Contents

RMBS

Agency avoidance

Originators set to turn to private market as fees rise

The GSE footprint in the US MBS market is set to shrink, and even a minor diminution would have a dramatic impact upon volume seen in the private label RMBS market, say analysts.

The potential reduction in MBS issued by Freddie Mac and Fannie Mae is due to two chief reasons. Firstly, the GSEs will increase the loan level pricing adjustments (LLPAs) in April, probably pushing a percentage of deals into the private market.

Secondly, originators are making more non-QM loans are rates rise, and, as only QM-qualified loans are eligible for purchase by the GSEs these mortgages are also more likely to end up in the RMBS market.

“Given the size and scope of the GSEs, and the amount of production that they’re doing, even a slight change in what they buy today will have an outsized impact on RMBS because RMBS is so much smaller than the agency business,” says Roelof Slump, head of structured finance operational risk at Fitch Ratings.

For example, in January 2021 there was $7bn of issuance in the RMBS market but $351bn in the agency MBS market, according to SIFMA. In December 2021, RMBS issuance had shrunk to $2.6bn while agency MBS issuance was $242bn - almost 100 times larger.

Last month, private issuers sold $3.1bn in the RMBS market while the agencies sold $245bn. So, even a drop of, say, only $5bn per month in the agency market could more than double RMBS issuance, based on December 2021 figures.

On January 5, GSE regulator the FHFA announced that there would be “targeted increases” to upfront fees for some high balance loans and second home loans from April 1. For the high balance loans, fees will increase from 0.25% to 0.75%, while for second home loans fees will increase a whopping 2.75% from 1.125% to 3.875%.

"These targeted pricing changes will allow the Enterprises to better achieve their mission of facilitating equitable and sustainable access to homeownership,” said FHFA director Sandra Thompson. In other words, the GSEs are seeking a cushion to allow them to widen the credit box and fulfil the mandate of increasing home ownership among the traditionally underserved.

Second home borrowers, for example, are not currently seen as core to the current mission of the GSEs, hence the sizeable increase in fees charged to originators who make this type of loans.

The agencies gave the originators three months to prepare for these changes. Higher fees obviously reduce the profit margin, leaving the originators with two choices. They can then push the fees onto borrowers, but this is likely to diminish the amount of product they generate. Or they can eschew the GSE market and choose private label issuers to whom to sell the loans.

“To the extent that higher LLPAs cause originators to look for alternatives for delivery of those loans, some percentage may be re-directed to private label RMBS.  Aggregators which purchase loans could provide an alternative outlet,” says Slump.

At the same time, refinancing - which has accounted for a large share of new business in the last year or two - is decreasing as mortgage rates rise. Lenders have an expensive infrastructure which cannot be easily downsized, so to maintain equivalent production levels they must look at alternative sources of lending.  The signposts point to increased non-QM lending.

Slump says that more participants have been seen in the non-QM space lately. “Non-QM is an area which has been underserved because it’s a lot easier to do a conforming loan refinancing delivered to the agencies rather than originating a new, rather more complex loan but the alternative is either you close a non-QM loan or you close fewer loans as rates move higher,” he explains

It is also possible that more investors, in the shape of bank portfolio lenders, will move into the market and snap up mortgages that are now too expensive to sell to the agencies. These loans would then sit on the books rather than enter the MBS market. 

This week Fannie Mae also lowered its forecast for 2022 mortgage origination by $172bn to $3.34trn. In Q1, there should be just under $800bn, of which slightly under half will be refinancing. There was $1.2trn in Q1 2021 alone, of which more than two-thirds was refinancing.

Fannie Mae and Freddie Mac have been unavailable for comment.

Simon Boughey

ABS

Going digital

Stablecoin securitisation tipped for growth

Appropriate regulation of digital payment could pave the way for the issuance of securitisations in stablecoins. However, this Premium Content article argues that further standardisation across the blockchain ecosystem is needed for the technology to reach a critical mass.

The regulatory attention that digital payment is currently attracting – as exemplified by the US Fed’s recent report on central bank digital currency (CBDC) and the US SEC’s examination of the stablecoin market - has been welcomed by the securitisation industry. It is hoped that appropriate regulation of this sector will allow for greater adoption by institutional investors and pave the way for securitisation issuance in stablecoins.

The size of the stablecoin market is estimated to be over US$150bn, while the ‘unpegged’ cryptocurrency markets - like Bitcoin and Etherium - are over US$3trn in size. Digital currencies are important to the blockchain ecosystem, as they provide a way of representing cash in real time. However, digital currencies can also introduce counterparty risk to financial transactions.

One way of minimising cryptocurrency credit risk is to use stablecoins backed by bank deposits. For example, blockchain securitisation issuer Figure Technologies is a founding member of the USDF Consortium, which launched last month and aims to further the adoption and interoperability of a bank-minted dollar-backed stablecoin assured by the FDIC (see separate box). The consortium currently comprises five community bank members, but plans to significantly grow the membership base by year-end.

Meanwhile, with Cadeia’s recent GreyPeak 2021-1 blockchain securitisation, payment was executed in a fiat currency (Swiss francs) instead of a stablecoin to avoid introducing counterparty risk to the transaction (SCI 7 December 2021). “We’re waiting for central banks to introduce central bank digital currencies - CBDCs - which would make transactions even more efficient. Depending on the set-up, CBDCs could enable settlement within milliseconds of execution and ensure direct transfer from one wallet to another within seconds,” notes Rolf Steffens, co-founder and md of Cadeia.

The Fed’s report on CBDC, which was published last month, examines the potential benefits and risks of CBDCs and identifies specific policy considerations. In the report, a CBDC is defined as a “digital liability of the Federal Reserve that is widely available to the general public.” The report notes that unlike stablecoins, a CBDC’s value would not depend on an underlying asset pool for its backing.

Further, the report indicates that if a CBDC were to be created, such a CBDC would need to be privacy-protected, intermediated, widely transferable and identity-verified, according to a Schulte Roth & Zabel client note. “While the report does not commit the Federal Reserve to any action, the report demonstrates the serious attention that financial government agencies and regulators are giving to digital payments (and the potential desire by the government to create its own form of digital payment),” the firm observes.

The Fed is requesting public comment on more than 20 questions on the benefits, risks and policy considerations for CBDCs, as well as CBDC design. Comments are being accepted through 20 May 2022.

The report follows one published by the President’s Working Group on Financial Markets (PWG) on stablecoins in November, which notes that “stablecoins, or certain parts of stablecoin arrangements, may be securities, commodities and/or derivatives.” As such, the report highlights a number of recommendations to address the associated public policy challenges, with the US SEC and CFTC noting that they will deploy “the full protections of the federal securities laws” to these products.

Fred Matera, md and head of residential at Redwood Trust, welcomes the SEC’s examination of the stablecoin market to evaluate what types of regulation are best to protect investors. “Smart regulation would allow for more adoption by institutional investors,” he suggests. “We would anticipate that the regulatory regime would provide clear guidance by the time we are ready to tokenise mortgages and issue securitisations in stablecoins. As with all of our new products, Redwood’s approach will be to work closely with our regulators to help inform what the ultimate structure looks like and to ensure support.”

The firm’s current approach to using blockchain in securitisations is as a tool running in parallel with existing reporting to assist with disclosures and transparency, all within the existing securitisation framework. But Matera says that eventually, Redwood foresees securitisations becoming ‘tokenised’ - in other words, issued in a stablecoin - which would allow for more efficient tranching and fractionalisation of risk.

Steffens says that financial assets – such as loans – are more straightforward to tokenise because all of the documentation can be executed electronically. But real assets, such as cars and real estate, require more human involvement - due to there being less standardisation in those sectors - and therefore they will likely take more time to be tokenised.

Matera accepts that applying blockchain to the more traditional aspects of the wider economy, like the mortgage market, is still in its nascent stage. He suggests that by introducing blockchain technology into Redwood’s existing residential jumbo securitisation framework, the firm is giving market participants a chance to vet the technology over time in a way that is safe and additive to their ability to collect relevant information.

“Currently the blockchain technology is additive to our traditional reporting and not in replacement of it. Overall, we believe that the technology can be helpful to the industry and, at Redwood, we have created an opportunity for blockchain to prove that thesis while simultaneously benefiting investors and market participants,” he explains.

In collaboration with Liquid Mortgage, Redwood last year became the first issuer to price a securitisation that used blockchain to provide this data (SCI 23 September 2021). This involves loan servicers reporting borrower-level payment activity for each securitised loan every business day to Liquid Mortgage, SEMT’s blockchain provider. Liquid Mortgage then makes that information available to registered users on its reporting site the same business day.

“We believe that this inclusion of enhanced payment and prepayment reporting within the Sequoia (SEMT) securitisation platform is the first step on a path to putting an entire RMBS transaction on the blockchain. By leveraging the speed and accuracy of distributed ledger technology, we believe we can drastically increase transparency and reduce the points of friction in the life of a residential mortgage loan, including legal documents and contracts, diligence, reporting and data. For example, we believe the loan level payment reporting introduced for this transaction may provide greater insight into borrower payment and prepayment activity on a more frequent basis than is traditionally available,” Matera observes.

Given the potential for such a wide range of applications, there is an opportunity for all securitised asset classes to be potential beneficiaries of blockchain technology, according to Matera. “Redwood has been a leader in securitising loans for over 20 years and we view utilising blockchain for reporting as a safe and efficient way to provide end users with more timely reporting of loan level payments,” he notes.

TJ Milani, general manager of Figure Marketplace, agrees that while generally any assets can be securitised on blockchain, the more streamlined the origination process is and the less manual intervention there is, the more savings can be achieved by using the technology. “Blockchain technology has come a long way over the last four years and is now becoming mainstream. Figure has executed three HELOC securitisations via blockchain and transacted with 100 different counterparties - from small regional banks to the likes of Jefferies, Nomura and Raymond James,” he notes.

He adds: “But to ensure that blockchain does what it’s supposed to do, a strong IT system is necessary – including different nodes to validate transactions and implementing proper encryption. Further, regulatory reporting should be integrated with end users’ general ledgers and compliance systems - so that they are receiving the information they need, but in a way that is compliant with their systems.”

Many financial institutions are currently exploring whether to implement private or permissioned blockchain environments, with the aim of keeping information private and reducing costs. In this context, Steffens highlights the issue of data secrecy.

“Ethereum is a public blockchain, so do not deposit confidential information on there, unless access to it can be controlled. Keep such information in the first level, outside of the blockchain, and controlled by using an application permission system or, alternatively, a permissioned blockchain,” he says.

The Cadeia platform, for instance, offers a two-level operating system – one level is a cloud application outside of the blockchain and the other is deposited on the blockchain of choice. In the case of the GreyPeak transaction, the firm used the Ethereum blockchain, but the platform is agnostic in terms of blockchain connectivity.

“The first level allows transaction participants to structure a securitisation, including the covenants and their trigger levels, as well as cashflow waterfalls and changes in the way principal and interest is distributed. Once this is agreed, we release a series of smart contracts that represent these attributes onto the blockchain via the second level of the platform,” explains Steffens.

He continues: “The smart contracts convert the attributes into blockchain language and execute them automatically. The platform enables users to speak blockchain language and use the blockchain environment as a trusted platform over the life of the deal – from the initial issuance down to the last payment on the refinancing instruments. The Cadeia platform can handle traditional, as well as tokenised asset and refinancing instruments, making the system future-proof.”

Ultimately, further standardisation across the blockchain ecosystem would facilitate its up-take. “There are no specific structural barriers to the wider adoption of blockchain – it’s available for anyone to use already. But the industry needs to get to the point where all banks/issuers and all investors are set up on blockchain – we need the buy-in of a critical mass of users,” Milani concludes.

Corinne Smith

Drifting wider

European ABS/MBS market update

The European ABS/MBS primary market continued to be impacted by macro volatility last week. However, while spreads drifted wider, the few deals that were done still generally managed to attract healthy investor demand.

“The market has been very calm in the past few weeks,” notes one European ABS/MBS trader. “Spreads have without a doubt widened, however not at the same magnitude as we are currently witnessing in credit.”

Last week saw Credit Agricole’s return to the RMBS market with its Habitat 2022-1. The single offered tranche priced inside fairly generous initial talk of low-30s with a 28bp DM and was 1.3x oversubscribed.

“CA was unlucky with its timing, “observes the trader. “The same deal last year would have landed in the low 20s. While 5bp-10bp outside is not enormous, it is still considerable for this asset class.”

The other widely offered deal to print last week was TwentyFour Asset Management’s UK RMBS Barley Hill 2. The senior notes landed at SONIA plus 92bp at the tighter end of low-to-mid 90s initial talk and were healthily oversubscribed at 2.6x. The B and C tranches followed a similar pattern, but the class Ds were only 1x covered and saw pricing at plus 210bp after final guidance at plus 200bp.

The only other deals to price last week were two private transactions. The primarily pre-placed and retained Irish NPL RMBS Warrington Residential 2022-1 saw all of its tranches price below par; and Santander Consumer Bank fully retained ABS SC Austria Consumer Loan 2021.

The secondary market was even quieter last week, the trader reports. “We are not seeing a lot of movement. Spreads have broadly widened; however, the market is particularly illiquid,” he says.

The only deal in the visible primary pipeline is Volkswagen’s VCL 35 with pricing targeted for the middle of this week. “It will be interesting to see how it performs,” says the trader. “It is much shorter than the Habitat deal at 1.3 years as opposed to five, which seems to be the sort of duration investors are looking for at the moment, so I think it will be better received. However, it will still price a lot wider than last year’s VCL deals.”

Looking ahead, the trader concludes: “Given the current volatility, issuers will take more time to come to come to market; and investors were also left rather perplexed with Largarde’s recent comments. However, ABS’s great advantage – with the current tensions regarding rates – is that it operates on floating rates.”

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

Vincent Nadeau

ABS

Trigger timing

Pro-rata rating volatility warning

Trigger timings and the portfolio realised credit performance of pro-rata securitisations may expose rated notes to higher rating volatility, compared with sequential transactions, according to DBRS Morningstar. In a new commentary, the rating agency reviews the additional risks associated with pro-rata transactions and the different factors that may determine when triggers are breached.

“Pro-rata structures tend to be very sensitive to cashflow assumptions, such as prepayment levels, default timing and how triggers are designed,” says Guglielmo Panizza, vp of European ABS at DBRS Morningstar.

European ABS transactions traditionally follow sequential amortisation structures, but an increasing number of consumer and auto ABS deals are featuring an initial pro-rata amortisation period. Auto lenders, in particular, have used pro-rata amortisation structures to simultaneously achieve significant risk transfer and allow funding costs to remain constant. For sequential transactions, funding costs typically increase as the notes start to delever.

From an investor perspective, senior notes in pro-rata structures typically have a longer WAL, thereby reducing the risk of reinvesting in lower-yielding securities.

Pro-rata transactions commonly include credit performance triggers that switch the transaction to irreversible sequential redemption of the notes when breached. While there have already been instances of sequential transactions switching to pro-rata amortisation after reaching a desired level of credit enhancement, DBRS Morningstar has observed a higher number of transactions amortising initially pro rata until performance deterioration is captured by the relevant trigger.

The length and shape of the default timing curve are the driving factors within DBRS Morningstar’s cashflow analysis, as they significantly influence the timing of a trigger's breach, determining the switch to sequential amortisation. The agency points out that in a scenario of very low defaults, the sequential trigger may only breach towards the tail end of a transaction, exposing the senior notes to a long redemption period.

Conversely, in a scenario of very high defaults, a transaction is likely to switch to sequential redemption earlier on. This would expose the mezzanine and junior notes to a longer redemption period, thereby benefitting the senior noteholders that are repaid faster.

“However, both senior and mezzanine noteholders may face increasing risks if a deterioration in credit performance materialises later than expected. Principal collections will have already been allocated on a pro-rata basis to all notes prior to any deterioration and excess spread may have already been used to cure principal deficiencies or made available to pay junior items, including excess spread notes. Unlike sequential structures, longer default timing curves combined with back-loaded losses are generally more stressful for the senior notes in pro-rata structures,” DBRS Morningstar observes.

The agency considers high prepayment scenarios to be the most stressful for pro-rata structures, as they reduce excess spread and allow higher levels of principal to be allocated to non-senior notes during the pro-rata amortisation period. “Performance permitting, a pro-rata ABS transaction can amortise pro rata until the portfolio has reduced substantially, exposing junior notes to tail risk that would not be present in a sequential-pay structure,” it adds. “In a benign environment, faster-than-expected recoveries and/or lower-than-expected yield compression may extend the pro rata period, increasing risks for the senior notes.”

Finally, DBRS Morningstar notes that some pro-rata structures may be sensitive to changes in the amortisation profile, depending on tranche thickness and trigger thresholds.

Corinne Smith

Structured Finance

SCI Start the Week - 21 February

A review of SCI's latest content

Last week's news and analysis
Aligning interests
Greek NPL market tipped for further growth
Bond exodus
Credit options tapped as floater shift begins
Comfort break
Motorway service area CMBS yet another blow to WBS
Fannie in the money
Income and net worth climb to new highs
Maturity extensions
Undrawn RCFs return but modelling issues persist
Modest uplift
Default outlook remains mild
Social mobility
'Cultural progression' puts social bonds in focus

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

Capital Relief Trades

Risk transfer round up-21 February

CRT sector developments and deal news

Piraeus Bank and Alpha bank are each believed to be readying synthetic securitisations for this year. The deals would be riding a wave of Greek significant risk transfer trades and follow deals that both banks executed last year (see SCI’s capital relief trades database).

Stelios Papadopoulos 

Capital Relief Trades

Risk transfer round up-22 February

CRT sector developments and deal news

Societe Generale is believed to be readying an upsize for a significant risk transfer transaction backed by capital call facilities that the lender executed in the summer of last year (see SCI’s capital relief trades database). Dubbed Opale three, the deal rode a wave of capital call SRTs over the 2020-2021 period (SCI 16 November 2021).

Stelios Papadopoulos  

RMBS

Borrower beware

Cost of living crisis to have 'unequal impact' on UK RMBS

The fallout from the UK’s ‘cost of living crisis’ will hit lower-income mortgage borrowers hardest, according to a recent DBRS Morningstar analysis. However, while inflation may cause challenges for all consumers, RMBS portfolios will not all be impacted equally.

The Bank of England anticipates that inflation rates will peak this spring, rising from the current level of 5.5% to a high of 7%, before falling towards the targeted level of 2% over the next two years. Although these rises in inflation are described as ‘transitionary,’ the situation could worsen if high rates persist over the next few years, leaving more borrowers facing debt servicing problems.

“Due to the rising cost of living with limited real wage growth, personal finances have been stretched more than ever in past two decades - especially in the UK, which has experienced higher energy and fuel costs, higher debt financing costs and increases in some taxes. The situation may become more serious as some borrowers face issues with debt servicing,” says Mudasar Chaudhry, head of European structured finance research at DBRS Morningstar.

The DBRS Morningstar study analysed 543,000 loans across 57 UK mortgage portfolios, in order to assess the potential implications of the rising cost of living across borrowers in the UK. Based on data provided by ONS, the rating agency expects borrowers to experience rises of 54% in energy bills, 10% in transport costs, 0.25% in mortgage interest rates and 5% in other household expenditures. This follows the Bank of England rate increase of 0.5% and Ofgem energy price cap increases earlier this month, as the UK works to minimise the impacts of rising inflation.

Borrowers thus face a rising cost of living alongside limited real wage increases, all while income bands remain static, resulting in decreasing debt affordability. As such, some borrowers with variable-rate mortgages or those with fixed rate mortgages seeking refinancing may face an increase in mortgage repayments.

Overall, lower-income borrowers will be the worst affected by the cost of living crisis, DBRS Morningstar notes. However, only 3% of mortgage borrowers are in the lowest income decile and only around 16% of borrowers are in the bottom three income deciles (with monthly household incomes of less than £2,000), versus 30% of borrowers in the general population in those segments.

Meanwhile, mortgage borrowers are over-represented in the mid- to high-income deciles (with monthly household incomes of between £2,000 to £7,000). There are also fewer mortgage borrowers compared to the relative population in the very high income band of greater than £7,500 monthly income.

For the lowest group, the increase in the cost of living reduces the remaining disposable income (assuming no growth in income) from £93 to -£10, a significant 110% drop. At the other end of the spectrum, borrowers in the highest income group will see a 10% drop in disposable income. For an average mortgage borrower, the reduction will be 36%.

However, DBRS Morningstar does not expect any instability imminently in terms of mortgage performance, with borrowers prioritising mortgage payments over other discretionary expenses.

Claudia Lewis

Structured Finance

TEAK wins CIFC philanthropic support

Sector developments and company hires

CIFC Asset Management has unveiled the second annual donation made on behalf of the CLO Initiative for Change, its philanthropic programme in connection with CLOs issued by CIFC. In support of educating and empowering students to reach their full potential regardless of financial means, CIFC has partnered with the deal parties of its latest CLO - CIFC Funding 2022-II – (including RBC, Appleby, Allen & Overy, Milbank, BNY Mellon and Locke Lord) to make a collective contribution of over US$225,000 to the TEAK Fellowship.

Founded in 1998 by Justine Stamen Arrillaga, TEAK is a free, 10-year college prep, access and success programme for middle school, high school and college students located in New York City. Beginning the summer after sixth grade, TEAK accompanies high-achieving, low-income students on journeys of academic and emotional preparation and mentorship. In addition to helping these students achieve entry into the nation's most prestigious high schools and colleges, TEAK provides its fellows with access to internships and professional coaches, ultimately helping to create career opportunities to which these individuals may not have otherwise been aware.

In addition to the financial contribution, CIFC team members will partner with TEAK to provide mentorship and/or educational support this year and potentially thereafter.

In other news…

EMEA

Mount Street has promoted co-ceo, Ravi Joseph, to the position of executive chairman, with fellow co-ceo, Paul Lloyd, taking over as solo ceo for the firm. Going forward, Lloyd will assume responsibility for all management duties at the firm. Joseph will maintain involvement with some investment management activities, however, will be primarily focused on strategic operations in his new role. Mount Street hopes this leadership transition will better place the ever-growing firm to meet the demands of future development and expansion.

North America

GoldenTree has announced the hire of new partner and head of private credit origination, Grady Frank. He will join the firm from Goldman Sachs where he served as md, having also recently worked as a senior member of the Financial and Strategic Investors Group. With more than 20 years of leveraged finance experience, Frank will lead GoldenTree’s expansion into the private credit space as the firm seizes rising opportunity within the market.