Contents

Asset-Backed Finance

Portfolio progress

Business model rethink continues apace

The trend of banks rationalising their business models continues apace across Europe. This Premium Content article explores the role of securitisation in their portfolio optimisation efforts.

The need for banks to fundamentally rethink their business models emerged post-financial crisis and continues still across Europe. Beyond disposals of non-performing assets, this entails focusing on core strategies and markets, while reducing exposure to or exiting others. Securitisation plays a crucial role in helping banks achieve these goals – whether that be via significant risk transfer transactions, NPL ABS, portfolio acquisitions or new lending activity.

“Across Europe, banks are rationalising their businesses and refocusing on core competencies, which provides us with opportunities to acquire unloved portfolios,” confirms Hubert Tissier de Mallerais, partner and senior portfolio manager at Chenavari Investment Managers. “Such activity has remained a theme over the last 12 years, with the realisation that capital is a scarce resource and needs to be managed properly. In turn, this has given rise to portfolio optimisation; in other words, reallocating capital from non-core areas of the business to those that are deemed to be core areas.”

Portfolio optimisation can be broken down into calculating the breakeven price of keeping certain assets on-balance sheet - taking into account the associated capital consumption and provisioning - versus selling out of those positions, according to Gianluca Savelli, co-founder and ceo of NPL Markets. “Selling a portfolio is only the final part of the process – the first steps are deciding the optimal portfolio composition, the correct parameters in which to reduce exposure to certain sectors and how to deploy the freed-up capital. Another question to answer is which expenses should be budgeted for in the sale process,” he states.

Usually, this is a chief risk officer/board-level strategic decision, in terms of whether a bank wants to remain in certain asset classes and jurisdictions. Savelli claims that platforms like NPL Markets can aid in this analysis by defining a bank’s current position, plus the risk factors it identifies as drivers of the decision. A user can decide which parameters – default rates, interest rates and so on - to stress and the platform will then calculate the optimal portfolio in terms of risk/reward and value at risk.

John Pellew, principal, distribution and securitisation at Arrow Global, notes that there are two sides to portfolio optimisation: portfolio construction – in other words, buying and servicing assets - and squeezing the most juice out of those assets. The foundation for both sides is data.

Generally, data is structured in a rigid, static XML framework, making it challenging to update the relationship between datasets. “Ideally, there should be a three-dimensional view of data, where the relational hierarchy is neural-linked and therefore more flexible,” Pellew observes. “This provides opportunities to run more sophisticated algorithms and AI tools to create better insights into the performance of the assets and therefore the potential to extract greater value. Ultimately, this enables an organisation to optimise their portfolio management.”

According to Pellew, such an approach requires a team with four skill-sets: data scientists, data architects, data engineers (to create appropriate analytics and extract the data) and a business subject matter expert to interrogate and interpret the patterns within the data.

Chenavari’s European loan portfolio private credit strategy invests in consumer, mortgage, SME and corporate assets across the SRT, portfolio acquisition and new lending segments. “The SRT market is typically easier to access than the portfolio acquisition and new lending spaces because the issuers are banks and buy-side participants can theoretically become involved in the flow. As such, there are periods when the SRT market becomes expensive, as well as periods of ‘feast or famine’ on the supply side. This is why we like the flexibility of not having to chase deals and being able to deploy capital selectively in different ways,” explains Tissier de Mallerais.

The portfolio acquisition strategy has a different construct in terms of risk/reward and the relationship with the counterparty. With SRT, the investor is seeking the best possible alignment of interest with the issuer – the aim is to truly share the risk. With a portfolio acquisition, the bank wants to exit the position.

“The bank provides representations and warranties on the portfolio, but otherwise it’s caveat emptor. Our approach is different as a result – we undertake the same due diligence, but there is limited reliance on the seller. It means that the deal can be riskier, so it is priced differently and hopefully offers greater upside potential via refinancing and eventually selling the assets,” says Tissier de Mallerais.

He continues: “The carry component in a portfolio acquisition is less important than the upside from exiting the position in the whole loan or securitisation market. Overall, the return we’re able to achieve in acquisitions and new lending is often higher than in SRT, which is a buy-and-hold carry investment.”

Opportunities in the new lending space, meanwhile, are being driven by evolving consumer habits and the emergence of non-bank lenders and fintechs, whose need for funding has increased following the withdrawal of banks from the segment. “Non-bank lenders don’t have the same access to capital as banks, so we can provide this capital. We seek alignment with the lender, but they tend to be thinly capitalised, which needs to be taken into account,” Tissier de Mallerais observes.

He adds: “The purpose of the deal is to help a business fund its assets and we view ourselves as a capital partner in this context – whether that is as a senior or a mezzanine lender, or via a forward flow or a warehouse agreement. The level of risk we assume and the requirements of the counterparty vary, but the challenge is to ensure the capital is deployed in the most attractive way.”

The originators are usually backed by private equity or venture capital firms, which perceive Chenavari as a good partner. As Tissier de Mallerais explains: “We speak the same language, given that we are levered investors and understand the whole loan and securitisation markets, albeit with differing return targets. Sourcing opportunities in this space requires familiarity with the fintech ecosystem and being viewed as a good partner, in terms of financing the assets and taking them to the capital markets.”

Barriers to entry across the new lending, portfolio acquisition, SRT and NPL ABS segments remain high. However, the latter has the potential to become more mainstream once there is greater availability of and trust in data.

“Once the data gap is bridged between buyer and seller, it follows that the bid/ask gap narrows and smaller investors can enter the market. Once the asset class becomes less specialised, liquidity increases and price discovery improves,” Pellew argues.

He reports that over a 12-month period, Arrow Global’s collection forecast accuracy levels are within plus or minus 1%. “With these kind of accuracy levels, the NPL market becomes less scary. NPLs are seen as a high-risk product because the assets are distressed; therefore, providing transparency around data and performance is key to the market perceiving the assets as a more manageable risk.”

One way in which Arrow Global is seeking to optimise the capital efficiency of its asset base is to structure more bespoke products that provide a better outcome for both buyer and seller. The aim is to apply a big programme mentality – like that seen in the US mortgage market - to securitisation by using blockchain technology to slice assets into any number of permutations.

“Once assets are digitised, buyers can build investment products based on their own requirements, with post-trade transparency provided by appropriate data and analytics. We can demand a premium for this service, which helps Arrow optimise its value proposition,” says Pellew.

He adds: “In this way, the market can move from a sell-side driven cycle, where the buyer chooses from the stock on a shelf, to a demand-driven model that is more bespoke and therefore of greater utility for the buyer and greater value for the seller. This, in turn, allows the seller to optimise the origination process – whereby assets are originated based on demand for the product.”

Looking ahead, there does not appear to be an end in sight for portfolio optimisation activity. “Banks are constantly having to reallocate capital. CRD 4 means that they are typically three times less levered than they were in 2004 and they’re compensating for this by focusing on their competitive edge and cross-selling opportunities, as well as by reducing exposure to credit losses and reputation/regulatory risk,” Tissier de Mallerais concludes.

Corinne Smith

CMBS

Retail woes

Euro CMBS divergence continues

A new Scope Ratings report shows that European commercial real estate valuations have generally increased across the board. However, challenges remain in the retail and hospitality sectors, with valuers continuing to take a bearish outlook on the sector.

The analysis of 69 publicly-rated securitised CRE loans issued since 2017 reveals that - with the exception of retail properties - valuations have generally increased, driven mainly by yield compression. The tenor of leases has reduced, while performance across CRE segments has diverged.

The industrial sector has performed well, with properties seeing a 6% median income growth. Office performance is mixed, while the hospitality and retail sectors remain weak, as rental income has slumped.

“Struggling retail landlords need to invest significant capex to fight back and repurpose their assets for a mix-usage, to create digital experiences or to introduce click-and-collect parcels. All these elements are embedded in valuers’ bearish outlook for the sector. We expect the trough to be soon reached for niche retail assets anchored to essential businesses,” observes Florent Albert, director of structured finance at Scope.

The pandemic has accelerated structural changes that already existed pre-Covid (SCI passim). Changes in consumer behaviour patterns and e-commerce growth have led to a sharp decline in footfall in shopping malls and high street shops. Retail tenants saw a drop in revenues and the ones who didn’t file for insolvency asked for rent reduction and flexible and shorter-term leases.

Median income growth across the retail segment has fallen by 20%, while hospitality is down by 36%. Both sectors face refinancing risk, as they approach a debt wall in 2023-2024.

Meanwhile, within the office sector, a prime location is no longer a guarantee of success. Occupiers continue to rethink their use of office space, while working practices coalesce around the hybrid working concept.

Scope predicts a ‘K-shaped’ performance between the ‘haves’ and the ‘have nots’. The haves will benefit from strong locations, strong tenant covenants, some operational leases to capture growth among in-place occupiers and environmentally-friendly features, including strong Energy Performance Certificates.

“All-time low risk-free rates pushed valuations up even for assets with declining income, particularly in the office sector. The new rising rate environment is a game-changer,” Albert oberves.

He adds: “We would expect cap rates to increase as risk-free rates continue rising. It will ultimately pressure property valuations, especially for the assets which don’t succeed to increase their income line.”

CMBS investors also appear more cautious in the current bearish environment to take exposure to transitional or non-traditional real estate assets, as evident in the demand for a number of recent transactions. Albert notes that the outlook for the CMBS market had been positive, following a record year in 2021 with €6bn of issuance. However, the crisis in Ukraine has dampened new issuances and investors are increasingly concerned by the environment of rising inflation and rates.

He concludes: “We expect 10 to 15 CMBS this year, mainly in the industrial and residential sectors. We could see a few CRE CLOs, if market conditions improve.”

Angela Sharda

Capital Relief Trades

Climate impact disclosed

Bank of England releases climate stress tests

The Bank of England has released its highly anticipated climate stress tests which show that UK bank balance sheets can absorb shocks from climate risks but the central bank and experts have underlined the fact that data and modelling gaps render any definite conclusions highly premature (SCI 3 December 2021).

The Bank of England’s climate stress test consist of three stylized thirty-year scenarios. The first is an early action scenario where climate policy is ambitious from the beginning, with a gradual intensification of carbon taxes and other policies over time. As a result, global warming is successfully limited to 1.8 degrees Celsius by the end of the scenario, falling to around 1.5 degrees Celsius by the end of the century.

The late action scenario sees policy measures delayed by a decade before they are implemented in a sudden and disorderly manner, leading to material economic and market disruption. Ultimately, global warming is still limited to 1.8 degrees Celsius by the end of the scenario relative to pre-industrial levels, but then remains around this level at the end of the century.

The no additional action (NAA) scenario involves governments around the world failing to enact policy responses to global warming. As a result, global temperature levels continue to increase, reaching 3.3 degrees Celsius higher relative to pre-industrial levels by the end of the scenario.

The NAA scenario leads to serious environmental impacts, including extreme weather events, destroyed ecosystems and rising sea levels. Although these changes take longer to manifest, they give rise to increasing and irreversible shocks that continue to grow beyond the scenario. The scenarios aren’t forecasts but illustrations of possible paths for climate policy and global warming.

UK bank and insurer projections suggest that they are likely to be able to bear the costs of transition that fall on them. The latter is partly explained by the fact that a significant portion of these costs may ultimately be passed on to their customers.

The aggregate loss rates are equivalent to an average drag on annual profits of approximately 10%-15%. However, losses were 30% higher in the late action as opposed to the early action scenario. Hence, early action is important to lower the costs of transition. The results are grimmer for the NAA scenario where projected impairment rates for banks are up 50% compared to normal levels.

Fernando de la Mora, managing director at Alvarez and Marsal notes: ‘’The results show that the impact is manageable. Over a thirty-year period, banks face £110bn in credit impairment charges due to climate. This compares to £90bn of three-year credit impairments for the Bank of England’s solvency 2021 test. However, the data and modelling issues mean that the results should be taken with a grain of salt so there could be a margin of error given the emerging nature of the discipline.’’

Indeed, the impact could be larger given the exclusions. Monsur Hussain, senior director at Fitch notes, ‘’the impact on the trading book for example has been excluded and the scenarios assume fixed balance sheets to render the results more comparable. The exclusion reflects the view that positions in trading books are held for a short term and will be traded over so it’s unrealistic to include them in the exercise’s thirty-year scenario.’’

The stress tests won’t have any impact on pillar one capital requirements since their purpose is to understand how bank business models will be challenged under various climate risk scenarios and to improve their management of climate risks.

De la Mora states: ‘’In the long run there could be an effect on Pillar one, but it will take decades to calibrate these risks by taking credit performance into account. Pillar two on the other hand is a more natural place for supervisors to capture in the case of banks that don’t transition effectively.’’

Sam Woods, ceo of the PRA, qualified that further work on climate risk is needed going forward and he pointed out in a press statement to the following.

First, to the extent that climate change makes the distribution of future shocks nastier, this could imply higher capital requirements, all else being equal. Hence, a key question is whether current capital levels are sufficiently high to guard against unexpected shocks during the transition.

Second, if capital levels are appropriate in aggregate, that does not mean that the capital is held in the right places, with some of these risks being highly concentrated in certain sectors. Consequently, another key question is whether capital frameworks capture climate risks at a sufficiently granular level.

Third, firms must have the right incentives to continue improving their capabilities and meeting expectations. Most fundamentally, the stress test results are a snapshot-based on current data and modelling capabilities- and focused on a specific set of scenarios and risks. Hence, significant uncertainty and gaps underlie these results.

Stelios Papadopoulos 

ABS

Slow and steady

Dutch auto ABS to remain stable as car ownership declines

Adoption of Mobility as a Service (MaaS) in the Netherlands could lead to the end of individual car ownership for the country’s residents. At present, Dutch auto ABS only represents 1% of the total European auto ABS market, so the impact of this shift is likely to be marginal overall. Nevertheless, concentration risk and residual value risk remain important factors to consider when evaluating portfolios.

Alex Garrod, svp within the European ABS team at DBRS Morningstar, considers that even with declining car ownership and a reduction of new vehicle registrations, auto leasing activity will remain active. Indeed, large fleet operators are expected to continue purchasing new vehicles in the same way as they have done historically.

Dutch auto ABS are typically collateralised by receivables relating to operational leases and, overall, leasing represents around one million vehicles of the wider national fleet of nine million across the Netherlands. “The impact may not be as severe as you may think on Dutch auto ABS transactions, as they are mostly collateralised by operational lease contracts, which are not granted to individuals but typically to corporate and commercial entities. So, while private ownership might substantially reduce, we still expect new vehicles to be purchased as leasing companies will continue to provide products and services to SMEs and corporates,” says Garrod.

He continues: “However, what this could mean for the Dutch auto ABS market is a further increase in concentration risk. If we have fewer vehicles directly sold to the consumer and more to commercial entities, the granularity of the auto ABS portfolios may decline.”

Concentration risk already plays a large role in Dutch auto ABS, due to the exposure to mostly commercial entities – leading to a naturally higher lessee concentration, compared to typical retail auto ABS portfolios.

Across Europe, priorities have been shifting away from vehicle ownership towards vehicle access and usability. “This mindset is more aligned with how we look at consuming products these days, which tends to be on a subscription basis,” explains Garrod.

The Netherlands benefits from other cultural strengths in support of this transition, as well from existing effective and reliable public transport infrastructure. However, with the gradual move towards MaaS associated with the rise of subscription culture for new vehicles in Europe, these shorter-term contracts can create greater residual risk within an auto ABS transaction.

“If you have a longer contract, you’re essentially looking at credit risk because you are amortising that balance to zero,” states Garrod. “Typically, where we do see residual value risk in a transaction, it tends to be the predominant risk that drives credit enhancement levels – so it is now often more important than credit risk when you’re assessing auto ABS transactions.”

He adds: “As we move towards Mobility as a Service, we expect this will continue to create more residual value risk, as these products rely on the value of the underlying asset to support ongoing refinancing activity.”

Nevertheless, the shift towards MaaS and the introduction of different financing models could prove advantageous in terms of introducing new originators to the market. “We may see more fintech-type originators that are looking to embed financing throughout the vehicle supply chain, and we could also see certain new jurisdictions accessing the European auto ABS market,” comments Garrod. “Jurisdictions outside the five main European auto ABS markets may also lend themselves to new originators, as we have recently observed in countries like Finland and Portugal.”

Meanwhile, current supply chain issues could spur more lessees to extend existing contracts. New vehicle registrations remain down by 20%, compared with pre-pandemic levels, with these numbers projected to remain subdued - although for Dutch auto ABS, the impact has been limited, due to historically low auto ABS transaction activity.

“For Dutch ABS, it tends to be quite positive when you extend a leasing contract because it allows the leasing company to recalibrate the residual value,” explains Garrod.

The use of electric vehicles in the Netherlands has been heavily influenced by government policy, with the introduction of registration taxes penalising internal combustion engine (ICE) vehicles. “Because of this action, we do not expect new vehicle registrations to revert back to their pre-pandemic levels,” explains Garrod.

New vehicle registrations in 2021 were approximately 500,000 a year, which declined to just over 300,000 in 2021. “Electric vehicles are more expensive and their availability is restricted, so we would expect fewer new vehicles to be registered going forward,” suggests Garrod. “While shifts in the Dutch auto market may not present an opportunity for ABS due to relatively low volumes, it’s more likely to be a restriction on auto ABS generally as portfolios contract.”

The shift away from ICE vehicles observed in the Netherlands is also occurring elsewhere across Europe, albeit at differing speeds. Norway leads the way for alternatively fuelled vehicles, and these represented over 90% of new vehicle registrations in 2021.

“It’s not a process that is going to happen overnight,” comments Garrod. “The vehicles are simply not immediately available and are more expensive, but it does seem like the Netherlands is transitioning faster than other markets - primarily due to government policies that are penalising ICE vehicles, while promoting the purchase and use of alternatively fuelled vehicles.”

Just five years ago, alternatively fuelled vehicles represented only 5% of new vehicle registrations in France, Germany and the UK, whereas last year they represented over 40%. With Europe’s 2030 net-zero target looming, further shifts towards more sustainable modes of transportation are expected.

From a credit risk perspective, Garrod takes a neutral stance on the transition from ICE vehicles to the newer zero- and low-emission vehicles (ZLEVs). He states: “These vehicles tend to be about 50% more expensive, with the average financed amount more aligned with what we already see in portfolios backed by premium vehicles. So, we still feel auto ABS portfolios are granular, despite the higher financed amounts. The portfolios we’ve seen in European auto ABS over the last decade have demonstrated good credit risk performance – with some markets consistently demonstrating default levels of under 2% or even 1%.”

For Garrod, the key takeaway for the transition to new vehicle types is the evolving residual value risk of electric vehicles where little or no historic performance data exists. “Market risk is something that’s really important to us and, where we do have some performance history relating to electric vehicles, it is usually fairly erratic. You may even observe vehicles being sold for similar prices to their initial purchase price - which, in the current market, is a function of the constraints on vehicle supply.”

The performance of electric vehicles in secondary markets has thus far proven resilient and comparable to other vehicle types – although there is a risk of technological obsolescence as the market evolves quickly. “At DBRS Morningstar, we’ve approached this proactively by engaging with one of Europe’s largest automotive data providers, which adopts a forward-looking view across most European markets. This has assisted us in deriving relevant residual value assumptions across our ratings,” explains Garrod.

Many opportunities remain for improving transparency and standardisation going forward, as present ESMA underlying exposure templates for autos fail to even distinguish between the different fuel types of vehicles. “The main point is just data,” concludes Garrod. “Most of the originators are still in the mindset that credit risk is the main factor that drives credit enhancement for the transaction. With these shorter contract durations moving towards a usage model over an ownership model, residual value risk is the most important risk in evaluating an auto ABS transaction.”

Claudia Lewis

Structured Finance

SCI Start the Week - 23 May

A review of SCI's latest content

Last week's news and analysis
Accelerating change
NPL ABS evolution gathers pace
Accountability required
Further transparency needed for ESG CLOs
Capital boost
European banks ready for cycle turn
Climate countdown
Green SRT challenges highlighted
Complex picture
European ABS/MBS market update
Fannie prints fifth CIRT of 2022
CIRT and ACIS ride high
Juicy CRT
Historical wides entice fast money
New path
Mexican securitisation marks firsts for StepStone
Prepare for take-off
If all indicator lights hold true, then the European CRE CLO market is primed

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

SCI CLO Markets
CLO Markets provides 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 David McGuinness at SCI for more information or to set up a free trial here.

Recent premium research to download
Green SRT challenges - May 2022
A green synthetic securitisation framework remains lacking, despite the current regulatory focus on ESG. This Premium Content article explores why.
Aircraft ABS turbulence - April 2022
The fallout from the Ukraine crisis is likely to affect the entire aircraft ABS market, rather than simply those deals with exposure to Russian assets. This Premium Content article outlines why the sector is bracing for a bumpy ride.
Marking 25 Years of cat bonds - April 2022
With the climate threat menacing ever more, is the catastrophe bond market set to see exponential growth? This Premium Content article investigates.
MDB CRT challenges - March 2022
A number of challenges continue to constrain multilateral development bank capital relief trade issuance. This Premium Content article investigates whether these obstacles can be overcome.

SCI events calendar: 2022
SCI’s 4th Annual NPL Securitisation Seminar
27 June 2022, Milan
SCI’s 8th Annual Capital Relief Trades Seminar
20 October 2022, London
SCI’s 3rd Annual Middle Market CLO Seminar
November 2022, New York

Asset-Backed Finance

El Clásico?

Groundbreaking AV bond closes

CVC Capital Partners has closed an innovative hybrid transaction backed primarily by revenues from audio-visual (AV) rights commercialised by La Liga, the organisation that runs the top two divisions of professional football in Spain. Dubbed Loarre Investments, the deal represents the first-ever European bond used to finance a leading sports league.

Late last year, Spanish football clubs voted overwhelmingly in favour of La Liga’s financing deal with CVC. Through such a strategic agreement, Loarre Investments has acquired the entitlement for the next 50 years to approximately 8.2% of La Liga’s AV rights – as well as non-AV activities, such as sponsorships and licences – through an investment of €1.99bn to fund the development of participating clubs and to increase the value of La Liga’s business in general.

The transaction comprises €500m 6.500% senior secured notes and €350m senior secured floating-rate notes, each of which is rated Ba3/BB by both Fitch and Moody’s. A private limited liability company domiciled in Luxembourg, the issuer features a high yield/securitisation structure, which is secured by a package including a pledge over the profits derived from the sale of AV rights.

Gaston Wieder, vp at Moody’s, states: “In our view, the transaction has aspects seen in whole business securitisation deals, in which notes are backed by a substantial portion of the assets and ongoing operations of a company or one of its lines of business.”

At the same time, the transaction documents contain a set of covenants typically found in high yield transactions, including a relatively high leverage level. Wieder adds: “Another aspect to mention is that the issuer in this transaction is owned by the equity investor, whereas in structured finance transactions, issuers are typically configured as bankruptcy-remote SPVs.”

Loarre is investing in La Liga's activities in the context of ‘LaLiga Impulso’, a plan for the future development of La Liga's competitions and the participating clubs. The agreement comprises two aspects, one which is a €1.929.4bn investment through a silent partnership agreement with La Liga, pursuant to which Loarre acquired the AV rights. La Liga will on-lend most of this investment amount to participating clubs for investing in digital and commercial capabilities, infrastructure and the fan experience, as well as to repay debt and fund player expenses.

The second aspect of the agreement is a €64.8m purchase of a 8.2% capital participation in LaLiga Group International (LGISL), which is jointly owned with La Liga and will provide certain business management and consulting services to La Liga. The dividends entitlement pursuant to this capital participation in LGISL entitles Loarre to revenues from La Liga's non-AV activities.

The €850m note issuance will provide a portion of the total Investment, with the remaining €1.2bn funded through an equity commitment letter between the sponsor and the issuer. Loarre will disburse the investment to La Liga in instalments, with around €633m having been disbursed to date. The remaining €1.3bn disbursements will be made between June 2022 and June 2024.

In terms of credit strengths, Moody’s points to La Liga’s robust domestic market position, as well as its strong and predictable revenue stream. The organisation also possesses strong financial controls and disciplinary powers on its member clubs, including controls on debt limits for individual clubs and salary caps for football players' salaries.

However, the transaction does not come without challenges, including loose debt-structure features and high leverage. Furthermore, La Liga’s most successful clubs - namely Athletic Bilbao, FC Barcelona and Real Madrid FC - opted out of Loarre Investments and are taking legal action against the vehicle.

The transaction includes a nullity agreement, which governs the course of action in cases where key investment documents might be ruled ineffective as a consequence of litigation. Wieder notes that “like in most litigations, there is a risk of scenarios resulting in amounts being insufficient for the issuer to fully repay the notes, and we will naturally monitor any developments on this front very closely.”

CVC, along with Advent International, previously attempted to acquire a minority stake in Italy’s Serie A football league through a €1.6bn bid.

Vincent Nadeau

Capital Relief Trades

Risk transfer round up-24 May

CRT sector developments and deal news

HSBC is believed to be readying a synthetic securitisation backed by derivatives exposures. The bank’s last significant risk transfer trade was finalized last year and referenced US corporate loans (see SCI’s capital relief trades database).

Stelios Papadopoulos

CDS

Restructuring event?

Yandex restructuring event rejected

The credit derivatives determinations committee has declined to consider the question of whether a restructuring credit event has occurred with respect to Russian company Yandex. The background to the decision is unclear but it’s perhaps another illustration of the subtleties of demonstrating restructuring credit events compared to failure to pay events.

On March three Yandex issued a press release confirming that its class A shares had been delisted from Nasdaq and the New York Stock Exchange on 28 February due to Western sanctions against Russia. If ongoing for five trading days, the delisting would trigger redemption rights of its US$1.25m convertible notes due 2025. Hence, holders of the notes could elect either to redeem the notes or to convert them into equity.

Indeed, on nine March, Yandex published a delisting event notice stating that on March four, a delisting event had occurred in relation to the notes. The notice stated that under the conditions of the notes, the delisting event had triggered an option for the noteholders to either convert them to equity or to exercise a put option on them. For the purposes of the put option, the original delisting event period was from nine March to nine May, and the put date was set for 27 May.

However, on 29 April, Yandex agreed to an extraordinary resolution with noteholders to extend that deadline to June seven.

Suzanna Brunton, Counsel at Linklaters comments: ‘’the resolution amended the terms of the bonds because the original put date of 27 May was postponed, so a market participant questioned whether this constituted a restructuring credit event under the credit derivatives definitions. The question was submitted on May 19th and rejected on May 23^rd, so the committee didn’t even consider the question.’’

The response of the committee may be explained by the fact that the number of voting members of the determinations committee weren’t enough to look at the question. Under the DC Rules at least two voting members need to agree to accept a question for the DC to deliberate the point. However, it could also be the case that the members reviewed the facts submitted and thought that it was unlikely to meet the test for a restructuring credit event.

Brunton explains: ‘’postponing payments isn’t enough for a restructuring credit event since there must be a causal link with a deterioration in the creditworthiness of the reference entity. The delisting and subsequent events pertaining to the notes was caused by Russia’s invasion of Ukraine so there’s no obvious causal link to a credit deterioration.’’

The determination of credit events is a highly subtle and technical procedure but in some cases the committees can stand back and-using their experience and expertise- determine whether a particular case in question is a credit event or not.

If the determinations committee rejects a credit event question, it’s still open to the contracting parties to determine on a bilateral basis whether this is a credit event, but there will be hurdles since it ultimately must be proved-including the link to a credit deterioration.

Overall, unlike Russian Railways, the Yandex case doesn’t set a precedent. Brunton notes: ‘’In the Russian Railways case, the payment by Russian Railways was blocked due to sanctions and the determinations committee concluded that a failure to pay event had occurred. Unlike restructuring, failure to pay is accompanied by guidance on whether there has been a credit deterioration.’’

She concludes: ‘’The guidance includes a provision which allows the determinations committee to presume a credit deterioration if the failure to pay is caused by certain events, which would include the imposition of sanctions. Consequently, even though Russian Railways attempted to make payments and there was no obvious evidence of a link to credit deterioration, the determinations committee were able to conclude that the credit deterioration requirement was satisfied.’’

Stelios Papadopoulos 

Structured Finance

Office sector concerns

The return to work has brought arguably more uncertainty than the initial transition to working from home, explains Steve Jellinek, head of CMBS research at DBRS Morningstar.

Uncertainty remains a key theme as corporate occupiers look to assess their current portfolios against their future office requirements. They must accommodate everyone who could be present in the building at any given time and must consider peak occupancy instead of average occupancy. A huge shift to hybrid work is abundantly clear for office and knowledge workers. Exceptions include buildings in high-growth markets, as well as life sciences and medical office properties.

Companies are prioritising the importance of office space and the result is companies are investing more in the quality of the space that they create, so that it can support the kinds of activities that are collaborative and require people to come together. An emerging norm is three days a week in the office and two at home, cutting days on site by 30% or more. Google was probably the most prominent, telling workers it wanted most of them back in the office three days a week starting April 4. Rather than bringing a huge drop in office demand, we see big reductions in density, not space. In another emerging trend, we see owners of some class B and C buildings experimenting with coworking models, turning to a flexible office space model on certain floors or throughout their entire building where pre-built suites and shorter-term leases are leased to tenants willing to snap them up.

Rents are a function of location and New York City is a good example. One Vanderbilt skyscraper just across from Grand Central Terminal, which opened in late 2020, is nearly entirely leased and commands some of the highest office rents in the city’s history. An office tower doesn’t have to be new to be successful, either. The one at 320 Park Avenue, built in the 1960s, hit 96% occupancy at the end of 2021, the landlords spent US$35m to US$40m on a modernisation program, which included new lobby, coffee bar and fitness center.

At the end of 2021, Manhattan’s highest office rents were being charged in the Hudson Yards district, where the skyscrapers are new and have all the latest bells and whistles. At the other end of the market, at about US$53 a square foot in average rent, was the City Hall area Downtown. Three submarkets, the other two being Penn Plaza and Times Square South and Downtown’s Financial District, were charging sub-US$60 rents.

Nationwide, on a year-over-year basis as of March, most markets are still above last year’s vacancy level, according to CBRE Econometric Advisors. Due to this, we believe that most markets are tenant friendly except for the tightest markets and premium spaces. We see this in the widening gap between asking and effective rents. Tenant concessions continue to increase, with landlords offering both rent abatements and higher tenant improvement allowances.

Flight to quality remains a dominant theme affecting market performance. Factors include enhanced amenities, health and safety protocols, and an expanded adoption of ESG. Because of this, we expect to see heightened competition for class A buildings, especially in markets with abundant new space such as San Jose, California, Austin, Texas, and Charlotte, North Carolina, where landlords have to compete more intensely to secure tenants that may be shrinking their overall footprint due to the rise of remote work.

After reaching a 14-year high in 2021, lenders and investors are taking a step back as acquisition and lending volume on office properties in CMBS has declined so far in 2022. CMBS issuance volume for office properties fell to US$6.8bn through mid-May from US$34.4bn for all of 2021. In addition to declining volume, loan size is up, and underwriting has become more stringent. The average CMBS office-backed loan size grew by more than 55% over 2018 even as the volume of loans declined. These larger loans boast lower loan-to-value ratios and tend to be secured by premium assets with strong sponsorship and superior locations. Average LTV declined for three out of the past four years, to 53.2% so far in 2022 from 57.4% in 2018.

Most corporate tenants are financially healthy and have continued to honor their leases, regardless of whether they are using their space or not. Cash flows have held steady and delinquencies on office mortgages remain muted. Rents and demand will eventually return to pre-pandemic levels, as the pandemic wanes and companies figure out how to navigate the new office landscape with different working models.

Structured Finance

Wilmington Trust adds new hires

Sector developments and company hires

Wilmington Trust has announced a further expansion to its CLO and loan administration division with three new senior hires. Michael Mooneyham, Ryan Murray, and Madhura Swadi all join the firm in an effort to boost the development of client relationships and increase innovation across the team. They will each join the firm as vps, with Mooneyham and Murrary leading the management of client relationships. Mooneyham joins from Barings where he worked as an associated director and senior portfolio analyst, and Murray joins from the structured finance team at Deutsche Bank where he served as avp and CLO client service specialist. Additionally, Swadi joins Wilmington as lead quantitate risk analyst, and will focus on building out compliance models alongside the analytics team, having most recently served as a senior analyst in data management and quantitative analysis at BNY Mellon. Mooneyham and Murray will both report to head of CLO and loan administration, Richard Britt, and Swadi will report to head of CLO analytics, Jin Lee.

In other news…                     

North America

CIC has named Marc Frenkenberg head of structured finance - Americas, based in New York. He was previously head - securitisation and debt capital market solutions for the firm in Paris. Before that, Frenkenberg worked at GE Capital and Société Générale.

Structured Finance

Arnold & Porter hires new partner

Sector developments and company hires

Arnold & Porter welcomes a new partner to its corporate and finance practice in New York in a move to bolster its offering to lenders and borrowers. Scott Berson joins the firm from Norton Rose Fulbright, with more than 25 years of experience across both secured and unsecured financings. Berson holds expertise on receivables-based transactions across different industries and products and will focus primarily on true sale securitisations.

In other news…

North America

Marc Steinberg has joined SMBC Nikko Securities America as a CLO trader, based in New York. He was previously an md at Brownstone Investment Group and before that worked at Guggenheim Capital Markets, Lehman Brothers, Morgan Stanley and Arthur Andersen, among other firms.

Structured Finance

Call for more 'hard' credit enhancement

Sector developments and company hires

The rise in Euribor swap rates will lead to materially lower excess spread for euro-denominated consumer ABS that close in the near term, Fitch suggests. The rating agency warns that higher hedging costs at closing mean that more ‘hard’ credit enhancement is needed to achieve the same ratings, particularly for high investment-grade ratings.

“How long this situation persists will depend on the speed at which originators reprice assets and their willingness to sell portfolios at higher discount rates. Existing transactions are not affected, as the rate paid for the fixed leg of the swap is set at closing,” Fitch notes.

As inflation and expectations for ECB policy rates have risen, swap rates relevant for euro-denominated consumer ABS have increased from negative 0.5% in 3Q21 to positive 1.2% today, making interest rate hedges substantially more expensive. At the same time, while asset yields in portfolios currently being securitised have not yet increased, note spreads have - dramatically shrinking the excess spread available to cover defaults in new transactions. Without the benefit of a material amount of excess spread, ‘hard’ CE - such as overcollateralisation or a cash reserve - is likely to be needed to cover the same scenario-specific loss assumptions to reach a certain rating.

In other news…

North America

Angelo Gordon has closed its second credit solutions fund, increasing its total in raised equity commitments across several funds in the last three years to US$11bn. The AG Credit Solutions Fund II marks the latest fund in a string of vehicles since 2019, and follows its 2020 predecessor in seeking to use the firm’s capital base and structuring expertise to partner with companies and create bespoke financing solutions aimed at resolving idiosyncratic liquidity and capital structure situations. The fund exceeded its initial US$3bn target within seven months, and closed with US$3.1bn total of equity commitments - with significant support from existing Angelo Gordon clients, as well as new global institutional and retail investors.