Contents

ABS

Nascent asset class

Non-performing lease ABS tipped for growth

Issuance of ABS backed by Italian non-performing leases is expected to reach €1bn over the next year, partially driven by increased defaults following the expiry of payment holidays. Recent legal developments and GACS-eligibility of the assets should also facilitate securitisation activity.

“The recent market conditions and legal framework developments have facilitated non-performing lease securitisations. The key challenges for the lease asset class will be gradually overcome,” says Rossella Ghidoni, director of structured finance at Scope Group.

As of December 2020, the stock of non-performing exposures (NPE) in the Italian lease market amounted to €11.4bn, around 23% lower than the previous year and 57% lower than the level reached six years ago. The sector faces three main challenges, one of which is the timing of recoveries, which can be volatile and uncertain given that it depends largely on the length of repossession, regularisation and sales activities for the leased assets.

Lease recoveries also pose hurdles as costs are higher and more uncertain than for non-performing loans. They relate mainly to recurring property management costs, whereas NPL costs are mainly one-off legal costs.

Finally, there are few specialised leasing asset servicers in Italy, in comparison to other jurisdictions - such as Spain and Portugal - where the repossession strategy is more common.

However, Ghidoni is hopeful that servicers will establish partnerships with real estate providers, to strengthen their capabilities for the management and the sale in the open market of the leased assets - skills that are less relevant for NPLs, where mortgaged assets undergo judicial sales. Strong real estate skills will shorten the total timing of collections, reducing the recurrent costs.

Elsewhere, in Spain, Portugal and Cyprus, mortgaged assets are typically repossessed before being sold in the open market. From this perspective, mortgage properties in those jurisdictions are similar to leased properties in Italy that can be sold only after being repossessed and transferred to a leasing company.

Ghidoni notes: “Unlike Cyprus, which has an embryonic servicing market, Spain and Portugal have a good number of servicers that have built specific real estate expertise to manage and prepare repossessed assets for sale. By contrast, the number of Italian servicers with such capabilities is modest.”

Overall, the non-performing lease sector is a nascent asset class. In volume terms, the lease asset class is modest compared to NPLs, and most of the deleveraging in the segment so far is due to disposals rather than securitisations. Indeed, prior to 2020, no public securitisations backed by non-performing leases were issued.

Ghidoni concludes: “Last year, the first two [non-performing lease ABS] were issued and we expect further securitisations up to €1bn by next year. The recent legal developments and the eligibility of the asset class for the state guarantee (GACS) will facilitate non-performing lease securitisations.”

Angela Sharda

CMBS

School's out?

Future of PBSA CMBS sector scrutinised

Conflicting factors such as depressed occupancy levels and excellent collateral properties, or a high dependence of international students and propitious domestic demographics, suggest that purpose-built student accommodation (PBSA) CMBS is a complex asset class. Whether the sector will ever recover from its Covid-induced collapse is a moot question.

A recent TwentyFour Asset Management blog questioned whether there is value in student housing CMBS. Contextualising such thought in light of the latest Taurus 2021-5 UK deal, it came to the conclusion that the asset class was at risk - following the Covid-19 crisis - of a prejudicial structural change.

“It is a difficult asset class to analyse, but also one which is riskier than it might actually appear to be,” notes Conor Downey, partner at gunnercooke. “Many deals are heavily reliant on international scholarship students, whose scholarships require them to pay a full year’s rent upfront.”

Of course, such students and thus a core segment of the UK student accommodation market have been significantly affected by recent geopolitical events. Indeed, the asset class was highly impacted by Covid-19-related travel restrictions and social-distancing rules. For instance, the valuation report for Taurus 2021-5 UK indicated that the pandemic caused a considerable occupancy decline for the portfolio to 71%, from historical levels of 97%-98%.

The sector did, however, experience record-breaking investment in 2019 and 2020. Figures suggest that the volume of transactions hit £5bn in 2019 and neared £6bn in 2020.

TwentyFour AM’s blog further points out that yields have come in significantly from the highs of 6.5%-7% in the early 2010s, especially in London. Despite the pandemic, the market has held up well, as exemplified by a June 2021 transaction of a London property closing at a yield of 3.8%.

Such figures are, however, calculated based on an assumption of nearly full occupancy. Evidently, these levels will be hard to attain in a post-pandemic environment.

Downey also highlights that the sector suffers from a certain inconsistency. “CMBS issuance in this sector has been sporadic over the last 10 years or so,” he argues. “Investors want single loans - £200m-300m at least - with a slightly higher interest rate and big-name sponsors. Needless to say that such deals do not come too often.”

Downey further highlights the speculative nature of such portfolios - particularly outside the spectrum of securitisation. “Another factor to bear mind is that quite a lot of companies out there will sell the individual units or flats to investors. A surprising amount of investment into these fractional ownership schemes - particularly from China - goes into student accommodation. Consequently, there is no real equity behind those deals.”

Looking ahead, there are nevertheless several mitigating factors for the PBSA sector. First of all, the demographics in the UK show the number of 18-year-olds increasing. The Universities and College Admissions Service (UCAS) in the UK also reported in February 2021 that the number of students that had applied to UK universities had increased by 8.5%.

“I think students do actually want the experience of physically going to university,” observes Downey. “Virtual lectures or distanced learning should not remain the norm in the long term. However, will we have the same volume of foreign students? That seems doubtful.”

The usual granularity of PBSA portfolios are also an obvious appeal for investors. “PBSA deals are obviously attractive for diversification reasons. It is a complex asset class subject to risk, which can make it a countercyclical product. It can function as an actual hedge against other investments,” Downey concludes.

Vincent Nadeau

Capital Relief Trades

Lower for longer?

SRTs to benefit from inflation

Significant risk transfer transactions are expected to receive a boost from anticipated interest rate rises, following increasing levels of inflation worldwide. Indeed, SRTs are floaters offering positive real returns, along with diversification and access to core bank lending books. However, investors remain cautious over the impact that significant increases in interest rates could have on growth.    

If interest rates go up as expected, the value of fixed-rate government and corporate bonds will drop and floating rate products such as loans will be in high demand. However, the high-quality institutional loan universe is limited and won’t be able to absorb all investment flows rotating out of bonds. Hence, investors will have to search for ‘alternatives’, including significant risk transfer transactions.

According to James King, portfolio manager at M&G: ‘’If your bond is delivering a couple of percentage points and inflation is at 4%-5%, you’ve gone from making a positive real return to a negative one. SRTs remain one of the few places where you can make a positive real return, given their illiquid and complex nature.”

Moreover, ‘’SRT premiums are largely non-directional, since investors aren’t taking any specific views on the market, so it’s a premium over pure credit risk,’’ says Michael Sandigursky, cio at Whitecroft Capital.

Nevertheless, SRTs are not the only floating rate product offering positive real returns. Currently, private debt investors make allocations to leveraged loans and direct lending strategies. These strategies provide a floating rate and have a relatively high yield.

According to Whitecroft Capital research, single-Bs are now yielding 3%-4% and triple-Cs around 7%. Direct lending funds yield roughly 7% and invest mostly in unrated companies, which can’t access bank loans.

However, the same research qualifies that the average one-year probability of default for a single-B credit is around 5% and for a triple-C it’s 12% and above. By contrast, the average credit quality of a bank’s loan book is BBB-/BB+ - the type of exposure that synthetic securitisations typically offer - and roughly translates into 0.4%-0.6% of annual defaults.

Whitecroft’s research is further confirmed by arguably the most comprehensive report on SRT performance; namely, the EBA’s final report on STS synthetic securitisations (SCI 7 May 2020). According to EBA analysis, the average annual default rate for SRTs when broken down by asset class is 0.59% for SMEs - with a maximum reported amount of 1.77% - and below 1% for all other asset classes.

Kaelyn Abrell, partner and portfolio manager at ArrowMark Partners, comments: ‘’It is important to analyse both interest rate risk and credit risk in an inflationary environment. The floating-rate coupons of SRTs mitigate the impact of interest rate changes.”

She continues: “We also believe that the higher quality of SRT collateral pools relative to other alternatives mitigates credit risk, by reducing the potential of a material change in fundamentals depending on a business’s ability to pass-through higher costs. This highlights the importance of performing a quantitative and qualitative evaluation of individual collateral pool exposures prior to issuance.’’

The higher quality collateral is explained by the fact that SRTs allow investors to access core lending books and thus benefit from strong underwriting skills and customer relationships across the globe. Another benefit of synthetics is diversification, since bank lending offers diversification to a wealth of loans extended to millions of different firms, while leveraging a bank’s infrastructure - including credit officers, relationship managers and operational and service staff.

Consequently, significant risk transfer transactions amount to a strong hedge against inflation. However, King strikes a note of caution.

He states: ‘’If there are significant increases in rates due to uncontrollable inflation, there’s a danger that GDP might fall, so there are two sides to the story. Whatever the case, you must look at sectors that will act as a hedge and that will inform your underwriting. We are less concerned about consumer loans than, say, smaller corporates, but large investment grade corporates remain a haven.’’

Overall, markets don’t expect rate rises of more than 2%. But it remains unclear to what extent the current bout of inflation is a transitory or a more long-term phenomenon, which will inform decisions on policy rates.

Supply chain disruptions and labour shortages are arguably a temporary challenge. However, if supply chain disruptions extend into 2022 and labour shortages last over the winter, at the very least - as Algebris estimates - the global economy may well be dealing with a more long-lasting complication.

Analysts though believe that consumer prices are, in fact, close to peak. According to Moody’s: ‘’Enduring supply issues related to commodities, industrial inputs and labour will likely keep inflation elevated through the first half of 2022. However, we expect base effects to reverse and the impact of one-off price increases amid reopening pressures to fade through 2022. Thus, the inflation rate should decline from currently high levels in most countries.’’

Nevertheless, the elephant in the room here is the historic government stimulus programmes. Algebris cautions that the US is unlikely to return to a balanced budget any time soon. Historically, large US deficits take between four to seven years to close, implying at least another two years of spending above 2019 levels.

Meanwhile, in Europe, Covid fiscal stimulus lagged other developed markets with minus 7% GDP in 2020 versus minus 14% GDP in the US and the UK. This may imply that Europe will be slower to close that fiscal gap. In fact, of the €750bn EU Next Generation Fund, only 13% has been spent in 2021, with the remainder to be spent over 2022-2023.

Yet, putting aside any macroeconomic arguments around the drivers and nature of current inflationary trends, there’s an arguably more important dilemma trapping the major central banks that will likely keep rates low for longer, albeit with gradual rises.

‘’On the one hand, withdrawing emergency stimulus might look like a policy mistake, should Covid variants kick in again. On the other hand, persistent negative real rates are unwarranted, given the current level of price increases and job gains, and might lead to misallocation of resources and asset bubbles later,’’ says Algebris.

Therefore, gradual rises and low interest rates that remain persistently below inflation could be expected and that won’t hamper growth. Nevertheless, future gradual rises won’t be sufficient in themselves. In fact, communication will be equally important.   

Looking forward, Moody’s concludes: ‘’Over the next two years, the focus of fiscal policy will shift from stabilisation goals to the strengthening of long-term growth potential and debt sustainability. Monetary and financial conditions will tighten as central banks adopt a neutral stance as they look to remove pandemic-era liquidity and interest rate support. If the tightening is gradual and well communicated, we do not expect it to derail growth.’’

Stelios Papadopoulos

Structured Finance

SCI Start the Week - 15 November

A review of SCI's latest content

FREE Webinar tomorrow - Post pandemic GSE CRT performance
Register here to join a distinguished panel of US Credit Risk Transfer industry experts as they discuss the capital regime, issuance trends and the regulatory landscape. Webinar starts at 10:00am EST November 16.

Last week's news and analysis
Back to back STACR
Second STACR in just over a week hits the tape
Evolving landscape
Consolidation, fintech driving banking evolution in Ireland and the UK
Hedges eyed
CPMs target post-pandemic concentration risks
Hurdles ahead?
Dutch RMBS market continues to face challenges
Indian securitisation market presents challenges
Market remains quite restrictive for both issuers and investors
Irish rebound
Second NPL securitisation marketing
Market movers
Leading agency MBS buyer talks taper, inflation and origination
More of the same?
Euro auto ABS tipped for further diversification
Risk mitigation
Euro CLO wraps gaining traction
Some softening
European ABS/MBS market update
Too slow
Disappointing timeline for call for evidence on STS reform

For all of last week’s stories including ‘Market moves’ and ‘Risk transfer round-up’ click here.

Free report to download - US CRT Report 2021: Stepping Up
The US CRT market – as with every other area of society – was tested by the Covid-19 fallout. But the sector arguably finds itself in a stronger position now.
This SCI Special Report tracks the major developments in the US CRT market during the two years since JPMorgan completed its ground-breaking synthetic RMBS in October 2019, culminating in a sea-change in policymaker support for the sector ushered in by the Biden administration.

Recent Premium research to download
Irish & UK Banking Evolution - October 2021
Consolidation among lenders and the proliferation of fintechs is driving change in the Irish and UK banking sectors. This Premium Content article investigates the impact on the jurisdictions’ RMBS markets.
Defining 'Risk-sharing' - October 2021
Most practitioners agree that ‘risk-sharing transactions’ is the most appropriate moniker for capital relief trades, but there remains some divergence around the term. This CRT Premium Content article explores what it means for investors and issuers alike.
GACS, HAPS and more? - September 2021
Given the success of both GACS and HAPS in facilitating the development of a market for non-performing loans, and consequently bank deleveraging, could similar government-backed measures emerge in other European jurisdictions? This Euro ABS/MBS Premium Content article examines the prospects for the introduction of further national guarantee schemes.
SOFR and equity - September 2021
Term SOFR is expected to be the main replacement for US Libor. This SCI Premium content article explores the challenges the new benchmark presents to US CLO equity investors.

Capital Relief Trades

New tender, new CAS

Debut Fannie tender and new CAS in the market

Fannie Mae has announced a debut tender offer for seven old CAS notes, with an original principal balance of $3.22bn, following the example set by Freddie Mac two months ago.

The notes are the CAS 2016-C03, class 2M-2, the CAS 2016-C04, class 1M-2, the CAS 2017-C02, class 2M-2, the CAS 2017-C06, class 1M-2, the CAS 2018-C02, class 2M-2, the CAS 2018-C04, class 2M-2 and the CAS 2018-C05, class 1M-2.

The largest original principal balance is $598.9bn represented by the CAS 2018-C04, class 2M-2 and the smallest original principal balance is $301.5bn represented by the CAS 2017-C02, class 2M-2

Bank of America is the lead dealer manager for the offer with Barclays as dealer manager.  The tender offer will run until 5pm Eastern Time on November 19.

At the same time, Fannie Mae is also in the market with a new REMIC CAS deal, designated CAS 2021-R02, which is expected to price shortly.

The lead managers are Nomura and Citi, while co-managers are Bank of America, Morgan Stanley, StoneX and Wells Fargo.

The 10-tranche offering has an initial balance of $35.95bn, and the largest tranche is the $33.95bn unrated 2A-H. There are 124,973 loans incorporated into the collateral pool, with an average balance of $280,994 which range from $7,541 to $906,507.

This is the second CAS deal Fannie has brought since it returned to the market a month ago.

Fannie Mae has been unavailable for comment.

Simon Boughey

Capital Relief Trades

SRT wave

Capital call surge continues

Credit Agricole has finalised a €70m CLN that references a €2bn portfolio of capital call facilities. Dubbed Premium Green Series 2021-5, the transaction is riding a wave of such deals as banks eye concentration limits pertaining to the underlying exposures (SCI 25 June). The transaction pays three-month Euribor plus 7.2% and all tranches amortise on a pro-rata basis.

Capital call facilities are a form of finance provided by banks to private equity funds and are typically secured against investors’ undrawn commitments. Originators of capital relief trades backed by such exposures do not usually execute them for capital relief but to hedge concentration limits and grow this line of business.

Nevertheless, banks benefit from some RWA relief. The rationale for using this technology for growing the balance sheet - as opposed to just receiving a CET1 boost - has been gaining ground in the market.

Banks that have successfully executed such deals over the last two years include BNP Paribas, Citi, Societe Generale and Standard Chartered. Indeed, the growing trend coincides with a refocusing of CPM function priorities.

According to a new IACPM survey, the importance of front-end origination tools increased for all reported measures between 2019-2021, with concentration limits ranking highest. Hedging exposures or risk mitigation is the main driver behind loan sales, credit risk insurance, financial guarantees, single name CDS and funded synthetic securitisations (SCI 12 November).       

Stelios Papadopoulos

Capital Relief Trades

SRT finalised

Credit Agricole completes capital relief trade

Credit Agricole has finalised a €168m five-year CLN that references a €2.8bn portfolio of corporate loans. Dubbed Premium Green 2021-4, the transaction is the French lender’s third significant risk transfer transaction this year and is more widely syndicated compared to previous corporate SRTs.

The transaction pays three-month Euribor plus 9.5% and all tranches amortise on a pro-rata basis. Further features include a portfolio that revolves over an eight-month replenishment period.

Corporate SRT issuance remains the dominant segment of the market, given the efficiencies of hedging such exposures – and, as the coronavirus crisis rocked markets last year, it was by far the most dominant segment. Large corporate deals are easier to underwrite, since investors can tap into widely available information from public sources, as well as more easily assess whether they will benefit from government stimulus and central bank funds.

Additionally, corporate revolver drawdowns last year boosted capital consumption and consequently the need for synthetic securitisations. However, as the market recovered in 2H20, banks and investors explored opportunities in other asset classes - including high LTV mortgages and capital call facilities to hedge concentration risks following the pandemic. Indeed, Credit Agricole has recently completed a transaction backed by capital call facilities for these reasons (SCI 16 November).         

Stelios Papadopoulos

Capital Relief Trades

Risk transfer round-up - 15 November

CRT sector developments and deal news

Citi is believed to be readying a capital relief trade backed by corporate loans. The transaction is expected to close in 4Q21. Santander is also rumoured to be readying its own corporate CRT for this quarter.

Meanwhile, Bank of Ireland is allegedly marketing another CRT from the Mespil programme, while Credit Suisse’s wealth management division is said to be prepping its own CRT called Athena. Indeed, Credit Suisse is believed to be working on another CRT, which is allegedly backed by US leveraged loans.  

CMBS

Optimisation impact

GSA CMBS exposure gauged

KBRA Credit Profile (KCP) has published a special report on US CMBS exposure to the General Services Administration (GSA), after federal agencies were instructed in June to evaluate new policies for the workplace, including remote-work strategies. The study finds that the leases for 116 properties – representing US$3.2bn in CMBS exposure – are past their termination date, thereby granting the GSA an option to terminate its lease at the property at any time.

As the independent US government agency that manages federal leases, the GSA has been tasked with consolidating and optimising the federal government’s footprint of more than 182 million square-feet across 7,800 leases. KCP suggests the move could have a considerable impact on commercial real estate markets nationwide.

One GSA initiative, dubbed Workplace 2030, aims to build on the success of remote work trends. The initiative outlines four primary objectives: reimagining the workplace, supporting real property strategies, providing smarter spaces and enabling workforce mobility. Efforts to achieve these objectives are already underway, as the GSA has contracted with multiple coworking providers - including WeWork - to consolidate and reduce its real estate footprint.

GSA leases are generally structured with early termination rights that allow for lease termination, in whole or in part, at any time following a specified date, subject to prior notice. This ‘rolling’ right to terminate differs from more traditional termination options seen in private sector leases, which allow for termination within a specified window, subject to sizable termination fees and more stringent notice requirements.

KCP has identified 317 properties collateralising 242 loans – representing US$10.57bn by allocated loan amount - across 233 CMBS transactions with exposure to a GSA tenant. From this sample, 434 individual GSA leases were identified with an aggregate footprint of 15.4 million square-feet, including more than 115 leases (over US$3bn) that can currently be terminated by the GSA.

There are 10 loans with a scheduled maturity date through 2023 that have 50% or more collateral exposure to the GSA. Most notable is the US$225.7m Two Independence Square loan, which is securitised across CSMC 2017-MOON, CSAIL 2017-CX9 and WFCM 2017-C39. The loan is secured by a fee simple interest in a 605,897 square-foot office property in Washington DC, where NASA occupies 99% pursuant to a lease that expires in August 2028.

Five loans within this cohort - US$89.8m by allocated loan amount - are exposed to a GSA lease scheduled to expire through year-end 2023. GSA is the sole tenant at each of the five collateral properties, which could further complicate refinancing prospects as these loans approach their respective scheduled maturities.

Indeed, the highest concentration of lease expirations (accounting for 43% of total GSA exposure) will occur through year-end 2023, according to KCP.

Corinne Smith

Capital Relief Trades

SRT chronicle: part one

In the first of a three-part series on bank risk transfer transactions, Olivier Renault* takes a historical view of the market

The bank balance sheet securitisation market has enjoyed significant growth over the past five years and looks set to continue apace on the back of clearer regulation, an increasing number of banks having acquired the technology and economic incentives for banks to free up risk-weighted assets (RWAs) rather than raising capital. In this series of articles, we will use significant risk transfer (SRT) – which is the EU regulatory terminology – to denote these securitisations, which are also referred to as balance sheet CLOs, bank risk-sharing transactions or ‘reg cap’ trades (SCI 29 October 2021). Our objective is to provide a historical perspective of the development of the SRT market, give a snapshot of the state of the market as of end-2021 and explore its prospects for growth in the next 5-10 years. While the SRT market includes both cash and synthetic securitisations, we will focus on the latter for this series, as it is by far the largest and most diverse one.

A synthetic SRT transaction involves a bank contractually transferring the risk of a tranche of a loan portfolio to an investor while remaining the holder and servicer of the portfolio¹. The transfer of risk is associated with a reduction in RWAs for the bank and therefore the transaction provides both risk and capital relief.

Historical perspective
Banks have used synthetic risk transfer to reduce RWAs since the 1990s, so the SRT market is not new. It has, however, evolved considerably over the past 30 years and the market has only existed in its current state (in terms of structures and nature of the risk transferred) since the implementation of Basel 2 from year-end 2007.

Under the previous regulatory regime (Basel 1), most transactions were supersenior hedges, where a counterparty sold protection to a hedging bank on the X%-100% tranche of a reference portfolio. The contract was typically a CDS and, due to restrictive definitions on eligible counterparties for RWA relief, many of the protection sellers ended up being other banks either intermediating the risk or keeping it in their trading books.

The Basel 2 regulatory standards - which are more risk-sensitive than Basel 1 - changed the banks’ incentives completely. Instead of having to hedge the senior risk, the banks got most of their capital benefits by protecting a junior tranche (first-loss or junior mezz) and retaining the senior unhedged with a low risk weight. The same remains true under Basel 3, albeit with a different methodology to calculate senior risk weights.

Figure 1 shows the number of transactions executed each year since 2010². The choice of the start date stems from: the fact that by that date, Basel 2 was implemented in most jurisdictions; and since 2010, transactions have all been real risk transfer trades with no bank-to-bank or short-dated year-end trades, while a few transactions executed during the 2008-2010 financial crisis lacked a genuine risk transfer element - which ended up tainting regulators’ perception of the asset class for many years. 

This chart only includes synthetic SRT transactions placed with private-sector investors; i.e. the many transactions executed by EIF/EIB and a few other public sector bodies are not included in the statistics.

While 2010-2014 saw a relatively small number of banks executing around 15 transactions per year on average, 2015-2020 saw a three-fold increase in the number of transactions and issuing banks. The inflection point in 2015 was to a large extent due to the ECB taking over banking supervision of the most significant financial institutions in the Eurozone from local regulators³. Prior to this date, local regulators in Italy, France and Spain were reluctant or even outright opposed to capital relief through synthetic risk transfer, while the ECB took an approach much closer to BaFin – the German regulator – which had long been comfortable with the technology.

In addition to more harmonised supervision, the clarification of a number of criteria by the EBA - most importantly related to what constitutes ‘significant risk transfer’ - was helpful in giving confidence to banks that they would execute transactions in the spirit of the rules set out by regulatory authorities.

The implementation of Basel 3 over the past decade has also given a lot of impetus to the SRT market, as banks were required to hold much more and higher quality capital. Consequently, freeing up RWAs became more economical for banks than raising capital on the liability side of their balance sheet.

2019 was the record year for the SRT market so far on all counts: highest volume issued (over US$12bn of junior tranches), largest number of transactions (around 60) placed with private investors⁴ and largest number of bank issuers (25). Several reasons explain this surge in issuance, including a very strong credit market with large demand at tight spreads making it very attractive for banks to issue and a temporary grandfathering of the Basel 2 supervisory formula for transactions executed before end-2019, which allowed banks to free up more capital than under the Basel 3 ‘SEC-IRBA’ formula.

The following year - which was marred by the beginning of the Covid-19 crisis - was a remarkable experience for the SRT market and should help consolidate the reputation of this product as a resilient and dependable capital management tool for banks and their regulators, and as a reliable source of investment opportunities for investors. Although volumes were down versus 2019 - which was an outlier for the reasons explained above - 2020 ended up delivering the second largest tranche volume and number of transactions on record, despite dramatic swings in structured credit markets and high uncertainties about credit fundamentals.

Perhaps counterintuitively issuance volumes in 2020 were actually limited by a lack of bank supply rather than investor demand. As part of Covid capital preservation measures, a number of regulators imposed dividend distribution restrictions to the banks while at the same time encouraging them not to take a too conservative approach to provisioning (in particular, for loans subject to payment moratoria).

Bank capital ratios therefore increased materially in 2020, making the need for capital relief less than in a normal year. Some banks decided therefore to reduce their SRT issuance for that year. In addition, the European Investment Bank group (EIB/EIF) executed a record number of transactions in 2020 (not included in our statistics), such that the gap in total volume between 2019 and 2020 was actually much lower than what is implied in Figure 1.

2021 marks a return to growth for the SRT market and the year is expected to close with issuance volumes second only to 2019 (at least US$11bn) across 50-plus transactions and around 25 issuing banks (see Figure 2), comprising traditionally active banks and a record number of first-time issuers, which bodes well for the continued growth of the market. A characteristic of 2021 is the extension of the Simple, Transparent and Standardised (STS) framework to SRT transactions, which will make it a lot easier for standardised banks to achieve an attractive cost of capital relief (see Box A for a discussion of STS).

In the second part of this series on bank risk transfer transactions, to be published next week, we will provide a snapshot of the state of the market as of end-2021.
 

Notes

1. More details of the structures are provided in Box B (see part two).
2. As transactions are mostly private, our database is probably incomplete. But we are confident that it covers over 90% of the market, including bilateral transactions.
3. The regulation on the Single Supervisory Mechanism (SSM) entered into force in August 2014.
4. 55 transactions are reported in Figure 2, but we expect our database to cover around 90% of total transactions.

*Olivier is a veteran of the SRT market and one of the leading originators and structurers on the asset class

Capital Relief Trades

The lessons of history

STACR founder Don Layton talks the early and current days of the market

In the latest Freddie Mac podcast former ceo Don Layton describes the birth of the CRT market and says that following the launch of the first STACR deal in early 2013 he was instructed by the FHFA to share the secret recipe with Fannie Mae.

“Interestingly, we were then told to take our documents and give them to Fannie Mae because the FHFA did not want them to take so much time to reinvent the wheel and they could then follow with their CAS bonds,” he recalls.

He says that the first FHFA GSE scorecard in spring 2012 advocated credit risk transfer, but when he arrived as the new ceo in May 2012 he found Freddie was “going around in circles” and the senior management and the board didn’t know what to make of the concept.

“I also learned from the FHFA that Fannie Mae had no interest in it and had done virtually nothing,” he adds, in conversation with current vp of single-family credit risk transfer Mike Reynolds.

Layton, however, came from a non-GSE background. He had spent the greater part of his career at JP Morgan and then JP Morgan Chase, occupying some very senior positions, including, for example, managing global capital markets and, from 2002-2004, serving as co-ceo of the investment bank.  These experiences profoundly coloured his views on how Freddie should proceed.

“I knew the buy and hold business was not a winner for a financial intermediary like a GSE or a bank, as it means you have too much concentration of risk and requires too much capital, and is usually low return,” he says.

He had seen the development of the syndicated loan mechanism and the concept of risk-sharing at JP Morgan in the early 1990s, for example.

Layton had also been involved in the evolution of bank capital concepts from the 1970s through to Basel I and knew that as CRT was about risk reduction it was also about capital reduction.

So, he had a clear roadmap and certainty of priorities when he came through the doors on his first day at Jones Branch Drive, McLean, Virginia.

“I arrive at Freddie Mac as the new ceo on Monday and by Thursday of the same week I was doing a deep dive into CRT. I overrode all management and board ambivalence and told them this something we had to do and why,” he says.

One of the first controversial decisions was to release loan data to the market so investors could assess risk and reward of STACR deals. Layton also had to preside over the development of an in-house capital system to determine the economic viability of the mechanism.

Looking back on those early years, Layton compares it to “Present at the Creation” -the memoir by Harry Truman’s famed secretary of state Dean Acheson about momentous foreign policy decisions that shaped the post-war world.

Nine years on, the CRT mechanism has gone through ups and downs, often in rapid succession, but with safe negotiation of Covid turmoil and the advent of Sandra Thompson’s regime at the FHFA it appears to be once again in an up period. Layton is convinced that it delivers two major benefits to the GSE sector.

Firstly, it reduces systemic risk. Until it came along the GSEs were a “giant glob of trillions of dollars of single family mortgage risk… and this didn’t work very well in 2008,” he says. CRT is the only method which can diversify risk.

Secondly, it provides market discipline, and this is particularly pertinent given the periodic waves of criticism the GSEs attract from both sides of the political divide. The GSE credit box is deemed either too loose or too tight, too generous or not generous enough, but the CRT market provides irrefutable evidence of the right market price for mortgage risk.

“We now have over 100 large financial institutions and investors who are deciding what an acceptable credit is and what they’ll pay for it, putting hard cash on the line,” he says.

Opponents inside the Beltway have also sometimes claimed that the CRT market is only open when conditions are propitious and could be shut for years on end, but in fact the evidence of the last decade indicates that the sector is far more resilient than its naysayers suggest.

During the Covid crisis it suffered losses, but remained open, and by May/June 2020 signalled it was willing to on new risk.

“Since we started in 2013 up until the pandemic hit, I estimate - and I’m not exaggerating here - it was available 99% of the time. I only remember it shutting for a short period of time with the surprise vote on Brexit - which obviously has nothing to do with mortgages in the US,” he says.

Simon Boughey

Structured Finance

ESG exclusion checklist unveiled

Sector developments and company hires

ESG exclusion checklist unveiled
The European Leveraged Finance Association (ELFA) has launched an ESG exclusion checklist for business activities, which aims to streamline the negative screening and exclusion process for CLO managers. The checklist is designed for arranging banks to complete at the time of a new corporate loan or bond syndication to help investors quickly determine if a corporate borrower is a suitable investment candidate based on their ESG criteria. It will also allow the corporate borrower to publish the data to its entire syndicate.

The ESG exclusion checklist provides information on the percent of revenue that a company derives from a range of areas that might touch on an investor’s internal ESG guidelines. Areas for consideration include weapons, tobacco, thermal coal, fossil fuels, gambling, hazardous chemicals and waste, intensive farming and palm oil.

The checklist also includes a specific section for utilities companies, asking the corporate borrower to declare the percentage of electricity generated by thermal coal, liquid fuels (oil), natural gas and nuclear generation. Corporate borrowers may also indicate if they are a signatory of the UN Global Compact principles and if they are in breach of any of the principles.

The checklist was produced as a collaborative effort across ELFA’s Loan Investor Committee, CLO Investor Committee and ESG Committee. The association is consulting with market participants on the checklist until 15 December and plans to release a final document in January 2022, following the consultation period. The tool will then be updated on a biannual basis to ensure it remains relevant and in line with latest market trends.

EMEA
Gallagher Re has hired Theo Norris as a dedicated cyber ILS broker, having previously worked as ILS avp at Aon Securities. Norris marks the tenth new hire in cyber reinsurance at the global reinsurance broker this year, and will lead the firm’s development of new and alternative capacity in the growing cyber ILS market.

Global
AXIS Capital Holdings has announced two new hires amid the expansion of its ILS team. The new appointments will join the recently rebranded capital unit at AXIS, in a bid to enhance global services for both clients and investors.

Patrick Witteveen will join the team in Zurich as the new head of AXIS ILS business development, effective 1 February 2022. He has over 20 years of experience and was most recently head of investor relations and business development at Securis Investment Partners.

Additionally, Kyle Freeman joins the firm as the new head of ILS structuring, property, in Boston - effective immediately. He was recently head of North America programmes pricing at AXA XL.

Italian NPL acquisition agreed
Banca Ifis has completed a record acquisition of non-performing loans from Cerberus for a total of €2.8bn, marking the largest true sale of NPLs in Italy this year and enabling the bank to reach its 2021 target for NPL portfolio acquisitions, equal to approximately €3bn. The stock comprises approximately 300,000 unsecured loans originated by Italian banks and financial institutions. The receivables - due from retail customers - mainly derive from consumer loan contracts.

As a result of this transaction, the Banca Ifis Group’s proprietary portfolio now stands at a nominal amount of €21.8bn. This is in addition to €3.4bn in management on behalf of third parties.

Structured finance group formed
Blackstone has formed a structured finance group, which brings together Blackstone Real Estate Debt Strategies (BREDS) and the firm’s various asset-backed finance activities. The formation of this combined group is expected to drive further scale in Blackstone’s lending capabilities across a variety of asset-backed finance markets, including consumer finance, real estate, transportation, trade receivables, fund finance and digital infrastructure.

Jonathan Pollack, currently global head of BREDS, has been named global head of the structured finance group. Timothy Johnson, currently global head of originations for BREDS, will become global head of BREDS, overseeing all commercial and residential lending activities.

Rob Camacho will continue to lead the firm’s investment activities in asset-based finance. Mike Wiebolt, who currently manages the real estate group’s liquid securities activities, will now also manage ABS.

Structured Finance

Dutch mortgage alliance expanded

Sector developments and company hires

Dutch mortgage alliance expanded
Achmea Bank is set to acquire a €500m mortgage portfolio from Dutch insurer a.s.r., which will continue to manage the mortgages for Achmea Bank. The two organisations have expressed the intention to conduct additional transactions of €500m in both 2022 and 2023. In addition, Achmea Bank will acquire roughly €190m of newly originated mortgages from a.s.r. annually for the next three years.

These are mainly mortgages with a short fixed-interest period. The acquisition has no impact on servicing related to customers in this portfolio.

These transactions are an expansion of the strategic mortgage alliance between Achmea and a.s.r., which began in 2019.

Overall a.s.r. manages roughly €11bn of mortgages on its balance sheet, as well as over €9bn for external clients through mortgage funds and external mandates. Meanwhile, the combined mortgage portfolio of all Achmea brands equals roughly €29bn, but the firm intends to further expand its share of the mortgage market in the next few years.

EMEA
Crestbridge has appointed Cheryl Bai as director, head of funds UK. Bai will help drive the firm’s expansion in the private equity, venture capital, private debt, real assets and structured credit sectors.

She joins Crestbridge from SS&C Technologies Holdings, where she was responsible for leading a large client services team in multiple jurisdictions and servicing an extensive portfolio of private equity clients. Prior to this, she held roles at IQEQ and Augentius.

Fidelity International has appointed Nick Haaijman to the newly established role of global head of private asset solutions, reporting to global cio Andrew McCaffery. Based in London, Haaijman will work with Fidelity’s private assets investment teams to support the firm’s growth plans by developing its global private assets solutions capabilities. He joins from CVC Credit Partners, where he served as head of client servicing.

SCOR Investment Partners has announced several internal promotions in a bid to enhance its third-party asset management business. The company’s current ceo François de Varenne will move to become the chairman of the supervisory board and be replaced by ex-cio Fabrice Rossary.

Benjamin Ayache and Eric Talleux will continue to serve in their current roles as coo and chief risk officer respectively. Joining the management board are Louis Bourrousse, who will move from head of investment business performance for SCOR Global Investments to work as the new head of business development, as well as Marie-Suzanne Mazelier - who takes on the role of cio, having previously served as head of aggregate.

Further appointments within the company include Thibut Lameyse, who worked previously as strategic investments manager for SCOR and will now report to Rossary as general secretary. Additionally, Alexandre Stoessel and Sophie Duclos Grenet have been named head of fixed income and head of fund selection respectively, reporting to Mazelier.

Structured Finance

GSE scorecard released

Sector developments and company hires

GSE scorecard released

The FHFA has released the 2022 Scorecard for Fannie Mae, Freddie Mac and Common Securitization Solutions (CSS). The purpose of the 2022 Scorecard is to hold the GSEs and CSS accountable for fulfilling their core mission requirements by promoting sustainable and equitable access to affordable housing and operating in a safe and sound manner.

The 2022 Scorecard focuses on specific enterprise goals that address affordability, fair lending and equity, in addition to promptly addressing examination and supervision findings, and ensuring sufficient liquidity to sustain the GSEs through severe stress events. It also ensures that the enterprises prioritise climate risk, as well as the principles of diversity and inclusion, throughout their decision-making processes. 

“Key to the enterprises fulfilling their statutory mandates is their ability to advance sustainable and affordable homeownership and rental housing opportunities, and to improve their capital position by transferring credit risk away from the taxpayer,” comments FHFA acting director Sandra Thompson.

In other news…

EMEA

Synthetic Libor usage confirmed

The UK FCA has confirmed it will allow the temporary use of ‘synthetic’ sterling and yen Libor rates in all legacy Libor contracts, other than cleared derivatives, that have not been changed by 31 December 2021. These synthetic rates will not be available for use in any new contracts. Many contracts that use Libor have already been switched to new risk-free overnight interest rate benchmarks or will do so at end-2021. But there is a risk of disruption to markets and consumers if interest payments in Libor loans, mortgages, bonds and other contracts that have not switched by end-2021 cannot be calculated. As a result, the FCA is requiring the publication of one-, three- and six-month Libor rates for sterling and Japanese yen on a synthetic basis until the end of 2022, to allow more time to complete transition. Although five US dollar Libor settings will continue to be calculated by panel bank submission until end-June 2023, the FCA has also confirmed that the use of US dollar Libor will not be allowed in most new contracts written after 31 December 2021.

North America

SitusAMC has announced the launch of its new insurance services branch, Securent. The new subsidiary will offer risk management and insurance programmes for mortgage and MBS stakeholders in a bid to increase profits and mitigate risk for RMBS sellers, issuers and investors. Justin Vedder will lead SitusAMC’s new insurance business, with over 20-years of experience in the mortgage banking and insurance industry and having previously served as svp of the national sales team at Altisource. Securent programmes will include loan defect insurance, mortgage application fraud insurance for RMBS, and are hoping to launch MSR loan defect insurance in the future.