Contents

ABS

Social mobility

'Cultural progression' puts social bonds in focus

Securitisations designated as social bonds are gaining traction, with the underlying asset classes expected to broaden. Indeed, at present, it is easier to define lending in a socially responsible way than defining it as ‘green’.

Edward Baker, capital markets director at Prodigy Finance, attests to the reasons this may be. “I think it perhaps chimes with the broader ethical and political environment - which is questioning social and inequality issues, as much as it does deal with the environmental ones. So, I think that’s why social could appear to be catching up with green,” he states.

Killian Walsh, director in ABS at KBRA, suggests that the recent shift in focus towards ‘social’ over ‘green’ assets is not related to the pandemic, but rather a separate cultural progression. “There is an acceptance that the social part of ESG is a very important part of the overall conversation – and I think it’s becoming more relevant, certainly across capital market transactions,” he says.

However, he does not believe it will ever match the green-focus. “I don’t think you’ll ever match the green element of it, but it will certainly become more important going forward.”

Gordon Kerr, head of European research at KBRA, adds that the growing interest is “all about the collateral.” He continues: “It’s easier from a social perspective to define that lending in a socially responsible way than defining it as green. There are a lot more boxes to tick and some science involved with it, which you don’t get on the social side, which needs to be there and in place to make sure that you are complying with the green bond principles or whatever the classification is.”

Across different asset classes, Kerr acknowledges that the intended social impact varies. However, “in theory,” Kerr comments, “this should be able to come back to the basic principles and create a social benefit for the borrower, and maybe for the broader community.”

Following the financial crisis, European mortgage lenders have sought methods of supporting borrowers in long-term financial distress. The solution, explains Kali Sirugudi, structured finance analyst at KBRA, is finding out “how you enable some of these borrowers to keep their homes, while also fine-tuning the repayment of the financial product, is by fine-tuning it to the status of the borrowers.”

Some issuers, including Bank of Ireland, have prioritised borrowers under financial stress retaining their primary dwelling homes. Sirugudi continues: “There’s an attempt to replicate the phenomenon of reperformance - that model - in other jurisdictions. But the social objective there for the regulators is to enable these borrowers to continue living in their primary dwelling home – so certainly, there is an opportunity I see here for issuance which can be labelled as social.”

Kerr agrees: “Over the last two years, there’s been a real sea change in the financial markets and within the financial industry. Investors are demanding this out of lenders and, as a result, we’re going to start to see a lot more collateral that qualifies for the social and the green principles, and so I think we will start to see a lot more coming out.”

This growth is expected to occur year-on-year and Kerr believes it will initially appear in the form of more use-of-proceeds transactions. “This might appear to be bit more self-serving, but the fact they’re still coming out there and are willing to commit to making use of those proceeds towards those projects is a positive thing. And at the back of this year and into next year, you’ll start to see a lot more in terms of the collateral side of things.”

Currently, the majority of participants follow the guidelines set by ICMA’s social bond principles, although Kerr notes that developments could progress more quickly if the EU produces its own social taxonomy. “Out of the green bond one, they created a green bond standard, and I wouldn’t be surprised if they create something similar for a social bond going forward,” he concludes.

Claudia Lewis

CMBS

Comfort break

Motorway service area CMBS yet another blow to WBS

Late last year Goldman Sachs issued Highways 2021, a £262m CMBS backed by a single loan secured by eight UK motorway service area properties. The transaction mirrored Welcome Break’s 1997 £321m bond issue, which represented the UK’s first whole business securitisation. Such a structural shift represents yet another nail in the coffin of the whole business securitisation sector, following a few high-profile blow-ups as well as having to compete with the rise of high yield bonds in Europe (SCI 29 July 2021).

“No-one is really doing WBS anymore,” notes Conor Downey, real estate finance partner in the London offices of gunnercooke. “The only ones still being issued in the UK are from utility companies, and I wouldn’t necessarily describe them as WBS.”

Mark Nichol, European CMBS/ABS strategist at Bank of America, shares this view: “The whole theory - sitting at the heart of WBS - that you could have 25 years of predictable and stable income was challenged as technologies and consumer habits change.”

Fundamental to the asset class was also the notion of “high barriers to entry,” highlighting some unique feature that guarantees the underlying business a leading position in the market. In the case of Highways 2021 or Welcome Break Finance, transactions secured by motorway service areas have been impacted by coronavirus lockdowns and prior to that, foot and mouth disease.

“The original Welcome Break deal went into default because of a sharp decline in travel during the foot and mouth crisis. It is rather surprising to see another deal in the midst of lockdowns,” notes Downey.

Interestingly, the same portfolio of motorway service station assets was securitised in both Highways 2021 and Welcome Break Finance. Such a transformation from a WBS to a CMBS raises the question of how similar - if not the same - assets receive different treatment or generate a distinct cashflow.

Downey states: “WBS deals were capped at a single-A rating because of operational risk and inability to take fixed security on all the assets. It looks like arbitrating the system to get the same assets rated triple-A because of a different rating methodology.”

A CMBS transaction also offers more structural protection. “What we learned from WBS is that the loans were too long-dated. Looking at Highways, Blackstone [acting as loan sponsor] has the ability to refinance or sell the assets within 2-5 years,” observes Nichol.

He concludes: “You don’t need a 25-year crystal ball. And if anything goes wrong, your leverage is significantly lower in the CMBS (57% LTV) than the original WBS (71% LTV). That is where your comfort comes with a CMBS.”

Vincent Nadeau

ABS

Aligning interests

Greek NPL market tipped for further growth

Activity across the Greek non-performing loan market is gathering pace. New players are expected to enter the sector this year, with a further uptake seen under the HAPS programme.

“There will be further uptake of HAPS – it has worked well to allow people to manage the size of investments that [they] made in the NPL space, so it has been helpful for people coming into that market that may not have otherwise entered the space,” claims Tim Monahan, senior associate at Allen & Overy.

The budget under the current law runs until October 2022 and Mohahan says he will be watching any future developments in this space.

Allen & Overy last year advised Bain Capital and Fortress Investment Group on the Project Frontier transaction, which involved the purchase of 95% of the mezzanine and junior notes from a securitisation backed by a portfolio of non-performing exposures sold by National Bank of Greece with a total gross book value of €6bn (SCI 19 October 2021). More recently, Eurobank closed a securitisation of the €3.2bn Mexico Portfolio, already under management by doValue (SCI 14 January). 

Each of these transactions feature a guarantee on the senior debt from the Greek state under the HAPS programme and are structured to achieve significant risk transfer recognition under the European Capital Requirements Regulation (575/2013).

One of the main challenges posed by these deals was ensuring that everyone’s interests were aligned. Previous transactions, such as Eurobank’s Pillar and Cairo and Alpha Bank’s Galaxy, had already been structured by the banks, and were then amended and sold to investors following a competitive bid process and negotiation.

In the case of Frontier, Sally Onions, partner at Allen & Overy, acknowledges that it was a day one closing with the investors, with a large number of counterparties and counsel involved, and the requirement for various regulatory approvals on the Greek side before closing.  She expects to see more Greek NPL portfolio sales come to the market, including some deals executed on a synthetic basis.

She adds: “We will see new players enter the market on the servicing side and the investor side. From our side, we are working on three deals that are yet to come to market, so we are expecting a busy 2022. And the larger banks will continue to look at how they manage their NPL exposures going forward.”

Issuance volumes are not expected to exceed the levels reached in 2021 and 2020. However, the full effects of the pandemic on the Greek NPL sector have yet to emerge, given that the market is still working through the coronavirus fall-out.

For example, Onions points out that some of the servicing patterns that would typically be expected to be seen - including enforcement of the underlying properties - came to a halt, and many borrowers were given grace periods to pay their loans. She concludes: “We may see more loans becoming NPLs going forward, as we see the effects of the pandemic come through to investors. How fast Greece and other jurisdictions bounce back is an ongoing concern in relationship to the pandemic – there could be an increase in defaults and more NPLs in the future.”

Angela Sharda

Capital Relief Trades

Bond exodus

Credit options tapped as floater shift begins

Bond investors have been tapping credit spread options and CDS indices to hedge the downside risk for their portfolios following rising levels of inflation and firm expectations of rate rises this year. More saliently, the use of credit derivatives coincides with a shift of investment flows from bonds to floating rate products.

The Federal Reserve is expected to raise interest rates this year as year-on-year inflation reaches the 7.5% mark. The USD 3- month LIBOR is anticipated to rise to 1.5% by year end compared to 0.29% a year ago according to Pearl Diver Capital research. The ECB is likely to follow suit with similar actions in the medium term.

‘’The ECB and the Fed are moving in a direction where they are tightening monetary policy. This presents a downside risk for bonds, so investors have turned to CDS indices and credit spread options to protect their portfolios from that risk’’ says Viktor Hjort, global head of credit strategy at BNP Paribas.

Credit spread options are options to buy an index at a given strike price. If an investor wants to hedge downside risks, they can go long on the underlying index and pay a premium for that. One key benefit of credit options for some investors is that they don’t have to take a view compared to allocating capital to floaters and it can also be a cheaper option.

Data for credit spread options aren’t available since they are traded over the counter but ISDA data point to an increasing trend for CDS indices and particularly in Europe. According to ISDA data, CDX HY traded notional grew by 30.4% between 4Q20 and 4Q21. Over the same period, CDX IG traded notional increased by 23.5% and iTraxx Europe led the way with a 138.5% boost.

Meanwhile, JPMorgan data show that fund redemptions ramped up across both investment grade and high yield to their highest levels in nearly two years, as the former saw outflows of nearly €2bn-largest since March 2020-and the latter around €750m-the highest since November 2020. The outflows from bonds mirror the inflows towards floating rate products. US loan funds for instance recorded US$11.5bn of inflows YTD notes Pearl Diver Capital research.

                  Figure one-US leveraged loans YTD total returns                                                                                                          

Indeed, net fund flows further coincide with the performance of both bond and floating rate products with the latter having performed better than the former. The reasons driving the demand for floaters are straightforward. As interest rates go up as expected and the value of fixed-rate government and corporate bonds drops, floating rate products such as loans become prized assets as hedges against rising rates and inflation.

                   Figure two-US high yield bonds YTD total returns                                                                                                                                                                                                                                                              

However, the high-quality institutional loan universe is limited and won’t be able to absorb all investment flows rotating out of bonds. Hence, investors will have to look for ‘’alternatives’’ and this is where significant risk transfer transactions stand to benefit as well.

SRTs remain one of the few places where investors can make a positive real return, given their illiquid and complex nature. Furthermore, SRT premiums are largely non-directional since investors aren’t taking any specific views on the market, so it’s a premium over pure credit risk.

Nevertheless, the more pertinent point is default performance since when compared to other floating rate products such as CLOs, SRTs offer average annual default rates below 1% for the vast majority of loans that back these transactions (SCI 18 November 2021).

Stelios Papadopoulos

Capital Relief Trades

Maturity extensions

Undrawn RCFs return but modelling issues persist

Santander has reopened the market for significant risk transfer trades backed solely by undrawn revolving credit facilities in December last year (SCI 4 January). The Spanish lender became the first bank to execute such a transaction in Europe with the Vespa and Meno deals (SCI 10 January 2020). However, calculating the maturity for these trades remains a challenge

David Saunders, executive director, at Santander CIB notes: ‘’The exposures consume less capital and generate lower income compared to drawn exposures. As such, it would be extremely hard to structure an SRT transaction that had to reference the nominal of a portfolio of underlying undrawn RCFs in an economically efficient manner. As such, the EBA’s Q&A confirmation regarding the ability to reference EAD instead was extremely helpful for issuers.’’

Undrawn corporate facilities are a typical product that banks must provide to corporate and financial institution clients, even though they are thinly priced and capital inefficient. The European Banking Authority (EBA) confirmed via a Q&A in 2019 that banks can reference the exposure at default (EAD) of such assets for purposes of achieving SRT.

EAD represents the predicted amount of drawn exposure a bank may be exposed to when a debtor defaults on a loan. Effectively, the new guidelines allow EU banks to buy protection for a portion of the credit line rather than the whole notional, rendering the economics of the SRT deals workable.

Investment grade firms typically require revolving credit facilities for liquidity backstop purposes. Most large firms finance their term debt by issuing bonds rather than borrowing via term loans and tend to be large issuers of commercial paper.

However, the latter come with maturity risks. Hence, to avoid a potential cash crunch they need backstops from banks, otherwise they lose their investment grade rating even if they have conservative capital structures.

The Coronavirus crisis saw these lines get drawn as borrowers were concerned about their access to capital markets. The latter in turn pushed up RWAs for the RCFs. However, even if credit lines are completely undrawn, this doesn’t mean that they don’t consume capital.

According to an SRT investor: ‘’even when RCFs are undrawn, regulators assume that they may be drawn at a future date, if a borrower’s credit quality declines and access to capital markets is reduced. Banks must use a credit conversion factor to calculate the EAD for these commitments. SRTs therefore provide capital relief upfront, and if these RCFs get drawn further, the transaction also acts as a hedge against the bank's RWA increase.’’

The transactions tracked by SCI typically reference a mix of drawn and undrawn exposures. Bank structurers note that this is simply a function of size. The deals require large portfolio sizes if they are to work and a mixture of both does the trick.

However, size is not one of the key challenges for pure play undrawn RCF SRTs. Saunders explains: ‘’one of the key challenges in these deals is the modelling of the maturities and particularly maturity extensions since corporate borrowers often don’t want them to mature. They are there to protect ratings.’’

Santander has tapped both reinsurers and hedge funds for these pools so there’s no reason to think that it might be more suitable for certain types of investors. Indeed, both Vespa and Meno went to reinsurers.

Stelios Papadopoulos 

Structured Finance

SCI Start the Week - 14 February

A review of SCI's latest content

Last week's news and analysis
CLN uplift
CLN deal volumes grow
Compounded calculations
First RMBS tied to Sonia index issued
Emulating efforts
Capital Four US answers SCI's questions
First loss guarantee tapped
EGF SRTs receive mixed reactions
Increasing allocation
Innovation, transparency attracting institutional investors
Positive change
Investor demand set to broaden CLO ESG screening
Spread surge
GSEs face sharply higher costs for CRT as spreads widen
Super-size STACR
Biggest ever $1.9bn STACR prices
Tender two
Freddie concludes second STACR tender offer
Wider spreads coming
European ABS/MBS market update

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.

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

Structured Finance

Fannie in the money

Income and net worth climb to new highs

Fannie Mae’s net worth ballooned during 2021 by $22bn to $47.36bn, the GSE reported this week in its annual and Q4 earnings.

Net income increased by almost 100% to $22.18bn from $11.81bn in 2020. Net interest income rose by $4.72bn YoY to $29.59bn, while credit related income moved from an expense of $855m in 2020 to revenue of $5.1bn in 2021.

Fannie made $451bn of single family home acquisitions in 2021, the highest on record, and 50% of these were first time buyers. It acquired 1.5m mortgages and 3.3m refinance loans during 2021.

Only 0.7% of all loans were in forbearance at the end of 2021, down from 3% at the end of 2020.

Last week Freddie Mac reported net comprehensive income of $11.62bn in 2021 compared to $7.53bn at the end of 2020. Net interest income rose by $1.1bn to $17.48bn, while net income decreased by 6% YoY to $2.7bn as higher net revenues were offset by an increase in credit-related expenses.

The mortgage portfolio increased in value by 20% to $2.79bn.

Simon Boughey

Capital Relief Trades

Modest uplift

Default outlook remains mild

The pandemic-fuelled default cycle proved to be short-lived and much less severe than prior cycles, as the strong economic recovery and abundant liquidity kept defaults low in 2021. However, default rates are expected to pick up this year, but forecasts estimate rates that are below the long-term average as well as pre-pandemic levels.

According to Moody’s, the trailing twelve-month global default rate for speculative-grade corporate issuers-including both financial and nonfinancial companies-was 1.7% at the end of 2021, down from 6.9% a year earlier.

Under the agency’s baseline scenario, the default rate will fall to 1.5% in the second quarter and then gradually rise to 2.4% by the end of the year. If these forecasts are realized, the 2022 default rate will remain well below the long-term average of 4.1% and the pre-pandemic level of 3.3%.

Nevertheless, the agency qualifies that the default rate could surge to 9.1% under its most pessimistic scenario, if economic and financial risks were to crystallize into a severe economic disruption resulting from the spread of new virus variants and more aggressive monetary policies. Under the optimistic scenario, the default rate could decline to 2%. The 2.4% baseline default rate forecast for year-end 2022 translates into 81 defaults, or roughly seven per month.

Underpinning the modelling are the following assumptions. First, although inflation concerns have caused many central banks to signal plans to end quantitative easing and raise interest rates, monetary policy will likely continue to support economic growth but will be less accommodative than earlier in the pandemic.

Second, although the recent emergence of the Omicron variant has led to a jump in new virus cases, Moody’s assumes that this latest virus wave will have minimal economic impact, as preliminary data appear to indicate that Omicron's symptoms are less severe than those of the Delta variant. The more pessimistic scenario hinges on the same assumptions while adding geopolitical and trade tensions and a regulatory reset from China that triggers widespread and drastic deterioration in credit and growth trajectories.

Measured by default rate, Moody’s estimates that the most troubled sector in 2022 will be hotel, gaming & leisure, with a one-year default rate forecast of 3.6%. This forecast is underpinned by the sector’s weak rating mix and watch/outlook distribution. The sector has recovered from the lockdowns of 2020, but its longer-term recovery remains vulnerable to new virus outbreaks. Within this sector, the global lodging segment is set to grapple with a prolonged business and group travel recovery.

Moody’s notes: ‘’Across regions, US regional gaming and Las Vegas margins remain strong, but growth in 2022 will likely slow compared to outsized 2021 growth. We expect a gradual and bumpy recovery in Macao's visitation and gaming revenue in 2022 amid continued stringent travel restrictions across China.’’

The rating agency concludes: ‘’when measured by default count, business services will likely have the most defaults in 2022 because of the relatively large number of low-rated companies in the sector. As for construction and building, the largest contributor to defaults last year, our model predicts a decline in defaults in 2022.’’

Stelios Papadopoulos

Capital Relief Trades

Risk transfer round up-16 February

CRT sector developments and deal news

HSBC is believed to be readying another synthetic securitisation following the recent execution of a capital relief trade backed by US corporate loans. The US transaction was a US$312m CLN that referenced a US$2.5bn portfolio (SCI 12 January).      

Stelios Papadopoulos 

Structured Finance

Continued growth

Sector developments and company hires

Briarcliffe has made two more new appointments as it continues the expansion of its private credit business. Kyle Abel joins the firm as new head of GP advisory from First Avenue, where he served as md and US head of project management. Additionally, Robert Molina has been promoted to head of origination, having previously worked as md of GP advisory, and will lead the firm in finding new and differentiated private credit offerings. Both new team members bring over 20 years of experience in the private markets to their new roles, which the firm hopes will further enable them to meet rising investor demand for the asset class.

In other news….

EMEA

Alpha Bank has announced its entry into binding agreement with Cerberus for the sale of a portfolio of Cypriot non-performing loans and real estate properties. The €2.4bn portfolio will be sold in the latest move from Alpha Bank Group in its mission to reduce its NPL stock. Dubbed Project Sky, the sale will further de-risk Alpha’s balance sheet by lowering the NPE ratio to an approximated 13%, with the transaction expected to be completed in 3Q22.

Structured Finance

Greater progression

Sector developments and company hires

Maples Group has announced the hire of two new structured finance professionals, expanding its offering in its London and Jersey offices. Emma Tighe will join the firm in its London office as vp, having spent more than 14 years working in structured finance and most recently serving as relationship manager on the US Bank CLO team. Tighe has expertise across securitisation and structured debt capital markets, and has expertise across multiple SPVs, including CMBS, RMBS, social housing bonds, student loans and aviation leasing.

The second new addition, Jodie Gray, will also be joining the firm as vp, and will be based in its Jersey office. Gray has over 25 years of experience in financial services, 16 of which were spent at wealth structuring group, VG, where she served most recently as associate director. Gray will work as a resident director in Jersey across private equity, real estate, and structured finance transactions.

In other news…

EMEA

Jacob Binnema has joined MUFG’s EMEA securitised products and supply chain finance team as head of public securitisation Europe. Based in Amsterdam, Binnema will focus on originating transactions with issuers to be distributed in the public securitisation market, on which the firm is acting as arranger or underwriter. He was previously head of ING’s structured solutions group in Germany and before that worked at Rabobank and ABN AMRO.

Man GPM has appointed new co-heads of its credit risk sharing business – Matthew Moniot and Jonathan Imundo. With over 40 years of experience in alternative asset management and banking between them, the pair have been recruited to increase the firm’s existing private credit offerings. Moniot joins Man GPM from Elanus, of which he was a founding member in 2010, where he served as cio and became one of the first specialised asset managers in the CRS market. He will utilise this expertise in his new role, where he will be responsible for managing the firm’s new CRS strategy from its London office. Imundo will also be joining the firm from Elanus but will maintain his position there as president and head of client solutions, alongside his new role at Man GPM based in New York. As co-head, Imundo will concentrate on business development and work closely with the sales team and clients to build new CRS solutions.

North America

Blue Owl Capital is set to acquire Wellfleet Credit Partners from Littlejohn and Co affiliates. The firm announced that it has entered into a definitive purchase agreement and is expecting to close on the transaction next month. Wellfleet currently has US$6.5bn in assets under management across a total of 16 CLOs, and is led by leveraged finance experts, Scott McKay and Dennis Talley. The Wellfleet team will report to Blue Owl co-founder and senior md, Craig Packer, with McKay and Talley continuing on as lead portfolio managers of the platform as part of the firm’s Rock division.