Contents

Capital Relief Trades

Morgan manoeuvres

JPM's heavier than most capital burden underpins its keenness for CRT

JP Morgan Chase has led the charge in the US CRT market in the last 12 months, but its urgency to make use of the mechanism has a lot to do with its specific and onerous regulatory capital burden, say market sources.

It is the biggest bank in the US with assets of around $2.7trn, almost $700bn more than its closest rival Bank of America. It also bears the heaviest capital burden, and, over the last year or so, it has grown even heavier.

In its Q3 earnings call on October 13, cfo Jennifer Piepszak said she expects the bank will probably be assigned a 4% GSIB surcharge once the Federal Reserve had completed its annual review of its balance sheet. This is a 0.5% bump from the current capital add-on of 3.5%  - already the highest tier - and will increase its regulatory capital requirement by billions of dollars.

On November 27, it was reported that the Federal Reserve had assessed JP Morgan's GSIB systemic risk score to be 731.5 at the end of Q3, up from 728.17 at the end of Q2. This does indeed put JP Morgan in line for a 4% surcharge unless the risk footprint can be shrunk to 730 by the end of this month.

This follows the news in June that, following the Fed’s annual stress tests, JP Morgan’s common equity tier 1 (CET1) capital ratio threshold had increased from 10.5% to 11.3%. This extra 0.8% was due to the Fed’s decision to introduce a new stress capital buffer to replace the previous capital conservation buffer. While the latter was a flat number, floored at 2.5%, the new stress capital buffer is based upon results of stress testing, and can thus increase, inflating the overall CET number.

Once again, this adds billions to the required thickness of JP Morgan’s regulatory capital buffer. Citigroup’s required CET ratio remained unchanged at 10% and Bank of America was also unchanged at 9.5%.

Based on 1Q RWA numbers, it increased JP Morgan’s required CET1 ratio from $168bn to $181bn, and, by 3Q this had increased still further to $198bn.

A lot of these pressures were anticipated in comments made at the 2019 Investor Day, held on February 26. On that day, it led what one source in the CRT market describes as an “uncharacteristically candid discussion around RWA constraints, especially for a US bank that is always supposed to have a fortress balance sheet.”

The presentation began with a slide that showed the gap between the assessment of RWA using standardized calculation and advanced calculation had grown markedly over 2018 to almost $100bn. Using the standardized approach, RWA was around $1.53trn but it was about $1.43trn using advanced methodology.

Subsequent incremental growth would be capitalized under standardized methodology, which is more expensive and less risk-sensitive, it said.

In the loan market, the focus henceforth would be on higher quality lending and the bank warned investors to expect a “slower pace of growth. Thus, “as marginal economics evolve, the Firm optimizes its balance sheet accordingly,” it said.

The significantly greater use of the CRT mechanism by JP Morgan over the past year, with six deals in total referencing mortgages, auto loans and corporate loans, must be seen in this context, therefore, of rapidly accelerating balance sheet pressures.

JP Morgan has declined to comment.

Simon Boughey

Structured Finance

ESN debate

Could structures cannibalise true sale ABS?

The European Parliament recently called for legislation to establish European Secured Notes (ESNs) to facilitate SME funding. The EBA is also supportive of an ESN funding option, alongside traditional covered bonds, but there are concerns about the potential for the instrument to eclipse true sale securitisation issuance.

“ESNs are touted as dual-recourse instruments and are expected to largely have the same features as covered bonds. The European regulatory regime for covered bonds provides for easy execution - without detailed due diligence and disclosures - and generous capital, repo and liquidity treatment, in contrast to the securitisation regime. For an issuer, it makes sense to choose the easiest and cheapest funding source,” says Alexander Batchvarov, international structured finance strategist at Bank of America.

While only banks can issue true covered bonds, many captive auto loan originators are registered as banks, so technically may be eligible to issue ESNs. “If banks begin issuing large volumes of ESNs backed by a variety of assets, the assets will remain on their balance sheets, constraining lending capacity. So, logically they will seek to transfer the related credit risk via the significant risk transfer mechanisms and market,” Batchvarov suggests.

He continues: “Hence, for the banks, it becomes a matter of issuing cash ESNs (say, auto loan covered bonds besides mortgage covered bonds) along with synthetic securitisations, for funding and credit risk management purposes respectively. In an extreme scenario, these markets could diverge, with only non-bank financial institutions issuing cash securitisations and banks doing synthetic securitisations.”

But there is potential for increased systemic risk too, according to Batchvarov. About half of covered bond volumes are typically distributed to banks, the majority of which are domestic banks, due to the associated repo and LCR benefits.

“These banks are both investing (via covered bonds) in and originating the same residential mortgage loans, thereby layering the same type of risk upon risk, magnifying system risk. Imagine how problematic it would be if, in addition to mortgages, banks could issue covered bonds to fund everything else on their balance sheets and sell these covered bonds to other banks which originate the same loans themselves. This is just one of the many market distortions due to the lack of a level playing field created by some aspects of the regulatory framework in the EU,” Batchvarov observes.

Based on an estimated €4trn in SME loans across Europe, the EBA puts the potential ESN market size at between €400bn and €1.12trn, or roughly half the size of the European covered bond market. However, ESN structures have to date had no lasting success or have remained blueprints that were never widely used (SCI passim).

As such, Scope suggests that ‘ESN 2.0’ instruments should combine a joint European funding platform with a guarantee structure similar to the EIB initiative, which could address the challenges single issuer and purely funding-focused ESNs might face. Such a guarantee could provide for preferential risk weightings and, depending on the guarantee, also support high credit ratings.

In a downturn, SME exposures eat into bank profitability and capital, and ultimately into bank credit quality. Adding additional credit support to an ESN could help to shield banks’ credit quality in a downturn.

Equally, pooled, single-country structures could allow for regular issuance and support secondary market liquidity. “Cover pool credit quality would benefit from diversification, and a flexible structure allowing for cover pool replenishment could support issuance of bullet bonds. Without replenishment, loan amortisation would push bonds below minimum issuance volumes needed for high LCR value for investors,” the rating agency explains.

Dynamic and risk-based guarantee premiums paid by banks when using such a structure would avoid moral hazard and establish a strong alignment of interest, according to Scope. Additional risk retention by the issuer could help maintain high origination standards and effective workouts.

A directive-based but locally implemented ESN law could facilitate a high degree of standardisation and harmonisation of underlying collateral and clarify transfer mechanisms, as well as roles and responsibilities. In addition, securitisation techniques could be used to outplace some of the residual risks borne by the EU as guarantor.

“We believe that if all the elements out there are combined, ESNs could provide funding to SMEs and take risk off bank balance sheets,” says Karlo Fuchs, md and head of covered bond ratings at Scope. “The US SBA market could provide a template for instruments that provide both funding and capital relief. A guarantor for the programme could enable ESNs to be pooled and outplaced.”

He continues: “Such a programme could ultimately benefit the securitisation market too: like the EIF initiatives, banks sign up and the risk is tranched. If investors and banks become more comfortable with SME risk as a result, there is no reason why appetite for public SME ABS wouldn’t return.”

Public SME securitisation issuance has been meagre at best in recent years. Scope notes that the €1.2bn placed with investors in 2019 was the largest volume in the past decade, with the majority of transactions retained.

Ultimately, the benefit of the ESN is that it could become a European safe asset, according to Fuchs. “Covered bonds are often seen as a rates product. But if ESNs attract a guarantee and become seen as a European safe asset, they will truly be a rates product and therefore a ‘no-brainer’ investment,” he concludes.

Corinne Smith

CLOs

Real return

Money managers unlikely to be able to resist CLOs

The rapid Covid-driven blow-out in US CLOs, followed by an equally dramatic reverse, wrong-footed many real money managers and skewed their perception of the sector’s risk-reward profile. Consequently, some have been hesitant to return to the market. But, as 2021 approaches, many will re-join investment managers that didn’t step away, along with new investors all seeking the returns they require.

“It will be interesting to see how people assess risk going forward,” says John Kerschner, head of US securitised products at Janus Henderson Investors. “But, in any event, if you’re a money manager and you want to charge a reasonable fee because you’re adding value, you have to find the necessary yield.”

While there are a multitude of factors that should be taken into account in risk assessment, it is also beneficial to first apply a fundamental approach. For his part, Kerschner primarily looks at risk as three legs of a stool – the duration risk being taken; the credit risk being taken; and the yield being received.

“Consensus is that rates are heading up and, given where they are, it’s difficult to argue against that – so taking a lot of duration risk doesn’t feel great,” Kerschner says. “On the credit front, some corporates look to be doing OK, but still no one knows how that is all going to play out and investors appear not to be being paid sufficiently to take that risk.”

He continues: “Then looking at yields, CLOs continue to be notable: with triple-Bs back to the mid-300s, they compare favourably to double-B rated high yield bonds. If you move to the top of the CLO stack, triple-As are in the 125-140 range and there are very, very few similar assets paying anything like that.”

In addition, the very nature of CLOs is attractive, according to Kerschner. “You may not love the upside/downside equation of these assets. But if you are a money manager, the appeal is that the CLO structure continues to prove itself. At the same time, CLO managers have done a pretty good job in general this year and the vast majority have proved their worth.”

Overall, he adds: “It’s still a good market and functioning well. There was so much talk about CLOs being the next train wreck last year, but they’ve made it through this far and what we hope is the worst of the Covid crisis, without any major issues.”

Indeed, all things being equal, Kerschner expects the sector to go from strength to strength. “Estimates vary, but the CLO market is currently seen as worth around US$750m in the US and another €130m in Europe, so it seems certain that sometime in 2021 it will become a trillion dollar market. That will add significance and mean for many investors who had hitherto been ignoring it that they will no longer be able to do so. I understand that many people are looking to add in the space and that should drive growth still further.”

Nevertheless, the CLO market will always provide opportunities for those willing to put in the effort, Kerschner suggests. For example, he says: “Over 90% of CLOs are likely to be callable by the end of 2021 and even though you never really know how that’ll end up, there are a lot of bonds still trading below par and if spreads keep coming in, a lot deals could be called. That’s where the money manager’s opportunity is – to identify through extensive credit work the deals that add value and enhance returns, rather than buying new issue deals, which may be cleaner and more straightforward, but because of that offer less yield.”

He continues: “Equally, it’s worth looking at deals out of reinvestment, even though they’re seen as being at a little bit at the mercy of macro events because the manager has no flexibility. But, again, when you compare them to new issue - which typically all price close to each other - why would you want to buy new? Why not wait a couple of years and see how the credit has played out, before getting involved for the longer term?”

As Kerschner concludes: “There are regularly examples of non-top tier triple-Bs that are maybe only middle of the road bonds at worst, but they trade 50bp wider to the rest of the market and we - through extensive credit work – recognise that they are still money good. The key is to ensure you fully understand the risk involved and are being correctly compensated for it.”

Mark Pelham

NPLs

NPL momentum

Call for specific securitisation framework

Regulatory support for the non-performing loan securitisation market has coalesced over the last few weeks, with the publication of the Basel Committee’s technical amendment (SCI 27 November) and Wednesday’s announcement that the European Parliament’s Economic and Monetary Affairs Committee and the European Council have reached an agreement regarding the targeted changes to the securitisation rules and the CRR (SCI 6 October). However, while these changes to the capital treatment of NPL ABS have been welcomed for being more risk-sensitive than the previous rules, there are calls for the industry to go further and introduce a specific framework for the instrument.

Under the Basel Committee’s new rule, a 100% risk-weight floor will apply if the internal ratings-based approach or standardised approach is used. However, if the external ratings-based approach is in place, the floor won’t apply. Importantly, the rule also specifies that servicers should hold the risk retention piece, rather than the originator.

Meanwhile, technical work on the NPE ABS text is currently being undertaken by the European Commission, Council and Parliament following the deal reached in the trilogue negotiations. But the text must then be approved by the Parliament as a whole before the rules are finalised.

“The Basel amendment is more risk-sensitive and illustrates that a one-size-fits-all approach is inappropriate for NPL ABS. It is also helpful in that it demonstrates the European legislature recognise that securitisation has an important role to play in the NPL market. The success of the GACS and HAPS programmes means that the direction of travel is clearly towards securitisation,” says Iain Balkwill, partner at Reed Smith.

Nevertheless, the Basel capital treatment differs from that under the NPE ABS proposals currently in the European legislative process, in which the risk weight for the senior tranche is floored at 50% and capped at 100%. While these differences may ultimately result in a divergence of the NPL ABS market, they also suggest that to properly address NPL securitisation requires more than what is effectively a ‘bolt-on’ to the existing securitisation regulations.

“NPL ABS and other securitisations are completely different products; they start from different places, and the underlying credit and risks are entirely different,” Balkwill explains. “Performing assets are cleaner and easier to securitise, whereas NPLs are distressed and both the seller’s drivers and the investor’s approach are different. Even transaction counterparties’ attitude is different, given the complexity and potential for litigation involved with NPLs.”

The development of the Basel and European Commission approaches to NPL ABS has been underway since the release of the EBA opinion last year (SCI 24 October 2019). But Balkwill notes that, with the onset of the coronavirus pandemic, the state of the NPL market has completely changed since the EBA released its opinion.

A surge in NPL volumes is still anticipated, but by what quantum remains unclear. “Not only does the industry still need to address the NPL overhang from the financial crisis, but there is also now the Covid fallout and a whole new set of ‘Covid loan’ NPLs (those that are temporarily backstopped by government) that will need to be dealt with. Policymakers appear to recognise that the sooner the overhang is addressed, the better. The major advantage of securitisation is that it enables huge volumes to be offloaded via sales to third parties or as a balance sheet management exercise,” Balkwill observes.

He continues: “However, the approach so far has been to tweak the securitisation regulation and CRR. Rather than a bolt-on to the existing regime, in many ways the industry needs to go further and introduce a specific framework that properly addresses NPL securitisation.”

Looking ahead, Balkwill anticipates that a steady flow of new NPL securitisations will emerge in the coming months, given that they take a while to structure and rate. He suggests that one way to bridge the current bid/ask gap is to introduce profit participation instruments, whereby the seller takes an initial hit on the value of the portfolio but receives a percentage of the profit later on.

Corinne Smith

Capital Relief Trades

Landmark SRT completed

Unusual synthetic securitisation inked

The EIB and the EIF have finalised a €795m guarantee with ING that will support new lending to Dutch SMEs and midcaps. The transaction is the EIB Group’s largest ever synthetic securitisation and will enable the Dutch lender to provide €1.1bn of SME and midcap financing.

The deal also applies the traditional standardised bank format to IRB banks by guaranteeing close to the full capital stack. Indeed, the latter has occurred as the supranational has moved away from that format in its recent standardised bank transactions.

Georgi Stoev, head of Northern Europe and CEE securitisation at the EIF, notes: “It’s the largest synthetic securitisation we have ever done. The only way this could work, given our limitations, was by allowing the EIB to counter-guarantee both the mezzanine and the senior tranche, which is very unusual. Typically, we only guarantee the mezzanine tranche, except for standardised banks where we cover close to the full capital stack.”

The synthetic securitisation forms part of the EIB Group’s Covid-19 response and is partially supported by the European Fund for Strategic Investments. According to the terms of the plan, the EIB Group will provide €40bn backed by guarantees from the EIB Group and the EU budget.

Virginia Gecaite, structurer at the EIF, states: “Given the size of the transaction, this is a high-quality deal with a granular and homogeneous portfolio. So, it was easy to make a positive selection. The granularity of the portfolio helped the economics.”

The ING deal follows another EIF transaction with Hypo Vorarlberg that was completed earlier this month (SCI 1 December). As part of the trade, the EIB Group provided a mezzanine guarantee for a €330m portfolio of Austrian SMEs and midcaps.

The provision of a mezzanine guarantee marks a notable difference compared to a previous significant risk transfer trade that the EIB Group finalised with Hypo Vorarlberg three years ago (see SCI’s capital relief trades database). In fact, for the latter, the supranational guaranteed both the senior and the mezzanine tranches. However, due to changes in regulations, the EIB Group is now able to guarantee thick mezzanine tranches for standardised issuers.

Stoev explains: “In 2017 it was impossible to get mezzanine protection and capital relief, since the SEC-SA formula wasn’t available for standardised lenders. IRB banks calculating PDs and LGDs according to the old regulations could use mezzanine protection, but standardised banks do not use IRB modelling and investors were not able to offer mezzanine protection. It’s a format that can also open up the standardised bank market to private investors, who can buy into the junior tranche.”

The SEC-SA formula usually results in a bank needing to sell a thicker tranche because if they don’t have an accurate assessment of expected loss, they need to build in a cushion so the regulator can be comfortable with the loss variability. More saliently, the formula allows standardised banks to assign risk weights to unrated tranches and reduces risk weights for retained tranches. In effect, this means that the EIF does not have to guarantee close to the whole capital stack to render the transactions cost-effective.

Before the advent of the new securitisation regulation in January 2019, banks using the standardised approach suffered a more punitive treatment for the unrated tranches of their synthetic securitisations. Until then, all such banks had to consider a more costly rating. But if they could not get ratings on a retained tranche, they had to apply a 1250% risk weight and a corresponding deduction from capital.

To avoid the rating option, their only alternative was the EIF. Under the old framework, EIF transactions were the most cost-effective deals, given that the supranational guaranteed close to the whole capital stack for a small spread. Nevertheless, thanks to the application of the SEC-SA formula, the new securitisation regulation has freed standardised banks from the rating requirement.  

Stelios Papadopoulos

ABS

Finish line

Trilogue agreement finalised

Negotiators from the European Parliament’s Economic and Monetary Affairs Committee (ECON) have reached an agreement with the European Council on targeted changes to the securitisation regulation and the CRR, with respect to the creation of an STS synthetics framework and changes pertaining to non-performing loan securitisations. The final text has not yet been disclosed, although official sources have confirmed the integration of sustainability criteria and a risk-sensitive capital treatment for NPL ABS.

The agreement is part of a review into the European Commission’s ‘quick fix’ proposals, which were initiated in July (SCI 31 July). The proposals consist of two legislative acts pertaining to amendments to the Securitisation Regulation and the CRR, both of which are critical for introducing an STS label for synthetic securitisations.

According to MEP Paul Tang: “Parliament has succeeded in clearly integrating sustainability into the securitisation framework. Standards will be developed to report on the sustainability of securitisation products and the European Banking Authority will draft a proposal for a dedicated framework for sustainable securitisation. The drive for sustainability reporting has now been embraced by the banking sector.”

Regarding the more risk-sensitive treatment of NPL securitisations, MEP Otmar Karas states: “I am particularly pleased that the European Parliament achieved a more risk-sensitive treatment of NPE securitisations. This gives the right incentive to support banks in freeing up their balance sheets of non-performing exposures, which can be expected to grow because of the current crisis.”

Furthermore, it is certain that the agreement will not ban time calls and pro-rata amortisations. The European Parliament initially suggested excluding the features from an STS synthetics framework, but retraced from that position amid a market backlash (SCI 11 November).

Technical work on both texts is now being carried out by the European Commission, Council and Parliament. The agreement must then be approved by both ECON and the European Parliament as a whole.

Stelios Papadopoulos

Structured Finance

SCI Start the Week - 7 December

A review of securitisation activity over the past seven days

Last week's stories
Collections conundrum
Italian NPL ABS amortisation eyed (Full story below)
Covid communications
The pandemic has meant greater negotiation over terms between CRT buyers and sellers
High-quality counterparties
Insurer involvement in SRT on the rise
Innovative SRT inked
Belgian synthetic RMBS finalised
SCI CRT Awards 2020
Advisor/Service Provider of the Year: US Bank
SCI CRT Awards 2020
Analytics Firm of the Year: Mark Fontanilla & Company
SCI CRT Awards 2020
Arranger of the Year: Credit Suisse
SCI CRT Awards 2020
Issuer of the Year: Intesa Sanpaolo
SCI CRT Awards 2020
Law Firm of the Year: Allen & Overy
SCI CRT Awards 2020
North American Arranger of the Year: BMO Capital Markets
SCI CRT Awards 2020
North American Issuer of the Year: Freddie Mac
SCI CRT Awards 2020
North American Law Firm of the Year: Clifford Chance
SCI CRT Awards 2020
Personal Contribution to the Industry: Steve Gandy
STACR due
BofA and Wells Fargo to underwrite imminent STACR deal
Tech solution
Peter Jasko, ceo at Semeris, answers SCI's questions
Test case
JPMorgan CRT details revealed

Other deal-related news

• The US Fed, the OCC, the FDIC and the UK FCA have welcomed a proposal by ICE Benchmark Administration, the administrator for Libor, that lays out a path forward in which banks should stop writing new US Libor contracts by end-2021 while enabling most legacy contracts to mature before the cessation of the benchmark (SCI 1 December).
• Credit quality will deteriorate for new European CLOs in 2021, but credit enhancement should help maintain strong performance among outstanding deals, according to a new report from Moody's (SCI 1 December).
• The EIB Group has provided a mezzanine guarantee on a €330m portfolio of mainly Austrian loans to SMEs and mid-caps, originated by Hypo Vorarlberg Bank (SCI 1 December).
• Pre-pandemic trends in US leveraged lending - including high leverage, weak covenants and declining recoveries - resumed by 3Q20 and should continue into 2021, absent a renewed downturn, according to Moody's (SCI 2 December).
• Dutch National promotional institution Invest-NL has signed a new guarantee agreement with the EIF to cover a lending portfolio to innovative Dutch SMEs (SCI 2 December).
• Summit Issuer Series 2020-1, the first securitisation backed by dark fibre communication infrastructure assets, is being marketed by Barclays on behalf of sponsor and manager Summit Infrastructure Group (SCI 4 December).
• Fitch says that it resolved its negative rating watch on 47 European CLO tranches in November (SCI 4 December).
• The EU Securitisation Regulation is unlikely to incorporate beneficial bank capital treatment for green securitisation holdings until the EBA has completed a similar analysis of the bank prudential framework, Fitch suggests (SCI 4 December).
• The New York Fed is undertaking a small value agency MBS sale open market operation on 10 December (SCI 4 December).

Data

Recent research to download
CLO Case Study Autumn 2020
Autumn 2020 CRT Report

Upcoming events
SCI's 2nd Annual Middle Market CLO Seminar
21 January 2021, Virtual Event
SCI's 5th Annual Risk Transfer & Synthetics Seminar
March 2021, Virtual Event
SCI's 3rd Annual NPL Securitisation Seminar
May 2021, Virtual Event

Collections conundrum
Italian NPL ABS amortisation eyed

The number of Italian non-performing loan securitisations with lagging collections is set to rise to 17 by 1Q21, Scope predicts. If the slowdown continues, the average time for deals to amortise will exceed 10 years, according to the agency's NPL Dynamic Coverage Index.

The index is based on the median of the net yearly proceeds by outstanding liabilities and measures the average number of years needed for transactions to amortise if the pace of collections remains unchanged. Scope's NPL Performance Index tracks the ratio between aggregated cumulative net proceeds and original cumulative business plan net forecasts.

"We expect both indices will continue to deteriorate in the short term, based on our projection of the slowdown in the pace of collections resulting from the coronavirus pandemic and the recent Italian lock-down," says Paula Lichtensztein, senior representative in the structured finance team of Scope. "Consequently, the Scope NPL Performance Index is likely to fall below 100, while the projected average number of years needed for transactions to amortise will exceed 10 years."

Scope examined the performance of 25 NPL ABS, with an aggregated gross book value of €73bn. The agency expects that by the next quarter, an expected average underperformance of 27% in terms of gross collections versus original business plans will be seen across the sector.

As at end-September, underperformance was seen in 14 of the 25 transactions, in terms of gross collections, and 12 of the 25 in terms of net collections. Subordination and/or underperformance events have been reported by nine out of 25 transactions.

Various factors drive underperformance, including initial servicing onboarding processes causing delays for servicers' activities, the slow-down in judicial proceedings this year, a deterioration in borrower affordability and liquidity conditions and real estate depreciation.

Out of 24 transactions, 22 are overperforming. Scope notes that overperformance has been driven by factors such as collections from cash-in-court positions and servicers reaching extra-judicial agreements, which leads to a frontloading of collections.

Given the risks brought about by lockdown measures, attention has turned to recovery strategies. Scope has identified judicial proceedings as the main recovery strategy, accounting for on average 49% of transaction collections. Discounted-pay-offs with 23% of transaction collections and note sales with 8% of transaction collections have also been seen.

Jasleen Mann

Capital Relief Trades

Synthetic RMBS debuts

Raiffeisen completes capital relief trade

Raiffeisen has completed a €182m unfunded mezzanine guarantee that references a static €3.3bn portfolio of Austrian residential mortgages. Dubbed ROOF Mortgages 2020, the transaction is the lender’s first synthetic RMBS and adds to this year’s boost in synthetic RMBS volumes. However, programmatic issuance by the lender remains unlikely. 

Oliver Fuerst, head of active credit management at Raiffeisen, notes: “Our approach here was to go for a clean and pristine transaction to get our first synthetic RMBS off the ground; this is why there’s no excess spread and no replenishment features. However, the transaction is a one-off trade. So, programmatic issuance going forward remains unlikely.” 

The mezzanine and senior tranches amortise on a pro-rata basis, but the retained first loss tranche does so sequentially. Further features include a time call that can be triggered after five years.

Raiffeisen opted for a static portfolio in this case, given the large size of the pool and the need to hedge against potential disruptive credit migrations. The pool is highly granular, comprising approximately 40,000 underlying borrowers.

Residential mortgages are not typically hedged in synthetic structures, due to already low risk weights. Large IRB banks that have completed them in the past, such as Lloyds, did so to hedge internal concentration risk limits and therefore lend more to the real economy (SCI 19 November).

However, for standardised or IRB banks with sufficiently large volumes of mortgages, synthetic securitisations can make sense from a cost of capital perspective. Indeed, the recent Axa Bank Belgium deal and Raiffeisen’s latest transaction were driven by regulatory capital considerations (SCI 2 December).

Nevertheless, earlier this year, residential mortgages were not at the top of Raiffeisen’s priorities. The original goal was to close a capital relief trade referencing a blind pool of mid-market corporate loans. However, the bank ended up rethinking its approach later in the year, before finally reconsidering its pipeline at the height of the coronavirus crisis in April and May.

Raiffeisen holds a large volume of mortgages and owns a standardised bank subsidiary. Consequently, executing a synthetic RMBS made sense from a cost of capital perspective.

At the group level, the transaction will strengthen the bank’s common equity tier one ratio by approximately 10bp.

Stelios Papadopoulos

Capital Relief Trades

Risk transfer round up-December 9

CRT sector developments and deal news

Santander is believed to have postponed the pricing of Project Spitfire as the lender and the investors were reportedly not able yet to negotiate a pricing for the equity tranche. The synthetic securitisation is allegedly backed by UK auto loans. The transaction would be Santander’s first post-Covid synthetic auto ABS.     

Insurance-linked securities

Bellemeade bonanza

The latest Arch trade covers the same insurance vintage as June's 2020-1

Arch Capital is in the market again with its latest mortgage insurance-linked note (MILN), designated Bellemeade 2020-4.The transaction entered marketing yesterday (December 10), is due to be priced next week and should close around December 22.

This is the fourth Bellemeade deal of the year, and the third since Arch re-opened the sector in late June with Bellemeade 2020-1 after the Covid 19 market dislocation had shut down the market for over three months.

The note will compose four tranches and final deal size will be between $276m and $337m, depending on the inclusion of an added reinsurance component,  confirms James Bennison, executive vice president for alternative markets.

This latest trade is unique in the MILN sector as it covers the same portfolio of insured mortgages that were covered with June's Bellemeade 2020-1, but at different attachment points. As it was the first trade since the acute market dislocation, Bellemeade 2020-1 incorporated an unusually high attachment point of 7.5% to coax investors back into the market.

Normally, MILNs attach at around 2.25%, but Arch needed to kick-start the market so it was prepared to accept a very generous degree of credit enhancement.

Consequently, the new Bellemeade 2020-4 attaches at 1.85% and detaches at 8%. However, the uppermost tranche of the deal, the M1C, which covers between 6% and 8% of the insured pool of assets, is retained by the seller. The remaining tranches, which are sold to investors, are designated M2A, M2B and B1 and cover 1.85% to 6% of the portfolio. “This new deal enhances the previous deal,” adds Bennison.

Arch has issued considerably more MILNs in 2020 than other insurance names. It has four to its name this year, and four since Covid, while National Mortgage Insurance Corporation has issued two Oaktown deals, and there has been one apiece for Essent, Radian and Genworth.

“Our intent is to be a regular programmatic issuer. Obviously we were delayed at the beginning of the year because of Covid, and we have used the recovery in the market to get back onto schedule,” he says.

Issuance levels have still not recovered to pre-Covid levels, however. Bennison estimates that spreads are still 100bp-150bp more generous than they were during pre-Covid execution in January, although given the heterogeneity of these trades exact comparisons are difficult.

For example, Bellemeade 2020-3, issued in early January, comprised five different tranches from M1A, which yielded one-month Libor plus 200bp, to the B1 notes which yielded one-month Libor plus 635bp.

“We’ve seen gradual improvement in pricing with each issue since 2020-1 and we hope that trend, will continue,” he adds.

Cheaper credit spreads have enticed a few new investors into the MILN market, but no established investors have abandoned the sector, so the pool of potential buyer has if anything increased.

Current mortgage origination is very robust, so it is possible that Arch will be an even more frequent issuer next year.

Simon Boughey

Structured Finance

Leveraged finance: stepping into the void

Contributed thought leadership by Ocorian

As funds continue to reallocate capital to direct lending strategies, Sinead McIntosh, business development director at Ocorian, a global leader in corporate and fiduciary services, fund administration and capital markets, highlights the crucial role of independent loan service providers in streamlining fund loan portfolios

In a continuation of the legacy of the 2007-2008 global financial crisis, large commercial banks remain distanced from lending to middle-market and lower-middle-market companies. Their successors, collectively known as 'alternative lenders' and largely made up of private debt funds, continue to fill the void left behind by providing the necessary capital for businesses seeking alternative sources of financing.

Institutional investors are increasingly engaging with these non-traditional debt options. They provide higher-yielding, shorter-term investments than public bond markets and have low correlation to public market volatility.

However, market uncertainty over the implications of Covid-19 and subsequent government stimulus saw direct lending deals completed in Europe in 1H20 fall by 29%, compared to the same period last year. This put the brakes on an increasingly competitive private debt market, with companies instead able to raise money from cheaper public debt markets. 

But fiscal support is now withdrawing and commercial banks are continuing to retrench, becoming increasingly risk averse and focusing on managing their existing portfolios. Moreover, optimism around a Covid-19 vaccine is returning confidence to markets. Together with pent-up demand and an absence of deals, alternative lenders are seizing the opportunity to step into the leveraged markets the banks have less appetite for, competing to deploy capital.

Growing pains
Every crisis brings with it an opportunity for reinvention, innovation and collective agility. And those firms that pivot to direct lending strategies with adequate scale, capital and expertise will be the most successful. However, many mid-market funds looking to diversify to direct lending strategies do not have the internal resources and expertise necessary to manage and rapidly upscale a large portfolio of loans.

Direct lending is a fast-paced market and the pressure to get to market quickly and deliver can create operational risks for under-resourced funds. But running loan books on inefficient systems can significantly hamper the effectiveness of a fund's operations, carries considerable operational risks and limits scalability. Focusing on these non-core operational tasks also drains internal resources that could otherwise be applied to revenue-generating activities.

Engaging with an experienced and responsive independent loan administrator can help eliminate the operational challenges and risks mid-market direct lending funds face. This can result in optimised operations and improved data and reporting quality.

Increase deal flow and reduce risk
Ocorian provide a complete end-to-end loan agency and administration package to direct lending funds. By blending our team's deep commercial experience with cutting-edge private debt software, we act as a seamless extension of in-house transaction teams.

This enables the effective management and oversight of loan portfolios and provides real-time data and dashboards for bespoke finance, management and investor reporting. Our scalable and operationally robust solution can be used across asset classes to instil efficiencies and allow firms to focus on their core business.

For more information about Ocorian's loan agency and administration services for direct lending funds, visit ocorian.com.

Structured Finance

CMBS value deficiencies compared

Sector developments and company hires

CMBS value deficiencies compared
DBRS Morningstar has identified US$9.79bn in US CMBS loans transferred to special servicing since March, whose collateral was subsequently reappraised. Although updated appraisals on properties backing these loans suggest an average value decline of 24% since origination, only about 17% have a loan-to-value ratio of 100% or higher, resulting in a value deficiency. The analysis also found that just US$372m - or 3.8% of the outstanding principal balance - had a value deficiency, which compares favourably with the 9.5% loss rate on loans issued in the run-up to the financial crisis.

In other news…

CLO approach adjusted
Moody's has adjusted its approach to assessing the default probabilities ratings of obligors included in CLOs; in particular, the analytical treatment of corporate obligors with a negative outlook or whose ratings are on review for downgrade. The update is expected to result in a generally positive impact on ratings, largely comprising reviews for possible upgrade and single-notch upgrades, totalling around 5% of the agency’s approximately 7,000 outstanding rated CLO tranches in the US and EMEA.

IBA consultation published
ICE Benchmark Administration (IBA) published its consultation on its intention to cease the publication of Libor settings (SCI 1 December). The consultation is open for feedback until 25 January 2021, after which IBA intends to share the results of the consultation with the UK FCA and to publish a feedback statement summarising responses from the consultation shortly thereafter.

North America
Intertrust Group has promoted Shankar Iyer to ceo, having previously been chief solutions officer at the firm. Prior to that, Iyer was ceo and co-founder of Viteos, which Intertrust acquired in 2019. He has over 30 years of international experience in scaling businesses and in integrating digital capabilities, including as president and ceo of Silverline Technologies.

Structured Finance

ADI securitisation review underway

Sector developments and company hires

ADI securitisation review underway
The Australian Prudential Regulation Authority is undertaking a review of securitisation practices, having recently identified repurchased residential mortgage loans at some authorised deposit-taking institutions that were subject to repayment deferral from their securitisations. In APRA’s view, this represents implicit support, which is inconsistent with Prudential Standard APS 120 Securitisation. APS 120 requires ADIs to be clearly separate from their securitisations and to permanently (except in limited pre-defined circumstances) transfer credit risk to the securitisation investors. 

Consequently, APRA has required the ADIs that it considers to have provided implicit support to publicly disclose their repurchases as part of upcoming Pillar 3 reporting requirements. They will also be required to have a third party review their programme’s APS 120 compliance and mitigate any findings prior to further securitisation issuance.

Based on these findings and engagement with industry stakeholders, APRA believes it is necessary to conduct a programme of securitisation thematic reviews, which will continue into 2021. 

Depending on the findings, the reviews may be expanded further. Identification of non-compliance with APS 120 may result in an ADI being required to publicly disclose their non-compliance and/or a requirement to hold additional regulatory capital.

Deficiencies already identified by APRA as part of its thematic reviews include: little or no procedures or controls to challenge or provide oversight of ongoing securitisation operations; requirements for ADIs to repurchase loans from their securitisations under certain circumstances; and considering capitalising interest to be a further advance and insufficiently considering the provision of implicit support.

EMEA
CVC Credit Partners has appointed John Empson as partner and co-head of private credit and Miguel Toney as a partner in the private credit team. Empson joins from Blackrock, where he was head of capital markets, EMEA. Prior to Blackrock, he was a partner at KKR, where he spent 11 years helping with the strategic build-out of the firm's credit and markets platform.

Toney joins from Park Square Capital, where he was a partner focused on the firm’s European junior capital strategy. Prior to this, he was an md at MV Credit, where he helped build out its European junior capital and senior debt capabilities.

Equity transfer agreed
The owners of Gravis Capital Management have agreed to sell 70% of the firm’s issued shares to ORIX Corp through the transfer of common equity. The transaction is expected to close during 1Q21 and, on completion, existing management teams and day-to-day operations will remain in place, supported by ORIX. Houlihan Lokey served as the financial advisor to Gravis and assisted in structuring and negotiating the transaction.

ESAs clarify STS impact
The Joint Committee of the European Supervisory Authorities (ESAs) has clarified the impact of Brexit on the STS framework. The committee states that existing STS transactions with a UK originator or SPV will cease to be STS in the hands of EU investors from 1 January. ESMA intends to remove all UK STS deals from its list by 1 January, irrespective of whether originators notify it.

North America
Susan Gueli has joined Common Securitization Solutions (CSS) as chief technology officer, evp and a member of the CSS executive committee, reporting to ceo Tony Renzi. Gueli is responsible for all technology initiatives for the company, developing and implementing all aspects of the Common Securitization Platform and its data offering. She was previously chief technology officer of Nationwide's program & application services, where she led in-house application development, digital transformation, shared services and a team of more than 3,000 IT professionals.

Sabal Capital Partners has hired Edward Hussey as head of agency lending. Based in Virginia, he will be responsible for managing production across all of Sabal’s Freddie Mac, Fannie Mae and other agency products. He will also oversee the recruiting, training and management of Sabal’s nationwide production team. Hussey joins Sabal from Truist Bank, where he was svp, head of multifamily production for agency lending.

Online lender expands into autos
Pagaya has expanded its consumer credit offering into auto loans, with hundreds of millions of dollars already invested in the space and multiple lending partners - including Flagship Credit Acceptance and Foursight Capital – signed up. In addition to unlocking new opportunities for marketplace lenders, the move enables Pagaya to work with original equipment manufacturers (OEMs) and their wholly-owned captive finance companies to bring more borrowers into their ecosystem.

The effort is led by Robert McDonald, the firm’s new general manager of auto finance. He was previously vp, head of auto and equipment - structured finance at Goldman Sachs.

RMBS upgraded on PDL correction
Moody's has upgraded from Ba2 to Ba1 the rating of the class E notes issued by Avon Finance No 1. The move is prompted by the correction of an input error in the cashflow model related to the transaction’s principal deficiency ledger mechanism that meant the principal residual certificates were not captured properly. The agency notes that during the original assignment of the ratings, the omission of the PDL mechanism for the principal residual certificates meant the modelled waterfall did not fully reflect all transaction features.

Structured Finance

Disclosure charges settled

Sector developments and company hires

Disclosure charges settled
BlueCrest Capital Management has agreed to pay US$170m to settle US SEC charges concerning inadequate disclosures, material misstatements and misleading omissions. These charges concern the firm’s transfer of top traders from its flagship client fund, BlueCrest Capital International (BCI), to BSMA Limited, a proprietary fund, and replacement of those traders with an underperforming algorithm. The SEC’s order finds BlueCrest in violation of antifraud provisions of the Securities Act of 1933, Investment Advisers Act of 1940 and the Advisers Act’s compliance rule.

BlueCrest did not disclose the reallocation of the transferred traders’ capital allocations in BCI to a semi-systematic trading system. This trading system was a replication algorithm that tracked trading activity of a subset of BlueCrest’s live traders. The firm is alleged to have kept more of any performance fees generated by the algorithm than by live traders.

In other news…

ABS CDO transferred
Dock Street Capital Management has replaced Duke Funding Management as collateral manager to Duke Funding X. Moody’s has determined that the move will not adversely impact any of its current ratings on secured notes issued by the ABS CDO. For more CDO manager transfers, see SCI’s database.

EMEA
Arcmont Asset Management has recruited Christian Roessling as head of DACH business development, based in Munich, Germany. He was previously associate director, business development Germany & Austria at Barings in London. Before that, Roessling worked at Deutsche Bank and Commerzbank.

Mark Mearing-Smith has joined Jefferies’ CLO structuring team in London. He was previously vp at NatWest Markets and has also worked at Trepp and Codean.

Uplift for Chinese auto ABS
Moody's has upgraded the ratings on 13 notes issued by nine Chinese auto ABS, following the upgrade of China's local currency country ceiling to Aaa from Aa3. The rating actions reflect the impact of: the revised local currency country ceiling for China; the level of financial disruption risk in the transactions; the presence of sufficient credit enhancement to the notes; and the performance of the securitised auto loans and leases.

Structured Finance

CLO liquidity complexity examined

Sector developments and company hires

CLO liquidity complexity examined
CLO secondary market activity is booming across the board, but the underlying liquidity picture is a complex one, according to a new report by JPMorgan CLO research analysts.

CLO BWIC trading volume has already reached an all-time annual high in 2020 at US$48.1bn for the US and €11.7bn for Europe, the JPMorgan report says. However, it adds that while this may suggest rising market depth, it’s important to note indicative ‘float’ (volume/market size) in mezzanine is much higher than in senior, which is probably due to the more buy-and-hold triple- and double-A investor base.

At the same time, the report notes that 2020 year-to-date TRACE volumes are US$175bn, the highest level since JPMorgan began tracking the data. That represents 23% of the outstanding US CLO market, which is the highest proportion since 2013’s 25%.

Nevertheless, the JPMorgan research analysts observe: “The broader point on liquidity isn’t so much trading activity, but the provision of CLO liquidity to loans. In this respect, with the lowest yield for the Loan index since April 2015, the market for the linchpin CLO equity buyer will be important as the traditional 'teens IRR' benchmark is taken into context of negative to low inflation-adjusted real yields on higher quality debt products.”

They continue: “While Libor floors will benefit US CLO equity, there is still a sizable portion with 0bp floors or no floors (41% of existing loans contain a Libor floor at 100bp), and CLO equity also needs to be compensated for the illiquidity and MTM risk. While difficult to compare, we observe indicative price volatility to similar-yielding triple-C leveraged credit (currently yielding around 10%).”

The report also notes that there is correlation between CLO manager platform size and absolute volume, though 'manager liquidity' is “in the eye of the beholder”. The top five traded US CLO managers are all first quartile AUM (CSAM, CIFC, PGIM, Carlyle and Octagon), but when normalising trading volume for AUM, the activity is highest for 3rd/4th quartile AUM. The top five traded managers as a percent of their AUM are Allianz, Ore Hill, Deutsche Asset Management, Birch Grove and Tortoise Credit.

In other news…

EMEA
Cadwalader has promoted Alexander Collins to special counsel within its London capital markets team. Collins focuses on structured finance, with an emphasis on CLOs. He has acted on a wide range of cross-border structured finance transactions and, in respect of CLOs, has represented arrangers, asset managers and warehouse finance providers in connection with a variety of European CLO 2.0 transactions and warehouse facilities.

NPL ABS completed
Phinance Partners has completed, as arranger and advisor of the securitisation SPV POS, the purchase without recourse from Banca Sella of a portfolio of unsecured non-performing retail loans, for a total gross book value of approximately €24m. The transaction marks the fifth NPL portfolio purchased by POS, bring its total GBV close to €400m, representing almost 30,000 debtors.

Portfolio management will be entrusted to NPR Management, a subsidiary of Phinance that monitors portfolios of non-performing loans on behalf of institutional investors.

With this latest purchase, the value of the portfolio of NPLs securitised by Phinance is approximately €1.2bn across gas and power receivables and financial receivables and loans, representing circa one million positions.

The securities issued by the POS SPV will be subscribed by institutional and professional investors. Centotrenta Servicing will be the master servicer of the securitisation, while 130 Finance will take on the role of calculation agent. The legal aspects of the transaction have been handled by DLA Piper.

QM final rules released
The CFPB has issued two final rules related to qualified mortgage (QM) loans, which aim to support a smooth and orderly transition away from the GSE Patch and maintain access to responsible, affordable mortgage credit upon its expiration. One of the rules - the General QM Final Rule - replaces the current requirement for general QM loans that the consumer’s DTI ratio not exceed 43% with a limit based on the loan’s pricing. The other rule creates a new category for QMs - Seasoned QMs.

In adopting a price-based approach to replace the specific DTI limit for General QM loans, the bureau determined that a loan’s price is a strong indicator of a consumer’s ability to repay and is a more holistic and flexible measure of a consumer’s ability to repay than DTI alone. Additionally, conditioning QM status on a specific DTI limit could impair access to responsible, affordable credit.

Under the General QM Final Rule, a loan receives a conclusive presumption that the consumer had the ability to repay if the annual percentage rate does not exceed the average prime offer rate for a comparable transaction by 1.5 percentage points or more, as of the date the interest rate is set. A loan receives a rebuttable presumption that the consumer had the ability to repay if the annual percentage rate exceeds the average prime offer rate for a comparable transaction by 1.5 percentage points or more but by less than 2.25 percentage points.

In addition, the General QM Final Rule: provides higher pricing thresholds for loans with smaller loan amounts, for certain manufactured housing loans and for subordinate-lien transactions; retains the General QM loan definition’s existing product-feature and underwriting requirements and limits on points and fees; and requires lenders to consider a consumer’s DTI ratio or residual income, income or assets other than the value of the dwelling, and debts and provides more flexible options for creditors to verify the consumer’s income or assets.

The Seasoned QM Final Rule creates a new category of seasoned QMs for first-lien, fixed-rate covered transactions that meet certain performance requirements, are held in portfolio by the originating creditor or first purchaser for a 36-month period, comply with general restrictions on product features and points and fees, and meet certain underwriting requirements. Specifically, the loan can have no more than two delinquencies of 30 or more days and no delinquencies of 60 or more days at the end of the seasoning period. The creditor or first purchaser also generally must hold the loan on portfolio until the end of the seasoning period.

The General QM Final Rule will have a mandatory compliance date of 1 July 2021.

RMBS placed on watch positive
Fitch has placed 1,209 US RMBS classes on rating watch positive and has revised the rating watch for an additional 16 classes to positive from negative, following an update to its US RMBS surveillance and re-REMIC rating criteria. All of the classes placed on RWP are from transactions issued prior to 2010.

The criteria changes include the following revisions: treatment of interest shortfalls; treatment of small pool concentrations; a revision to the treatment of loan documentation for loans originated prior to 2009; and the removal of a rating upgrade constraint based on expected months to pay off. The criteria also added additional flexibility for analysts to make model over-rides without it being considered a criteria variation, although this change is not expected to result in any immediate rating impact.

Strategic partnerships
Carlson Capital has reached a strategic agreement with Jefferies Group and Hildene Capital Management to support the new issuance of CLOs on Carlson’s Cathedral Lake platform. Under the terms of the agreement, Jefferies and Hildene will provide CLO equity capital to support the new issuance of four Carlson CLOs within the next three years. As strategic investors, Jefferies and Hildene will share in the growth of the Cathedral Lake CLO platform.

CANDRIAM and its affiliate New York Life Investments Alternatives (NYLIA) have entered into a strategic partnership with Kartesia Management and acquired a minority stake in the firm. Terms of the transaction - which are subject to certain customary closing conditions - were not disclosed, but it is anticipated to close by year-end.

Under this partnership, Kartesia will retain its existing management and investment autonomy, while benefiting from the operating and financial resources, distribution network and scale of both CANDRIAM and NYLIA to enter a new phase of development. In Europe, the partnership will add European private credit to CANDRIAM's multi-specialist offerings and in the US complement the strong US private credit capabilities of NYLIA.