News Analysis
Capital Relief Trades
Legitimate questions
STS synthetics adoption discussed
The adoption of STS synthetic securitisation has helped legitimise the capital relief trades market. However, this Premium Content article outlines how the EBA’s most recent consultations could prove challenging.
STS synthetic securitisation issuance has soared since the execution of the first transaction in June 2021, adding momentum to this year’s capital relief trade deal flow, further legitimising the market and broadening the investor base. However, the EBA’s recent consultations on synthetic excess spread and homogeneity criteria could pose challenges for the market going forward, if the proposals are implemented as they stand.
The impact of the coronavirus crisis on the European economy boosted efforts to establish an STS framework for synthetic securitisations. Indeed, based on an EBA report from May 2020 and swift action from regulators, the STS label for synthetic securitisations was introduced by the European Commission in April 2021 as part of the Capital Markets Recovery Package (CMRP).
The CMRP amended the Securitisation Regulation to include STS requirements for on-balance sheet securitisations, thereby extending the STS framework to synthetic securitisations (SCI 26 March 2021). The main objective was to facilitate Europe’s economic recovery and allow banks to maintain and enhance their capacity to lend to SMEs and the real economy.
According to ESMA data, the number of STS synthetic securitisations now total 40 in number, following the finalisation of the first STS synthetic securitisation in June 2021. The high transaction activity seen in the first year of STS synthetic ABS demonstrates that the framework has added positive momentum to the development of the CRT market.
The figures are substantial when compared to overall market notional issuance. SCI data show that the number of deals for the first half of this year has now reached 34 overall, compared to 31 for the first half of last year. Last year proved to be a record, with nearly 70 transactions executed.
PGGM has been one of the most active investors in the STS SRT space. The firm has now closed €1.1bn across five such transactions, referencing underlying portfolios of €27.6bn with banks across Europe. Most of these trades were executed with Swedish pension fund Alecta.
As expected, the bulk of the STS SRT market consists of corporate and SME loan deals. ‘’We started seeing STS deals in mid-2021 and the underlying pools have been dominated by large corporate and SME loans, but we’ve also seen residential and shipping loans,’’ says Michael Osswald, md at STS Verification International.
Single concentrations for the transactions must be less than 2% of the portfolio for the deal to be able to benefit from the favourable capital treatment of the STS regime. This could be a problem for less granular portfolios, but is in practice mitigated by banks syndicating the loan or limiting the size of the exposure that goes into a securitisation.
Moreover, the synthetic format works better for some portfolios compared to the cash format. Harry Noutsos, md at PCS, notes: ‘’STS synthetics can be done on a wide range of assets, including CRE or shipping. The biggest challenge for cash deals backed by CRE or shipping loans is refinancing risk.’’
He continues: ‘’If unguaranteed residual value risk is over 50% in a cash ABS, then you cannot achieve STS. These types of loans amortise partially and not down to zero, so they struggle to meet the 50% requirement of cash deals. Yet no such requirement exists for synthetics where investors take on the refinancing risk.’’
Deal structures are varied and include unfunded deals with EIF participation, funded structures using SPVs with collateral in the form of cash on deposits or 0% risk weighted debt securities and direct CLNs.
STS brings additional requirements for synthetic securitisations - most notably stipulations on termination events, stricter collateral requirements and additional transparency requirements. The STS requirements around termination events, in particular, raise real challenges for banks wishing to turn their legacy deals into STS-compliant ones.
Suzana Sava Montanari, partner at Latham & Watkins, comments: ‘’One of the major issues with legacy SRTs is that certain termination rights can’t be used by investors in STS deals. The only terminations available to them are failure to pay and material breaches by the originator. Termination rights are a particular challenge for SPV structures, since although banks can support the SPV, there are situations where if that doesn’t pay over to the investors, then the investors can’t terminate the deal.’’
Legacy trades can be amended into STS synthetic securitisations and the Securitisation Regulation allows this on a retroactive basis. Yet the problem with existing deals more generally is that some STS criteria must apply at the time of notification, while others apply at the time of original closing. Hence, amendments are achievable but cumbersome (SCI 14 April).
Furthermore, determining whether loans acquired from other originators in secondary transactions were underwritten according to the same standards isn’t straightforward. The latter is further complicated by the need to carry out an agreed-upon procedure (AUP) or audit, for which the same criteria as traditional cash ABS AUPs do not necessarily apply.
Nevertheless, the greatest challenge for STS SRTs right now are the latest proposals under the EBA’s consultations regarding the homogeneity criteria and the determination of the exposure value of synthetic excess spread in STS synthetic securitisations.
As part of the CMRP, the EBA is mandated to develop draft regulatory technical standards (RTS) that further specify which underlying exposures are deemed to be homogeneous as part of the simplicity requirements (SCI 5 August), as well as clarify how banks will determine the exposure value of synthetic excess spread (SCI 11 August). From the EBA’s perspective, the aim of the consultation on the RTS for the homogeneity criteria of STS synthetic securitisations was to level the playing field with traditional ABS.
One of the main ways of doing so was to draw a line around the definition of large corporate exposures. This aims to ensure sufficient obligors in the portfolio and an easier analysis of the underlying pool.
In particular, the proposals adjust the homogeneity factors for on-balance sheet securitisations and more specifically the ‘type of obligor’ related to corporate and SME exposures. The latter exposures comprise the bulk of the synthetic ABS market. According to the consultation, banks treat large corporate exposures differently from the rest of their corporate book, which in turn are subject to similar credit granting criteria as SMEs.
Consequently, to ensure a consistent and harmonised application of the requirements - considering that the term ‘large corporate’ varies greatly across jurisdictions - it was decided that the ‘large corporate’ definition would be used from the Commission’s CRR 3 proposals. The CRR 3 proposals define the term as ‘’any corporate undertaking having consolidated annual sales of more than €500m or belonging to a group where the total annual sales for the consolidated group is more than €500m.’’
The EBA wanted to use the same concepts from Basel 3, which explains the choice of the definition of large corporate exposures. Eirini Kanoni, policy expert at the EBA, notes: ‘’The treatment of large corporate loans changes under Basel 3, since the modelling of LGDs under the IRB approach will no longer be possible for large corporates. Overall, risk drivers are therefore expected to be treated differently on bank balance sheets, so we had to align those balance sheets with the new securitisation rules. This explains our choice of the definition of large corporate exposures, which we are now consulting on.’’
However, CRT structurers argue that Basel 3 isn’t yet in force, while pointing out that the EBA has missed the deadline in making these changes. Nevertheless, the larger issue is the inability to mix corporate and SME loans, with no clear rationale and with the risk of ending up with less granular portfolios and less financing to SMEs.
Regarding the consultation on synthetic excess spread, the EBA provides two approaches - called the full model and simplified approach respectively - although both are effectively the same, since the focus remains on lifetime expected losses. Pablo Sinausia, policy expert at the EBA, explains: ‘’The simplified model approach stipulates that if a deal has a 10-year legal final maturity, you can calculate it to the time call rather than the maturity. It also includes a scaler that reduces the exposure value of ‘use it or lose it’ (UIOLI) synthetic excess spread mechanisms.’’
He continues: ‘’In the full model approach, on the other hand, the lower loss absorbing capacity of UIOLI synthetic excess spread compared to a trapped mechanism is already considered in the modelling.’’
The ECB’s approach is very different and is based on the amount of committed excess spread in excess of expected losses - mimicking the approach currently used for true sale securitisations, which originators are unequivocally in favour of.
David Saunders, executive director at Santander, comments: “The EBA’s paper is so prescriptive regarding the calculation of synthetic excess spread that when you consider it with all the other regulations, it raises real modelling complexity. The main driver of complexity in synthetic securitisations in the EU now is regulation by some distance.’’
The EBA has responded to lender concerns by stating that the revisions to the CRR prescribe a focus on lifetime expected losses when it comes to the capital calculation approach of synthetic excess spread. However, lenders have noted that the CRR can be interpreted in ‘’different ways’’.
Stelios Papadopoulos
22 September 2022 09:17:00
News
Capital Relief Trades
STACR six priced
Sixth low-LTV STACR of 2022 priced
Freddie Mac priced STACR 2002-DNA6, its sixth low LTV STACR of the year, on Friday (September 16) afternoon. The GSE was reported to be in the market last week.
The bookrunners were Bank of America and Morgan Stanley, while the co-managers were Amherst Pierpoint, Cantor, Citigroup and StoneX.
The offering consists of three investment grade tranches - a $388m M1-A priced to yield 215bp over SOFR, a $473m M-1B priced to yield 370bp over SOFR and a $304m M-2 priced to yield 575bp over SOFR.
Another DNA STACR is planned for 3Q 2022, with a reference pool comprised of mortgages acquired in 1Q 2022. One more DNA, alongside two high LTV STACRs, is scheduled for 4Q.
Simon Boughey
19 September 2022 16:09:10
News
Capital Relief Trades
Investment slowdown
EIF expected to reduce SRT investments this year
UniCredit and the EIB Group have finalized three synthetic securitisations that will enable UniCredit to provide €5bn in new loans to small and medium-sized enterprises (SMEs) in Italy, Germany, and Bulgaria. The guarantees are three of the last EGF trades as the EIF is expected to halve its tranche notional investments this year compared to the height of the coronavirus crisis.
The transactions have been executed under the European Guarantee Fund (EGF). The latter was a key part of the European Union’s response to the 2020 coronavirus crisis.
Overall, between the EGF’s inception last year (SCI 18 August 2021) and its expiration this year, EGF SRTs totalled €1.4bn in tranche notional and spread over fifteen transactions, with ten of those fifteen benefiting from the STS label. As a result of those EGF transactions, originators committed €12.4bn for SME lending in Europe.
The combined pool size for all three UniCredit guarantees was €4.6bn and featured tranche sizes between €90m-€150m. The German deal was the largest one featuring a €2bn portfolio and benefited from an STS treatment.
The Italian transaction securitises a €1.7bn Italian loan portfolio via a junior tranche guarantee. The capital released from the securitised portfolio will be used to disburse €1.8bn of new loans at preferential rates by 2023 to support new investments and the working capital of Italian SMEs.
In Germany, UniCredit has securitised a €2bn corporate loan portfolio through a junior tranche guarantee. The bank intends to support German SMEs with new loans at preferential rates to the tune of €2.5bn which will be disbursed by mid-2024.
Finally, in Bulgaria, the Italian lender has executed the first synthetic ABS by the group’s CE and EE (Circular Economy and Energy Efficiency) division via a junior tranche guarantee. The deal references a €1bn portfolio of loans which will be deployed for new loans at preferential rates to small businesses in the country.
Between 2021-2022, UniCredit and the EIB mobilized over €9bn in financial resources for companies in countries where UniCredit operates.
Looking forward, well-placed EIF sources confirm that the fund’s tranche notional investments this year are expected to be halved compared to the roughly €4bn invested in 2020 at the height of the Coronavirus crisis.
Stelios Papadopoulos
20 September 2022 14:58:05
News
Capital Relief Trades
Singular CRT
One-off entry into CRT from PacWest
Pacific Western Bank (PWB), a $41bn Beverly Hills, California-based lender wholly owned by PacWest Bancorp, has become the third US regional bank to venture into the CRT market.
It is reported to be in the market with a four-tranche CLN designated PWB 2021-01, which securitizes residential mortgage assets and is set to close this week.
The forerunners in the US regional bank CRT market were Texas Capital Bank, which did its first and so far only deal in March 2021, and Western Alliance Bank, which has done a trio of deals securitizing mortgages and, most recently, capital call facilities.
PWB's deal is unusual is one or two key aspects. Primarily, this is a one-off transaction and is not the beginning of a larger programme.
Unlike its predecessors, PWB is not a mortgage originator or a mortgage warehouse lender but has acquired residential mortgages from other lenders simply because, at this particular juncture, the assets fitted their risk/return requirements.
“They advised us that this was a one-off acquisition of residential mortgage assets, and that they won’t be doing it again,” says KBRA senior managing director Edward DeVito.
This is the way the deal struck observers in the capital relief sector as well. “This looks like a one-off as they don’t do their own mortgages, and it could only be programmatic if they actual had a production/acquisition platform.” says a source.
The mortgages acquired fall into three main buckets. Firstly, it bought mortgages originated and serviced by AmWest Funding Corporation, a West Coast home loan lender founded in 1995. In this case, AmWest has retained the servicing rights.
“This in itself is unusual, as usually in these types of trades you have bank originated assets and bank originated servicing rights on 100% of the portfolio,” comments DeVito.
Another bucket consists of mortgages acquired from JP Morgan and Morgan Stanley, and the third from a host of smaller lenders. All were acquired in H2 2021.
Combined, this creates a pool of 3,819 mortgages owned with an unpaid principal balance of over $2.68bn. It is described as a “heterogeneous pool” of residential prime quality mortgages, non-QM mortgages and business purpose investor loans.
The offering consists of a retained first tranche, and an M-1, rated A-, and an M-2, rated BBB, an M-3 rated BB and an M-4 rated B. The bookrunner is Credit Suisse - not a usual name in the US CRT market either. The CLN structure follows that used by previous US borrowers.
Significantly, PWB is a West Coast lender and thus falls under the jurisdiction of the San Francisco Federal Reserve. This body is reputed to be considerably more sympathetic to regulatory capital relief trades than the New York Fed.
The borrower did not respond to calls or emails.
Simon Boughey
20 September 2022 18:37:48
News
Capital Relief Trades
Risk transfer round up-21 September
CRT sector developments and deal news
Royal Bank of Canada is believed to be readying a synthetic securitisation backed by leveraged loan exposures. The transaction would be the lender’s first capital relief trade. Meanwhile, a US bank is allegedly readying a synthetic securitisation of capital call facilities.
Stelios Papadopoulos
21 September 2022 18:02:09
News
Capital Relief Trades
CRT wave continues
Goldman Sachs prices leveraged loan CRT
Goldman Sachs has become the first large US bank to execute a synthetic securitisation after US regulators effectively put the market on hold this year (SCI 9 August). Indeed, given the regulatory complications, the transaction is more likely akin to a concentration hedge (SCI 11 August), as is the case with a slew of leveraged loan CRTs which have been finalized or are still pending (SCI 9 September).
The transaction features a 0%-15% tranche thickness and was priced at 12.5%. The pricing is notably tighter than Deutsche Bank’s recent leveraged loan deal from the LOFT programme (SCI 30 August), where the first loss closed at 19%.
The nature of the underlying assets couldn’t be disclosed but leveraged loan CRTs tend to be backed by revolving credit facilities (RCFs). RCFs are more attractive for lenders for various reasons. First, they typically reference the exposure at default (EAD) which is the predicted amount of drawn exposure a bank may be exposed to when a debtor defaults on a loan. This matters simply because banks buy protection on just a portion of the notional. Second, from the buy side’s perspective, RCFs are better quality lending books that aren’t typically available in the CLO space.
The Goldman transaction is riding a wave of capital relief trades backed by leveraged loan exposures as regulatory and internal pressures push banks to hedge concentration risks. Societe Generale, Credit Agricole and more recently Royal Bank of Canada are all expected to close such deals this year.
Stelios Papadopoulos
22 September 2022 08:57:20
Market Moves
Structured Finance
Performance triggers finalised
Sector developments and company hires
Performance triggers finalised
The EBA has published its final draft regulatory technical standards (RTS) specifying the minimum performance-related triggers for STS synthetic securitisations that feature non-sequential amortisation. With the purpose of standardisation, the amended Securitisation Regulation sets out that sequential amortisation shall be applied to all tranches of STS on-balance sheet securitisations.
However, as a derogation, STS on-balance sheet securitisation might feature non-sequential amortisation to avoid disproportionate costs of protection, as long as some minimum performance-related triggers determine the application of sequential amortisation. This will ensure that tranches providing credit protection have not already been amortised when significant losses occur at the end of the transaction.
These draft RTS further specify the minimum backward and forward-looking triggers and establish criteria to be fulfilled by the parties involved in the securitisation in order to set the level of the triggers. For this purpose, in the case of the minimum backward-looking triggers, the parties involved in the securitisation shall test the effectiveness of the trigger in a back-loaded loss distribution scenario, taking into account the losses expected over the maturity of the transaction at inception.
Additionally, these RTS contain transitional provisions in respect of STS on-balance sheet securitisations that include triggers related to the performance of the underlying exposures in accordance with Article 26c (5) of the Securitisation Regulation, which were notified to ESMA before the entry into force of this Regulation.
In other news….
EMEA
Bank of America has appointed Mikael Andersson as director - structured finance origination, based in London. He was previously director, securitised products at NatWest Markets and worked in debt capital markets at Swedbank before that.
Simon Gold has joined Chenavari Investment Managers as senior trader, ABS and CLOs, based in London. Gold was previously portfolio manager for ISP Group’s Ardesia CLO fund. Before that, he worked in CLO trading at Bank of America, Cantor Fitzgerald, ICP Capital and Bear Stearns.
Mizuho International has announced the hire of new head of CLO origination and syndication, Hernan Quipildor. In his new role, Quipildor will report to head of structured trading and finance, Mikey Nguyen, and will work to support the creation of Mizuho’s EMEA European CLO business. The new business is important to both the firm’s Japanese and global securities clients, as well as Mizuho EMEA strategy as Japanese investors are very active in the European CLO market. Quiplidor joins Mizuho to spearhead this mission from Natixis, where he served as head of CLO and loan fund financing for Europe and led a team with high quality structuring capabilities.
North America
Fannie Mae is in the market with its ninth CAS REMIC deal of the year, called CAS 2022-09. The GSE was last seen in the market at the beginning of last month with CAS 2022-08. This is a low LTV deal, with all loans having an LTV of between 60% and 80%. Spread levels and issue sizes have changed significantly over the course of the year. For example, the first Fannie Mae deal of the year, CAS 2022-01, was worth US$1.5bn and the M1 was priced at SOFR plus 100bp. The most recent deal of the year, CAS 2022-08, was worth US$626m and the M1 was priced at SOFR plus 255bp.
21 September 2022 15:52:00
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