News Analysis
ABS
Existential challenge
Activist agency, 'originalist' Court clash
The US Court of Appeals for the Fifth Circuit last month ruled that the CFPB is unconstitutionally funded. This Premium Content article investigates what this landmark judgment means for the securitisation industry.
Those in the securitisation industry concerned by the implications of the lawsuit brought by the Consumer Financial Protection Bureau (CFPB) against National Collegiate Master Student Loans Trusts (SCI 12 April 2021) will have been encouraged by the 19 October ruling that the CFPB is unconstitutionally funded. The significance of this judgment for the CFPB, made by the US Court of Appeals for the Fifth Circuit, cannot be underestimated.
It means that some defendants in past actions taken by the CFPB are likely to claim such suits are invalid, as the Bureau was unconstitutionally structured. It also means the Bureau is perhaps less likely to pursue new cases, as these are likely to be challenged on the same grounds, say lawyers.
The appeals court gave its verdict in the case of ‘Community Financial Services Association of America, et al. versus CFPB, et al.’, in which the plaintiffs challenged the CFPB’s 2017 Payday Lending Rule on a number of counts. One of these was that the funding structure of the CFPB violates the Appropriations Clause of the US Constitution, and it was this point with which the court agreed.
But the ramifications of the decision spread far beyond payday lending, as it rests on the fundamental financial underpinning of the CFPB and consequently amounts to “an existential challenge to the agency and to all of its actions,” according to law firm Hunton Andrews Kurth in a note on the topic.
“The court has said that the CFPB was relying on funding that was unconstitutional to roll out the payday lending rule and therefore it’s unwinding that rule. This is the biggest ripple effect. Everything that they have now done could be subject to challenge based upon the funding issue,” says Eric Hail, a partner at Hunton AK in Dallas, Texas.
Unlike the great majority of executive agencies, the CFPB does not rely on annual appropriations for its funding, as agreed by Congress. The Fifth Circuit determined that the Appropriations Clause ensures exclusive Congressional power over the Federal purse and is vital to the separation of powers.
In its defence, the CFPB claims that it is not in any way special. “There is nothing novel or unusual about Congress’s decision to fund the CFPB outside of annual spending bills. Other federal financial regulators and the entire Federal Reserve System are funded that way and programmes such as Medicare and Social Security are funded outside of the annual appropriations process,” a spokesperson for the Bureau told SCI.
This argument has some validity. The Federal Reserve, the Commodity Futures Trading Commission (CFTC), the Office of the Comptroller of the Currency (OCC) and the Federal Housing Finance Authority (FHFA) also bypass the appropriations process.
But, says the Fifth Circuit, the CFPB has what amounts to a “double insulation” from normal process, in that it not only receives money directly from the Fed but also the director of the Bureau stipulates exactly how much it needs. The Fed is obliged to pay this as long as it doesn’t exceed 12% of total operating expenses (US$6.47bn in 2020). This is unique, and this is what is unconstitutional, says the Fifth Circuit.
The CFPB is almost certain to contest this ruling, which is then likely to make it way all the way up to the Supreme Court unless Congress steps in. Given the current disposition of the Supreme Court, and its so-called ‘originalist’ stance on a number of topics, it seems quite likely that it will side with the Fifth Circuit.
“If I had to bet one way or another, I think the Supreme Court will agree with the Fifth Circuit. They did agree with the Fifth Circuit on the FHFA director being subject to presidential dismissal, for example,” says Chris DiAngelo, a partner with Katten Muchin Rosenman in New York.
If indeed it does agree, Congress would have to step in and a new funding structure arranged. But at the very least, this throws a spanner into the works of the CFPB. Past actions will now be subject to appeal on the grounds that they were made by a body unconstitutionally founded, and future actions may well be curtailed.
“I think they are bruised. The Bureau may well be more hesitant to take certain actions, given the potential challenges. Put another way, it has given ammunition to people that are unhappy with an action taken by the CFPB,” says Hail.
This is welcome news to interested parties in the securitisation industry that had been perturbed by the 2017 case against student loan trusts, and the subsequent refusal to have this case dismissed by the Third Circuit Court of Appeals in December 2021.
The CFPB sought to define these student loan trusts as ‘covered persons’ under the terms of the Consumer Financial Protection Act (CFPA) and make them thus liable for abusive practices carried out by debt servicers. Of course, trusts are merely shell vehicles, and any financial penalties incurred by the trusts would have to be borne by investors.
By agreeing with this definition, the Court opened up a large can of worms for the structured finance business in the US. As Cadwalader, Wickersham and Taft said at the time: “The Court’s ruling thus creates a new line of potential exposure for entities, like securitisation trusts and other whole loan buyers, that acquire consumer loans on a servicing retained basis or enter into a servicing agreement with a third-party servicer acting as an independent contractor.”
In February 2022, Fitch also noted: “The recent ruling that 15 national collegiate student loan trust issuers are subject to the enforcement authority of the CFPB could result in increased risk of unforeseen monetary losses for these NCSLT issuers and also could result in monetary losses in the future for other US structured finance transactions backed by consumer assets, where similar misconduct is found to have occurred.”
In view of the widespread concern in the market caused by the covered persons argument, the verdict of the Fifth Circuit on 19 October is certain to have aroused relief. The CFPB, however, denies that its wings have been clipped.
“The CFPB will continue to carry out its vital work enforcing the laws of the nation and protecting American consumers,” a spokesperson told SCI.
The confirmation of Rohit Chopra as the director of the CFPB in September 2021 caused alarm bells to be rung along Wall Street. On the progressive wing of the Democratic party, he has, for example, advocated closer scrutiny of financial institutions and called for the cancellation of student debt.
At the SFA Conference in Las Vegas in October last year, less than a month later, Rachel Rodman, a partner at Cadwalader, Wickersham and Taft, warned that with his appointment the securitisation industry should be prepared for “more frequent enforcements and bigger fines.”
She added that there would be “new and novel interpretations of what constitutes a covered person.”
The inauguration of Chopra at the head of an Obama-era agency, erected after the credit crisis of 2008/2009, seemed to be symbolic of a very new spirit on Washington, DC from an administration committed to intervention in many areas of the US economy to secure policy aims.
While many of the CFPB initiatives could be seen to be well-intentioned, there was a general fear that the law of unintended consequences would apply and that an area of the financial industry of acknowledged benefit to the American consumer would be damaged, perhaps fatally.
Some of the long-term effects of CFPB action might not always be unintended either. “With the Bureau, it’s always a case of, ‘Oh that sounds like a good idea’. And then when you get into it, you realise that there’s an angle,” says another lawyer.
However, even before the 19 October verdict, there was no guarantee that actions undertaken by the CFPB would not run into the unswerving, and final, opposition of the Supreme Court. While federal agencies might be awash with a new mission and sense of purpose to right wrong wherever they see it, the Supreme Court has a very different view of the limitations of agency powers.
Of the nine current justices, three were appointed by President Trump, two by President George W Bush and one by President Bush. These six have what has been described as an “originalist” view of the separation of powers and believe in making sure that agencies are accountable to Congress and thus the electorate.
This view was announced very clearly in the June ruling on West Virginia versus the Environmental Protection Agency (EPA), in which the Court determined the EPA does not have the power to set emission targets for power plants, as this should be a question for individual states to decide.
In doing so, the Court side-stepped the landmark Chevron versus Natural Resources case of 1984, which essentially held that if a statute is not very clear, then a federal agency is free to interpret it as it sees fit. It has been seen as the salient case in this area of administrative law for almost 40 years, but has received no citations in the recent judgments.
“As Chevron gets shunted aside, older concepts of statutory interpretation and regulatory power have come back. There is a change of expectations,” says DiAngelo.
So, while many of the federal agencies are packed with Biden appointees and determined to do battle with Wall Street and corporate America – perhaps, in the process, damaging markets on which many consumers knowingly and unknowingly depend - they will run into an implacable foe in a Supreme Court determined to bring unfettered activist bureaucrats to heel.
Simon Boughey
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News
Structured Finance
Stress-testing resilience
Climate-change risk assessment approach debuts
Scope has introduced a stress-testing methodology to assess climate-change impacts on securitisations. The objective is to help gauge the resilience of a transaction to transition and physical risks.
“We have introduced a quantitative and scenario-based stress-testing approach to assessing climate change impacts on the credit risk of securitisation transactions. The climate-change scenarios identified offer a range of outcomes for the crystallisation of transition and physical risks that will impact corporate borrowers in structured finance transactions more or less severely, depending on geography and business sector,” observes Benoit Vasseur, executive director in Scope’s structured finance team.
Scope’s approach seeks to understand how, in a particular climate change scenario, key economic aggregates at macro and microeconomic levels are affected over time. Variations in key credit-risk drivers are then derived as a result of the stressed environment.
There are two categories of climate risk under the approach: transition risk and physical risk. Transition risks relate to actions taken to reduce emissions to reach net zero greenhouse gas emissions. For example, transition risk drivers include public sector - which are generally government policies, legislation and regulation - changes in technology and changes in market and customer sentiment.
Meanwhile, physical risks relate to chronic climate impacts driven by rising temperatures and acute climate impacts, represented by natural disasters, such as floods, landslides, storms, water scarcity, extreme heat or wildfire.
“Stress testing is a key component of credit analysis. Climate change does present risks to securitisation,” Vasseur notes.
He adds: “Whether they are related to transition risks, chronic physical risks or acute physical risks, credit analysts cannot ignore them. A consistent, transparent and flexible approach is needed in order to address them.”
Benjamin Bouchet, director in Scope’s structured finance team, explains that physical risks have always been embedded in the structured finance rating process. “While most approaches were and are still very much qualitative, we have introduced a quantitative approach – in line with what most regulators are contemplating in their climate-change scenarios. This fosters discussions with market participants who are changing their views as a result and highlights a theme that needs to be more transparent and consistently assessed.”
Looking ahead, Bouchet believes there will be more scrutiny around energy efficiency and other environmental factors and the location of properties is likely to become more critical. For example, investors may not want to invest into securitisations backed by loans predominantly in areas or regions exposed to high risks of flooding, or only at discounts that they deem sufficient for such risks.
He concludes: “Large corporates are less exposed to acute physical risks, as they generally operate across multiple sites. However, SMEs could be significantly exposed. To mitigate such geographical concentration risks, we might start to see more cross-jurisdiction SME securitisations or enhanced due diligence as to the level of insurance each borrower has to mitigate the risk.”
Angela Sharda
News
Structured Finance
SCI Start the Week - 31 October
A review of SCI's latest content
FREE Webinar: the outlook for global risk transfer activity
Join SCI’s panel of leading capital relief trades practitioners from Arch MI, ArrowMark Partners, Credit Benchmark and Guy Carpenter on 2 November at 2pm GMT for a complimentary webinar discussing risk transfer trends in light of today’s macroeconomic headwinds. For more information and to register, click here.
Last week's news and analysis
Comeback king?
European 'regulation tsar' mooted
Mixed impact
Basel impact assessed
New opportunities
CRT opportunities assessed as central banks pull back
Reaching milestones
Toorak Capital Partners answers SCI's questions
Risk transfer return
African Development Bank stages comeback
SCI CRT Awards: Arranger of the Year
Winner: UniCredit Bank
SCI CRT Awards: Broker of the Year
Winner: The Texel Group
SCI CRT Awards: Contribution to North American CRT
Winner: Bank of Montreal
SCI CRT Awards: Credit Insurer of the Year
Winner: RenaissanceRe
SCI CRT Awards: Impact Deal of the Year
Winner: FCT Greendom 2021
SCI CRT Awards: Innovation of the Year
Winner: Sumeru IV
SCI CRT Awards: Investor of the Year
Winner: PGGM
SCI CRT Awards: Issuer of the Year
Winner: Santander
SCI CRT Awards: Law Firm of the Year
Winner: Simmons & Simmons
SCI CRT Awards: Personal Contribution to the Industry
Winner: Jessica Littlewood, global operations and business transformation partner at Clifford Chance
For all of last week’s stories including ‘Market moves’ and ‘Risk transfer round-up’ click here.
Free report
SCI has published a Global Risk Transfer Report, which traces the recent regulatory and structural evolution of the capital relief trades market, examines the development of both the issuer base and the investor base, and looks at the sector’s prospects for the future. Sponsored by Arch MI, ArrowMark Partners, Credit Benchmark and Guy Carpenter, this special report can be downloaded, for free, here.
Podcast
SCI has launched a new podcast series covering all things securitisation and engaging with some of the best minds in the industry! To access the podcast, search for ‘SCI In Conversation’ wherever you usually get your podcasts (including Spotify and iTunes), or 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
Euro 'regulation tsar' - October 2022
The sustainable recovery of the European securitisation market is widely believed to lie in the hands of policymakers. This Premium Content article investigates whether a ‘regulation tsar’ could serve as a unifying authority for the industry to facilitate this process.
US CLO ETFs - October 2022
The popularity of CLO ETFs is set to increase, given the current rising interest rate environment. This Premium Content article investigates how the product has opened up the CLO asset class to a broader set of investors.
STS synthetic securitisation - September 2022
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.
SCI events calendar: 2022
SCI’s 3rd Annual Middle Market CLO Seminar
15 November 2022, New York
News
Capital Relief Trades
Risk transfer launch
Deutsche Bank executes corporate CRT
Deutsche Bank has executed a US$480m 7.5-year CLN that references a US$6bn global portfolio of over 100 corporate borrowers. Dubbed CRAFT 2022-1, the trade’s portfolio was upsized from an initial US$4bn reflecting investor demand, but the deal has priced wider compared to the last CRAFT as with other recent market transactions.
The synthetic securitisation was priced at SOFR plus 12% or 3.5% wider in spread terms compared to CRAFT 2021-1 (SCI 20 September 2021). Structurally the trade is broadly similar to previous CRAFT transactions.
Oliver Moschuering, global portfolio manager, strategic corporate lending at Deutsche Bank notes: “CRAFT 2022-1 is part of our broader synthetic securitization programmes that have been in operation for many years. The deal follows our successful leveraged loan securitisation LOFT 2022-1 in August. CRAFT is our flagship programme providing cost-effective hedging of default and concentration risk, while at the same time reducing the amount of capital that needs to be held against the securitized loans.”
The LOFT deal was carried for hedging purposes as more banks in the US and Europe attempt to hedge concentration risks (SCI 30 August). Further features include a time call and a 2.5-year replenishment period as well as pro-rata amortization with triggers to sequential.
Stelios Papadopoulos
News
Capital Relief Trades
Risk transfer round up- 2 November
CRT sector developments and deal news
BNP Paribas is believed to be readying another synthetic securitisation of corporate loans from the Resonance programme. The bank closed two deals from the programme this year (see SCI’s capital relief trades database).
Stelios Papadopoulos
News
Capital Relief Trades
Risk transfer boost
Bank of Montreal continues ramp up
Bank of Montreal has finalized a US$625m financial guarantee that references a portfolio of US and Canadian senior secured and senior unsecured corporate loans. The transaction is the Canadian bank’s largest capital relief trade in tranche notional terms this year as it continues to boost its capital position for its ongoing acquisition of Californian based lender bank of the West (SCI 17 October).
BMO declined to comment on the transaction or the motivations behind the bank’s record 2022 issuance. The latest deal is the originator’s eighth synthetic ABS this year. However, well-placed sources note that this year’s issuance is driven by the ongoing acquisition of Bank of the West.
The acquisition was announced in December last year. Under the terms of the agreement, BMO acquires Bank of the West for a cash purchase price of US$16.3bn. BMO funds the transaction primarily with excess capital given its strong capital position and anticipated capital generation.
Bank of the West has traditionally served retail, small business, commercial and wealth clients and was previously owned by BNP Paribas. On closing, the acquisition will bring nearly 1.8m customers to BMO and will further extend its banking presence through 514 additional branches and commercial and wealth offices in key U.S. growth markets.
Stelios Papadopoulos
News
Capital Relief Trades
SRT hedge persists
Getin Noble collapse leaves SRT unscathed
SCI understands that the bankruptcy of Getin Noble Bank (GNB) in September hasn’t terminated the credit protection for a synthetic securitisation that the Polish lender executed in the summer of this year (SCI 4 July). The bank is one of only two SRT originators to have undergone the EU’s Bank Recovery and Resolution Directive (BRRD).
The bankruptcy of an originator exposes synthetic ABS investors to the risk of a deterioration in the originator’s servicing standards during the bankruptcy phase. The early termination clause allows investors to mitigate these risks as the bankruptcy occurs, thus maintaining an incentive for the protection provider to participate in the market.
From an originator’s perspective, the termination of the protection in a bankruptcy scenario means reduced regulatory capital against the hedged portfolio due to the previous achievement of significant risk transfer and the consequent capital relief that follows. Consequently, under both STS and SRT rules, early termination linked to an originator’s bankruptcy is prohibited.
The EU’s BRRD offers a helping hand in these scenarios. Indeed, the introduction of the BRRD, as an alternative to liquidation, means that originators can be subjected to resolution measures. The BRRD foresees that, as originators enter resolution, structured finance transactions and other specific classes of arrangements are subject to specific provisions safeguarding transaction counterparties, in the context of partial property transfers and other resolution measures.
However, without the right structure in place, any of the SRT transaction parties could suffer in a resolution scenario.
Robert Bradbury, head of structured credit execution at Alvarez and Marsal notes: ‘’in any SRT trade, any of the transaction parties could in principle suffer in a resolution scenario if incorrectly planned, for example through protection termination or collateral being ‘trapped’. It’s crucial in any transaction to ensure that both the credit protection and the rights of investors are protected from a legal and operational perspective.’’
The details of that structure in the case of the Getin Noble Bank SRT haven’t been disclosed, but Banco Popular’s bankruptcy offers an instructive precedent although details are again scant. In particular, the Spanish lender executed a synthetic securitisation in January 2016 called STAR, before the bank went bust the next year and acquired by Santander as part of the BRRD process.
Hence, the STAR deal proved to be the first test case for SRT deals of failing banks subjected to BRRD resolution. Well-placed sources confirm that the credit protection wasn’t terminated given that there was no ‘’event of default’’ where the bank stops paying coupons to investors.
Synthetic securitisations differ in this respect from CDS contracts where bankruptcies can trigger a close out. If the bank keeps paying protection premiums, the hedge remains in place.
However, the cases aren’t exactly similar since Popular was acquired by Santander who then decided to keep the STAR trade. GNB’s resolution plan on the other hand stipulates that after the bank has been resolved, its main assets and liabilities will be transferred to a newly created ‘’bridge bank’’. The purpose of this transfer is to simply preserve the continuation of normal banking operations.
The bridge bank will serve as a temporary solution to prevent a sudden exit of GNB from the market and to provide sufficient time to organise an orderly sales process for the bridge bank.
Polish authorities will ensure that the newly created bridge bank is adequately capitalised and has access to sufficient liquidity via direct support measures such as cash injections.
Stelios Papadopoulos
News
Capital Relief Trades
Risk transfer round up- 3 November
CRT sector developments and deal news
Santander is believed to be readying a synthetic securitisation of French auto loans. The lender’s last synthetic auto ABS was finalized last year and was called project Spitfire (SCI 24 November 2021).
Stelios Papadopoulos
Talking Point
Capital Relief Trades
Global Risk Transfer Report: Chapter one
In the first of six chapters surveying the synthetic securitisation market, SCI explores the recent regulatory evolution of the sector
Synthetic securitisation, once tarnished by association with the global financial crisis, has long since come in from the cold. The regulatory framework has developed significantly in Europe since the introduction of the new European Securitisation Regulation in January 2019, culminating in the inclusion of significant risk transfer transactions in the STS regime in April 2021. This label has provided CRT deal flow with additional momentum, broadened the issuer base and helped to legitimise the market.
So, how has the landscape evolved since then? While Europe has historically been the centre of CRT activity, what are the prospects in the US and beyond? SCI’s Global Risk Transfer Report traces the recent regulatory and structural evolution of the capital relief trades market, examines the development of both the issuer base and the investor base, and looks at its prospects for the future.
Chapter one: regulatory evolution
The regulatory framework for capital relief trades in Europe has evolved since the implementation of the EU Securitisation Regulation[1] in January 2019, culminating in the inclusion of SRT transactions in the STS regime. But among the most significant regulatory developments is something that isn’t formal regulation at all.
In 2017, the EBA published a discussion paper on SRTs. David Saunders, executive director of Santander’s European securitised products group, says: “Theoretically, it had no application into law or regulation – however, the joint supervisory teams (JSTs) at the ECB have essentially used it as their manual when analysing SRT transactions. It’s almost become de facto regulation.”
The 2017 paper, along with subsequent improvements in the ECB’s approach, helped make the regulatory process for SRT clearer, enabling banks to better understand the various steps they need to take when issuing a synthetic securitisation. In a lengthy section on structures, it provided a number of key points and indicated how banks need to address them in order to gain regulatory approval.
The EBA’s subsequent SRT report from 2020 built on the 2017 discussion paper and the lessons learned since then. Seamus Fearon, Arch MI evp, CRT and European markets, says the report set the scene and the European Commission largely adopted what the EBA had been advocating.
“There was a good coming together of technical grounding and political will to get something done quickly,” he observes. However, he adds: “In comparison to the timeline of the original securitisation framework, it was potentially rushed.”
Robert Bradbury, head of structured credit execution and advisory at Alvarez & Marsal, notes that the 2020 report was useful. “It spells out the specific details of the quantitative tests you can run to demonstrate that you have transferred risk, taking into account all the different factors, such as premium, timings and how your losses are allocated. If you pass all such tests, it’s quite challenging to say the bank has not transferred risk. It’s not an absolutely final result, but it gives a very helpful quantitative backdrop.”
He continues: “It certainly doesn’t guarantee success, as there are qualitative and other transaction aspects to consider, but it lays a very solid foundation for that discussion. The expectation of most parties is that you should probably start with that.”
Kaikobad Kakalia, chief investment officer at Chorus Capital Management, agrees that the guidance on SRT is helpful for issuers to understand how they should structure in order to claim RWA relief from the ECB or their home country regulator. “One of the key differences is the setting of the first call date. Historically, that used to be set at the weighted average life (WAL) of the portfolio. But the EBA is now guiding towards the WAL of the transaction, the portfolio WAL plus the replenishment period,” he says.
He adds: “A typical European SME transaction, which would have had its first call set at three to four years, is now likely to be a couple of years longer if it includes replenishment.”
But the EBA’s proposed treatment for high cost of credit protection creates a meaningful issue, because higher risk portfolios may fail SRT and become more difficult to structure for SRTs, thereby reducing options for banks.
Mistaken assumptions
Indeed, some market participants are critical of the 2020 EBA report. Olivier Renault, md, head of risk sharing strategy at Pemberton Asset Management, says: “When it came out, that was a big deal - except that very little has happened since then. That’s bad, due to lack of clarity, but also good that it hasn't been fully implemented by domestic regulators because some of the details were incredibly impractical.”
He explains: “The high cost of credit protection is an issue because it can create the wrong incentive for banks. It can also be very difficult to apply some of the tests that the EBA is recommending.”
Saunders agrees: “The 2020 report updated the tests and reduced them to two. Unfortunately, they didn’t cover all possible scenarios and there were some mistakes made in the assumptions used when calibrating them.”
He continues: “We ran a number of scenarios to show that they fail for almost every transaction we’ve ever done. That’s presumably not the intention. If the report was ever to be used by the regulator or converted into regulation, these tests would have to be fixed because they are just fundamentally flawed.”
Fortunately, the ECB has agreed a workaround. Saunders says: “Our JST is still using the 2017 paper as part of their supervisory process. The regulator has told us we don’t need to follow the 2020 report.”
Some feel that the report has resulted in a confused picture and that the failure to harmonise regulation across Europe is a huge missed opportunity. Renault says: “The recommendations haven't been turned into regulation, so each regulator can just feel free to incorporate as much of that or as little of this as they want. Even within the ECB, there are different approaches.”
He adds: “The different sub teams take different views. Some sub teams take the view that your transaction needs to comply with all the tests, while others ignore them completely. So, it hasn't led to the desired effect of having a completely equal playing field.”
Such lack of consistency has been described as “painful” when structuring a deal. Renault comments: “It is very difficult to design a transaction on the basis that you don't know which rules we need to comply with.”
While this may be the case, Andrew Feachem, md at Guy Carpenter, notes that “with a well-designed SRT process and full transparency with the regulator, there is a way to navigate through this uncertainty that increases the likelihood of success.”
New options
Regulatory change for the CRT market hasn’t been confined to the EBA’s reports, however. The EU Securitisation Regulation opened up a whole new set of options that didn’t exist previously.
Bradbury says: “It completely changed the way that standardised banks are able to apply securitisation to achieve SRT. It went from a framework in which it was very difficult to demonstrate, typically required ratings and was very expensive and inefficient, to a version in which they can use the securitisation standardised approach, which is much more flexible. Compared to the prior options, it typically gives better results and is more cost-effective.”
A further significant development was the requirement for thicker tranching in order to achieve meaningful capital relief for banks through an SRT. Feachem says: “The banks adapted by issuing dual tranche structures, which also enabled new risk takers to join the market. While the traditional credit opportunity fund investors continued to participate in the junior mezz, the senior mezz tranche appealed to the (re)insurance community and also prompted new funds to be raised targeting lower returns.”
Kaelyn Abrell, partner at ArrowMark Partners, comments: “With institutional and individual investors increasingly relying on private credit as a source of uncorrelated returns, especially in a potentially more volatile market environment, dual tranche structures enable the asset class to potentially align with the objectives of a broader universe of investors.”
Generally, regulations have sought to level the playing field for both SRT issuers and investors. In Europe, under the Capital Requirements Regulation (CRR), there are now well understood procedures that issuers must adhere to in order to execute a successful SRT transaction.
Feachem notes: “This gives confidence to first-time and less frequent issuers to commit the resources required to adopt SRT in their portfolio management toolkit. Similarly for investors, there is a greater appreciation of the features of a transaction needed by the issuer and this helps the due diligence process to be more focused and efficient.”
He continues: “As regulations have evolved, so have the structures. In particular, the implementation of Basel 3 encouraged (re)insurers to become active and for mezzanine focused funds to be raised, and the implementation of Basel 4 is prompting the growth of residential mortgage SRT.”
With banks recognising the benefits of including (re)insurers within their SRT programmes, the flexible combination of funded and unfunded protection within single structures is viewed as a key innovation since 2018. “It has significantly diversified banks' sources of capital relief, improved SRT price discovery and reduced execution risk. There has been an increase in the flexibility, and standardisation, of banks' SRT programme documentation to more readily accommodate this combination of funded and unfunded investors across tranches,” adds Feachem.
Kakalia notes that while some structural elements - such as tranche thickness and the setting of the first call date - are driven by regulatory requirements, “investors can have a meaningful say in the setting of replenishment criteria, risk retention and counterparty risk mitigation features,” thus balancing the needs of the issuer with the investors while accommodating all regulatory requirements.
SCI’s Global Risk Transfer Report is sponsored by Arch MI, ArrowMark Partners, Credit Benchmark and Guy Carpenter. The report can be downloaded, for free, here.
*For more on the outlook for global risk transfer activity, watch a replay of our complimentary
webinarheld on 2 November.*
[1] incorporating both the EU Sec Reg 2017/2402 and the 2017/2401 amendment to the CRR
Market Moves
Structured Finance
Chinese CMBS 'structural deficiencies' eyed
Sector developments and company hires
Chinese CMBS ‘structural deficiencies’ eyed
The recent near-default of a Chinese CMBS issued by Yango Group - together with the two previous defaults of PKU TechPark and Hongbo Exhibition Center - expose several structural deficiencies in Chinese CMBS transactions, according to Fitch. Such deficiencies include low DSCR and collateral quality - due to weak underlying cashflow - limited protection through external credit enhancement and highly correlated counterparty risks.
A trustee report for the Yango Group CMBS earlier this month indicated that the single borrower had failed to transfer the required funds to the trust account, leading to insufficient underlying cashflow to cover the senior class B’s scheduled interest payments and senior class A’s scheduled principal payments. However, a noteholder meeting passed a proposal to waive an EOD and adjust the repayment schedules. This follows defaults of the single-borrower CMBS issued by PKU TechPark and Hongbo Exhibition Center in March 2020 and October 2018 respectively.
Fitch notes that single-borrower CMBS in China often include lower-grade properties in the tier-1 and tier-2 cities, with more cyclical and volatile cashflows. DSCR can also be overstated, as recurring expenses are sometimes borne out of the trust and not included in the calculation.
To compensate for the weak underlying cashflow, most Chinese CMBS feature external credit enhancement in the form of a commitment by the borrower to provide liquidity support. “However, such arrangements had failed to provide additional protection in the three CMBS defaults and near-default. The external credit enhancement providers also faced financial hardship when the borrower went into distress, implying a high correlation in default risk,” the rating agency observes.
Lack of fund segregation is another common issue, as collection funds are often commingled with borrowers’ funds until they are transferred quarterly or semi-annually. In the three cases, the borrowers failed to transfer such funds due to financial hardship, reflecting elevated counterparty risk.
Finally, Fitch suggests that the limited progress on their recoveries years after two previous defaults highlights complications in the workout process. For example, the recovery process on the PKU TechPark deal has stalled due to insufficient noteholder votes to agree upon the special resolution plan.
As of end-June 2022, 288 CMBS have been issued in China, mostly via private placements - with the most common underlying assets being malls, office, hotel, other retail and logistics storage.
In other news…
EMEA
Arrow Global has appointed Daniele Patruno as ceo of its Europa Investimenti business in Italy. Patruno has worked at Europa Investimenti since 2009, most recently as head of credit strategy, and he was at Barclays before that. As Europa Investimenti’s new ceo, Patruno will focus on maximising distressed opportunities that are increasingly presenting themselves in Europe’s largest non-performing loan market.
Incumbent ceo Stefano Bennati will in his role as chairman of Arrow Global Italy. Patruno will be supported by Armando Ranucci in his capacity as general manager.
M&G Investments has appointed Anuj Babber as head of structured and private asset research and analysis. He was previously head of securitisation credit, fixed income at the firm, which he joined in August 2003. Before that, Babber was a securitisation associate at Morgan Stanley.
ESG indices launched
Bloomberg has launched the Bloomberg Global Aggregate Green, Social and Sustainability Bond Indices. The indices utilise the flagship Bloomberg Global Aggregate Index, the Bloomberg Sustainable Finance Group’s green, social and sustainability bond indicators, and fields that show alignment with ICMA’s Green Bond, Social Bond and Sustainability Bond Principles and Guidelines.
By launching the indices with datasets from Bloomberg’s ESG data team, Bloomberg Terminal clients will also benefit from transparency into underlying bond documentation - such as use of proceeds allocation to the eligible project categories and subcategories, as well as alignment to the UN Sustainable Development Goals - offering more seamless integration across portfolio management workflows, including for performance and attribution.
The universe of eligible instruments - ranging across corporates, sovereign, supranational and agency bonds (SSAs), municipals and structured products - are individually researched and maintained by a dedicated Bloomberg fixed income and ESG data team to ensure securities are reviewed and appropriately tagged. All securities are further reviewed to ensure ongoing reporting is confirmed through the filing of impact and allocation reports by the issuer.
The indices are now available for benchmarking, asset allocation and product creation purposes. The indices can be further customised to meet specific individual investor needs using additional fields, such as specific exclusions, regulatory ‘aware’ fields - including SFDR and EU Taxonomy inputs - and sector-specific weightings.
Market Moves
Structured Finance
Euro CLO footprint established
Sector developments and company hires
Euro CLO footprint established
Cross Ocean Partners has completed Bosphorus CLO VII, the seventh European CLO from the Bosphorus team and the first under Cross Ocean's management. Cross Ocean acquired the Bosphorus European CLO platform, its three CLOs and five-person team from Commerzbank last December (SCI 2 December 2021).
The transaction established Cross Ocean's footprint in the European CLO market. Concurrent to the acquisition of the platform, Cross Ocean closed on a €130m risk retention fund - alongside a strategic investor - to help fund the issuance of future Cross Ocean CLOs and enable the business to grow successfully.
Since the team – which is led by London-based senior portfolio manager and head of European CLOs Guy Beeston - joined Cross Ocean, it has hired two new members and been fully integrated into the wider Cross Ocean business.
In other news…
EMEA
Apollo Global Management
has appointed Sebastian Zilles as a partner in its European principal finance team, based in London. He is tasked with identifying opportunities within real estate equity, non-performing loans and non-corporate structured credit. Zilles was previously head of commercial real estate, EMEA at PIMCO and, prior to that, worked at Corestate Capital and Morgan Stanley.
Anatoly Sorin
has joined GLAS as head of its UK operation, based in the firm’s London headquarters and reporting to head of EMEA Joanne Brooks. Sorin brings more than 15 years of experience in the loan agency and corporate trustee industry, including longstanding expertise in complex securitisations, such as CDOs and CLOs.
Sorin joins GLAS from US Bank, where he most recently served as svp and head of relationship management within its global corporate trust services business. In this newly created position, he will be responsible for GLAS’s loan agency and trustee businesses in London, directly managing the transaction management group, middle office, DCM and client services teams.
Market Moves
Structured Finance
Call for Och 'feud' to end
Sector developments and company hires
Call for Och ‘feud’ to end
Sculptor Capital Management’s independent board members and Jimmy Levin, the firm’s current cio and ceo, have issued statements in response to a recent court filing related to a dispute brought by former chairman and ceo Daniel Och. The filing mentions a “personal issue” from Levin’s past, which was thoroughly reviewed at the time and resulted in his exoneration.
Och is suing Sculptor, alleging that the firm he helped found is allowing its ceo to extract increasing levels of remuneration, despite its subpar performance. The lawsuit seeks books and records concerning Levin’s pay to assess whether there were breaches of fiduciary duty and whether Sculptor’s board is truly independent.
In his statement, Levin discloses that 20 years ago he was falsely accused of sexual misconduct, having been exonerated after a thorough Harvard University administrative review. The statement says that the matter was brought to the attention of the firm, its officers and its directors in 2015 and that after the firm’s review, Levin received unconditional support, including from Och as then chairman and ceo. In the years that followed, Och promoted Levin multiple times, consistently praised him in various internal and external communications and executed a long-term employment contract with him.
Levin goes on to explain that his relationship with Och changed in late 2017, after he supported the independent board members’ efforts to restructure the firm’s governance and finances in ways that would have resulted in Och ceding his unilateral control of the firm (following SEC charges against him) and making financial concessions to ease the burden of significant debt and liabilities incurred to settle the firm’s FCPA bribery matter. This culminated in Och overruling both the decision of the independent directors to appoint Levin as the next ceo and their recommendation to adopt a series of financial restructurings.
The statement ends with a plea for Och to “end this feud he continues to pursue”.
Meanwhile, the board’s statement confirms the soundness of the firm’s review of Levin’s personal matter, when Och was chair. It further states: “Mr Och has long been aware of the facts, including when he championed Mr Levin and promoted him to senior ranks of the firm. Mr Och raising this now, with knowledge of the facts, is extremely disappointing.”
Levin succeeded Robert Shafir as ceo of Sculptor on 1 April 2021. Prior to joining the firm in 2006, he was an associate at Dune Capital Management and an analyst at Sagamore Hill Capital Management.
Och-Ziff Capital Management Group changed its name to Sculptor Capital Management in September 2019, to reflect the leadership and governance changes that transferred ownership and control from Och to the executive mds and led to him resigning as a director.
Och and Joel Frank, the cfo at the time, agreed to US SEC orders in September 2016 finding that they contributed to Och-Ziff’s violation of the books and records provisions of the FCPA, after two former employees participated in a bribery scheme.
In other news…
EMEA
Pemberton Asset Management has recruited Jessica Xian as an associate, based in London. She was previously avp, EMEA credit structuring at Citi, specialising in originating and executing credit risk-sharing transactions.
US CMBS loan refis gauged
Fitch has conducted three plausible scenarios to determine if the nearly US$26.5bn, or 1,493, of non-defaulted and non-defeased US conduit and agency CMBS loans within its rated universe that are due to mature by year-end 2023 are able to meet certain DSCR and LTV parameters in order to secure refinancing. The agency notes that these loans’ combined weighted average coupon of 4.70% is well below current market rates.
At a 6.75% market interest rate, Fitch’s analysis shows 65% to 68% of the maturing loan volume is able to satisfy the two DSCR scenarios, based on a threshold of 1.25x for an amortising loan and 1.40x for an interest-only loan. In the LTV scenario, which sets a maximum 75% LTV, 72% is able to secure refinancing based on current market capitalisation rates.
However, 23%, or US$6.2bn, of maturing volume would not be able to refinance under any of the scenarios. NOI growth averaging at least 1.5x current in-place NOI or a new equity infusion that deleverages existing debt by at least one-third, on average, would be needed to pass the refinancing thresholds.
Fitch anticipates that servicers will grant loan modifications and extensions for stable performing assets and those with committed borrowers. The agency believes servicers are appropriately staffed to address the US$6.2bn of potential maturity defaults for loans unable to refinance under any of the scenarios, which is below the peak volume of coronavirus-related transfers to special servicing in 2020 and 2021.
Webinar free to view
Leading capital relief trade practitioners from Arch MI, ArrowMark Partners, Credit Benchmark and Guy Carpenter discussed current risk transfer trends yesterday, during a webinar hosted by SCI. Watch a replay here for more on the outlook for the synthetic securitisation sector, in light of today’s macroeconomic headwinds.
structuredcreditinvestor.com
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