Contents

ABS

Geographical divergence

CSEE moratoria more likely to underperform

EU banks set aside large provisions in 2020 in anticipation of Covid-induced higher default rates, but most loans that benefited from payment holidays in the region resumed regular payment schedules during 2020 with less than expected difficulty. However, the credit performance of loans exiting moratoria weakened in the last quarter of the year, indicating that loans under long-running moratoria are more likely to underperform. The latter is particularly true in Cyprus, Portugal, Italy and Hungary, where a large share of loans will exit moratoria in 2021.

Close to €900bn of loans benefited from payment holidays following the coronavirus outbreak last year. At the end of 2020, loans still benefiting from these temporary payment suspensions in the EU declined to €318bn from €587bn in September 2020, according to EBA data.

However, Moody’s analysis notes that the reduction was not distributed evenly across banking systems. In fact, several countries in Southern, Central and Eastern Europe placed a stronger emphasis on payment moratoria as a crisis mitigation tool. In other European countries, solvency and liquidity support measures offered households and corporates ample alternatives to absorb the economic shocks of the crisis.

The split remained evident in 4Q20 and shifted the distribution of remaining moratoria towards banks domiciled in Cyprus, Hungary, Portugal and Italy. From this group, Cyprus had the highest volume of loans subject to moratoria as a percentage of total loans (50%). Given that the EBA has limited the maximum time for further moratoria extensions, most remaining moratoria will expire in the first half of this year.

The performance of loans exiting moratoria has been solid, with only 3.9% classified as problem loans (Stage Three under IFRS 9) as of year-end 2020 and 20.1% classed as Stage Two loans. Nevertheless, the reported performance of post-moratorium loans was weaker at the end of December last year than at the end of September. Only 2.6% of former moratoria loans were classified as problem loans at the end of September and 17.2% were classified as Stage Two.

‘’We believe this slight weakening is attributable to a mix of subsequent deterioration in the credit quality of loans that had initially resumed payments during Q3 and the exit from moratoria of less resilient borrowers that had remained under moratoria support for longer,’’ says Moody’s.

On balance, the rating agency expects problem loans to increase in most EU countries as support measures are reduced. Moody’s explains: ‘’We believe remaining loans benefiting from moratoria will be the main pockets of potential credit deterioration because they are likely to be of weaker credit quality than those that resumed repayments earlier. In addition, the presence of loans classified as Stage Two under IFRS 9 accounting rules increased last year, rising to 26.4% of total loans in December from 16.7% in June, according to EBA data.’’

Another reason that problem loans are likely to rise is that, as pointed out on several occasions by supervisory authorities, practices among banks as to early recognition of loan credit quality deterioration differ considerably. This could mean that loans that are seemingly performing well may start to turn sour when support measures recede.

Looking forward, Moody’s states: ‘’By the end of June 2021, we expect a large part of remaining moratoria to have expired, which will improve visibility as to the credit quality of borrowers who have not yet resumed regular debt service as a result of long moratoria. The possible future classifications of such loans include a resumption of payments, which would in most cases mean such exposures maintain their current Stage One and Two classifications, a modification of terms that could be classified as an individual forbearance case or a significant debt relief or failure to pay, which would trigger a default.’’

The agency concludes: ‘’Updated bank and EBA reports with end of June data will likely deliver further evidence as to the post-moratorium performance of loans coming off-moratoria, in particular the ones in Greece and Cyprus that expired in 4Q20. It will then also become clearer to which extent reserves banks had set aside for performing loans will require further additions due to the performance of weaker loan segments.’’

Stelios Papadopoulos

ABS

Bad weather bonds

Utilities to make use of ABS to rebuild after extreme weather

This year has already seen two utility recovery charge (URC) ABS transactions in the US and, say analysts, more will be priced as extreme weather becomes more common – which some climate modellers predict.

“We’ve seen two so far this year and there is rumbling of more to come due to legislation already in place, as well as possible future legislation being put in place. The general market expectation is that there will be more. In recent years we’ve seen maybe one or two a year at most,” says Inga Smolyar, senior credit officer at Moody’s in New York.

Earlier this month, California utlity PG&E received permission from the Public Utilities Commission of California to issue a $7.5bn recovery bond to finance costs and expenditures related to the devastating 2017 wildfires. When priced, this will be the largest public utilitty securitization ever seen.

At the end of April, Wisconsin Electric Power (WEPCO) raised $118m in environmental trust bonds to recover costs associated with the retiring of a coal-fired energy plant.

In all these deals, special dispensation was required from the state legislatures but the latter seem more willing to alllow utlities to seek restitution of costs through the ABS markets. In February, for example, the Texas authorities granted permission to utilities to seek recovery of costs incurred in system restoration after such events as hurricanes and violent storms.

The receivables in a URC ABS are derived from additional one-item fees levied on customers, based on their utility usage. The scheduled payments in the bond are based upon the projected additional fees, which are generally highly predictable.

Moody’s affiliate Four Tweny Seven, a Callifornia-based cllimate risk data firm, says that in the next one to two decades the risk of water stress, hurricanes, excessive rainfall and extreme heat will worsen in certain regions of the US.

The damage that utilities incur and the loss of revenue as a result of such incidences of extreme weather can leave utilities dangerosuly exposed. Indeed, PG&E accepted culpability for its role in the 2017 wildfires which left it facing billions of dollars in legal claims. Utilities also need to rebuild infrastructure after violent weather conditions.

Not only do extreme weather events leave utilities needing to issue more debt to cope with increased costs and expenses, such events can also interrupt the payment flows into existing ABS deals. The weather need not be apocalyptic to interrupt payments; warmer than usual winters or cooler than normal summers can result in reduced elecric usage

Moreover, certain states have imposed moratoriums that prevent the disconnection of customers from the power grid in cases of severe weather, and this can lead to a significant proportion of fee-payers failing to make payments.

However, these developments do not pose a significant risk of delinquency to UCR bonds, says Moody’s. Transactions incorporate legislatively mandated true-up mechanisms, which are periodically adjusted to ensure that the ABS deal makes scheduled payments even when revenue derived from fees falls short of expected levels.

In addition, deals have reserve accounts, generally equal to 0.05% of the initial note balance or equivalent to one semi-annual bond payment.

It would also be highly unusual for electric usage to completely shut down for a long period over the entire area to which the utility supplies power. The only incident in recent times when this did occur was Hurricane Sandy, which devastated large areas of New York in 2012, but even then no interest payments in affected utility ABS deals were missed.

“We are not aware of legislation authorizing UCR bonds being revoked in the past, and at the end of the day we don’t see a credit impact to the bonds from extreme weather either, given the true-up adjustment mechanisms,” says Smolyar.

Simon Boughey

Capital Relief Trades

Lone Star rising

A soup to nuts profile of TCBI's inaugural CRT

It took Texas Capital Bank nine months to finalise its landmark capital relief trade, becoming the first US regional bank to tap the risk transfer market (SCI passim). This CRT Premium Content article tracks the deal’s progress from inception to launch.

When Texas Capital Bank began to contemplate issuing a capital relief trade in late spring of 2020, it was not the first time that the Dallas-based lender had looked at a stratagem designed to improve its balance sheet. It explored whether to bring a securitisation in 2016, for example, and a year later examined the possibility of a risk-sharing partnership with other banks. But neither of these achieved the goals of keeping the revenue on the balance sheet while at the same time securing the accounting treatment required for effective capital relief.

However, the CRT mechanism was the game-changer. TCBI was researching different options in April-May 2020 when Citi, a veteran of the market as issuer and underwriter, presented its version of the trade.  This clarified the route for TCBI: after being pitched the notion, the bank spent the next two quarters researching CRT from all possible angles and came to the conclusion that it would hit the bullseye.

“We had been pitched a number of options over time and with each one there was always some technical piece that was an insurmountable obstacle: whether the regulators deemed it acceptable, whether it achieved the accounting policy requirements, whether it was a true transfer of risk – each one of them never quite made it,” says Madison Simm, evp, business optimisation at TCBI.

The search had been both prolonged and patient as TCBI has more reason than most lenders to seek capital relief. Some 40% of its assets are denominated in warehouse loans to around 200 non-bank mortgage originators, making it the biggest warehouse lender among US regional banks.

It extends credit to cover between 95% and 99% of unpaid mortgage principal balance to the client to finance origination, prior to securitisation. This type of lending was particularly harshly treated by the new US bank capital rules that were unveiled by the OCC, the FDIC and the Federal Reserve in July 2014.

Incorporating the precepts of the Basel 3 framework, the new guidelines applied a revised version of the standardised approach for regulatory bank capital. As the regulators noted in their introduction to the 2014 rule, published in the Federal Register on 30 July  2014: “Among other changes, the 2013 capital rule amended the methodologies for calculating risk-weighted assets under the advanced approaches, as well as the standardised approach for regulatory capital in subpart D (standardised approach) of the 2013 capital rule, which is generally consistent with the methodologies for calculating risk-weighted asset established by the Basel Committee on Banking Supervision (BCBS) through its international framework.”

What this meant for TCBI was that warehouse loans were treated as consumer lending and received the full 100% risk weighting. If it had been offering mortgages as a principal, then these assets would have received only a 50% risk weighting, but warehouse lending was viewed as a commercial line of credit.

This is despite the fact that the loans are on TCBI’s books for only around 30 days before the mortgages are securitised and are also 100% QM and GSE-eligible. In fact, TCBI has never had a loss in this form of lending.

“We were very confident that the risk weighting applied to this asset was dislocated from the actual risk, but the regulators viewed it as appropriate, as it is seen as a commercial line of credit. So our next thought was ‘Can we develop a pathway to transfer a portion of that risk to the investor?’” explains Simm.

For six years the quest for that pathway was frustrated, but in mid-2020 light dawned at the end of the tunnel when Citi made its overtures. But much work remained to be completed. Having been shown the blueprint, Simm and his team commenced a four-month deep research project.

The bank contracted the services of KPMG to conduct much of the vital policy and regulatory research and, at the end of that period of four months, a 50-page white paper had been produced. “From June 2020 onwards, we spent every waking moment with our research partners KPMG going through every capital regulation book, every precedent, every other type of deal with a fine tooth comb,” says Simm. They also examined in detail the ill-fated JPMorgan trade from late 2018, which was pulled after the regulators gave it the thumbs down.

Armed with his voluminous white paper, Simm then began a tour of the C-level suite and the board to convince senior management that a CRT deal was not only practicable, but would also substantially improve the bank’s capital status. Approval to go ahead was granted and work on the actual transaction began in the middle of October, some five months before the deal priced. Citi was an integral part of this process and, according to sources, it also introduced TCBI to Clifford Chance - a law firm with extensive expertise in the CRT market, for legal and documentation work.

Citi has had more experience of the CRT market than any other US bank. It has been using the mechanism as a tool to improve its own balance sheet since 2007.

“All our decisions were based on our experience executing transactions for our own balance sheet,” says Mark Kruzel, global spread products, FIG solutions at Citi.

A key part of the structure developed was that it would be a CLN. A common or garden securitisation wouldn’t fit the bill, as the assets are taken off the balance sheet.

But a CLN means that the warehousing programme remains on the balance sheet. The investor takes the first loss and receives in return a preferred yield - in this case, Libor plus 450bp. But in spite of this generous coupon, the transaction remains earnings neutral, as the extra capital capacity created allows TCBI to take on more business and replenish the revenue.

"The CLN structure also creates fewer regulatory headaches, because there is no swap and therefore no swap regulatory issues,” comments David Felsenthal, a partner with expertise in structured finance, at Clifford Chance in New York.

Clearly, the next four months or so until launch were dominated by discussions with the regulators. Unless the regulators could be convinced that actual transfer or risk would be accomplished, they would not give the deal the green light. And while US regulators have become more au fait with the capital relief trade mechanism over the last year or two, they are not as comfortable with it as European regulators.

Moreover, this was the first deal by a US regional bank and the first US CRT deal to reference a pool of warehouse loans. Their assent was by no means certain.

TCBI also had to deal with three different regulators - the OCC, the FDIC and the Fed - which made the whole experience more cumbersome and protracted than is customary in Europe.  The ground had been well-prepared by TCBI, as it has spent years fostering a good and amicable relationship with the OCC, the FDIC and to a lesser extent the Fed.

The bank never takes a step without fully informing the chief regulators of its intentions and strategy, and this stood it in good stead. As Simm notes, TCBI is not a global bank which has used this type of financial technology in the past.

Nonetheless, starting in October 2020, an exhausting three-month discussion and negotiation period was required. The bank made an initial presentation to the OCC and the FDIC, and then the regulators called it back in for more detailed explanations and Q&A sessions.

“[The regulators] were constructive. They are very aware that this technology is out there; they are aware that other regional banks are researching this. But it is still new to them so they had a series of technical experts on regulatory rules, the securitisation markets, etc and these experts are brought to these calls to ask probative questions and we were happy to answer those questions,” says Simm.

Unsurprisingly, the nitty gritty of regulatory capital rules and how the proposed transaction would qualify the underlying assets for more lenient risk weighting under standardised rules were fully investigated. But, crucially, the regulators wanted to be sure that this was not a one-off deal but part of an ongoing strategy. They did not want to see TCBI complete a single trade and then face a capital cliff when the deal matures.

Once they became satisfied on this point, the tone of the conversation changed and the regulators became collaborative and constructive. Simm pays tribute to the role played by KPMG during this gruelling process: “We wouldn’t have wanted to go through this alone. Having KPMG in our corner to help with the research and preparation was hugely beneficial.”

As Kruzel says, this type of detailed planning is essential in the US as there is no prescriptive guidance from regulators. Each would-be issuer needs to build its own internal standards and make sure that the infrastructure is in place before proceeding any further.

TCBI had to demonstrate to regulators that it has the infrastructure to deal with the day-to-day itemisation of warehouse loans and the seamless creation of a pool of loans for the CRT market. The bank has US$10bn of residential loans on its balance sheet, and the average loan size is US$250,000. It adds about 10,000 new loans every month, and it has a bespoke in-house system to manage the pool of debt.

But it has specific CRT technology which not only creates a reference pool of loans, but can also be halted if there is a credit event on any of the loans. Each loan has to meet specific criteria before it can be included in a CRT pool, and a system attests on a daily basis that the reference pool meets all the specified obligations.

The regulators needed to see and understand every aspect of this process. They also needed to be shown TCBI’s investor reporting procedures, which was an onerous undertaking as TCBI has no regular capital markets presence.

“It was a major ordeal. We had to stand-up a process to facilitate investor reporting requirements. We have four or five of fractional resources across our team that are taking a piece of the operational requirements. The regulators wanted to see and feel each piece of [the operational preparedness] to become comfortable with the CRT,” says Simm.

The regulatory green light was flashed in January, and TCBI could then begin the process of bringing the deal to market. It was not out of the woods yet though.

Warehouse loans are very high quality, and thus it was going to be challenging to find buyers for this type of asset. As Kruzel notes: “It’s difficult to create an investor base for middle mezzanine exposure.”

The first loss tranche attaches at 0% and detaches at 12.5%. This is much thicker than is common in European deals.

The coupon of Libor plus 450bp - though generous, compared to many investment opportunities in the US debt market at the moment - is much thinner than is the case in Europe. Tranches of 0%-6% paying 11% or 12% are usual in European markets.

In the end, TCBI’s debut CRT was sold to two investors in March, both of whom are said to be well-known names in the space. The three-year CLN paid Libor plus 450bp on a US$2.2bn portfolio of mortgage warehouse loans, with a first loss position of US$275m, or 12.5%.

This first loss tranche was risk weighted at zero, while the remaining US$1.925bn of loans carries a risk weighting of 20%. Thus, the risk weighting on the entire pool of US$2.2bn drops from 100% to 17.5%, reducing RWA by US$1.815bn.

According to analysis carried out by Keefe, Bruyette & Woods, this drastic reduction of risk weighting will have boosted TCBI’s Tier One capital ratio by 73bp from 10.92% to 11.66%, while total risk-based capital ratio will have increased by 85bp from 12.76% to 13.61%. This significant creation of excess capital could be used to increase the size of the mortgage warehouse by up to US$500m, according to the research.

It has been a long and arduous road for TCBI, but the rewards are clear. The bank also executed a US$300m perpetual preferred offering in the same quarter it issued the debut CRT. But in terms of creation of capital relief, the CRT was the more effective trade.

Other US banks, particularly those with large warehouse lending books, are thought to be looking at the structure. Regionals thought likely to follow the example set by TCBI include First Horizon (headquartered in Memphis, Tennessee), Flagstar Bank (based in Michigan), Independent Bank Corporation (based in Texas) and Veritex Community Bank (headquartered in Dallas, Texas). None of these banks have commented on whether they are likely to dip their toes into the waters of CRT.

According to data from Inside Mortgage Finance and quoted by S&P Market Intelligence, the most active warehouse lenders in 4Q20 were JPMorgan, Flagstar, TIAA Bank of Jacksonville, Florida, Merchants Bank of Indiana and Wells Fargo.

“CRT should be thought of as a capital tool. If you’re looking for balance sheet optimisation, the precedent has been set,” Kruzel concludes.

Simon Boughey

CLOs

Demand drivers

Fundamentals and technicals support US CLOs for now

On the back of the exceptionally heavy supply in Q1, US CLO spreads softened, but had reversed back to one-year tights at the end of last week. The move was driven by continuing voracious investor demand, unlikely to be diminished even by expected record primary issuance, unless macro events intervene.

“Most people still see CLOs as pretty good relative value,” says John Kerschner, head of US securitised products at Janus Henderson Investors. “For example, at the top of the stack, they’re by far the cheapest asset out there – mortgages are at or very near all-time tights, CMBS triple-As are in the 50s-60s or thereabouts, RMBS in the 65-70 range and autos have single-digit spreads.”

Further, he points to Bank of America’s research ranking of spread products taking into account volatility. The resultant list of risk-adjusted spreads is currently topped by leveraged loans and the next six places are all taken up by CLOs.

“That shows where the cheapness is and that, combined with CLOs being floating rate products, is ensuring demand continues,” Kerschner adds. “Consensus is that the Fed will keep rates steady for now, but investors still have rate and inflationary concerns and CLOs provide a way to insure against that changing.”

He continues: “One thing we are keeping an eye on, particularly at the triple-A level, is bank investment, which we think is going to increase. Banks took a break last year because of Covid and were maybe more biased towards buying assets like mortgages and Treasuries, but all our sources tell us banks are coming back with big demand.”

That is not to say that Kerschner only focuses on the top of the stack; he looks at all parts of the capital structure above single-B to find value. For example, he says: “Double-Bs still look somewhat cheap to us in the mid-600s, maybe even the lower 600s for very top tier managers. But it’s also an asset class with a decent amount of spread vol, so investors need to be cognisant of that. For our part, we’ve made 1%-2% type allocations to our funds that can take that kind of risk.”

One level up the stack, the argument is currently less obvious, but it is still there, Kerschner says. “Triple-Bs in the low 300s don’t scream cheap. But if you are looking for investment grade assets, I can’t think of anything off the top my head that even comes close to a 300 zip code, unless you want to take a bunch of liquidity risk.”

Overall, Kerschner suggests it will take external events to dilute CLO demand. “The only potential area of concern would be if we suddenly go into a pocket of risk-off activity on the back of something like higher-than-expected economic numbers causing a sustained broad market decline. I wouldn’t say risk assets are priced for perfection, as many do, but they are priced for a very rosy market scenario. So, a risk-off environment - no matter what the relative value play is - won’t be all that kind to CLOs.”

Meanwhile, Janus Henderson’s triple-A CLO ETF, JAAA, has now passed the six-month milestone since launch (SCI 21 October). “JAAA is going well for similar reasons as the CLO market itself – retail investors are equally concerned about rising rates and see in the ETF a good complement to cash investments, in terms of safety and yield,” reports Kerschner. “Demand has been strong out of the gate, liquidity is improving and trading volumes continue to go up.”

He concludes: “Given it’s only six months old, we’re pleasantly surprised with the take-up on the product and really believe that will increase as we get more of track record. One investor on a call yesterday commented that the NAV graph looks like a dead person’s ECG! That pattern is exactly what we want in our short-term products – the NAV isn’t changing, but we continue to clip the dividend every month.”

Mark Pelham

Structured Finance

SCI Start the Week - 10 May

A review of securitisation activity over the past seven days

Last week's stories
Niche exposure
CFE Finance answers SCI's questions
NPL rebound?
Secured loan sales set for 2022 return
Tight pricing
Standard Chartered prints CRT
Alternative support
Infrastructure ABS boosts Italian direct lending
Further details have emerged regarding the debut syndication of an Italian infrastructure loan via a securitisation vehicle (SCI 4 May). The transaction was undertaken with aim of enabling alternative lenders to access the Italian credit market.

"The objective of the deal was to syndicate both drawn and undrawn loan commitments to non-banking institutions that were not licensed to make direct lending in Italy. To this end, the securitisation tool effectively allows alternative lenders to access the Italian credit market," explains Pietro Bellone, counsel at Allen & Overy Italy.

Société Générale is the original lender and arranger of the transaction, which securitises a portion of a loan granted to a telecommunication company by a pool of banks comprising Société Générale and other financial institutions. Allen & Overy advised Société Générale on the deal, but the other parties involved could not be disclosed, due to confidentially issues.

The transaction involves both the acquisition of receivables arising from drawdowns already made and the direct lending by the securitisation vehicle of further funds, pursuant to article 1, paragraph 1-ter of Law 130/99. "This is the first time that non-banking institutions which are not licensed to make direct lending in Italy provide financing through a securitisation vehicle for infrastructure. This is particularly important, considering the need for alternative sources of funding to support infrastructure," says Bellone.

He adds that the transaction has been structured in such a way as to get investors comfortable that they have the same economic and administrative rights and protections as if they were direct lenders. In particular, the deal - which comprises a single tranche of notes - required a lot of engineering to ensure that the bonds work effectively as a loan for the investors.

Bellone suggests that the originator is likely to bring further deals such as this to the market in the future. "There is a lot of pressure from banks in Italy to deleverage loan exposures, thus releasing resources for new financing. At the same time, we see an increasing appetite from alternative lenders to partner with banks in strategic sectors."

He concludes: "Infrastructure is a key priority in Italy and, with no doubt, this unprecedented deal will pave the way for others."

Angela Sharda

Other deal-related news

• The Hong Kong Insurance Authority has released details of the two-year Pilot Insurance-linked Securities Grant Scheme promulgated in the jurisdiction's 2021-2022 Budget (SCI 4 May).
• Mount Street has replaced CBRE as special servicer in relation to the Maroon loan, securitised in the Elizabeth Finance 2018 CMBS, pursuant to a special servicer replacement deed instigated by the controlling class D noteholders (SCI 4 May).
• Fitch will begin distributing ESG-enhanced operational questionnaires as part of its US RMBS reviews from this month (SCI 4 May).
• As US CLO primary volumes continue to fall, JPMorgan CLO research has taken stock of the market's current standing (SCI 5 May).
• Approximately 13% of US CMBS assets are located in New York City and about 80% of these properties are - in the absence of owner remediation - on track to incur Local Law 97 (LL97) fines that would impair property cashflows, according to Moody's (SCI 5 May).
• The EBA has published a discussion paper to facilitate a review of the standardised non-performing loan data templates (SCI 5 May).
• Scope Ratings has upgraded to single-A from single-A minus the two tranches issued under the SME Initiative Uncapped Guarantee Instruments for Romania deal (SCI 6 May).
• Trinity Industries has priced its inaugural green railcar ABS, following the publication of its green financing framework in January (SCI 7 May).
• Fitch's US CMBS delinquency rate rose 2bp to 4.12% in April from 4.10% in March 2021, marking the first increase after five consecutive months of decline (SCI 7 May).
• The UK FCA has launched a consultation on proposals for a new category of fund designed to invest efficiently in long-term, illiquid assets (SCI 7 May).

Company and people moves

• Investec has appointed Megan Sachs as assistant portfolio manager for its Private Debt Fund I, with responsibility for co-ordination and management of the fund, alongside her existing role in the firm's growth and leveraged finance team (SCI 4 May).
• Ruhi Patil has been promoted to managing associate in Linklaters' London derivatives and structured products department (SCI 4 May).
• Jefferies Credit Partners (JCP) has expanded its capital formation capabilities and its investor relations team with the addition of two senior hires (SCI 4 May).
• Redding Ridge Asset Management has recruited Patrick McCarthy as a principal, based in New York (SCI 4 May).
• Confluence and JPMorgan have partnered together to deliver a multi-asset portfolio analytics solution to fund managers and service providers (SCI 5 May).
• Gateley Legal has named Christopher Lister partner in its banking and finance team, based in Manchester (SCI 6 May).
• Akin Gump has appointed Deborah Festa as a partner in its corporate practice, resident in Los Angeles (SCI 6 May).
• Ommeed Sathe has joined Lafayette Square as head of strategy, responsible for leading various thematic impact-driven investment strategies (SCI 6 May).

Data

Recent research to download
The Collins Amendment - March 2021
CRT 2021 Outlook - March 2021
Synthetic RMBS - March 2021
CLO Case Study - Spring 2021

Upcoming events
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

Structured Finance

Virtuous circle?

Bullish sentiment underpins securitisation opportunity

A strong rebound in global growth appears to be underpinning the opportunity in securitised credit, notwithstanding the ongoing impact of the coronavirus pandemic. As economic activity picks up and more collateral is available to be securitised, further supply should hit the market and generate increased interest from investors.

Sentiment in the securitisation market remains bullish, according to Mark Hale, ceo and cio at Prytania Asset Management. “Optimism is strong and people are looking ahead to improved fundamentals and strong technicals in the year ahead,” he says.

The sharp increase in saving rates since Covid-19 struck and pent-up demand is expected to drive a rise in consumption across the personal sector and appetite in the housing market. At the same time, a number of corporates have high liquidity and improving cashflows, which should support investment and inventory replenishment.

Hale observes that confidence in the markets around the post-coronavirus recovery has built progressively as vaccinations programmes have spread. “This might be more advanced in some jurisdictions than others, but market participants have been increasingly willing to look beyond any bad news that can emerge during these still testing times to a bullish scenario of renewed prosperity.”

He emphasises the effect of ongoing constrained supply in both primary and secondary markets - especially when the buoyant CLO sector is excluded from the statistics - that reinforces the impetus towards tighter spreads arising from increased demand for ABS. “I would hope that there would be more issuance – leading to more interest in the market from investors – as economic activity picks up and more collateral is available to be securitised. Tighter spreads should also enhance the appeal of ABS as a funding mechanism, even if most banks enjoy both plentiful supplies of cash on balance sheets and the ongoing effect of quantitative easing.”

Finally, asset allocation into securitised credit - particularly given the sectors which are floating rate - also appears appealing in Hale’s view, given the twin effects of higher asset values and upward pressure on interest rates as the recovery builds momentum.

Angela Sharda

Capital Relief Trades

Mortgage-backed SRT priced

Credit Suisse executes Elvetia refinancing

Credit Suisse has priced a mortgage-backed SRT dubbed J-Elvetia Series 2021-1. The capital relief trade is a refinancing of a 2018 deal, but - unlike the previous one - the new transaction has been sliced into a mezzanine and a junior tranche (SCI 13 April).

The original trade, named Elvetia Finance Series 2018-2, was a Sfr300m CLN that referenced a Sfr5bn Swiss mortgage portfolio. The new structure splits the tranche into a Sfr100m mezzanine and a Sfr200m junior piece. Pricing for the unfunded mezzanine tranche is not officially known, but it has been confirmed that the junior piece priced at Libor plus 800bp.

Credit Suisse once again tapped insurer investors for the mezzanine tranche after it distributed the first such ticket to them back in 2019 with Elvetia Eleven. Insurers typically require lower pricing, since they can offer protection on an unfunded basis.

The transaction follows a significant risk transfer trade that closed last month, which referenced sub-investment grade corporate loans. The lender intends to issue a similar transaction in 3Q21 (SCI 14 April). 

Stelios Papadopoulos

Capital Relief Trades

Risk transfer round-up - 11 May

CRT sector developments and deal news

Bank of Montreal has called Muskoka Series 2020-1. The US$132m financial guarantee was executed in April 2020, becoming the first post-Covid capital relief trade (SCI 15 May 2020). The lender exercised another call option on 9 February for Muskoka Series 2017-2 (SCI 9 February).   

CLOs

Biden bonanza

Vast infrastructure package to energise project finance CLOs

The project finance CLO market, somnolent for a decade, will receive a shot in the arm from the Biden administration’s ambitious infrastructure spending programme, say market-watchers.

Around $600bn of the planned $2trn package is earmarked for improvement of transport networks, and another $200bn or more will go on housing. The details of how and in what form this money will be distributed are not clear yet, but it seems clear that a lot will end up in the secondary capital markets to disperse risk.

“The amount of overall funding and the number of projects we’re talking about is huge, and it won’t be sustained by traditional lenders. There will be significant volumes in the secondary capital markets, maybe huge volumes,” says a lawyer who specialises in structured finance.

Traditional and new infrastructure lenders will be supported by government intervention in the form of grants, guarantees and capital either as debt or equity, it is speculated. The original CARES Act, for example, involved substantial support for the aviation industry in grants and loans and this coud be a template for the imminent infrastructure package.

But this capital won’t work its way into the project finance CLO sector until perhaps 2023, say analysts. No bill has been passed yet and there are no details about the type of funding provided. Moreover, any subsequent CLO trades will need to be rated by the agencies, and this will not be a speedy business. Every individual loan needs to be examined.

“There will be a lot of discussion at ratings agencies about concentration and about loan sizes. The bigger the loans the more difficult they are to put into CLOs as they don’t give you the diversity agencies want to see,” says an analyst.

Nonetheless, when the deals hit the market there should be no problems with digestion. Investor appetite, stimulated by several rounds of giveaways from the government and a still accommodative Federal Reserve, cannot be sated at the moment.

CLOs should be priced at Reg S 114a deals, but yields should be punchy enough to attract a range of institutional buyers.

This projected boom time for project finance CLOs comes at the end of a very thin decade. It has been too difficult to package project finance loans into ABS deals, given the often lumpy and assymetric nature of the assets.

However, three project finance CLOs have priced so far this year. These are Sequoia Infrastructure Funding I (priced on 22 February), STWD 2021-SIF1 (23 February) and RIN IV (19 March).

Within two years, this trickle of business could be dwarfed by a waterfall of new project finance CLO activity derived from President Biden’s largesse.

“The secondary markets will lag, but they could take off in a crazy way in 2023,” says the lawyer.

Simon Boughey

Hertz reorganisation proposals weighed

Sector developments and company hires

Hertz reorganisation proposals weighed
Hertz has determined that a revised proposal to provide equity capital to fund its exit from Chapter 11 - made by affiliates of Knighthead Capital Management, Certares Opportunities and Apollo Capital Management - constitutes a superior proposal than the one contemplated by its agreement with its existing plan sponsors, affiliates of Centerbridge Capital Partners, Warburg Pincus and Dundon Capital Partners. The revised proposal includes an amended plan that would result in payment in full for all secured and unsecured debt, as well as provide 50c per share in cash to holders of common stock, warrants and in specific cases rights offerings.

Hertz says it will comply with the procedures established by the bankruptcy court's 28 April order that: establishes a bidding and auction procedures relating to the submission of alternative plan proposals; sets a hearing for the approval of the successful bidder and the authorisation of supplemental solicitation materials; and grants related relief governing Hertz's evaluation of the alternatives. If the current plan sponsors intend to make a counteroffer to the proposal by the KHC group, then Hertz will proceed to an auction in accordance with the process established by the bankruptcy court. 

In other news…

CLO facility agreed
Mount Logan Capital subsidiary Great Lakes Senior MLC I has entered into a facility and security agreement with a large US-domiciled financial institution, as administrative agent. Pursuant to the agreement, the agent shall arrange for lenders to advance to the MLC subsidiary on a revolving basis up to US$60m, the proceeds of which - drawn over time - will be used to fund the purchase of loans.

The facility matures on 7 February 2022, subject to earlier repayment at the option of MLC. It is intended to be temporary in nature and MLC expects to terminate it this summer, following the contribution of the acquired loans and pre-existing loans currently held by MLC to a newly formed SPV structured to refinance one of the CLOs managed by Mount Logan Management, in consideration for cash that shall be used to repay the facility.

EMEA
Blazehill Capital has hired Jake Hyman as business development director, signalling its commitment to sourcing and executing complex credit opportunities in the UK mid-market. Hyman will lead the origination efforts for Blazehill Capital in London and the South. He started his career at EY, before working for Wells Fargo, where he spent four years developing a range of mid-market lending opportunities.

UK SME funding partnership formed
SME Capital, SCIO Capital and Prytania Asset Management have formed a funding partnership to help support UK SMEs take the next step in their evolution, whether that is growth, acquisition or succession. The aim is to offer timely and affordable long-term debt solutions to UK businesses via a rigorous investment process. The SME Capital platform provides innovative and flexible products, supported by a strong origination process and team.

Structured Finance

STS BTL RMBS prepped

Sector developments and company hires

STS BTL RMBS prepped
Domivest is in the market with the first-ever STS buy-to-let RMBS. Dubbed Domi 2021-1, the €352.2m transaction is backed by a €370.7m provisional pool of Dutch BTL mortgage loans, including €30.61m in prefunding.

Interest-only loans comprise 93.5% of the pool, according to Moody’s. Loans with initial LTVs above 70% amortise linearly to either the 70% LTV (representing 88.3% of the pool) or 60% LTV mark (11.7%).

Rabobank credit analysts suggest that the STS label is typically not sought for BTL RMBS because BTL loans are not eligible collateral under the LCR rules. However, they note that benefits of the label can be gained when additional requirements are met, which allow for preferential capital treatment of the notes for banks and insurers under CRR and Solvency 2. PCS has verified that Domi 2021-1 complies with its CRR assessment.

The full capital stack is being offered, ranging from €313m in triple-A paper down to unrated class X1 and X2 notes. Barclays, BNP Paribas and Macquarie are joint arrangers and lead managers on the deal.

In other news…

Agribusiness JV established
Brazilian alternative investment firm Vinci Partners Investments has established a joint venture with agribusiness investment firm Chrimata involving a new strategy, which will be co-managed by Vinci Partners’ real estate and credit teams (securitisation is one of the latter’s core strategies). The partnership already has a pipeline of 12 potential investments in the sector, representing over R$1bn in total transaction volume, and will provide competitive custom-made financial solutions for the agribusiness industry.

Lower mid-market fund formed
Family Legacy Capital Management has formed FLC Credit Partners, a private credit fund manager providing financing solutions to capital-constrained, lower middle market companies in North America. Headquartered in New York, the investment team is led by partners and mds Peter Eschmann, Matthew Hart and Jay Rogers, who have collectively completed over 250 transactions and deployed more than US$15bn of capital in their previous roles. The group targets US$10m-US$100m transactions to fund refinancings, LBOs, add-on acquisitions, recapitalisations, growth/working capital, rescue capital, DIP loans and exit finance.

Eschmann brings over 25 years of private credit experience, including 16 years at Cerberus Capital Management and earlier at Deutsche Bank, Chase Manhattan and Bankers Trust. Hart has over 20 years of private credit and restructuring experience, including as head of private and transitional finance at Jefferies and earlier at Lazard, Merrill Lynch, Intrepid Financial Partners and Eos Partners. Rogers has over 20 years of private credit experience, including seven years at Cerberus Capital Management and as chief credit officer at Catalyst Capital.

Also joining the team as vp is Brian Mullin, who has over 10 years of experience in capital raising and investor relations for investment funds, including at Neuberger Berman and Campbell & Company.

North America
Frost Brown Todd (FBT) has promoted three CMBS attorneys in its Louisville office. FBT has named Devon Callaghan, Colin Stouffer and Doug Walter members of the firm.

True lender repeal censured
In a letter to US Senate Majority Leader Chuck Schumer and Minority Leader Mitch McConnell, the Structured Finance Association has expressed its opposition to Senate Joint Resolution 15, which would invalidate the true lender rule issued by the OCC last year (SCI passim). The association argues that Congress’ use of the Congressional Review Act (CRA) to nullify the rule will lead to “costly uncertainty” regarding the foundational aspects of the legal and regulatory framework financial services providers need to provide consumers and small businesses access to affordable credit.

“It is critical that the OCC provide clarity and transparency through rulemaking for loans originated by national banks. If the OCC’s authority on true lender is removed, appropriate safeguards within the true lender rule to prevent predatory practices will also be put at risk, as will the overall safety and soundness of the banking system,” the SFA notes.

Structured Finance

Iberian RMBS investment disclosed

Sector developments and company hires

Iberian RMBS investment disclosed
The EIB has disclosed that it invested €50m in UCI’s latest RMBS, Prado VIII, aimed at promoting the renovation of existing residential buildings in Spain and Portugal, as well as the purchase of new near zero energy housing. The project is expected to contribute to climate change mitigation, delivering energy savings of almost 57GWh a year and cutting CO₂ emissions by 10,269 tonnes a year (equivalent to the annual energy use of 14,000 households). In addition, the projects financed by UCI with EIB support are expected to create around 940 jobs per year during the construction period.

This operation is the second partnership in 12 months between the EIB and UCI. The previous operation, worth €100m, was in connection with the Portguese Green Belém 1 RMBS from May 2020.

These green investments are part of UCI’s sustainable financing strategy for individuals and condominiums.

In other news…

Capital adequacy consultation underway
The Australian Prudential Regulation Authority has launched a consultation on proposed measures to enhance the capital adequacy of authorised deposit-taking institutions (ADIs). The consultation package includes a response paper and a revised draft standard, entitled ‘Prudential Standard APS 111 Capital Adequacy: Measurement of Capital’ (APS 111).

The revised draft standard is designed to: reinforce financial system resilience, with changes to the capital required to be held by ADIs for their banking and insurance subsidiaries; promote simple and transparent capital issuance, through the removal of complex issuance structures such as SPVs; and clarify various aspects of the standard, with additional technical information and updated guidance from the Basel Committee. APRA notes that the revised capital treatment of ADIs’ equity investments in their subsidiaries is the most material change to APS 111.

The revised draft standard also contains further minor revisions for consultation, including measures to clarify that CET1 capital is not permitted to have any unusual features that could undermine its role as the highest quality loss absorbing capital. 

The consultation period closes on 10 June. APRA expects to finalise changes to APS 111 in 2H21, with the revised standard coming into force from 1 January 2022. 

North America
Bain Capital Ventures has named Noah Breslow operator in residence, based in New York. He was previously chairman and ceo of OnDeck, and led the strategic process of the firm’s acquisition by Enova International (SCI 30 July 2020). Breslow was OnDeck’s first employee, joining the online lender in 2007 as svp, products and technology.

Income Research + Management has strengthened its client service team with two new recruits. Ken Johnson has been appointed svp and senior client portfolio manager, while Philip Machoka has been appointed vp and client portfolio manager.

Johnson has 20 years of experience in client relations at Loomis, Sayles and Company, where he was most recently vp, fixed income product manager. Earlier in his career, he was vp of business development at PNC Bank affiliate Investment Counselors Incorporated.

Machoka was previously md of investor relations at Garda Capital Partners, responsible for capital raising and business development from a global client base of institutional investors. Before that, he was an associate of business development and relationship management for BlackRock Investment Management’s Middle East and Africa institutional client business, based in London.

IR+M’s client service team is managed by Molly Manning, director of client service.

US CLO sensitivity scenario revised
Fitch says it will no longer include a near-term stress sensitivity scenario that notches down half of ratings with negative rating outlooks with a floor of triple-C minus in its analysis of US CLO notes. The application of the CLOs and corporate CDOs rating criteria adequately addresses default expectations, according to the rating agency.

Driving this change is the Fitch US corporate ratings team’s downgrading of fewer issuers with negative outlooks and recently lowering the 2021 default forecast for US leveraged loan defaults. However, the agency will continue to use the negative outlook notching sensitivity scenario - where half of ratings with negative outlooks are lowered one notch with a floor of triple-C minus - to inform rating outlooks for European CLO notes, considering the still-fragile macroeconomic backdrop and varying pace of vaccine rollout in the region. Any CLO note rating changes will be based on actual rating changes of the underlying issuers, as and when rating downgrades materialise.

Structured Finance

Asset managers partner on pensions initiative

Sector developments and company hires

Asset managers partner on pensions initiative
DWS has launched the DWS Secured Income Fund, aimed at small to medium-sized defined benefit pension plans seeking stable, long-term returns. The fund provides a diversified portfolio of secured income assets, including ABS and CLO bonds.

Over half of UK defined benefit pension plans are in deficit, with insufficient assets to meet their liabilities. For small and mid-sized defined benefit pension funds that may have been restricted from investing in individual asset classes, due to minimum size or governance requirements, this fund offers the opportunity to invest in a pooled fund of secured income assets.

The fund is a partnership with Tikehau Capital, as part of a strategic alliance with DWS in connection with growth initiatives.

EMEA
Alok Kumar has rejoined Channel Capital Advisors as head of portfolio analysis in the trade finance team, responsible for leading the sourcing, analysing and negotiating of transactions. Kumar was previously chief risk officer at fintech start-up Finverity, having joined Channel for the first time as risk management officer in December 2016. Before that, he worked at Kotak Mahindra Bank, Union Bank of India, HSBC and HDFC Bank.

Gallagher beefs up in ILS
Arthur J Gallagher & Co is set to acquire certain Willis Towers Watson reinsurance, specialty and retail brokerage operations as part of a proposed regulatory remedy for the pending Aon and Willis Towers Watson combination. The operations - which include certain Willis Re treaty and facultative reinsurance brokerage units, as well as certain UK specialty, European and North American brokerage operations – generated US$1.3bn of estimated pro forma revenue and US$357m of estimated pro forma EBITDAC for the year ended 31 December 2020.

Under the agreement, Gallagher will acquire the combined operations for a gross consideration of US$3.57bn. The acquisition is expected to enhance the firm’s ILS and analytics capabilities, including catastrophe modelling, dynamic financial analysis, rating agency analysis and capital modelling.

The transaction is expected to close during 2H21, with the integration of over 6,000 new colleagues likely to take approximately three years.

Irish mortgage agreement inked
M&G has launched long-dated fixed rate mortgages in Ireland with its origination partner Finance Ireland. The move will provide homeowners with access to a range of mortgages of up to 20 years, a first for the Irish market.

M&G has been Finance Ireland’s long-standing residential funding mortgage partner since 2018. The agreement has been made by the specialty finance team within M&G’s £67bn private and alternative assets division.

Due to regulatory changes resulting in banks managing capital and balance sheets more efficiently, asset managers have been stepping up to provide long-term capital to the consumer lending market on behalf of institutional investors seeking long-term income and diversification with a premium to the public markets.

North America
Adams Street Partners has recruited Leland Richards as a partner on the private credit team. He is responsible for supporting all aspects of the team’s decision-making processes, including sourcing and structuring investment opportunities, as well as helping shape the strategic direction of the business. Richards most recently served as md in Churchill Asset Management’s sponsor coverage group, having previously worked at GE Capital and JPMorgan.

Structured Finance

ESG incorporation challenges highlighted

Sector developments and company hires

ESG incorporation challenges highlighted
The Principles for Responsible Investment (PRI) has published a report that examines the challenges associated with incorporating ESG in securitised products. The report notes that investors are grappling with two issues: building a rigorous framework for assessing ESG factors in mainstream securitisations and enhancing credit risk assessment beyond traditional fundamental analysis; and promoting standards within the nascent ESG securitisation market to ensure its veracity.

Among the report’s key findings is that client demand, risk management and the desire to have a more positive environmental and societal impact are driving ESG considerations in securitised products. Regulation is also influencing investor behaviour, as lawmakers focus on improving ESG disclosure and standardisation throughout financial markets.

However, while investors’ fixed income ESG policies are expanding, they are typically not yet tailored to securitised products. The PRI report suggests that most investors are exploring how they can adapt and apply the ESG incorporation practices used with other types of debt instruments to these products.

A lack of adequate data to conduct ESG due diligence appears to be the main challenge preventing many investors from systematically integrating ESG factors in their securitised products analysis.

Negative screening remains the most widely adopted incorporation approach for European ESG-labelled CLOs. But the legal documentation accompanying them is not harmonised; CLO managers’ ESG evaluation processes are vague and – for now – little price differential versus mainstream products exists.

In other news…

Blockchain fund launched
Von der Heydt Asset Servicing and Immutable Insight Capital Management have partnered to securitise the blockchain fund, Blockchainfonds II. By securitising a blockchain fund, investors can invest in a crypto-asset alternative investment fund via a custodial security.

The fund aims to deliver a superior risk-return profile in crypto and tokenised assets on the basis of the analytics performed in-house at Immutable Insight. The strategy is based on real-time analyses of how blockchains are being used.

Bankhaus von der Heydt is handling the financial commission business for the crypto and tokenised assets and will then hold them in custody as a regulated crypto custodian. GSK Stockmann advised von der Heydt and Immutable Insight on project implementation in Germany and Luxembourg.

ILS options expanded
Leadenhall-backed Nectaris Re, a Bermuda-based Class 3A reinsurance company, has obtained a financial strength rating of A (Excellent) and a long-term issuer credit rating of ‘a’ from AM Best. Nectaris’ initial focus will be primarily to underwrite non-life reinsurance and retrocessional covers and to cover the risk using collateralised capacity from funds and segregated accounts managed by Leadenhall, net of any hedging and retrocession.

Nectaris is managed and administered by Horseshoe and will be joined on a part time basis by Leadenhall’s Ben Adolph as a director, acting as Nectaris Re’s head of underwriting. He will also remain an employee of Leadenhall Capital Bermuda and is a managing partner of Leadenhall Capital Partners, where he is head of non-life portfolio management.

Nectaris Re will complement the transactional options available to Leadenhall in building a broad book of insurance-linked relationships, including collateralised insurance-linked investments and transactions written in cooperation with and via the firm’s joint venture partners at MS Amlin.

Nectaris Re sits alongside Horseshoe Re II, a segregated cell company supported by capacity from Leadenhall funds and segregated accounts, which can provide direct collateralised cover to those counterparties interested in having the direct benefit of high-quality collateral posted in trust accounts. Horseshoe Re II is also expected to provide fully collateralised cover to Nectaris Re to support its underwriting.

First SDR registered
The US SEC has approved the registration of its first security-based swap data repository (SDR) - DTCC Data Repository (US) (DDR). DDR intends to operate as a registered SDR for security-based swap transactions in the equity, credit and interest rate derivatives asset classes.

This action sets 8 November 2021 as the first compliance date for Regulation SBSR, which governs regulatory reporting and public dissemination of security-based swap transactions. A key component of the Dodd-Frank Act, Regulation SBSR provides for the reporting of security-based swap information to registered SDRs and for public dissemination of transaction, volume and pricing information.

UCITS partnership agreed
Schroders has launched the Schroder GAIA Oaktree Credit fund, a global multi-strategy credit portfolio that offers investors access to high-conviction liquid credit opportunities. Investors will now be able to access Oaktree Capital Management's global credit strategy through Schroders' alternative UCITS platform.

The Oaktree strategy - which was launched in 2017 - has over US$5.3bn of assets under management, as at 31 December 2020. The fund will harness Oaktree's extensive credit expertise to create a highly diversified liquid portfolio that invests across US and European high yield bonds, corporate and real estate structured credit, emerging markets debt and global convertibles.

Oaktree co-chairman and cio Bruce Karsh will be the lead manager of the fund, alongside md and co-portfolio manager David Rosenberg. The launch of this scalable fund marks the beginning of what Schroders expects will be a long-term partnership between the two firms, building on Oaktree's suite of liquid and illiquid credit capabilities.