News Analysis
Asset-Backed Finance
Optimal efficiency
CRE back leverage gaining traction
Private debt funds are gaining CRE market share via back leverage structures. This Premium Content article explores how these facilities can optimise risk, tax and regulatory treatment.
Private debt funds are gaining market share in the commercial real estate sector by originating loans that are financed by banks via bespoke back leverage structures, including private securitisations. These facilities have increased in complexity this year, as sponsors and lenders sought to optimise the risk, tax and regulatory treatment of the arrangements.
Back leverage is financing advanced to private debt funds for the funding, leveraging, acquisition or origination of one or more loan positions. Funds typically use leverage provided by commercial banks to enhance returns on their real estate debt investments at a lower cost than that of direct equity investments into the fund. In return, back leverage providers obtain indirect exposure to illiquid assets, as well as additional asset-backed structural and contractual safeguards.
“Back leverage became popular as interest rates reached historical lows. In an era of cheap debt, it makes sense for debt fund sponsors to expand using back leverage,” observes Richard Hanson, partner at Morgan Lewis.
A variety of structures can be utilised to achieve back leverage, including loan-on-loan facilities, repo agreements and private securitisation - whereby loans are transferred to an SPV, which issues a senior note to the bank lender and the junior note is retained by the fund sponsor. Among the advantages of employing a structured solution is achieving favourable regulatory and tax treatment, which allows banks to hold less capital against the position.
“The structural driver is finding a balance between the right regulatory treatment for the bank lender and the right tax and accounting treatment for the fund sponsor, with the overall objective for the fund sponsor being to create cheaper funding and diversify funding sources. We’re seeing more structures being combined to achieve those aims,” Hanson explains.
Nick Shiren, partner at Cadwalader, notes that loan-on-loan financings are typically used to finance smaller sized transitional assets. Drawing on repo technology, a traditional facility treats each asset as being referable to a separate loan, but it is also possible to structure the facility more akin to a typical borrowing base facility.
In the US, loan-on-loan facilities are documented under a master repurchase agreement. From a business and financial standpoint, these work in the same way as financing and entail the same reps and warranties, covenants, event of default clauses and remedies.
Aaron Benjamin, partner at Cadwalader, notes that a repo structure benefits from a statutory exemption from automatic stay that US courts would impose on most key contracts of a bankrupt sponsor or borrower under the US bankruptcy code. This exemption allows lenders to liquidate collateral, notwithstanding the imposition of the automatic stay that would otherwise apply.
He adds that there are three other credit pillars that support this structure: daily mark-to-market rights; a partial recourse guaranty by the sponsor, with some ‘bad act’ full recourse and loss recourse carve-outs; and a repurchase obligation by the sponsor of defaulted loans or breaches of loan-level R&Ws. The ‘bad act’ carve-outs under the partial recourse guaranty include collusion in bankruptcy, fraud, breach of environmental R&Ws and intentional misrepresentation.
The structures are commonly performing loan facilities, but they aren’t exclusively. For facilities that allow non-performing loans as collateral, a lender would require some control or consent rights over the contemplated workout plan, among other conditions.
Shiren views the product as part of the relationship lending offering between an investment bank and debt fund sponsor. “Loan-on-loan financings are one of the funding tools used by sponsors, which may look to the CRE CLO or CMBS market as well, as part of their funding strategy. Essentially, the bank buys into the business strategy of the sponsor,” he explains.
He continues: “The debt fund originates assets and asks the bank whether it can put them on the line; the lender can agree or decline to fund the asset. If it agrees, the bank typically takes a strong interest in the sponsor and its ability to adhere to its business plan.”
The approval process for onboarding assets is usually collaborative and there are different methods of mitigating risk, including pricing, assuming a greater percentage of recourse and margin calls. “For example, if the NOI or NCF declines such that the repo buyer (lender) determines that the market value of the property securing the mortgage loan has declined, then the lender can issue a margin call to rebalance its advance rate against the new market value of the property (and hence the loan). Additionally, it’s possible to solve for unusual asset risk by providing for increased recourse for specific assets,” explains Benjamin.
He continues: “The structure is a flexible way for REITs and other funds to obtain leverage at asset-backed financing rates. Part of the business plans for real estate funds has been to use these facilities in order to obtain levered returns.”
In terms of tax treatment, vehicles are often domiciled in Ireland, which is attractive for both banks and sponsors – especially US sponsors – if their aim is to achieve tax-neutrality. Shiren is aware of cross-border and multicurrency facilities (in sterling and euro) being structured, encompassing continental Europe, Ireland and the UK.
“This brings additional complexity and requires understanding the lending and regulatory regimes across different jurisdictions. For instance, it is necessary to undertake due diligence on the different banking monopoly rules to ensure that an SPV can actually lend in a given jurisdiction,” he says.
Whether a transaction will technically be a securitisation within the regulatory framework is often discussed early on in negotiations and is typically led by the bank, which wants to achieve the associated regulatory capital benefits. Shiren confirms that most banks would take the view that the facilities are securitisations.
As such, it is necessary to address the associated risk retention and transparency requirements. “Risk retention tends not to be an issue because it’s usually possible to find an ‘originator’ within the sponsor group and, since the advance rate of the facility is less than 95%, the sponsor will have to provide some equity to the vehicle. This is structured as a first loss piece and is usually sufficient to satisfy retention requirements,” he notes.
However, Hanson warns that smaller funds need to be careful in such a scenario. “Securitisation can be beneficial from a pricing perspective, but they also need to be cognisant of their obligations under the securitisation regulation,” he notes.
Equally, smaller funds are more exposed to potential margin calls in repo arrangements by the bank. Hanson says that standard features that are always negotiated are mark-to-market terms and decisions regarding control over enforcement and material modifications.
“Banks have become more focused on due diligence and control recently, in order to mitigate downside risk. While certain parameters can be set, ultimately a bank has absolute discretion as to whether to finance an asset,” he adds.
Back leverage transactions either provide matched funding or have historically been termed out into the securitisation market. Hanson expects such activity to return, once the public market begins to stabilise following this year’s challenging conditions. This may be facilitated by the emergence of a CRE CLO market in Europe, although he points out that many hurdles need to be overcome for this to occur.
“CRE CLOs can be expensive to structure and it can be prohibitive for smaller debt funds to access warehouse lines to ramp portfolios. On the other hand, CRE CLOs tend to offer more competitive advance rates compared to repo and are attractive to fund managers because they allow more discretion over the assets,” Hanson remarks.
Shiren says he is seeing continued interest in CRE CLOs in Europe and believes it is only a “matter of time” before a market emerges on this side of the Atlantic. He adds that many loan-on-loan mandates have CRE CLO take-outs contemplated in the documentation.
Benjamin confirms: “We’re seeing certain sponsors warehousing assets that satisfy CRE CLO rating requirements, for example, and sometimes they securitise those assets and other times they maintain their leverage through the repo facilities.”
Looking ahead, Hanson anticipates that the real estate finance market will be characterised by the need to address loan refinancings, ICRs being breached and LTVs potentially being breached – which will result in banks seeking to delever and funds looking to take market share. “Back leverage is a solution. Although back leverage providers are currently charging higher interest rates, if it is undertaken in a structured way, funds will still be able to enhance their returns,” he concludes.
Corinne Smith
22 December 2022 17:32:03
News
Structured Finance
SCI Start the Week - 19 December
A review of SCI's latest content
Last week's news and analysis
Battle begins
EU and industry lock horns over p factor
Landesbank boost
LBBW executes financial guarantee
Mind the gap
'Regulatory impediments' stalling ESG securitisation
Play it forward
Evolution of BNPL securitisation eyed
For all of last week’s stories including ‘Market moves’ and ‘Risk transfer round-up’ click here.
Podcast
In the latest episode of the ‘SCI In Conversation’ podcast, we chat to Reed Smith partner Iain Balkwill about prospects for a CRE CLO market in Europe. To access the podcast, search for ‘SCI In Conversation’ wherever you usually get your podcasts or click here.
SCI Markets
SCI Markets provides deal-focused information on the global CLO and European/UK ABS/MBS primary and secondary markets. It offers intra-day updates and searchable deal databases alongside CLO 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
CRT regulatory storm - December 2022
Concern over the future viability of synthetic securitisation is rising, in light of the impending Basel output floor and the EBA’s synthetic excess spread proposals. This Premium Content article investigates whether such regulatory change is likely to be as severe as it seems.
BNPL Securitisation - December 2022
The cost-of-living crisis and growing regulatory scrutiny are set to shape the evolution of the BNPL securitisation sector. This Premium Content article explores what the next 12 months may bring for the asset class.
US equipment ABS - November 2022
US equipment ABS has had a good year, notwithstanding macro-driven spread widening. As this premium content article shows, there is also hope for 2023.
CFPB judgment implications - November 2022
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.
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.
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.
Upcoming SCI events
SCI's 7th Annual Risk Transfer & Synthetics Seminar
9 February 2023, New York
SCI’s 2nd Annual ESG Securitisation Seminar
25 April 2023, London
SCI's 9th Annual Capital Relief Trades Seminar
19 October 2023, London
19 December 2022 10:56:12
News
Structured Finance
Capital ideas
Taxonomy-aligned RWAs, sustainability-linked pricing touted
SMARTER Finance for Families has submitted a number of policy recommendations to the Climate Bonds Initiative, as part of the organisation’s recent public consultation entitled ‘101 Sustainable Finance Policies for 1.5°C’. The SMARTER recommendations include top-down and bottom-up policy frameworks that harness the securitisation market.
“Engaging the capital markets is crucial in order to achieve net-zero – an estimated US$250trn of spending is necessary between now and 2050 to do so. Saving energy is now an even bigger imperative and is playing into the demand side of the equation,” says Ted Kronmiller of SMARTER Finance for Families.
The top-down policy framework recommended by SMARTER is to link the EU Taxonomy Metrics and Thresholds with the EU Capital Requirements Regulation risk-weighted assets framework, whereby higher degrees of environmental performance and climate risk reduction translate into RWA reduction at the property, project and portfolio-level. As the degree of environmental ambition of underlying projects increases, RWAs will proportionally decrease, reflecting the reduction in climate risk. The cross-risk impact of climate risk reduction will be captured through the Metrics and Thresholds of the Technical Screening Criteria in the EU Taxonomy and translated into RWA reductions.
“The result would be an incentive to mobilise capital to the green sector, while improving the economics of green real estate finance and the real estate sector itself. Banks would then have greater capabilities to developed climate-aligned finance product-sets under the EU Green Bond Standard," Kronmiller notes.
As well as providing increased balance sheet capacity for banks to expand lending for green real estate projects, EU Taxonomy-aligned RWAs could serve as a foundation for banks to report their Green Asset Ratio (GAR) - a KPI showing the extent to which the financing activities in their banking book are aligned with the Taxonomy Regulation, the Paris Agreement and the UN Sustainable Development Goals (SDGs). Kronmiller suggests that the GAR can also act as a form of ESG credential signalling to the capital markets that would allow access to additional pools of capital.
“By positioning taxonomy-alignment as a precondition for achieving regulatory capital relief, banks will be incentivised to do more green lending and benefit from reporting their GAR,” he says.
Meanwhile, the bottom-up policy framework concerns sustainability-linked pricing for climate risk reduction. By calibrating real estate product-set features to an environmental performance coefficient, structured finance deals that demonstrate higher degrees of environmental performance can benefit from lower credit enhancement and overcollateralisation requirements.
“Residential real estate finance that is underwritten with an environmental performance coefficient can serve to transform the sustainability profile of the building stock, improve the supply of sustainable finance and provide investors with certainty about environmental performance over time. The EP coefficient establishes a means of incentivising development of EU Taxonomy-aligned real estate projects and origination of sustainable real estate finance product-sets and transaction structures necessary for issuance under the EU Green Bond Standard,” Kronmiller explains.
Given that sustainable real estate finance exhibits lower credit, market, liquidity and funding risk, he notes that the relationship between environmental ambition, economic outcomes and financial performance can be a source of alpha.
The remaining piece of the puzzle, according to Kronmiller, is the need to establish a certification accreditation scheme that creates equivalency across the major building certification systems - SMARTER, LEED, BREEAM, HPI, DGNB and HQE. As such, he suggests that the European Commission should facilitate the development of an external review platform that demonstrates a certification system’s alignment with the EU Taxonomy.
“If a minimum of equivalency is defined, it creates an incentive to disclose how far above the minimum a firm is,” Kronmiller concludes.
The CBI’s ‘101 Sustainable Finance Policies for 1.5°C’ is a package of coordinated sustainable finance policy frameworks designed to help policymakers direct capital to facilitate a rapid green transition.
Corinne Smith
21 December 2022 17:17:29
News
Capital Relief Trades
Shipping boost
Eurobank finalizes shipping CRT
Eurobank has executed a US$220m financial guarantee that references a US$2bn portfolio of shipping loans. Dubbed project wave three, the transaction is one of only three shipping CRTs to have been backed exclusively by shipping exposures and is the largest of such deals in portfolio terms.
The biggest challenge for capital relief trades backed by shipping loans is finding high performing portfolios and being able to model expected losses. Indeed, investors need to see that there’s no volatility in the historical data as well as advanced capabilities in portfolio management.
Moreover, LGD estimation is hard and that is where you find disagreement between originators and investors. The process would require banks digging into their historical data and carrying out a scenario analysis to reassure investors on recoveries.
Consequently, the market has only seen a handful of such deals. Nord LB executed a shipping CRT in 2017 but the trade featured a mixed portfolio. Piraeus’ project Triton that was launched this year, a Citigroup transaction from 2013 and Eurobank’s latest ticket are the only pure plays (see SCI’s capital relief trades database).
According to sources close to Eurobank’s latest trade, there are several ways to address these idiosyncratic issues around shipping exposures, but clearly the composition of the portfolio is the first place to start.
Indeed, the underlying portfolio has excluded the more volatile parts of the shipping market such as LNG carriers. Furthermore, it’s important for banks to partner with investors who can analyse the portfolio but also ones who can trade in the secondary market. Investors can then optimize losses by second trading the vessels and becoming effectively brokers.
Stelios Papadopoulos
22 December 2022 18:43:36
News
Capital Relief Trades
Project Maverick launched
BCP returns to the CRT market
Banco Comercial Portugues (BCP) has finalized its first synthetic securitisation following an eight-year hiatus amid a resurgence in the Portuguese market. Dubbed project Maverick, the deal references a portfolio of Portuguese SME loans.
According to market sources, the transaction features a 2%-9% tranche thickness and was priced at 12.95%. The bank’s last capital relief trade was finalized in May 2014 and was called Caravela SME no.4 (see SCI’s capital relief trades database)
The bank’s return coincides with a resurgence in the Portuguese market as two deals are being prepped including an SME trade from Novo Banco. Moreover, BCP’s Polish subsidiary is readying a capital relief trade backed by Polish corporate and SME loans.
The choice of synthetic securitisations is perhaps not surprising from BCP’s perspective. The bank has a plan to grow capital organically and tapping the cash market wouldn’t make sense since as a retail bank BCP gets most of its funding from deposits.
More saliently, issuing equity at this point is a non-starter because it is a more expensive and dilutive option. Hence, synthetic securitisations for capital generation purposes are a one-way street.
The bank reportedly went straight to private investors as opposed to the European Investment Fund since the private option allows the lender to put out there a larger portfolio. Overall, the private option gives banks more flexibility due to the EIF’s more standardized criteria.
Stelios Papadopoulos
21 December 2022 11:37:31
Market Moves
Structured Finance
NPL data templates introduced
Sector developments and company hires
NPL data templates introduced
The EBA has launched NPL transaction data templates, aimed at introducing information standardisation to increase the efficiency of secondary markets for non-performing loans and to reduce entry barriers for smaller banks and investors. The proposed NPL transaction data templates are built on previous voluntary loan-by-loan templates and consider the experience of market participants from the sell- and buy-side and other stakeholders.
The EBA’s final draft implementing technical standards (ITS) specify the required information that credit institutions selling NPLs shall provide to prospective buyers. The objective of the draft ITS is to provide a common data standard for NPL sales or transfers across the EU, enabling cross-country comparison and thus reducing information asymmetries between the sellers and buyers of NPLs.
The templates cover information regarding counterparties related to the loan, contractual characteristics of the loan itself, any collateral and guarantee provided, any legal procedures and enforcement procedures in place, and the historical collection of loan repayment. They are also complemented by a data glossary and the instructions for filling in the templates.
The EBA says the draft ITS are based on strong proportionality arrangements, focusing on the sales of NPL portfolios and setting different information requirements - depending on the nature of the borrowers and of the loans included in the portfolios to be sold - by specifying mandatory data fields. Proportionality is further reinforced by allowing all data fields to be treated as not mandatory for certain types of transactions.
The draft ITS have been submitted to the European Commission for adoption.
In other news…
EMEA
Dentons has recruited Niamh Keogh to its Dublin office, with experience in advising on inward investment into Ireland and a specialist on the use of Irish regulated fund structures and securitisation vehicles. She joins the firm from Mason Hayes & Curran, where she is a partner and co-head of tax.
Elliot Milton, a former svp at SMBC Aviation Capital, has joined Walkers' asset finance team in Dublin as Of Counsel. He previously worked in private practice in Dublin, London and Brussels for several years, before working as a diplomat in the Irish foreign service, including at its Embassy in Tokyo.
Spanish relief to have ‘limited’ RMBS impact
The Spanish government late last month approved a range of relief measures to support Spanish households, including a new code of good practices for those considered to be at risk of becoming vulnerable. DBRS Morningstar expects the proposed measures – which feature mortgage forbearance – to have a limited impact on the asset performance of RMBS portfolios, however.
According to the rating agency, around 11% of the current balance of household mortgages across the Spanish RMBS universe could meet the required conditions to apply for the relief measures included in the new code of good practices. However, it believes that the perimeter of eligible households may be lower than 11%, as the RMBS universe sample has different characteristics than the domestic stock of mortgages on Spanish banks’ balance sheets.
Nevertheless, DBRS Morningstar notes that while providing access to temporary payment holidays and maturity extensions to low-income borrowers in distress may reduce RMBS collections in the short term, such flexibility should also help to reduce delinquency levels and prevent defaults.
19 December 2022 12:51:12
Market Moves
Structured Finance
Italian mid-cap deal debuts
Sector developments and company hires
Italian mid-cap deal debuts
illimity Bank has closed what is believed to be the first securitisation backed by a portfolio of 82 unsecured loans granted to Italian mid-caps and corporates that are predominantly guaranteed by the country’s export credit agency SACE. Dubbed Colt SPV, the €570.11m transaction was originated based on the ‘Liquidity decree’, enacted in June 2020 to help kickstart the Italian economy.
The majority (76.2%) of the portfolio is guaranteed by SACE, with the remainder guaranteed by the Central Guarantee Fund for SMEs, managed by Banca del Mezzogiorno (MCC). Most of the loans benefit from a pre-amortisation period.
The average loan ticket within the pool is €6.5m and the maximum loan ticket is €25m. Debtors active in the cyclical construction and building sector represent only 19% of the total portfolio, while the top region – Lombardy - accounts for 41%.
However, Moody’s notes that the transaction has several challenging features, including the lack of granularity - with 69 debtors, the top 1 and 10 represent 5.3% and 41.1% of the pool respectively. Further, the borrowers' average credit quality is relatively low in the low single-B range.
The servicer (illimity Bank) can also renegotiate several terms and conditions of the loans up to certain limits. These renegotiations could affect loan maturity and the interest rate applied to the loans.
Rated by DBRS and Moody's, the transaction comprises €375m A/A1 rated class A notes, €79.1m B(h)/B2 class B notes and €116.01m unrated class J notes.
Lanterna Finance from June 2021 was the first ABS to benefit from the ‘Liquidity decree’, but it is backed by a granular portfolio of small ticket unsecured loans fully guaranteed by the Central Guarantee Fund for SMEs (SCI 30 June 2021).
In other news…
ABS CDO transferred
Dock Street Capital Management has replaced Barings as successor collateral manager for the Monroe Harbor CDO 2005-1 transaction. Moody’s has confirmed that the move won’t impact the ratings assigned to the notes.
Global
Cadwalader has elected nine attorneys to the firm’s partnership and promoted eight attorneys to special counsel and counsel, effective 1 January 2023, including five from the firm’s capital markets practice with experience in structured finance.
Among those promoted to partner is Alexander Collins, based in Cadwalader’s London office, who focuses particularly on CLOs. Michael Ruder – who is based in Charlotte and focuses on CMBS - has also been named a partner.
Among those promoted to special counsel are: Elena Bernal, who is based in London and focuses on CLOs and private asset-backed facilities; and Cassidy Nolan, who is based in Charlotte and focuses on CLOs and other ABS. Finally, Hunter White – who is based in Washington, DC and focuses on structured finance transactions – has been named counsel.
21 December 2022 06:44:49
Market Moves
Structured Finance
NPL forward flow sale agreed
Sector developments and company hires
NPL forward flow sale agreed
NPL Markets has acted as advisor to UniCredit on the sale of a portfolio of Italian non-performing unsecured loans with a claim value of approximately €90m to a vehicle managed by Kruk and to Credit Factor. Concurrently, the forward flows of Italian consumer loans that will be classified as bad loans in 2023 and 2024, up to a claim amount of €460m, have been purchased by Kruk.
The agreement is part of UniCredit’s ongoing strategy to reduce non-performing exposures. The sale process was managed via NPL Markets’ online platform, allowing UniCredit to streamline the disposal process and accelerate the deal execution.
In other news…
Loan opportunity fund closed
CVC Credit has closed the Cordatus Opportunity Loan Fund, a long-term financing facility structured similarly to a CLO, with expected purchasing capacity of circa €400m notional of leveraged credit. To date, the fund has ramped around €175m of assets at an average price of 91.9%.
The fund was raised in partnership with Royal Bank of Canada and a strategic third-party investor. The closing will increase the aggregate value of new assets raised in 2022 across the CVC Credit CLO platform to nearly €3.6bn.
North America
Eagle Point Credit Management founder and managing partner Thomas Majewski has resigned as a non-executive director of Marble Point Loan Financing. He has been replaced as the investment manager's nominee to the board by Thomas Shandell, ceo of Marble Point Credit Management. The move follows the recent announcement that Investcorp is to acquire Marble Point (SCI 2 December).
23 December 2022 12:40:10
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