Contents

Capital Relief Trades

CLN uplift

CLN deal volumes grow

Global CLN deal volumes witnessed a boost last year following recent lows. However, additional risk factors lie behind the surface along with accompanying mitigants.

According to Scope ratings, global CLN deal volumes crossed the US$46bn figure in 2021, with the past year narrowly surpassing the high set in 2019. The Industrial and Commercial Bank of China (ICBC) was behind the surge in volumes following an easing in 2020. German banks have also developed a strong presence in this market, particularly LBBW.

Repackaged notes and CLNs are instruments whose performance are tied to the creditworthiness of an entity, reference asset and all counterparties. These notes create exposure to the credit risk of the reference asset, which is typically highly rated and can transform cashflows from existing instruments into payoffs which can be tailored to an investor’s needs.

Repackaged notes and CLNs are both funded instruments as opposed to CDS which is unfunded. The coupons typically pay a risk premium and both instruments involve the use of embedded swaps to achieve a bespoke payoff.

Although sharing similar characteristics with CLNs, repackaged notes involve interest-rate or currency swaps as opposed to embedded CDS. Hence, the cash flows of repackaged notes generally move further away from the coupons of the reference assets, and external market conditions exert greater influence.

Repackaged notes and CLNs are typically issued by banks or bank sponsored SPVs. Indeed, through banks, investors bear the direct credit risk of the issuing bank on top of the reference asset. SPV structures help to limit exposure to the issuer.

Nevertheless, Scope ratings notes that the bespoke nature of the payoff as well as common structural features introduce additional risks that need to be assessed when considering such investments.

First, although typically highly rated, the reference asset carries over its risk characteristics into the repackaged transaction, driven by the borrower’s probability of default. Default of the reference asset prompts early termination of the transaction and most likely results in a loss of principal and coupon to the investor.

Another risk driver is counterparty risk. The swap counterparty defaulting on its obligations under the swap agreement can lead to early termination of the repackaged note. Upon such an event, the reference asset will be sold, and the swap agreement terminated, exposing the issuer to potential losses if the full marked to market value due by the swap counterparty cannot be recovered under the terms of the swap agreement.

However, replacement mechanisms can be included within the repackaged note structure to mitigate counterparty risks. Such mechanisms are typically linked to the credit rating of the entity in question. If its current credit rating is below a defined threshold for instance, a new counterparty meeting the criteria will fulfil the role. Further credit mitigants include the posting collateral.

The rating agency concludes: ‘’If the swap counterparty defaults, the replacement mechanism would prevent an early termination of the repackage note. However, replacement costs and swap marked to market payments may occur depending on several factors such as the time taken to find a replacement, changing market conditions, and whether the SPV is in the-money or out of-the-money.’’

Stelios Papadopoulos

CLOs

Positive change

Investor demand set to broaden CLO ESG screening

CLO ESG screening has to date largely been conducted on an exclusion basis. However, a shift towards positive screening is anticipated, as CLO managers work to meet rising investor demand and comply with the Sustainable Finance Disclosure Regulation.

A recent European Leveraged Finance Association (ELFA) ESG investor survey suggests that the switch to a more integration-based positive screening of portfolios is already underway. Representing the views of 66 investors across 37 organisations, the findings indicate a rapid decline in the use of negative screening as a primary approach to ESG analysis – falling from 34% in 2019 to just 6% in 2021.

Andrew Lennox, senior portfolio manager at Federated Hermes, notes that “performing screening on an exclusion basis was a first step, and very much in our view always seen as the first step.” He continues: “What we are looking for is managers who don’t just exclude loans but have reasons for loans being in their portfolio - not just from a credit point of view, but also an ESG point of view.”

Lennox explains that just two years ago, the small few that were screening for ESG were doing so on an exclusion basis. However, CLO managers are now starting to screen individual loans for both positive and negative ESG factors.

“It’s a way for managers to start differentiating themselves, whether they do it or not. But at some point, it will become whether they are doing it well or not,” he states.

Negative screening does provide greater access for managers to the ESG CLO market. For this reason, the European Supervisory Authorities still consider exclusion-based screening an adequate method for the qualification of Article 8 CLOs.

Nevertheless, with interest increasing in the market, new means of differentiation between ESG analysis in CLOs could also enhance the positive impact of investments in ESG CLOs. ELFA reports that within the last year, 98% of the polled investors have had to pass on, reduce or even sell out of investments due to ESG issues.

“Exclusion-based screening hasn’t made a huge amount of difference over what goes into CLOs or not,” comments Lennox. The present process of negative screening does not guarantee the quality of loans that are going to be securitised. He continues: “Whereas with positive screening, you have to justify each and every position for its ESG factors – which is not the case at the moment.”

ELFA’s survey found that one of the key requests from investors regarding the growth of ESG across the high yield and leveraged loan markets is greater data availability and standardisation of disclosures. Establishing feasible methods of comparing CLO managers’ ESG considerations is likely to remain quite difficult until these issues are resolved.

Lennox argues that finding a benchmark-establishing, standardised scoring system would be a useful way for managers to differentiate themselves. “That’s going to be good for the market and certainly good for investors like us at Federated Hermes, and those investors who are more ESG-focused.”

Across the market, participants are increasingly directing more attention towards ESG and its screening processes – and are therefore interested in greater data disclosure. Lennox understands that “it’s important to get as much information as possible out of every stage of that, in order to really justify why that company is favoured from an ESG point of view or not.”

He suggests that coming up with a range for ESG scoring across the market would be a helpful tool for differentiating between CLO managers, both those that are ESG-focused and those that are less so. While he notes that exclusion-based screening offers some level of standardisation for the screening process across the market, he believes it does not differentiate enough.

“It doesn’t really tell you if one manager is doing better than the other on an ESG-front,” he remarks.

Currently, most of the information available across the market is qualitative. However, by assessing ESG with quantifiable data instead, market participants would be able to offer a clearer basis for differentiating/marketing their CLOs for ESG factors.

But Lennox believes that establishing this is a further hurdle in terms of transparency and private information. He comments: “Getting to that point is going to be challenging, but it is somewhere that the market will have to move.”

The issue of quantifiability is most present in the social and governance aspects of ESG - which is why, so far, most ESG-related securitisations have been environmentally-linked.

A further fundamental challenge of data disclosure and transparency is urging borrowers in the private market to provide similar ESG information disclosure. Lennox agrees: “It is a conversation that could progress the ability to better score attributes across the loan universe.”

According to ELFA’s survey, the issue of transparency is of key importance to approximately 44% of its respondents. The survey also found that 98% of the reporting investors would all agree that ‘good data availability’ currently presents the biggest challenge to the process of solid ESG analysis across the broader market.

Certainly, Lennox believes that what will really make a difference is moving to manager scoring. “But also it’s not just a score on day one; it’s an ongoing reporting.”

Federated Hermes adopts a universal ESG scoring system across its business and Lennox argues that lacking business-wide standardisation is a hurdle to overcome, even before market-wide standardisation. “We don’t have a different ESG scoring system to our colleagues in credit or equities. We’ve aligned it, so it means something across the platform,” he explains.

He adds: “I think that’s going to be quite helpful in order for us, as a CLO investor, to really understand what this scoring means.”

However, it is common for companies to adopt internal scoring systems, which reduces ESG transparency and makes it challenging for CLO investors to analyse the merits of the product. Lennox concludes: “Understanding what each manager is doing and how they approach scoring will be really important, because at the moment a manager can come to you and say we score everything, but we have no real understanding of what that means. We’re not going to necessarily see that as good for us as an investor in that CLO until we understand what exactly they’re doing, why those scores are meaningful and what difference it makes to the portfolio.”

Claudia Lewis

Structured Finance

Increasing allocation

Innovation, transparency attracting institutional investors

The majority of institutional investors polled in a recent Aeon Investments survey have increased their allocation to structured credit investments across different asset classes over the past 18 months. When asked why there is growing interest in structured credit investment vehicles, the top three reasons were given as greater innovation in the sector, an improving regulatory environment and greater transparency.

“At the end of last year, we had 20% of global debt in negative yield territory due to various central bank actions over the years. Structured credit, offering a substantial yield premium for equivalent risk, has been increasingly attractive to asset managers,” observes Oumar Diallo, ceo at Aeon Investments.

The firm commissioned Pureprofile to interview 100 institutional investors - collectively representing around US$440bn in assets under management - across the US, the UK, Switzerland, Sweden, Norway, the Netherlands, Germany, Finland and Denmark. The results show that across the structured credit space, 91% of those surveyed increased their allocations to commercial real estate over the last 18 months, 75% increased their allocations to specialist corporate finance, 73% to consumer credit and 65% to residential real estate. Looking ahead, 83% plan to increase their allocation to CRE over the next 18 months, 73% plan to increase their allocation to specialist corporate finance, 69% to consumer credit and 63% to residential real estate.

“The message has been clear - the interest and asset allocations are growing for structured credit, and that trend will continue. There is also likely to be further innovation in the asset space from alternative finance providers, who have been able to pick up where traditional banks have reduced their exposures due to various regulatory requirements,” says Diallo.

He claims that increasing transparency from improvements in regulatory frameworks and governance through measures like the EU Securitisation Regulation has also opened up the asset class further to investors who require a more robust regulatory framework. Further, structured credit products provide the potential to improve risk-adjusted returns and serve as an important diversification tool. Given that they mainly embed a floating rate payoff compared to most government and corporate bonds paying fixed-rate coupons, structured credit products are exposed to a much lower correlation to overall headline interest rate fluctuations.

Indeed, following the Bank of England interest rate rise to 0.5% from 0.25%, Diallo expects that there will be a bit of readjustment and repricing in the short term, as most pension portfolios are heavily exposed to government and corporate bonds. This means that in the longer term, higher rates will be beneficial by reducing the gap to pension liabilities.

He notes: “Central bank tightening will only increase in pace this year, and traditional fixed income investments are likely to continue to underperform structured credit.”

Overall structured credit issuance volumes are forecast to continue rising, with commercial real estate accounting for a relatively small proportion, thereby presenting opportunities for new entrants into the space.

Angela Sharda

Capital Relief Trades

Spread surge

GSEs face sharply higher costs for CRT as spreads widen

The last couple of weeks have seen significant spread widening in the GSE CRT market, making the mechanism less friendly to the balance sheets of Freddie Mac and Fannie Mae.

This week, Freddie Mac priced its second DNA STACR of the year at levels considerably wider than STACR 2022-DNA1 priced on January 20.

The most recent M-1A tranche came in at SOFR plus 130bp and the M-2A at SOFR plus 240bp, compared to SOFR plus 100bp and SOFR plus 185bp for equivalent tranches in the earlier deal.

Further down the capital stack, the differences were even more marked. The M-2 priced at plus 375bp, 125bp wider than the same tranche in the January transaction. The B-1 was priced at SOFR plus 475bp versus plus 340bp and the B-2 came in at plus 850bp versus plus 710bp.

Moreover, tranches have been printing wide of guidance, it is said. Though it declined to comment in detail, Freddie Mac confirmed that in the most recent STACR 2022-DNA2, “The issuance priced within guidance with the M1 to M2 tranches on wide end and the B1 and B2 on tight end.”

The Fannie Mae deal, designated CAS 2022-R02, also printed wide of guidance, say reports, at SOFR plus 120bp, plus 300bp, plus 450bp and plus 765bp for the four tranches. The levels were also about 30% wider than the most recent low LTV CAS trade.

The sharp widening of CRT levels is due to a number of different reasons. Primarily, assets of all descriptions are suffering stress as inflation climbs in the US economy. Yesterday, (February 10) it was reported that the Consumer Price Index (CPI) had hit the highest level seen since February 1982. Stocks duly crumbled while Treasury yields also backed up.

But bumper supply in the CRT market is part of the picture too. Already this year there have been four CRT transactions. Freddie Mac says it expects to execute credit transfer deals worth $25bn in 2022 compared to $19bn in 2021 while Fannie Mae should be especially prolific to make up for its prolonged absence 2020-2021.

There is also risk-sharing supply from the mortgage insurers to consider. At the end of last month, Arch was seen in the market with a $282 mortgage insurance linked note (MILN) under the Bellemeade programme - the first of 2022 and 18^th since the programme began in 2015.

This deal placed five tranches of risk ranging from the M1-A notes paying SOFR plus 175bp to the B2 paying SOFR plus 550bp.

All in all, there will be a lot of supply this year. Fannie Mae has scheduled another 10 CAS REMICs before yearend while Freddie plans to do another eight STACRs. A recent report by JP Morgan suggests the market will see $40bn in risk sharing capital markets transactions in 2022, including MILNs, and this is double the previous high. This suggests spreads are likely to widen out even further.

However, there is confidence in the market that spread weakness will not affect willingness to issue as the CRT mechanism continues to yield benefits to the GSEs despite widening yields.  The JP Morgan report suggests spreads will have to move out by a further 500bp-650bp before CRT ceases to provide economic benefit for Fannie and Freddie.

This is an enormous spread widening and is unlikely to occur unless the economy enters a meltdown similar to the financial crisis of 2008/2009. In lieu of this, Freddie and Fannie will continue to issue STACR and CAS.

“In other words, CRT issuance will continue until the cost of reinsurance is aligned with the capital relief received through CRT,” says the report.

One of the report’s authors, securities analyst Kaustub Samant, explains, “When we say cost of reinsurance, I mean CAS / STACR spreads.” In other words, spreads must rise to the point that the cost of CRT transactions outweighs the capital relief afforded, and this is a long way away.

Market watchers and CRT experts concur that CRT continues to make sense for the GSEs in the face of market turmoil. ““Despite widening spreads, these transactions still provide an attractive cost of capital and will likely continue to be an effective risk transfer tool even at substantially wider spreads,” says Tim Armstrong, md in mortgages and structured credit at Guy Carpenter in Philadelphia.

Others point out that though spreads are now at recent wides, they are not historic wides. “Although CRT funding costs have been markedly rising, the GSEs have seen higher before," observes Mark Fontanilla, founder and ceo of Mark Fontanilla & Co, which produces the market-leading CRTx Index.

Fannie Mae and Freddie Mac declined to comment.

Another factor to bear in mind is the GSEs are mandated to execute CRT trades. This point was stressed in the most recent scorecard. Fannie Mae and Freddie Mac must answer to two powers: the market, and Washington DC.

Unless there is a change in occupancy on the Hill, the GSEs will be asked to carry out risk transfer to a certain extent irrespective of the economics of doing so.

Simon Boughey

ABS

Wider spreads coming

European ABS/MBS market update

The hawkish pivot of the ECB, combined with lingering inflation-driven volatility conspired to drive spreads wider and dampen activity in the European ABS/MBS primary market over the past week. The two transactions in the near-term visible pipeline will have to scramble to price against the currently strained market backdrop.

Finnish auto ABS Tommi 2 (LT Autorahoitus) is due to price this week and has already issued initial price talk, with the class As in the low-20s against the 17bp DM print of its predecessor deal last April. While prime RMBS Credit Agricole Habitat 2022-1 may not print until next week, depending on market conditions.

“The French RMBS will give us a strong indicator as to where we stand currently,” notes one European ABS/MBS trader. “It is a big deal – sized at €1bn – therefore it will be interesting to see if there is any widening in this segment of the market.”

With the ECB’s decision to keep rates unchanged and to pursue a “step-by-step” reduction in bond purchases, the European ABS/MBS market will have to adapt to the withdrawal of monetary policy support. “Usually, the ABS market is very slow to pick up on such news,” says the trader. “But the fact that the ECB is openly discussing when the programmes will end is significant. What will be the effects of such a huge buyer walking out?”

Looking past monetary tightening measures and cycles, the trader underlines the trends in the broader credit markets. “Government bonds are currently being pushed much wider and this will have a strong effect,” he concludes. “For the ABS market, unless there is a huge substitute demand coming in, then there needs to be a little widening to force issuers to come back.”

For more on all of the above deals, see SCI’s Euro ABS/MBS Deal Tracker.

Vincent Nadeau

Structured Finance

SCI Start the Week - 7 February

A review of SCI's latest content

Last week's news and analysis
Big business
Strategic shift favours alternative credit M&A activity
Climate stress tests launched
ECB releases climate scenarios
Fannie CAS prices
New high LTV CAS, second CAS of 2022, prints
Fannie surge
Second CAS of 2022 in the market
Freddie fever
Freddie in the market with 2nd STACR of 2022, 4th GSE CRT deal
MBS meltdown
Fed ends MBS purchases, will reduce portfolio
Positive outlook
Hildene Capital, shares its views on the CLO market
Risk transfer boost
Barclays tops annual SRT issuance
Sea sick CRT
GSE CRT investments punished by January blues
STS SRT finalised
BNP Paribas completes synthetic ABS

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

SCI CLO Markets
CLO Markets is SCI’s new service providing deal-focused information on the global primary and secondary CLO markets. It offers intra-day updates and searchable deal databases alongside BWIC pricing and commentary. Please email Jamie Harper at SCI for more information or to set up a free trial here.

CRT Training
SCI offers a Capital Relief Trades training course, providing complete, deep-dive intelligence on the CRT sector. Aimed at new market entrants, this is a fast track opportunity to get the intelligence you need on the Risk Sharing sector. The course will take place on the 8-9 March 2022, and will be held online.
To find out more about the course, the people who will be leading the training and to download a brochure, please click here or to book click here. If you’d like to discuss any aspect of this course please email David McGuinness at SCI here.

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
16 March 2022, London

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

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

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

SCI’s 8th Annual Capital Relief Trades Seminar
October 2022, London

Capital Relief Trades

Tender two

Freddie concludes second STACR tender offer

Freddie Mac concluded its second tender offer of old STACR notes yesterday (February 8) at 5pm EST.

Twelve tranches, all M2s and M3s, from 2015, 2016, 2017 and 2018 had been offered for tender, though the bulk - 10 of the 12 - date from 2016 and 2017.

The most popular tranches for tender were the STACR 2017 DNA M2 and the STACR 2018 DNA1 M2, for which 92.48% and 93.03% of the original principal amount was tendered and accepted.

At the other end of the scale, only 1.12% of the STACR 2016 HQA1 M3 and 7.29% of the STACR 2016 DNA2 M3 was tendered and accepted.

In total, $2.14bn of the original principal of approximately $3.65bn was tendered and accepted.

Bank of America and Barclays were the lead managers for the tender, which commenced last week on February 1.

Freddie Mac executed the pioneering tender CRT tender offer last September, and with record issuance scheduled for this year it is likely that the utility of the mechanism will be more evident rather than less.

At the time of the first tender offer in September, Freddie Mac said, ““None of the STACR notes in the tender offer provide any capital relief to Freddie Mac.  Freddie Mac considered, among other things, the macroeconomic environment, overall CRT market condition and Freddie Mac risk management objectives.”

Simon Boughey

Capital Relief Trades

Super-size STACR

Biggest ever $1.9bn STACR prices

The largest STACR in the history of the programme, designated STACR 2022-DNA2, has been priced.

Sized at $1.9bn in five tranches, it outweighs any deal since the first STACR printed in the summer of 2013, confirmed the GSE. It will settle on February 11 2022.

Both M1 tranches are in excess of $500m. The $576m M1-A priced at SOFR plus 130bp while the $597m M1-B priced at SOFR plus 240bp.

The $320m M2 priced at SOFR plus 375bp, the $213m B1 at SOFR plus 475bp and the $213m B2 at SOFR plus 850bp.

Price guidance has not been divulged, but, according to Freddie Mac, “The issuance priced within guidance with the M1 to M2 tranches on wide end and the B1 and B2 on tight end.”

Recent new issue spreads in the GSE CRT market have been wider than at the end of last year, due to market turmoil and, in all likelihood, unprecedented supply.

Co leads are Citi and Wells Fargo.

Freddie sold STACR 2022-DNA1 two weeks ago and has now printed $3.2bn of new CRT debt since the beginning of the year. It is expected to sell at least $25bn in the STACR market this year compared to $19bn last year.

Simon Boughey

Capital Relief Trades

Risk transfer round up-10 February

CRT sector developments and deal news

Credit Suisse is believed to be readying a significant risk transfer transaction backed by US leveraged loans from the Kronen programme. The latter would follow another US leveraged loan SRT from the same programme that was executed in December 2021.

Stelios Papadopoulos 

CLOs

Emulating efforts

Jim Wiant, ceo, partner and portfolio manager of Capital Four US, answers SCI's questions

Q: Capital Four launched its first US CLO last year. What were the motivations behind expanding into the US market?
A: If you look at Capital Four’s history and its path to growth, since 2007 the firm has meaningfully extended its investment capabilities beyond just European high yield. The firm now covers a wider range of investment capabilities in Europe – having broadened its investor base, and then importantly expanding its geographic base too. Even prior to the contemplation of establishing the US effort, Capital Four has been increasing its efforts and focus on global funds which could broaden the investment scope beyond Europe and looking towards US issuers.

Prior to the formation of the US platform, the firm saw a real need and interest in being able to provide even stronger global capabilities to its investors. Capital Four has been managing around US$2bn-US$3bn in US issuers - of its total US$18bn - on a consistent basis. By extending those capabilities and having a senior team in the US, we were able to not just grow the business, but better serve our existing investors interests in managing and investing in these global vehicles that have exposure to the US markets.

As the US business gets started, I think the emphasis will initially be on loans and in performing high yield. Establishing the CLO platform in the US is of the greatest importance to us – Capital Four’s CLO business began in 2019 in Europe and is currently working on its fourth CLO.

This is coupled with the fact that the firm has a strategic investor, Northill Capital – which has provided significant equity capital in the launch of both the European and the US CLO businesses. This strategic equity enables us to get the business off the ground and to scale, quickly, with our core strategic focus in mind. 

Q: Currently, what are your primary areas of focus for the new CLO business?
A: When I look at the backdrop of the current investment opportunities in US loans, there has been a dramatic recovery following the pandemic period. We’re probably now at a point in the cycle where it feels like risk is maybe being undercompensated.

We are speaking to an environment where it pays to construct more conservative portfolio structures and then be in a better position, should you get more volatility more broadly within the market. We’ve obviously seen this volatility in equities and in US high yield; however, because of their floating rate nature, loans so far have been quite immune to this volatility.

So, it’s not just about being conservative for conservative’s sake, but being able to create the flexibility, should you encounter volatility – and to take better advantage of that. Then, in the meantime, continuing to make smart credit decisions and being effective in terms of the trading of the portfolio, so we are able to create incremental equity return.

Q: What have been the main challenges you’ve encountered during your expansion into the US market?
A: We have been fortunate in several ways. First, the amount of support which the US business has had from the broader capital franchise has been incredible – both from a capital and a resources perspective. While we are a newer effort, and currently only eight people in size, the amount of resources we can tap in to - from research to operations and portfolio management – really helps us to work as a global operation. Even when I look at CLO 1, because our European analysts have been following US credits for so long, a quarter to a third of the portfolio is actually coming from investment ideas from them.

Another important factor is the decision the team made to base the expansion with real capital and build strong capabilities from the beginning. This has served us very well.

Sometimes, businesses take the approach of first establishing satellite offices before fully committing to growing its business in a new market or region, whereas we decided to invest in a strong and highly capable team from the beginning. Our team averages at about 17 years of experience - most of our investment analysts have been in their sectors for more than a decade and have invested in both the CLO and high yield markets before.

The market, as well, has also been quite accepting of us. I’ll attribute this to being a recognition of the success that Capital Four has already attained in Europe, with the hope being that the US business will follow in those footsteps. Because of this, and the experience of myself and the team, we’ve been able to attain the right credibility – which is critical when you’re marketing a CLO.

Q: How are you expecting the Libor to SOFR transition to impact your US business?
A: It’s interesting, because I think if you were to fast forward 18 or even 24 months, it’s going to appear to have been a non-event. By that point, your assets will have largely migrated over and your liabilities will obviously be in SOFR, so you’ll be back in that natural state of consistency.

I think in this current initial period, there could be some mismatches. First would be how the CSA looks – this bridge from Libor to SOFR.

There has been a lot of uncertainty and discussion about what range that could be and whether that was going to steer more towards the benefit of equity or liability, which could lock up the market for a little bit. However, we’ve spoken to credit analysts in investment grade liabilities and in equity investment teams, and although there’s only been a couple of deals that have come through so far under SOFR, this isn’t an area of any major meaningful concern to either party.

It seems as if there is potential to have a relatively seamless transition and because we are bringing our own equity for the first several deals at Capital Four, it makes us a little less exposed. We want the right equity return for our investors, but for us it’s really about building franchise value and establishing a platform.

So, if we’re going to build conservative portfolios and establish the right track record, if that equity IRR pencils out in our particular case at 12% or 11.5%, there’s going to be some third party of equity investors that won’t be interested. However, for us, we are interested in establishing ourselves and building the business the right way for the long run.

Q: Have you differentiated your approach to the US CLO market versus your existing CLO business in Europe?
A: This is one of the things that has been critical in establishing our US platform. There was about a year of discussion, which followed a pre-existing eight-year relationship with the team at Capital Four, making sure that the way we think about our investment philosophy - about building businesses in general - is aligned. It is important when you’re trying to build a global franchise that all parts of the business reflect the same investment philosophies – because investors expect to see similar portfolio composition and trading strategy between the different regional CLOs.

Q: What are the primary areas of focus for your European CLO business?
A: I think about it in a couple of ways. If you look at successful entrants in the CLO space – and I think this applies to Europe as well – you will find managers who show the ability to ramp conservative portfolios to be able to demonstrate strong performance have been rewarded with lower liability levels much faster than before. Five years ago, as a new entrant, you would have been put at the back of the line in terms of liability levels because it was very much a hierarchy – it was based mostly on scale.

The biggest managers, even if they were mediocre performers, would’ve gotten the tightest spreads – and the newer managers got the opposite. There was a long road for the newer managers to get from one to the other, and because they had higher liabilities, it would force them to form their portfolios accordingly.

Now, I think there’s a path towards getting your liabilities tighter, which gives you a much better strategic footing in the CLO space. So, I think it links up well because the market environment speaks to it, and because of how current liability investors think about younger managers.

In 2022, I think the other areas to be mindful of are inflation and supply chains. How that’s going to play through businesses could define some of the winners and losers here.

We also have to understand what aspects of these risk are analysable. If you can assess for a company that there could be headwinds on the cost-side and it could bring margins from 20% to 16%, I’d much rather be able to box that and ask if we have the appropriate capital structures, for example.

However, when you’ve got something that could be a potential headwind, which could lead to a potential impairment of your loans, where it’s more difficult to analyse or more out of your control – like the price of a commodity. I think those are more concerning to us, and so that’s an important touchstone - particularly within the loan space - to avoid.

Q: How do ESG considerations fit into Capital Four’s CLO business?
A: If you look at the history of Capital Four, I think it speaks to not just a lot of European but particularly Scandinavian investment managers, ESG has been a consideration for longer than a decade. It has been embedded from a cultural perspective long before it was important to investors, or the introduction of increased regulatory scrutiny. Not only is the business broadly well positioned, but the US business especially has been integrated into the existing ESG infrastructure.

There has been an increasing emphasis on ESG across credit broadly, with CLOs being no exception. I think you’re seeing a transition in Europe – which is unsurprisingly further along than the US – of migrating from just an exclusion basis ESG policy in these five or six industries.

Which, if we are being honest with ourselves, isn’t eliminating many potential loan issuers. So, moving towards a more ESG-integration approach may ultimately lead towards firms actually differentiating themselves by having their portfolios geared towards rewarding performing companies from an ESG perspective. In addition, this isn’t just the companies that are the greenest of the green, but the ones that are also making positive steps in that direction.

Today, we manage ourselves consistently from an ESG perspective. Within Europe, our CLOs do not just have exclusions but have actual ESG scoring integration in the indentures and the reporting of our internal ESG scores.

The US is currently predominantly an exclusion-based market, but that does not mean in a few years it will not be different. In the US we are moving forward, and in Europe we expect very soon to be managing some of our portfolios as light green under the European Sustainable Finance Disclosure Regulation.

Effectively, this means the organisation is being run under those principles. So, the US market is at a different starting point, and is perhaps on a slightly flatter trajectory than the pace of change in Europe. However, I think it’s clear the direction that the business is going, and I think the CLO market will follow.

Q: What are your expectations for the future of the market and Capital Four’s role in it?
A: From a credit perspective, we expect defaults to remain quite modest here. There’s a lot of liquidity and, in general, companies are performing quite well.

I think we saw a lot of companies demonstrate their ability to deal with rising costs quite well, either through cost containment efforts or by raising prices – although this can lead to inflation. So far, however, credit issuers have managed okay.

In the high yield space, I expect it’s going to be driven by what’s happening with the expectation on rates. You’re seeing a variation between equity and high yield and what is occurring broadly in the loan market, which has proven to be much more resilient.

I don’t think it’s resilient in an absolute sense, because there are Libor floors which can create a fixed-rate component which would mean rising Libor could hurt your liabilities. Maybe some of your assets float, and some others don’t, but it won’t be a massive area of concern.

I think the CLO market has shown in the US, across a trillion dollars, that it has fully made the transition from a cottage industry dominated by a narrow set of players to being a who’s-who in credit. Regardless of your roots, having a CLO strategy has become the standard.

Last year was a record year from an issuance perspective, and I’d expect 2022 to also demonstrate a strong level of growth. I think we’ll see that continue to develop going forward. The industry has gained a broader acceptance and investor base – both at an equity and a liability level – and there continues to be an interest in supply from managers that view it as a high strategic area of focus.

Claudia Lewis

Structured Finance

CIP, Whitecroft partner for infrastructure SRT

Sector developments and company hires

Copenhagen Infrastructure Partners (CIP) is marketing its inaugural debt fund – the CI Green Credit Fund I (CI GCF I) – having secured €320m in seed capital. Targeting a size of €1bn, the fund will provide private project finance debt with subordinated risk characteristics supporting renewable energy projects globally.

Focus will be on green- and brownfield projects in offshore wind, onshore wind, solar PV, biomass, storage and transmission assets. Geographic focus of the fund will be Europe, North America and selective jurisdictions in the Asia-Pacific region.

The fund will mainly make direct investments, but it is also able to participate in risk-sharing transactions. For risk-sharing transactions, CIP has partnered with Whitecroft Capital Management.

CI GCF I will be co-headed by CIP partners Nicholas Blach-Petersen and Jakob Groot. Additionally, the firm has hired a number of senior project finance and credit specialists in Copenhagen, London and New York to support the fund, which expects to make its first investments in the coming months.

Seed capital is provided by a small group of investors, including a large Danish pension fund and Singapore-based Singlife with Aviva.

In other news…

EMEA

Morgan Lewis has hired a new structured transactions partner as it continues to broaden its global capabilities. Merryn Craske will join the firm’s London office from Mayer Brown where she served as partner. Well experienced in conducting transactions across a range of jurisdictions and asset classes, Craske also has extensive experience in handling other banking and financial transactions.

The firm hopes the addition of Craske and her in-depth experience advising financial institutions on structured finance transactions will enhance its UK business and services available for clients on complex transactions.

Structured Finance

KIS embraces asset management

Sector developments and company hires

Kuvare Insurance Services (KIS) has launched a third-party asset management business. Over the past two years under the leadership of president and cio Brian Roelke, KIS has built a seasoned team of insurance industry professionals and asset class specialists to drive portfolio performance across Kuvare’s operating companies. The firm now plans to extend its experience across private asset-backed and structured credit, private corporates and commercial mortgage debt to non-affiliated insurance clients.

In conjunction with the launch, Roelke has recently added three key members to his executive leadership team. Ana Morales joins KIS as md, head of business development and product strategy. She joins from Goldman Sachs, where she was an md, senior relationship manager in the firm’s insurance asset management business.

Joseph Orofino joins as md, head of investment risk management. He was most recently at Further Global Capital Management, where he was a member of the executive team for two operating companies.

Finally, Thomas Pasuit joins as chief legal officer, having spent over 16 years at MetLife - most recently as head of MetLife Investment Management’s fixed income and alternatives legal team.

In other news...

EMEA

Glennmont Partners has invested in a €100m bond programme dedicated to financing energy efficiency improvements on residential buildings in Italy through its Green Credit Strategy REBS1 (Renewable Energy Backed Securities). The energy efficiency works will benefit from the ‘Superbonus’ tax credit programme implemented by the Italian government in 2020 to support energy efficiency improvements of Italian homes.

In October 2021, Glennmont announced its third green ABS issuance under its Green Credit Strategy REBS1 - an ABS backed by a project finance loan to a Spanish solar photovoltaic plant with a total installed capacity of 20MW. To date, the firm has made credit investments across seven European countries and over 1,000 renewable energy assets, representing a total installed capacity in excess of 8GW.

Structured Finance

Agencies win 'valid-when-made' cases

Sector developments and company hires

Agencies win ‘valid-when-made’ cases
The US OCC and FDIC yesterday received favourable court rulings in cases challenging their ‘valid-when-made’ rules. In each case, the plaintiffs were three states – California, Illinois and New York – challenging the validity of the rulemakings.

The states' attorney generals alleged that both federal agencies violated the Administrative Procedure Act. In particular, the plaintiffs claimed that each rulemaking exceeded their authority, were arbitrary and capricious, and violated federal rulemaking standards.

According to the SFA, the District Court applied a Chevron analysis to determine that both the FDIC and OCC acted within the authority delegated by Congress, and that their actions were a permissible construction of the authorising statute. The court also found that the OCC correctly interpreted the National Bank Act and did not impermissibly preempt state law.

Further, plaintiffs challenged the OCC rulemaking on the grounds that it violated the Madden versus Midland ruling. Again, the court sided with the OCC that the ruling in Madden did not preclude the OCC’s interpretation of the National Bank Act when promulgating the rule in question.

In other news…

EMEA
Clifford Chance has enhanced its structured credit and securitisation services within its financial markets group in Amsterdam with the hire of new counsel, Marijke van der Weide. She joins the firm from Lovens and Loeff, where she served as a senior associate since 2011, and brings expertise in advising corporations, lease companies, mortgage providers and financial institutions. Van der Weide has seconded on a number of global teams – namely the capital markets and treasury team at Rabobank in 2015, the capital markets team at Cadwalader, Wickersham & Taft in 2017 and Dechert’s finance and real estate team in 2017.

Pemberton has hired new md, Matthew Kirsch, to its credit team in London. Kirsch will work in the firm’s 10-person credit team and advise on risk in both existing and new investments. Prior to joining the firm, he was a founding member of Apollo’s European private credit team and has also worked as director on the leveraged finance teams at both Sumitomo Mitsui Banking Corporation Europe and GE Capital.

TwentyFour, UKML merger agreed
The boards of TwentyFour Income Fund (TFIF) and UK Mortgages (UKML) have agreed the terms of a proposed merger of the two companies, effected by way of a scheme of reconstruction of UKML. This will consist of the winding-up of UKML, the transfer of UKML's assets to TFIF and the issue of new ordinary shares by TFIF to UKML's shareholders. 

Shareholders of an aggregate circa 47% of UKML’s shares have provided written support for the scheme, which is expected to be completed by the end of the current financial quarter. UKML has granted TFIF exclusivity in relation to its portfolio until the expected date of completion of the scheme.

Both boards believe that the scheme has compelling strategic, operational and financial rationale - including a strengthened market position due to greater scale and combined asset management and securitisation expertise, with 11 investment professionals at TwentyFour Asset Management focused on the combined entity. The NAV of the enlarged group is anticipated to be circa £720m and the gross mark-to-market yield circa 7.2%.

The consideration for the transfer of the portfolio to TFIF will be satisfied through the issuance to UKML shareholders of new TFIF shares at a price representing a 1.25% premium to the NAV per TFIF share, as at the calculation date for the scheme. The proposed acquisition value per UKML share will be 84p per UKML share, less UKML's costs in relation to the scheme and the retention to meet unknown and ascertained liabilities, divided by the total number of UKML shares in issue.

Structured Finance

HKMC inks infrastructure MoUs

Sector developments and company hires

HKMC inks infrastructure MoUs
The Hong Kong Mortgage Corporation (HKMC) has signed a memorandum of understanding on an infrastructure loans framework with 14 partner banks. The MoUs set out the principal terms for potential infrastructure loan cooperation between the HKMC and the partner banks on both primary participation and secondary sale bases, including the loan selection criteria, mode of participation and engagement process.

The partner banks are: ANZ, Bank of China (Hong Kong), BNP Paribas, China Construction Bank (Asia), Citi, DBS Bank, Industrial and Commercial Bank of China (Asia), JPMorgan (Asia Pacific), Mizuho Bank, NAB, Oversea-Chinese Banking Corporation, Banco Santander, Societe Generale and Sumitomo Mitsui Banking Corporation. The MoUs could assist the partner banks in identifying infrastructure-related loan assets for the HKMC and would further the mandates of the HKMC’s infrastructure financing and securitisation business to fill the infrastructure financing market gaps, while consolidating Hong Kong’s position as an infrastructure financing hub.

In other news…

EMEA
Jonathan Laredo has joined Slate Asset Management as md. He was previously ceo of Yew Grove REIT, having been cio at Solent Capital and cio Europe at Aladdin Capital Management, among other securitisation-related roles.

North America
Dechert has appointed global finance partner Stewart McQueen as the new head of its CMBS practice, based in Charlotte, North Carolina. McQueen has been with the firm since 2005 and his expertise resides in securitisation transactions, complex real estate finance and capital markets. Under his leadership, Dechert hopes to further expand its global finance and real estate business.