Contents

Structured Finance

Growth constraints

Disconnect between Euro ABS ambitions and reality?

European securitisation issuance for the first 11 months of the year stood at a decade high of over €112bn, up by more than 65% compared with the same period in 2020, according to S&P figures. However, despite such record growth, a disconnect appears to remain between the industry’s ambitions and what is being seen on the ground - which is a market that is still struggling post-financial crisis.

“The intention expressed by the securitisation industry when it began considering the STS regime was for the European market to become central to the financial architecture of the EU and for securitisation to be embraced by banks to proactively manage capital as part of a deep market that would grow to around €400bn-€600bn in size,” says Ian Bell, ceo of PCS. “The European Commission subsequently lowered its expectations to an additional €100bn in volumes. We’re likely to see an extra €20bn-€30bn of issuance this year, most of which is accounted for by CLOs.”

He notes that the biggest driver behind the disconnect is monetary policy. “The ECB’s TLTRO essentially represents direct lending to banks at ultra-low rates and securitisation can’t compete.”

Under TLTRO 3, €2.1trn is set to be repaid in 2023-2024, but it is unclear whether this funding will be replaced by a new version of the TLTRO. Similarly, the Bank of England’s TFS and FLS are repayable in January and February, while the TFSSME matures in 2025.

“Will this funding be replaced by further BoE schemes or will banks return to the securitisation market? The ECB and BoE schemes are supposedly emergency non-standard monetary policy measures and, as such, how long should they continue? Answering these questions is key to understanding the growth trajectory of the securitisation market,” observes Bell.

A second macro factor that will shape the future of the market is the implementation of Basel 3, with the final package now in front of the European Commission. Three elements of the package could be relevant to securitisation: the output floors; regulatory oversight of climate risk and bank sustainability reporting; and third-country branches.

The latter proposal envisages non-EU banks with over €30bn in assets being investigated for systemic risk and if they are found to be a systemic risk, they will have to become a subsidiary or be regulated as such. “If that happens, they will have to be separately capitalised and manage their own capital, which could drive more significant risk transfer volume,” Bell indicates.

Meanwhile, the Commission pushed back the output floor implementation date to January 2025, with a five-year transition period where the floor increases from 50% to 72.5% (SCI 29 October). The Commission expects the output floors to increase bank capital by an average of 9%, but many banks expect it to be higher, according to Bell.

“Again, this could drive more securitisation volume – given that the technology enables banks to lower their RWAs - assuming there is a workable SRT regime,” he notes.

The UK’s implementation of the output floors is still scheduled for January 2023, but the government seemingly has yet to make key post-Brexit strategic decisions on macro principles of financial regulation. “There is currently a debate within Treasury and No 10 in the context of Brexit as to where the UK should be on the spectrum between London becoming Singapore-on-the-Thames - with a low regulatory burden on financial services and acting as an offshore centre for Europe - and the UK remaining broadly in-line with the EU and therefore having some, if attenuated, access to the EU financial services market,” Bell explains. “These are high politics macro decisions that will then drive micro decisions. But it is difficult to gauge where the UK is headed in terms of financial services generally and securitisation regulation specifically until those macro decisions are made.”

Regarding climate risk, this can be seen as both an opportunity and a potential threat for the securitisation market. It is an opportunity because there is a paucity of ESG investable assets and huge demand, which could enable securitisation issuers to print cheaply and without much competition.

The threat lies in the possibility that regulation makes it much more costly and complicated to issue a green securitisation, compared to any other type of green bond. As such, securitisation needs to find a comfortable niche within the green ecology in order to flourish.

“There are concerns around how the Commission’s draft green bond standard and the EBA’s sustainable securitisation framework will fit with each other, both in timing and content. There is a risk that securitisation could end up with its own regime because the sequencing of regulation hasn’t been thought through properly,” Bell warns.

He continues: “Nonetheless, the ‘use of proceeds’ argument seems to be gaining traction among policymakers. This issue needs to land in the right place because there aren’t currently enough assets to execute green-asset securitisations.”

The final constraining factor is calibration issues, which Bell says are “overly conservative” and the resolution of which would “materially help” the European securitisation market. Key issues raised by the industry in connection with the securitisation regulation include: CRR calibration of STS securitisation and the ‘p’ factor; Solvency 2 calibration of STS; and LCR eligibility criteria.

The Commission indicated that such calibration issues are up for review with its call for evidence to the European Supervisory Authorities (SCI 11 November). However, the ESAs are not required to respond until September 2022; thus, there is unlikely to be a concrete proposal until 2023.

As for the UK, no discussions about securitisation regulation calibration issues appear to be taking place. Policymakers have the additional question to address of whether to extend the STS regime to synthetic securitisations.

Corinne Smith

Structured Finance

Starz gazing

Euro CRE CLOs tipped for take-off

Starz Realty Capital’s Starz Mortgage Securities 2021-1 transaction was notable for being a first-of-its-kind European dual-currency CRE CLO (SCI 1 October). A handful of further such deals are expected next year, given the need for a funding tool for funds active in the CRE lending space.

“I expect a handful of transactions next year – at least one in Q1, as it is a new product which has received immense interest. Since the deal closing, we have been answering questions from market participants and are having conversations around the different types of CRE CLO structures,” observes Sabah Nawaz, special counsel at Cadwalader, Wickersham & Taft, which was lead counsel on the Starz deal.

She says that as it was a first-time deal, the firm didn’t have a clear precedent to use as an OC or a set of precedent transaction documents to work with, given previous deals were issued pre-financial crisis and the securitisation market has evolved since then. A particularly challenging issue was the dual-currency nature of the transaction and coming up with a solution to match assets and liabilities.

“That was overcome with dual-currency on both the liability side and the asset side. This deal relied on natural hedging,” explains Nick Shiren, partner at Cadwalader, Wickersham & Taft.

He notes that his firm had been looking to do this type of deal for a while, since it plays to its strengths with a leading practice in the US together with European expertise. For the last 10 years, Cadwalader has been working on warehousing transactions in Europe, with the hope that there would be a capital markets exit for those transactions. The Starz transaction represents the first such exit.

Iain Balkwill, partner in Reed Smith’s structured finance team, confirms that his firm has been working with Starz for a number of years and from the start, a structured exit has been a key part of its business model. He adds: “We definitely expect to see more deals like this in Europe next year – after all, these structures have an important role to play, as demonstrated by the US market. The fundamentals on a myriad of levels makes total sense, especially as a funding tool for those funds active in the CRE lending space. Although we have seen banks move away from CRE lending since the financial crisis, until now, the capital markets have not offered a viable funding tool for those funds that have stepped into fill the shoes of the banks.”

Balkwill concludes: “When you put together a European first, that will always create challenges – in the way in which the product works, CRE structures work, the many jurisdictional elements and how it all glues together. The product is now in the market and here to stay; there is a lot more confidence and more regulatory certainty. CMBS held up well during the pandemic and we are now at a point where everyone accepts that securitisation has an important role to play in financing CRE.”

Angela Sharda

ABS

Digital ABS debuts

Fully blockchain-based securitisation completed

German fintech Cadeia has completed the first-ever fully blockchain-based corporate loan securitisation via its Digital Services Platform (DSP). Dubbed GreyPeak 2021-1, the deal was privately placed in the form of digital securities.

“GreyPeak 2021-1 is the first loan securitisation to fully store and execute the complex terms and processes of a securitisation transaction in a blockchain,” explains Rolf Steffens, md at Cadeia. “The Cadeia DSP system and the associated Smart Contract Engine enable users to implement complex financial transactions in a transparent, fast, secure and traceable way over the long term - regardless of whether assets or refinancing instruments are already tokenised or not. This opens a new chapter in the history of rapidly evolving distributed ledger technology usage for originators and investors.”

Liechtenstein-based Bank Frick is the originator and servicer on the GreyPeak 2021-1 deal. The transaction – which is denominated in Swiss francs – comprises a senior, a junior and an equity tranche in the form of digital securities. These so-called Asset Backed Security Token (ABST) tranches are identified by International Token Identification Numbers (ITINs) provided by the International Token Standardization Association.

The entire transaction - including securities issuance and settlement, ongoing covenant testing and rule-based cashflow management via predefined waterfall structures - is processed through a series of automatically created smart contracts on the Ethereum blockchain. The large degree of automation that this allows cuts costs and time by minimising manual workflows and by providing a common database for all stakeholders, according to Cadeia. In this way, banks and financial intermediaries are able to execute securitisations in smaller volumes, while improved risk and liquidity management allows them to originate new loans more efficiently.

Whereas smart contracts have in previous blockchain-based securitisations been used solely to tokenise receivables, in this transaction Cadeia also uses smart contracts for the automated and rule-based control of cashflows. Consequently, interest and principal payments from the securitised loans are calculated depending on transaction performance and are allocated to the holders of the digital securities.

However, since no Swiss franc-denominated Central Bank Digital Currency (CBDC) or widely adopted Swiss franc stablecoins exist yet, the smart contracts access the transaction bank account directly via a PSD2 interface. For this purpose, an investor’s bank account is linked to their token wallet (the digital securities account), in order to ensure a secure payout allocation.

Cadeia nevertheless intends to incorporate stablecoins and CBDCs in the future, which should enable even more efficient processing.

Corinne Smith

ABS

Year-end?

European ABS/MBS market update

With primary European ABS/MBS market activity fading further away, year-end feels awfully close. As a result, focus is already being directed on the upcoming new year.

“I think it is fair to say that we have hardly looked at any potential trades this week,” says one European ABS/MBS trader. “As is appropriate for this time of year, there isn’t much new issue activity and there are other priorities to focus on before year-end.”

If renewed concerns about the Omicron variant have spooked and occupied European markets and politicians, a clear correlation in ABS/MBS spreads is yet to materialise. “There has not been a specific reaction to the new variant,” notes the trader. “In fact, pricing execution has been soft in primary for the past month or so.”

However, there has been an uptick in the secondary market. “There has been quite of a lot of BWIC activity in the last few weeks, and most of it has been absorbed pretty well – particularly the senior covers,” the trader says.

Looking ahead, the trader sees favourable issuing conditions as perduring. “I think the strong technical backdrop will keep spreads low. Barring any drama, I do not expect any changes in the supply/demand dynamics,” he says.

As for monetary policies and purchase programmes, the outlook is again stable. “Monetary policies will obviously play a significant role. But the message I am getting is that central banks will be more accommodative or even hike interest rates. In the short term, we do not expect any big impact on spreads,” the trader concludes.

Vincent Nadeau

Structured Finance

SCI Start the Week - 6 December

A review of SCI's latest content

Last week's news and analysis
Enhanced value
Securent answers SCI's questions
ESG countdown
ECB climate stress tests pending
GACS pair print
Mixed NPE pool debuts
Meeting opportunity
New trading platform to capitalise on multifamily growth
Mespil refinanced
BOI completes leveraged loan CRT
Ramp-up continues
Barclays completes capital relief trade
Restructurings eyed
Real estate and hospitality assets targeted
SRT chronicle: part three
The final instalment of a three-part series on bank risk transfer transactions
Winding down
European ABS/MBS market update

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.

SCI Events calendar: 2022

SCI’s 1st Annual ESG Securitisation Seminar
2 February 2022, London

SCI’s 6th Annual Risk Transfer & Synthetics Seminar
April 2022, New York

SCI’s 3rd Annual Middle Market CLO Seminar
June 2022, New York

SCI’s 2nd Annual CLO Special Opportunities Seminar
June 2022, New York

SCI’s 4th Annual NPL Securitisation Seminar
September 2022, Milan

SCI’s 7th Capital Relief Trades Seminar
October 2022, London

Capital Relief Trades

UK SME return

Lloyds completes capital relief trade

Lloyds has finalised a significant risk transfer transaction referencing a portfolio of UK SME loans. Dubbed Salisbury Four, the £175m six-year CLN references a £1.83bn portfolio and is the first post-Covid UK SME SRT.

The transaction amortises on a pro-rata basis and features a portfolio that replenishes over a one-year period. The pool has a weighted average life equal to around eight years and comprises over 2,000 borrowers.

UK SME SRT issuance took a dive last year along with the broader SME sector, amid wider market uncertainty following the aftermath of the coronavirus crisis. More saliently, the Coronavirus Business Interruption Loan Scheme (CBILS) provided financial support to smaller businesses across the UK amid the fallout from the Covid-19 outbreak. The scheme expired at the end of March, with Lloyds having granted £2.5bn in CBILS. 

Under the rules of the scheme, banks cannot securitise CBILS exposures and therefore none are included in the recent Salisbury Four deal. Consequently, the pool is comprised entirely of standard SME loans - although Lloyds confirmed that a portion of the portfolio will consist of performing SME borrowers that accessed the scheme during the coronavirus crisis and some borrowers that accessed it may be added via replenishment.  

According to the rules of the programme, firms wishing to access CBILS needed an ‘’undertaking in difficulty’’ assessment. The criteria for the classification include partnerships, limited partnerships or unlimited liability companies that have accumulated losses greater than half of their capital in their latest annual accounts or firms that have entered collective insolvency proceedings.

Any business that was an ‘’undertaking in difficulty’’ on 31 December 2019 but, at the date of application for a scheme facility is no longer an ‘’undertaking in difficulty’’, was - in principle - eligible for the scheme. Indeed, a Lloyds source close to the latest transaction states that some small businesses that tapped CBILS ‘’did so prudently and put on deposit the amounts that were accessed’’.

‘’CBILS and their potential enforcement was something that we discussed extensively with investors,’’ adds the same source. 

Salisbury is a programme with an enviable performance track record. Fitch data notes, for instance, that there are no delinquent loans in Salisbury II-A 2017, 72bp for Salisbury 2015 and 10bp for Salisbury Two 2016. The cumulative default rates and cumulative loss rates have been very low in all three transactions, with 0.6% and 0.1% in Salisbury 2015, 0.13% and 0.06% in Salisbury Two 2016 and none in Salisbury II-A 2017.

The last capital relief trade from the Salisbury programme closed in June 2019 (see SCI’s CRT Database). Dubbed Salisbury Three, the £323.5m CLN referenced a £3.3bn portfolio of UK SME loans. Lloyds launched the Salisbury programme in December 2015.

Stelios Papadopoulos

Capital Relief Trades

CRT bonanza

Record 2021 origination and Fannie's return to drive banner 2022 for CRT

Next year will see record GSE CRT issuance of around $20bn, around $6bn higher than 2021, predicts Pratik Gupta, head of CLO and RMBS research at Bank of America.

In addition, he predicts a resurgence of interest in CRT issuance from mortgage insurers seeking to lay off risk and suggests that there could be as much as $10bn of supply in this sector in 2022.

This makes $30bn in total in the CRT market next year, not including any bank deals.

Several factors will drive the record supply in CRT. Firstly, Fannie Mae is back in the market after an absence of 18 months and has sold two large CAS deals in quick succession since September. Secondly, CRT issuance generally lags agency origination by about six months and Q2 and Q3 were particularly active. “2021 was a banner record year for agency origination,” says Gupta.

Gupta was responding to questions as BoA this week presented its annual end of year outlook for the structured finance market.

In the agency MBS market, BoA believes there will be $461bn of net new supply, significantly down from $722bn in 2021.  Much lower issuance will to some extent balance the impact of the Fed taper upon spreads.

The consumer and commercial ABS sector, meanwhile, is expected to see slightly lower gross and net volume in 2022, according to Theresa O’Neill, head of consumer ABS at BoA.

New issue volume is expected by BoA to hit $255bn, with net issuance of $32bn. This compares with gross issuance of $265bn and net issuance of $28bn in the YTD.

Spreads are expected to widen a little in Q1 as the economic backdrop remains confusing and uncertain. However, the long term trend is for spreads to narrow.

Consumer ABS paper will weaken moderately in 2022, due to the termination of government stimulus programmes. Commercial ABS, however, should do a little better due to higher infrastructure spending and a loosening of the grip of Covid 19 upon the world economy - although the extent to which the latter is true remains currently moot.

The areas of the market with the most potential for tightening are those where current spreads are 10bp or more wider than the 24-month minimum and/or pre-Covid levels. Single-A aircraft ABS, for example, trended around plus 360bp at the end of November, compared to a 24-month minimum of plus 194bp and a pre-Covid average of plus 159bp.

Nonetheless, despite the potential for tightening, the aircraft sector is still acutely vulnerable to bad news about Covid and ramped-up travel restrictions.

New issuance in the consumer ABS market will be led by the auto sector, with gross issuance of $115bn predicted compared to YTD issuance of $120bn. This equates to net new issuance of $4bn next year.

The structured finance market in 2022 will be beset by considerable economic uncertainty. On the one hand, inflation is now an established fact and recent reports suggest that the Fed might commence a rate hiking programme as early as the spring.

On the other hand, the much-watched labour participation number still looks anaemic. The non-farm payroll for November, announced at the end of last week, showed only a gain of 210,000 compared to estimates north of 350,000.

This does not seem to give the Fed as much room to hike rates as it would like.

“There are two influences upon securitised products markets in 2022 - and it’s trying to gauge how these will play out,” says Chris Flanagan, head of securitised products markets research at BoA.

In general, he expects that the sector will continue to generate positive returns for investors in 2022, just not as much as in 2021.

Simon Boughey

Capital Relief Trades

Landmark SRT inked

Wealth management unit completes synthetic ABS

Credit Suisse’s wealth management arm has finalised a significant risk transfer transaction referencing a US$2bn portfolio of loans collateralised by financial and real assets, such as private jets, yachts and real estate. Dubbed Athena, the capital relief trade is the first issued by the lender’s wealth management division, with the risk transfer achieved via financial guarantees.

The transaction consists of an US$80m funded first loss tranche, which priced at SOFR plus 11.5%, and a US$10m unfunded second loss tranche. The tranches amortise sequentially over an approximately three-year portfolio weighted average life.

Further features include a 2.5-year replenishment period and a time call that can be exercised following the end of the replenishment period. The pool comprises over 100 borrowers.

The transaction is strategic in nature, featuring a multi-issuance vehicle, as the bank seeks to expand this line of business. Hence, further issuance is expected.

The utilisation of synthetic securitisation technology for expanding certain lines of business is a strategy that has been gaining a foothold in the market, as evidenced by this year’s capital call SRTs and transactions issued by LBBW as well as Lloyd’s Syon programme (see SCI’s capital relief trades database).

Stelios Papadopoulos

Capital Relief Trades

Positive prospects?

CRE tops Stage Two allocations

Commercial real estate loans were allocated the largest share of Stage Two classifications, according to the latest EBA data. This coincides with an overall growth in Stage Two allocations following the coronavirus crisis, as well as a boost in significant risk transfer transactions backed by Stage Two exposures and commercial real estate.

According to the EBA’s latest risk assessment report, 13.7% of non-financial corporate (NFC) loans were classified under Stage Two - up from 11.5% in June 2020 - with the highest share of Stage Two loans observed in CRE exposures, accounting for 16.6% in June 2021 versus 12.3% in June 2020. By contrast, Stage Two allocations for household loans were lower compared to last year - 6.7% in June 2021 versus 7.1% in June 2020.

Households might be better protected by support measures like furlough schemes. Additionally, banks may be more effective in assessing and acknowledging possible credit deterioration for NFC exposures, since external data sources as well as regular information on creditors’ financial positions might allow for quicker assessments of credit quality.

The boost in Stage Two allocations for commercial real estate loans coincides with two trends in the SRT market. First, SRT trades backed by Stage Two exposures have already been completed given these migrations in credit quality, following the advent of the coronavirus crisis. Intesa Sanpaolo and Monte dei Paschi have finalised such transactions this year (SCI 8 October).

The criteria used for classifying the underlying assets as Stage Two follow the IFRS 9 accounting standard definition, in that the creditworthiness of the assets has deteriorated to a significant extent since initial recognition – although they remain performing. Should any of the assets in the portfolio move to Stage Three, then a credit event is triggered. This is in line with prudential regulation in terms of the credit events being ‘past due’, ‘unlikely to pay’ and ‘bad loan’.

Second, the pipeline of synthetic securitisations backed by commercial real estate has been growing, as evidenced by several deals - including one by Intesa Sanpaolo. Hence, these trends suggest that the prospects for synthetic securitisations of Stage Two exposures referencing commercial real estate are promising.   

Compared to the beginning of the pandemic, Stage Two classifications have grown. EBA data show a growth from 6.5% in December 2019 to nearly 9% in June 2021.

Stage allocations differ widely among banks and countries. For instance, several banks reduced their Stage Three allocations between June 2020 and June 2021, including Southern European banks that engaged in non-performing loan disposals through securitisations or outright sales. The biggest increases in Stage One against Stage Two allocations were reported by Nordic countries.

Stelios Papadopoulos

Capital Relief Trades

New STACR, last STACR

Freddie prices 10th and final STACR of the year

Freddie Mac has priced a $963m STACR, making its third CRT transaction of Q4 and final offering of the year.

The trade, designated STACR 2021-HQA4, was underwritten by joint leads Barclays and Bank of America. The co -managers were Amherst Pierpoint, Morgan Stanley, Nomura and StoneX Financial.

It comprises four tranches, an M-1, M-2, B-1 and B-2. The $445m M-1 was priced to yield SOFR plus 95bp, the $222m M-2 yields SOFR plus 235bp, the $148m B-1 yields SOFR plus 375bp and the $148m B-2 yields SOFR plus 700bp.

The trade is expected to settle on December 10.

Previously this quarter Freddie sold STACR DNA6 and STACR DNA7, both of which are low LTV bonds. Today's bond is its fourth HQA bond of the year, which reference higher LTV loans.

In total, it has priced 10 STACR bonds this year.

The pace of issuance in the CRT market is expected to hot up next year with the return of Fannie Mae to the market and also due to the record pace of mortgage origination in 2021.

Simon Boughey

Capital Relief Trades

SME boost

German STS synthetic printed

Deutsche Bank and the EIB Group have executed a €75m unfunded mezzanine guarantee that references a €1bn German mid-market corporate portfolio. The guarantee will provide capital relief to Deutsche Bank and enable the lender to finance €300m of SME and mid-cap lending. The transaction is expected to support smaller businesses in their recovery from liquidity shortages caused by the coronavirus crisis.

The guarantee is among the last to use EFSI resources, as the EIB Group is currently moving towards EGF transactions (SCI 18 August). Under the EFSI, a counter-guarantee from the EIB will fully mirror the EIF’s obligation, so that the EIB covers the credit risk related to the mezzanine tranche.

The transaction was structured to comply with the STS requirements for synthetic securitisations adopted by the European Parliament in April. In fact, the latest Deutsche Bank transaction was signed in June, shortly after the STS framework for synthetic securitisations came into effect.

Oliver Moschuering, global portfolio manager, strategic corporate lending at Deutsche Bank, notes: ‘’We opted for a transaction with the EIF/EIB in this case to achieve an attractive cost of capital relief. The selection of hedging structures depends on the particular goal we are trying to reach – for example, our usual GATE structures are typically first loss tranches with higher single obligor constraints to manage concentration risks.”

The tranches in this latest deal amortise on a pro-rata basis - with triggers to sequential - over a two-year portfolio weighted average life. Credit enhancement is present in the form of a 1.5% retained first loss tranche and a ‘use it or lose it’ synthetic excess spread mechanism that corresponds to the one-year expected loss of the portfolio.

According to Oliver Gehbauer, director, credit structuring at Deutsche Bank: ‘’We looked at the economics and considered that an STS label is required to soften the potential effects of the EBA’s pending RTS with respect to synthetic excess spread. We are still waiting for the EBA consultation, but the challenge arises when regulators apply a different time horizon to synthetic excess spread versus the offsetting loan provisions.’’

He adds: ‘’However, we do realise that STS does not necessarily offset those effects, as contemplated by the EBA. It is regrettable, because within the synthetic securitisation market, synthetic excess spread is most prominent in EIF transactions, which are obviously pursuing a valuable policy goal.’’

Market participants have raised concerns about the new STS framework for synthetics (SCI 4 November) and there’s a likelihood that issuance will remain restricted. One major issue for banks are the collateral requirements, including the requirement for a CQS2 rating.

One way to address the STS collateral requirements is by issuing directly from the balance sheet. Gehbauer explains: ‘’Balance sheet issuance - rather than using an SPV - is one way of addressing the issue around collateral requirements, but we understand from our clients that it is not necessarily a practical route for all banks.”

Overall, STS for synthetic securitisations remain far from the panacea to the potential challenges posed by the future implementation of the EBA’s proposals on synthetic excess spread. Yet it could make a hard landing somewhat softer. 

Stelios Papadopoulos

Capital Relief Trades

HSBC hits the US trail

HSBC USA markets corporate loan CRT, Santander brings auto loan CLN

HSBC USA is in the CRT market with a new trade backed by large revolving corporate loans originated in North America, say well-placed sources.

The deal, which is expected to close before the end of the year, is self-led.

The reference pool of loans is worth $2.5bn and the new issue size will be $300m, add sources.

Tranche thickness is 0%-12.5% and the trade is expected to pay floating rate plus 850bp - in line with European bank name SRT trades.

There are three investors, say market sources. Two are based in the US, and said to be traditional SRT type buyers.

As this deal emanates from a separately capitalised US entity and is subject to US regulation, it counts as a US SRT deal, say outsiders.

HSBC USA has been unavailable for comment.

In addition, Santander NA is in the market with a US auto loan-backed SRT deal, in the form of credit-linked notes (CLNs)

The deal, designated Santander Bank Auto Credit-Linked Notes series 2021-1 (SBCLN 2021-1).will comprise six tranches - A-1, A-2, B, C, D and E. The A-1 and A-2 are expected by Fitch to be unrated, the B tranche to be BBB-rated, and C tranche to be BB-rated, and the D and E tranches will be not rated.

The reference pool is prime auto loans originated by Santander. The collateral pool is strong, with an weighted average (WA) FICO score of 774 with 92.5% over 675.

The pool's WA loan-to-value ratio (LTV) is 94.1%, and WA seasoning is 12.0 months. It also has a larger concentration of extended term loans, with 84-month loans totalling 15%.

Pre-sale details were released by Fitch yesterday, December 8.

Santander last month finalised a synthetic securitization of UK auto loans, dubbed Project Spitfire.

Simon Boughey

CLOs

Record breakers

Strong Euro CLO market set to continue

European CLO issuance volume is set to hit a post-financial crisis high of €40bn by year-end, boosted by record reset and refinancing activity. Prospects for the market in 2022 remain positive, reflecting strong leveraged debt issuance expectations, improving CLO arbitrage and a positive macroeconomic outlook.

“It’s been a very busy market – even if there has been a sizeable share of refinancings or resets. The issue will be is there enough new lending going on within Europe and the UK to generate collateral to fill a healthy new CLO issuance pipeline? I think there is a decent chance that this will happen, as the European and UK economies recover from pandemic related slowdowns,” observes Julia Tsybina, counsel at Clifford Chance.

Resets and refis accounted for roughly 65% of the 171 deals closed as of end-September, according to Moody’s figures. The rating agency reports that most 2019 deals with standard two-year non-call periods and 2020 deals with 6- to 18-month non-call periods were reset or refinanced in the first three quarters of 2021.

Given that most eligible deals have already been refinanced, such activity is expected to slow in 2022. Nevertheless, new CLO issuance activity should remain strong next year, reflecting strong leveraged debt issuance expectations, improving CLO arbitrage and a positive macroeconomic outlook across major European countries.

In contrast to the European CLO market, US CLOs are securitising more new lending activity. Ultimately, the size of the CLO market is constrained by the amount of new lending, Tsybina notes.

She adds: “If the US economy continues to support new lending, there will be US players looking to place CLOs with European investors. This will happen over the next 12 months; indeed, it is happening now.”

Looking ahead, European CLO structures will continue to reflect the desire of managers for flexibility around the acquisition of assets in connection with workouts of defaulted assets. Meanwhile, CLO WALs will continue to adapt to investor needs, with longer WALs (typically nine years) persisting. WAL test requirements are likely to remain weak, but any credit impact should be less material in a low default environment, Moody’s suggests.

The agency estimates that speculative-grade default rates will remain between 1.5% and 2.1% over the next 12 months.

Angela Sharda

CMBS

Covid-19: Lessons for the CMBS market

Iona Misheva, partner at Allen & Overy, explores the lessons that the pandemic provided for the European CMBS market

Issuance has been at consistently high levels this year.  This has shown that the asset class recovered quickly from the temporary forces of the pandemic, which resulted in very few deals coming to market in 2020.  In contrast, 2021 has seen near record levels of issuance of euro and sterling CMBS notes.  We’ve not only seen interesting and varied asset classes, from cold storage to social housing, but also a variety of jurisdictions (Spain, France, Germany, the Netherlands, to name a few), some multi loan deals and some dual currency transactions. 

In terms of the key points, ESG has been a massive focus for investors.  Green CMBS, in line with other parts of the securitisation market, is a trend that we will continue to see increasing emphasis on.  In the CMBS space, this started at the beginning of 2020 with the River Green transaction, and has recently continued with the Frost issuance.  While the ESG credentials of a CMBS transaction are very much driven by the nature of the underlying properties, expect to see increasing focus on borrower ESG reporting at the time of origination of a loan and on an on-going basis.

We have also seen increased attention on the level of discretion that servicers have in relation to signing off on borrower requests.  Is the level of discretion correctly calibrated?  Pre-pandemic, there were certain matters that servicers could not sign off on without noteholder consent.  During the pandemic, with an increased amount of borrower requests that were not run of the mill, the servicing documents were continuously tested in terms of what a servicer could and couldn’t sign off on.  This was especially apparent where borrowers sought to defer interest payments on loans.  In recent deals, this has led to increasing levels of servicer discretion, with fewer restrictions on what they can sign off on.  Ultimately, this doesn’t give the servicer free reign, as it will always need to act in accordance with the servicing standard. 

The benefit of a strong sponsor has also really been highlighted during the pandemic.  Rather than deferring loan interest payments, there were a number of instances of borrowers injecting equity into transactions.  This was especially apparent, and needed, in the hardest hit hotel and leisure sectors.  

Coming back to multi-loan deals, there has been recent market hype about CMBS CLOs.  There has been one recent issuance, with several rumoured to be in the pipeline for next year.  This will be an area to watch next year.

So, how do we leave the year?  Quietly optimistic, with steady levels of excitement for next year.

CMBS

Flowers among weeds

CMBS yields value to canny buyers despite distress

In the first of a series of interviews with SCI, investment managers discuss where they have seen most value recently and where they expect to see it in 2022.

Despite - or because of  - the continued uncertainties that beset many areas of the CMBS market, this is the sector of the structured finance marker that currently offers the best returns to the discerning investor and will continue to do so next year, according to Karlis Ulmanis, portfolio manager at DuPont Capital Management.

At a time when many investors have been exiting the sector, Ulmanis has increased his CMBS portfolio from $100m to around $140m over the last year. He believes that it will continue to offer buying opportunities in 2022.

Not only that, he has headed right for the areas that many other investors wouldn’t touch with a barge pole - hotels, office space and especially retail.

It is worth noting that this approach marks a sea change from when SCI last caught up with Ulmanis three months ago.

“My alpha has been the best it has for 10 years. My whole CMBS sector has been yielding an average of over 7.5%, which, considering most of it is BBB-rated and investment grade, is pretty high,” he told SCI.

Opportunities arise when other investors get spooked by the distress shown in the some areas of the market and want to get out at any price.

“In 2021, I bought a couple of bonds that yielded 45%. We found an investor that was trying to get out of retail and was prepared to bail at any price. But in fact they were pretty solid bonds, and could tolerate large valuation discounts in the underlying properties and still perform well,” he says.

This is the point: there is no doubt that some loans underpinning CMBS deals particularly in the retail mall, hotel and office areas have suffered losses, but not all are equally distressed. There has been a tendency to throw the baby out of with the bathwater, and deals supported by better loans have been marked down alongside the bad ones. General illiquidity in the sector has not helped.

Retail CMBS is perhaps more troubled than any other area. It is generally believed that Covid has merely accelerated what was a long-term decline, and while the hotel sector, say, might bounce back retail might not.

But this is where Ulmanis sees most openings. “I see bonds with a high percentage of retail collateral. A lot of investors are fearful of these and because of that fear this is where I focus. Investors probably fear retail more than hotels or offices,” he says.

It needs to be stressed, however, that he is not merely snapping up any CMBS bonds which no-one else wants and which happen to be offering currently above market yields. Each loan in the deal is investigated closely. He looks for notes which have collateral where the LTV is generally 55% or lower and the debt to service ratio is two or higher.

Clearly some CMBS deals will incorporate loans which are delinquent, or have higher LTVs or low debt to service ratios. These are accorded a larger discount factor, and then the extent to which the property valuation can be lowered before a loss is realised is calculated.

“The bonds I buy can generally tolerate a risk adjusted valuation decrease of 55%/60% before they hit a loss - which is quite significant,” he says.

He also looks when the last valuation was conducted, and generally sees more value in the older, legacy deals issued eight to ten years ago. Within this segment he targets bonds with lower WALs. These offer a couple of advantages. Firstly, while the retail sector might go belly-up in a decade from now, it is less likely to do so by 2023. Secondly, capital from short-term bonds can be reinvested at a higher rate as coupons tick up - as is widely predicted.

“Last week I picked up a CMBS bond with a short WAL of a year which was yielding 6%. This is 4.5% above the benchmark yield for this sector. I’ve been really surprised to find bonds at such deep discounts,” says Ulmanis.

There are two main reasons why the CMBS sector will continue to find itself under pressure in 2022: the persistence of Covid 19 and inflationary pressures. Neither of these show any sign of being over the horizon any time soon.

Every new strain of Covid, greeted with almost exultant fanfare by news media, is a body blow to the retail, hotel and office sectors of the CMBS market. Investors worry that, for example, that the move to working from home is a permanent one, or that retail malls will never see a meaningful return of foot traffic.

Meanwhile, there is a good chance that inflation might prove to be even worse than it looks currently. The Case Schiller home price index, now renamed the S&P CoreLogic Index, rose fully 19.5% in September.

Meanwhile, growth is only limited and held in place by Covid. The November employment data was much less robust than was hoped. This is seemingly a different type of inflation than has been seen before, driven by supply chain interruptions and labour shortages rather than an overheated economy. The traditional blunt instrument of rate hikes may prove less effective than hoped.

In these conditions, key areas of the CMBS market will continue to be pressured.

“I go to sectors where there is stress to make money, and CMBS offers the best opportunities. I’m not seeing much value in other structured products right now,” he says.

Simon Boughey

CLOs

Exploiting inefficiencies

Jay Huang, md and head of structured credit investments at CIFC, answers SCI's questions

Q: How has investor perception changed around CLOs, given the resiliency of the asset class in 2021?
A: Three years ago, when I was visiting investors, I would have to bring up the resiliency of the CLO product. However, I have noticed a trend that when I come into investor meetings now, they are bringing up the resilience of the product more than I am.

A lot of this has to do with the number of distressed cycles that we have been through. Remember, CLOs have only existed for around 25 years. Yet since then, there have been many distressed cycles.

In each one of these periods, the CLO structure has held up its end of the bargain and performed well. The more cycles we endure where the benefits of the CLO structure materialise, the more people will believe in them. It has become a more accepted product than it was just a few years ago, given the attractiveness of the yields and performance of the asset class as a whole.

Q: How do CLOs compare to other structured credit products?
A: Relative to other securitised products, the nature of the CLO product allows the investor to maximise the value of the term matched, non-mark-to-market, non-recourse financing embedded within the structure. CLOs are the only mainstream product in the securitised markets where the underlying loans are actively managed, whereas most other structured products tend to be more static in nature.

With CLOs, there is a reinvestment period where you can reinvest proceeds as loans in the portfolio prepay or mature. This is especially valuable when the market becomes dislocated and assets can be purchased at favourable prices. Specifically, with respect to the equity tranche, a manager may be able to capitalise on dislocations in the market to the benefit of the product – making it more secure and stable.

Q: Where in the CLO capital stack are you finding the most opportunity?
A: Looking at the capital stack, we have recently been most focused on CLO equity. Bigger picture, however, what we find most interesting are opportunities to exploit the inefficiencies that exist in the CLO market.

To be clear, what I mean by that is not that the returns are going to be higher than people think, but rather differences as it relates to market data and models. Take, for example, the upcoming Libor to SOFR transition. What we have observed is that there is generally inconsistency about how the transition will impact CLOs – specifically with respect to loan documentation – which creates market inefficiency and a trading opportunity [SCI 21 September].

Another example relates to market underwriting assumptions. We have found that that commonly used models in the market tend to contain outdated or imperfect data. Sometimes the coupons on underlying loans are even incorrect in the models that the market uses.

At CIFC, we leverage our proprietary data and analytics capabilities to construct in-house models that we find to be more up-to-date and accurate. We also leverage these capabilities to run stress tests on the credits we are buying. Through these tests, we have identified several instances where the market underwriting assumptions tend to be more severe than people have realised, which gives us conviction in our investments even during periods of market stress.

Q: How has record CLO issuance impacted your investments in the asset class and the overall landscape?
A: Record supply of CLOs has been driven by record demand, as more and more new investors enter the asset class. This supply, coupled with record trading volume, has benefitted our investment process, as it has broadened our selection of product and enhanced our ability to more easily find bonds that cater to our risk profile. Record supply has also kept spreads relatively wide to corporate bonds, which may prove to be important to attract the marginal investors who are currently sitting on the sidelines.

Q: What is your outlook for 2022 and do you expect the pace of new CLO issuance to continue?
A: We are very bullish on the continued growth of the CLO market. 2021 set a new CLO issuance record and while we don’t expect 2022 to break that record, we don’t think it will be very far away. We also expect activity in the secondary market to continue to be as actively traded as that of the record-breaking volumes in 2020-2021.

We are looking out for Q2/Q3 next year – we are expecting supply to potentially drop-off in a significant way because we expect many fewer CLO refinancing and reset transactions to take place. The record-breaking volumes of reset and refinancing transactions in 2021 was amongst the biggest technical contributors of 2021 that kept spreads wide to other spread products and we think that technical will be more muted next year.

Q: Do you expect the opportunity to invest in CLO equity will continue? What about mezzanine debt?
A: Eventually the mezzanine debt opportunity will normalise and spreads will tighten, but we do believe CLO equity will present an attractive investment opportunity for an extended period of time.

Angela Sharda

Structured Finance

ESG data coverage scrutinised

Sector developments and company hires

The European Leveraged Finance Association (ELFA) has analysed coverage by three ESG data vendors for three debt indices - the CS Western European Leveraged Loan Index, the ICE BofAML Developed Markets High Yield Constrained Index and the BBG Global Aggregate Corporate Index – and found what it describes as “major discrepancies” in data coverage across asset classes. The research shows that leveraged loan coverage levels ranged from only 4%-10% across the three vendors, yet high yield coverage stood between 40%-79% and investment grade borrowers stood between 62%-95%. These figures also highlight the varying ranges of coverage between different vendors even within the same asset classes, ELFA notes.  

The association reports that although the supply of ESG data in leveraged finance is improving, it is not keeping up with investor demand – which it predicts will likely be “supercharged” as the Sustainable Finance Disclosure Regulation (SFDR) and other elements of the EU’s sustainable finance action plan come into effect. Further, ELFA reports that ESG disclosure lacks consistency and is often not presented in a user-friendly manner.

To make coverage by data providers easier, the association suggests that corporate borrowers should provide ESG disclosure in as public a way as possible and aim for disclosures that are comprehensive. Equally, investors should engage with borrowers on the disclosures they would like to see and encourage data vendors to increase coverage. Meanwhile, data vendors could adjust their methodologies to address the fact that leveraged finance borrowers tend to be smaller, while at the same time not compromising the integrity of their products.

In other news……

EMEA

AFME has named Shaun Baddeley as its new md of securitisation, following the retirement of Richard Hopkin. Baddeley brings over 18 years of experience to the role, having previously worked as md at Fitch Ratings and most recently serving as head of securitisation at Santander.

AlbaCore has announced the promotion of Deborah Cohen Malka to be the firm’s fourth partner. As former md and deputy portfolio manager, she will now work at the European credit specialist as partner and portfolio manager alongside the three founding partners at the firm. She has been with the firm since it was founded in 2016, and has played a major role in establishing the firm’s ESG strategy as well as leading on the firm’s developing CLO business. AlbaCore has also added ESG commitment member, Faatwima Diljore, to the firm’s investment committee. Additionally, the firm has promoted several new investment team directors - Armin Akhavan, Joe Alston, Helene Ba, Adriano Di Sandro, Itay Peer, and Alex Walkey.

North America

Angelo Gordon has announced the hire of Allison Binns, who will join the firm in the newly created role of head of ESG and Sustainable Investing Strategies. Binns will join the alternative investment firm from Morgan Stanley, where she served as executive director of Global Sustainability Research, and brings over a decade of ESG experience to the role. Binns will report to Angelo Gordon’s co-ceos, Josh Baumgarten and Adam Schwartz, as the firm seeks to enhance its strategic approach to ESG. Alongside the new hire, the firm has demonstrated its commitment to ESG across the platform by also becoming a signatory to the UNPRI.

Regions Bank has confirmed the completion of its acquisition of Sabal Capital Partners. Initially announced on 4 October, the agreement will widen the borrower audience of Sabal’s commercial real estate lending platform - following Regions’ strategy to acquire businesses which generate new opportunity while deepening relationships with existing clients. Sabal presently maintains a servicing portfolio of almost US$5bn, and since its inception has originated nearly US$6bn in financing. Regions hopes the introduction of Sabal to its Real Estate Capital Markets division will meet additional needs of both new and existing clients by enhancing the bank’s agency multifamily and non-agency lending capabilities. While the terms of the arrangement have not been disclosed, the acquisition does not include funds managed by Stone Point Capital or Sabal’s investment management business (which will remain with the sellers). The acquisition will see several members of Sabal’s leadership team join Regions; however, ceo Pat Jackson, cfo Mike Wilhelms, and cio Kevin McKenzie will remain with the investment management business.

Structured Finance

Extendable CRE loans scrutinised

Sector developments and company hires

Extendable CRE loans scrutinised
Fitch has published an unsolicited comment on highly extendable commercial mortgage loans that offer borrowers up to 20 years of successive annual extension options, as featured in the recent Sage AR Funding 2021 and HAUS (ELOC 39) CMBS. The agency notes that it does not treat this loan feature as credit enhancing because interest rate risk is an inherent aspect of long duration.

Such loans have no upfront interest rate hedging beyond the first maturity. Instead, each option is conditional on the borrower purchasing an extra year of interest rate cap.

“Giving rating credit to additional cash sweeps after loan extension assumes that limited-recourse borrowers would willingly purchase hedging even at considerable cost if interest rates rose,” the agency says. “Fitch does not assume borrowers offer this subsidy. Instead, we test how our high interest rate stresses affect loan recoveries.”

A series of borrower extension options may seem to ward off loan default risk, but a loan EOD is also an option, available to the lender rather than the borrower. “Highly extendable loans weaken the lender’s bargaining position by transferring this valuable optionality to the borrower. If also covenant-lite, even borrowers in negative equity can ‘buy back in’, ostensibly to begin asset repositioning or await a recovery, but possibly to extract nuisance value,” Fitch observes.

The agency further suggests that a more insidious risk arising from long duration is property obsolescence. Although both the Sage and HAUS deals could face significant refinancing risk at final loan maturity, they are secured on granular housing portfolios, offering some insulation from obsolescence risk.

In other news…

North America
Amherst has appointed a new portfolio manager to co-manage its MBS portfolio. Rahul Grover will join existing portfolio manager Eric Seasholtz as a co-leader on the MBS team, where he will be responsible for asset selection, transaction execution and risk management. Grover joins the firm from E-Trade Financial, where he served as md for portfolio management – and was responsible for the company’s fixed income portfolio, as well as being instrumental in establishing its hedging strategy.

Commercial real estate data platform CRED iQ has expanded into the operating advisory business for CMBS. As part of this expansion, the firm has hired Jim Reed and Mark McDevitt. Reed has over 15 years of asset management and workout experience at Oppenheimer and Capmark. As a senior member of KBRA, McDevitt previously led a team of analysts responsible for identifying, monitoring and valuing distressed commercial properties.

Toorak has named Kevin Chavers and Francis Byrne as the latest appointments to the board of directors, as the company continues to seek growth opportunities. Chavers will join Toorak from BlackRock, where he served as md and helped to develop the firm’s residential mortgage whole loan investing platform while working on the global fixed income securitised asset investment team. Byrne brings over 20 years of industry experience and will join the firm from Fifth Light Capital, where he was managing partner – having previously held leadership positions in securitisation at UBS, Deutsche Bank and Credit Suisse.

Structured Finance

Climate risk analytics firms acquired

Sector developments and company hires

Climate risk analytics firms acquired
Intercontinental Exchange has acquired risQ and Level 11 Analytics, which deploy data-driven technologies for managing climate change risk. RisQ and Level 11 Analytics leverage a variety of advanced geospatial mapping systems and provide extensive expertise in analysing and joining vast amounts of disparate public, corporate and third-party data sources.

This data is integrated and mapped to financial securities to provide high quality climate risk analytics and investment decision-making tools for the industries the companies serve. Initial offerings have included climate risk and ESG data for the US municipal bond, MBS and real estate markets.

ICE and risQ started working together in January 2020 with the launch of ICE Climate Risk, an offering that allows investors in the US municipal bond market to incorporate climate risk into project and investment decisions. Level 11 Analytics developed much of the underlying geospatial technology and analytics and, together with risQ, offers ESG and economic data on physical land use and the financial assets tied to it in the MBS market.

In other news…

EMEA
TwentyFour Asset Management has appointed Ben Hayward as ceo, replacing Mark Holman, who has been the firm’s ceo since its inception in 2008. He will relinquish his role in January 2022 and focus on portfolio management as a member of the firm’s multi-sector bond team.

Hayward was a founding partner of TwentyFour and has been a member its executive committee for six years, and will remain so in his new role as ceo. He will be relinquishing day-to-day portfolio management responsibilities in the ABS business but remain a member of the firm’s asset allocation committee. The three existing partners in the ABS business - Rob Ford, Douglas Charleston and Aza Teeuwen, alongside eight other investment professionals - will continue to drive that strategy.

TwentyFour will also be expanding its executive committee with a further two partners - Eoin Walsh and Sujan Nadarajah - following the addition of John Magrath earlier in the year.

North America
Greystone has expanded its commercial team with two new hires. Gary Stellato joins the firm as md and counsel from Cantor Fitzgerald, where he was md and assistant general counsel. In the new role, Stellato will manage and offer legal oversight for the team’s structured finance transactions, having also previously served as an attorney at Sidley Austin and Willkie Farr & Gallagher.

Meanwhile, Peter Fogarty will take on the role of director on the commercial team, and maintain responsibility for large loan credit and underwriting. Fogarty joins Greystone having previously worked in real estate structured finance at Société Générale, and alongside Stellato, will report to head of commercial and business development Scott Chisolm.