Contents

CLOs

US CLO rally rolls on

Current focus on mezz looks set to move down the stack

Strong demand continues to drive secondary spreads tighter across the US CLO capital stack. But – similar to triple-As before them – as mezz tranche prices near par, trading is becoming stickier and the focus is likely to shift down to equity.   

“Demand for floating rate assets has continued this year so far, with distressed loans and CLOs heading back to par,” confirms one trader. “For instance, loans are up 15 cents today and that continues to give fuel to the CLO mezz rally.”

The trader reports that lower mezz, in particular, has been in focus since mid-December, rallying around 20 points overall. “That’s pretty much all I’ve been trading this month,” he says. “Brokers are trying to sit there, cross bonds and do their regular stuff, but it's amazing how the balance sheet of the bigger houses, and now even some of the mid-size banks, is driving the velocity of the rotation of everyone’s offer sheets.”

A month ago, double-Bs were trading in the 80-85 price range and are now broadly back to between 90 and 95, with the strongest bonds even higher. Single-Bs have come in from 1250DM in December to about 1050-1075DM at the start of January and are now inside of 1,000. “They’re at 950-975 for some of the not-so-strong names and inside of 900 for the really strong ones, with higher MVOC,” the trader says.

He continues: “When you have price appreciation of that level in a month and a half, you’d be stupid not to take some of the profit off the table. So, there’s has been trading across the cap stack, but primarily the larger guys are trading double-As down to triple-Bs bilaterally, while the non-investment grade mainly trades on BWIC and on the follow. Sellers are looking to see how deep the bid is for US$1m or US$2m and if it makes sense to sell, they’ll pump the rest out.”

However, with prices strengthening and primary volumes surging, the demand for secondary mezz may be cooling - especially from hedge funds, as the ability to access new, cleaner, longer-dated, higher MVOC paper at broadly similar DMs has arrived. “It’s kind of saturated there a bit in terms of secondary relative value to new issue, particularly this week,” the trader says.

Consequently, he adds: “A double-B BWIC due this afternoon got a lot of attention to see how it went, especially as it had a bunch of good names who should be in the mid to high 90s. Real money is still there for the bid, but liquidity is a lot thinner once the price gets to 98.” See SCI’s Daily Cover or PriceABS for more detail.

Looking ahead, the trader believes that the CLO rally will continue but attention will move on to the bottom of the stack. “I think the most interesting forward trade with loans rallying and the general market improving is going to be equity,” he says. “There’s a lot of flow coming into the market now and even bonds that are a lower dollar price are probably NAV trades in the hope they can start IOing again. Some of those - not the majority, but some - will continue to rally on value.”

The trader continues: “Over the last two weeks, we’ve seen volumes gradually increase and once all the January payments have come out, we’ll be seeing really decent amounts and that will test the appetite of the players in the equity space. The small pieces that have been trading so far – market value for US$2-7m on average – have been absorbed pretty well. However, some of the larger hedge funds have not yet got involved this year – the trade hasn’t yet clicked on for some of the usual guys, but we’re seeing plenty happy to add gradually and try to pick up some delta.”

If the macro picture remains positive, the appeal of equity will only continue to grow over the next few weeks, the trader argues. “Single-Bs, which are essentially glorified junior equity, are getting paid at 875-900 now and a lot of investors are beginning to realise they can just buy equity instead at 9.5-10% with the same risk profile parameters.”

Mark Pelham

ABS

Mind the gap

Innovative ILS structures creating Asian capacity

MS Amlin’s recent Phoenix 1 Re deal marks the tenth catastrophe bond issued in Singapore (SCI 11 January). The transaction is also an example of how innovative ILS structures can help narrow the insurance protection gap in Asia.

Asia leads the world in economic growth but is also the continent that experiences the largest number of natural catastrophe events. The devastating impact of these events is magnified by the relatively low level of insurance penetration in the region.

“Insurance markets in this region are still in their relative infancy or, at least, some way off from achieving their full potential. But to even release a proportion of the potential of these insurance markets, a fundamental change in the approach to risk management needs to happen, involving all parties - from the primary policyholder through to the reinsurance provider,” observes William Ho, ceo of MS Amlin Asia Pacific.

There is currently a meaningful disconnect between perceived reinsurance pricing levels and the confidence in the quantification of the associated risk in many Asia regions, according to Tim Yip, executive director and portfolio manager at ILS Advisers, the ILS business unit of Hong Kong-based asset manager HSZ (Hong Kong). “Reinsurance pricing is perceived as often inadequate for many reasons, and especially to compensate for risks and perils that many funds and alternative capital providers have yet to spend the resource and time required to get to a comfortable level. Further, given the way these are currently distributed, often those reinsurance transactions that are being shown and reach the other side of the world are not the most attractive,” he notes.

He continues: “The region is still growing; additionally, governments are encouraging individuals to self-manage financial risks and household incomes continue to rise. Concentration of exposure is also increasing. Sourcing alternative capital can facilitate the development of better solutions to meet the increasing demand for insured parties across the region and help reduce the protection gap, which continues to grow. We hope that the Phoenix 1 transaction will help to provide the confidence to other cedants that innovative solutions can be created to attract alternative capital providers and, at the same time, give confidence to alternative capital providers that there is value that can be extracted from the region if sourced and originated creatively.”

Ho agrees that initiatives like Phoenix 1 Re help to create further capacity in the region. “Historically, the supply of capacity has not been an issue within the region until now, due to limited demand. But by creating diversification of capacity provision, there can be a greater level of protection against catastrophe risks and a more developed and mature response post-natural catastrophe events, when the chance to show the value of insurance/reinsurance is at its greatest,” he says.

He adds: “There is a great desire and attention to reducing the protection gap in the region, particularly through public-private partnership initiatives such as ours. Phoenix 1 Re will provide us with needed additional capacity to help meet the reinsurance needs of these initiatives as and when they are ready.”

Phoenix 1 Re is noteworthy for being one of the first ILS transactions developed specifically for Asia’s emerging economies. Ho says the aim was to create something structured in Asia, specific for Asia, with partners who truly understand the market and its dynamics.

“We are covering 10 different territories in the region that typically have lower insurance penetration levels than the peak zone markets,” he notes.

MS Amlin worked in conjunction with ILS Advisers, as well as the Monetary Authority of Singapore (MAS) and Lloyd’s Asia to establish Phoenix 1 Re. The cat bond is exposed to Asia-only risk (excluding Australia, New Zealand and Japan) and minimises the potential for what Yip describes as “surprise losses”, such as snowstorms, Tianjin type events and other non-modelled perils that have often remained in the memories of underwriters. The key perils are Beijing, Taipei and Manila earthquakes and typhoons.

“The transaction takes advantage of the fragmentation across the region; in other words, the diversification on offer. It’s difficult to find diversification in the ILS market, as it’s very US-centric,” Yip observes.

He adds: “We wanted to source diversifying exposure from Asia in a way that makes sense from the differing risk appetite and economics that ILS funds have, compared to traditional reinsurers. At the same time, I believe our investors prefer to invest in something that could be front-page news: the risk of surprise losses from the other side of the world are less appealing to them than risk that is closer to home.”

Although there are many large local reinsurance companies in the region, most don’t yet have the internal resources and experience necessary to efficiently utilise alternative capital sources in the same way that many in, for example, North America and Europe have. As such, Yip suggests that through working together with cedants - rather than competing with them – allows them to source and originate higher quality investments that are mutually beneficial to all parties.

From Yip’s perspective, MAS was very supportive during the structuring of the Phoenix 1 vehicle. In particular, the authority’s grant scheme allowed ILS Advisers to allocate funds to the modelling process and independent analysis, which helped investors gain the required comfort level to invest.

As the Asian economies continue to grow, an Asian ILS hub will likely be needed to create a trading environment for capital markets to access the appropriate risk in the region. Phoenix 1 Re is being seen as helping to put the Singapore market in a strong position to be that Asian hub, when the time is right.

Certainly, Yip believes that Singapore has now reached a point where its local service provider community can efficiently support these transactions and continue to develop, as the domicile expands the types of structures and offerings that can be provided to cedants in the future.

Meanwhile, Hong Kong is developing its own ILS regime and is believed to be close to implementing it. Yip indicates that both Hong Kong and Singapore have benefits as cat bond domiciles: while Singapore tends to be focused more on the wider Asia region and maintain its place as a regional reinsurance hub, Hong Kong is likely focused on attracting investment to provide capacity to support the growth and development of the Mainland.

“Hong Kong can provide Mainland insurance and reinsurance companies with a presence close to home, while continuing to act as a gateway for foreign investment into the Mainland,” he concludes.

Corinne Smith

Capital Relief Trades

Positive prospects

Secondary CRT market gains traction

The coronavirus crisis has increased the prospects for a more active secondary market for capital relief trades. Nevertheless, relatively small clip sizes and a dearth of syndicated transactions means that it will be some time before activity matches last year’s all-time record.

According to investor data, approximately US$1bn notional in CRT paper was traded last year as the coronavirus crisis rocked markets. Activity was driven by investors either rebalancing their portfolios or targeting higher yielding bonds to compensate for losses in other deals (SCI 28 April 2020).

According to Steve Gandy, head of private debt mobilisation, notes and structuring at Santander Corporate Investment Banking: “At the beginning of the Covid crisis, investors were looking for buyers and were prepared to sell at a discount, which is why other investors bought additional positions in our deals to take advantage of the dip in price. Covid has shown investors that even in a buy-and-hold market as this one, there is enough liquidity to liquidate positions.”

Similarly, an arranger at another bank notes: “We trade quite regularly throughout the year, but secondary financing has gone up because it creates different pockets of money, offers familiarity and bidding for bonds as well as standardisation. However, trading has been relatively restricted to syndicated deals, due to their track record - although we have seen some small club deals. The transactions also tend to be smaller in size, since they trade at a discount.”

Indeed, the bulk of the trading occurs with syndicated deals; hence, why most of last year’s transactions were 2017, 2018 and 2019 vintage deals, when there was a pick-up in syndicated and overall issuance. Investors may usually approach other investors who initially bought the deals with them, since they know the bonds well. Alternatively, they can target those who may have undertaken the due diligence in primary, but who may not have been allocated any bonds or fewer bonds than desired.

This begs the question as to why a secondary boost did not occur in those years when syndicated activity was on the rise. Gandy explains: “Normally investors hold on to their bonds for a couple of years before deciding to sell, so BWIC volumes won’t arise immediately. Second, investors generally focus on primary issuance where they can invest larger amounts, and they see the secondary market as an opportunistic secondary option. Nevertheless, as more deals and investors come into the SRT market, more secondary deals should be expected.”

However, some market practitioners are more sceptical. One investor comments: “Secondary may have been buoyed recently, but the latest primary activity doesn’t bode well for secondary. Most transactions closed in 2020 were bilateral or small club deals.”

The investor continues: “Very few syndicated transactions have closed recently and I expect the first half of 2021 to be like 2020. The absence of syndicated transactions and a narrowing of the investor base is likely to hamper secondary activity in the near term, as these investors are unlikely to sell their investments.”

As the market returns to a more normal state in late 2021 or 2022, transaction distribution is expected to change and the secondary market should, in turn, experience a boost. “Secondary is useful for the growth of the market, as it gives some investors liquidity and allows them to rotate between asset classes, as is typically the case with multi-strategy funds,” the investor observes.

Another issue is the bespoke nature of the securities. Kaelyn Abrell, partner and portfolio manager at ArrowMark Partners, states: “The secondary market has been a permanent fixture of CRT for several years; however, it has been typically characterised by low volumes, due to limited offers. Periods of broad market stress and idiosyncratic credit events have been the exception. Although the concept of a consistently more active secondary market - similar to more traditional market sectors - would potentially attract a larger and more diverse group of investors to the asset class, the potential is likely limited in the near term, due to the bespoke nature of securities and other factors that limit a more active investment approach.”

 Additionally, given the private nature of CRT transactions and the typical short timeframe associated with secondary market transactions, it can be difficult for investors that do not already own a security to assess fundamentals and appropriately price an opportunity. This situation is further complicated by the fact that most of the deals are owned by long-term investors, so there is normally not a significant need for liquidity for a large portion of the market.

Looking ahead, Abrell concludes: “Barring a significant spike in market volatility, we expect 2021 CRT secondary volumes to decrease from the level of activity that occurred in 2020.”

Stelios Papadopoulos

ABS

ABS at the races

Fundamental and technical factors power US ABS, led by autos

Fuelled by very healthy technicals and fundamentals, the US ABS market has entered 2021 at a gallop, led by the auto loan sector, agree ABS analysts.

Barring an unforeseen and drastic pandemic-related downturn, there is little to derail the market at the moment. Spread levels in many sectors are already at the lowest prints seen for a decade, but the market appears biased towards even narrower spreads.

As an indication of the powerful factors at work, two auto loan deals, one from DriveTime Auto Group and one from American Credit Acceptance, last week each printed at the tightest levels seen for a BBB-rated auto loan deal since the end of the financial crisis, over a decade ago. The $410m ACAR 2021-1, comprising six classes of notes, printed at swaps plus 85bp, as did the DriveTime deal.

In the space of a week, BBB-rated sub-prime auto spreads narrowed from plus 90bp to plus 70bp, the rally reflecting not only these two new issues but also even tighter secondary market prints.

Most deals that have printed since the start of year - including not only prime and sub-prime auto loan securitizations, but also student loan deals, aircraft leases and auto leases - have seen record over-subscriptions.

“Normally, if an ABS deal is described as over-subscribed it means about five times over, but in January we’ve seen deals ten times, 15 times, even 18 times over. These sorts of numbers are generally only seen in the corporate space,” says Amy Sze, md and ABS analyst at JP Morgan in New York.

The reasons for such performances are not difficult to discern. On the one hand, the fundamentals are encouraging and much better than might have been expected a year ago. Consumer credit has held up very well largely thanks to the several layers of stimulus packages introduced by the federal government, but even commercial credit performance gives cause for encouragements as well.

“There are fundamental issues in commercial credit, especially in the travel sector, but we still see demand for product. Several lessors are well-respected and are deemed to be strong. In the credit card space, there are minimal differences between issuers in term of spreads, which is testament to how stable they are seen to be,” says Theresa O’Neill, md and senior ABS strategist at Bank of America in New York.

Three year AAA-rated floating rate credit card deals currently yield around Libor plus 20bp, about 3bp narrower over the week and 10bp narrower in the last ten weeks.  Five year AAA-rated floating paper is around Libor plus 40bp.

But perhaps even more importantl,  the technical are also very strong. Treasury yields have dwindled to virtually zero in the face of a hurricane of issuance, so any product which offers spread is popular and ABS products offer more spread than their competitors. For example, three year BBB-rated FIG corporate paper yields around swaps plus 75bp while three year BBB-rated auto loan ABS yields plus 85bp.

The strength of the eight-month rally is revealed by the fact that three year BBB-rated subprime auto paper touched around swaps plus 550bp in 1Q of 2020 during the height of pandemic panic.

Moreover, while a healthy portion of ABS paper is issued in the one-year to three-year window there is often little comparable corporate paper in these maturity buckets. In addition, ABS deals incorporate structural protection that is attractive to buyers. As deals season, the senior notes pay down and this builds the credit enhancement buffer relative to the subordinated tranches.

“The losses have been mitigated by the pandemic relief so deals are paying off faster than losses are coming in,” says Sze.

The auto loan sector is also particularly well-liked as the borrowers are seen as stable and car sales have been very buoyant. Investors seek short-dated cash flows that appear strong, and paper is still cheap to corporates. It is also the biggest area of the ABS market. Nonetheless, there isn’t much more room for a rally in the most highly rated auto paper.  Two year AAA-rated bonds are trading at swaps plus 8bp in secondary markets.

JP Morgan predicts that 2021 issuance volume will equal that of 2019 - the last full year before Covid 19 hit. This is another indication of how far and fast the market has recovered from the dark days of March 2020.

Of course, not everything in the garden is lovely. Consumer credit is still expected to be moderately weaker in 2021 as unemployment remains at elevated levels.

Moreover, though there have been extensive government and lender-based payment relief programmes which were put in place early in the pandemic, evidence suggests that borrowers that spent some time in forbearance are more likely to default at some stage than those that spent no time in forbearance even if debt payments are current at the moment.

The spectre of Libor replacement also hangs over the market. Even though the day of reckoning is likely to be set back until mid-2023, this is merely a stay of execution rather than a reprieve. All ABS markets will be affected by whatever decisions are made new benchmarks to replace Libor but none more so than the student loan market. Most student deals are long-dated, will be around after 2023 and have no transition language in place.

For example, Federal Family Education Loan Program (FFELP) ABS bonds have not demonstrated the same capacity for recovery as have other sectors of the wider market. Subordinate tranches are 80bp wider year-on-year, 125bp wider than the 24-month lows, and 50bp wider than the post-pandemic 24-month average.   

Simon Boughey

SCI Start the Week - 25 January

A review of securitisation activity over the past seven days

Last week's stories
CMBS sailing
Stormy waters ahead and astern, but the US CMBS market has avoided the iceberg
Eviction limitations extended
New law poses risk for Spanish asset quality
Issuer substitutions
VAT reversal results in redomiciled CLOs
Italian green SRT debuts
GARC programme broadened further
Libor lives on
Likely postponement of USD Libor expiry gives structured finance market breathing space
Litigation on the cards?
SLABS default rates causing concern
Risk transfer return
Commerzbank inks private SME SRT
Italian SRTs finalised
Third-party risk-sharing prospects raised
The EIF has completed two synthetic securitisations with Banca Monte dei Paschi di Siena (BMPS) and Banco BPM (BBPM). The transactions were the last significant risk transfer trades to be carried out with the supranational as the Juncker plan came to end in December 2020. Consequently, this opens the junior tranche segment to private investors and hence the possibility of more risk-sharing transactions (SCI 9 January 2019).

The BMPS trade is a €100m guarantee that references a €1.5bn portfolio, with tranches that amortise over a three-year WAL and a time call that can be triggered after the WAL. According to Nils Boesel, structurer at the EIF: "Our guarantee for MPS is under the SME initiative, so it covers virtually the whole stack - including the mezzanine and junior tranche - while MPS retains the senior. This enables substantial lending to SMEs, since it reduces the margin for SME loans in Italy. However, close to 30% to around 40% of the portfolio is subject to payment holidays and that was something that our SME approach had to adjust for."

Meanwhile, Banco BPM's €76m mezzanine trade references a static €1.8bn Italian SME portfolio that amortises over a two-year portfolio WAL and features a time call that can be exercised after the WAL has run its course. Further features include synthetic excess spread and a 1% retained first loss tranche.

Karen Huertas, structured finance analyst at the EIF, comments: "Unlike the MPS trade, the BBPM transaction doesn't fall under the SME initiative but under the Juncker plan, so it only covers a mezzanine tranche and does feature excess spread in line with most of the more traditional EIF SRTs. According to the terms of the agreement, the bank will have to originate new loans at six times the size of the mezzanine tranche. Most of the additional lending will go to the most Covid-affected Italian regions, such as Lombardy."

The transaction was arranged by UniCredit. Banco BPM has only issued two capital relief trades until now and both have been with the EIF, although it has confirmed that it is open to transactions with private investors.

A bank source notes: "We are open to transactions with private investors, although the extent to which we will tap the market will depend on market conditions. According to our capital management plan, we intend to issue more than one synthetic securitisation over the next three years."

Looking ahead, Giovanni Inglisa, structured finance manager at the EIF, concludes: "The Juncker plan has come to an end in December 2020, so now we aren't in a position to do single-B deals, but only double-B transactions. Nevertheless, this opens the junior segment to private investors. I would expect more risk-sharing deals this year, where we guarantee an upper mezzanine tranche, but a private investor takes on the junior or lower mezzanine piece."

Stelios Papadopoulos

Other deal-related news

• Annualised equity dividend yields across European CLOs averaged 12.9% in 2020, down from 15.1% in 2019 and below the 15% yearly average for the 2014-2020 2.0 era, according to research from Bank of America (SCI 18 January).
• Moody's has upgraded the ratings of two CLNs and three credit protection deed tranches of Santander's UK synthetic auto securitisation Motor Securities 2018-1, reflecting increased levels of credit enhancement for the affected notes (SCI 18 January).
• The EIB Group has guaranteed a mezzanine tranche of a synthetic securitisation issued by Bank für Tirol and Vorarlberg (SCI 20 January).
• Morgan Stanley is in the market with an Irish RMBS that securitises a portfolio of 2,405 owner-occupied and buy-to-let predominantly reperforming loans. Dubbed Shamrock Residential 2021-1, the €425.4m deal features an innovative yield supplement overcollateralisation of 4% that is included to mitigate the low weighted average rate of 1.7% on the loans (SCI 20 January).
• The IHS Markit CMBX.14 index is expected to launch on 25 January, uniquely referencing 25 conduit CMBS issued between September 2019 and December 2020 (SCI 21 January).
• Castlelake has priced Castlelake Aircraft Structured Trust 2021-1, its seventh aircraft ABS and the first such transaction to be completed since the beginning of the Covid-19 pandemic (SCI 21 January).

Company and people moves

• Jennifer Law has joined Aon's Asia Pacific capital advisory unit within its reinsurance solutions business (SCI 18 January).
• Loomis Sayles has promoted Kyra Fecteau to portfolio manager for securitised credit strategies managed by its mortgage and structured finance team, which helps oversee US$30.4bn in securitised investments across both dedicated mandates and as part of broader investment strategies (SCI 18 January).
• Fidelity International has established a new private credit capability with experienced hires from AnaCap-owned MeDirect Bank (SCI 20 January).
• Integral ILS has received a cornerstone investment from New Holland Capital. Integral has now secured US$600m of signed commitments for its new dedicated ILS strategy (SCI 20 January).
• LendingClub has signed a definitive agreement to acquire Radius Bancorp and its wholly owned subsidiary Radius Bank in a cash and stock transaction valued at US$185m (SCI 20 January).
• New York finance partner Bonnie Neuman has been appointed head of Cadwalader's real estate finance practice (SCI 20 January).
• Jan Petersen is set to succeed Michael Curtis as head of corporate credit at MeDirect Bank, based in its London office (SCI 21 January).
• Varagon Capital Partners has named Edward Kung as an md in the business development and investor relations team (SCI 21 January).
• Lionheart Strategic Management has entered into a loan acquisition agreement with Schroder Investment Management North America, targeting US$250m in transitional and distressed real estate credit investments (SCI 21 January).

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

Upcoming events
SCI's 2nd Annual Middle Market CLO Seminar
25 February 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

ABS

NPL pipeline builds

European asset disposals intensify

The European banking system’s disposal of non-performing loans intensified in 4Q20, particularly in December, closing the year at €38bn in NPLs sold. An additional €40bn of NPLs could be sold on the market in 2021, with around €30bn of this amount already announced for imminent disposal, according to the latest Banca Ifis Market Watch NPL report. Transaction volumes involving unlikely-to-pay portfolios are also set to rise, with approximately €24bn in sales anticipated, split equally between this year and next.

The estimates contained in the Banca Ifis report generally indicate a sharp increase in non-performing positions on bank balance sheets and a default rate – in other words, the percentage of performing loans that become non-performing - rising from 2.6% in 2021 to 3% in 2022, primarily due to defaults on loans to businesses. Indeed, around €80bn of new flows are expected in the two-year period 2021-2022. However, the forecasts do not call for a return to the peak of 4.5% seen in 2013.

Last year’s default rate remained unchanged on 2019’s rate (1.1%), due to public interventions, including payment moratoria and legislative decrees. The total volume of NPEs - including non-performing, UTP and past-due positions - is estimated to have reached €340bn in Italy in 2020, but in 2021 it could climb to €389bn and even reach a record high of €441bn in 2022.

The amount of NPLs on the balance sheets of EU banks more broadly is also expected to increase by 40%, after years of decline, to reach €700bn this year. The report states that since 2015 the Italian NPE ratio has fallen faster than the European average, from 17% to 6%. Italian NPLs account for 21% of the European total (based on figures from 30 June 2020), compared to 34% in 2015.

Meanwhile, the report suggests that over €50bn was invested in the NPL market between 2017 to 2020 to purchase approximately €214bn in NPL portfolios. The average sale price of unsecured portfolios remained stable during the period, whereas valuations of mixed, secured and UTP portfolios were influenced by the GACS scheme and jumbo deals.

From its establishment in 2016 to the present, GACS has supported €85bn of NPL disposals across 35 securitisations. Seven servicers are currently engaged in transactions closed at end-2020 and all but two of the GACS portfolios are showing declining portfolios due to the Covid-19 pandemic.

Against this backdrop, the NPL Market Watch report indicates that the secondary NPL market should reach maturity in 2021 and account for 29% of total transactions, compared to the 23% exchanged on the secondary market in 2020. Sale flows are estimated to remain elevated into 2022, due to the Covid-19 crisis, in addition to the need for alignment with European targets of an NPE ratio of 5%.  

Corinne Smith

Structured Finance

Liquidity impact

Post-Brexit divergence highlighted

Liquidity is one area of concern following the UK’s withdrawal from the EU, given that UK securitisations are no longer considered eligible collateral at the ECB. Potential divergence over the revised retention regulatory technical standards is another.

“The ECB will look at EU deals and data templates. UK securitisations are no longer eligible collateral, which may impact liquidity. The biggest challenge is related to liquidity,” says Salim Nathoo, partner at Allen & Overy.

He adds: “If you are a UK originator trying to gain access, it is potentially more difficult and there has been no noise or indication about what they intend to do about that. EU investors do not have the same benefits as UK investors.”

Notably, EU legislation is narrower and it will exclude non-EU investment firms from being originators. “The regime going forward will require looking at who is eligible. ‘Investment firm’ has a broader definition in the UK. Some deals can be purchased by UK investors, while equivalent investors in the EU would be precluded from doing so,” says Nathoo.

Another area of comparison is listing regimes. Nathoo adds: “There are practical operational differences. There are differences in transparency between public and private offerings and the disclosure of information and completion of certain templates.”

He highlights the importance of keeping documents updated to ensure they are addressing the relevant regime. Template language must also be kept up to speed.

The UK will experience a transition period until March 2022. Until then, for the most part, compliance with EU requirements will mean compliance with UK requirements.

Nathoo says: “So, with deal compliance, it could be said there has been a relaxation. There are other considerations, such as the application of the capital requirements regulation and the market abuse regulation. Many of these reasons relate to whether you have a public offering.”

With regards to risk retention, the regime is currently the same between the EU and UK. Any divergence will depend on whether the UK implements the changes that are being proposed in the EU, including in relation to non-performing exposure retention or the revised retention regulatory technical standards.

Jasleen Mann

Capital Relief Trades

Consumer SRT prepped

Santander readies full-stack ABS

Santander is marketing a full-stack capital relief trade backed by a €1.9bn portfolio of Spanish consumer loans. Dubbed Santander Consumo Four, the transaction is significant for its size and can only be matched by a German full stack deal that the lender finalised in October 2020 (see SCI’s capital relief trades database).

Rated by DBRS Morningstar and Moody’s, the securitisation consists of class A, B, C, D, E and F tranches. The amortisation of the notes - excluding the F tranche - takes place on a pro-rata basis.

The transaction benefits from high excess spread, as evidenced by a portfolio weighted average interest rate of approximately 7.2%. Additionally, the eligibility criteria provide for a weighted average minimum portfolio yield of 6.8%, after the addition of receivables during the one-year revolving period.

Loans with Covid-19 payment holidays have been excluded from the initial pool, as per the eligibility criteria. However, the seller will neither replace nor repurchase loans subject to moratoria.

If sufficient, any excess spread - after covering principal and interest for the more senior tranches - will be used to amortise the class F bonds by 10%. This feature is included in many of Santander’s deals and aims to shorten the average life of the tranche, thereby lowering the coupon that investors would otherwise demand for a longer maturity tranche. 

The securitised portfolio is highly granular, with the largest and 10 largest borrowers representing 0.007% and 0.064% of the preliminary pool respectively. The weighted average remaining maturity of the portfolio is approximately 5.3 years and the weighted average seasoning is 1.4 years. The loans were used to finance mainly living expenses (24.2%), home improvements (11.3%) or the purchase of vehicles (10.1%).

Approximately (53.4%) of the loans have no loan purpose information, which is mostly explained by increased pre-approved loan origination volume, where the borrower does not have to indicate the purpose of the loan. Pre-approved loans are mainly extended to existing clients of the bank that have shown a strong credit history.

The transaction is expected to price in the second week of February.

Stelios Papadopoulos

Capital Relief Trades

SME SRT debut

Montepio inks first synthetic securitisation

Montepio Bank and the EIF have finalised a synthetic securitisation that references a revolving €395m Portuguese SME portfolio. The transaction is the Portuguese lender’s first significant risk transfer trade. 

The EIF has guaranteed close to 98.3% of the portfolio, including the senior and mezzanine tranche, bar a 1.7% retained first loss piece. The weighted average life of the portfolio is equal to two years and the tranches amortise on a pro-rata basis. Further features of the deal include a 0.54% ‘use it or lose it’ excess spread mechanism and a one-year replenishment period.

Nils Boesel, structurer at the EIF, comments: “It's the first EIF-EIB Group synthetic securitisation for a standardised bank in Portugal and it uses the typical guarantee structure for standardised banks, whereby we guarantee close to the full capital stack, except a thin retained junior tranche. Overall, it will allow for an additional €750m of SME lending in Portugal."

Daniel Grencho, associate director at Montepio, notes: “We have been originating cash securitisations since 2001 for funding purposes or NPL disposals, but we are a small bank, so we have to manage capital adequately. Yet, in the beginning, we were divided as to whether to raise equity or deleverage. Raising equity was expensive and the issues were small, so there was a liquidity concern.”

He continues: “So we had to deleverage and this is where synthetics offer benefits. Outright sales would not work because we are already cash-rich and any further injections would be inefficient, due to negative interest rates.”

The bank also did not want to reduce the size of its balance sheet and wanted to maintain relationships with its SME clients. “Synthetics enable you to maintain the size of your balance sheet and client relationships, while managing capital,” Grencho says.

Montepio can use the SEC SA formula, which effectively allows standardised banks to assign risk weights to unrated tranches and reduce risk weights for retained tranches. In effect, this means that the EIF does not have to guarantee close to the full capital stack to render a capital relief trade cost-effective from the bank's perspective. Consequently, a question arises as to why the bank chose a full cap stack transaction, as opposed to just a mezzanine guarantee. 

Montepio has confirmed that it can in fact use the SEC-SA, but prudential regulation would potentially be dependent on the CRT tests and a three-month notice period to the regulator. The full cap stack option, on the other hand, allows for more control of the timeframe and simplifies the route to capital relief, since it allows the lender to avoid both the CRT tests and the notice period.

Stelios Papadopoulos

Capital Relief Trades

2021 STACR debut (update)

Freddie Mac prints first CRT trade of 2021 inside guidance

Freddie Mac yesterday priced STACR 2021-DNA1, its first CRT debt markets transaction of 2021, the GSE has informed SCI. The underwriters were Bank of America and Barclays.

The trade consists of four tranches for a final size of $970m. The 208m M-1, rated BBB/BBB+, printed at SOFR plus 65bp, carries a 2% credit enhancement (CE) and a weighted average life (WAL) of 1.71 years.

The $310m M-2, the largest tranche, is priced to yield SOFR plus 180bp, has a 1.25% CE, a 4.28 year WAL and is rated BB/BB+.

Next in line is the $208m B-1 tranche, priced at SOFR plus 265bp, carrying a 0.75% CE, a 7.91 year WAL and is rated B/BB-.

The unrated $244m B-2 tranche yields SOFR plus 475bp, has a 9.99 year WAL and a 0.25% CE.

As with STACR deals seen at the end of last year, these prints were well inside guidance. The price guidance issued for the M-1 tranche was SOFR plus 75bp-80bp, while for the M-2 it was SOFR plus 185bp-195bp, for the B-1 SOFR plus 275bp-285bp and for the B-2  SOFR plus 485bp-500bp.

Each tranche also incorporates a month-long window in which the bond receives a portion of principal based on an assumed speed of 10% conditional prepayment rate (CPR) and no defaults to early redemption date.

According to the Freddie Mac calendar, it will print another DNA STACR in 1Q and also one HQA deal. The HQA series of notes incorporate mortgages with a higher LTV.

Freddie was unavailable for further comment.

Capital Relief Trades

Risk transfer round-up - 28 January

CRT sector developments and deal news

BNP Paribas is believed to be readying a capital relief trade backed by capital call facilities. The transaction is expected to close this quarter and reportedly follows four other such transactions that were finalised last year.

Structured Finance

CLO outlook updated

Sector developments and company hires

CLO outlook updated
Fitch says it expects to change a significant portion of its CLO outlooks to stable from negative, following the revision of its CLO coronavirus stress scenario to assume half of the corporate exposure on negative outlook is downgraded by one notch instead of 100%. Approximately one-third of corporate issuers with loans in CLOs currently have a negative rating outlook. A one-notch downgrade on half of that exposure is equivalent to a 1.5 point increase in the Fitch weighted average rating factor (WARF).

As some transactions have a higher share of issuers on negative outlook and others carry a lower share, the sensitivity analysis will be transaction-specific, thereby considering the actual share on negative outlook for each CLO portfolio. The analysis is based on the current portfolio and focused on a stable interest-rate scenario using all default timing scenarios. Any tranches that show some vulnerability under this scenario will be placed on negative outlook or rating watch negative. Any CLO rating changes will be based on actual rating changes of the underlying corporates as and when these rating downgrades materialise, Fitch states.

For broadly syndicated loan CLOs, all triple-A tranches and the vast majority of other investment grade tranches globally are currently on stable outlook. In contrast, about two-thirds of sub-investment grade tranches are currently on negative outlook, driven by the agency’s previous stress scenario.

Hertz forbearance extended
Hertz auto ABS noteholders and the company have agreed to extend the forbearance arrangement for another nine months through to September 2021. Hertz had complied with the terms laid out in the earlier forbearance agreement, which ended on 15 January, with fleet reduction and depositing the monthly base rental payments totalling US$650m.

Under the new agreement, between now and September, Hertz is required to downsize its fleet by a total of 121,510 vehicles and make the monthly base rental payment of US$84m. In return, ABS noteholders will forgo their rights to seek missed payment and administration claims from June 2020 through September 2021.

Hertz also agreed to provide a general release and will not dispute the concept that the master lease trust is a single indivisible entity, according to JPMorgan ABS strategists.

Manager replacement
Dock Street Capital Management has been appointed as the replacement collateral manager to ABS CDO TABS 2004-1. The deal's previous manager - Ramius Trading Strategies - itself replaced original manager, Tricadia CDO Management, in May 2017. See SCI's CDO Manager Transfer database for more.

Multi-Class model published
Moody's has published a freely available version of its Multi-Class model, which enables users to evaluate a given capital structure for certain ABS and RMBS asset classes. Multi-Class uses portfolio-related assumptions in the form of a portfolio expected loss and a loss equivalent to a Aaa stress to calibrate a lognormal collateral loss distribution. Moody's uses the model to derive the potential losses for the different bonds, taking into consideration the relevant capital structure, and sometimes supplements its modelling with additional analysis of special structural features.

UK auto interest rates eyed
Downward pressure on interest rates in the UK auto market is anticipated, due to increased disclosure requirements and a ban on discretionary commission models that come into effect on 28 January. S&P suggests that the move could compress excess spread and soft credit enhancement across UK auto ABS transactions.

However, underwriting standards should also improve, due to enhanced affordability assessments. “The combination of enhanced affordability assessments and lower interest rates could improve collateral performance, although - from an auto ABS transaction perspective - this is likely to be outweighed by a potentially lower amount of excess spread available to cure defaults, along with the general deterioration in performance we expect as a consequence of the Covid-19 pandemic,” S&P notes.

Structured Finance

Call for aircraft ABS protections

Sector developments and company hires

Call for aircraft ABS protections
Fitch reports that a material number of aircraft failed to be novated to two aircraft ABS - START III and Lunar 2020-1 – last year, following closing. The failure of aircraft to novate in START III resulted in the asset count falling to just two aircraft from 19 initially, while six of 18 initial aircraft did not novate following the closing of Lunar 2020-1. Meanwhile, the structures continued to pay note principal pro-rata and thus the class A notes remained outstanding, alongside the class B and C notes.

As such, Fitch downgraded the START III notes by multiple rating categories and the Lunar notes by one category, due to a significant increase in concentration risk that exacerbated the negative impact of stresses in the aviation sector. At year-end 2020, all other aircraft had transferred into each transaction, so novation risk no longer exists for outstanding Fitch-rated aircraft ABS.

The agency notes that novation risk, although occurring in only a couple of transactions to date, can be addressed in future new issuances if structures employ a priority-of-payment trigger that switches principal payments to sequential if a material number of assets fail to novate into deals, with senior notes paid down fully before subordinate notes receive any principal. Similarly, concentration risk could be mitigated with additional structural protections for senior notes, such as triggers that switch the structure to fully sequential under certain conditions related to pool count and/or concentrations.

In other news…

Auto datasets offered
dv01 has launched auto benchmark datasets, with the aim of providing investors with loan-level performance transparency on auto ABS. The new benchmarks pull Reg AB data from EDGAR to create both a prime dataset - consisting of 133 transactions valued at US$232bn in original balance - and a subprime dataset, consisting of 45 transactions valued at US$62bn in original balance. The data library at launch represents roughly 53% of all auto loan issuance since 2017 and, going forward, dv01 will onboard all new deals to the platform at the point of issuance in real-time.

North America
Golub Capital has made a number of senior-level promotions in its direct lending, structured products and investor partners group teams. Andy Steuerman has been appointed to the new role of vice chair of direct lending. He will continue as a senior member of the firm’s investment committee, oversee its special situations and late stage lending businesses and spearhead new strategic initiatives.

Greg Cashman will succeed Steuerman as head of direct lending. He has been with Golub Capital for over 24 years as an underwriter, originator and member of the investment committee.

Meanwhile, Spyro Alexopoulos, Craig Benton, Alissa Grad, Gregory Robbins, Marc Robinson, Rob Tuchscherer and Jason Van Dussen have been promoted to senior md.

Structured Finance

UK social bond debuts

Sector developments and company hires

UK social bond debuts
Kensington is prepping its inaugural STS and what is believed to be the UK market’s first ESG RMBS. Dubbed Gemgarto 2021-1, the £472m transaction is labelled as a social bond and is backed by a pool of UK specialist prime, performing, first-ranking owner-occupied mortgages.

The loans are made to underserved borrowers with complex incomes and therefore contribute to the UN Sustainable Development Goals of ‘reduced inequality’ and ‘sustainable cities and communities’. The deal is aligned with the ICMA Social Bond Principles of 2020 and adheres to Kensington’s Social Bond Framework, which has received a second-party opinion from ISS ESG.

The transaction also features a four-year revolving period, during which excess available principle over the class A target notional amount can be used to purchase additional eligible mortgages originated by Kensington. A portion of the issuance proceeds will be used to refinance a £141.5m pool previously securitised in Finsbury Square 2018-1.

The lender has mandated Lloyds as arranger and joint lead manager, alongside BNP Paribas and NAB.

In other news…

Leadership transition, governance review underway
Apollo Global Management chair and ceo Leon Black is set to retire as ceo by 31 July and will be succeeded by Marc Rowan as ceo, but continue as Apollo’s chair. In addition, Apollo’s board will be expanded to include four new independent directors, while Apollo co-presidents Scott Kleinman and James Zelter have also been named to the board and will take on increased responsibility for the day-to-day operations of the company.

Concurrently, the board and the executive committee will evaluate new measures to further enhance Apollo’s corporate governance, many of which are expected to be differentiating in the alternative industry. They include moving to a ‘one share, one vote’ structure and empowering the board to oversee all aspects of the company. The board currently delegates much of the responsibility and legal authority for supervising the business to the executive committee.

These announcements follow the completion of an independent review of Black’s previous professional relationship with Jeffrey Epstein. At the company’s October board meeting, Black requested the conflicts committee to retain outside counsel to conduct the review, which was undertaken by Dechert.

Dechert’s review found, among other things, that: Apollo never retained Epstein for any services; Epstein never invested in any Apollo-managed funds; and advice Epstein provided to Black was vetted by professional advisors. Dechert also found no evidence that Black was involved in any way with Epstein’s criminal activities at any time.

Structured Finance

Equity boost for Olympus spin-off

Sector developments and company hires

Equity boost for Olympus spin-off
Singapore-based direct lender Orion Credit Capital Asia has received an equity investment from OMERS, the pension plan for municipal employees in Ontario, Canada. The move follows last month’s spin-off and rebranding of the business by the management team that spearheaded the private credit efforts of Olympus Capital Asia.

Orion Capital Asia manages investment vehicles that provide medium-term secured loans to middle market businesses that are owned by both private equity sponsors and local entrepreneurs. The investments are across diverse industry sectors and, in many cases, involve bespoke financing solutions spanning multiple jurisdictions.

The investment by OMERS will significantly strengthen Orion Capital Asia’s existing platform and accelerate its growth plans.

In other news…

EMEA
Jonathan Graber has joined SC Lowy’s European distressed debt and special situations trading and investing team in London. He was previously a member of Morgan Stanley’s distressed and special situations trading team.

ILS asset manager established
Gildenbrook Group founder and ceo Daniel Brookman has launched Gildenbrook Capital Management (GCM), an independent ILS fund manager. The firm advises US$850m in institutional assets and focuses on the global life and non-life (re)insurance market.

GCM is one of the three pillars that constitute Gildenbrook, namely an alternative asset manager, a reinsurance platform and a financial technology development firm. The firm has operations located in Bermuda, the British Virgin Islands and Singapore.

Brookman was previously partner and head of alternative capital at AXA XL, which he left in October.

North America
Rebecca Levy has joined CIFC Asset Management as an md in the firm’s investor solutions group. In this new role, Levy will create tailored solutions for clients and develop new institutional relationships. She most recently served as a senior portfolio advisor at Aksia.

Credit Suisse Asset Management has named Kevin Lawi md, portfolio manager and head of origination - private credit, based in New York. He was previously senior director - credit investments at PSP Investments and before that was vp - leveraged finance at Goldman Sachs.

Matthew Downs has joined Greystone as md on the CMBS lending team, reporting to md Robert Russell. Downs will originate CMBS, agency and balance sheet loans for clients nationwide. He joins from MonticelloAM, where he was head of CRE originations.

Origination investment inked
LendInvest has secured a £500m investment from JPMorgan in future mortgage originations, following the sale of a £125m mortgage portfolio to the bank in September. The transaction further expands LendInvest’s capacity to lend in the UK buy-to-let market. JPMorgan joins a growing roster of global financial institutions and institutional investors working with LendInvest, including Citi, HSBC and NAB.

Structured Finance

PHEAA investor forum formed

Sector developments and company hires

PHEAA investor forum formed
PHEAA has launched a series of consent solicitations seeking investor approval to amend the terms of indentures related to its outstanding tax-exempt bonds and notes issued by various PHEAA student loan ABS trusts, for which the organisation acts as administrator. The amendments would provide for the flexibility to sell the student loans pledged under certain indentures to the servicer at a higher percentage of the initial pool balance than is currently provided in the indentures and enable the proceeds to be used to retire the related series of bonds.

To facilitate the process, PHEAA has established a confidential online forum powered by DealVector that is designed to facilitate rapid and effective communication with and among investors in securities backed by federally guaranteed student loans. The new forum – which is free for investors - allows PHEAA to prioritise consent solicitations on trusts where investor demand is greatest and participation highest.

In the case of the PHEAA notes, the consent of holders representing at least a majority of the aggregate outstanding note principal balance is required to approve the optional purchase provisions in the indentures. In the case of the PHEAA Student Loan Trusts, the consent of noteholders representing 51% of the aggregate outstanding principal balance of the notes is required to amend such provisions.

In other news…

EMEA
KKR has appointed Michael Small as a partner in its European credit and markets team, with origination, execution and fundraising responsibilities for the private credit business. He will also help grow KKR’s global mezzanine strategy and sit on several of the firm’s credit investment committees.

Small will join KKR in mid-2021 from Park Square Capital, where he was a partner responsible for the sourcing and execution of private credit investments. Before joining Park Square, he served in Dresdner’s principal finance group and at Babcock & Brown.

Infrastructure loan MoU inked
Hong Kong Mortgage Corporation (HKMC) and MUFG Bank have signed a memorandum of understanding regarding an infrastructure loan sales framework, with the aim of facilitating loan sale cooperation between both parties. The MoU sets out the principal terms for potential infrastructure loan sales by MUFG to the HKMC, including the loan selection criteria, mode of sales and engagement process. This represents the first MoU that the HKMC has signed with a commercial bank and furthers the mandate of HKMC’s infrastructure financing and securitisation (IFS) business to fill the infrastructure financing market gap in the region.

Trade finance fund manager charged with fraud
David Hu, managing partner and cio of New York-based investment advisory firm International Investment Group (IIG), has pled guilty before US District Judge Alvin Hellerstein to investment adviser fraud, securities fraud and wire fraud offenses in connection with an over US$100m scheme to defraud IIG’s investment advisory fund clients and investors. From approximately 2007 to 2019, Hu conspired to: overvalue distressed loans held by the IIG funds; falsify paperwork to create a series of fake loans that were classified, fraudulently, as positively performing loans and to otherwise hide losses; sell overvalued and fake loans to a CLO trust and new private funds established and advised by IIG; and use the proceeds from those fraudulent sales to generate liquidity required to pay off earlier investors in a Ponzi-like manner.

The US$220m CLO, dubbed Trade Finance Funding I (SCI 11 February 2014), enabled IIG to hide losses and generate liquidity through the purchase of defaulted loans, distressed loans and fake loans from its portfolio. The CLO also entered into fake loan transactions with Panamanian shell entities.

In connection with his plea agreement, Hu has agreed to forfeit more than US$129m, representing proceeds traceable to the commission of the offenses.