO buyers have to borrow under TALF at an even wider spread of plus 150bp, it is of little use to this area of the securitization market, as numerous prominent market commentators have noted.

There are other logistic caveats to TALF as well. It is limited at $100bn, and, as sources say, if the programme is needed then that relatively slim sum of money will be exhausted quickly.

Secondly, it is scheduled to expire on September 30, and, with Memorial Day looming in the USA, it is unlikely that programme documents will be released by the Fed until early June. As deals cannot be packaged and potential buyers lined up overnight, the first TALF deals would not probably hit the tape until July. This makes TALF’s borrowing window particularly narrow.

There are a couple more impediments to usage. Under TALF’s terms, investors must be publicly disclosed; this could be a sticking point for some wealth management platforms.

There is also an attestation provision, termed by one source “an odd requirement”. It means that a potential TALF borrower has to show that alternative forms of financing are not available. Many would be investors will find this requirement difficult to meet.

Certain classes of ABS are boxed into an even tighter corner. Commercial real estate CLOs, SASBs and, most strikingly, legacy CMBS deals are not eligible under TALF. With regard to the latter, only recently issued fixed-rate senior conduit CMBS rated triple-A by two rating agencies (from Fitch, Standard and Poor’s or Moody’s) and not on downgrade watch are eligible.

This is different to TALF 1.0. “The intention of the other parts of TALF is to see new issuance. Clearly this is not the case for CMBS. For whatever reason, making sure there is additional liquidity in the commercial real estate lending market wasn't a priority," says Stuart Goldstein, a partner and co-chair of the CMBS group at Cadwalader.

Moreover, TALF loans are for only three years, and the great majority of CMBS deals are of much longer duration so investors have to work out what to do with the investment when TALF expires. This makes the question of relative value even more germane to the CMBS sector.

“How much use will TALF be to the CMBS market?  Not very.  It could limit spread widening in the (super) duper but that is about it. I am not sure what the take up will be,” says Lea Overby, a CMBS strategist at Wells Fargo in New York.

Five year new issue triple-A conduit CMBS paper is dealing at plus 160bp, more than 100bp outside the 52-week lows but also almost 200bp narrower than the recent wide prints.

The Federal Reserve in Washington was unavailable for comment on the reasons for these various restrictions and exclusions in TALF 2.0.

However, there are several caveats to be made. There are good reasons why the Federal Reserve has drawn the net of eligibility so tightly. It has a responsibility to husband the nation’s resources carefully, and some classes of ABS deal represent a degree of credit risk that it perhaps feels it should not countenance. A SASB deal, for example, means exposure to a single hotel.

For broadly the same reasons, the Fed has set the borrowing rate deliberately high, surmise dealers. TALF only becomes remunerative for investors if spreads have backed up sufficiently widely, and at this point it forms a backstop to prevent further widening. Public funds are supposed to be last resort financing, and, in the case of TALF 2.0, it seems the Fed has taken its responsibilities very seriously.

“If the test of TALF is to function as a safety net, then it has already done a good job of making an impact,” says Stuart Litwin.

Moreover, despite the many misgivings those in the US securitization markets express, there are plenty of potential investors, say sources. Both US and offshore funds are circling TALF assets. For the latter, the attraction of safe haven US assets at a time of considerable crisis remains undimmed despite the strictures TALF imposes, it seems.

Consortiums of fund investors and ultra-high net worth individuals particularly from Europe and Latin America are showing interest, while among the potential domestic buyers, traditional wealth managers and pension funds are lining up, as they did in TALF 1.0, says Dorothy Mehta, a partner at Cadwalader.  

These investors have not yet, of course, committed  capital, but neither are they dismissing TALF out of hand. “We’re taking calls from funds every day,” says Mehta.

Simon Boughey

ABS

Auto ABS boost

European ABS market update

Yesterday’s print of BMW Bank’s latest auto loan ABS marks a significant step in the reopening of the primary European securitisation market. The STS transaction was placed with 33 accounts, with the final spread tightening to one-month Euribor plus 40bp at the senior level.

One European ABS trader suggests that there is a lot of confidence that Bavarian Sky German Auto Loans 10 will be supported by the ECB and that there will not be too much market volatility. “There was a significant pick-up, as the deal’s triple-As priced in the 40s. IPTs started off in the high-40s and ended up in the low-40s, given how big the book was.”

Ultimately investors put in combined orders of €1.9bn for the transaction and the senior tranche was upsized to €700m with a coverage ratio of around 2.7x.

Meanwhile, Mercedes-Benz Bank announced an STS auto ABS transaction - Silver Arrow Compartment 11 – yesterday via BNP Paribas. The deal’s triple-A rated class A notes are being publicly offered, with the coupon set at one-month Euribor plus 70bp. A portion of the senior notes will be retained, along with the unrated fixed rate class B notes.

Fitch notes the static provisional pool consists of 125,701 contracts. The total balance is €2.5bn, which is more than double the previous deal, according to Rabobank credit analysts.

The majority of the loans are balloon loans (accounting for 78.6% of the pool). No loans in the pool are currently subject to payment holidays.

The deal is expected to price next week. “Public issuance from two major auto lenders after a long period of inactivity is an encouraging sign. However, my expectation is that the primary market won’t restart properly for a couple of months,” the trader concludes.

Jasleen Mann

ABS

Waivers required

WBS covenant breaches eyed

The probability of covenant breaches within UK whole business securitisations has increased, due to coronavirus-related restrictions on businesses. However, covenant breaches do not necessarily result in negative rating actions.

There are multiple types of covenants and they provide protection for bondholders in different ways. George Abbatt, director, global infrastructure and project finance at Fitch, says: “One example is debt service coverage-based covenants, which focus on cashflow generation relative to debt service. Another is minimum maintenance expenditure, which focuses on maintaining asset quality over time. In the absence of such a covenant, the borrower would not be obliged to spend any minimum amount and asset quality could deteriorate.”

Radim Radkovsky, director, global infrastructure and project finance at Fitch, adds: “In essence, covenants are promises by borrowers to do or not to do something or comply with certain financial thresholds. They are implemented in order to protect bondholders. Some covenants can act as early-warning signals of deteriorating financial performance.”

Covenants are tested periodically, one either a quarterly or annual basis. A borrower’s non-compliance with a covenant may be recorded as a breach.

Abbatt notes: “Financial covenants can be a trigger for bondholders to enforce their security. Financial covenants, if breached, offer optionality in terms of how the assets are managed. There is also often the possibility to cure a breach.”

Fitch confirms that breaches of suspension-of-business covenants within its rated WBS portfolio have occurred due to Covid-19 stress. Notably, the Marston's Issuer and Mitchells & Butlers Finance issuers last month secured temporary waivers for their breaches (SCI 23 April).

As a result of the uncertainty surrounding the length of restrictions placed on businesses, further waivers may be required. Indeed, the Greene King Finance borrower has been approached by a major noteholder, indicating its support for a waiver package - should this be required to cover covenant breaches or defaults caused by Covid-19 mandatory pub closures.

The borrower also reports that it "continues to take active measures to preserve its cash reserves and liquidity", including ceasing all discretionary capex and reaching an agreement with HMRC to defer its tax payments until 2021.

Fitch began the process of reviewing all bonds within its UK WBS pub portfolio on an individual credit basis in March. The agency applied two scenarios, consisting of a rating case and a more severe sensitivity case.

As a result of the reviews, most classes of Fitch-rated UK WBS pubco notes are currently on rating watch negative. The classes will be reviewed within six months, which means that the ratings could be affirmed or downgrades may occur. 

Jasleen Mann

Structured Finance

SCI Start the Week - 11 May

A review of securitisation activity over the past seven days

Last week's stories
CRM tool
CBILS guarantees eligible for CRR recognition
EC decision awaited
Preferential capital treatment mooted for STS synthetics
Known unknown
Lack of data in MM CLOs leaves future open to interpretation
Modifications up
MPL impairments bucking the trend
NPA opportunities
Global investors target Indian distressed debt
On hold
Italian NPL ABS to pick up next year
On the rack
Recent limitations on liability leave unanswered questions for mortgage servicers
Pipeline clearance
Structural features support CMBS
Ratings resilience
Shorter pro-rata periods to benefit SRTs
Romanian SRT inked
Uncapped guarantee completed

Other deal-related news

• The EBA has published its final guidelines on the determination of the weighted average maturity of the contractual payments due under the tranche of a securitisation transaction, as laid down in the CRR (SCI 4 May).
• S&P has confirmed that its triple-A ratings on the class A1 and A2 notes issued by BMW Floorplan Master Owner Trust series 2018-1 are unaffected after amendments to the trust undertaken by BMW Financial Services (SCI 4 May).
• CIM Group has launched a new closed-end interval fund dubbed CIM Real Assets & Credit Fund (CIM RACR), which will invest in a mix of institutional-quality real assets and credit instruments, including CLOs (SCI 5 May).
• Ginnie Mae has introduced a new version of the existing Pass-Through Assistance Program (PTAP) for use by multifamily MBS issuers facing a temporary liquidity shortfall directly attributable to the Covid-19 national emergency (SCI 5 May).
• European CLOs are generally showing strength in the face of Covid-19, according to a new S&P report (SCI 6 May).
• Restructuring Advisory Group has negotiated the restructuring of one CMBS loan and two conventional commercial real estate mortgages, as well as one major office lease for clients in Georgia, Texas and Massachusetts, as a result of the Covid-19 shutdown (SCI 6 May).
• A number of UK RMBS issuers have started to report data on borrowers' take-up of Covid-19 payment holidays, as of the April 2020 remittance period (SCI 6 May).
• European DataWarehouse has registered the first green prime RMBS backed by Portuguese assets - the €385m RMBS Green Belém No. 1 deal issued by the UCI branch in Portugal (SCI 6 May).
• Swedish pension fund Alecta and PGGM have signed a co-investment agreement in relation to credit risk-sharing transactions, whereby Alecta will purchase 30% and PGGM 70% of each co-investment transaction (SCI 6 May).

Data

BWIC volume

Secondary market commentary from SCI PriceABS
7 May 2020
USD CLO
15 covers today with a continued tightening tone - 1 x AAA, 3 x AA, 5 x A, 4 x BBB and 2 x BB. The AAA is CBAM 2019-10A A1A (CBAM) cover 190dm / 5.52y WAL - despite the tight DM this is not a completely clean transaction (sub80 21.5%, ADR 0.9% and CCC spilled to 8.07%) but this does provide a backstop for cleaner deals to price tighter.
The AAs trade 251dm-285dm which are more in line with the tighter levels seen yesterday in 240a but this cohort has been trading 240dm-330dm since month end. At the wide end is Hayfin's KING 2019-1A B1 285dm / 6.1y WAL driven by weaker MV metrics (119 MVOC) versus peers (121-123) with other fundamental metrics good.
The single-As trade 297dm-364dm (2022/2023 RP profiles) which is tight to comps around month end 350dm-500dm, there is an outlier trade today CATLK 2013-1A BR (Carlson Cap) 476dm / 6.3y (high ADR 0.99, 18.5% sub80 bucket, 3247 WARF and a spilled CCC bucket 10%).
BBBs trade in a narrow dispersion 518dm-548dm (2018-2025 RP profiles) tight to comps since month end trading 505dm-756dm, there is an outlier trade today GALXY 2018-29A D (PineBridge) at a very high 1003dm / 4.5y WAL - MVOC 98.9, sub80 24%, 3710 WARF and 11.6% CCC bucket as pretty clear explanations.
The BBs trade 1164dm-1340dm (2023/2024 RP profiles) with comps since month end trading 1175dm-1675dm, both the bonds today aren't covered by MV (95-96 MVOC) but CCC baskets remain within the 7.5% limit.
EUR CLO
2 x BBB & 1 x BB today. The BBBs traded around 575dm. This is quite a bit tighter than the previous day when there were a number of trades in the LM600s and a few wider than that. Both these deals are in good shape with WA Collateral price of over 90.00, both have CCC cushions of around 4% and MVOC around 106.50%.
The BB traded at 1110dm. This is the tightest BB level we have seen since the crisis started. Most of our previous observations have been in the 1200 to 1350 DM range. The MVOC is 96.51 and it looks like the CCC test has been breached. The WA collateral price is 88.21.
SCI proprietary data points on NAV, CPR, Attachment point, Detachment point & Comments are all available via trial, go to APPS SCI + GO on Bloomberg, or contact us for a trial direct via SCI.

Structured Finance

Portfolio resilience

Technology-driven investment gaining traction

Pagaya has expanded to the US West Coast, beefing up its origination group. At the same time, the fintech firm is seeking opportunities in new asset classes and new partnerships.

As part of its expansion, Pagaya has appointed Jason Hass as svp of originations and Mike Cannatella as vp of originations, in Phoenix and Los Angeles respectively. Hass will oversee Pagaya’s strategic partnership initiatives, while Cannatella is responsible for sourcing and managing partners.

Theo Ellis, who joined Pagaya in Autumn 2019 as a vp of originations, will work alongside them. Led by Pagaya capital markets and originations head Benjamin Blatt, the origination group establishes asset acquisition channels and strategic partnerships with a focus on consumer industries, including credit card receivables, unsecured consumer installment loans and auto loans.

Blatt says: “Pagaya started in the marketplace lending space and, as assets under management have grown, so has the desire to expand to new asset classes. In order to do this, you need to find partners and originators that are able to sell you that collateral.”

Indeed, Pagaya’s new recruits are expected to help the firm “break into new verticals”. “They have brought new issuers and originators along with them, which will allow Pagaya to launch into new partnerships,” Blatt explains.

Residential mortgages and home equity lines of credit are new asset classes that Pagaya is conducting research and gathering data on. The firm highlights the importance of data-gathering in quantitative asset management prior to deployment.

Blatt explains: “Artificial intelligence is at the crux and forefront of what Pagaya does. It is incredibly difficult to run a regression model on a consumer, as there are thousands of data points. The origination team is helping platforms and borrowers get access to the funds that they need and investors get the returns they need.”

He continues: “In terms of the ABS shelf, there is no reason it has to be sequestered to marketplace loans. This is the beauty of being an investor. Most issuers in the ABS space are bound by the constraints of what they produce; as an active manager, we are always on the lookout for value.”

Pagaya’s shelf draws from various securitisation products, as opposed to just traditional ABS. The development of its PAID programme is based on the idea that most investors in the consumer space like to own assets in bond form.

Blatt compares the programme to a CLO for consumer assets. “It is closer to a managed vehicle. We like to say it is a consumer CLO, in that the company is an active manager on the transactions.”

Looking ahead, Blatt expects structural innovation to increase, given the challenging issuance environment for securitisation issuers following the outbreak of the coronavirus. “At Pagaya, our technology-driven investment approach has resulted in a more resilient portfolio with above-average market returns, even in uncertain environments. Part of our approach is drawing from a number of securitised products as a managed vehicle, which allows for more creative structuring than traditional ABS.”

Jasleen Mann

Capital Relief Trades

SRTs unlocked

BMO launches capital relief trade

Bank of Montreal has finalised a US$132m five-year financial guarantee dubbed Manitoulin Muskoka Series 2020-1. The trade is the first transaction to close in the SRT space following the coronavirus outbreak.

The portfolio is believed to reference mid-market corporate loans, which wouldn’t be the first time BMO ventured into the asset class, after expanding its exposure to it in July 2019. This was accomplished through the issuance of another SRT called Manitoulin USD Algonquin 2019-1 (SCI 26 July 2019).

Past Manitoulin deals typically reference corporate and leveraged loans (see SCI’s capital relief trades database). SCI data going back to July 2017 shows that the junior tranches of the Manitoulin transactions have priced anywhere between 8.5% to 12.75%, which is close to the typical 9%-12% range for SRTs.

A rebound in issuance - especially in the corporate sector - has been expected, thanks to government and central bank support, as well as the need to manage capital as firms draw down their revolvers (SCI 14 April). Known SRT issuers have already disclosed the impact of these drawdowns for RWAs.

Barclays, for instance, reported in its latest quarterly results that RCF drawdowns contributed to a £7.2bn increase in credit risk RWAs. At HSBC, such drawdowns fed a US$35.8bn RWA boost and a US$7bn rise at Standard Chartered. Hence, corporate deals are already either being prepped or discussed for the second half of the year.

Going forward, investors are also confident that portfolios can be constructed with exposures to industries that are relatively protected from the negative effects of the virus. Bank of Montreal is believed to be readying another risk transfer transaction that is expected to close in 3Q20. 

Stelios Papadopoulos

Capital Relief Trades

Risk transfer round-up - 13 May

CRT sector developments and deal news

Bank of Montreal is rumoured to be prepping a corporate loan capital relief trade for 3Q20. The lender’s last risk transfer trade was completed in January and was called Manitoulin Algonquin 2020-1 (see SCI’s capital relief trades database).

NPLs

Positive outlook

Survey indicates distressed debt pick-up

A new survey of private markets suggests that a pick-up in distressed debt activity is likely over the medium term due to the Coronavirus crisis. However, live deals are being renegotiated or postponed, with servicers adopting more consensual resolution strategies.

Private market participants are already finetuning their outlook and strategies for the next 18 to 24 months, even though the overall outlook remains uncertain. According to the private markets survey, compiled by Oxane, over 70% of respondents have a favourable investment outlook towards distressed debt - citing better investment attractiveness in the coming quarters as the after-effects of the coronavirus disruption manifest.

The biggest drop in the investment outlook across asset classes was seen in real estate, with more than 50% of respondents highlighting that the investment attractiveness of the sector has taken a big hit for them. Renewables and infrastructure maintained the most stable position, with half of respondents citing no change in the investment attractiveness of the asset class.

The survey notes that that the healthy flow of non-performing portfolio deals in Europe seen in the past few years is likely to slow during the coming quarters (SCI passim). Deals where offers have already been made are being renegotiated, triggering the Covid-19 clauses that were set in place when the impact was unclear. Live deals have been put on hold, while others in the late stages of planning have been postponed.

Expectations are mixed - with some market participants anticipating deal activity to resume only in 4Q20, while the optimistic ones are hopeful that deal flow would return to normalcy by June, especially in active markets like Greece and Cyprus.

As lockdowns shift to normalcy in some geographies - where early actions were taken to contain the pandemic - courts are expected to preside over debt settlements in the coming few weeks. Investments firms though are already factoring in a four- to 12-month delay in resolutions through court processes. Servicers have shifted their resolution strategies to be more consensual and focus on DPOs, restructurings and negotiations.

Looking ahead, Oxane notes: “Investment firms are also readying themselves to expand into single name distressed situations to take advantage of the expected opportunities that will emerge in the coming few months. In addition to the sectors that are losing - airlines, shipping, oil, tourism and hospitality - investment firms are analysing and planning for investments in secondary and tertiary industries impacted by the disruption, causing favourable price dislocations.”

Oxane’s private markets survey gathered inputs from over 120 investment professionals from the UK, Europe and the US across private market asset classes, including real estate, private equity, private credit, distressed debt, specialty finance and renewables/infrastructure.

Stelios Papadopoulos

RMBS

Forbearance frontiers

4.7m home loans now in forbearance

Almost 4.7m US homeowners are in forbearance plans as of May 12, an increase of 200,000 in seven days, according to Black Knight, which provides data and analysis on the mortgage markets.

This represents 8.8% of all active mortgages and over $1trn in unpaid principal. Around 7% of all GSE-guaranteed loans and 12.4% of all Federal Housing Authority (FHA) and Veterans Affairs (VA) loans are now in forbearance plans.

These numbers mean that mortgage servicers need to advance a cumulative $3.6bn a month in interest and principal to holders of GSE-backed MBS. That is in addition to the $1.5bn in tax and insurance payments that they are also obliged to make on behalf of mortgage-holders.

Meanwhile, servicers of private label mortgages (of which more than 9% are also in forbearance) must advance $2.1bn per month in interest and principal to MBS invvestors.

The total number of mortgages in forbearance has increased to 4.7m from around 2m on April 5 and only 100,000 or so on March 24, as the tornado of economic devastation that is Covid 19 swept through the US.

Of the 4.7m loans in forbearance, 1.95m are Fannie Mae and Freddie Mac mortgages, representing $414bn in unpaid principal, 1.5m are FHA and VA mortgages ($256bn in unpaid principal) and 1.2m are private label loans ($355bn in unpaid principal).

The good news is that the rate of increase in loans in forbearance has slowed. In the last seven days, the average net increase was 26,000 loans per day, a reduction of 85% from the rate seen in early April.

Using a momentum-based methodology based on the one week average and assuming an optimistic 10% daily decline, Black Knight estimates that 4.9m loans could be forbearance by the end of May and 5m by the end of June - which would represent 9.4% of all mortgages.

However, using a more pessimistic scenario based on the two-week average and assuming that the 10% daily decline doesn’t begin until June 15, then 5.4m loans could be in forbearance by the end of May and 11.8% by the end of June. This would represent 11.8% of all mortgages.

Simon Boughey

Capital Relief Trades

Drafting issues

Assia Damianova, special counsel at Cadwalader, Wickersham & Taft LLP, considers the potential effect on capital relief trades of the current market volatility arising from Covid-19 restrictions

CRTs typically consist of a credit transfer instrument entered into between the credit institution and an SPV, with notes issued by the SPV to investors, the payments in respect of which are linked to payments on the credit transfer instrument. Most CRTs use a financial guarantee (“FG”) as the credit transfer instrument (instead of a CDS that requires daily mark-to-market).

Following the occurrence of a credit event in respect of an asset in the reference portfolio, a cash settlement amount is paid by the SPV to the credit institution under the FG and the principal balance of the notes is written down by a corresponding amount. The notes issued by the SPV may be tranched to suit particular investors’ risk appetite.

Credit events
The drafting of the credit events is dictated in part by the requirements of the Capital Requirements Directive in the EU (or other Basel 3 implementing legislation in other jurisdictions). The credit events typically include ‘failure to pay’, ‘bankruptcy’ and ‘restructuring’ in respect of an asset in the reference portfolio. Unlike the standard operation of CDS credit events, under an FG, the credit events will be determined by reference to the servicing principles of the relevant credit institution and will be linked to that credit institution’s determination of the likelihood of payment, past due period or, in the case of a restructuring, the time when the profit and loss account of the credit institution has been impaired.

The impact of the current market volatility on the failure to pay or bankruptcy credit events under an FG is likely to be immediate. This is because most CRTs are structured so that a pre-determined assumed loss is paid by the SPV under the FG as soon as the relevant credit event notice is sent, with further payments being made under a true-up mechanism after actual loss is determined - typically after the work-out process of the defaulted asset is complete.

Specific asset class issues
The different asset classes that have been subject to CRTs may present their own challenges during the Covid-19 crisis. For example, the mortgage and other payment holidays that are currently in force in various jurisdictions would not necessarily be anticipated by CRT documentation. Whether a credit event has occurred as a result of non-payment during these payment holidays would depend on the specific drafting in each deal.

Valuations
After a credit event occurs and the assumed loss is paid, the defaulted asset would have to be worked out and the final loss established. Such final loss determination dates now may take longer to occur, given the difficulties with immediate enforcement and/or sale of collateral in the current market conditions - in particular, some jurisdictions have enacted temporary moratoriums on enforcements against entities such as housing associations and certain business tenants.

This delay in the ability to determine the final loss may result in the application of a fall-back valuation mechanism, although such mechanisms typically involve the use of market bids, which would present its own challenges in the current illiquid markets. In addition, potentially significant interest adjustments may be required in deals that contain make-whole provisions to compensate the investor (where the final loss is smaller than the assumed loss) or the originator credit institution (where the final loss is greater than the assumed loss) for the period  between payment of the assumed loss and payment under the true-up mechanism following determination of the final loss.

Finally, regulators have often expressed concerns with CRTs where losses crystallise towards the end of the deal, while the tranches of notes have been amortising on a pro-rata basis resulting in the originating credit institution having a lower level of protection through the FG. Parties that have negotiated specific provisions permitting such pro-rata amortisation (typically based on the credit quality of the reference portfolio) may see renewed regulatory focus on such features.

Recoveries
In determining the final loss, CRTs give credit for recoveries received and applied by the relevant lender in respect of the defaulted asset. Assuming that the Covid-19 crisis results in a slower enforcement process, the treatment of late recoveries may become an issue – again, depending on the terms of the deal documents.

For example, it may be that the originator credit institution is contractually obliged to account for recoveries received even after the final loss for the defaulted asset is determined, and further, it may be that those amounts require verification by a third-party accounting firm by a pre-agreed work-out cut-off date for the relevant deal. In some CRTs, instead of third-party verification, the true-up payment in such circumstances is made on the basis of the actual loss suffered by the originator as recorded or certified by the credit institution.

Replenishments
CRTs involve largely static portfolios with adjustments permitted in limited circumstances, such as in the case of repayments, amendments and/or the refinancing of the underlying assets. The mechanism for replenishments is usually highly negotiated and involves the concept of permitted replacements of like-for like obligations. Depending on the conditions imposed under each deal, during the Covid-19 crisis, replenishments may become more difficult where, for example, internal ratings of the proposed new assets have been reduced and/or some other prescribed procedure for rating confirmation cannot be satisfied. In those cases, the originator credit institution would not be able to take full advantage of its CRT structure.

Early amortisations or termination
There may be some CRTs with early amortisation provisions, such as: deterioration in the credit quality of the underlying exposures to or below a predetermined threshold; losses rising above a predetermined threshold; and/or failure to generate sufficient new underlying exposures that meet the predetermined credit quality. During the Covid-19 crisis, any such triggers will need to be assessed, to determine if any such triggers have been hit.

Generally with CRTs, time calls are used under very limited circumstances and typically cannot be used to provide credit enhancement to investors. In most CRTs, the originator credit institution will only be allowed to terminate the deal for regulatory change events and for clean-up calls.

Structured Finance

Residual value buffer provided

Sector developments and company hires

Residual value buffer provided
Volkswagen Financial Services UK will calculate a collateral residual value buffer to be made available to its UK auto ABS issuers in respect of the monthly period in which a payment holiday with a term extension is granted for a purchased receivable. The collateral RV buffer will be £300 for each purchased receivable in respect of which a payment holiday with term extension has been agreed. The move aims to mitigate residual value risk to the issuer as a result of VW FS UK not reducing the guaranteed minimum future value and balloon payment to take into account extensions to the term of a purchased receivable.

In other news...

North America
Greenberg Traurig has recruited Jon Robins as a shareholder in its Philadelphia real estate practice. Robins handles complex finance, equity investment and real estate activities. He joins Greenberg Traurig following a 16-year tenure at Klehr Harrison Harvey Branzburg, having previously practiced law at Dechert for eight years.

ISDA has appointed two new directors to its board: Tina Hasenpusch, md, global head of clearing house operations at CME Group; and Taihei Okabe, md, head of derivatives trading at Mizuho Securities. Okabe replaces Yutaka Amagi, md and head of global markets planning division at MUFG Bank. The election of other primary member board directors and the appointment of subscriber and associate directors will take place at the association’s AGM in November.

PACENation has elected 22 new directors to its board, with backgrounds in public policy, programme administration, community resilience and clean energy finance. A number of the appointees are involved in the securitisation market, including: Peter Grabell, svp of commercial PACE at Dividend Finance; Lain Gutierrez, ceo of CleanFund Commercial PACE Capital; Mike Lemyre, svp at Ygrene Energy Fund; Stephanie Mah, vp of ABS at DBRS Morningstar; Jim Reinhart, ceo of Ygrene Energy Fund; Shawn Stone, ceo at Renovate America; and Olivia White, vp at Renew Financial.

Structured Finance

SFSF investments disclosed

Sector developments and company hires

SFSF investments disclosed
The AOFM has disclosed the recent investments it has made under the Structured Finance Support Fund. In the primary market, the fund was the sole third-party investor in the A2 tranches of FirstMac 2020-1 (it also invested in the A1 through D tranches) and Liberty Series 2020-1 on 27 March and 8 May respectively. It has also acquired 35 bonds in the secondary market between 6-11 May, issued by Firstmac, LaTrobe, Liberty, Mortgage House, Pepper, RedZed, Resimac and ThinkTank between 2011 and 2019. Finally, the fund invested in warehouses sponsored by AFG, Columbus Capital, Judo Bank, RedZed, Resimac and ThinkTank last month. The AOFM notes that to date, all of its secondary market activity has been to facilitate ‘switches’ from investors seeking to enter into new primary market transactions by the SFSF bidding for outstanding securities.

In other news…

APAC
Tikehau Capital has bolstered its investment capabilities with two hires. The firm has appointed Neil Parekh as partner and head of Asia, Australia and New Zealand, responsible for growing its business across the region. Parekh will join Tikehau at end-Q2, after completing his tenure with NAB as general manager, Asia. He benefits from more than 30 years of global experience in the financial services industry in the Asia Pacific, US and Europe. Meanwhile, Raphael Thuin has been named head of capital markets strategies at the firm, overseeing the management of its bond, equity and flexible investment strategies globally. Thuin was formerly head of fixed income management at TOBAM in Paris, having previously also worked at Topaz Fund and Société Générale in New York.

EMEA
Cairn Capital has recruited Charis Edwards as a junior portfolio manager, focusing on risk transfer and reporting to Brandon Kufrin, senior portfolio manager. Edwards joins Cairn Capital from Bank of Montreal, where she led the London-based risk and capital solutions team responsible for the structuring and distribution of risk transfer transactions. Prior to this, she worked in a variety of structuring roles at RBS, Deutsche Bank and JPMorgan, specialising in bank capital and balance sheet solutions, credit derivatives and securitisations.

Fixed severity CRT affirmed
Moody's has affirmed the ratings of the CAS 2014-C04 class 1M2 and 2M2 credit risk transfer RMBS notes, affecting approximately US$514.3m of securities. The bonds had previously been placed on review for possible downgrade, due to a lack of clarification on whether delinquencies caused by loans impacted by Covid-19 would qualify for ‘casualty event’ treatment. The rating action reflects updated guidance that reference obligations in a forbearance period due to Covid-19 in certain Fannie Mae fixed severity CRT transactions would qualify for such treatment.

Irish RMBS prepped
Barclays is in the market with the €796.99m Fingal Securities RMBS, a securitisation of part of the circa €5bn Irish mortgage loan portfolio it purchased from Bank of Scotland in May 2018 (SCI 24 May 2018). The €594.95m class A notes are expected to be publicly offered, while the class B notes have a ‘call desk’ status and the remainder will be preplaced. The provisional pool consists of 4,547 loans with a weighted-average (WA) indexed loan-to-value of 70% and a WA seasoning of 13.6 years. The portfolio comprises principal dwelling house (accounting for around 78%) and buy-to-let mortgages, with about 56% concentrated in Dublin. No loans in the portfolio are greater than three months in arrears.

North America
Nassau Private Credit has hired Vincent Chan as a portfolio manager, focusing on investments in investment grade and non-investment grade CLO securities. Chan is based in the firm’s Darien, Connecticut office. He joins NPC from Assurant Investment Management, where he was md and portfolio manager, responsible for structuring CLOs.

SME SRT performing ‘better than expected’
Scope Ratings reports that the class A, B and C notes of York 2019-1 CLO have amortised to £1.675.9bn, £185m and £65.2m respectively, representing 70% of their initial balances. Credit enhancement has increased to 26.6% from 23% since the closing date for the class A notes, to 18.5% from 14.5% for the class Bs, to 15.7% from 11.5% for the class Cs and to 10.2% from 7.5% for the class Ds. The agency notes that the portfolio performed better and amortised faster than expected, increasing the credit enhancement available to the rated notes. The transaction is a synthetic securitisation of a £2.283bn (£3.08bn at closing) portfolio of 2528 referenced obligations (3177 at closing) granted to 1121 SMEs and self-employed borrowers (1268 at closing), originated or acquired by Santander UK.

Structured Finance

TALF CLO rules clarified

Sector developments and company hires

TALF CLO rules clarified
The US Federal Reserve has clarified its CLO eligibility rules for TALF. It defines its stipulation that all or substantially all of the leveraged loans underlying CLOs must have been “newly issued” as those originated or refinanced on or after 1 January 2019. The Fed also announced additional CLO portfolio requirements: maximum second lien loan concentration of 10%; maximum debtor in possession loan concentration of 7.5%; maximum covenant lite loan concentration of 65% for BSL CLOs and 10% for middle market CLOs; and a maximum single underlying obligor concentration of 4%. In addition, eligible CLOs must include at least one OC test redirecting cashflow from the equity and subordinated tranches to the TALF-eligible senior tranche in the event of deterioration in the underlying loan portfolio.

In other news…

CLO supervisory concerns raised
ESMA has published a thematic report on CLO credit ratings in the EU, which identifies the main supervisory concerns and medium-term risks in this asset class, including credit rating agencies’ (CRAs) internal organisation, interactions with CLO issuers, operational risks, commercial influence on the rating process and the need for proper analysis of CLOs. The report also highlights the impact that Covid-19 may have on CLO methodologies. ESMA says it expects CRAs to continue to perform regular stress-testing simulations and to provide market participants with granular information on the sensitivity of CLO credit ratings to key economic variables affected by the pandemic.

Data partnership
Dv01 has partnered with Andrew Davidson & Co (AD&Co) to provide investors with access to AD&Co’s LoanDynamics Model to forecast prepayment, delinquency, default and loss severity for non-QM and prime jumbo RMBS available on the dv01 platform. Access to credit risk transfer data will be available in the coming weeks.

Microcredit guarantee inked
The EIF has signed a Skr200m guarantee agreement with Aros Kapital to provide loans of up to Skr275,000 for micro-enterprises in Sweden. Loans under this agreement – which will be guaranteed up to 80% under the EaSI Guarantee - will be available to companies with a maximum of nine employees and whose annual turnover or annual balance sheet total does not exceed €2m.

Rental payments deferred
The borrower under the Bel Air facility, securitised in the Taurus 2018-1 IT CMBS, has received requests for deferral of rental payments from a majority of the tenants of the underlying properties. Given the impact of Covid-19 on the real estate market, the borrower says it wishes to accommodate these requests to support tenants facing financial difficulties and to avoid termination of the leases. It has therefore approached CBRE Loan Services to facilitate a number of amendments to the lease agreements, including a deferral of payments due in April until Q4, without constituting a breach of the provisions of the transaction. The servicer has been provided with cashflows from the Bel Air borrower showing sufficient cash reserves to cover operational expenses and debt service until end-December 2020.

Structured Finance

Corporate actions slow down

Sector developments and company hires

Corporate actions slow down
Negative rating actions on corporate loan issuers continue to accumulate within US BSL CLOs, though the pace is moderating, according to S&P. Since early March, more than 28% of US BSL CLO collateral has been downgraded or placed on credit watch negative by the agency, while triple-C buckets have tripled to 12.3% from about 4% (though the pace has slowed) and 418 tranches across 316 CLO transactions are currently on negative watch. S&P notes: “The CLO structures are working as intended during periods of economic stress: about 10% of CLOs within the CLO Insights 2020 Index with failing junior OC tests have begun diverting interest proceeds away from equity holders to reduce the outstanding balance of the CLO senior notes.”

GSEs defer forborne payments
Fannie Mae and Freddie Mac have announced that borrowers who have been impacted by Covid-19 may now defer all their forborne payments into a non-interest-bearing balance that is due when they sell their home, refinance their mortgage or at maturity. Effectively, providing they restart their monthly payments at the end of their forbearance, borrowers can defer the rest of the payments as a balloon payment until they pay off their mortgage. This will not be treated as a prepay or credit event and therefore is expected to be positive for both homeowners and mortgage investors.

Structured Finance

Conflict of interest charge settled

Sector developments and company hires

Conflict of interest charge settled
The US SEC has charged Morningstar Credit Ratings for violating a conflict of interest rule designed to separate credit ratings and analysis from sales and marketing efforts. Morningstar has agreed to pay US$3.5m to settle charges including that from mid-2015 through September 2016, credit rating analysts in Morningstar’s ABS group engaged in sales and marketing to prospective clients. According to the order, Morningstar’s head of business development instructed analysts to identify business targets and pursue them through marketing calls, meetings and offers to provide indicative ratings. The order further finds that Morningstar issued and maintained ABS ratings for certain entities where an analyst who participated in determining or monitoring the credit rating also participated in the sales or marketing of a Morningstar product or service. In addition, between at least June 2015 and November 2016, Morningstar failed to maintain written policies and procedures reasonably designed to sufficiently separate the firm’s analytical and business development functions. 

In other news…

Deferral waivers ‘credit neutral’
The impact of the Italian government’s Rilancio Decree – which was introduced this week and allows for a temporary waiver of deferral triggers on servicing fees under the GACS scheme - is credit neutral for Italian non-performing loan securitisations, Scope Ratings notes. As a response to the Covid-19 outbreak, the government has suspended court activity and legal proceedings, with a consequent slow-down in servicers’ judicial recovery strategies. The aim of the decree is to prevent servicers being disincentivised from collection activity as a result of a temporary reduction in their total compensation if deferral triggers are hit. The agency notes that fees subject to deferral are typically only 20% of total servicing fees, while cash reserves should mitigate short-term liquidity shocks.

EMEA
Paul Petkov has joined Texel Finance's structured and bespoke solutions group in London. He was previously head of securitisation advisory at Qbera Capital. Before that, Petkov held various senior roles in structured portfolio management, balance sheet optimisation and credit risk management at Tier 1 banks, including Deutsche Bank, HSBC, JPMorgan, Lloyds and RBS.

Key persons solicitation
The Staniford Street CLO issuer is soliciting noteholder consent to designate James Fellows, Robert Hickey and Michael Herzig as key persons - succeeding Andrea Feingold, Timothy Conway and Scott D'Orsi respectively – under the collateral management agreement. The CMA states that a key persons event occurs upon the departure of two of the three key persons from the collateral manager. Fellows is cio of the collateral manager, First Eagle Private Credit Advisors (formerly known as NewStar Capital, which was formerly known as Feingold O'Keefe Capital), while Herzig and Hickey are senior mds. The collateral manager intends to effect the key person succession on the first date on which consent is received from the holders of at least a supermajority of the aggregate principal amount of the class BR notes and a majority of the aggregate principal amount of the class F and subordinated notes, voting together as a single class. The solicitation will expire on 25 June.

TCA receiver appointed
The US SEC has appointed a receiver over TCA Fund Management Group Corp, its affiliate TCA Global Credit Fund GP (TCA-GP) and several funds managed by TCA to protect investors from a fraudulent scheme allegedly conducted by TCA (SCI 27 January). The SEC’s complaint, filed in the US District Court for the Southern District of Florida, alleges that TCA improperly recognised revenue in order to fraudulently inflate net asset values and performance for several funds it managed, resulting in the funds always reporting positive returns. TCA allegedly distributed promotional materials to current and prospective investors that included the inflated asset values and false performance results. According to the complaint, the funds’ reported NAV of US$516m, as of November 2019, was inflated by at least US$130m. TCA and TCA-GP also allegedly distributed monthly account statements to investors falsely representing monthly returns and investment balances based on the inflated asset values. The complaint further alleges that the funds paid inflated management fees to TCA and inflated performance fees to TCA-GP.