Contents

CLOs

Structural hurdles

US CLO managers face restructuring challenges

Restructurings and workouts are an increasing focus for US CLO managers as credit deterioration continues and defaults rise. However, they face significant structural hurdles that restrict their involvement in the process.

“There are two main issues standing in the way of CLO managers fully participating in restructurings and workouts,” says Craig Stein, partner at Schulte Roth & Zabel. “Chief of them is that most US CLOs are Cayman corporations designed not to be engaged in a US trade or business.”

CLOs generally operate under "will" level US tax guidelines to ensure that they will not be engaged in a US trade or business. A CLO must comply with the restrictions set forth in those tax guidelines relating to the CLO's participation in a workout or restructuring or the extension of additional advances. Were the US tax authority, the Internal Revenue Service (IRS), to take the view that a CLO is engaged in a US trade or business, it could cause a non-US corporate CLO's net income attributable to such trade or business to be subject to US federal income tax at a rate of 21% and "branch-profits" tax at a rate of 30%.

“The normal course of trading secondary loans is generally not treated as being engaged in a US trade or business and some tax guidelines allow managers to advance new money in order to protect an existing investment that was not in financial distress when it was initially acquired, provided certain requirements are met, but 'originating' loans for your CLO is prohibited,” explains Stein. “So, it’s a fine line that CLO managers have to toe to avoid loan origination for tax purposes when participating in a restructuring or workout, since there is a risk that you might cross over that line under such circumstances.”

He continues: “A CLO at issuance generally receives a law firm tax opinion to the effect that the CLO will not be engaged in a US trade or business and tax guidelines that must be followed throughout the life of the deal. However, there are no hard and fast rules; given the lack of authority from the Treasury and the IRS in this area, the trade or business tax guidelines from different law firms will typically look different.”

Once the need for a restructuring or workout emerges, things can change, says Stein. “Lenders in underlying loan deals often know exactly what CLO managers can and cannot do and they have been known to try to push restructurings in a manner that would cause CLO managers to be unable to participate fully in the workout and take advantage of CLO lenders in the syndicate.”

While a CLO manager must at all times comply with the tax guidelines, it generally has the ability to deviate from the tax guidelines provided that it receives advice of the law firm that rendered the US trade or business opinion at closing or an opinion of another nationally recognised law firm with expertise in the area that such deviation will not cause the CLO to be engaged in a US trade or business. “They can go to the same law firm or another law firm in connection with a restructuring or workout scenario that is not permitted under its tax guidelines, so there is some flexibility,” says Stein. “But sometimes the way a restructuring or workout deal is structured, we have to say you just can’t do that.”

A secondary, though still important issue for managers taking on restructurings or workouts involves the Volcker rule. While CLOs can receive Volcker-compliant securities in exchange for their debt, CLOs generally cannot purchase new securities issued pursuant to a rights offering, which could be part of a defaulted borrower's plan to reshape its balance sheet.

To combat this, Stein reports: “There is a proposal to amend the Volcker rule in response to market participants lobbying for change to allow a 5% or 10% bucket of securities to help CLO managers fully engage in the restructuring process. At the same time, in new deals we are attempting to add more flexibility around workouts where we can.”

Meanwhile, as the Covid-19 crisis continues to develop, there is already talk circulating of the potential for litigation against CLO managers. Stein, however, is sceptical of this materialising to any great extent.

“If you look at what happened in 2008, CDOs suffered greatly, but CLOs - which have similar structures - did well,” he says. “That shows it’s the asset class and its performance, not the structure that was the issue.”

Stein continues: “Of course, when investors lose money, there is the potential for litigation, but this crisis is different than 2008 and may not be necessarily parallel. Given CLOs past performance, I’m not convinced we’ll see anywhere near as much litigation this time around as we saw with CDOs. Though it will of course depend on how deals perform and how managers manage – we’ll undoubtedly see manager differentiation, of course – but will just have to wait and see how this plays out this time around.”

Mark Pelham

RMBS

Investor interest

UK RMBS market update

The launch of Morgan Stanley’s buy-to-let transaction, Tudor Rose Mortgages 2020-1, yesterday marks the reopening of the UK RMBS market post-coronavirus. Investor interest shown in this deal is expected to encourage further market participation.

One trader says: “I expect a few more deals to come to the market in the not-so-distant future. Issuers and arrangers will have the confidence to come to the market following the Tudor Rose print. I think there is a decent backlog of deals in the pipeline.”

Pricing of the transaction demonstrates the tightening of spreads from their coronavirus-induced peaks, according to the trader. IPTs for the senior notes were SONIA plus mid-100s, with guidance subsequently set in the 150bp area and then revised to 140bp-150bp. The final print was plus 140bp.

The deal began with a coverage ratio of 1.7x for the senior tranche. An increase to a coverage ratio of 2x was seen, but the final coverage ratio was not disclosed.

Final spreads for the mezzanine tranches were in line with IPTs.

The trader says: “Being the first placed UK deal out of the box since the outbreak of Covid-19, it is always a very welcome reaction because it shows the amount of interest in this type of paper. It is generally a very positive development. All the counterparties involved should be happy with it.”

Jasleen Mann

Structured Finance

SCI Start the Week - 15 June

A review of securitisation activity over the past seven days

Last week's stories
Addressing inconsistencies
Performance metrics switched
Calabria confidence
FHFA director was bullish at Senate Banking, but day of reckoning may be at hand
Changing focus
US CLO primary garners more attention
HAPS ABS debuts
Eurobank finalises Cairo transaction
LCR eligibility eyed
Final credit mapping framework awaited
Perfect storm
Hertz bankruptcy to reshape auto ABS?
Resolve and resilience
Content sponsored by Ocorian
Risk transfer rebound
Deutsche Bank completes SRT
Risky retention
Haircuts become more severe in Covid 19 world
Robust pipeline
Distressed debt fund exceeds target
Spread compression
European ABS market update
Strategic review
Direct lending JV formed
Synergy search
CLO manager consolidation to stay sporadic?

FREE - Capital Relief Trades Virtual Panel - Recording
Watch a free recording of SCI's 9 June virtual debate on how the Covid-19 fallout has impacted the capital relief trades market here. Password: 09June!20

Other deal-related news

• RBC's US-based CLO management business is being integrated into BlueBay's CLO management platform (SCI 8 June).
• Fitch has downgraded 20 tranches from across 15 Spanish RMBS, reflecting the recent corresponding rating downgrade of Societe Generale (the SPV account bank provider for the deal) from single-A to single-A minus, as the RMBS ratings are capped by the bank rating (SCI 8 June).
• Chenavari Toro Income Fund is enhancing its dividend policy (targeting a quarterly dividend yield of 2.5% and quarterly special distributions of available excess cash) and rebalancing its investment strategy, with the aim of reducing the discount between the company's share price and the net asset value per share (SCI 8 June).
• JCPenney has revealed the names of 154 stores slated for closure, representing about 60% of the total store closures planned as part of its bankruptcy (SCI 8 June).
• The Finsbury Square 2017-2 issuer has disclosed that various discussions have been held with Kensington Mortgage Company (in its capacity as indirect holder of the RMBS certificates) in relation to the purchase of the loans in the mortgage pool (SCI 8 June).
• Fitch has affirmed 37 notes and maintained its rating watch negative placement on nine notes from 12 National Collegiate Student Loan Trust (NCSLT) securitisations (SCI 9 June).
• The European High-Level Forum on the capital markets union has published its final report, which proposes 17 inter-connected "game changers" - measures that the EU needs to implement to remove the biggest barriers in its capital markets (SCI 11 June).
• The ECB's draft guide on climate-related and environmental risks - which it released last month - is credit positive for mortgage collateral in RMBS because it will require banks to proactively manage and disclose such risks, according to Moody's (SCI 11 June).
• A rapid amortisation event has occurred in connection with the Kabbage Asset Securitization Series 2019-1 small business ABS, caused by an asset deficiency after the collateral pool balance fell below the required amount (SCI 11 June).
• The Westlake Automobile Receivables Trust 2020-2 issuer has disclosed that the state of California is considering new legislation - Assembly Bill No. 2501 (AB 2501) - that could significantly impact auto loan securitisations with high concentrations of Californian loans (SCI 12 June).
• The credit quality of many US and European BSL CLOs will likely deteriorate over the coming months as asset defaults increase, although credit conditions as reflected in negative rating actions on corporate issuers are stabilising, according to a new report from Moody's (SCI 12 June).
• NewDay Cards has confirmed that it does not intend to exercise its option to extend the NewDay Funding Series 2017-1 scheduled redemption date (SCI 12 June).

Data

BWIC volume

Secondary market commentary from SCI PriceABS
12 June 2020
USD CLO
28 covers today to round out a very liquid week - 3 x AAA, 1 x AA, 5 x A, 12 x BBB, 6 x BB and 1 x B. The 1st pay AAAs trade softer in a 173dm-197dm range, however these are all from the same manager American Money Management Corp, the ADRs are high on the 2 bonds at the wide end of the range (in 1.2-1.3 context) as well as negative par build and weaker MV metrics. AMMC 2018-22A A trades at the tight end 173dm / 4.3y WAL with good performance metrics.
The AA TRNTS 2018-9X B1 covers 297dm / 6.7y WAL, this trades wide to the 190dm-240dm range seen this month to date - the manager has a weak record, negative par build -0.65 and ADR 1.45.
The single-As trade 275dm-399dm across 2021-2025 RP profiles, the comparable trading range this month for this cohort has been 250dm-460dm so today's trades sit firmly within these boundaries.
The BBBs trade 415dm-601dm with comparable liquidity in 360dm-650dm range this month so the trading levels today are also within these boundaries.
The BBs trade 775dm-1499dm, at the wide end is OFS's OFSBS 2017-1A E with MVOC shortfall 97.53 from an inexperienced manager with a slightly weaker performance record vs benchmark. At the tight end is Symphony's SYMP 2018-20A E cover 775dm / 8.72y WAL - MVOC is 5pts higher than the OFS trade at 102.52, ADR is low 0.18 and the manager's record is strong.
The single-B trade is CIFC's CIFC 2018-3A F cover 1238dm / 8.44y WAL (2023 RP profile), with single-Bs trading this month to date in a wide dispersion 1100dm-2200dm this trade is at the tight end - the manager has an excellent profile, ADR is near zero, sub80 is 9% and CCC is 4.2% whilst MVOC is near 100 (99.54).
EUR CLO
A quieter end to a busy week. There are 9 CVRs. Both AAAs traded around 165dm. This is in line with AAA trading earlier in the week.
The single As traded between 300dm and 320dm. On 11 June we saw trades between 260dm and 290dm and earlier in the week they were more like 250dm - so the sell off continued to the end of the week.
The BBB and BB trades are both in PURPLE 2 - the Natixis shelf. The BBB traded at 507dm. On 11 June the BBB trading range was 400dm to 500dm - so it is hard to reach too much of a conclusion from this one trade. The PURP 2 BB traded at 840dm. On 11 June the traded range was 700dm to 820dm. PURP 2 BBB has an MVOC of 108.15 which is on the low side and a BB MVOC of 101.06 which is also low however the Junior OC cushion is quite healthy at 4.04%. The deal closed in Oct 2019 so it is still pretty clean.
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

Take-up rates

Significant variations across European moratoria

Payment holidays have so far assisted in deterring defaults during the coronavirus crisis. However, borrowers who have suffered severe financial difficulties are nevertheless expected to eventually experience defaults.

Antonio Tena, vp-senior analyst at Moody’s, says: "The more stringent a jurisdiction's eligibility criteria, the more moratorium levels will correlate with defaults, given that the profiles of eligible borrowers are weaker. This correlation is especially useful, given that moratoria mask delinquency and default data [SCI 12 June]. Transactions from two countries with the same take-up rate do not share the same level of risk if one country's moratoria is subject to strict eligibility criteria while the other's allows self-certification."

Some jurisdictions only provide limited information regarding take-up rates for virus-related payment holidays. For example, the information is available in 30% of German ABS and more than 50% in UK deals.

Countries that have stricter eligibility criteria are able to minimise the level of payment holidays. Some may rely on state guaranteed loans.

Moody’s identifies Spain and the Netherlands as the countries with some of the strictest criteria. In these countries, the agency notes that payment holidays will have a stronger correlation with future defaults.

In Spain, in order to receive the government payment holiday, borrowers must be unemployed as a consequence of the pandemic, their household income cannot exceed a certain threshold, their DTI must exceed a minimum ratio considering all family members and this new DTI must be at least 30% higher than what it was prior to the pandemic. Dutch lenders offer payment moratoria on a discretionary basis in consideration of borrowers’ individual circumstances. Consequently, the country has low take-up rates.

SME ABS, particularly in Italy, have the highest take-up rates of up to 50% of collateral. However, ABS backed by smaller consumer debts have the lowest take-up rates. This includes credit card and auto ABS.

Take-up rates are currently understated by a lag in processing, according to Moody’s. In addition, reports do not differentiate the loans from standard renegotiations and payment holidays are not reported as arrears.

JPMorgan payment holiday tracker
JPMorgan’s latest UK RMBS Covid-19 payment holiday tracker – which covers data reported in the May and early June remittance periods - includes information for 62 distributed, standalone UK RMBS transactions and three master trust programmes, with an aggregate current balance of £65.5bn. This represents a significant increase in coverage versus the bank’s inaugural version of the tracker, which included 19 standalone transactions and two master trust programmes with an aggregate current balance of £15.5bn.

Across all deals, the cumulative balance of loans that have been granted payment holidays stands at £9.1bn (or 13.8%), up from £1.5bn (9.7%) in the previous tracker. Of these deals, 15 standalone transactions and one master trust programme (Santander’s FOSSM) are reporting concentrations above 20%, with the non-conforming sector seeing the highest aggregate payment holiday concentration at 20.7% across 15 deals. In terms of the duration of payment holidays, three-month holidays remain the most common with an aggregate proportion of nearly 94%.

Jasleen Mann

Capital Relief Trades

Risk transfer round-up - 17 June

CRT sector developments and deal news

Credit Suisse is rumoured to be readying a capital relief trade from the Elvetia programme that is scheduled to close in 2Q20. The Swiss lender’s last Elvetia SRT was closed in May 2019 and referenced SME loans. Elvetia transactions are typically backed by Swiss corporate and SME loans (see SCI’s capital relief trades database).  

Capital Relief Trades

SRT debut

Sabadell completes first synthetic securitisation

Sabadell has completed a €96m mezzanine guarantee with the EIF. The transaction references a €1.6bn Spanish SME portfolio and is the Spanish lender’s first synthetic securitisation.

The guarantee will enable the issuer to provide €576m of financing, primarily to self-employed, SME and mid-cap borrowers. The structure comprises senior and mezzanine tranches that amortise on a pro-rata basis, and a junior tranche that amortises sequentially.

Further features include a time call that can be exercised after the end of the portfolio’s weighted average life, which is equal to three years. Credit enhancement is present in the form of a retained first loss tranche.

Pablo Sanchez Gonzalez, structured finance manager at the EIF, comments: “It is one of the inaugural post-Covid-19 transactions, which shows the commitment of the EIB group with our financial intermediaries, even in difficult situations. As a multilateral development bank deploying EFSI funds, our goal is to be right there when there is a market gap. A big challenge for this deal was the structuring and modelling, since we needed to incorporate additional adjustments to the historical information in order to account as much as possible for the current situation.”

The agreement includes a commitment to direct part of the new financing to climate investments. In particular, the financing will go to projects with a focus on energy efficiency, renewable energy and investments aimed at the purchase of low-emission commercial vehicles and agricultural equipment with low fuel consumption.

The agreement was signed under the Investment Plan for Europe, which enables the EIB group to expand its financing capacity for investment projects with inherently higher risk profiles. Estimates indicate that this operation will make it possible to support over 1,400 companies employing around 79,000 people. 

The deal is Sabadell’s first synthetic securitisation, although it launched its first SRT in full stack form last year (SCI 2 October 2019). UniCredit provided advisory services for the latest transaction.

As a response to the Covid-19 crisis, the EIB group announced a raft measures designed to provide support to SMEs and midcaps (SCI passim). The European Council approved on 23 April the EIB group's €25bn pan-European Covid-19 guarantee fund, which mobilises approximately €200bn of additional SME financing. In March, the group announced a package of emergency measures, including an ABS purchase programme that will enable banks to pass on the risk of their SME loan portfolios to the EIB.

Stelios Papadopoulos

Capital Relief Trades

Lift off

Credit Suisse finalises SRT

Credit Suisse has priced an Sfr130.5m equity tranche that references a Sfr1.8bn blind pool of medium to large Swiss corporate borrowers. Dubbed Elvetia Finance Series 2020-1, the transaction is the Swiss lender’s first capital relief trade following the outbreak of the coronavirus.

The transaction’s pricing hasn’t been disclosed, but it’s believed to be in the double digits. The last Elvetia deals were priced at tight levels, given the low default record of the programme and investor demand. The deals were closed in May 2019 and November 2018 and were priced respectively at Libor plus 7.9% and Libor plus 7.75% (see SCI’s capital relief trades database).

The latest deal features a sequential amortisation structure, a 2.1-year weighted average life, a time call that can be triggered after the WAL has run its course and a 2.5-year replenishment period. Under normal circumstances, Elvetia trades are typically structured with a replenishment period that can be equal to three years, although in this case the lender reduced the length as a concession to investors. 

The portfolio consists of corporate loans granted to approximately 800 Swiss borrowers - mostly drawn commitments - including revolving credit facilities, although the latter make up less than 10% of the pool. Similar to Deutsche Bank’s post-Covid CRAFT deal, Credit Suisse denies that revolver drawdowns were a driving factor behind the trade’s execution (SCI 12 June). Market practitioners suggested during the peak of this crisis in March and April that revolver drawdowns would be a major driver behind any post-coronavirus SRT rebound.

Another similarity with the CRAFT trade is the fact that portfolio composition was an important pricing driver. Credit Suisse excluded certain industries that are considered to be vulnerable to the current crisis, such as hospitality, and raised the minimum rating threshold for each borrower in the portfolio.

The transaction is the third capital relief trade following the Coronavirus outbreak. The rebound began with a Bank of Montreal SRT in early 2Q20 and Deutsche Bank followed suit with a CRAFT deal in the same quarter. Large corporate pools are expected to dominate the bulk of activity, given a high level of disclosure that allows investors to carry out their credit analysis, as well as government and central bank support for the sector.  

Stelios Papadopoulos

Capital Relief Trades

Sicilian CRT launched

BAPR completes SME securitisation

The EIF and Banca Agricola Popolare di Ragusa (BAPR) have completed a synthetic securitisation referencing Sicilian SMEs. The €22m guarantee references an approximately €200m portfolio and is the Italian lender’s first capital relief trade.

“We are pleased to sign this agreement with Banca Agricola Popolare di Ragusa, a regional financial intermediary committed to supporting local SMEs. The operation will release a sizeable amount of funding from credit guarantee consortia or Confidi, which will thus be made available for lending to small and medium-sized businesses,” says Alessandro Tappi, cio at the EIF.

BAPR will be able to provide €200m of SME financing due to a guarantee issued by the EIF and backed by the EIF itself, the EIB, structural funds from Italy’s Ministry of Economic Development (MISE) and the EU’s COSME programme. All four financing sources fall under the EU’s SME initiative. According to the terms of the transaction, over the next three years, around 2,000 Sicilian SMEs will be able to access financing.

The transaction consists of a €22m junior and lower mezzanine tranche, as well as a middle mezzanine, an upper mezzanine and a senior piece that all amortise sequentially. The junior tranche has been priced at zero and the lower mezzanine at expected loss.

The EIF is guaranteeing 50% of the underlying portfolio, which has a weighted average life of nearly three years. Further features include a time call that can be exercised once the WAL has ran its course. Banco BPM subsidiary Banca Akros acted as financial advisor on the transaction.

Giovanni Inglisa, structured finance manager at the EIF, notes: “The transaction has a long enough weighted average life and because of this, it wasn’t necessary to add any replenishment features. The longer the life of the deal, the longer the period in which the bank is able to release capital. The transaction also doesn’t lose efficiency, since we are guaranteeing 50% of the portfolio.”

The EIF hasn’t fundamentally changed its expected loss methodology, following the coronavirus crisis. Inglisa states: “We look at through the cycle PDs in the form of either vintages or transition matrices, so we always anchor ourselves on historical data. The only difference is just more stressed PDs, but fundamentally the methodology remains the same. Our analysis is a rating analysis, so we don’t simulate cashflows in just one base-case scenario, but look at vast number of different PD outcomes.”

He continues: “One difference with Covid are payment holidays, but these are actually credit positive for the deals. Furthermore, under the Italian Banking Association scheme, the principal can be forgiven but the interest still has to be paid. Nevertheless, payment holidays can make it hard to estimate expected losses, but again, we just stress the whole portfolio and look at some additional sensitivities. The through-the-cycle approach remains the same.”

The EIF is readying at least three more Italian synthetic securitisations for this year.

Stelios Papadopoulos

CMBS

Demand decline

Remote working accelerates change for office CRE

A decline in demand for office real estate is expected amid the coronavirus fallout and record job losses. Occupancy and rental rates will come under pressure as a result.

The Covid-19 outbreak has accelerated the adoption of remote working, which is likely to lead to a gradual reduction in the office footprint. “This epidemic marks a watershed in demand. We’ve been thinking about the disruptive impact of technology on the office sector and published our thoughts on it a couple of years prior to the virus, which we think is just compressing the timeline of change, intensifying the forces that favour greater remote working,” says Euan Gatfield, head of EMEA CMBS at Fitch.

The sustainability of co-working concepts could also add pressure to the office sector, particularly in gateway markets. “The impact will differ a little market to market; for instance, based on how centralised a city is, which is not the easiest thing to measure. There will be differences in terms of cultural issues as well, like how far attitudes towards remote working among managers and their staff have softened, and it will also depend on what prevailing lease structures look like,” Gatfield notes.

He adds: “Central London is a candidate for reduced demand because it is a high-volume hub for prime offices. Where its offices have reasonably long leasing and blue chip occupiers, this can shield CMBS deals secured on assets such as Broadgate a little bit from the factors in play.”

A decline in demand for office space is likely to dampen overall occupancy and rent levels across the sector. As a result, tenants may seek flexibility in their leases.

“There are local factors that play into this. But, of course, businesses will be facing cost pressures as a result of the crisis, and will be tempted to cut costs where they can. Remote working offers scope to do so, and we expect a reasonable amount of caution in terms of signing leases,” Gatfield concludes.

Jasleen Mann

RMBS

Champagne on hold

Latest forbearance numbers encourage, but end of July cliff edge looms

Despite the reported recent drop in the number of home loan borrowers in forbearance, Moody’s strikes a cautionary note in its latest report on the RMBS sector, released this week.

“Yes, we’ve observed a flatlining in forbearance numbers lately, but we’re not say ready to say it’s all over and it’s business as usual just yet,” says Karandeep Bains, senior credit officer at Moody’s in New York.

In particular, notes Bains, the various Federal relief plans such as CARES begin to run out at the end of July, so the market is still in the dark about how mortgage-backed assets will perform when the safety net is taken away.

The latest report on RMBS from Moody’s is the first in which the full effect of Covid 19 is demonstrated, and there are several key takeaways. Although forbearance numbers have started to descend, they are still many multiples higher than was the case before Covid 19 struck.

In the first week of June, 8.55% of total loans in servicers’ portfolios were in forbearance compared to just 0.25% at the beginning of March. Forbearance plans help “shore up” a home owner’s finances, notes the report, but they also threaten interest and principal payments in MBS.

During May, delinquencies led to interest shortfalls in 39 bonds out of 1,172 re-performing tranches which Moody’s rates. Re-performing transactions are more adversely affected by delinquency as they typically do not incorporate servicer agreements. So, if 20% of borrowers represented in RPLs are in forbearance, that means that there will a 20% shortfall in interest, at least in the bottom of the capital stack.

Perhaps surprisingly, there is no marked relationship between the combined loan-to-value (CLTV) ratios and delinquency rates until CLTVs reach 80% or more among GSE and post-2008 mortgages.

Less surprisingly, the areas with the highest 30-day delinquency rates are those most vulnerable to a collapse in tourism or those who have suffered more Covid 19-related infections than others. The top ten are Vermont, New York, Hawaii, Puerto Rico, Delaware, Louisiana, New Jersey, Florida, California and Nevada. Of the above, Puerto Rico had structural weaknesses in the housing market before the pandemic.

Contributing to the general uncertainty about the long-term effects of Covid 19 upon MBS values is the fact that, encouragingly, the 2008 crisis is not an adequate guide to how the market will react to the recent slump.

"The 2008 crisis was different. Underwriting going into this crisis was very strong, and the housing market, including home prices, is well supported by the fundamentals such as inventory and demand - it’s a lot better. We don’t see all those factors that were apparent in the 2008 crisis,” says Bains.

One of the largest uncertainties surrounds the resilience of the mortgage servicers. The latter are required, in most cases, to advance principal and interest if borrowers fail to make payments until the point at which those advances are deemed non-recoverable. However, at the moment, Moody’s does not expect large-scale servicer failures, says Bains.

Simon Boughey

Structured Finance

Seductive specifieds

An investor's view

SCI spoke to Brendan Doucette, government bond portfolio manager of GW&K Investment Management in Boston. The firm has assets under management of $40bn, of which $1bn is invested in the MBS market. It invests only in GSE-backed bonds.

Q: Where do you see value in the MBS market at the moment Brendan?

We like owning mortgages versus Treasuries, but it is a little bit more difficult to make the case versus corporates. We have come back closer to neutral on MBS given the intervention in the market by the Federal Reserve. We’ve sold out of some of lower coupon pools that the Fed was buying. We think higher coupon pools offer good value at the moment at the moment, specifically specified pool MBS. Given the bear steepening in rates over this quarter we like keeping our key rate duration concentrated in the front end, as this is where the Fed can control rates a little bit better. We’re told they aim to keep rates stable over next couple of years.

Q: What value do you see in specified pool MBS?

Quite a lot of specified pool bonds were fire sold by leveraged investors in March to meet margin calls. We saw significant value there at the time and we continue to add to our holdings of specified pools. Although mortgage rates are now at all-time lows, the secondary spread is still high so we think mortgage rates will drift continue to lower and  specified pools will continue to provide value. We’ve seen pay-ups on those pools increase significantly this quarter.

Q: Why do you think mortgage rates will go lower still?

The so-called secondary spread is a key indicator. This measures the 30yr mortgage rate minus the 30y MBS yield. It’s at 165bp right now, but the historical mean is around 100bp. What this is telling us is there is further room for mortgage rates to drift lower, particularly as the Fed does purchase operations. It clearly wants to narrow that spread. It was as wide as 200bp in worst days of the recent sell off. Currently, the 30y mortgage rate is around 3.125%, so it could drift lower by 40bp-50bp to a fair value 30y mortgage rate of, say, 2.625%.

Q: Obviously, forbearance rates have leapt since the beginning of the Covid 19 crisis. This should feed through to greater delinquency as well. How do you see this development as an investor?

From an investor’s perspective, forbearance and delinquencies create opportunities. There are certain dates and specified pools that will have higher delinquencies. This can be beneficial as it will slow down prepayment speed more than projected. So we like owning low FICO, high LTV MBS and also pools from certain areas of the country, like New York. Wells Fargo, for example, has shown delinquencies that are two times greater than other multi lender pools. I saw a report which said Wells Fargo delinquencies were running at 8.9%, compared to a multi-lender average of around 3.2%.  This is something that creates opportunities for us. With higher delinquency rates, you get slower prepayment, especially in the higher coupon pools, so you can get a lot more carry.

Q: What about the CMBS market? Where are you seeing value there?

We like Freddie K paper. This got pretty wide lately, north of 150bp over swaps. The latest deal this week priced at low 40s in A2 tranche. We own 6 year to 8 year, which admittedly carries quite a high dollar price as there is not much of a bank bid. However, that paper is in 60s/70s and we find that pretty attractive, particularly as it is eligible for Fed operations. It has been buying paper in the 5 year-8 year weighted average life area.

(SCI: The last Freddie K deal was announced by Freddie Mac on June 11. The GSE said it “recently priced” a $729m multi-family MBS, incorporating four tranches. The A1s were swaps plus 65bp, the A2s were swaps plus 75bp, the X1s were Treasuries plus 385bp and the X3s were Treasuries plus 675bp).

Q: What is your view on the outlook for the primary MBS market in the remainder of 2020?

The primary market is the biggest risk to mortgage rates. Origination supply is very elevated and there is also a higher than normal securitization rate from lenders. Rather than holding the loans on their balance sheet lenders are securitizing them immediately, and this trend towards greater securitization will continue. Lenders don’t want to be stuck holding a loan that goes into forbearance. So we will see more net supply, I think. This could be tempered by refinancing, which has started to come back, and the Fed will take a lot of this supply that will be hitting the market from higher securitization rates but it remains a risk.

Q: What kind of supply do you think we’ll see then this year?

From the GSEs we’ll see net supply of around $250bn in the TBA and specified markets. The Fed has been pretty transparent about its intentions, which is why I think a lot of the Fed buying has been priced into the lower coupons. The Fed has already taken down $700bn since March and will do about $40bn net per month.

Q: Purchase mortgage applications have rebounded a lot, and we’re seeing something of a V shaped recovery here. Why is that, do you think?

Applications are up again this morning so there continues to be this drive of people to purchase homes. There was a dip there is some pent up demand. Millennials need a place to live and there’s not enough inventory in the market. Applications are higher than they were a decade ago. plateau of Mortgage forbearance seems to have plateaued, and this week started to drop ever so slightly.

I also think the market underestimated how much difference could be made by technological advances and the speed of regulatory changes in order to increase closing of mortgages. Everyone thought Covid 19 would impact mortgages closing much more than they did. They were much higher than expected last month, and this factor will affect market going forward, leading perhaps to greater convexity.

Q: The first subscription date for TALF 2.0 loans was yesterday, June 17. What do you think the take-up will be?

We are not participating in the TALF market. It’s chiefly a non-agency/ABS market. From what I’ve seen, a lot of the spread might have been taken out as once it was announced ABS tightened in significantly. The windfall that people got in the great financial crisis ten years ago just isn’t going to be there.

Simon Boughey

Structured Finance

Older CLOs underperforming

Sector developments and company hires

Older CLOs underperforming
A significant proportion of all the US BSL CLOs S&P has on negative watch closed in 2015 or before. The rating agency reports that such deals also experienced a steeper average decline in OC cushion, falling by 3.23%, and their average junior OC cushion is now approaching 0%.

Of the 410 currently reinvesting deals within the S&P Global CLO Insights 2020 Index, 111 originally closed in 2015 or earlier. This cohort of CLOs typically went through a reset in 2017 or 2018, extending their reinvestment end dates to 2021 and later, but keeping their capital structure broadly unchanged.

The 2015 and prior cohort of CLOs had been through the energy slowdown and are likely still reinvesting through the current recession, S&P says. Further, these deals entered 2020 with a notably lower average junior OC cushion, at 3.29%, due to credit deterioration and potential par loss as managers tried to remove energy related exposures. In contrast, 2016 vintage deals did not experience as much deterioration as they closed in the middle of the energy slowdown and typically have much less energy related exposure.

In other news…

GSE advisors named
Fannie Mae and Freddie Mac have hired Morgan Stanley and JPMorgan respectively as their financial advisors to help facilitate the GSEs’ recapitalisation and exit from conservatorship. The move follows competitive requests for proposals announced last month (SCI 20 May). While developing the appropriate strategies, the advisors will work closely with the GSEs, the FHFA and the US Treasury to consider business and capital structures, market impacts and timing, as well as available capital raising alternatives.

TALF rates set
The New York Fed has released the rates for the first TALF 2.0 subscription, which is scheduled for tomorrow (17 June) at between 8am and 3pm ET. For fixed rate loans with WALs of less than two years, the rate is two-year OIS plus 125bp; for fixed rate loans with WALs of over two years, it is three-year OIS plus 125bp (for SBA 504 loans, it is 75bp). The rate is 30-day SOFR plus 150bp for leveraged loans and Top of the Fed Funds Target Range plus 75bp for SBA 7(a) loans. There is also a 10bp administrative fee.

Structured Finance

CMBS scores in first TALF window

Sector developments and company hires

CMBS scores in first TALF subscription
Investors requested US$252m in loans under the first TALF 2.0 subscription window. Of this total, US$145m was for CMBS purchases, with the remainder almost evenly split between premium finance and small business deals. Wells Fargo CMBS analysts note that although wider spreads in the CMBS sector relative to the ABS sector may continue to result in higher TALF allocation to the former, they believe that utilisation of the facility may be limited. They point out that tight duper spread levels and the high adjusted haircut to premium dollar prices serve to cap expected returns under TALF.

EMEA
Philippe Deloffre and Aisling McCarthy have been appointed mds in the partnership capital strategy of Intermediate Capital Group’s real estate division. Deloffre, based in Paris, will be responsible for leading the European (excluding UK) origination and investment for the partnership capital and senior debt strategies. He joins ICG from BNP Paribas Asset Management, where he was head of real estate debt. McCarthy, based in London, will focus on UK, North American and Irish sponsors that invest across Europe. She joins ICG from Coimmvest.

Jefferies has beefed up its EMEA securitised markets group with a trio of recruits from Citi. Laura Coady will co-head the group, alongside Craig Tipping, reporting to EMEA fixed income head Fred Jallot. New hires Hugh Upcott Gill and Luis Leon Carsi will co-head the EMEA CLO primary business at Jefferies.

Massimo Passamonti will assume the position of ceo at Privatam, responsible for coordinating the company’s strategy. Stan Perromat will represent Privatam and its digital platform PARity externally and take responsibility for marketing, communication and philanthropic partnerships. Arthur Bauch will be responsible for improving content and expanding the firm’s supplier base. Steve Price will lead Privatam’s technology team and co-ordinate its PARity development programme.

New ownership
Bridgepoint is set to acquire EQT’s credit business, which has approximately €4bn of AUM as of 31 December 2019 across three strategies – special situations, direct lending and senior debt. Employing 40 professionals, including five partners, the credit business has raised over €7bn of capital and invested in over 180 companies since inception.

North America
Aeolus Capital Management has promoted Andrew Bernstein, managing partner and co-head of portfolio management, to ceo. Chris Grasso, managing partner and co-head of portfolio management, and Trevor Jones, managing partner, will be co-chairmen of the board. Bernstein, Grasso and Jones have since January 2017 comprised a management committee which oversees the day-to-day operations and strategic leadership of Aeolus on behalf of the board. Frank Fischer, partner and chief analytics officer, has been elected to the board, while Henry Kingham, portfolio manager, and Daina Casling, general counsel and chief compliance officer, have been made partners at the firm.

NPL underperformance projected
Scope has analysed the Q2 data for 21 of the 25 Italian non-performing loan securitisations it rates, representing a total GBV of €73bn, and forecasts that 14 of them will underperform this year in terms of both timing and volumes. This would lead to average underperformance of -25% for 2020, against original business plan projections, compared to the -13% registered so far in Q2. The remainder are expected to show performance in line with or above original business plans. Covid-19 containment efforts have affected monthly collections since April, causing a drop of 46% against January and February averages. Seven of the 21 deals reported the occurrence of subordination and/or under-performance events, resulting in class B interest (on one transaction) and servicing fee deferrals (on all). However, Scope does not expect the impact of the pandemic to be fully reflected in performance until the second half of the year. The agency projects €30bn of new NPL inflows out to 2021.

RMBS settlement
Maryland Attorney General’s securities division has entered into a US$20m settlement with Wells Fargo, resolving financial crisis-era claims that the bank misled investors in its issuance of RMBS. The consent order alleges that as an issuer, Wells Fargo was required to disclose complete and accurate information about the loans backing its securities. But through two channels, the bank received information that its disclosures were inaccurate with respect to certain loans.

Small value sales due
The New York Fed’s Open Market Trading Desk intends to conduct two small value agency MBS sales operations, which will occur on 23 June and 25 June. The total current face value of sales across the two operations will not exceed US$180m.

Structural tweaks
Kensington is in the market with its latest UK non-standard prime RMBS, Finsbury Square 2020-2. The deal features a couple of structural tweaks designed to address Covid-19 stresses: a 1% Covid-19 reserve fund on top of the 2% general reserve fund; and a payment holiday reserve fund equal to 0.9% of the A-F notes. Rabobank credit analysts notes that each quarter until March 2022, 0.15% of the fund will be released into the revenue waterfall. Additionally, credit enhancement stands at 19%, compared to 14.5% for the FSQ 2020-1 transaction. The preliminary pool is a mix of new originations (nearly 60% originated this year) and assets previously securitised in FSQ 2017-2, which has its FORD on 14 September 2020.

Waivers agreed
The senior loan facility agent for the Magenta 2020 CMBS has agreed to certain waivers, consents and amendments aimed at avoiding a number of senior loan EODs, following the coronavirus-related closure of the underlying hotels. In return, the sponsor will make an initial equity injection of £17.5m, £4.55m of which will be paid into the operating account to cover operating expenses for June and the remaining £12.95m to be deposited into the cure account. Each month the sponsor will pay cash ‘top-ups’, such that the cure account is funded to cover forecast shortfalls for the next six months. These amounts will be applied by the senior loan facility agent on a monthly basis against senior and mezzanine debt service, operating expenses, asset management fees and hotel franchise fees. Separately, a loan EOD has been triggered by the Emerald Italy 2019 CMBS, after the borrower failed to pay the full interest due on 15 June and missed a hard amortisation payment of 0.375%.

Capital Relief Trades

Bridging gaps

Linking SRT originating banks with insurance partners

Texel is aiming to help insurers and banks bridge gaps in their understanding of how each sector approaches significant risk transfer transactions. With insurers expected to become more active in the capital relief trades market, the firm’s structured and bespoke solutions group last month recruited former Qbera Capital securitisation advisory head Paul Petkov (SCI 15 May), who has previously held several senior balance sheet optimisation roles at a number of leading banks.

Alan Ball, of Texel’s structured and bespoke solutions team, notes: “Given Paul’s experience in the banking sector - where he established and ran several major SRT programmes for a number of banks - our aim is to add value to our clients by bridging the gaps in knowledge, understanding and perspective that can sometimes exist between our bank clients and insurers entering the SRT space. We are able to help underwriters understand what does and doesn’t make sense for the bank and the parameters our clients must operate within in order to make a deal work with insurance. Equally, we’ve always considered it important to articulate to our bank clients how insurers think about risk, particularly in developing areas of the market such as SRT transactions.”

Being able to share the insights of somebody who has been on the origination and structuring side of the SRT market should give underwriters greater confidence that they are thinking about and approaching these transactions with the right perspective and expectations, which ultimately benefits clients by helping them to close deals. Ball explains: “Insurers don’t necessarily have a full view of how banks think about SRT transactions and vice versa. Without this insight, there is scope for increased execution risk, which we want to mitigate for our clients while minimising any additional heavy lifting required from the deal teams at our clients.”

With underwriters, Texel is able to work through how they might think about modelling a deal or a particular aspect of a portfolio, or why a particular mechanic has been included in the structure. On the other hand, with banks, Ball says the firm is well positioned as an insurance broker to understand their needs and, uniquely for an insurance broker, it has in-house the commercial, structuring and legal expertise necessary to take an SRT deal from start to finish - including any preliminary feasibility exercises looking at the deal’s efficiency.

For SRTs to reach their potential, it’s imperative that more investors properly understand the risk and believe it’s worth entering the space, according to Petkov. “Texel can act as a conduit linking originating banks with insurance partners and speed up the time to market. The aim is to create long-term partnerships, whereby banks can continue to recycle their assets and use SRT for balance sheet optimisation and credit risk mitigation,” he observes.

Petkov points to the pressing need for banks to recapitalise, given profitability issues, concentrated exposure to certain sectors and the roll-out of Basel 4 by January 2023. “The European banking sector has an estimated €120bn-€160bn hole in terms of capital that needs to be filled by then. And it’s unclear yet how much additional provisioning banks will have to make due to coronavirus stress.”

While Texel’s bespoke and structured solutions team have a strong focus on SRT transactions, Ball notes that they work across a range of structured credit and bespoke transactions that have an insurance element, where Petkov will add further value for their clients. These include transactions using insurance as an embedded credit enhancement - to repackage bank credit assets in a format suitable for the institutional investor market - and transactions focused on helping banks mitigate CCAR/peak exposures.

Corinne Smith