Contents

Capital Relief Trades

SRTs eyed

Pension funds target risk transfer

Pension funds are targeting capital relief trade opportunities as the coronavirus crisis renders pricing more attractive and other credit opportunities become scarcer. However, access remains a challenge, with some new pension fund investors using joint ventures with established investors as an alternative way for overcoming entry barriers.     

According to IACPM data, pension funds represent 30.6% of the investors in distributed SRT tranches over the 2008-2019 period, with hedge funds capturing the bulk of this distribution over the same period (39.6%). The same data state that between 2017-2019, pension funds decreased their share of volumes by nearly 10%. However, as other markets retrace following the coronavirus outbreak, SRT opportunities begin to look more attractive.

Chris Redmond, head of manager research at Willis Towers Watson, explains: “Following the impact of Covid-19 and the oil shock, risk premia across markets increased significantly. Since the initial fallout, traditional syndicated markets such as high yield loans have retraced significantly.”

He adds: “However, less liquid and illiquid markets are still offering value, particularly in those markets with greater complexity, more leveraged participants and a narrower buyer base. SRT is one of the markets that investors should consider, alongside a range of other assets that still offer significant value, in our opinion.”

On the primary side, both pricing and banks’ willingness to work with investors have improved. “Banks are willing to provide higher quality portfolios and offer 100bp-250bp higher spreads,” Redmond confirms. “This reflects both a change in the number of accounts able to participate and overall market conditions. Investors, such as pension funds, with the ability to invest for three to five years can take advantage of the current market and generate attractive risk adjusted returns.”

Janne Gustafsson, senior portfolio manager at Ilmarinen, concurs: “If you have a high-quality portfolio, such as investment grade firms in non-cyclical industries, you can build an SRT that works even in the current environment. From an investor perspective, SRTs can offer a good risk/return profile. The yield may be lower than in CLOs, but potentially better underlying collateral compensates for that.”

Ilmarinen typically targets 8%-10% returns with SRTs, but Gustafsson says it is now aiming for 3%-4% more than usual and expecting a better risk profile than before. The Finnish pension fund started investing in SRT trades three years ago by committing over €100m with an asset manager after the 2015-2016 drop in oil prices.

“If you looked at the risk/return profile of CLO equity after the crisis in 2017, it seemed challenging and we wanted to find alternatives to it. Normally, we buy CLOs, but we weren’t comfortable with the marketed assumptions, especially if you stressed them,” Gustafsson remarks.

He continues: “The challenge with SRTs is the information asymmetry between the buyer and the seller and the fact that they require comparatively large investment sizes. Furthermore, if you want to do syndicated deals as a small investor in the deal, you end up being a rule-taker. However, if you are a big player who can drive a deal, you can get the data and negotiate deal features such as veto rights. This is one of the main reasons why we prefer to invest through established asset managers.”

Indeed, Ilmarinen has maintained its long-term exposures and raised allocations. Gustafsson notes: “We started with a bit over €100m in 2017. However, it takes time to ramp up and our more recent fund commitments were made to maintain our existing exposure for the long term, while modestly raising our allocations for risk transfer deals. When a closed-ended fund passes its investment period, the principal from maturing investments is returned to you. Therefore, you need new funds to maintain your allocation for the long term.”

Committing capital via established asset managers is the typical route by which pension funds try to gain access. However, more recently, new investors have opted for a joint venture approach.

Earlier this month, Swedish pension fund Alecta finalised a co-investment agreement with long-standing SRT investor PGGM (SCI 6 May). According to the terms of the agreement, PGGM will purchase 70% of each transaction, while Alecta will acquire the remaining 30%.

Tony Persson, head of fixed income and strategy at Alecta, comments: “SRTs require a lot of resources to implement successfully; being able to share resources and split costs with a like-minded investor in a similar position in their own pension market makes a lot of sense and creates a lot of benefits for our customers. This cooperation with PGGM will effectively make us a relevant counterparty for global banks in this area. Given the size of our €90bn portfolio, our focus is on primary transactions.”

Similarly, Mascha Canio, head of structured credit at PGGM, remarks: “For new entrants, it may not be so easy to get the same access to deal-flow and the same transaction standards in place. Last but not least, we are both directly focused on doing what is best for pension fund customers and hence focused on low cost execution as well. We feel that these co-investment partnerships can be repeated more often across different pension fund investors. It simply makes a lot of sense.”

Given the size of its client PFZW’s €218bn AUM, PGGM needs to insist on minimum levels of tranche sizes. Since 2006, that has been €100m, with the investor known to have purchased deals equal to €500m (see SCI’s capital relief trades database). As of the end of March, PGGM’s SRT portfolio stands at nearly €5bn.

Looking forward, Canio states: “We continue to believe in the benefits of risk-sharing transactions for the financial system. More banks will want to enter into such trades and grow volumes, with regulations such as the recent EBA report on STS synthetic securitisations contributing to that. The current economic environment is unprecedented and credit risk will continue to go up for a while as a result, but we don’t believe that 100% of corporates will default. At the same time, central banks and governments are providing lots of liquidity and support.”

Stelios Papadopoulos

Capital Relief Trades

Moratoria mulled

Payment holidays set to test CRT provisions

Portfolios referencing loans subject to payment holidays may create a new sub-asset class within the capital relief trades market. Nevertheless, it remains to be seen whether provisions in outstanding synthetic securitisations will prevent lenders from being paid due to the implementation of moratoria.

Roberto Savina, head of structured risk solutions at AmTrust International, confirms that he has been asked to look at moratorium portfolios and potentially take a share of the risk of their performance post-moratorium. He says the assessment of such deals would be similar to the assessment of non-moratorium pools, albeit technicalities around pricing change.

“An investor would know in advance that the performance of the transaction will be more volatile compared to a regular mortgage pool and the term will be shorter. They would still have to understand the pool composition and get comfortable with the servicing of the portfolio, but recoveries are likely to be determined by whether the economic recovery post-coronavirus is V-, U- or an extended U-shaped,” he notes.

Savina says his firm has witnessed payment holidays related to mortgage portfolios in the past; in particular, during the 2012-2015 Italian sovereign crisis. “Our previous experience has largely been positive: where payment holiday schemes are applied properly, they work. Delinquencies post-moratorium were aligned with our expectations, suggesting that the schemes were appropriately targeted at borrowers facing short-term liquidity issues but who were expected to remain solvent in the long run. If the borrowers’ issues are more long term, it is better to increase provisions because holidays are unlikely to work.”

Indeed, there are two key drivers behind the success of payment holidays, according to Savina. One is to target borrowers with no missed payments before the moratorium was implemented, as they typically demonstrate better performance post-moratorium. The other key driver is implementing a moratorium as soon as possible.

“If a lender can offer a holiday before a borrower misses a payment, the holiday will be more effective. As the borrower is proactively offered a solution, they are more likely to behave positively in the future. For existing deals, the differentiating factor will be quality of servicing,” he explains.

However, it remains to be seen whether older CRTs will work in a way that means the lender won’t be paid due to the implementation of moratoria. “The regulatory expectation is that if a bank has achieved risk transfer, it should be paid for losses quickly,” observes Assia Damianova, special counsel at Cadwalader. “The question now is whether, depending on the drafting of the deal documentation, the moratoria means a notice will be sent to pay immediately. While the CDS market has its mechanisms to deal with this issue, the CRT market - now using financial guarantees - hasn’t had to consider such concentrated occurrences before and it will be an interesting test for those deals.”

Under a financial guarantee, it is likely that banks will have to wait until the moratoria are lifted to claim for losses sustained during payment holidays. But this presents its own challenges: if it becomes difficult to value and work defaulted loans out, it is disadvantageous to sustain losses at the end of a deal.

“If a deal is maturing and losses haven’t been realised, there is usually a fall-back valuation mechanism. But if the asset is illiquid, how realistic is a market bid in terms of its value?” Damianova asks.

For new post-coronavirus CRT issuances, she anticipates that there will be more of a focus on what happens if/when defaults start materialising. “Documentation will be tested for any unintended glitches and depending on their negotiating strength, investors may seek more robust fall-back mechanisms in cases where assets haven’t been worked out. Similarly, if failure to pay doesn’t clearly envisage payment, parties may want to make clear who bears the risk of a payment holiday.”

She continues: “Will failure to pay have to be waived for three months, for example? If it’s simply a technical delay due to moratoria, the lender will be paid eventually, so there are no losses. Nevertheless, a payment holiday may indicate that the business is struggling and may be unable to pay; if the CRT deal is nearing its end, the ability of the originator to reserve its rights for potential defaults will be important in that example.”

Corinne Smith

Insurance-linked securities

Mobilising MILNs

The MILN market is in deep freeze but thaw might be due

The mortgage insurance-linked note (MILN) market has been closed for three months as a result of the Covid 19 dislocation, but well-placed sources say the smoke is clearing and that the market shutdown will not be as protracted as was originally feared.

“Through April, we had no discussions with investors that were at all constructive about new deals. But in the last week or two, we have seen more detail about forbearance and delinquency which has provided a degree of clarity, and I think we’re in the first stage of recovery,” says a senior manager at one of the big six mortgage insurers - which are Radian, Arch, Essent, Genworth, National Mortgage Insurance Corporation and MGIC.

The last deal offered in the MILN market was the five-tranche $488.4m note sold by Eagle Re 2020-21 (the SPV operated by Radian Guaranty) in February. However, notice of the market’s closure was afforded in unequivocal terms a month later when, on March 9, Arch pulled a planned transaction through its Bellemeade 2020-21 SPV.

“There was no investor interest in the deal. When it was pulled, it marked the line of demarcation between open and closed,” says a market source.

At this juncture, it was widely believed that the market, which has provided an increasingly important avenue of reinsurance, capital relief and credit rating support for mortgage insurers, would be shut until 2021 at the earliest.

But the mood has lifted. Market participants now feel that the next deal will be priced well before the end of this year, though it remains some months away.

A couple of factors have buoyed optimism. Firstly, the latest numbers suggest that forbearance might have run its course. Data released on 29 May by Black Knight, the mortgage data and technology provider, shows there were only 7,000 new forbearance plans last week compared to 325,000 in the first week of May and a whopping 1.4m in the first week of April.

Moreover, and perhaps more tellingly, it seems that by no means all loans in forbearance will become delinquent. Recent data shows that 46% of borrowers in forbearance, around 4.25m in number, still made the required April payments while 54% did not.

This aligns with a Lending Tree survey reported last week which divulged that only 5% of borrowers in forbearance said they could not have made payments without the relief afforded by forbearance.

It seems that a healthy percentage of borrowers in forbearance have taken it as a free option, but are not necessarily on the verge of delinquency. This knowledge has provided some comfort to potential MILN investors.

Also, when the black clouds of Covid 19 suddenly and unexpectedly darkened markets in March, investors and analysts turned unsurprisingly to the events of 2008/2009 as a guide to what might happen in the mortgage market on this occasion.

But the financial crisis does not provide an adequate template for events in 2020, say sources. Underwriting standards have been better over the last ten years, and borrower discipline stricter than in those tumultous days. “The comparison to 2008/2009 is not appropriate. We’re starting with far stronger foundations this time over,” comments a MILN manager.

So, the market closure could be shorter than was at first feared and predicted. In the short-term, however, the mortgage insurers must turn to the reinsurance market to back up their mortgage policies rather than the capital markets. The disadvantage of this is that the traditional reinsurance markets offer less efficient capital treatment.

According to the stipulations of minimum required assets under the Private Mortgage Eligibility Requirements (PMIERS), which insurers must fulfil before they can insure GSE-issued transactions, full capital credit is given for MILN reinsurance but only partial credit is afforded for traditional reinsurance.

“We don’t get full PMIERS credit for partially collateralised deals. The credit is haircut so it’s less efficient. How much credit we get depends on the individual deal,” explains another senior manager at one of the mortgage insurers.

Dependence on the traditional reinsurers will vary according to the PMIERS sufficiency ratios at the respective insurers. At the last count, these varied from about 117% to 200%, so insurers at the lower end of this range have less room for comfort.

Alternatively, the insurers will have to put up the required capital themselves, or raise capital in a more traditional manner such as the equity markets. But none of these routes are as satisfactory as the MILN market.

The MILN market tracks the GSE CRT market (CAS for Fannie Mae and STACR for Freddie Mac) and prices in that sector indicate that any hypothetical new deal would, at the moment, be forced to come at much wider levels than those seen in the Eagle Re transaction posted three months ago.

The $83.8m M1-A notes sold by Eagle Re came at one-month Libor plus 90bp, the $133.2m M1-Bs yielded plus 145bp, the $88.8m M1-Cs yielded plus 180bp, the $155.8m M2 notes yielded plus 200bp and the $24.7m B1 notes were priced to yield plus 285bp.

According to data provided by Mark Fontanilla & Co, upper mezzanine structures (M1s for Fannie Mae CAS and M1s/M2s for Freddie Mac STACR) were at around plus 275bp-300bp in the actual loss vintages at the close on 28 May. The lower mezzanine actual loss vintages (M2s for CAS and M2s/M3s for STACR) were around plus 400bp-425bp while the B class subordinated notes were around plus 1200bp.

Newer vintages, those issued in the last 12 months, were slightly narrower in the upper and lower mezzanine stacks, but wider in the subordinated stack. Upper mezz notes were around plus 240bp-260bp, lower mezz notes were around plus 375bp-400bp while the B1s were at least 1500bp over benchmarks.

Data providers are keen to point out that these levels are only indicative, and, due to volatile and illiquid trading conditions, change substantially each day.

The MILN market has become a valued method of private capital funding for insurers since the first deal in 2015. There were 10 new transactions in 2019 compared to seven in 2018 and, until Covid 19 brought about a juddering halt, it was predicted that 2020 would be a bumper year.

“We are very keen to see the market reopen. We are trying as hard as we can to get it open again, but we’re not quite there yet,” says the senior manager at one of the big six mortgage insurers.

Simon Boughey

Structured Finance

SCI Start the Week - 18 May

A review of securitisation activity over the past seven days

Last week's stories
Auto ABS boost
European ABS market update
Drafting issues
The potential effect of current market volatility on capital relief trades
Forbearance frontiers
4.7m home loans now in forbearance
Liquidity support
Amendments mitigate forbearance impact
Portfolio resilience
Technology-driven investment gaining traction
Positive outlook
Survey indicates distressed debt pick-up
Questionable idea?
Central bad bank proposal raises concerns
SRTs unlocked
BMO launches capital relief trade
Tortuous TALF 2.0
Markets question TALF usage
Unknown unknowns
Covid-19 modelling challenges persist
Waivers required
WBS covenant breaches eyed

Other deal-related news

• 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 (SCI 11 May).
• The AOFM has disclosed the recent investments it has made under the Structured Finance Support Fund (SCI 12 May).
• 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 (SCI 12 May).
• 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 12 May).
• 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 (SCI 12 May).
• The US Federal Reserve has clarified its CLO eligibility rules for TALF (SCI 13 May).
• 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' internal organisation, interactions with CLO issuers, operational risks, commercial influence on the rating process and the need for proper analysis of CLOs (SCI 13 May).
• The EIF has signed a Skr200m guarantee agreement with Aros Kapital to provide loans of up to Skr275,000 for micro-enterprises in Sweden (SCI 13 May).
• 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 (SCI 13 May).
• Negative rating actions on corporate loan issuers continue to accumulate within US BSL CLOs, though the pace is moderating, according to S&P (SCI 14 May).
• 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 (SCI 14 May).
• 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 (SCI 15 May).
• 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 (SCI 15 May).
• 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 15 May).

Data

BWIC volume

Secondary market commentary from SCI PriceABS
15 May 2020
USD CLO
Another buoyant day with 27 covers - 1 x AAA, 14 x A, 8 x BBB and 4 x BB.  The AAA is ARES managed ARES 2019-52A A2 which is a 2nd pay and covers 222dm / 7.04y WAL, with another Ares mezz AAA trading in 260s dm context around April month end this gives some illustration of the tightening this month.
A lot of single-As today with the trading range 283dm-428dm for a range of RP profiles (2020-2024) with trading range mtd 280dm-540dm, at the wide end today is BlueMountain's BLUEM 2016-1A CR 428dm / 5.01y WAL - high ADR 1.7%, high sub80 bucket 20.1%, high WARF 3458, neg par build -1.05 and a spilled CCC bucket 8.1% whilst the manager has a weaker record vs peers.  At the tight end is CSAM's MDPK 2018-30A C 283dm / 5.24y WAL - low ADR 0.46, 18% sub80, WARF is also high 3379, 1.6% CCC and a strong manager record.
The BBBs trade 487dm-609dm (versus a volatile 500dm-1000dm trading range mtd), OFS's OFSBS 2014-6A CR cover 487dm / 2.31 is the tightest BBB trade post-vol albeit short dated (2018 RP end).
BBs continue to tighten with a trading range today 940dm-1051 so clean deals are now in 1000dm context and three have now penetrated 1000dm post-vol, at the tight end today is Blackrock's MAGNE 2015-12A ER 940dm / 8.1y WAL - 0.57 ADR, <10 ADR (9.94), 5.1% CCC and 3120 WARF from a benchmark manager.
EUR/GBP ABS/RMBS
Got 2 ABS CVRs today, the first CVR prices we have seen on a BWIC for a long time. BRICQ 2019-1 A (AA rated Italian Consumer Loan deal) traded at 98.83 / 150dm to step up date. In Nov 2019 it traded at 100.37 / 51dm. BRICO 2019-1 A (also AA rated class of Italian Consumer Loans from the same originator - Creditis Servizi Finanziari) traded at 99.05 / 161dm. This bond traded in Jan 2020 at 100.53 / 37dm.
EUR CLO
Just one AAA today. SPAUL 3RX AR traded at 97.01 / 204dm. This is on top of SPAUL 9 A which traded at 205dm on 11 May.
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.

Capital Relief Trades

Risk transfer round-up - 22 May

CRT sector developments and deal news

Santander is rumoured to be readying its fourth SME significant risk transfer deal from the Magdalena programme for the second half of the year. Magdalena Three was finalised in June last year. The €342m ticket referenced Spanish SME loans (see SCI’s capital relief trades database).

CLOs

Equity uptick

CLO equity back in focus in the US secondary market

The US CLO secondary market saw a pick-up in equity activity last week. At the same time, focus has shifted to more recent vintage pieces.

“Cleaner longer-dated equity pieces are gaining support,” says one trader. “We’re also seeing a strong preference for 2019 deals versus the 2018 vintage, which is a reverse of what was going on pre-crisis. 2019s have a higher cost of capital than 2018s, but buyers don’t seem to care if they’re getting the excess.”

Pricing transparency is opaque as trading remains bilateral and the few equity pieces that do make it on to BWIC rarely have colour released. However, on 13 May OCT45 2019-1X SUB was seen to cover on SCI PriceABS in the 60 area. “The actual trade broke the 60 barrier, which isn’t something we’ve seen in equity since the crisis began,” the trader notes.

The source of the current equity buying interest is equally hard to divine. “It’s not 100% clear who is getting involved,” says the trader. “Dealers certainly don’t have the appetite for equity right now, so it’s being left to a few of the usual hedge funds, though I hear new money is being raised for equity as well.”

Double-Bs are the other part of the stack generating interest and attracting new money, the trader reports. “People like longer-dated paper there even though prices are running up against loans – with loans at 86 and CLO double-Bs at 80, there’s not enough premium – but there is now a realisation you’re not comparing apples to apples and that CLOs won’t move up as fast as the loan index. So if we’re in the 80s now, it’s not going to be 90 next week, so a lot of people are now willing to stay put to see where we go. That said, there are pockets of money – mainly non-mark-to-market funds in PE type structures – being put to work and lifting the market.”

Wherever investors look to add, they are going to have to navigate choppy waters for quite some time yet, the trader warns. “The current spate of rating downgrades is directly impacting deals, but in the end increasing triple-C buckets alone isn’t going to bring the market down. My big concern is where we’ll end up once the default cycle starts – no one can know what’ll happen there, as it’s a whole new world now and a whole new way of working, which will drive correlation risk across industries and financial sectors. We will just have to see how it plays out.”

However, the trader suggests that overall CLO investment decisions will remain unchanged. “It has always been about managers, but differentiation has been made even more obvious by this crisis, right down to the individual deal level. People are looking at better or bigger managers with deep pockets, who are likely to be able to stick around, and longer-dated deals so there is time to cure them – shorter deals and weaker managers are really suffering right now. Undoubtedly, the ultimate winners will be the most prudent risk takers and the most conservative platforms.”

Mark Pelham

CLOs

Back on hold

European MM CLOs stymied by pandemic

The long hoped for pick up in European middle market (MM) CLO issuance was expected to arrive in 2020. However, thanks to the Covid-19 crisis, plans have had to be put on hold as middle-market firms focus on survival.

A new report from DBRS Morningstar suggests that the crisis has set back the progress of MM CLOs in Europe for a while, but does view positively the overarching positioning of direct lenders, which helps them take advantage of lending opportunities to SME borrowers. In the long run, the agency says that MM CLOs could offer an opportunity to support the availability of funds for these types of activities.

“The US middle market CLO sector is well established and has seen a spurt in growth while Europe just recently had the first and only Spanish-focused SME and middle market CLO Alhambra SME Funding 2019-1 issued [SCI 14 November],” the report says. “While there are talks of more deals coming to the market in Europe, the recent sell off means these projects will be shelved for now.”

DBRS Morningstar notes that the current crisis could in theory present opportunities for CLO managers, whereby if a CLO is in its reinvestment period with a large cash balance or is in a warehousing phase, then it is potentially possible to selectively take advantage of stressed prices.

The agency adds that opportunity is even clearer for European MM CLOs as the underlying loans tend to be originated by the manager, enabling them to be more selective and to adjust lending rates to match market pricing. However, it adds that given the market for CLO investors is still new, there is a limited degree of transparency into the potential pricing of a new transaction.

Nevertheless, the report is cautiously optimistic in the long term. “We believe SME and MM direct-lending platforms fill a gap in the market that is currently still preferred and dominated by traditional banks. Direct lending to larger borrowers took root in the GFC and now is a well-established alternative, and direct lenders often work alongside the banks than to compete as both are working in separate risk/reward sections of the market with some overlap. The supply of borrowers needing credit is high, but the exit strategy of lenders in the form of a CLO is not to the taste of every investor.”

However, the rating agency concludes: “Since the issuance of Alhambra MM CLO, we have seen an increase in queries of either rating warehouse funding facilities or standalone lending facilities, and their CLO take-outs. However, in light of the current crisis, focus has shifted to managing existing facilities.”

Mark Pelham

NPLs

Limited effect?

Performance trigger suspensions eyed

The Italian government last week passed the Decreto Rilancio, a decree that aims to restart the economy following the country's coronavirus-driven lockdown (SCI 15 May). The decree allows the Ministry of Finance to approve temporary suspensions of performance triggers that allow for the payment of special servicing fees for GACS guaranteed non-performing loan securitisations. If implemented, the change is expected to negatively impact the cashflow of GACS ABS.

According to Moody’s: “If implemented, the change will have a negative effect on the cashflow for the GACS deals that we rate because it will raise the senior costs of transactions. In GACS deals, servicer fees are the first item to be paid in the waterfall, just before the state guarantee fees and interest on class A notes. However, the temporary hold on performance triggers related to servicing fees will persist for a specific number of months and will affect only a portion of servicing fees, limiting the effect on overall cashflow.”

The ruling will help ensure that special servicers receive full servicing fees until July 2021, even when recoveries underperform the original business plan. This will help preserve servicers' ability to operate in an environment of limited recoveries and reduced servicing fees, while avoiding any servicer disruption that would have negative effects on transactions.

The document notes that a performance trigger suspension can occur if lower recoveries are the result of coronavirus-related actions, such as the closure of tribunals, and is conditioned on an agreement between transaction parties. Additionally, this change in documentation may only occur as long as it doesn’t trigger a change in the rating of the senior notes.

A portion of the servicing fees in NPL deals are based on performance targets and part of those fees can be postponed if actual recoveries fall short of business plan expectations. Currently, some transaction triggers have been breached and a portion of performance fees have not been paid. Fee reductions have partially compensated for lower collections, also resulting from the closure of tribunals.

All 15 Italian GACS deals rated by Moody’s include effective provisions to defer or subordinate some of the servicing fees to a lower position in the payment hierarchy, in the event of underperformance. Deals that closed after May 2019 must have at least 20% of the payments postponed or subordinated if performance falls below 90% of the original business plan. All other rated deals that closed before May 2019 have provisions with targets set at different levels.

Looking ahead, Moody’s notes: “We do not expect a change in the alignment of interests between noteholders and special servicers because of current market conditions, given that underperformance is out of the control of the special servicer and mainly the result of tribunals shutting down and the real estate market halting because of the pandemic.”

The agency concludes: “There are uncertainties about how the decree's implementation might change deal documentation, given the number of conditions listed in the new law. Additionally, the ability of special servicers to take advantage of the fee postponement provision will depend on the types of noteholders in each transaction, such as notes retained by the seller and a party closely related to the servicer.”

Stelios Papadopoulos

Real Estate

Forbearances falter

Forbearance volumes slow, but the next stage is daunting

The rate of increase of US home loans in forbearance plans has slowed significantly lately, according to data compiled by Black Knight, the mortgage technology and data provider, but the overall picture remains sobering.

Only 7,000 new mortgages were added to the overall total of 4.76m homeowners in forbearance plans in the week-ending May 26. This compares to a 325,000 net increase in the first week of May and a mammoth 1.4m increase in the first week of April.

But, while new forbearances might have peaked, forbearance plans will be discontinued in the near future and what are currently delinquencies will then be on the cusp of becoming actual defaults. Moreover, it is possible that the rate of forbearances will climb once again as the effect of government stimulus plans fades.

“While the levelling off of active forbearance volumes is welcome news, the focus of industry participants, especially servicers and mortgage investors, is already shifting from pipeline growth to pipeline management. The question now becomes how to handle the upcoming wave of forbearance expirations and/or extensions, as well as assessing default risk and what comes next for the nearly five million homeowners in active forbearance plans,” as Andy Walden, Black Knight’s economist and director of market research, told SCI.

Given the number of loans in forbearances, mortgage servicers need to pay a total of $3.6bn per month to holders of government-backed MBS bonds to meet the interest and principal payments. Adding in the interest and principal due to holders of private label mortgage securities, the grand monthly total the servicers must bear is $5.8bn.

This is in addition to the $2.1bn they must also advance to cover tax and insurance payments on behalf of borrowers in forbearance, including both government-backed loans and private label loans.

Of the total 4.758m loans in forbearance, 1.997m are owed to Fannie Mae and Freddie Mac, 1.526m are owed to the Federal Housing Authority (FHA) and Veterans Association (VA) and the remainder (1.238m) are owed to non-government backed lenders. Some 7.2% of all GSE-backed loans and 12.6% FHA/VA loans are currently in forbearance plans.

Simon Boughey

NPLs

Leading the way

A look at the European DataWarehouse's role in the NPL securitisation space

The all too real impacts of the pandemic-driven crisis are already finding their way in to European DataWarehouse's (ED) loan-level data. While it does not relish that particular leading role, the repository intends to remain at the forefront of the development of the NPL securitisation market throughout the crisis and far beyond.

"We're already starting to see very early impacts of COVID 19 in our data set," says Christian Thun, ceo at ED. "They are especially prominent in countries that saw an earlier spread of the virus, such as Spain and Italy. For example, we are seeing an increase in new delinquencies for Spanish credit card loans compared to residential mortgages and consumer loans in the country."

ED reports that all sectors are beginning to show increasing delinquency rates, though defaults are yet to take hold. Thun cautions: "This data is only to the end of March and it's likely to be much more severe in April and over the course of the coming months. As time goes on, the picture will become clearer and the data more robust. But it's already clear that southern Europe will be hit harder than northern Europe and based on previous trends we expect that the self-employed will be most drastically affected."

The impacts will be widespread, however. "It hasn't started in earnest yet, but the recession is coming," Thun says. "The worldwide government economic support measures can only be temporary and once they are finished, non-performing loans will unfortunately start to rise, reversing the trend seen in recent years."

As a result, he says: "We expect to see an increase in NPL securitisations in the wake of Corona. While they don't satisfy ECB eligibility criteria, which require underlying loans to be performing, there is still strong investor appetite for this sort of product thanks to the yields they offer."

Equally, once the market begins to pick up, ED intends to resume its Q1 2020 activities. "Our pre-crisis focus for NPLs, in alignment with our general mission, was and still is transparency and standardisation," says Thun. "Standardisation will come with the ESMA templates for the securitisation market."

To that end, ED has been contributing to a number of Europe-wide projects in the NPL space for some time. Since 2019 it led and continues to lead a technical working group on the implementation of EBA Data Templates, for example.

In addition, ED attended two NPL Round Table discussions in January and June 2019 in Brussels hosted by the European Commission (DG FISMA). The objective of these round tables was to spur work to achieve pan-European NPL platforms. The initial intention of the discussions was to establish what would be needed to achieve this goal and within what timeframe; with a long-term aim of devising a plan for developing industry standards for European NPL platforms.

As part of this initiative, ED volunteered to set up a technical working group to make the EBA data template operational. To this end, ED organised and led four NPL technical working group meetings in the last six months, which are working to define standards for the NPL data collection and to draft a road map for the implementation of the EBA NPL loan tape. The meetings brought together more than 40 representatives from 20-plus organisations. The working group submitted a report on its findings to the European Commission in early April 2020.

Meanwhile, ED is also participating in discussions for creating a secondary platform for trading NPLs, for which ED has long since been a strong advocate. "We are confident that transparency within the transaction platform will widen the investor base, lower entry barriers to potential investors, improve data availability, support price discovery and facilitate the development of the NPL secondary market," says Thun.

Prior to 2019, ED implemented the first NPL templates and collected test files for NPLs, in accordance with reporting templates developed by the European Banking Authority (EBA), between February and June 2018. The templates provided a common EU data set for the screening, due diligence and valuation of NPL transactions.

The EBA templates were introduced as part of the EC Action Plan to tackle NPLs in Europe and aimed to further develop secondary markets. By providing a platform for the collection of test data, ED enabled banks, servicers and other market participants to become familiar with the EBA templates and loan-level reporting for residential mortgages and loans to small and medium corporations.

Before that, ED leveraged available NPL data in 2017 to provide insight into Italian NPLs. It published a report that provided an overview of the, then, current status and challenges for enhanced NPL transparency and summarised the lessons learned in the context of the ECB ABS Loan-level initiative.

ED has also been quoted in numerous publications released by the ECB and European Commission where it is recognised and referenced as a market leader and key stakeholder in the NPL market. These include the 'Commission Staff Working Document on European Platforms for Non-Performing Loans' (2018); the 'Report of the FSC Subgroup on Non-Performing Loans' (2017); and the ECB's article on 'Overcoming non-performing loan market failures with transaction platforms' (2017).

Despite its list of past achievements, ED is more interested in looking ahead. Thun concludes: "We remain dedicated to the future of NPLs in Europe and plan to continue our efforts in the market for the coming years."

Mark Pelham

About the European DataWarehouse
European DataWarehouse (ED) is the first and the only centralised securitisation repository in Europe for collecting, validating and distributing detailed, standardised and asset class specific loan-level data for ABS and private whole loan portfolios. ED stores loan-level data and corresponding documentation for investors and other market participants. Through ED's data, users are able to analyse underlying portfolios and compare portfolios on a systematic basis.

ED was established in 2012 as part of the implementation of the ECB ABS loan-level initiative. Since its inception as an initiative by the leading participants of the European securitisation market, ED has collected loan-level data and relevant documentation for more than 1,400 transactions.

Structured Finance

SME CLO, SRT PD adjustments mooted

Sector developments and company hires

SME CLO, SRT PD adjustments mooted
DBRS Morningstar is considering additional adjustments to reflect expectations of a higher probability of default (PD) for borrowers underlying SME CLO and significant risk transfer deals operating in economic sectors considered to have a ‘mid-high’ or ‘high’ risk of experiencing higher levels of default, due to the coronavirus fallout. For borrowers in the ‘mid-high’ risk sectors, the adjustment will generally correspond to lowering the borrower rating by one notch or the equivalent increase of the one-year base case PD for SME CLO transactions. For borrowers in the ‘high’ risk sectors, the adjustment will generally correspond to lowering the borrower rating by two notches or the equivalent increase of the one-year base case PD for SME CLO transactions. The agency notes that exposures to ‘mid-high’ or ‘high’ risk sectors vary significantly across transactions, the main drivers of which are the originators' regional and sectoral focus or specialisation. Meanwhile, DBRS Morningstar’s analysis indicates that the Colonnade UK transactions are the SRTs most exposed to the ‘high’ risk sectors, with an average 42% of the portfolio notional referencing borrowers in those sectors. The transactions under the Colonnade Global programme, on the other hand, show exposure that on average is 22% to the same ‘high’ risk sectors. Exposure to the ‘mid-high’ risk sectors is limited in both groups, averaging 2% in total.

In other news…

Cofina financings inked
FMO has closed two transactions with microfinance group Compagnie Financiere Africaine (COFINA): €7.5m is issued to Cofina’s subsidiary in Senegal and €5m to Cofina Côte d'Ivoire. The majority of this funding will specifically support lending to women and youth-owned businesses, in countries where nearly half the population still lives below the national poverty line. The aim is to drive financial inclusion, which is critical in reducing poverty and achieving inclusive economic growth. The funding will be provided by the Dutch government’s MASSIF fund, which is designed to take early investment risks and catalyse the growth of the private financial sector, while stimulating financial inclusion in developing countries. Cofina provides tailor-made financial products and services to the ‘missing middle’ - SMEs whose needs are too large for smaller MFIs and whose structure is too informal or risky for commercial banks.

ELIZA 2018-1 standstill
The special servicer has entered into a standstill agreement with the borrowers behind the Maroon loan, securitised in Elizabeth Finance 2018, until the loan’s initial maturity date in January 2021, pursuant to which the obligors acknowledge the suspension of their right to operate the working capital account, borrower general accounts and the holdco general account - all of which will now be operated by the special servicer. In addition, the obligors are required to submit to the special servicer before 1 October 2020 a repayment plan to ensure the repayment of all amounts due by the loan’s initial maturity date (SCI 30 March). Meanwhile, a mezzanine payment stop event has occurred, meaning that payments to the mezzanine lender have stopped.

Rent relief strategy
The borrowers behind the DECO 2019-Vivaldi and Pietra Nera Uno CMBS have suspended April rent invoicing and deferred payment of 50% of the service charges they levy on the underlying properties (SCI 14 April). The rent relief strategy may be further extended during 2Q20, depending on the extent of the coronavirus fallout. As of 29 April 2020, 64% and 81% of rental revenue for the respective securitisations due from tenants in respect of the quarter ended on 31 March 2020 was collected.

Structured Finance

Covid-19 relief initiative launched

Sector developments and company hires

Covid-19 relief initiative launched
Community Capital Management has launched an initiative to invest US$100m of assets in Covid-19 relief efforts. The aim is to offer organisations that wish to contribute to the long-term US recovery post-pandemic an opportunity to complement their philanthropic and volunteer resources through a seasoned fixed income strategy designed to provide high current income consistent with the preservation of capital. The initiative will invest in high-quality bonds that have positive societal impacts, including: agency RMBS financing loans to low- and moderate-income borrowers; agency CMBS financing affordable rental housing; and ABS financing small businesses, job creation and economic inclusion opportunities.

EIF boost for Irish enterprises
Social Finance Foundation has signed two funding initiatives aimed at community organisations and social enterprises in Ireland. Under the first agreement, AIB/EBS, Bank of Ireland, Permanent TSB and Ulster Bank will make available an additional €44m in low cost funding to the Foundation over the period 2021 to 2025. Under the second agreement, the EIF will provide loan guarantees totalling €25m to support new lending by the Foundation as part of the EU’s Employment and Social Innovation programme (part of the Investment Plan for Europe). The guarantee will cover 60% of any loan losses, with the Foundation and its partners taking the remaining 40%. The guarantee covers loans up to a maximum of €500,000 and is valid for the first 10 years of the life of the loan. Typical projects funded by Social Finance Foundation include community centres, social care organisations and niche housing associations.

Structured Finance

TALF subscription date announced

Sector developments and company hires

TALF subscription date announced
The New York Fed has scheduled the first TALF ABS loan subscription date for 17 June, with the first loan closing date to be 25 June. On fixed days each month, borrowers will be able to request one or more three-year TALF loans. The Fed has published a Master Loan and Security Agreement, which provides further details on the terms that will apply to TALF loans. Separately, the Fed intends to conduct four small value agency MBS coupon swap operations on 26 and 27 May. On these days, it intends to swap out of a number of unsettled June TBA positions for other readily available MBS - 30-year UMBS 3.0 and 3.5 percent coupons, 15-year UMBS 3.0 percent coupon and 30-year Ginnie Mae II 2.5 percent coupon. Each operation will have a face value of US$5m, for a total current face value of US$20m across the four operations. 

In other news…

GSEs set to hire financial advisors
Fannie Mae and Freddie Mac have commenced request for proposals processes to hire an underwriting financial advisor that will assist in developing and implementing a plan for recapitalising and responsibly ending their conservatorship. The financial advisor will work closely with the GSEs and the FHFA to consider business and capital structures, market impacts and timing, and available capital raising alternatives. Engaging a financial advisor is an important milestone in meeting the GSEs’ 2020 FHFA scorecard objective to prepare a responsible transition plan for a potential exit from conservatorship.

SIUGI upper mezz upgraded
Scope has reviewed its rated SRT tranches of the SME Initiative Uncapped Guarantee Instruments (SIUGI) issued under the EIB’s Spanish SME initiative. The agency has affirmed the €608.3m (as of 30 September 2019) SIUGI senior risk cover notes at triple-A and upgraded the €124.3m SIUGI upper mezzanine risk cover to triple-A from single-A plus. The rating actions are driven by an increase in the instruments’ credit enhancement, as a result of amortisation, and the solid performance of the reference portfolio. This is illustrated by the 90-days overdue assets in the portfolio which account for only 0.57% of ramped and outstanding portfolio balances; the cumulative default rate of 2.90% of the ramped-up portfolio’s original balance; and amortisation at 56.3%, as of the reporting date. Credit enhancement available to the senior risk cover and the upper mezzanine risk cover has increased to 56.7% and 47.9% respectively, compared with 47% and 39.7% at the last monitoring date. The upgrade reflects the deal’s expected resilience to the distressed Spanish macroeconomic environment caused by Covid-19, driven by the substantial increase in credit enhancement.

Standards Board guidance released
The Standards Board for Alternative Investments (SBAI) has published three memos on alternative credit fund management, focusing on fund structuring considerations, valuation and conflicts of interest. The memos aim to provide guidance to managers and investors on these topics and a framework of questions investors may wish to ask managers when conducting operational due diligence. The memos reaffirm the SBAI Alternative Investment Standards that were established over a decade ago and have been adopted by many of the largest managers in the alternative investment industry.

Subprime auto settlement
Attorneys General for 35 US states have agreed a settlement with Santander Consumer USA that includes approximately US$550m in relief for consumers, with even more relief in additional deficiency waivers expected. The settlement resolves allegations that Santander violated consumer protection laws by exposing subprime consumers to unnecessarily high levels of risk and knowingly placing these consumers into auto loans with a high probability of default. The agreement stems from a multistate investigation of Santander’s subprime lending practices, which began in 2015. Under the settlement, Santander is required to provide relief to consumers in the form of restitution payments and debt cancellation and, moving forward, is required to factor a consumer’s ability to pay the loan into its underwriting.

Structured Finance

CLO manager performance assessed

Sector developments and company hires

CLO manager performance assessed
JPMorgan has issued its latest CLO manager quarterly reports for both the US and Europe.

72% of US CLOs are now failing their S&P triple-C test and 38% are failing their Moody’s Caa1 test, but there are still three managers passing both tests in all of their transactions: Blackrock, DFG/Vibrant, and Silvermine. Meanwhile, JPMorgan CLO research analysts note: “European ratings are less onerous than in the US, but the monthly reporting deteriorated very recently. Overall, the percentage of CLOs exceeding triple-C haircut thresholds has risen to 19% and 35%, failing Moody’s and S&P respectively.”

They continue: “Par build (or burn) has been in focus through the crisis as managers trade leveraged loan market volatility and experience defaults.” The US average par change was -14bp in April and -31bp year-to-date. Only 19% of managers built par both in April and YTD. Of those, nine managers (GoldenTree, New York Life, Eaton Vance, Credit Suisse Asset Management, Sculptor, Invesco, PGIM, Pinebridge and Neuberger Berman) did so while “keeping a lid on risk” (i.e. with below average WARF).

Among the 45 European CLO managers JPMorgan assessed, 49% built par in April, compared to an overall average -5bp par burn. On a YTD basis, 40% built par, compared to overall average of -9bp. Again, there were nine managers that built par in 2020 YTD and currently have below average WARF across portfolios: Black Diamond, Hayfin/Kingsland, Apollo/Redding Ridge, BNP Paribas, King Street, Invesco, Commerzbank, GSO/Blackstone and Natixis.

In other news…

CMBS delinquencies spike
The majority (96%) of remittances for May within the Fitch-rated US CMBS conduit universe have been reported, showing that 30-day loan delinquencies increased exponentially, rising 12 times as much as for April. Approximately US$13.5bn across 733 loans was newly categorised as 30-days delinquent this month, of which nearly 78% by balance were hotel and retail loans. An additional US$924m across 49 loans was added to Fitch's delinquency index as 60-days delinquent. These delinquencies are expected to contribute nearly 20bp to the agency’s overall delinquency rate, which was 1.32% in April, with US$1bn reported as 30-days delinquent.

Korean ABS Act to be updated
South Korea’s Financial Services Commission (FSC) is set to amend the country’s Asset-backed Securitization Act, taking into account feedback from market participants at an industry meeting this week. The FSC acknowledges that due to reforms in the registered securities system being delayed, the securitisation market has been unable to fully accommodate diverse demand.

Among the necessary improvements highlighted by the FSC are: introducing a risk retention rule, requiring asset holders to retain 5% of credit risk to prevent conflicts of interest; establishing a consolidated information system to facilitate transparency in data management; improving the ABS-specific credit evaluation system; removing the double-B rated credit requirement for businesses when issuing ABS; allowing multi-seller programmes to facilitate securitisation of receivables; and including intangible property rights and future assets as ABS underlyings. The government also plans to test run intellectual property (IP) royalty-backed ABS by establishing a KRW20bn IP investment fund.

Separately, the government, the Bank of Korea and the Korea Development Bank are creating a KRW10trn SPV to help stabilise the country’s corporate bond market, with the possibility of increasing its size to KRW20trn. Funding sources comprise KRW1trn equity capital from KDB, KRW1trn in subordinated loans from KDB and KRW8trn in primary loans from BOK. Double-A to double-B rated corporate bonds (including junk-rated bonds that were downgraded from investment grade, due to Covid-19) and A1 to A3 rated CP and short-term debt with a maturity of up to three years will be purchased under the facility.

North America
Jonathan Green has stepped down from the Annaly Capital Management board, upon the scheduled expiration of his term at the company’s annual meeting of stockholders held yesterday (20 May). Green joined the board prior to the company’s IPO in 1997 and had been serving as a vice chair alongside Annaly’s co-founder Wellington Denahan, as well as chair of the corporate responsibility committee and a member of the compensation committee and risk committee. Following the annual meeting, Denahan assumed the role of chair of Annaly’s risk committee, while independent director Katie Beirne Fallon replaces Green as chair of the corporate responsibility committee.

RFC on GSE reg cap
The FHFA is seeking comments on a notice of proposed rulemaking that establishes a new regulatory capital framework for Fannie Mae and Freddie Mac. The proposed rule is a re-proposal of the NPR published in July 2018 and comments will be due 60 days after the notice is published in the Federal Register. The enhancements in the new proposal preserve the mortgage risk-sensitive framework of the 2018 proposal, while increasing the quantity and quality of the GSEs’ regulatory capital and reducing the pro-cyclicality of the aggregate capital requirements. The re-proposal is also a critical step towards responsibly ending the conservatorships, according to the FHFA.

Structured Finance

CLO tender offer launched

Sector developments and company hires

CLO tender offer
The Black Diamond CLO 2015-1 issuer has launched a tender offer to all noteholders of the €176.3m class A1 and the US$67.2m class A2 notes. The purchase price for any bonds tendered under the offer will equal 98.75% of the principal amount outstanding of each note. The offer expires on 2 June, with settlement due on 9 June.

Credit card trust amended
The Master Credit Card Trust II Canadian credit card ABS programme has been amended to incorporate mechanisms to allow for the servicer to deposit into the collection account amounts equivalent to the monthly interest rate credit temporarily granted to card holders impacted by the coronavirus pandemic. Moody's confirms that the amendments will not result in a downgrade or withdrawal of the ratings currently assigned to any class of outstanding notes issued by the trust.