Contents

NPLs

Positive prospects

Italian NPL ABS growth pending

Italy’s NPL market remained busy last year despite Covid-related uncertainty, and investor demand for Italian NPL sales and securitisations is expected to persist this year as the economy recovers.

Italian banks' non-performing loans (NPLs) fell to 4.1% of their gross loans in December 2020 from 6.7% a year earlier, down materially from a peak of 17% in 2015, according to European Banking Authority (EBA) data. Italian banks' aggregate NPL ratio still exceeds the European Union (EU) average of 2.6% but is below that of their peers in Greece (25.5%), Cyprus (11.5%), Poland (5.1%) and Portugal (4.9%). In fact, last year's fall in NPLs marked the fifth consecutive annual improvement in Italian banks' asset quality.

The reduction has been driven mainly by NPL sales and securitisations. According to Moody’s, during 2020, there were over €40bn of NPL sales and securitisations under the Italian government's GACS guarantee scheme, up from €34bn in 2019. This demonstrates that Italy's NPL market remained active despite coronavirus-related uncertainty. The rating agency expects continued investor demand for NPLs in 2021 as the economy recovers.

The GACS scheme is due to expire in May 2021, but the Italian government is negotiating a potential one-year extension of the program with EU authorities. Moody’s also expects Italy's state-owned asset management company, AMCO, to continue playing a major role in purchasing NPLs, particularly if demand from private investors is weaker than expected. AMCO has been involved in several NPL transfers from Italian banks, including recent purchases of over €8bn from Banca Monte dei Paschi di Siena and almost €3bn from Banca Carige.

Large Italian banks were behind the biggest NPL disposals and securitisations in 2020. Intesa Sanpaolo securitised €4.3bn of NPLs via the GACS scheme in the final quarter of 2020 and has announced disposals of over €5bn of NPLs so far in 2021. Unicredit sold €3.4bn of NPLs from its non-core division last year, while Banco BPM sold over €1bn of UTP loans in 4Q20 and announced a further €1.5bn of NPL sales in 2Q21.

Meanwhile, the EU seeks to facilitate the sale and securitization of distressed assets as part of its post-pandemic economic recovery plans. The objective is to ensure that the coronavirus outbreak does not result in a build-up of NPLs on bank balance sheets, potentially impairing the flow of credit. These plans should favour Italian banks' continued efforts to reduce their problem loans through sales and securitisations.

Under EU legislative amendments that took effect in April 2021, the 5% share of securitized NPL portfolios that originating banks must retain is based on the portfolio's nominal value minus any non-refundable purchase price discount. The amendments further allow the servicer of the securitized portfolio rather than the originator to hold the risk retention amount.

Looking forward, Italian banks' non-performing loans (NPLs) are expected to rise in the next 12 to 18 months, partly reversing a steady decline over the last five years, as the expiry of coronavirus-related repayment moratoria triggers an increase in borrower defaults.

Most of the asset quality deterioration will likely start in 2022, as the Italian government's decision on 20 May to extend loan moratoria by six months to December 2021 will keep NPL formation in check this year.

The increase in NPLs in 2022 could be substantial, given the relatively high share of Italian loans still subject to moratoria. However, ‘’we do not expect the bank's problem loan burden to return to its historical peak’’ concludes Moody’s.

Stelios Papadopoulos

Capital Relief Trades

Risk transfer round up-3 June

CRT sector developments and deal news

Sabadell is believed to be prepping a capital relief trade backed by SME loans that is expected to close in 3Q21. The bank’s last significant risk transfer trade was finalized in June 2020 (see SCI’s capital relief trades database).  

Capital Relief Trades

Canuck rumours

Canadian banks said to be circling CRT

Rumours continue to swirl about the possibility of an imminent regulatory capital relief trade issued by a Canadian bank.

In January, there were strong rumours that a CRT trade was in the offing in the near future, probably from Scotia. These rumours have recently resurfaced, though as yet nothing has come to light. It was thought originally that Scotia would issue in 2Q, but nothing as yet has materialised.

If Scotia were to issue a CRT trade, it would become only the second Canadian bank to make use of the CRT mechanism. BMO has been the pioneer among Canadian banks, having issued three trades in the last two years.

Scotia has been unavailable for comment.

Another Canadian bank is said to be circling the market at the moment as well. Aside from BMO, the other three major national banks are CIBC, TD and RBC - none of which have issued in the CRT sector before.

“I heard that there was something else going on, but it is not Scotia. This is the second bank considering issuing, but no-one could identify it,” says a source in Canada.

Alongside the big five, there is National Bank of Canada, the sixth largest commercial bank in the country and headquartered in Montreal, and that has been slated as a potential issuer as well. It is the second largest bank in the province of Montreal and has 2.4m account holders.

National Bank was unable to comment beyond saying there is "nothing to report here."

So, despite the lack of concrete details, it looks as of things might be about to hot up north of the border.

Simon Boughey

Capital Relief Trades

FHFA under fire

Arch takes aim at FHFA report on GSE CRT

David Gansberg, president and ceo of Arch Mortgage Insurance, has taken serious issue with the recent Federal Home Financing Authority (FHFA)’s report on the GSE CRT programme, published last month.

Writing in Housing Wire last week, Gansberg accuses the FHFA of missing out vital evidence on the CRT scheme to present a distorted picture of its efficacy.

The FHFA report, titled Performance of the Enterprises’ Single-Family CRT, notes that since the introduction of the CAS, STACR. CIRT and ACIs, the GSEs have paid out $15bn in interest and premium to investors but have received just $0.05bn in write-downs and reimbursements covering 5% of historic loss on the reference pools.

“To date, the only CRT tranches or layers that have incurred write downs or counterparty reimbursements (i.e., benefits to the Enterprises) have been in a few transactions issued in 2015, 2017, and 2018 in which the Enterprises sold first-loss tranches or layers,” it adds.

As far as Gansberg is concerned, this is missing the whole point of CRT. The purpose of CRT, he says, is not to provide a return for GSE investors but to safeguard the GSEs against catastrophic loss. A homeowner in Oklahoma’s tornado alley would not think his home insurance a waste of time and money if he never had to file a claim, he explains.

“CRT serves as a lower cost source of alternative capital for the GSEs. In fact, given that — up until recently — GSE capital has been near zero, CRT was the only thing standing in front of taxpayers. Between July 2013 and February 2021, reports FHFA, about $126 billion of risk in force (RIF) had been placed through securities issuance and insurance/reinsurance transactions. As of February 2021, $72 billion of the RIF remained in force. Today, that $72 billion still stands between the GSEs and taxpayer exposure on future unexpected losses,” writes Gansberg.

The FHFA also says that the CRT mechanism has never been tested by a serious loss event, and that Covid 19 has raised concerns among investors. Some has said that they were unwilling to invest in CRTs unless the GSEs amended some of the provisions of early fixed-severity CRTs. The latter have now been superseded by actual loss deals.

Gansberg concedes that improvements can be made but ends with a resounding “But make no mistake: CRT is working and together we can make it even better.”

This war of words shows clearly the direction in which the FHFA wants to take the GSEs. It seeks to to afford less capital relief to the GSEs from the CRT programme and, instead, wants Fannie and Freddie to build up much more capital. The Enterprise Regulatory Capital Framework rule, a 375-page document released a year ago, calls for the GSEs build up a capital buffer of almost $300bn.

However, all this could quickly become redundant if the Supreme Court determines that the executive can fire FHFA director Mark Calabria. This decision is expected very shortly, and if Calabria is pushed out the FHFA war on CRT could come to a speedy ceasefire.

Simon Boughey

Capital Relief Trades

Pandemic hedges

CRT solutions for pandemic events mulled

Munich Re’s Epidemic Risk Solutions (ERS) unit is targeting credit risk transfer solutions that incorporate pandemic events, although the initiative remains in its early stages and coverage will for now amount to only an economic hedge without capital benefit.

The latter is currently not available to banks under existing Basel rules, but this could change as the ESG agenda across credit markets continues to gather pace.

According to Leigh Hall, senior originator at Munich Re ERS, “Accessing the capital markets is crucial for hedging and diversifying pandemic risk but for now our proposal is purely an economic one. Hopefully, at some point it will be reflected in the capital charges.’’

He adds: ‘’The first generation of products that hedge pandemic events have been sold to corporates to cover extra expenses and loss of income during a pandemic and we are now focussing on second generation solutions that tackle credit losses, increased cost of funding and real estate rent protection.’’

Indeed, the capital markets will play a crucial role in covering pandemic risk. Hall believes. ‘’ We are warehousing risk and have already transferred risk to capital markets because our risk capacity is limited and-similar to other insurance linked products-we are looking to partner with external capital. On a risk-adjusted basis, it offers investors attractive features such as low correlation, low mark-to-market volatility, short maturity, and a yield pick-up when compared to conventional investments,’’ he says.

However, it is not clear what form will this economic hedge take. ‘’It could be a credit derivative or  just an insurance policy and we could also use such hedging techniques for pandemic affected industries that are intentionally excluded in current SRTs such as hospitality, leisure and travel,’’ according to Juan Carlos Martorell, consultant at MunichRe.

Additionally, banks could simply target the ILS market, which has a proven track record in covering these types of risks, without trying to incorporate pandemic events into CRT structures. However, “We want to look at the value chain of a bank, including the underlying corporate borrowers. Covid-19 unveiled the liquidity issues caused by pandemics, as companies drew down their revolvers to survive the crisis’’ says Gunther Kraut, head of epidemic risk solutions at MunichRe.

He continues: ‘’One solution could be to cover revolver drawdowns as a pandemic evolves or insure credit spreads. Alternatively, we could look at things at an aggregate level by covering not just individual borrowers but the whole portfolio.’’

Still, no transaction can be launched without a workable definition of pandemic events. Kraut responds: ‘’Defining it could be done by looking at WHO declarations of pandemics and the imposition of associated restrictions. Further parameters that we have explored include the scale of the outbreak or the probable fatalities related to it. However, it must be a unique event and that is where the challenge lies.’’

Pricing is another consideration. Kraut explains: ‘’There’s a lot of publicly available data on outbreaks such as WHO alerts. Most of these outbreaks remain small, but some become more significant. It is not a black swan and although we do look at historical data for our internal modelling, we also must consider epidemiological information as well. Available vendor models tend to be stochastic random ones, but they focus on mortality rates rather than credit impacts.’’

The initiative remains in its infancy and it must be seen whether bank CPM functions are willing to go beyond current parameters. Martorell notes: ‘’Bank CPM functions have to manage a bank’s balance sheet and at present, current metrics do not detect non-financial risks.’’

Perhaps more saliently, it is unclear whether banks are willing to consider a pure economic hedge without capital relief, although perhaps interest will likely grow over time as the ESG agenda in the broader credit markets continues to gather pace.

More importantly, epidemic risk is now a high probability, high impact event due to man-made environmental shifts such as deforestation, urbanisation, and global mobility.

According to the IPBES (Intergovernmental Science Policy Platform on Biodiversity and Ecosystem Services) ‘’The risk of pandemics is increasing rapidly, with more than five new diseases emerging every year, any one of which has the potential to spread and become a pandemic.’’

Finally, the situation is further complicated by the fact quantifying pandemic risk is challenging and not immediately remunerative for investors. Munich Re’s Epidemic Risk Solutions unit aims to facilitate the transfer of risk concentrations found on balance sheets to pockets of capital for whom bearing such risk is attractive.

Stelios Papadopoulos

NPLs

Revised expectations

Italian NPL business plans underperform

Italian NPL transaction collections are largely underperforming expectations, partly due to the impact of the pandemic, according to the latest data. Some 21 Italian NPL securitisation servicers have updated their business plan at least once and only two servicers have revised their latest gross collection expectations upwards, while ten trades have been downgraded due to a combination of Covid-related factors, say reports.

According to DBRS Morningstar, coronavirus-related drivers include the slowdown in judicial activity resulting from the implementation of extraordinary measures imposed by local governments to contain the effects the pandemic, such as court closures and temporary suspension of the foreclosure actions against residential assets. These have caused delays in legal procedures and disruption to servicers’ judicial strategies resulting in longer time-to-recovery compared to initial expectations.

Alternatives such as amicable settlements and sales of exposures to third parties exist and they were initially envisaged in the business plan. However, DBRS Morningstar states that these collection strategies are sometimes executed with lower than initially expected proceeds, offsetting the faster realisation of recoveries. Ultimately, the current uncertainty concerning the duration of the crisis and the expectations that it might continue throughout 2021 explains more conservative views on real estate liquidity and recovery timing.

“The expectation is that the actual impacts of the pandemic in terms of expected recoveries will more likely be reflected by the servicers in their updated business plans that are due to be issued later in 2021 and 2022, once it is possible to better assess the actual effect of the crisis on the local economy’’ says the rating agency.

The DBRS Morningstar analysis considered a number of transaction features such as borrower type, portfolio granularity, the secured composition of the pool, the nature of the real estate collateral, weighted-average portfolio vintage, geographical concentration, performance data, and servicing framework.

The analysis and the considerations it takes into account point to the fact that a certain degree of correlation can be identified between reductions in recovery expectations and factors such as transaction performance, the type of real estate collateral, and actual workout strategy implemented to date.

Stelios Papadopoulos

RMBS

Domi debut

Domivest transaction attracts strong investor appetite

The debut STS-compliant buy-to-let (BTL) RMBS transaction, issued by Dutch lender Domivest and dubbed Domi 2021-1, has now closed and the transaction saw significant demand across the capital structure and also from new investors, according to the borrower.

Investor response to the transaction demonstrates the validity of the structure and the market is likely to see more of it in the future, suggests Domivest.

“We are really pleased with the execution of the transaction. The deal brings Dutch mortgage exposure to investors, which is rare these days. Banks are not securitizing their owner occupied mortgages to the market anymore. It is the first time a Dutch BTL transaction has obtained the STS label. We have also kept the transaction pretty much the same as our previous three deals,” Jeroen Bakker, co-founder of Domivest explains.

He adds that it was decided to opt for an STS label, given that BTL loans aren’t eligible under the LCR rules.  “We spoke to investors quite a bit on the Covid situation and our performance, which has helped in expanding our number of investors. This has all helped the deal execution,” Bakker explains.

Following pricing, Domi 2021-1 has now provided one of the best direct pricing comparisons for STS versus non-STS transactions within the same shelf, as the senior STS pricing level of 3 month Euribor plus 63bp compares to senior pricing DMs of 85bp-90bp for the three previous, non-STS, Domi deals issued in 2019 and 2020.

Bakker believes that the STS label aided its execution at such aggressive levels. “The increased comfort that investors have with the Domivest shelf and the more favourable market circumstances than Domivest had in its last two deal also helped,” Bakker says.

“It is difficult to quantify how much the STS label helped but given the broader investor base more people can look at it, which definitely helped,” he adds. 

He concludes that Domi will consider the STS label again in the future as it worked well on this occasion.

Angela Sharda

Structured Finance

Private debt investors doubt ability to handle defaults in post-pandemic downturn

Contributed thought leadership by Ocorian

An overwhelming majority (87%) of capital markets investors are pursuing direct lending strategies, though almost half (47%) lack confidence in their ability to manage loss recoveries, which could have serious implications if corporate defaults rise as pandemic-driven government support schemes are withdrawn. This is according to a new Ocorian report, entitled ‘Navigating CovExit: searching for value in the debt markets’, which canvassed the opinions of decision makers from investment banks and private capital managers. The report also reveals the majority (57%) of capital market investors have an existing direct lending strategy which they are looking to expand and 30% have a strategy that they are in the process of executing.  

With US$207bn having been deployed by 327 direct lending funds globally over the past 10 years, the Ocorian study highlights a shortage of confidence among investors that their direct lending abilities will be sufficient to weather the storm. They expressed the least confidence in addressing loss recoveries (47%), risk assessment (53%), statement production (54%) and covenant monitoring (57%). 

The report is based upon independent research among 100 capital markets decision makers working in investment banks and private capital firms in Europe, North America, Africa and Asia to assess their operational readiness as they plan their post-Coronavirus pandemic investment strategies.

Respondents from younger firms less than 10 years old were least sure of their loss recovery capabilities when it came to direct lending, with only 41% expressing confidence. Regionally, confidence levels in having robust loss recovery capabilities were lowest among European respondents (28%) – significantly behind North American (40%), African (48%) and Asian (72%) respondents.  

Despite their concerns, some 92% of respondents expect corporate insolvencies and restructurings to present opportunities to them over the next 12 months, including 22% who believe these opportunities will be significant.

Alan Booth, Global Head of Capital Markets at Ocorian, says: “Relatively few defaults to date suggests that private debt investments have been resilient, but government support and the low cost of funding may be masking a varying degree of trauma in the market. As this support is wound down and interest rates rise, we can expect to see distress and indeed opportunities in certain sectors. How private debt managers react will be varied and we are likely to see the hawks outnumber the doves."  

He continues: “Despite their operational concerns and a weakening in the short-term fundamentals in private credit markets, investors are increasingly drawn to the sector in anticipation of debt restructurings, as well as M&A activity arising from the pandemic. However, funds pivoting from private equity or real estate towards direct lending may have challenges in adapting their infrastructure to meet their need for quick execution. It’s vital managers have sufficiently robust and scalable operational, risk and compliance processes in place, either in-house or through an outsourced arrangement, to avoid delays and unnecessary risk to themselves and their LPs.”

To find out more, download the full report Navigating CovExit: searching for value in the debt markets here.

Register for Ocorian's upcoming webinar 'Debt in distress'

Structured Finance

New moves

Rob McDonough, director of ESG and regulatory initiatives at Angel Oak Capital, Advisors discusses its issuance of the US's first-to-market non-agency social bond securitisation

1./Can you provide more detail on the framework you developed to quantify the deal’s social impact at the loan level?

The core strategy underpinning the formation of Angel Oak’s Non-QM mortgage lending operations in 2011 was to address the material social inequities caused by the tightening of mortgage underwriting standards under the Dodd-Frank Act and other legislation in the aftermath of the financial crisis.  Many potential borrowers with non-standard sources of income, primarily self-employed individuals, were effectively denied access to mortgage credit under U.S. government agency loan guarantee programs. 

Angel Oak uses the securitisation markets to provide longer term financing for their non-QM mortgage lending programs, and one of the critical success factors of our Angel Oak Mortgage Trust securitisation platform has been the strong performance of the loans originated under our non-QM lending programs.

Angel Oak Capital Advisors, LLC became a signatory to the UN’s Principles for Responsible Investing in 2017 and formally adopted these principles to integrate ESG across the firm’s operations.  As one component of our ESG integration program, Angel Oak had been closely following the market to identify an appropriate framework that aligned with our core strategy of providing positive social impact by increasing access to housing for underserved borrowers. 

Angel Oak observed the securitisation markets began to coalesce around the International Capital Market Association (ICMA) Social Bond Principles in late 2020 when both Fannie Mae and Freddie Mac began successfully issuing residential and commercial mortgage-backed securities under their internally-developed social/sustainable bond frameworks.  Kensington Mortgage, a private UK-based mortgage lender, also implemented a social bond framework under the ICMA standards in February 2021 and subsequently issued a RMBS under this framework in March 2021.  The Yorkshire Building Society, another UK mortgage lender, did the same in March 2021.

2./How important was securing a second-party opinion to the deal’s success? What did this involve?

ISS ESG provided a Second Party Opinion (SPO) on Angel Oak’s social bond framework dated April 2021.  Angel Oak reached out to a number of social bond SPO providers through an RFP process and selected ISS based on their previous experience providing this service for the Kensington UK residential mortgage Social Bond securitisation in March 2021, which at the time was the only non-government guaranteed Social Bond RMBS to have been successfully issued.

3./Has the proportion of underserved homebuyers in the US grown due to the Covid-19 fallout?

The underserved borrowers that are targeted by our social bond framework, primarily self-employed small business owners and sole proprietors, did not inherently increase in number during the pandemic.  However, their financial position became substantially more precarious as a result of local and federal government requirements to implement lock-downs.  These policies had a disproportionate impact on small businesses that did not have access to capital to operate under lock-down scenarios where restaurants, retailers, and storefronts were required to shutter their operations for weeks and sometimes months at a time.  Angel Oak’s ability to provide residential mortgage credit to these borrowers provided much needed relief to these individuals during a time when small business owners needed to utilize any available working capital to sustain their businesses under these challenging conditions.

4./Angel Oak oversaw the entire process from origination to securitisation thanks to the vertical integration of its lending and capital entities. What did this involve?

Angel Oak Capital Advisors, LLC (AOCA), an SEC registered investment advisor, manages the overall securitisation process for bonds issued from the Angel Oak Mortgage Trust (AOMT) platform.  Non-QM mortgages originated by Angel Oak Mortgage Solutions and Angel Oak home loans, both affiliates of AOCA, are initially funded by warehouse lines of credit but are eventually purchased by private fund structures managed by AOCA.  Once a sufficient amount of loans have been aggregated, each loan is subjected to a third party diligence review for adherence to specific credit, compliance and valuation standards. 

5./What were the drivers behind creating this model?

Angel Oak was one of the very first mortgage lenders to develop lending programs conforming to the new non-QM underwriting requirements in 2011.  In addition, we were one of the first issuers of non-agency RMBS in the post-financial crisis period.

6./Did the social label enable you to broaden your investor base?

The investors in the AOMT 2021-2 had generally participated in previous securitisations issued by Angel Oak or were broadly familiar with the non-QM space and had looked at previous transactions.  Conversations with our syndicate bankers did indicate broader interest from other investors that had not participated in previous securitisations, but it is not clear if this interest was due specifically to the social bond aspect of this transaction.

7./Are you expecting to issue further social/ESG deals in the near future?

While Angel Oak may issue future securitisations that do not completely conform to our Social Bond Framework, the intention behind developing and implementing our framework is to support the consistent issuance of securitisations that are formally designated as social bonds going forward.

8./Do you anticipate other RMBS issuers to follow with similar transactions?

The substantial demand from investors for social, sustainable and green bonds is likely to increase the probability of other issuers developing their own frameworks. 

9./What are the current challenges and opportunities involved in bringing social/ESG securitisations in the US?

The challenge is to identify appropriate target populations and develop lending programs that can generate a positive social impact for those populations.  Angel Oak is restricted by federal and state level regulations from providing favorable credit terms to any class of borrowers, because even if one underserved class received a benefit, this would nevertheless be in violation of Fair Lending/Fair Credit laws which require that we provide equal access to credit.

Angel Oak’s non-QM lending model was calibrated to specifically address potential borrowers who have been excluded from the Agency lending process.  These underserved borrowers are most frequently self-employed sole proprietors or small business owners with non-standard source of income that cannot be easily evaluated by the automated underwriting programs used by agency lenders.

Other non-QM lenders might develop and implement social bond frameworks under which they could issue social bonds.

Angela Sharda