Contents

Structured Finance

SCI Start the Week - 16 January

A review of SCI's latest content

SCI ESG Securitisation Awards 2023

The submissions period has opened for the 2023 SCI ESG Securitisation Awards, covering the European cash securitisation market over the 12 months to 31 December 2022. Nominations for the awards should be received by 15 February and winners will be announced at the London SCI ESG Securitisation Seminar on 25 April. For further information about the SCI ESG Securitisation Awards, click here: https://www.structuredcreditinvestor.com/SCI_Awards-ESG.asp.

Last week's news and analysis

Balancing the equation
Positive start for CLO assets and liabilities

Capital boost
Capital requirements set to rise

Correlation risk
New report sheds light on post Covid correlations

First CAS since September
B1 levels contract

Tight pricing persists
BNP Paribas executes synthetic securitisation

Unemployment eyed
Labour market key to Euro ABS outlook

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
CEE CRT activity - January 2023
Polish SRT issuance boosted synthetic securitisation volumes last year. This Premium Content article assesses the prospects for increased activity across the CEE region.

CRE back leverage - December 2022
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.

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.

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

Structured Finance

Governance impact highlighted

Asset isolation, payment continuity eyed

Fitch reports that governance remains the leading cause of elevated ESG Relevance Scores (ESG.RS) across structured finance, reflecting the importance of asset isolation and payment continuity for securitisations. The rating agency notes that governance is a highly relevant ESG factor for 484 transactions it rates (where 412 have an ESG.RS of 4 and 72 have an ESG.RS of 5), while social is a highly relevant factor for 353 (where 330 have an ESG.RS of 4 and 23 have an ESG.RS of 5) and environmental is highly relevant for 44 (where 42 have an ESG.RS of 4 and two have an ESG.RS of 5).

Within the governance segment, the factor that is most prominent when assigning ESG.RS is ‘Transaction Parties & Operational Risk’ within RMBS pools, according to Fitch. In a recent review of its ESG.RS, the agency highlights a couple of case studies that demonstrate the impact governance factors can have on transactions.

The first case study is Banca Monte dei Paschi di Siena’s Siena Mortgages 07-5 (Series 2008) RMBS, for which Fitch assigned an ESG.RS of 5 in relation to the ‘Transaction & Collateral Structure’ governance factor. The transaction features a cash reserve below its target that can be drawn to cover asset losses and is exposed to payment interruption risk (PIR), which – given it is a structural risk that could affect payment continuity - has a negative impact on its credit profile.

PIR is mitigated up to single-A plus by the servicer (BMPS) holding funds for no longer than two business days. However, Fitch has tested the current reserve amount coverage in the short to medium term and determined that the cash reserve - which is below the floor and has been subject to continuous drawings - is not adequate in rating scenarios exceeding the rating cap of single-A plus.

The second case study highlighted by Fitch is WiZink Bank’s aZul Master Credit Cards ABS, for which Fitch assigned an ESG.RS of 5 in relation to the ‘Rule of Law, Institutional and Regulatory Quality’ governance factor. The category captures laws, regulations, supervisory oversight and government support and interventions geared towards consumer and commercial assets, including foreclosure and personal bankruptcy laws.

The Spanish Supreme Court ruled March 2020 that the 26.8% annual interest rate charged by WiZink on a specific credit card contract was usurious under Spanish Usury Law, as it was materially above the market average rate of about 20%. The contract was therefore considered invalid, resulting in customers only being obliged to pay back the drawn principal amount, with the bank having to reimburse all interest and fees collected from the contract start date. As a result, the high degree of uncertainty on the set-off risk linked to future usury claims led to a single-A rating cap for the notes.

While Fitch expects governance to remain highly relevant to ratings, the agency believes that social risk issues are likely to develop further. “Many elements considered under the social category arise from the consumer-based nature of securitised residential mortgages and consumer credit. Many medium-to-high rating impact scores relate to legacy US and EMEA RMBS transactions with a significant proportion of loans exposed to the risk of predatory or misleading lending practices,” it explains.

Meanwhile, environmental factors are set to gain more importance in Fitch’s SF asset assumptions and ratings, but will only become apparent in the longer term once a more homogeneous set of historical data is available. The agency expects climate change-related risks to most likely start having discernible credit implications for new structured finance transactions issued within the next five to 10 years.

Fitch’s ESG.RS communicate how ESG factors affect SF and covered bond ratings. The ESG.RS consider 14 general ESG issues and are expressed on a ‘1’ to ‘5’ scale, with ‘1’ indicating irrelevance and ‘5’ being highly relevant for the rating. An ESG.RS of ‘4’ or ‘5’ can be positive or negative to a rating decision.

Corinne Smith

Capital Relief Trades

Generating impact

Banco BPM executes project finance SRT

Banco BPM has finalized a significant risk transfer trade that references a static €1bn portfolio of Italian project finance and CRE exposures. Dubbed Sofia, the synthetic securitisation is riding a pickup in project finance SRTs.

The transaction features a funded junior and an unfunded mezzanine tranche with an 18.5% and a 2.5% thickness respectively. The junior tranche was priced at less than 10%. Additionally, the portfolio WAL is equal to approximately 4.5 years and the time call can be exercised after the end of the WAL. Banca IMI acted as the arranger in the trade. 

Project finance CRT issuance has been growing and especially in Spain and Italy (SCI 13 October 2022). However, these exposures are not as diversified as corporate exposures, so the transactions must be well-structured and have a robust risk-return profile. The latter means that the performance should not be fully driven by one or two single defaults.

Indeed, concentration risk, along with project finance idiosyncrasies - such as construction and technology risk - require specialist knowledge of each project from the investor side.

Consequently, not many synthetic ABS investors have been able to participate in such deals. The Sofia transaction addresses these risks via the presence of a static portfolio and a relatively thick junior tranche.

Meanwhile, Banco BPM completed another synthetic securitisation backed by a €1.5bn Italian SME portfolio, structured with the support of Société Générale in its role as arranger in the deal. Dubbed Greta, the capital relief trade consists of an approximately €70m mezzanine tranche and a retained €10m junior tranche. The mezzanine piece was priced in the lower double digits.

SME portfolios would typically go to the European Investment fund and Banco BPM has tapped the fund’s resources in the past. However, given that the European Guarantee Fund has come to an end last year, the bank opted for the private option.

Looking forward, Giovanni Prati De Pellati, head of funding and capital management at Banco BPM concludes: ‘’For future transactions we can rely on our SME and large corporate book and further issuance of project finance SRTs is possible but remains to be seen given the limited size of our book. Residential mortgages are an asset class that could be explored, although they have a lower risk weight so it wouldn’t necessarily make sense from an efficiency standpoint.’’

Stelios Papadopoulos

Capital Relief Trades

Italian boost

Intesa ramps up CRT issuance

Intesa Sanpaolo has executed a slew of significant risk transfer transactions in 4Q22 as the Italian lender continues to ramp up its capital relief trade issuance.

Indeed, in 4Q22 the bank’s Active Credit Portfolio Steering Unit finalized two Italian synthetic securitisations under the GARC Program that referenced nearly €10 bn of loans and with Banca IMI acting as the arranger of the deals.

The first transaction features a funded junior tranche (0-7%) backed by a €7.5bn corporate portfolio that consists of 4,500 borrowers mainly located in the north of Italy and mostly active in manufacturing sectors. The originator retained the senior tranche and 5% of the underlying loans.

The second transaction marks Intesa Sanpaolo’s first synthetic securitization of a portfolio of corporate loans and project finance in the infrastructure sector. The trade references an approximatively €2.3bn portfolio. Further features include a two-year replenishment period subject to criteria for replacing prepaid and amortized loans.  

Intesa notes in a statement that ‘’as with the previous GARC Energy Renewable one and GARC CRE one, the transaction is focused on borrowers with the highest ESG score and it is structured with a view of supporting new origination in the infrastructure sector in partnership with specialized investors.’’

The lender’s latest synthetic securitisations follow a slew of SRT trades brought to market last year by the Active Credit Portfolio Steering team for a total size of around €20bn, including a €6.5 bn leasing securitization.

Stelios Papadopoulos

Capital Relief Trades

Rabobank returns

Rabobank launches synthetic securitisation

Rabobank and the European Investment Bank Group have finalized two transactions that mobilize €1bn of new lending for Dutch SMEs. The first is for impact loans and the second is a significant risk transfer trade intended as COVID relief among other reasons. The guarantee marks the Dutch lender’s return to capital relief trades as it plans to tap the market more regularly following a four-year hiatus.  

Impact loans are available to entrepreneurs and small businesses that hold one of the selected sustainability labels, certifying their commitment and effort towards making their businesses socially and environmentally sustainable. Under the terms of the operation, the EIB will lend €300m to Rabobank, who will then match this with another €300m.

Secondly, through a separate credit risk sharing transaction with the European Investment Fund, Rabobank will make available a further €445m for businesses looking to grow their way out of the difficult conditions caused by, among other reasons, the Coronavirus pandemic.

The EIF will guarantee a junior tranche on a portfolio of SME loans held by Rabobank and this in turn will be counter-guaranteed under the European Guarantee fund, effectively freeing up part of Rabobank’s capital. This is the second capital relief transaction entered into between the EIB Group and Rabobank since 2018.

The synthetic ABS is Rabobank’s first STS SRT and features a €750m Dutch SME pool that amortizes over a 3.5-year portfolio weighted average life. The junior tranche amortizes on a pro-rata basis with triggers to sequential. As stipulated by EGF rules the portfolio is static and there’s no synthetic excess spread. 

The EGF transaction was signed last year before the expiration of the EIB group’s scheme in the summer of 2022, but the credit protection became effective at the end of 2022.

Looking forward, Thomas Wilson, head of structured asset distribution at Rabobank concludes: ‘’We intend to tap the market every one or two years. It’s important to stay active given how the regulations change and keep internal teams up to date in case you need the capital optimization.’’ 

Stelios Papadopoulos

CLOs

Seeking stability

Philip Pirecki, head of business development at Jersey Finance, argues that picking the wrong international finance centre could shut off an investment manager's fundraising

There are few things more disruptive to the investment management industry than instability. Financial institutions are experts in managing risk in their investments. One of the reasons they can achieve this is due to developed processes for anticipating and predicting events – they can rely on their models. Managers expect the same for their operations.  

Structured finance - particularly the CLO market - has remained a robust subsector of capital markets, even during this year’s intense volatility. However, US investment managers in this sector appear largely unaware of the existential threat to this market beyond the tumultuous macroeconomic outlook. For many, there is a major disruption in business on the horizon, particularly for fundraising new securitised structures. 

There are some key figures to understand about CLOs that set the scene. First, according to S&P’s 2021 Leveraged Commentary and Data report, nearly 80% of CLOs are managed by US firms. Additionally, the Federal Reserve reported in 2019 that nearly 75% of US CLO securities, at the time of publication, were issued out of the Cayman Islands.

Why does this matter? Not all investors are also based in the US and European investors could actually be completely shut off from this market. 

In 2015, the EU adopted a modernised regulatory framework that incorporates various Anti-Money-Laundering Directives (AMLDs). One such directive contains a feature that maintains a list of jurisdictions with strategic deficiencies in their regimes that are considered a significant threat to the financial system of the EU – this is widely known as the ‘blacklist’. Article 4 of the EU Securitisation Regulation prohibits EU investors from investing into vehicles domiciled in a country that appears on the blacklist or are domiciled in jurisdictions that are likely to be on the blacklist. 

In early 2022, the Cayman Islands and eight other jurisdictions were placed on the AML blacklist. Since European investors are prohibited from investing in CLOs that are domiciled in blacklisted - or likely to be blacklisted - jurisdictions, US managers will either have to migrate the structure to another offshore jurisdiction or forego continued fundraising from European investors (SCI 9 June 2022). 

The blacklisting of these jurisdictions and the migration of investment vehicles with a European investor nexus creates a serious consideration for all international finance centres: how to help assure stability and resiliency for managers, without compromising innovation. 

Managers want their structures to have longevity. It is inefficient, costly and possibly even a governance concern for a manager to set up a vehicle in one jurisdiction to then later have to migrate it to another.

Financial jurisdictions should be stable, predictable and resilient. Investment managers want to be sure that there will be no significant or disproportionate changes to the structures that they are establishing. 

A jurisdiction must be able to address change in a timely and effective way to maintain stability for its investment managers. To be adaptive to change - which often comes quickly, as in the case of the securitisation market - a healthy collaboration between the government, regulator and industry is key.

When a partnered approach between these stakeholders is present, new regulations can be addressed in a timely and effective way. By adapting to changing regulation without material disruption to fund structures, jurisdictions can provide managers the confidence in the operations they seek. The only volatility managers should be worried about is in prices, not their funds.   

CMBS

The perils of interest rate risk

A structured finance investor talks the big 2023 themes

Karlis Ulmanis is a portfolio manager at DuPont Capital in Delaware, which has total AUM of $20.1bn. The core fixed income portfolio is worth $1.3bn, and Karlis manages the $550m securitized debt section comprised of CMBS and RMBS. He manages these assets against structured products sub-index of the Bloomberg USA Bond Index.

This week SCI asked him where he sees value at the moment.

Q: Nice to talk again Karlis. What are the dominant features of your areas of the market at the start of this new year?

A: Interest rate risk hangs over everything. This has changed everything. Last year we started with overnight rates around 0.25% and they’re now between 4% and 5%. That is a big difference. And we don’t know where things go from here. Every time there is a good print or a bad print in CPI, PPI or retail sales, the market reacts. Volatility has greatly increased and I’m trying to get through it.

Q: What impact does this have in RMBS?

A: Well, in addition to the obvious interest rate risk, there is much less loan turnover. Refinancings are down to levels we haven’t seen since 1996. This affects prepayment speeds. So, for example, there are heavily discounted Fannie Mae 1.5% mortgage TBAs which are trading at 80 cents on the dollar, but you need to factor in when you might get paid back. So I’m very wary of deep discount bonds as prepayments are so slow. Going from 2% mortgages to 6.5% mortgages adds about $350 per month per $100,000 borrowed to a borrower’s mortgage payment, so no-one wants to do that.

Q: How have you responded?

A: I don’t think there is much value in shifting around. I am doing very little trading at the moment. There is nothing that really jumps out at me. I’m just waiting for paydowns and then invest that. I was underweight the lower coupons, but now am flat.

Q: You were focused on pockets of value in CMBS last year. How has this changed?

A: Like RMBS, interest rate risk is the dominant feature. It is much more difficult for CRE loans to be refinanced so existing loans tend to be modified or extended. I did buy short duration CMBS conduit bonds last year, which overall have done well but they’re not paying out as soon as I would like, which would allow me to reinvest at a higher rate and realise yield. It’s the same dynamic as in RMBS.

Q: Tell us a bit more about the short duration CMBS bonds you own?

A: I’m happy with them as they are high quality in terms of collateral. They have low LTV, high debt service coverage ratio and generally high occupancy. They have performed well from that standpoint but I’m just not getting the money back as soon as I would like.

Q: What areas of the CMBS market look better, or worse, than others?

A: All last year I was focused on the retail space as it looked undervalued. But there are problems with refinancing this year, as I’ve alluded to. As long as a bond has good credit support I’m not too worried, but you have to be careful of not stepping into a hole and buying a mall that doesn’t look good at all.

This year I’d be wary of the office building space. There’s negative risk here as people aren’t coming back to work. That needs to change, or the supply needs to adjust downwards, for this to look better, or both.

Q: So it’s a bit of a hold and wait strategy at the beginning of this year then?

A: I’m afraid so. I’m just not seeing anything terribly exciting at the moment!

Simon Boughey

RMBS

Where's the money?

Top agency MBS buyer talks value at the start of 2023

Brendan Doucette is a portfolio manager with GW&K Investment Management, based in Boston, which manages around $5bn in taxable fixed income assets. Of this, some $1.4bn is invested in the agency MBS market.

SCI caught up with him last week to see how he views the market and likely developments at the start of 2023.

Q: Hi Brendan, nice to talk to you again. Where do you see value in agency MBS at the beginning of this new year?

A: Well, last year owning what the Fed didn’t paid off and I expect this will continue. By owning what the Fed did not you have higher coupon pools, meaning they have inherently lower rate and spread duration. So, when rates sold off more than the market expected and MBS spreads blew out due to quantitative tightening, what you owned outperformed the MBS Index and sometimes had positive returns to Treasuries. Nominal spreads are still two standard deviations wide of the longer term mean, so we still see value in agency MBS.

Q: What impact did rate hikes have on the agency MBS market last year, and how will that continue this year?

A: Earlier last year, spreads moved out a long way due to QT and lack of bank demand, but from about the middle of the year became correlated with rate volatility – which was back to pandemic highs. This was volatility induced by the Fed and weighted towards the front end of the curve. Our view is that as the Fed slows rate increases, volatility will fall. Rate vol has already come in quite a long way since October and with it MBS spreads have narrowed. Nominal spreads are about 45bp tighter in the last three months. We expect this to continue in 2023, though as spreads are now at the low end of the range there could be some volatility. But, in the longer term we still like agency MBS.

Q: Which areas of the curve do you think will perform the best?

A: We like the higher, newer production coupons, and we’re still underweight the lower coupons. Some of the 30-year 2% coupons are trading with an $83 handle on them, which obviously looks good because they’re so heavily discounted. But what you’re hoping for there is faster prepayments, and from a fundamental perspective prepays have continued to slow due to the decreased affordability of homes, lower sales and lower refinancings. When bonds are so deeply discounted, spreads can widen significantly when prepayments are lower than markets anticipate.

The Fed owns a lot of paper which securitized mortgages in the 2.5%-3% ranges, when rates were at the lows of the cycle. Since then, rates have touched 7% so there was significant extension in duration and no natural buyers.

Q: There was a rather abrupt shift from QE to QT, rather more abrupt than the market expected I think. Has that been absorbed by the market?

A: Yes, I think it has, and the technical picture is  improving. With mortgage rates now sharply higher, we’re going to have lower refinancing, lower turnover in the housing market, lower origination and less supply. The non-organic supply from the Fed has also slowed. Their monthly cap is $35bn and we’re seeing less than half that at the moment.

Q: How much supply are you expecting to see in 2023?

A: Estimated net supply is $250-$300bn this year. This compares to $450bn last year and $850bn in the previous year, so that is a significant drop off.

Q: There is still the possibility of rate-based volatility this year isn’t there?

A: Yes, very much. There is a dislocation between what the Fed is saying about where rates are going to be and what the market is actually pricing in. There’s not necessarily a difference on what the terminal rate will be, but more on whether the Fed will cut rates later in the year.

Q: Making homes more affordable is clearly a priority of the FHFA, and the GSEs have announced initiatives to help underserved borrowers. Are you worried that a widening of the credit box will hurt credit quality of the collateral?

A: No, not really. Right now home prices are relatively high and mortgage rates are also high so what the GSEs and FHFA are doing isn’t really going to increase affordability. In the future it could, but I’m not expecting much of an impact in 2023. There’s also data which suggests borrowers with a lower credit quality actually have better convexity profiles than someone who could more easily refinance their mortgage, so I’d be more worried about deterioration in the TBA market from higher conforming loan limits than widening the credit box.

What would sound the alarm bells is a significant amount of poor quality loans followed by a disruption of the housing market, turning into delinquency and faster prepayment speeds. As you know, in the agency MBS market we only care about rates, not credit, and that would be our worry. But I think there is more risk from higher conforming mortgages in 2023.

Q: Any other thoughts?

A: I think specified pools will be well supported this year. They’re now included in the MBS Index, which is one factor, but as conforming loan limits were set higher at $726,000 at the end of 2022 - an increase of $79,000 –this makes them more vulnerable to interest rate risk. There might be higher turnover and higher prepayments, so your way round that is to buy specified pools.

Q: How much spread tightening could we see in Q1?

A: Well, it’s difficult to say Simon. We’ve rallied 45bp since October so we’re a bit vulnerable right now. I think the long term mean is perhaps 30bp inside where we are now, but I’m not sure when or if we get there. We’ll see what happens with Fed rates and vol.

Simon Boughey

Structured Finance

Chenavari bolsters continental footprint

Sector developments and company hires

Chenavari bolsters continental footprint

The Chenavari Group has established a French subsidiary – Chenavari Asset Management – approved and regulated by the Autorité des Marchés Financiers (AMF). The move is designed to help develop Chenavari’s standing in France, as well as across continental Europe. The firm has recorded strong growth in this region in recent years across its three investment platforms: tradable credit, private debt and leveraged loans and CLOs.

The Paris office is headed by chairman Stéphane Parlebas - who has been working at Chenavari since 2010 as a senior portfolio manager covering European financials - and general manager Olivier Nolland, who joined the group in March 2022. Currently, there is a team of eight professionals based in the Paris office.

Beyond promoting Chenavari to institutional clients, the French asset management company aims to develop new investment strategies locally. The AMF authorisation covers management of collective investment undertakings through a large number of financial debt instruments and real estate lending activity.

Currently managing over €5bn for its institutional clients, Chenavari has been active in European credit markets for 15 years and has two existing offices located in London and Luxembourg.

In other news…

APAC
International insurance broker, Howden CAP, has appointed new executive director, Christopher Evans, to expand its capabilities in the Asia-Pacific region. Evans joins the firm with more than 20 years of experience in global banking and structured finance, having most recently served as a director in distribution at NAB, maintaining responsibility for procuring credit risk insurance within the corporate and institutional division. With Evans’ arrival, Howden hopes to be able to now offer clients seamless coverage across the APAC and Gulf Cooperation (GCC) regions – hoping to leverage Evans’ experience to help clients better harness the powers of insurance and optimise their exposure management, regulatory capital, and achieve strategic aims.

EMEA

Jacob Walton has joined Sona Asset Management as CLO manager, leading the firm’s efforts to establish a European CLO management platform. He was previously a director in Rothschild & Co’s credit management team, which he joined in August 2011. Before that, Walton worked at Elgin Capital, ABN AMRO/LaSalle and RBS.

North America

Antares Capital has recruited Seth Katzenstein as md, head of broadly syndicated loans, based in New York. He was previously md, head of US loans and high yield at ICG, leading US CLO and liquid credit fund portfolio management at the firm. Before that, Katzenstein worked at Black Diamond Capital Management, GSC Group and Salomon Smith Barney.

Samuel Hu has returned to Chapman and Cutler as senior counsel, based in New York, having been an associate in the firm’s securitisation and banking team between April 2012 and June 2014. He began his career at Orrick Herrington & Sutcliffe and has also worked at VeriClock, Button Finance, PeerIQ, OnDeck, Fundation Group and Morgan Stanley.