News Analysis
Capital Relief Trades
The puzzling case of the disappearance of Fannie Mae
FNMA's absence from CRT investigated
Fannie Mae has not issued a CRT deal since 1Q20. This SCI CRT Premium Content article investigates the circumstances behind the GSE’s disappearance from the market and what might make it come back.
Fannie Mae, one of the co-founders of the ground-breaking GSE credit risk transfer market, has not issued a CAS or CIRT transaction since 1Q20. There is no knowing when it might return to the market, but there is some reason to believe that Fannie’s non-attendance will not continue for much longer, given the sea-change in policy under the Biden administration.
Fannie began issuing CAS bonds in 2013 and by the end of 1Q20 had sold a total of US$47bn, transferring risk on US$1.5trn of unpaid principal balance of mortgage loans. In 2018 and 2019 - the last two full years of issuance - it sold around US$7bn a year to investors.
The great majority of disinterested observers would agree that the CRT schemes unveiled by Freddie Mac and then Fannie Mae in 2013 have been a great success. The two GSEs created a whole new asset class that proved very popular with investors and one which successfully helped reposition Fannie and Freddie as careful, prudent organisations that would not again endanger the wallet of the taxpayer.
Although it declined to comment for this article, Fannie explained why it had stepped away from the market in its Q2 10-Q, released on 3 August 2020. “We did not enter into new credit risk transfer transactions in the second quarter of 2020, due to adverse market conditions resulting from the Covid-19 pandemic. Market conditions improved in the second half of 2020, but we have not entered into any new transactions as we evaluate their costs and benefits, including a reduction in the capital relief these transactions provide under FHFA’s enterprise regulatory capital framework. We may engage in credit risk transfer transactions in the future, which could help us manage capital and manage within our risk appetite, particularly given the growth and turnover in our book in 2020,” the GSE said.
Since then, it has offered no update or embellishment to this statement. As the market has now recovered substantially, it seems that the FHFA’s enterprise regulatory capital rules - released at the end of May 2020 - are now entirely responsible for Fannie Mae’s continued absence from the CRT market.
These rules are considerably less friendly to CRT mechanisms than the previous 2018 rules. The GSEs are required to use the more binding of either a risk-based capital formula or a leverage ratio, but the latter affords much less capital benefit than the former. Indeed, according to some calculations, there is zero capital benefit derived from CRT if a leverage ratio is applied.
The rules also applied the Simplified Supervisory Formula Approach (SSFA) for capital to be held against retained tranches under risk-based capital rules. Using this approach, CRT schemes cut required capital by only 40%, at the most, rather than 75% as under the 2018 rules. This brought the GSEs more into line with the capital treatment meted out to banks, which was one of the FHFA’s objectives.
The adjustment also reflected the fact that the regulator did not regard CRT as anything like the equal of common equity in absorbing unexpected losses. And this, it might be argued, is fair enough as common equity can be used to plug any holes, while CRT can only ameliorate losses in a specific reference pool of assets.
And that, as far as Fannie Mae is concerned, is that. It hasn’t been back to the CRT market in 18 months and there is no indication of it reappearing.
However, the overall market appears to be functioning just fine without one of its founders. While Fannie Mae has not been around, Freddie Mac has stepped up the pace of its STACR issuance.
In 2019, for example, there was US$7bn of issuance under the CAS programme and US$8bn under STACR for a combined total of US$15bn of CRT new debt. In 2020, while there was only US$2bn of issuance under the CAS programme, there was US$11bn under STACR for a combined US$13bn - only US$2bn less than in 2019.
At the end of July, Freddie issued its sixth STACR of 2021 - designated STACR 2021-DNA5 - and has now issued US$6.2bn under the programme this year. There were some notable firsts in this deal as well: the class B1 and B2 tranches were the largest yet seen for this part of the capital structure, while the B1 drew 39 investors - the most in programme history. Spreads for the M1 and M2 tranches were also the narrowest seen for two years.
So, there is no shortage of investor interest in the asset class and no real shortage of product either. Fannie Mae has been away from the CIRT market as well, but there hasn’t been much impact in this arena either.
“It’s just Fannie Mae that has been on pause. So far, origination volumes - in both the purchase and refinance market - have been very strong and enough to make up for the slack in demand that would have otherwise been seen in the CRT market,” says Tim Armstrong, an md at Guy Carpenter. The latter is one of the two big names in the CRT reinsurance space, alongside Aon.
Indeed, Freddie Mac’s combined STACR and ACIS programmes attained record half-yearly issuance of US$9.9bn in the first six months of 2021, it was announced in early August. The GSE sold five STACR deals and seven ACIS deals in this period, which included the two largest STACR transactions ever sold. The first quarter was particularly lively, with a total of US$6.4bn issued.
That Freddie Mac should have had a very different response from Fannie Mae to the capital rules appears at first sight puzzling. The two institutions are, after all, very similar. But there are differences between them as well.
First, Fannie Mae is much older than Freddie Mac. It was established as the Federal National Mortgage Association in 1938 by Congressional decree through amendments to the National Housing Act, as part of President Roosevelt’s wide-ranging and far-reaching interventions into the US economy.
The Federal Home Loan Mortgage Association was founded by Congress in 1970 to further increase the availability of funds to finance mortgages, but also – specifically - to provide competition for the newly privatised Fannie Mae.
Both GSEs were received into conservatorship in September 2008, wherein they have remained ever since, but differences in culture and attitude remain. Fannie sees itself as a government agency, while Freddie sees itself as a street firm, say market sources.
“I would say that Freddie is more market sensitive and Fannie is more programme sensitive,” says another source. In other words, Freddie appears to find current spread levels too good to turn down, while Fannie seemingly is worried about the long-term effects of the capital rules upon the entire CRT programme.
Speaking to SCI, Mike Reynolds, vp of single-family CRT at Freddie Mac, elaborated on Freddie’s attitude to the CRT market. “We evaluate and update our CRT strategy as needed, depending on our overall business strategy, regulatory requirements and market conditions. We receive capital relief as a result of our CRT transactions and, by transferring credit risk on a portion of our single-family mortgage portfolio to the private market, we reduce the risk of future losses to us when borrowers default. CRT has been one of our biggest success stories since Freddie Mac pioneered the asset class in 2013,” he says.
So, it would seem, from Freddie’s perspective, the capital relief afforded is still sufficient to make the CRT market worthwhile. This is a different perspective to that of Fannie Mae.
At the moment, then, Fannie’s absenteeism has not had a marked effect on prices or availability of investment opportunities. However, notes Krohn: “Fannie Mae’s absence has not made all that much difference so far, but it will if they stay out of the market long term. Then it will have an impact.”
While the GSE CRT sector has continued to operate relatively smoothly over the last 18 months without Fannie Mae, there is no doubt that it would be better if the elder GSE returned to the market. And there is some reason to believe that Fannie’s non-attendance will not continue for much longer.
In June, Mark Calabria was fired as director of the FHFA and a sea-change in policy is under way. Sandra Thompson, the new acting director of the agency, has very different objectives to her predecessor and it would be a surprise if a speedy exit from conservatorship is one of them.
Under Calabria, the FHFA was openly sceptical of the value of the CRT market. In a now notorious paper published in May, entitled ‘Performance of the Enterprises’ Single Family CRT’, the FHFA suggested that the CRT market is an expensive waste of money. This attitude is likely to become a thing of the past under the new administration, say sources.
“The FHFA supports CRT as a valuable tool to mitigate credit risk at the Enterprises,” a spokesman for the FHFA told SCI.
Calabria, moreover, was a notorious regulatory capital hawk. In the words of Larry Platt, a partner at Mayer Brown who specialises in housing finance: “Calabria had a love affair with regulatory capital.” The new leadership of the FHFA perhaps does not share that affection.
Consequently, some investors believe that a return to the CRT market for Fannie Mae is on the cards. “In our view, given the recent change in the FHFA, it will be the status quo from here on out. I would think that the resumption of the programme from Fannie Mae makes a lot of sense, particularly as they hopefully want to continue to provide homeownership opportunities for the US in an increasingly complex housing market,” says Sam Dunlap, cio of public strategies at Angel Oak Capital Advisors. Angel Oak is a long-time investor in agency CRT securities.
However, it is worth noting that there are unlikely to be any penalties for Fannie Mae if it continues to abjure the CRT market. The GSE’s 2021 scorecard, released by the FHFA in February, was a little woollier than in the past.
The scorecard adumbrates three specific areas of focus for the GSEs: the fostering of competitive, liquid, efficient and resilient housing markets; ensuring safety and soundness; and preparing for exit from conservatorship. Under the second of those targets, the GSEs were told to “continue to transfer credit risk to private markets in a commercially reasonable and safe and sound manner.”
But, unlike previous years, it did not designate an amount of CRT that the GSEs should complete. For example, the 2019 scorecard said the GSEs should “transfer a meaningful portion of credit risk on at least 90% of the unpaid principal balance of newly acquired single-family mortgages in loan categories targeted for credit risk transfer.”
Moreover, the scorecard’s recommendations on risk transfer are not limited to CRT. It also encourages the sale of less liquid assets, such as non-performing loans and re-performing loans, which Fannie has continued to do.
The 2021 scorecard is also considered contradictory by critics of the FHFA under Calabria. While it encourages CRT, it also enjoins the GSEs to “ensure the efficient utilisation of capital targeted to support the core guaranty business with adequate returns to attract the private capital necessary to enable an exit from conservatorship.”
Yet the new capital rules do not provide the capital relief to make CRT deals as economically beneficial as they once were. In effect, say the critics, the scorecard asks the GSEs to face both ways at once and it is no surprise that the result is confusion.
Even if Fannie were to be considered in breach of the scorecard, it is not clear what action the FHFA might take anyway. As one source with long experience of the GSE CRT programme asks: “What could really happen; the GSEs are in conservatorship under the FHFA?”
There are unlikely then to be any repercussions for Fannie if it stays out of the market. It can, moreover, legitimately claim that it is following the spirit of the new capital rules by continuing to stay out of the market.
So, we’re back to the capital rules unveiled in May of last year. These need to change before Fannie Mae returns. But they haven’t been changed yet, and there are perhaps other items in Sandra Thompson’s in-tray requiring more pressing attention than capital rules.
“My feeling is that reversing the capital rule is not high on the interim director’s to-do list. She will likely focus more on expanding the credit box on loans eligible for purchase and furthering the public mission of entity. The capital rule is done for now, I think,” says Larry Platt of Mayer Brown.
However, there are strong rumours in the market that a succession of interested parties has been through the doors of the FHFA in recent weeks to make strenuous representation to the new acting director that Calabria’s capital rules will be ditched. The agency is listening to a new set of voices.
“We are hopeful the new acting director of the FHFA and current administration make some changes to the Enterprise Capital Rule that are reflective of the true economic benefits of CRT,” says Jeff Krohn, the head of Guy Carpenter’s mortgage credit segment.
It seems public policy action is needed before investors can feast upon CAS and CIRT once again, and that action is perhaps not that far away.
As one leading participant in the CRT market says: “Under the prior director, the now current capital rule was written in a way that was not reasonable and impairs the future viability of CRT.”
For Fannie Mae to come back, the rules have to change.
Simon Boughey
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News Analysis
CLOs
Bullish sentiment
CLO, loan opportunity set to continue outperforming
The global CLO market is now pushing US$1trn in outstandings. Against this backdrop, both CLOs and the underlying loans are expected to outperform, as investors continue seeking higher risk-adjusted returns.
Mohamed Seif, co-founder and md of Lakemore Partners, notes that growth and demand in the US CLO market is being driven by a number of factors. First, CLOs have become better understood by a wider group of global investment professionals. Second, many traditional asset categories that historically offered enhanced returns within acceptable levels of risk have diminished in the current low rate environment.
Many investors believe that rates are likely to stay low for the foreseeable future and so they are searching for attractive, higher risk-adjusted return alternatives. Seif says: “The challenge facing new investors is to adequately quantify the associated risks to ensure they can remain invested through a down cycle. The robustness of the structure and the reliability of returns are attractive features, given the associated risks.”
Dan Norman, md and head of US business operations at Lakemore Partners, adds that CLO liability spreads have tightened much more rapidly than they did in the post-financial crisis period. Typically, CLOs have historically performed well in post-recessionary periods and spreads are now back to 2018 levels.
Indeed, activity across the CLO market has picked up as the cost of funding compressed since mid- to late-2020, while loan spreads continue to offer attractive opportunities. Sentiment in the US loan market is improving and, coming out of the effects of the pandemic, most companies are well-funded and haven’t over-extended their borrowing.
Seif suggests that the pandemic demonstrated who the better borrowers are and which industries will withstand, or even benefit from, the changes occurring as a result of the coronavirus crisis.
Additionally, Norman observes that there is more push-back on the weaker parts of loans, so there is a perception that credit is better and cashflow coverage is good. He says: “The loan market will continue through 2022 and beyond in terms of being the global finance instrument of choice for investors. CLO deals will be a growing part of that story and demand will continue for unleveraged loan funds globally.”
Overall, increasing demand across the CLO and loan markets is anticipated for the remainder of 2021. Seif concludes: “The opportunity set is getting better in the US and I expect the next two to three years will witness increased interest in the CLO market.”
Angela Sharda
News Analysis
Structured Finance
Robust recovery
Bumper "summer" for Aussie securitisation
The Australian securitisation market has experienced a deluge of activity in the last few weeks. With a total of A$8bn placed in July, the sector experienced its busiest month since 2007.
Australia's effective management of the coronavirus and macro-policy response generally facilitated a robust economic recovery throughout 2020. “The securitisation market has obviously shown a dramatic recovery since the onset of the pandemic in March last year. It snapped back fairly rapidly on the back of strong government response to counteract the impact of Covid-19, with a comprehensive approach for the securitisation market,” notes Martin Jacques, head of covered bond and securitisation strategy at Westpac.
He continues: “Investors gained a lot of confidence. In fact, since July 2020, none of the issuance has required support from the AOFM’s Structured Finance Support Fund.”
Notably, non-bank issuers dominated the market, making up A$8.7bn of the A$10.9bn overall issuance in Q2. The ascendancy of this segment highlights favourable demand dynamics and ADIs being absent from some areas of capital markets, while the Term Funding Facility (TFF) and other low-cost funding options remain available.
“Given the broad range of cheaper funding options, the likelihood of issuance for major banks remains low,” notes Jacques.
Nevertheless, the search for yield is ongoing. Jacques adds: “Spreads have contracted to levels well inside GFC tights, so that investors are looking further down the capital structure in certain cases, with new structures and asset types coming to market. Advantageous returns and strong performance have naturally enticed new investors to the market. However, a trend we have seen in some deals is the tightening of structures to become more issuer-friendly via reduced subordination or longer call dates.”
For example, the Firstmac Mortgage Funding Trust No.4 Series 2021-2 issued at the end of April was the largest non-ADI transactions since 2007. The senior class A notes priced at one-month BBSW plus 73bp, which was inside the original plus 75bp area IOI, representing the tightest margin for the non-ADI sector post GFC.
With August now well underway, this “deluge of activity” looks set to last. This week alone, three deals have priced and four remain in the visible pipeline (see SCI's pipeline database).
Liberty Financial’s prime RMBS Liberty Prime Series 2021-2, Bank of Queensland’s auto loan ABS Series 2021-1 REDS EHP Trust and Think Tank Group’s non-conforming RMBS Think Tank Residential Series 2021-1 account for this week’s prints. The transactions in the pipeline comprise: Mortgage House’s prime RMBS Mortgage House RMBS Series 2021-2; Prospa’s SME ABS PROSPArous Trust 2021-1; SocietyOne’s consumer ABS SocietyOne PL 2021-1; and Bendigo & Adelaide Bank’s prime RMBS Torrens 2021-2.
“Obviously, we need to wait and see how the recent lockdowns affect the broader economy, though it is worth noting that the current securitisation pipeline is extremely robust. One thing fixed income investors have been waiting on domestically is the return of major banks to the senior unsecured market and, along with it, the expectation that supply would push spreads wider with a knock-on effect to other risk products. However, following a benchmark senior transaction from one of the major banks this week, it is clear that this concern was unfounded,” Jacques concludes.
Vincent Nadeau
News Analysis
Capital Relief Trades
Double bind
New SRT tests pose complexities
The European Commission’s new consultation on the Securitisation Regulation (SCI 26 July) for the first time officially offers banks the opportunity to raise questions on the workability of the new significant risk transfer tests included in the EBA’s final report on SRT (SCI 27 November 2020). The tests pose several complexities for banks, due to the design of the stress scenario.
The Securitisation Regulation sets out a general framework for all securitisations in the EU and a specific framework for simple, transparent and standardised (STS) securitisations, as well as prudential requirements for securitisation positions. In the context of the efforts to boost the post-Covid economic recovery, the scope of the STS label was extended to synthetic securitisations on 6 April (SCI passim).
The European Commission’s capital markets union (CMU) action plan, published on 24 September 2020, commits the EU executive to review the current regulatory framework for securitisation to enhance banks' credit provision to EU companies - particularly SMEs - to scale-up the securitisation market in the EU. Hence, in order to deliver on that CMU commitment and prepare the mandated report, the July consultation from the Commission seeks stakeholder feedback on a broad range of issues - including the new SRT tests, as laid out in the EBA’s final report on significant risk transfer.
According to Leanne Banfield, counsel at Linklaters: ‘’The existing SRT tests set out in the CRR are certainly in need of a revamp - there are uncertainties in the market around how each of the first loss and mezzanine tests can be satisfied, and ultimately competent authorities have broad discretion to determine whether SRT can be achieved even without satisfying these tests. So, in that sense, the introduction of clear guidance and firm safeguards would be very welcome.’’
However, the question is whether the proposed changes and the methodology set out for the allocation of LTEL and UL to the tranches are appropriate. Banfield suggests that banks will need to look at this very carefully, considering other important structural features, such as excess spread.
“In practice, it would not make sense to have an overly complex methodology determining whether SRT has been achieved. This is something that regulators should ultimately retain some discretion to determine based on guidance. Clear guidance, certainly, but guidance, nonetheless,’’ she observes.
The new SRT tests are complex. The EBA’s final report on significant risk transfer finalised the commensurate risk transfer tests, but they have introduced the requirement of a stress scenario, where banks must show that the structure can sustain two-thirds of unexpected losses without losses attaching to the retained senior tranche. The test is called the principle-based approach test (PBA). Consequently, the allocation of lifetime expected, and unexpected, losses plays a fundamental role in the tests.
However, the EBA calibrated the test based on a hypothetical pool of five-year corporate bullet loans, all of which mature on the same date with prepayments. According to bank structurers, the latter is a highly unrealistic scenario and the result is that virtually all deal structures with pro-rata amortisation fail the test.
One option is to construct the scenario based on the assumption that the time call would be exercised. In synthetic securitisations, time calls and the application of Article 252 of the CRR on maturity mismatches will affect the outcome of the tests. Time calls shorten the life of the deal and the stress test can accordingly be modelled to allocate losses to the protected tranches before amortisations have reduced them significantly.
However, Article 252 effectively stipulates that if there is a maturity mismatch between the credit protection and the underlying assets in a synthetic securitisation, then originators must take a haircut on the capital relief that they receive. Time calls that are structured with an incentive to call - such as step-up coupons - would be considered to have a maturity mismatch and the haircut would apply.
The same structurers note that the issue within the context of the new PBA test is that the stress test can only be calibrated to the time call’s date if there is a positive incentive for the bank to call the deal, in which case they must calculate the maturity mismatch under Article 252 and thus defeat the whole purpose of executing a capital relief trade.
If, on the other hand, lenders calibrate the scenario to the maturity of the underlying loans, they will usually fail the PBA test because of the unrealistic scenario that the banks must model. Nevertheless, the structurers note that the EBA has recognised this issue and they understand that they will be re-evaluating the formula considering the maturity mismatch issue.
Finally, the consultation opens the possibility of revising the non-neutrality correction factors. The factors allocate higher risk weights to securitisation tranches even if this does not correspond to the risk profile of the underlying portfolio. The situation has been rendered worse with the new Basel output floors, since the formula leads to less capital relief and hence more inefficient SRT trades.
Robert Bradbury, head of structuring and advisory at StormHarbour, concludes: ‘’The non-neutrality correction factors have been largely assumed as fixed until now, in some cases after much back-and-forth discussion, so the paper arguably opens up the possibility for changing some fundamental aspects of the framework in the future. Similar conclusions can be drawn for the LCR eligibility of STS securitisations. If STS securitisations qualify as level 2A assets rather than 2B, then that would be a potentially very major change on both the issuing and investing sides of the market.’’
Stelios Papadopoulos
News
Structured Finance
SCI Start the Week - 16 August
A review of SCI's latest content
Last week's news and analysis
Amortization antics
Vehicle inventory shortage forces ABS issuers to forestall amortization
CMBS fillip
Hotel sector leads recovery in US CMBS but retail still depressed
Downward trend
Corporate defaults continue to drop
Equity ownership
Lakemore Partners discuss plans to strengthen its US presence
Simulation analysis
Covid-19 boosts capital ratios
Sponsor momentum
Record-setting quarter for the ILS market
'Synergistic' CMBS prepped
Hollywood creative campus refinanced
For all of last week’s stories including ‘Market moves’ and ‘Risk transfer round-up’ click here.
Recent research to download
EIF risk-sharing deals - August 2021
Risk-sharing deals involving the EIF and private investors are yet to gain ground. This CRT Premium Content article surveys the likelihood of such collaborations going forward.
Euro ABS/MBS primary pricing - Summer 2021
In this first in a new series of Euro ABS/MBS premium content articles, we examine the demand and consequent pricing dynamics seen across European and UK ABS, CMBS and RMBS new issuance in Q2 and July 2021. Read this free report to discover coverage levels for every widely marketed deal and the impact on price movements broken down sector by sector.
CLO Case Study - Summer 2021
In this latest in the series of SCI CLO Case Studies, we examine the uptake of loss mitigation loan language in European deals since the concept emerged a year ago. Read this free report to find out the background, challenges and deal numbers involved in the necessary significant documentation rewrite required.
Upcoming events
SCI's 3rd Annual NPL Securitisation Seminar
14 September 2021, Virtual Event
The volume of non-performing loans on European bank balance sheets is expected to increase due to Covid-19 stress and securitisation is recognised by policymakers as key to enabling these assets to be disposed of. SCI’s NPL Securitisation Seminar explores the impact of the coronavirus fallout on performance and issuance, as well as on pricing assumptions, servicing and workout trends across the European market. Together with recent regulatory developments, the event examines the establishment of an asset protection scheme in Greece and the emergence of synthetic NPL ABS.
SCI's 7th Capital Relief Trades Seminar
13 October 2021, In Person
Event
Last year saw significant regulatory developments in connection with capital relief trades, including the publication of the EBA’s final SRT report and the introduction of an STS synthetics regime. SCI’s Capital Relief Trades Seminar will explore the impact of these developments, as well as the latest trends and activity across the sector.
News
Capital Relief Trades
Chowa finalised
NatWest executes leveraged loan SRT
NatWest has finalised a significant risk transfer transaction referencing leveraged loans. Dubbed Project Chowa, the synthetic securitisation was issued under the Nightingale programme and is a boost to this year’s leveraged loan SRT issuance.
The second loss deal features a 10% tranche thickness (1.5%-11.5%) and comes on the back of another leveraged loan SRT, called Sauble, from BMO that was executed in June (SCI 12 July). NatWest attempted to close Chowa last year, but alleged pricing discrepancies between the originator and investors precluded it from moving forward. The latter would not be surprising in 2020, since CRT investors opted for the most part for large corporate loans as the coronavirus crisis rocked markets.
Indeed, corporates have large, diversified balance sheets and access to capital markets, with plenty of disclosure that allows investors to formulate a view on the underlying default risk. NatWest itself couldn’t escape these market forces, as evidenced by a corporate SRT it closed in December 2020 (SCI 14 December 2020).
Second, leveraged loan and corporate default rates have been dropping (SCI 12 August). According to an S&P report from June, the S&P/LSTA leveraged loan index issuer default rate is expected to fall to around 1.75% by March 2022 from April’s 2.7%. The amount of liquidity available to speculative-grade issuers since the pandemic began, together with the improved trajectory for near-term economic growth should limit defaults in the leveraged loan index over the next 12 months.
The execution of Chowa reflects broader market sentiment. Similar to leveraged loans, appetite for Southern European SME pools last year was restricted to the EIF. But private investors have been slowly returning to the asset class, as shown by transactions in Greece, Italy and, more recently, Portugal (SCI 4 August).
Stelios Papadopoulos
News
Capital Relief Trades
Financing boost
EGF extended to synthetics
The European Commission has approved the extension of the EIB’s European Guarantee Fund’s support to synthetic securitisations, following an assessment of EU state aid rules. The extension to significant risk transfer deals applies under certain conditions pertaining to SME origination levels and the deployment of released capital.
The envisaged €1.4bn budget is expected to mobilise at least €13bn of new SME lending. This is a significant contribution to the overall target for the European Guarantee Fund to mobilise up to €200bn of additional financing in the 22 participating member states (SCI 27 May 2020). The participating member states are Austria, Belgium, Bulgaria, Croatia, Cyprus, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Lithuania, Luxemburg, Malta, the Netherlands, Poland, Portugal, Slovakia, Slovenia, Spain and Sweden.
The European Council endorsed the establishment of the European Guarantee Fund in April 2020 under the management of the EIB Group, as part of the overall EU response to the coronavirus outbreak. It is one of the three safety nets agreed by the European Council to mitigate the economic impact on workers, businesses and countries. So far, the EIB and the EIF have approved a total of €17.8bn worth of projects under the fund, which are expected to lead to some €143.2bn in total mobilised investments.
The private and bespoke nature of synthetic securitisations render them hard to assess for state aid purposes - unlike the Italian GACS scheme, for instance, where the government guarantee is market priced and calculated based on a basket of single name CDS. ‘’This is why it took over a year to extend the financial support of the European Guarantee Fund to synthetic securitisations,’’ says Daniela Francovicchio, senior structured finance manager at the EIF.
She continues: ‘’Because of this, we had to negotiate certain restrictions or ‘safeguards’ for our synthetic securitisations, including SME origination characteristics - such as levels and weighted average life - in return for the capital relief, as well as how much capital released should be redeployed. The capital deployment constraints prevent any one lender from acquiring a competitive advantage, which is important for state aid assessments and offers meaningful support to European SMEs.’’
The Commission produced its assessment under Article 107(3)(b) of the Treaty on the Functioning of the European Union (TFEU). The latter enables the Commission to approve state aid measures to remedy severe economic disruption.
The financing boost of the European Guarantee Fund will enable the EIF to guarantee for the first time first-loss risk as an alternative to mezzanine tranches. But any enhanced capital relief following the hedging of the riskier junior tranches will have to be accompanied by higher SME origination levels.
Synthetic securitisations will continue to benefit from the support of the European Guarantee Fund until July 2022.
Stelios Papadopoulos
News
CMBS
There's gold in them thar malls
Retail CMBS notes have bucked the recovery, but rewards are there
The currently much-spurned retail CMBS market contains pockets of great value, according to Karlis Ulmanis, portfolio manager at DuPont Capital.
In general, CMBS spreads have bounced back to pre-pandemic levels. CMBS based on the hotel sector have made great strides lately, for example. This week Fitch removed 14 single borrower hotel deals from negative ratings watch.
But CMBS deals exposed to retail credit have lagged this broad improvement, and this investor fear allows discerning investors to buy notes that have the potential for very considerable price improvement.
For example, Ulmanis speaks of one retail CMBS bond that he bought at the beginning of March at a price of 91.5 and now is priced above par. Moreover this gain was realised in only the last seven days.
“A lot of people haven’t realised what is going on and that allows me to fill my bucket. I don’t mind investing in bonds that are above the Bloomberg BVAL valuation because the pricing service hasn’t caught up but when it does I get that back and a lot more besides,” he says.
This is, however, a short-term strategy. The prospects of retail CMBS notes over the longer haul are not impressive due to the likelihood that digital shopping will continue to gain ground. Moreover, notes with longer maturities inevitably carry greater interest rate risk.
Consequently, Ulmanis is looking for notes with a short WAL and high upfront coupons. He is drawn to notes issued in the 2011-2014 window as such notes were generously priced to tempt investors back into the CMBS market after the disasters of the Financial Crisis. Older deals also have had enough time to incorporate greater property price appreciation which has lowered the LTVs.
“There’s still obviously credit risk in this sector but there are so many other factors that make me comfortable owning these bonds,” he says.
The unnamed bond which was at 91.5 last week, for example, rated A- by S&P and BBB- by Fitch, is a 2012 vintage conduit CMBS offering consisting of 28 loans with a composition of 19% defeased, 23% anchored retail, 19% mixed use, 15% office and 8% hospitality.
It carries a 4.7% coupon, and currently yields around 4%. When it was valued at 91.5, it yielded 12.84%, or a whopping 1265bp over the swaps curve. During the worst of the Covid-related sell-off in April 2020 it collapsed to 60.5.
Ulmanis uses a valuation methodology he developed to identify areas of interest. This incorporates such metrics as the LTV, debt service coverage ratio, occupancy, credit enhancement, WAL, NOI trends, servicer advances and payment histories. Of these, he values the information provided by the LTV score a little more highly than the other.
One of the unique features of this his process is that the characteristics of each individual loan are evaluated rather than the CMBS deal as a whole. This approach is particularly useful when it comes to consideration of the LTV risk.
For example, if a pool has 50% of its loans with a 100% LTV and the remaining 50% possess a 5% LTV, then this produces an aggregated LTV of a little over 50%. But the bond is considerably more risky than a pool in which every loan has an LTV of a little over 50%.
“The actual safety margin is driven by the highest LTV loans in the pool which are the most likely to incur a loss. Our approach shows the virtue of looking at individual loans because generally the LTVs are combined and skew the reading,” he says.
Ulmanis manages, as of 30/6/2021, a $745m portfolio consisting of structured products and RMBS investments. DuPont has, also as of 30/6/2021, $27.4bn AUM.
Simon Boughey
News
RMBS
Unanswered questions
Mixed outlook for the UK RMBS market
The outlook for the UK RMBS market is mixed for the rest of the year. Indeed, questions remain over issuance volumes and performance once the furlough scheme ends on 30 September.
UK collateral has constituted 67% of total European RMBS issuance so far this year. At €12.3bn, UK non-conforming RMBS issuance year-to-date has already crossed Deutsche Bank’s full-year forecast of €12bn, while UK BTL issuance - totalling €2.8bn - is within touching distance of the bank’s forecast of €3bn.
“This hasn’t been the most active year in UK BTL issuance – which isn’t surprising. Our prediction at the start of the year was that 2021 would be similar to 2020 but lower than 2019, in terms of issuances,” says Ketan Thaker, head of European RMBS and covered bonds at DBRS Morningstar.
Although RMBS issuance levels are lower than last year, Thaker notes that BTL mortgage lending volumes have been healthy and the mortgage market remains active. “The stamp duty holiday has been a factor in increased BTL mortgage volumes and investment property purchases. I would expect that once the holiday is over, in Q4, we will see a decrease in activity.”
Thaker expects RMBS issuance volumes will remain soft for the rest of the year and he doesn’t expect to see a significant increase in BTL RMBS transactions. “The RMBS market has fared well during the pandemic – a lot of the borrowers took payment holidays. However, we see that this has reduced significantly now and the positive thing is that the majority of people that have come of these holidays are performing.”
He adds that on the mortgage credit performance side, borrowers have performed reasonably well, considering pandemic-induced stresses. “There is reasonable demand on the asset class and the sector has escaped the worst of the pandemic. We remain hopeful that the sector will perform well for the rest of 2021.”
UK prime and BTL arrears remain minimal in absolute terms, while UK non-conforming arrears are ticking higher, yet are significantly lower than during the peak of the financial crisis. Overall, Alastair Bigley, senior director, sector lead European RMBS at S&P, says that most market participants expect some level of deterioration after the end of September in terms of asset performance.
He concludes: “It has been a bit of a journey – however, things never got as bad as people expected in April 2020. Inevitably, there is always the question mark of what happens when the furlough scheme ends. There is an acknowledgement of some level of uncertainty in the air.”
Angela Sharda
Provider Profile
Structured Finance
Pretium steps out
New hires signal new products and added depth to old ones
The three key hires that specialist mortgage and real estate investment manager Pretium announced earlier this month signal its intention to widen its footprint in the US residential mortgage space by adding depth in existing product ranges but also adding new instruments to the roster.
Sarah Kong joins the resi credit trading team as head of mortgage whole loan trading from Goldman Sachs - quite often a dependable farm team for senior Pretium executives. Her mandate is to complement the trading team and expand the product base.
Andrew Miller joins Pretium from Fortress Investment Group to build up a mortgage servicing rights (MSR) business, which constitutes a new line of business for the firm.
Peter Morreale comes to Pretium from Cadwalader, Wickersham and Taft and brings 20 years of experience of securitization law. In addition to its buy-side capabilities, Pretium is an issuer of securitized debt derived from its mortgage assets, RPLs and NPLs, and generally sells between $2bn and $3bn per annum. Morreale’s hire signals its intention to be more active in this sphere.
“If you add Sarah and Andrew to increase and grow your business, then you add Peter to keep up with its growth. Peter was hired specifically so we can be more active in securitizations,” explains co-head of residential credit Jonathan Babkow, another Goldman alumnus.
The addition of a MSR capability adds an important new dimension to the firm, explains Babkow. Not only does it marry with the existing mortgage origination business MSR tends to prosper in a rising rate environment.
All in all, Pretium feels positive about the US mortgage market and its role in it. Not only are house prices soaring with no end in sight, the firm sees opportunities for customers that are currently underserved by the existing banking structure.
For example, banks tend to eschew potential home loan borrowers without traditional employment status, backed up W2 tax filing, but an increasing proportion of the US working population is self-employed. Banks haven’t yet caught up to this sea change.
Moreover, the current Washington administration has made it a clear priority to expand credit. The central and established role of the GSEs is thus likely to continue unabated.
“Add it all together and we see there being more mortgage products we can invest in. There are a lot of legs to the mortgage market,” says Babkow.
The expansion of credit will also mean an expansion of MSRs. By building out this new business, Pretium hopes to grow its existing origination business. One will help the other.
Babkow also notes the current paucity of good MSRs in the market apart from banks.
The buy/sell firm, now with $26bn in assets, was founded in 2012. In addition to its resi real estate and resi credit business lines, it also has a corporate credit market.
The real estate business was the first piece of the puzzle, to which single family mortgages were added in 2014 and the corporate credit business in 2017.
Simon Boughey
Market Moves
Structured Finance
Corporate, PF businesses bolstered
Sector developments and company hires
Corporate, PF businesses bolstered
KBRA has enhanced its corporate and project finance businesses by forming new sector teams to focus on the intersection of infrastructure, energy, renewables and middle market lending. The aim of the sector-focused teams is to meet demand for KBRA’s thought leadership across these segments.
Andrew Giudici, senior md and global head of corporate, project and infrastructure finance at KBRA, will oversee this effort. Three new sector leads have also been appointed to run the teams.
Marisol Gonzalez de Cosio will lead the infrastructure team, focusing on companies and projects financing social infrastructure and other non-energy related projects. She is an md at KBRA, having joined the rating agency in May 2016. Before that, she worked at S&P, including in its emerging markets structured finance group.
Shane Olaleye will lead the power, energy and renewable finance team, concentrating on companies and projects operating in the dynamic power and energy sectors. He is a senior director at KBRA, having joined the agency in June 2016 from Morgan Stanley Investment Management.
Finally, Steve Schutzman will lead the corporate credit evaluation team to focus on the growing use of KBRA's credit assessments in funds, structured credit and ABS transactions. He is an md and joined the agency in December 2016 from RBC.
EMEA
Barclays has hired Jekaterina Muhametova as a CLO structurer, based in London. She was previously a CLO credit analyst at S&P, which she joined in August 2015.
Gordon Kerr is set to join KBRA later this month as md and head of European structured finance research. Kerr brings more than 20 years of experience to the role, most recently serving as head of structured finance research for Europe at DBRS, which he joined in April 2013. Before that, he was head of European securitised products research at Citi.
North America
Greystone has strengthened its CMBS lending and special servicing groups. Brett Gaffan has joined the former as a senior md, based in New York. In this role, he will focus on CMBS loan production and report to Rob Russell, president of special servicing.
With over 20 years of CMBS sector experience, Gaffan joins Greystone from Societe Generale, where he served as a director responsible for CMBS, mezzanine and floating-rate balance sheet CRE loans. Prior to that, he held various CMBS loan origination roles at Barclays, CIBC and Morgan Stanley.
Meanwhile, David King has joined Greystone’s special servicing group as an md, reporting to Russell. King is tasked with driving strategic growth of the division, which currently manages a portfolio of assets totaling US$21.1bn.
He joins Greystone from CWCapital Asset Management, where he served as svp and head of CRE credit and underwriting, overseeing the acquisition of servicing rights on over US$125bn of new issue CMBS and agency subordinate bond offerings. Prior to CWCapital, King was an acquisitions associate at Stoltz Real Estate Partners.
Wilmington Trust has added three senior relationship managers within its CLO and loan administration division – Henry Brigham, Willis Hwang and David Knecht. Brigham and Hwang will be responsible for managing client relationships, including onboarding and ongoing servicing, while Knecht will be responsible for managing client relationships and overseeing the loan processing team focused on quality control and data integrity.
The trio joins from Deutsche Bank's corporate trust unit and collectively brings over 43 years of experience in CLO trustee and loan administration services. All three will be based in Wilmington Trust's Costa Mesa, California office and report to CLO and loan administration head Richard Britt.
Market Moves
Structured Finance
APAC ILS issuance on the rise
Sector developments and company hires
APAC ILS issuance on the rise
Continued efforts from Asia Pacific reinsurers to source alternative capital through the ILS market is anticipated, following on the heels of the seven catastrophe bonds that were issued using Singapore-domiciled vehicles through July. Indeed, the first Hong Kong-domiciled catastrophe bond is being prepped.
The Singapore cat bonds issued in 2021 comprise: Security First Insurance Company’s US$225m First Coast Re III; Universal Property and Casualty Insurance Company’s US$150m Cosaint Re Series 2021-1; Tokio Marine & Nichido Fire Insurance Co’s US$150m Kizuna Re III; Palomar Speciality Insurance Company’s US$400m Torrey Pines Re Series 2021-1; St Johns Insurance Company’s US$120m Putnam Re Series 2021-1; Tokio Marine & Nichido Fire Insurance Co’s Umigame Re Series 2021-1; and Frontline Insurance & First Protective Insurance Company’s Astro Re Series 2021-1. In addition, MS Amlin Asia Pacific launched a locally domiciled special purpose reinsurance vehicle named Phoenix 1 Re in January (SCI 27 January), becoming the first Singapore-domiciled sidecar transaction to solely feature APAC (excluding Japan and Australia) catastrophe risks.
Hong Kong is also progressing its plans to become a regional hub for the insurance-linked market, with the regulator introducing a grant scheme that covers some of the costs of issuing a catastrophe bond in the region. Greater Bay Re has since been registered as an ILS SPV to issue a catastrophe bond on behalf of China Reinsurance in Hong Kong, according to Fitch.
“We think potential catastrophe bond issuers will be from countries whose reinsurers have lower profitability, such as Japan and China, given the urgency to lower the cost of capital. On the other hand, reinsurers in Indonesia and Korea may enter the market later,” the rating agency suggests.
Fallback language updated
The Alternative Reference Rates Committee (ARRC) Securitization Working Group has released a supplemental update to its recommended contractual fallback language for US dollar Libor securitisations. In March, the ARRC confirmed that announcements by ICE Benchmark Administration (IBA) and the UK FCA constitute a benchmark transition event, with respect to all US dollar Libor settings, officially beginning the transition process. The supplemental update amends the definition of a benchmark transition event within the recommended fallback language to acknowledge its occurrence as a result of the March 2021 IBA/FCA announcements.
NN IP acquired
Goldman Sachs is set to acquire NN Investment Partners from NN Group for approximately €1.6bn. The transaction is expected to close by end-1Q22, subject to regulatory and other approvals and conditions.
NN Investment Partners has approximately US$355bn in assets under supervision and approximately US$70bn in assets under advice. The firm employs more than 900 professionals in 15 countries and combines the use of data and technology with fundamental analysis in its investment processes.
NN Investment Partners’ employees will join Goldman Sachs Asset Management following the closing of the transaction, with the Netherlands becoming a significant location in Goldman’s European business. The bank believes that NN Investment Partners’ expertise will strengthen its fund management and distribution platform across retail and institutional channels in Europe, particularly in investment grade credit and green bonds.
As part of the agreement, Goldman Sachs Asset Management will enter into a long-term strategic partnership agreement with NN Group to manage an approximately US$190bn portfolio of assets, reflecting the business’ global insurance asset management capabilities and alternatives franchise.
Pro-rata loss allocation warning
Rules on pro-rata loss allocation in some non-Fitch-rated EMEA multi-loan CMBS expose senior bonds to risks inconsistent with their high ratings, Fitch reports. The agency notes that senior investors in affected CMBS could share exposure to loan losses with holders of notes rated multiple categories lower.
Fitch-rated multi-loan CMBS preserve the loss-absorbing capacity of junior classes by being fully or substantially sequential, becoming permanently sequential upon any loan defaulting or adjusting pro-rata pay for actual or deemed loss. However, Fitch warns that credit enhancement (CE) in some other multi-loan CMBS could collapse, depending on when loans potentially default and others pay off.
The agency cites an example where, prior to a performing loan paying off, another loan defaults and recovers some principal (sequentially) while suffering a loss. When the performing loan pays off (pro rata), the most senior notes then outstanding will share a portion of the prior loan losses with junior classes.
“This results from not netting off actual or deemed loss from notes’ principal amount outstanding (PAO) used to weight pro-rata distributions,” Fitch explains. “Performing principal will therefore continue to be paid pro rata to classes that would otherwise have been written off. Adverse outcomes - such as jump-to-default of class A notes - become possible, given the volatility of risk drivers caused by this structural flaw.”
Not all EMEA multi-loan CMBS featuring pro-rata allocation of performing principal expose senior notes to this risk. In the Fitch-rated Taurus 2021-4 UK, for example, if one loan defaults and returns some recoveries, the notes’ PAO reduces for two amounts - the actual amortisation caused by sequential allocation of principal recoveries, and the reverse-sequential allocation of the loan’s actual or deemed loss.
Reducing junior note classes’ PAO – and the principal paid to them pro rata from the performing loan – ensures they absorb loan losses, although this does not fully eliminate risks from pro-rata pay.
Upscale hotels hit hardest by business travel dip
US conduit CMBS lodging delinquencies continue to decline from early pandemic highs, but remain elevated at 19.5%, according to KBRA figures. A review of these loans undertaken by the rating agency indicates that delinquency levels continue to be negatively influenced by the higher delinquency rates of hotel chains that focus on business and conference travel.
The KBRA study shows that within the chain scales, the upper upscale chain had the highest delinquency rate (at 23% of outstanding principal balance), with Sheraton, Marriott and Hilton posting some of the higher delinquency rates (up to 46.8%). The high delinquency rate parallels the upper upscale chain’s revenue per available room (RevPAR) performance, which also had the largest RevPAR decline (38.7%) among the chain scales, when comparing June 2019 to June 2021.
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