News Analysis
Capital Relief Trades
The Collins catalyst
Dodd-Frank amendment could provide tipping point for US CRTs
The take-off of the US capital relief trades market has been predicted for several years. This CRT Premium Content article explores whether the increasingly onerous impact of the Collins Amendment could provide the tipping point.
This amendment to the 2010 Dodd-Frank Act, named after Senator Susan Collins of Maine, requires US banks that are entitled to use their own internal risk-based (IRB) models to determine risk weighted assets (RWAs) to also calculate RWAs according to the standardised methodology and to then apply whichever of the two is the toughest. Banks would thus be prevented from use of sleight of hand to reduce the value of assets and thus lessen capital requirements, and in a post-financial crisis world this was deemed a primary objective.
The standardised approach to RWA calculation had been initially unveiled as part of the capital adequacy standards of Basel 2, which were quickly superseded by the financial crisis and then Basel 3. According to Basel 3, the advanced or IRB-based approach could only apply to entities that have consolidated assets greater than US$250bn or balance sheet foreign exposures greater than US$10bn.
The Collins Amendment was codified into US financial law in the US acceptance of Basel 3 in 2013, but for a number of years its impact was tangential. The value of RWAs as calculated by IRB models was always higher than under the standardised approach. However, as banks began taking riskier assets off the balance sheet, a shift occurred: the standardised approach began to value RWAs more highly than through IRB models.
In this way, the Collins Amendment - a backstop designed to prevent banks going off-piste - had become a binding constraint. In its investor day of February 2019, JPMorgan addressed the issue head-on: a chart shows that somewhere around the end of 2016, the value of RWAs calculated by the standardised approach became greater than through the advanced approach. By the end of 2018, the gap was over US$100bn.
Indeed, research conducted by Seer Capital suggests that at the top four US commercial banks – Bank of America, Citi, JPMorgan and Wells Fargo – the average differential between the calculation of RWAs according to the standardised methodology and by the advanced approach is now 4%. Clearly, 4% of trillions of dollars is a lot of money, with profound implications for capital requirements.
“In 2015, RWAs as calculated by IRB models, were higher by a total of US$160bn, so there has been a significant shift,” explains Terry Lanson, an md at Seer Capital. By the end of 2019, RWAs calculated under the standardised approach exceeded those calculated under the IRB approach by an aggregate of US$210bn across those four banks.
Consequently, there is added and growing incentive to reduce RWAs through the use of capital relief trades, bringing them more in line with valuation according to the standardised approach. Moreover, as the standardised approach has become the binding constraint, there is added incentive to take higher quality assets off the balance sheet as standardised calculation is something of a blunt instrument and does not differentiate between differing asset qualities.
It is worth noting in this regard that the US application of the standardised approach is also more onerous than the European version. For example, all loans secured by consumer debt - whether they are credit card loans, auto loans or personal finance loans - are given a 100% risk weighting, irrespective of the credit of the borrower. Equally, all first lien residential mortgages receive a 50% weighting irrespective of type, while all corporate loans receive a 100% weighting.
“Basel 3 does allow loans to be treated somewhat differently under the standardised approach, but in the US all corporate loans are 100% risk weighted, notwithstanding the fact that some loans might be highly rated and may have a much different risk profile. The IRB approach assigns some corporate loans risk weighting of 20% or lower if they have low default probability, low loss given default and short tenor,” says Lanson.
So banks are incentivised to construct pools composed of higher quality assets as they receive exactly the same degree of capital relief as if the pools contained lower quality assets, with the added advantage that they are an easier sell to investors at a more aggressive price.
This phenomenon has been demonstrated in the relatively few syndicated transactions seen in the US over the last year or so. JPMorgan issued several trades referencing its corporate loan book, while Goldman Sachs issued its Absolute trade in September last year.
“What we saw in the JPMorgan and Goldman Sachs trades were super high quality loan portfolios, so absolutely not the type of portfolios that European banks would have hedged. There is no benefit to doing lower quality loans as, under the standardised approach, all loans are treated the same,” explains Olivier Renault, global co-head of FIG solutions at Citi in London.
Tranche thickness was another giveaway that these trades seen in the US were designed to reduce RWAs as calculated by the standardised approach. For CRTs to achieve the required reduction of RWAs as calculated by the standardised approach, the simplified supervisory framework approach (SSFA) must be used and this requires thicker tranches.
Hedging IRB assets, however, generally means the use of the supervisory framework approach (SFA), which delivers the same capital relief on thinner tranches. So the JPMorgan deals incorporated tranches in the region of 0%-12% or 0%-13%, whereas in Europe - where IRB modelling is common and there is no Collins floor – tranches are more generally in the region of 0%-7% or 0%-8%.
Lawyers agree that the tide is turning in the US and the increasing disparity between RWAs calculated by IRB models and by the standardised approach is one of the influences bearing down upon issuers and potential issuers. “I’m hearing banks are more interested in this, which suggests they want to reduce capital associated with higher quality assets. If the standardised approach is the binding constraint, then by definition you’re holding too much capital against higher quality assets because the standardised approach does not differentiate based on credit quality of exposures,” says Carol Hitselberger, a partner at Mayer Brown.
There are other reasons for doing CRT trades, aside from regulatory capital relief. Citi is the pioneer of this market and it says that the risk relief is every bit as important as regulatory capital relief.
Citi has a very large emerging markets lending book. Only HSBC rivals it in terms of global footprint. And it has been using CRT since 2007 to reduce counterparty exposure, a significant number of which are not investment grade names.
The bank completes perhaps five or six trades a year, all of which are either bilateral transactions or with a couple of investors. They are not syndicated or broadly distributed and largely occur below the radar screen.
The advantage of this approach is that Citi does not have to divulge details about its lending book, its loan history and how it originates loans, all of which is sensitive information but all of which would have to come to light if it did capital markets trades. Moreover, amending the payment terms or maturity of a transaction is considerably easier if dealing with only one investor.
The bank agrees that the economic capital benefits are as important as the regulatory capital relief benefits. “Citi likes doing these deals for economic capital reasons as well. It’s absolutely essential we can look our regulator in the eye and say, ‘We’re not arbing this. This is real risk transfer; we are doing this to free up capacity to do more lending and an important side benefit is RWA relief’,” says Renault.
While not every US bank possesses the sort of diverse loan book Citi does, the use of CRT mechanisms to reduce economic risk is clearly germane. It provides a template for others to follow.
The fact that the major names in the banking world, like JPMorgan and Goldman Sachs, have initiated CRT transactions in the last year or so is also expected to allay some of the apprehensions and misgiving smaller banks might have felt about taking to the waters. “The Goldman Sachs and JPMorgan deals show the regulatory framework is in place. The regulators gave their stamp of approval and other banks will be looking. The fact that JPMorgan and Goldman are doing it makes a difference,” says Lanson.
Hitselberger agrees that there has been a sea change in the last 12 months. “JPMorgan is doing high-profile deals; other banks are doing bilateral non-capital markets deals. So I think there is more appetite out there.”
She continues: “We’re getting calls about it literally every day. We’ve got investors talking to us as well. Everybody is pitching it to each other.”
Ironically, the disparity between IRB models and the standardised approach shifted once more last year as volatility shot up and banks downgraded a large portion of their loan books as a result of the Covid-19 market dislocation. Citi reports that in 2020 it was constrained by its advanced model for the first time since 2017.
But this is not expected to be a longstanding development; rather a temporary phenomenon as a result of exceptional circumstances. In 2021, the top US banks are expected to be constrained by the Collins floor once more as IRB RWAs plummet.
So, the impetus for the top US banks to make more use of CRT is maintained. Renault points out that the market is already changing.
“Last year, there were 40 transactions in total, and 16% of these were US. Normally it’s about 5%. Seeing the top two or three banks do deals like this might make the next tier much more comfortable,” he says.
The advantages of doing CRT transactions from an RWA perspective and from an economic capital relief perspective now seem unarguable.
Simon Boughey
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News Analysis
CMBS
Manager maintenance
CRE CLO credit quality maintained by manager strategies
CRE CLOs have performed well through the pandemic, maintaining their OC cushions, largely as a result of their managers' actions. Those actions, including reinvestment loan workouts and credit risk exchanges, have been supported by the evolution to stronger structures in the sector since the financial crisis.
Deryk Meherik, svp/manager at Moody’s, says: “I have seen how the product, the asset class, has migrated over time. Since 2008, the transactions have been collateralised primarily by whole loans as opposed to mixed asset types.”
At the same time, deal docs now typically impose limits on the proportion of assets by sector that can be brought into the pool. Deals appear to have performed well as a direct result of those restrictions.
None of the 62 CRE CLOs Moody's rates has tripped an OC trigger since the Covid crisis began despite significant strains on certain assets' credit quality and performance during the pandemic, namely hospitality and discretionary bricks-and-mortar retail properties. In fact, none of the 101 deals the agency has rated since 2014, the first year of material CRE CLO issuance after the financial crisis, has failed an OC test.
Equally, a key driver behind the good credit quality of deals has been property composition. Multifamily comprises the majority of assets and these deals have performed very well. Some CRE CLOs are up to 100% comprised of multifamily loans, a trend that Moody’s expects will continue.
Previously, managers experienced more flexibility when managing deals. However, current criteria are considered to be more objectively based, leaving less space for manager discretion.
Moody’s notes that this method is working well and Meherik says: “Each manager has their own niche, and managers are incentivised to act in alignment with investors’ interests, given the cashflow mechanisms in the transactions and large portion of equity retained by the issuer/manager.”
With that alignment in place, managers were able to successfully utilise the structural mechanisms available to them throughout the pandemic. For example, the ability, unique to CRE CLOs, for managers to fund future funding obligations, which increases deals' exposure to underlying loans' upside as the loan continues to stabilise and build cashflow. However, if performance deteriorates, the deal can withhold future funding reserves as additional credit enhancement.
Loan workouts are also used to help mitigate potential losses. Francis Teo, avp-analyst at Moody’s, says: “Given the structural mechanisms, such workouts typically are undertaken outside the trust. The ongoing contact between managers and borrowers helps maintain the real-time information flow on loan performance.”
He adds: “Loan modifications such as interest rate reduction or holidays, reserves rebalancing and changes to business plans are also possible. Many deals also have a credit risk exchange option, which enables managers to protect the trust from potential impaired assets by swapping out loans.”
Jasleen Mann
News Analysis
CLOs
Short-lived slowdown?
CLO primary volumes temporarily ease but set to return
The CLO primary market is slightly easing up into quarter-end, albeit from hitherto unseen volumes. However, any slowdown is likely to be short-lived as the market’s supply-demand dynamics kick back in in Q2, amid an increased ESG focus.
JPMorgan CLO research reports that to the end of last week, 19 March 2021, 199 US CLOs have priced year-to-date totalling US$90.3bn (70/US$34bn new issue and 129/US$56.3bn refi/reset/re-issue), already surpassing the highest quarterly tally ever. Over the same period, 59 European CLOs have priced totalling €21.3bn (18/€7bn new issue and 41/€14.3bn refi/reset/re-issue).
However, the JPMorgan analysts note: “The torrid pace is slowing by some counts. This is not unreasonable in the backdrop of some investor fatigue, broader volatility and a steepening US yield curve.”
Over the first four sessions of this week, SCI has recorded a slight reduction in volume with a total of 21 prints. They comprised 18 US CLOs (four new issue, 11 refis and three resets) and three European deals (two resets and a refi).
While offering plenty of opportunity, such high issuance volumes also make life difficult for investors. “We track every single live transaction and when you get to these levels it’s tough for us and other investors to stay on top of it,” says Laila Kollmorgen, md and CLO tranche portfolio manager at PineBridge Investments. “We also don’t, of course, have inexhaustible funds, so we have to make choices about which deals we are going to focus on – part of that is manager tiering, part of that is about the structural details of the transaction and then obviously we look at spread.”
She continues: “You also have to consider the market environment. For example, we have to be cognisant that the European market has a much smaller mezzanine buying base than the US and if you have a lot of deals in the market just the technicals alone will mean that spreads are going to be widening out. You find that in the US as well, but it takes a much higher number of deals before you start to see technical widening coming through.”
While investor fatigue is currently in evidence across the board, Kollmorgen believes overall demand is unlikely to fade significantly. “Spreads are now widening back out to where, whatever type of investor you are and wherever you’re based, the yields European and US CLOs offer are very attractive compared to corporates, high yield and so on, while offering floating rates,” she says. “All of which means that we are seeing investors who maybe hadn’t invested in the CLO space for well over a year are revisiting the sector.”
Equally, supply is unlikely to diminish once quarter end is over. “The pattern is going to continue as long as there is a demand, certainly for triple-As, at attractive levels for dealers to place new deals, refinance or reset their transactions,” says Kollmorgen. “Managers also have every incentive in the world to do all those three things if they have the capacity to do so.”
At the same time, ESG is becoming an increasingly prevalent issue in the market. Consequently, Kollmorgen expects ESG language will be brought into increasing numbers of CLO transactions.
“There are two main drivers behind that,” she explains. “First it comes from investors, predominantly European ones initially, but we are also finding that a lot of US asset managers are becoming signatories to the UNPRI. Second, there are also whispers that the Biden administration through the Department of Labor will be taking a look at setting guidelines for US pension funds and how they invest.”
From PineBridge’s perspective, the firm is taking its lead from what regulations allow and has already set up ESG-specific funds, but is looking to do more. “Ultimately, we are looking at how we can apply ESG principles to a wide variety of fixed income asset classes on a consistent basis,” Kollmorgen concludes.
Mark Pelham
News Analysis
ABS
Flexible financing
Alternative auto ABS structures eyed
Due to the digitalisation of the auto finance industry, many buyers of vehicles are able to start and complete their purchases online, which is driving a switch from vehicle ownership to usage. Accelerated by the impact of the coronavirus pandemic, these changes could pave the way for alternative structural features in auto ABS.
New auto finance products have emerged and loan products have evolved in order to support a wider trade cycle management (TCM) approach pursued by captive finance companies. This supports new vehicle sales and shortens the ownership or usage cycle.
The rise in flexible financing products characterised by shorter contract tenors could, in turn, pave the way for alternative structural features in auto ABS. For example, portfolios could become increasingly dynamic, as opposed to static. Consequently, changes in obligor and asset concentrations, as well as volatility in residual value and credit risk exposure are possible.
“Automotive finance products that support vehicle sales are being used in a different way. People pay for the time that they use the vehicle,” notes Alex Garrod, svp, European structured finance at DBRS Morningstar.
He continues: “This is now becoming more prevalent in southern Europe; notably, in Spain and Italy. With these trade cycle products, it is not just about whether the customer can make the instalment; it’s about the risks associated with the settlement of the final balloon payment.”
Lower monthly instalments sacrifice the equity position for the customer at maturity, which could be used to facilitate the customer’s next purchase.
Aside from payment risk, other risks associated with TCM products include direct residual value risk/market risk. The guaranteed future value could be higher than the market value of the car, which could result in losses for dealers or financial captives.
Garrod says: “These products bring different types of risk, but there are lots of short-term benefits for the vehicle manufacturer, as it accelerates the trade cycle. Market risk is different to credit risk and this results in comparatively higher subordination levels.”
Marketplace platforms and new entrants to the space have introduced online showrooms that deliver vehicles directly to customers' homes. However, this introduces operational risk, as the originators’ new business models are fully digitalised. As such, explicit back-up servicing arrangements are expected to become common.
Jasleen Mann
News
ABS
Landmark NPL ABS inked
Banca Ifis completes salary assignment securitisation
Banca Ifis has finalised a securitisation backed by a €1.3bn non-performing loan portfolio in gross book value terms. The transaction is the first Italian NPL ABS to be secured directly by salary and pension assignment loans.
Rated by Moody’s and Scope, the transaction consists of €158.7m A2/A- rated class Ax notes, €206.2m A2/A- rated class Ay notes, €74.4m B2/B+ rated class B notes and €23.6m unrated class J notes. Classes Ax and Ay are paid pari-passu and pro-rata, while classes B and J are sequentially amortising.
The structure features an amortising liquidity reserve with a target amount equal to 4.5% of the outstanding class Ax and Ay balance. Interest rate risk on the class Ax and Ay notes is partially hedged with an interest rate cap.
According to Scope, the deal benefits from an above average share of residential assets, which are more liquid than other types of property. Indeed, 61% of collateral value is associated with residential assets against the peer average of 47%. Additionally, 90% of the property’s valuations have been performed recently or from 2018 onwards.
Furthermore, the salary assignment loans that back the trade typically generate more regular cashflows than those serviced following other recovery strategies. The seizure of borrower incomes or pensions ensures the issuer is paid monthly, although recovery cashflows are generally spread over several years. However, the agency notes that there is a high share of undercollateralised secured exposures with around 77% of secured loans’ GBV having an LTV of more than 100%.
The securitised pool is mostly composed of unsecured loans (69.3%), with the remaining exposures senior (30.3%) or junior secured (0.4%). Loans are granted mainly to individuals (80%) and about 91% of the unsecured portfolio references salary and pension assignment exposures. Secured loans are backed by residential and non-residential properties (60.8% and 39.2% of total first-lien property value respectively) that are concentrated in the south of Italy (68.4%).
Stelios Papadopoulos
News
Structured Finance
Corporate failures
Default study sheds light on governance
Governance failures have been shown to be a contributing factor in a large percentage of corporate defaults, according to a new study. Nevertheless, economic downturns remain the driving factor for most defaults.
According to a new Fitch study, economic downturns are the driving factor for most corporate defaults. However, in the observed period, weaknesses in governance were also a contributory factor in a large percentage (43%) of cases. The reference period includes the financial crisis (GFC) and the California wildfires.
The Fitch study examines the prevalence of governance as a component in the default drivers of non-financial corporates that defaulted between 2006 and today, while having been rated triple-B minus or higher by Fitch within the five years prior to default. Among the issuers meeting these conditions and analysed in the study is Weatherford International, which was referenced in a capital relief trade (24 April 2020).
The rest of the list consists of the Tribune Media Company, Ameren Energy Generating, Controladora Comercial Mexicana, Energy Future Competitive Holdings, YRC Worldwide, Chongqing Energy Investment, The McClatchy Company, Andrade Gutierrez Engenharia, Noble Group, Odebrecht Engenharia e Construcao, Oi, PG&E Corporation, Samarco Mineracao, Usiminas and Tewoo Group.
Governance failures were the primary driver in three defaults and a contributory factor in four. Weak governance contributed to the defaults via efficacy of management controls, accountability, insufficient checks and balances and risk management frameworks.
Most cases explained by weak governance in the study are Brazilian companies (four). The other cases involved a single company in each of the US, Mexico and Singapore.
The concentration in Brazil is largely the result of the period chosen. Consequently, Fitch notes that this does not suggest that governance problems are unique to Brazil, but rather that the governance characteristics often found in emerging markets - such as concentrated ownership, key person risk, aggressive corporate cultures and greater prevalence of corruption - are relevant factors to governance analysis more generally.
Nevertheless, seven of the defaults conformed to the classical pattern of secular industry declines and/or unsustainable capital structures. Management may have failed to take corrective action, but the failures were not materially impacted by failures in governance standards per se. Weatherford was one of the cases that fitted the classical pattern.
Time from the last day of investment grade rating to default varied from less than a week for Controladora Comercial Mexicana, one month for PG&E and to more than four years for Usiminas. Natural disasters resulted in the shortest time to default, whereas those driven by economic conditions tended to take more time.
Stelios Papadopoulos
News
Structured Finance
SCI Start the Week - 22 March
A review of securitisation activity over the past seven days
Last week's stories
Bifurcated bother
Stress for CMBS secured by ground fees, leaseholds
Diversification play
MPL platforms broadening product offerings
Greek synthetic debuts
Piraeus Bank finalises capital relief trade
Legislative hoops
Multiple layers of regulatory assent hinders US CRT development
Performance indicators
Footfall data, CMBS spread correlation highlighted
Record breakers?
Chart-topping CRT issuance volumes anticipated (Premium Content)
Target recalibration
UK SME synthetics to regain traction
Bank boost
US CLO triple-As see strong bank demand, but for how long?
Significant support from US banks has contributed to the 2021 rally at the top of the stack. Inevitably, though, that level of support will be finite.
Notwithstanding the slight wobble seen in the last few sessions, the primary-secondary basis in US triple-A spreads has compressed significantly in recent months and looks likely to continue at similar levels for a while yet. That, in part, is thanks to the broad-based participation of US banks and the all but unprecedented position in which they find themselves.
"We haven't seen an environment like this for the banks for all but five decades," says Charlie Wu, strategist at Morgan Stanley. "Deposit growth in 2020 clocked in at 23% (on an end of period basis), the highest annual growth rate experienced since 1974. And it isn't slowing down."
A recent report from the US CLOs and Large Cap Banks teams at Morgan Stanley Research expects that in 2021 deposit growth will increase 30% faster than in 2020 due to QE and the roll-off of the Treasury General Account, which it estimates will increase bank reserves by US$2trn, 30% above 2020's US$1.5trn. At the same time, consumers, corporates and investors are not spending all of their QE or government-funded stimulus. As a result, savings are high and operating deposits are growing.
According to Morgan Stanley this is critical, as it means banks can take duration and credit risk with operating deposits. Last year, when the pandemic hit, banks weren't sure how quickly these new savings would be spent, so they kept the reinvestment of these deposits short and liquid. But now, as the period of high savings has stretched on, banks could boost their assumptions for how much of this savings is operational and start to take more duration and credit risk.
Consequently, the report adds: "Banks are more flush with deposits than they have been in 50 years, with the loan-to-deposit ratio at 63% for all commercial banks in the US, and even lower at 56% for the largest 25 banks. They are obviously keen to find reinvestments that deliver more than the 10bp generated from overnight reserves at the Fed."
However, the banks' resultant demand for triple-A CLO paper will not be sustained at current levels forever. Morgan Stanley believes that lower CLO demand will be a function of two factors. Either loan growth re-emerges faster than deposit growth, or QE ends, whichever comes first. They expect loan growth to pick up in 2H21, slowing bank demand for securities in the back half of the year. But demand for securities will likely remain higher than normal until QE ends, which economists pencil in for mid-to-late 2022.
The report continues: "The wild card is if loan demand surges above forecast, so watch that space. Typically, we would also highlight rising credit risk as an offset to reinvesting bank liquidity in CLOs, but we are in unprecedented times with US$1.9trn stimulus a credit positive event, reducing risk in many asset classes including CLOs."
In any event, banks reducing demand is unlikely to have as major an impact as their increased uptake has had so far this year. As Wu concludes: "Banks are obviously an important investor in the CLO triple-A space, but they're by no means the only investor. We're not saying they are the only driver of recent spread tightening; they are just part of the puzzle."
Mark Pelham
Other deal-related news
- Defence Bank is prepping its inaugural public Australian prime RMBS, the A$300m DBL Funding Trust No. 1 Salute Series 2021-1 (SCI 15 March).
- Bank of America is in the market with its third European CMBS in the space of a month, following Taurus 2021-1 UK and Taurus 2021-2 SP (SCI 15 March).
- Moroccan fertiliser giant OCP Group has subscribed to the notes issued by the first synthetic securitisation in Morocco (SCI 16 March).
- Kensington Mortgage Company has delinked its Gemgarto 2018-1 RMBS from its tie to three-month sterling Libor by amending the asset, liability and hedge sides of the deal, which matures in September 2065 (SCI 17 March).
- Pagaya has completed the largest-ever consumer loan marketplace ABS - the US$900m Pagaya AI Debt Selection Trust 2021-1 (SCI 17 March).
- Sizable auto production cuts due to semiconductor shortages in the US will provide support for used vehicle values, a credit positive for securitisations and captive auto finance companies, according to Moody's (SCI 18 March).
- The New York Fed's Open Market Trading Desk says it will no longer conduct regular operations to purchase agency CMBS at the conclusion of the current schedule, in light of the sustained smooth functioning of the markets (SCI 18 March).
Company and people moves
- AerCap Holdings has entered into a definitive agreement with General Electric to acquire 100% of GE Capital Aviation Services, both regular aircraft ABS issuers (SCI 15 March).
- SoFi is set to acquire for US$22.3m Golden Finance Bancorp and its wholly owned subsidiary Golden Pacific Bank, a California-based community bank that is regulated by the OCC (SCI 15 March).
- British Business Bank has recruited Jeremy Hermant as a senior manager (SCI 16 March).
- KBRA has appointed Stacie Olivares as its newest independent board director (SCI 16 March).
- Scope Group has acquired Euler Hermes Rating, a unit of Allianz SE's credit insurance arm Euler Hermes (SCI 17 March).
- Freddie Mac has named board member Mark Grier as its interim ceo (SCI 17 March).
- Signal Capital Partners has held a final closing for a new €900m fund targeting European credit and real estate special situations investments, completing the fundraising between August 2019 and February 2021 (SCI 17 March).
- Scott Bommer has joined Blackstone as cio of the new Blackstone Horizon platform, an initiative being launched by Blackstone Alternative Asset Management (SCI 18 March).
- PIMCO has promoted a number of its staff to the position of md, including two professionals with securitisation experience (SCI 18 March).
- Upstart Holdings is set to acquire Prodigy Software, a provider of cloud-based automotive retail software (SCI 19 March).
- Credit Suisse has named Ulrich Körner ceo, asset management and a member of its executive board, effective 1 April (SCI 19 March).
- Zenith Service has appointed Stefano Corbella as head of real estate and UTPs, with responsibility for real estate and unlikely-to-pay stranded credits (SCI 19 March).
Data
Recent research to download
CRT 2021 Outlook - March 2021
Synthetic RMBS - March 2021
CLO Case Study - Spring 2021
Upcoming events
SCI's 5th Annual Risk Transfer & Synthetics Seminar
21-22 April 2021, Virtual Event
SCI's 3rd Annual NPL Securitisation Seminar
26 May 2021, Virtual Event
SCI's 1st Annual CLO Special Opportunities Seminar
29 June 2021, Virtual Event
SCI's 7th Capital Relief Trades Seminar
13 October 2021, In Person Event
News
Capital Relief Trades
Risk transfer round-up - 22 March
CRT sector developments and deal news
NatWest is believed to be readying two more capital relief trades in addition to a UK SME deal that is expected to close this year (SCI 19 March). The first is allegedly backed by corporate loans, while the second references project finance exposures. Both transactions are expected to close in 2Q21.
News
Capital Relief Trades
SRT upsized
Reverse enquiry for agricultural loan trade
Lloyds has upsized all three tranches of its Fontwell Two capital relief trade by a combined total of approximately £28m. The initial notes were successfully placed with institutional investors in December 2020, despite significant headwinds from the Brexit negotiations (SCI 24 December 2020).
The upsize was not embedded in the documentation executed on the closing date, but was instead finalised this quarter, following a reverse inquiry. Lloyds carefully chose the timing of the upsize to coincide with the deal’s first interest payment date and thus achieve ease of execution. The UK lender remains one of the few originators to have boosted the tranche size of their significant risk transfer transactions, along with Bank of Ireland (see SCI’s capital relief trades database).
The Fontwell upsize is not strictly speaking a tap of the transaction, since taps in the traditional sense would be stipulated in the legal documents and would amount to programmatic issuance. Effectively, taps are a mechanism that allow originators to replicate the same terms while issuing more as they add exposures to the portfolio. The Fontwell Two upsize, on the other hand, was rendered possible because there was headroom for additional issuance from the original trade.
One question is whether taps can occur on a more regular basis in the capital relief trades market. Market practitioners believe that this is likely to be more feasible with granular pools, such as SMEs and mortgages and clear loss protection terms. Nevertheless, this remains to be seen because investors have a strong preference for customised pools and this has been particularly the case in the post-Covid era.
Stelios Papadopoulos
News
RMBS
Assessing arrears
Withdrawal of UK support measures eyed
Most UK residential mortgage borrowers who took coronavirus-related payment holidays in 2020 have restarted payments. Indeed, performance data for UK RMBS master trusts shows that prime mortgage arrears did not increase after payment holidays ended in 2H20.
During 4Q20, early-stage mortgage arrears for UK prime RMBS master trusts averaged 0.49%, which is lower than pre-pandemic arrears and unchanged from arrears levels in Q2 and Q3. Meanwhile, in Q2 payment holidays rose to up to 18% of outstanding mortgages and this number fell to 4% in Q3. Moody’s estimates that around 2% of loans subject to payment holidays (accounting for around 0.5% of all mortgages) fell into arrears when payment holidays ended.
"Almost all UK borrowers who took payment holidays on their home loans during the first wave of the coronavirus crisis had resumed payments by the end of 2020," comments Edward Manchester, svp at Moody's. "This is credit positive for UK covered bonds and RMBS because it shows that payment holidays did not conceal a rise in non-performing loans."
There had been a risk that payment holidays would mask the extent of NPLs and that consequent delays in classifying payment holiday loans as NPLs could weaken the effectiveness of structural protections in RMBS. This would, in turn, have impacted asset coverage tests and delinquency triggers. Since most payment holiday borrowers have resumed their payments, these potential problems have not materialised.
Temporary government policy measures, such as furlough payments, have supported borrowers to make mortgage payments during the pandemic. As this support is withdrawn, Moody's expects that arrears will rise.
The extent of the risk depends on how well the UK economy – and particularly the employment market – recovers over the coming months. The average UK unemployment rate for 2021 is expected to increase to 6.4%, up from 4.4% in 2020.
After 31 March 2021, UK mortgage borrowers will no longer be able to apply for coronavirus payment holidays.
Jasleen Mann
Market Moves
Structured Finance
CLO fallback language reviewed
Sector developments and company hires
CLO fallback language reviewed
S&P has reviewed the indentures of the 870 CLOs it rates to assess Libor fallback language governing a transaction's liabilities. The majority (76%) of its rated CLO transactions closed between 2018 and 2020.
ARRC-like fallback language can be found in 26% of the agency’s overall transactions, including 76% of the transactions that closed in 2020. However, approximately 130 US CLOs could theoretically become fixed-rate obligations post-Libor transition – although S&P expects this number to decline significantly in 2021, as large numbers of existing CLOs reset or refinance and update their Libor transition language.
In between, there are CLOs where the manager has the flexibility to select a replacement rate post-transition, with restrictions concerning what the new base rate can be. A handful of other approaches are also in place, including some relatively recent transactions with weaker replacement language. This can occur when a transaction is partially refinanced without amending the Libor fallback language for all Libor-linked liabilities.
EHMU 2007-2 payment error
An error in the Eurohome UK Mortgages 2007-2 cash manager’s quarterly report for the payment date on 15 June 2020 has resulted in an underpayment of £247,482 of principal to the deal’s class A2 notes and an overpayment of the same amount of interest to its residual certificates. As a consequence, there have also been small overpayments of interest to the class A2 noteholders on the two payment dates since 15 June 2020. The issuer has requested that the cash manager instruct the relevant clearing systems to effect recalls to amend the incorrect distribution of principal and interest.
NPL trading platform expands
Credit management services provider doValue has expanded its online non-performing loan trading platform doLook to Greece and Cyprus through an exclusive partnership with Debitos. The platform will be adapted to the needs of the Greek and Cypriot markets to facilitate the sale of NPLs, serviced both by doValue and third parties, by leveraging the technological infrastructure developed by Debitos that is already available in the Greek language. As such, doValue clients and third parties will be able to access more than 1,200 institutional investors from 16 countries already registered on Debitos.
The cooperation between doValue and Debitos started in April 2020, with the launch of doLook in Italy. More than 10,000 loan transactions have been created on doLook, as of end-2020. doValue has €37bn of AuM in servicing assets in Greece and Cyprus.
Market Moves
Structured Finance
Red Cross in humanitarian cat bond first
Sector developments and company hires
Red Cross in humanitarian cat bond first
The first-ever humanitarian catastrophe bond covering pure volcanic eruption risk has been completed using a Guernsey ILS structure. Sponsored by the Danish Red Cross, the US$3m issuance was privately placed by Replexus and Howden Capital Markets via Dunant Re IC, an incorporated cell of Replexus ICC (Guernsey), which is managed in Guernsey by Aon Insurance Managers. The bonds were settled using Replexus’ blockchain-based ILS platform, dubbed the ILSBlockchain.
The cat bond covers the risk of eruption of 10 volcanoes across three continents and the proceeds will be used to support humanitarian aid in the aftermath of an eruption. Initial investors in the issuance included Plenum Investments, Schroder Investment Management and Solidum Partners.
In other news…
EMEA
Tikehau Capital has appointed Simon Males to lead its UK institutional business, based in London. Males will work closely with Carmen Alonso, head of UK, and Frederic Giovansili, deputy ceo of Tikehau Investment Management and global head of sales, marketing and business development. He is tasked with strengthening the firm’s relationships with UK institutional investors, as well as the consultant and fiduciary management community. Most recently, Males founded Carrick Roads Capital, an institutional consulting and capital-raising firm.
Global receivables programme inked
Finacity Corporation has provided origination, analytic and structuring support for a US$2.09bn global securitisation programme for one of the world’s leading container shipping and logistics group. The programme is based on the integration and expansion of the group’s existing receivables funding facilities. Backed by both billed and unbilled receivables, the multi-bank securitisation incorporates 61 agencies, over 180 collections offices, 30 currencies, four enterprise resource planning systems and 68 obligor countries and selling jurisdictions. Finacity serves as the ongoing administrator and back-up servicer for the programme.
North America
Annaly Capital Management has elected Eric Reeves, md, head of private capital investments of Duchossois Capital Management and general counsel & secretary and chief administrative officer of The Duchossois Group (TDG), as an independent member of its board. He has been appointed to the board’s nominating/corporate governance and corporate responsibility committees. Reeves has worked at TDG since 2007 and was formerly a law partner of McDermott, Will & Emery and a corporate attorney at Jones Day.
Market Moves
Structured Finance
Securitisation tax consultation underway
Sector developments and company hires
Securitisation tax consultation underway
The UK HMRC has launched a consultation seeking views on the taxation of securitisation companies. The UK government says it has identified - through ongoing dialogue with the industry - areas where it may be beneficial to make changes to such tax regulations and is therefore keen to explore the associated benefits and potential difficulties.
Specifically, the consultation is in connection with clarifying and/or reforming certain aspects of: the taxation of securitisation companies, as set out in the Taxation of Securitisation Companies Regulations (Statutory Instrument 2006/3296); and the stamp duty loan capital exemption (section 79 Finance Act 1986) as it applies to securitisations and ILS. The four areas of interest are: circumstances where an originator acquires more than 50% of the securities from the note-issuing company, possibly on a short-term basis (in other words, retained securitisations); what types of assets can be securitised; the operation of the note issuance threshold for the note-issuing company; and the application of stamp duty exemptions for loan capital to securitisation arrangements and to ILS arrangements.
The government says it would like to explore these issues to ensure that the UK’s tax code “keeps pace with the evolving nature of the capital markets” and contributes to maintaining the UK’s position as a leading financial services centre. In considering any changes, the government notes that it will continue to ensure that the relevant parts of the tax code are well targeted and minimise the risk of exploitation for tax avoidance.
The consultation will last until 3 June 2021 and the government expects to publish a summary of responses in the summer, which will include information on any next steps. It is envisaged that meetings with organisations with specialist interests will be held both during the consultation and after all responses have been evaluated.
In other news…
Loan forgiveness ‘positive’ for FFELP maturity risk
Student loan forgiveness would have a positive effect on FFELP student loan ABS trusts exposed to maturity risk, if it were passed into law and FFELP loans were ultimately included, Fitch says. Student loan forgiveness of any amount would generate a one-time prepayment that could reshape maturity risk for the most vulnerable trusts, as high levels of cashflow would - in most cases - pay down the senior-most bonds with the closest maturity dates.
President Biden last month indicated support for US$10,000 in student loan forgiveness (SCI 18 February). Other key provisions of any forgiveness programme remain undecided and will influence to what extent FFELP ABS are affected.
Fitch estimates that US$10,000 forgiveness could result in an average maximum prepayment of 57% of portfolio balance, but the impact will vary considerably based on average borrower indebtedness (ABI) and how many loans a borrower has across multiple trusts. Approximately 92% of Fitch-rated pools have an ABI over US$10,000, with an average ABI of US$20,601 for all transactions. While most trusts would remain outstanding with a US$10,000 prepayment, the reduction in pool levels could be significant.
If FFELP loans are excluded from loan forgiveness, the rating agency expects them to be increasingly consolidated into the federal direct loan (DL) programme, resulting in increased prepayments to FFELP trusts.
Market Moves
Structured Finance
CLO pricing service selected
Sector developments and company hires
CLO pricing service selected
SCI Valuations has been selected by Bloomberg’s Enterprise Data business to provide daily CLO debt pricing to integrate with Bloomberg’s Liquidity Assessment (LQA) tool. The integration of this data with LQA will enable Bloomberg customers to more effectively and easily view and manage their portfolios, the companies say.
SCI Valuations provides automated valuations for US and European CLO debt, as well as bespoke pricing for CLO equity and European ABS/MBS. It employs sophisticated proprietary algorithms that take into account refi/reset effects, manager performance, bond margin and many other relevant performance metrics to generate price, DMs and WALs.
SCI Valuations also monitors the BWIC and new issue market daily and calibrates inputs accordingly, as well as deploying a multi-factor deep-dive algorithm that takes into context credit and liquidity/MV factors, along with the idiosyncratic nature of CLO debt securities.
In other news…
EMEA
Blackstar Capital has appointed Khalid Javaid as head of legal, responsible for providing structuring, legal and execution advice in relation to transactions and new business. He will also provide legal oversight of regulatory matters and government affairs. Javaid joins from DLA Piper, where he was a legal director.
North America
Angelo Gordon has appointed Nicholas Smith as md to lead the firm’s whole loan business and expand the team’s capability across multiple asset classes. Rodney Hutter has also been hired as md, responsible for private credit origination.
The pair will be based in New York and report to TJ Durkin, Angelo Gordon’s co-head of structured credit. Smith was previously head of non-agency residential mortgage trading and ABS trading at Bank of America, while Hutter was previously md and head of originations in the structured lending group at Waterfall Asset Management.
RFC on trade receivables update
S&P is requesting comments on proposed updated methodologies and assumptions to rate ABS backed by trade receivables. The proposed criteria apply globally to all new and outstanding trade receivable, factoring and supply chain financing transactions. The criteria also apply to trade receivable transactions used as collateral in partially supported ABCP conduits.
Among the changes that S&P is proposing are: a new approach for addressing elevated levels of country risk in trade receivable transactions; a change to its approach for analysing the yield reserve element of the carrying cost reserve; and a new approach that explains under what circumstances the agency may be able to rate single or concentrated obligor trade receivable pools. The proposed criteria, if adopted, are expected to have no impact on any outstanding structured finance ratings for term trade receivables or on S&P’s liquidity enhanced credit analysis for trade receivable pools in partially supported ABCP conduits.
Comments on the proposed criteria should be submitted by 26 April.
Market Moves
Structured Finance
STS amendments passed
Sector developments and company hires
STS amendments passed
The European Parliament has passed amendments to the existing STS Regulation and concomitant changes to the CRR, including allowing certain synthetic on-balance sheet securitisations to achieve STS status. PCS notes that to qualify for this status though, a synthetic securitisation will need to meet 145-160 criteria, depending on the type of transaction. The new rules also amend certain provisions around non-performing loan securitisations, correcting some unintended consequences in the original legislation.
These two legislative acts now need to be approved by the Member States and published in the Official Journal. While laws usually come into force 21 days following publication in the OJ, the Parliament accelerated this process by requiring only three days to pass after publication. This implies that these reforms may come into force before the end of April.
In other news…
Call for sustainability KPIs
ESG key performance indicators (KPIs) for the securitisation industry are achievable and necessary, according to members of ICMA’s Asset Management and Investors Council (AMIC). These metrics should be accessible, of sufficient quality and applicable to different jurisdictions.
As such, AMIC members are encouraging regulators to prioritise five objectives: disclosure of material and standardised ESG data for collateral asset pools; reporting of material ESG risks at least annually; support market participants to introduce ESG metrics; introduce specific ‘green’ securitisation metrics and standards; and collaboration between the structured finance industry and regulators in terms of collating and approving data transfers and embedding further market changes.
The EBA - in coordination with ESMA and EIOPA – has been tasked with creating a report on sustainable disclosure requirements for securitised assets by 1 November 2021, which should be followed by a legal proposal by the European Commission. AMIC members note that while KPIs are not a silver bullet, they are essential, since they can provide standardised raw information for further analysis by asset managers to improve comparability of performance.
“Adopting KPIs for each sub-asset class can also facilitate the reporting process and transparency on material sustainability issues to underlying investors. The characteristics of the asset class should reflect the choice of KPIs. The EU Taxonomy and SFDR reporting guidelines might not always be the most appropriate set of sustainability metrics,” the members observe.
CRE acquisition
Slate Asset Management is set to acquire Annaly Capital Management’s commercial real estate business – comprising a portfolio of performing real estate loans, debt securities and real estate equity positions - for US$2.33bn. As part of the transaction, Slate will add a US$400m portfolio of grocery-anchored real estate assets located in major US markets to Slate Grocery REIT, its pure-play grocery anchored business. Subject to customary closing conditions, the transaction is expected to complete by mid-2021.
Declining values hit aircraft collections
Aircraft ABS rent collections are down by 40%-60% in March 2021 compared with January 2020, driven by ongoing airline credit deterioration and declining asset values, according to Fitch. The agency notes that lessors trying to mitigate softening in collections have offered payment solutions to lessees, including power-by-hour schedules and lease deferrals - typically three to six months of reduced rent, followed by a six- to 12-month repayment period.
Nevertheless, weakened collections have resulted in almost all ABS note principal payments falling behind schedule - although transactions continue to pay timely senior interest payments. Several transactions drew on liquidity facilities last year, but these amounts have been repaid as of end-4Q20.
Further, almost all transactions tripped their DSCR triggers last year, resulting in early rapid amortisation events. Pre-pandemic DSCR levels were well above typical trigger levels of 1.1x-1.15x. But as of March 2021, DSCRs remained low, with most in the range of 0.40x-1x.
Currently, 70% of Fitch-rated transactions are below 1.15x, compared with only 5% pre-pandemic. Some DSCRs have spiked, driven by large end-of-lease payments, contributing to a short-term uptick in recent net collections.
MBS climate risk analytics offered
Climate risk analytics provider risQ and geospatial data provider Level 11 Analytics have launched a new climate and ESG analytics capability focused on MBS, including residential and commercial, as well as agency and non-agency securities. A common data platform of climate risk, socioeconomic and demographic data, and localised real estate performance is now being applied to municipal bonds and securitised mortgages at the CUSIP level, all linked to the underlying assets in any given security. The launch of the subscription-based MBS offering expands on an ongoing collaboration with Delta Terra Capital, which initially engaged with risQ to focus on climate risk to RMBS.
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