Contents

Structured Finance

Action stations?

Reporting template review welcomed

The European Commission’s conclusion in its much-awaited report on the functioning of the Securitisation Regulation that more time is needed to assess the impact of the new framework (SCI 11 October) has broadly been accepted by the securitisation industry, while calling for more action as soon as possible to help boost the securitisation market in Europe. The Commission’s invitation to ESMA to conduct a review of transaction reporting templates - noting the need to simplify requirements for private transactions to make the framework relevant and proportionate – has also been welcomed.

“A focus of this review will be on private securitisation templates, which - as the Commission recommends - should be distilled down to one dedicated template that meets the needs of the supervisors. Investors do not rely on ESMA-style reporting, unlike public deals, given the extensive bespoke due diligence that is performed as part of the investment process for private deals. As it stands, it is reported the same as public securitisation, but private securitisation is very different,” observes Shaun Baddeley, md of securitisation at AFME.

He explains that in the past three years since implementation of the Securitisation Regulation, through their usage, shortcomings in the templates have become clearer. Therefore, a review via a formal industry consultation - led by ESMA - is important, and this process has now begun.

However, without a change in the definition of a private securitisation, many private transactions will be treated as public for disclosure purposes - in part, defeating the purpose of the review. This will at best create real challenges for smaller borrowers reliant on bank relationships to finance themselves efficiently via private securitisation and at worse prevent them from accessing such funding at all.

The Commission acknowledges that adaptations to the new regulatory framework might be contributing to the rise in the volume of private securitisations. In this context, a period of two years is not considered enough to establish with certainty whether there has been a real shift from public to private transactions. The Commission also notes that data is not available on the number of private non-STS transactions, nor on the volume of transactions, which makes a comprehensive assessment of the development of private transactions difficult.

Baddeley notes: “The review will allow for a rethink of what is required. The private securitisation framework needs to be amended and this is a welcomed move. There was no perceived need to amend any Level 1 legislation, given that the Commission’s view was that the framework was broadly fit for purpose and that it was too early to warrant it.”

The Securitisation Regulation requires institutional investors to conduct thorough due diligence before holding a securitisation position. A prudent and diligent analysis of the risks involved in a securitisation critically depends on access to information.

To facilitate investors’ due diligence and support competent authorities in supervision, Article 7 requires originators, sponsors and SSPEs to make available all relevant documentation describing the features of the securitisation and to regularly disclose all materially relevant data on the credit quality and performance of underlying exposures. One part of investors’ duties of due diligence is to check that the securitisation complies with the transparency requirements in the Securitisation Regulation.

Baddeley says that, within the report, he would have been keen to see the EU clarify whether EU investors in non-EU ABS who do not receive reporting that is required of EU issuers cannot invest (SCI CLO Markets Daily – 12 October). He adds: “Given that EU regulation is so much more prescriptive than anywhere else in the world, this will lock them out of 90% of the non-EU investment opportunities.”

Indeed, AFME believes the opportunity to foster EU investor growth has so far been missed. “While the report acknowledges market participants' concerns that investor due diligence obligations are disproportionate, creating high barriers to entry for new investors, there is no action to address this issue. The industry awaits with interest the recommendations from the Joint ESAs report on their review of the prudential capital framework for banks and insurers, which will present another important opportunity to attract investors back to securitisation. It will also be a chance to recalibrate bank capital to address disproportionate capital treatment for both parties, when compared to other asset classes,” the association notes.

Looking ahead, Baddeley says that the one area of the market that has grown over the past decade is SRT and this has an important role for the CMU, as it allows banks to recycle risk to the non-banking sector, freeing up capital to lend. He claims: “In 2021, bank capital on more than €80bn of bank lending was freed up through SRT - or the equivalent of nearly 10% of SME lending across Europe that year - and there are pieces of regulation in the pipeline that will stop this activity in its tracks.”

The future of the securitisation space, according to Baddeley, is dependent upon the changes and developments made within the regulatory space. He concludes: “It all depends on which way the regulatory wind blows in the EU and the UK. However, within the US and APAC, issuance remains strong.”

Angela Sharda

Capital Relief Trades

Risk transfer round up-14 November

CRT sector developments and deal news

The Royal Bank of Canada is believed to be readying another synthetic securitisation in addition to its pending leveraged loan CRT (SCI 21 September). The trade is said to reference a corporate loan portfolio and would further add to the record Canadian deal flow this year (SCI 10 November).

Stelios Papadopoulos

Capital Relief Trades

Risk transfer round up-16 November

CRT sector developments and deal news

Piraeus Bank is believed to be readying a synthetic securitisation of corporate and SME loans that is expected to close by the end of the year. The Greek lender’s last capital relief trade was finalized in July and referenced shipping loans (SCI 28 July). Meanwhile, Intesa Sanpaolo is said to be prepping a significant risk transfer trade backed by leasing assets.

Stelios Papadopoulos

Capital Relief Trades

Test case

Bayern LB executes first synthetic ABS

Bayern LB, Chorus Capital, and M&G have finalized an STS significant risk transfer trade that references a €1bn corporate portfolio of primarily German exposures. Dubbed Tiesto 2022-1, the transaction is the German lender’s first capital relief trade and acts as a proof of concept for future issuance.  

The trade features a €60m-€70m mezzanine tranche that was priced in the single digits. The tranche amortizes on a pro-rata basis with triggers to sequential amortization. The estimated portfolio weighted average life is equal to 3.5-years and the replenishment is capped at one-year.

As is typical with these deals, the time call can be triggered after the WAL and the replenishment period. The structure of the deal is unusual in the sense that it’s an STS trade that was executed as a direct CLN.

Bjorn Schumacher, managing director at Bayern LB notes: “We executed this SRT to expand our risk and capital management toolbox. It’s a transaction that required a significant amount of preparation including the structuring and placement of the securitisation. We view ‘Tiesto’ as a proof of concept for potential future issuance and are very happy with the result of this project and the collaboration with our partners and investors.’’

The transaction is riding a pickup in issuance from German Landesbanks with Helaba having already closed a capital relief trade (SCI 12 July) and LBBW currently working on its own deal that is expected to close this quarter (SCI 12 September).

Deutsche Bank acted as the arranger in the Tiesto deal and White and Case as legal advisor.

Stelios Papadopoulos

Capital Relief Trades

ECB review disclosed

CET1 ratios decline amid weaker ROE outlook

The European Central Bank has released its latest financial stability review. The report notes that bank capital ratios declined in 1Q22 albeit remaining at robust levels. CET1 declines coincide with a weaker profitability outlook for European banks. Weaker profitability along with capital management objectives have typically rendered synthetic securitisations a more attractive option for European banks compared to US lenders.

According to the ECB’s latest financial stability review, bank capital ratios declined in 1Q22 but remained at robust levels. The average CET1 ratio of Euro area banks dropped by nearly 60bps to 15% in 1Q22 and stabilised at this level in 2Q22. On aggregate, risk weighted asset (RWA) growth was the largest contributing factor to the decline in the first half of the year mainly due to the robust growth of credit risk RWAs.

The report notes that the rise in credit risk RWAs was in turn driven by the continued strong lending to the private sector, while the migration of Russia related exposures to lower credit ratings and regulatory effects-such as higher RWAs on mortgages-also contributed to the increase in risk weights for some banks.  

At the same time, the change in CET1 capital had a close to neutral effect on the aggregate CET1 ratio. This is because the positive impact of higher retained earnings was broadly offset by higher dividend payouts and share buybacks, as well as the negative effect of widening sovereign spreads on accumulated other comprehensive income.

Moving on to profitability, the ECB states that despite the positive impact of further expected rate increases, overall profitability prospects have deteriorated, and market expectations may be too optimistic.

Consensus analyst forecasts for listed banks’ 2023 ROE have been revised slightly upwards since May, as the positive effect of higher rates is projected to more than offset the negative impact of weak economic activity on loan loss provisions.

However, banks’ profitability outlook is subject to four sources of downside risk according to the ECB. 

First, net interest income growth could be negatively affected by lower loan volume growth in an economic downturn.

Second, revenues from investment banking and asset management have already declined and stalled in the first half of 2022 and remain vulnerable to larger asset price corrections.

Third, operating costs are expected to remain under pressure in a high inflation environment, while consensus analyst forecasts predict no increase in listed banks’ aggregate operating costs from (expected) 2022 levels.

Finally, worse than currently expected macroeconomic outcomes could lead to a higher increase in provisioning than anticipated at this juncture.

Looking forward, ‘’impairment losses are almost certain to worsen amid growing recession risks, suggesting that banks should accelerate their provisioning’’ concludes the ECB.

Stelios Papadopoulos

CLOs

SCI MM CLO Awards: Issuer of the Year

Winner: Owl Rock, a division of Blue Owl

Owl Rock, a division of Blue Owl Capital, is recognised in this year’s SCI Middle Market CLO Awards for continuing to grow its platform and remaining an active issuer in challenging market conditions. For closing four MM CLOs during the awards period, three of which were issued after the Russian invasion of Ukraine, the firm has won the Issuer of the Year category.

The transactions comprise: a refinancing of Parliament Funding II in November 2021; a refinancing of Owl Rock CLO V in March; and Owl Rock CLO VII and VIII in June and September respectively. “CLOs are important in enabling us to finance our funds: they provide stable term financing, price attractively and tap into a differentiated investor base relative to our other sources of debt financing. We made a strategic decision to enter the CLO market early on, because we understood the value of the form of financing and recognised that it would take time to develop a brand and attract an investor base,” says Jerry DeVito, head of structured products and portfolio finance at the Owl Rock division of Blue Owl.

The firm has 11 MM CLOs outstanding, representing approximately US$5bn in total capitalisation as of issuance date, with a roster of over 60 CLO investors participating across the Owl Rock platform. Following its debut issuance in 2019, the firm now operates three CLO verticals: one has exposure to diversified direct lending, via the Owl Rock moniker; another has exposure to first lien/lower leveraged loans via the Parliament Funding moniker; and the other has exposure to technology/enterprise software loans via the Owl Rock Technology Finance Corp moniker.

Founded by Doug Ostrover (formerly of GSO), Marc Lipschultz (KKR) and Craig Packer (Goldman Sachs) in 2015, Owl Rock’s thesis is to target the upper middle market, which sits between the broadly syndicated and traditional middle market loan segments. “Historically, there has been less competition in the upper middle market space, due in part to the required scale to accommodate larger transactions. In order to be relevant to private equity clients, you need scale – in other words, a large capital base and plentiful access to financing,” confirms DeVito.

He continues: “For example, our first BDC – Owl Rock Capital Corporation – launched with US$5.5bn equity and is about 1x levered, which translates into US$11bn or more of investing power. Across Owl Rock Funds, we had approximately US$56bn of AUM, as of 30 June 2022.” 

DeVito notes that the Covid-19 crisis marked the first real test for the Owl Rock CLO platform, with the firm still able to attract financing. “Our ability to navigate the current challenging market is supported by our track record and our transparency with investors regarding the underlying assets. Investors are being more selective and spending more time reviewing portfolios and performance, while gravitating towards the regular issuers. In this sense, we are helped by the nature of our portfolios: many investors accept our thesis that upper middle market companies tend to be less risky than traditional middle market firms.”

Although spreads have widened across the CLO market generally, there is still capital to deploy and significant demand for MM CLO paper, according to DeVito. “We’re sensitive to spreads, but we also recognise that if funding spreads have widened, our asset spreads are also likely to have widened. We want to minimise funding costs, but because we manage permanent capital and long-duration vehicles, we seek to maintain a certain level of leverage to generate an expected return,” he says.

He adds: “Consequently, we sometimes change up what we issue – sometimes only triple-A and double-A notes; sometimes deeper in the capital structure – depending on the cost of financing, financing alternatives available and the market environment at the time. We’re not trying to time the market and we believe our investors understand this.”

Looking ahead, Owl Rock expects to continue executing on its plan - which is to increase capital under management and provide relevant solutions for its clients. “Dislocation in public markets and banks slowing capital commitments to leveraged lending has provided more opportunities for us. We anticipate continuing to be a regular CLO issuer when the market is available and remain optimistic about the middle market CLO product. With a growing market and more regular issuance, more data and performance information is and will become available, which we believe will increase demand as a reliable way for investors to deploy capital – all of which provides the framework for investors to become more and more comfortable with the asset class,” observes DeVito.

He concludes: “The Owl Rock platform is not arbitrage-driven in the traditional CLO sense – we need access to the CLO market as a funding source; it’s not a stand-alone transaction based on relative market parameters at a point in time.”

For the full list of winners in this year’s SCI Middle Market CLO Awards click here.

CLOs

SCI MM CLO Awards: Innovation of the Year

Winner: Lake Shore MM CLO IV

Priced on the very first day of our awards year, 1 October 2021, First Eagle Alternative Credit’s Lake Shore MM CLO IV, led the way in so many other respects. Our innovation of the year not only provided an innovative structure subsequently duplicated by other managers, but took the unusual step of syndicating, via arranger Wells Fargo, such a tailored product, while seeking to encourage insurance companies further into the middle market space.

“Lake Shore IV was designed to meet insurers desire for yield through middle market exposure while offering ratings from a major agency like S&P,” says Michael Herzig, senior md, head of business development, at First Eagle Alternative Credit (FEAC). “In recent years, partnerships between private credit managers and insurers have given way to outright M&A activity between the two groups. CLOs and direct lending products are among the most actionable examples, and thus, we see Middle Market CLOs are a natural intersection of these two trends.”

FEAC has a long history of working closely with insurance company investors both in direct lending via private funds, rated insurance feeders, SMAs with ratings, and so on; as well as through its own BSL and MM CLOs. It took things a step further with Lake Shore IV, which featured an updated MM CLO structure designed to appeal to insurers.

Lake Shore IV used a more comprehensive X note as opposed to the historically more common “Fat BBB” tranche. This was done to guard against some scepticism over the validity of the latter. Utilising an X note, which is used very frequently in BSL CLOs, was seen as a simpler solution and one that provided more capital efficiency faster, amortisation and a cheaper cost of funding; thereby increasing the deal structure’s efficiency and therefore attractiveness to investors.

The deal uses “turbo” amortisations of mezzanine tranches in an effort to shorten duration and provide greater stability. Herzig explains: “There is often an argument to be made that perhaps turboing down your highest cost of debt is a good use of proceeds in the vehicle. Once money leaves to the equity it doesn't really help the mezzanine in the structure, but if you take some of that money to amortise the junior, most expensive debt you're helping the structure overall – it increases cash flow, takes a little bit of risk out of the structure and it effectively delevers the deal.”

He continues: “The insurance companies who were the target audience for this deal have a similar focus on balance in their CLOs, where they are as concerned about mezz security as they are about high equity returns. That fits with our experience in that the deals that perform the best over time don't wring every free dollar out and instead use excess par or excess capital or early excess returns to reinforce the vehicle, and it's something we and investors really like about this structure. Overall, we want a good experience for the senior, the mezzanine and the equity investors; not one of those is more important than the others – the balance among them is absolutely critical for us in our CLO business.”

Lake Shore IV was also the first of this style of MM CLO to carry S&P ratings through the mezzanine. “Many insurance companies are rating sensitive and there has been an evolving set of creative solutions for achieving ratings on alternative assets,” Herzig notes. “US insurers have a pre-determined list of nationally recognised credit ratings organisations, but for non-US insurers, it usually has to be either Moody’s, S&P or Fitch and that’s something we wanted the structure to facilitate.”

Tailored MM CLO Investments such as Lake Shore IV are not typically syndicated and are usually structured for a single investor, but the deal was syndicated to a number of insurance companies, including the equity. The Lake Shore MM CLO platform is all third-party equity investor led, which is not the traditional norm for MM CLOs.

Syndication was a key element to the deal, according to Herzig. “We wanted to take what was cutting edge technology developed by and with one of our key insurance clients and spread it around to a number of different insurance companies,” he says. “At the same time, unlike a BSL deal when most of the ramping can be done after pricing MM CLOs typically have assets in place before pricing so have to be warehoused and the warehouse hurdle for a lot of insurers is a really tough one – it is long and not very capital efficient.”

To overcome this, FEAC utilised one insurance company to provide the majority of the warehousing and then was able to bring other firms in, in a minority role, to co-invest. “Through syndication and this process, we were able to offer these insurance companies access to a deal that they probably wouldn't be able to do themselves, because it is quite a large capital commitment,” says Herzig

Demand for Lake Shore IV overall was significant resulting in an upsize to US$544m, much larger than any prior Lake Shore MM CLO. As Herzig concludes: “The structure proved so popular that it has since been used numerous times by managers ranging from Blackrock to Mass Mutual to Maranon; but First Eagle Alternative Credit’s Lake Shore IV was first.”

For the full list of winners in this year’s SCI Middle Market CLO Awards click here.

CLOs

SCI MM CLO Awards: Deal of the Year

Winner: Golub Capital Partners CLO 18(M)-R2

A second reset of a middle market CLO upsized for a second time to now stand at over US$1.2bn would be notable enough. But GC Investment Management’s Golub Capital Partners CLO 18(M)-R², arranged by SMBC Nikko, was also successfully priced while the market was still coming to terms with a new benchmark and amid heightened market volatility following the invasion of Ukraine only a month earlier and is SCI’s middle market CLO Deal of the Year.

The deal was originally issued in March 2014 totalling US$453.4m and previously refinanced in October 2017, when it was increased to US$898.5m. The previous iteration of notes were repaid in full on 18(M)-R²’s 21 April 2022 refinancing date.

Alan George, Managing Director, Head of Structured Products at Golub Capital, recalls: “The deal was done in March and there was still quite a bit of fact-finding that needed to be done in terms of where the CLO market was going to be in a post-Libor world.”

He continues: “We needed to navigate and problem-solve to get the deal done. You had people still trying to figure out what the bid-ask was going to be on new CLO formation, while worrying about the impact of geo-political factors over the longer term. All the while, liabilities were also becoming more expensive.”

Despite the somewhat significant widening of liabilities at that point in time, Golub Capital took the decision to act. “As we typically do, we continue to issue through volatile periods and we, of course, work closely with our investors,” George says.

For the full list of winners in this year’s SCI Middle Market CLO Awards click here.

Capital Relief Trades

Global Risk Transfer Report: Chapter three

In the third of six chapters surveying the synthetic securitisation market, SCI tracks the evolution of the investor base

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 three: growing the investor base
Given the complexity of the instrument, CRT was once a minority sport, involving only a small number of highly sophisticated investors. But the picture is changing, in line with a better understanding of the regulatory environment, as well as the risk and rewards involved.

Kaelyn Abrell, partner and portfolio manager at ArrowMark Partners, says: “Market dynamics support our belief that SRT is already exhibiting characteristics of more mature financial markets. Examples include the shift from predominantly bilateral transactions to club and syndicated deals, the development and growth of a secondary market – with a particular focus on the period following the initial onset of the Covid pandemic in 2020 – as well as increasing access to financing through various forms and counterparties.”

She adds: “All of these factors are representative of the maturation of the asset class and increasing acceptance by banks, asset managers and investors.”

Indeed, a significant number of new investors have entered the market in recent times, with (re)insurers also emerging as key participants. Jeffrey Krohn, mortgage and structured credit leader at Guy Carpenter, notes: “The US CRT market is supported by over 30 reinsurers, which will provide almost US$19bn in capital relief in 2022. Many of these reinsurers see the opportunity in the SRT market and are attracted to the thicker tranche requirements that better appeal to their appetite. The challenge is to attract this growing pocket of capital in a thoughtful way as we move into a Basel 4 world.”

Andrew Feachem, md at Guy Carpenter, adds: “We have seen a number of the junior tranche-focused investors raise mezzanine funds with lower target returns, a trend we expect to continue. Finally, new investors have also joined the market in line with the growth of new SRT asset classes, such as residential mortgages and auto loans.”

Relationship building
Increased investor appetite is driving a higher volume of deals, year on year, across a wider range of collateral types, originators and geography. At the same time, originators recognise the need to diversify their capital base, so they're actively building relationships with new counterparties.

Seamus Fearon, Arch MI evp, CRT and European markets, believes: “Relationships with the client are very important in Europe. Many of our clients want to deal directly with the insurer, rather than an intermediary. In comparison to GSE CRT, I think we will see a smaller number of large insurers in the space, potentially partnerships between insurance companies to combine capacity, more bilateral deals and potentially less intermediation.”

He adds: “New investors have specific risk appetites and, as there are a wider range of deals to pick from, different investors can build a diversified portfolio specific to their risk appetite.”

The growing demand for more diversified sources of capital may point to some issuers seeking multilateral transactions to aid new investors to enter the market and develop their appetite for SRT. Tim Armstrong, md at Guy Carpenter, notes that “the market is undoubtedly growing and third parties will be needed to grow investor and (re)insurance capacity in line with banks’ issuance needs. Increased investor and (re)insurance uptake will lead to a more balanced and transparent market, while also addressing the counterparty limit constraints already being faced by some issuers.”

Abrell agrees that the expansion of the issuer base and asset types allow investors to tailor their strategies, based on the risk/reward targets that they are trying to achieve, and provide greater choice in meeting those objectives. “We believe CRT continues to offer a unique and attractive value proposition for investors. The primary reason is the supply and demand dynamic,” she explains.

Overall, investors are now seeing CRT as a more sustainable asset class. As such, there is greater comfort in investing in building teams and the necessary modelling tools.

“Access to data and appropriate modelling tools are key – most SRT transactions are bespoke and so the usual off-the-shelf models don't really apply,” says Feachem.

This is an area of focus for Guy Carpenter, where provision of analytics is a key factor in engaging with unfunded investors. “(Re)insurers will reserve judgement on a given transaction until they are compared to other transactions in which they’ve participated. Thoughtful analytics and comparisons to other available data are essential to facilitate underwriters’ decisions,” adds Feachem.

However, Abrell notes that in order for investors to allocate capital to CRT, estimated returns must be in line with other comparable private assets or provide an illiquidity/complexity premium compared to liquid credit markets. “As a result, there is a floor on spreads that, if breached, would begin to limit the amount of capital available to deploy in the asset class.”

Barriers to entry
Indeed, complexity remains a key issue. Kaikobad Kakalia, chief investment officer at Chorus Capital Management, says: “Investors need to develop an understanding of banking regulation, in order to understand the issuer’s motivation and the transaction’s structure. They need to combine this with knowledge of structured finance and have the ability to analyse credit.”

Feachem agrees that risk takers need to get to grips with the underlying regulation, as well as which features in an SRT are a ‘must-have’ rather than a ‘nice-to-have’. This, in turn, speeds up due diligence and, critically, reduces execution risk from a bank’s perspective.

“This business is not designed with insurers in mind,” observes Giuliano Giovannetti, co-founder of Granular Investments. “The whole contract language and structures are similar to credit default swaps. It's very unfamiliar territory for a lot of insurance companies and requires a lot of education and investment on their side to get into this space.”

A further barrier to entry for investors is the ability to raise capital, with a seven- to eight-year lock-up for an illiquid and complex strategy that is not straightforward to explain to clients. The investor base is the constraining factor for bank issuance: the amount of assets on bank balance sheets is massive, compared to the amount of money that investors have raised to invest in those assets.

On average, large European and North American banks have used about 4%-5% of their corporate credit assets to issue risk-sharing transitions. Only a handful of banks have gone well above 6%-7%.

Roughly 50 to 55 banks have issued CRTs in the last five years, of which 40 are in the Eurozone and regulated by the ECB. This represents around 32% of the banks directly regulated by the ECB, so there is significant room for that number to grow. For banks with subsidiaries in different parts of Europe, SRT technology is expected to spread across geographies relatively quickly.

“Bank issuance is growing at a 25%-30% rate per annum. This allows the market to grow with proper controls and in a sustainable manner, while doubling in size every 3-5 years,” Kakalia says.

Representative of this dynamic, spreads at issuance have ranged approximately +/-200bp from 2013 levels, despite other areas of credit experiencing very different pricing dynamics.

Kakalia adds: “All the requirements for the growth of this market are now in place. As the market grows, we will see increased appetite from existing and new investors.”

Abrell notes: “We agree that the investor base will continue to experience incremental growth; however, we believe that sensitivity surrounding confidential bank information will always be a moderating factor.”

ESG potential
The potential for SRT to unlock ESG financing is particularly attractive to some investors. Adelaide Morphett, an associate at Newmarket Capital, says: “SRT represents one of the most catalytic, scalable investment opportunities pertaining to net zero. By investing in structures that free up regulatory capital, SRTs have the potential to unlock a significant amount of positive new impact lending.”

Newmarket specialises in turning brown finance green. Morphett believes that her firm is “the only private sector SRT investor that has embedded requirements for a bank counterparty to lend freed-up capital towards new positive impact.”

Referencing a pool that isn’t 100% green under the EU Taxonomy but incorporates some kind of on-lending requirement “is an innovative and creative approach to net zero,” she adds.

Importantly, issuers still need to improve data integrity and transparency to ensure ESG deals live up to their promise. Proposed legislation, such as the SEC’s ESG disclosures, and the requirements for SFDR Article 8 and 9 funds “suggest that expectations are shifting,” Morphett says. She continues: “More visibility into ESG criteria is a great step towards eliminating greenwashing, but it will be important to ensure standardisation does not come at the expense of innovation.”

Supranationals are key players in the CRT market, in terms of both facilitating ESG financing and stimulating bank lending to the real economy.

The EIF, for instance, has been investing in synthetic securitisations in different shapes and forms since the 1990s. SRT transactions enable issuers and investors to create more impact with fewer resources, according to Georgi Stoev, head of Northern Europe and CEE at the EIF.

“With SRT, for a single euro, we are able to support more lending in the European economy. A €100m SRT investment would result in anything between €400m-€1bn of loans, of which the green share could be upwards of 10%. We're moving towards expecting the originators to commit to 10%-30% to be composed of green loans,” he says.

In fact, the EIF has begun moving towards a system where new portfolios are formed of loans that allow various climate-related issues to be solved. “We very much want to support leases or loans, where the SME wants to invest in an electric vehicle fleet or insulate its buildings, or exchange old equipment for new energy saving equipment,” Stoev explains. “If we enter into a transaction with e.g. Santander Leasing Poland on a portfolio that comprises leases for diesel cars, we can ask them to build a new portfolio - e.g. five times the invested amount - which is entirely used for loans for electric cars. That’s ‘use of proceeds’: we invest in something that could be as brown as it can get, but the outcome must be green.”

Stoev is confident about the future of the ESG SRT sector. “Growing awareness that climate action needs to be taken as soon as possible makes me a firm believer that the share of use-of-proceeds specifically targeted for climate-related issues can only grow. Such commitment over and above the payment of a guarantee fee or insurance premium for protection provided was not the norm in pure market-driven organisations up until a couple of years ago.”

However, Newmarket sees some potential dangers ahead. Morphett says: “It largely depends on regulatory considerations. Regulations could certainly hold back ESG SRT issuance, due to potential thresholds and limits.”

An EBA report from last December raised the question of whether synthetic securitisation needs its own sustainable framework, or whether issuers can adhere to existing frameworks. Morphett notes: “The main tension when it comes to sustainable securitisation is whether the underlying reference pool must be green as per the EU Taxonomy, or whether the use of proceeds - meeting certain green standards - can qualify a securitisation as sustainable.”

She adds: “The volume of ESG investments increasing will largely depend on where that regulatory conversation lands. My hope is that the market will continue to support green redeployment, as well as transactions that embed greening over time, through replenishment or a pricing incentive for certain ESG-aligned KPIs.”

She cites as an example Newmarket’s 2021 Project Boquerón transaction with Santander, which references a €1.6bn pool of renewable energy assets and champions ESG lending through three features, both at inception and during reinvestment.

Not only is the portfolio focused on ESG assets at issuance, coupon incentives also exist to replenish the portfolio with further ESG assets during the revolving period. Additionally, the trade includes coupon incentives for utilising the capital released to further grow Santander’s lending to new ESG assets.

A pilot exercise on climate risk, published by the EBA in May 2021, estimated an average green asset ratio of just 7.9% for a sample of 29 EU banks. Against this backdrop, Morphett emphasises: “There isn’t enough supply of assets to sustain a green SRT market, when we are exclusively looking at underlying reference portfolios.”

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.*

Structured Finance

Liquidity event shows ABS 'did its job'

Sector developments and company hires

Liquidity event shows ABS ‘did its job’

The volume of European ABS and CLO bonds listed on BWICs between the UK government’s ‘mini-budget’ announcement on 23 September and the resignation of former chancellor Kwasi Kwarteng on 14 October totalled €6.9bn, roughly equivalent to the quarterly volume seen in Q1 and Q2 of this year, according to TwentyFour Asset Management figures. However, even more bonds are believed to have changed hands via bilateral trades, including portfolio sales.

The forced selling during this period – triggered by asset managers’ need to meet short-term liquidity requirements – was mostly concentrated in triple- and double-A rated UK RMBS and European CLO paper. Indeed, in a recent blog post, TwentyFour AM suggests that the fact the paper was investment grade highlights that the motivation for the selling was due to liquidity rather than credit concerns. 

“The post-mini-budget period was one of the largest liquidity events we have seen since the global financial crisis and it was certainly the largest volume of pension fund selling we have witnessed since 2008,” the blog notes. “While the cost of liquidity certainly rose, bid-offer spreads on triple-A and triple-B rated RMBS and CLO bonds remained relatively stable at 0.5%-1% and 2%-3% respectively through the period. Bonds did trade and the asset class did exactly what it was supposed to do.”

The proportion of CLO bonds listed on BWICs in September and October that were ultimately traded was between 85% and 93%, compared to a low of 49% during the Covid-19 triggered sell-off in March 2020, according to TwentyFour AM. Dealers appeared more willing to put balance sheet to work, given the level of investor appetite to buy high quality bonds at wider levels.

Bank treasuries have reportedly stepped into the secondary markets over the past few weeks and absorbed a large volume of UK prime RMBS at a yield of around 5%, as well as UK buy-to-let and non-conforming RMBS triple-As at yields of more than 6%. With the cash price of double-A rated CLOs dropping by 5-7 points into the mid-to high-80s, the convexity and yield of 6.5% in euros attracted hedge funds and private equity buyers. Further, demand from US buyers has been particularly strong, as lower levels rendered European ABS cheaper than domestic bonds.

“The recent liquidity crisis has put ABS in the spotlight, but for a good reason. First, the ABS market has done its job in providing liquidity to UK pension funds and has comfortably absorbed an unprecedented level of supply in a short period of time, probably even better than we expected. Second, it has highlighted the attractiveness of the asset class from a yield and credit perspective, with multiple buyers stepping in,” TwentyFour AM concludes.

In other news…

Blockchain POC prints

Liquid Mortgage says it has successfully replicated an MBS structure and bondholder payments on a blockchain, under a first-of-its-kind proof of concept. The underlying collateral is loan-backed digital assets, with full payment history, data and documentation attached. The aim is to provide investors with transparency from borrower payment through to noteholder payment.

EMEA

Cadwalader has promoted James Hoggett to special counsel, effective from 1 January 2023. Based in the firm’s London office, he focuses on fund finance, advising both lenders and GPs on a wide range of products, including asset-backed facilities and co-invest structures across all asset classes.

North America

Citi has appointed Brian Hochhauser as a director, CLO trading, based in New York. He was previously a director at Credit Suisse, which he joined in March 2011, and worked at Bank of America before that.

Medalist Partners has formed a strategic partnership with Semper Capital, in a bid to capitalise on structured credit opportunities. The partnership will see the two firms leveraging their complimentary expertise to co-invest across multiple structured credit products. Medalist will offer investment support and institutional resources under the new partnership to support Semper’s existing capabilities and will also work to launch new products together going forward as interest in alternatives from retail investors continues to rise worldwide. Medalist will make a minority investment in the Semper platform.

Structured Finance

Conflict of interest charge settled

Sector developments and company hires

Conflict of interest charge settled

The US SEC has charged S&P with violating conflict of interest rules designed to prevent sales and marketing considerations from influencing credit ratings, in connection with a jumbo RMBS it was engaged to rate in July 2017. The SEC’s order finds that over a five-day period in August 2017, S&P commercial employees on several occasions attempted to pressure the S&P analytical employees to rate the transaction consistent with preliminary feedback the analytical employees had given the customer that turned out to include a calculation error.

Despite sending the communications through the compliance department, as required by S&P’s policies and procedures at that time, some emails sent by the S&P commercial employees to the S&P analytical team contained statements reflecting sales and marketing considerations. The order finds that, as a result of the content, urgent nature, high volume and compressed timing of the communications, the S&P commercial employees became participants in the rating process during a time when they were influenced by sales and marketing considerations.

After discovering the circumstances surrounding the rating of the transaction, S&P self-reported the conduct at issue to the SEC, cooperated with the SEC’s investigation and took remedial steps to enhance its conflicts of interest policies and procedures. Without admitting or denying the SEC’s findings, S&P agreed to settle this matter by paying a US$2.5m penalty and agreeing to the entry of a cease-and-desist order, a censure and compliance with certain undertakings.

In other news….

North America

Alternative asset manager, Atalya, has recruited structured finance veteran, Bharath Subramanian, to lead the expansion of its capital solutions business. Subramanian will join the firm as an md in its specialty finance division, which concentrates on providing capital to consumer finance, commercial finance and other financial services businesses. He joins Atalya from Bayview Asset Management, where he most recently helped lead its expansion into private equity and special situations investing and brings with him a wealth of experience in handling investments and client relationships, bolstering the firm’s capital solutions capabilities. In his new role, Subramanian will work alongside the firm’s investment team to source and complete asset financings, portfolio purchases, corporate level debt solutions, equity transactions and an array of other structured capital solutions.

Paul Petkov has joined ATB Financial as md, credit portfolio management, based in Toronto. He was previously in the structured and bespoke solutions team at Texel in London, having worked in balance sheet optimisation and credit risk roles at Qbera Capital, HSBC, Lloyds, Morgan Stanley, Deutsche Bank, RBS and JPMorgan before that.

Structured Finance

ESG activation consortium launched

Sector developments and company hires

ESG activation consortium launched
Dexai-Etica Artificiale, Establecimiento Financiero de Crédito, European DataWarehouse (EDW), Hypoport, Unión de Créditos Inmobiliarios, Università Ca’ Foscari Venezia and Woonnu have launched the ‘Engage for ESG Activation Investments’ (ENGAGE) project, which has received a grant by the European Climate, Infrastructure and Environment Executive Agency (CINEA) under the EU’s LIFE programme. ENGAGE aims to create a future-proof data and innovative funding framework for energy efficient mortgage and renovation financing, making sustainable energy investments more attractive to private investors and aligning them with the EU’s sustainable finance policy.
Over a three-year period, the ENGAGE team will work on developing a standardised energy efficiency data disclosure template for mortgage loans in line with the most relevant European regulations. The template will be operationalised through the Green Investment Portal.
The ENGAGE framework for energy efficient mortgages and renovations will create transparency through the translation and application of the relevant sections of the EU Taxonomy into the Dutch and Spanish national building and mortgage-lending practices that will ultimately contribute to standardisation of innovative and decarbonisation-targeted capital markets financing transactions.
The project is being coordinated by EDW head of business development and regulatory affairs Marco Angheben.

In other news…

Climate risk financing facility launched
The World Bank Group has unveiled its Global Shield Financing Facility, which aims to help developing countries access more financing for recovery from natural disasters and climate shocks. This facility will support the Global Shield Against Climate Risks, a joint initiative launched at COP27 by the G7 and V20 to better protect poor and vulnerable people from disasters by pre-arranging more financing before disasters strike.

The Global Shield Financing Facility will channel grants to developing countries through World Bank projects or through projects prepared by other participating partners, including UN agencies and multilateral development banks. It will also work closely with key stakeholders, such as civil society organisations, risk pools, private sector and humanitarian partners.

The Global Shield Financing Facility will finance integrated financial protection packages that offer coordinated and consolidated financial support to those vulnerable to climate shocks and disasters. These financial packages will complement investments in climate adaptation and disaster risk reduction. Such packages will also enable and mobilise private capital for improved financial resilience, by offering private financial solutions, including insurance and other risk transfer instruments, such as catastrophe bonds.

The World Bank says it will also provide advisory and financial support to client countries to improve financial protection of poor vulnerable people and to actively contribute to the collective efforts to make the global risk finance architecture more impactful.

EMEA
Eric Huang has joined Barclays as an ABS and MBS trader, based in London. He was previously an ABS, MBS and CLO trader at Societe Generale, and worked at RBS before that.

Starz continues its relationship with StepStone Real Estate as it secures further investment to be used for its CRE debt fund. The pan-European commercial real estate lending platform’s fund, dubbed Starz Zenith Capital, will be used to originate middle market commercial loans valued between €15m and €100m. The funding marks StepStone Real Estate’s second investment with Starz, having previously anchored its Starz European Loan Fund I with an investment of €125m. This latest initial investment from StepStone follows the firm’s anchor investment from Mubadala Investment Company, Abu Dhabi’s sovereign investor, and will allow the fund to originate an additional €250m in loans. The fund offers loans for acquisition and recapitalisation of high quality, value-add commercial real estate assets across the eurozone and the UK, and since its launch in December last year, has succeeded in originating more than €300m in loans.

North America
Jean-Louis Monnier has added ceo of Swiss Re Capital Markets Corporation to his existing responsibilities as head of retro and ILS structuring at Swiss Re. Based in New York, he joined the firm in April 2002, having previously worked at Gen Re Financial Products, CIBC and Societe Generale.

SPG sale inked
Credit Suisse has confirmed that it has entered into definitive transaction agreements to sell a significant part of its securitised products group (SPG) and other related financing businesses to Apollo Global Management (SCI 28 October). This transaction, together with the contemplated sale of other portfolio assets to third-party investors, is expected to reduce SPG assets from US$75bn to approximately US$20bn, through a series of transactions expected to be completed by mid-2023. The approximately US$20bn of remaining assets - which will generate income to support the exit from the SPG business - will be managed by Apollo under an investment management relationship with an expected term of five years, to be entered into at the first closing.
Apollo is expected to hire the majority of the SPG team and will receive customary transitional services from Credit Suisse following the closing of the transaction, in order to maintain a seamless experience for clients. Credit Suisse will also provide financing for a portion of the assets transferred to Apollo.
Completion of these transactions is expected to achieve a release of RWAs of up to approximately US$10bn, depending on the scope of assets ultimately transferred.