News Analysis
Capital Relief Trades
Fee fears
FHFA opens another front in the war on affordability to industry concern
The mortgage and securitization market has reacted with anxiety to the changes to the Loan Level Price Adjustments (LLPAs) announced by the Federal Home Finance Agency (FHFA) at the end of last week.
Essentially, these changes make it less costly for borrowers with lower credit scores to secure a mortgage while and more costly those borrowers with higher credit scores.
Not only, of course, do the changes make it easier for lower credits to borrow money, it lowers the collateral quality of MBS deals – exposure that is likely to find its way into CRT deals.
“It’s LLPA risk transfer, transferring risk from higher risk borrowers to lower risk borrowers,” comments a risk transfer expert.
Under the new fee structure, if a borrower has a FICO score of 659 and wishes to borrow 75% of the property’s value, fees are now 1.5% rather than 2.75%. On a property worth, say $400,000, that is equivalent to a saving of $5000 in closing costs.
However, borrowers with higher FICO scores will end up paying a little more than they did before. A 759 FICO borrower is now looking at charges of 0.375% for at 75% LTV loan.
New credit bands at 720-739 and 740-759 have also been introduced, both of which are faced with higher fees.
The measures, which were foreshadowed by an FHFA announcement last October, will go into effect on May 1. They are part of the FHFA’s well-publicized drive to make home ownership more affordable, particularly in communities deemed “under-served”.
“Once again, it’s more of the core/higher income products (as seen in the added categories of LLPA) getting a lot of the LLPA rises, while affordability products on average are getting reduced/no change to LLPAs,” says a mortgage market analyst familiar with the GSEs.
In announcing the changes, director of the FHFA Sandra Thompson said, “These changes to upfront fees will strengthen the safety and soundness of the Enterprises by enhancing their ability to improve their capital position over time. By locking in the upfront fee eliminations announced last October, FHFA is taking another step to ensure that the Enterprises advance their mission of facilitating equitable and sustainable access to home-ownership.”
Industry lobby groups were less convinced that this is a step in the right direction.
“Fees are raised on some borrowers with good credit scores and moderate down payments, hitting middle-wealth homebuyers,” the National Association of Realtors (NAR) noted in a statement at the end of last week. “In the wake of a three-percentage point increase in mortgage rates, now is not the time to raise fees on homebuyers,” it added.
The Mortgage Bankers Association (MBA) also expressed concern. “With the peak homebuying season coinciding with these changes, FHFA should consider additional program changes to improve affordability, including raising the area median income threshold for the GSEs’ low down payment products,” said Bob Broeksmit, the trade group’s president and CEO.
The MBA urged the FHFA to delay implementation.
Simon Boughey
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News
ABS
Ramping up?
Auto ABS early-stage delinquencies 'vary broadly'
Early-stage delinquency performance across European auto ABS has started to deteriorate as macroeconomic challenges ramp up. However, new research from DBRS Morningstar reveals that while there are deteriorating trends, early-stage delinquencies actually remain higher than historic lows.
Based on an analysis of loan- and lease-level data from the European DataWarehouse’s exposure templates for EU-domiciled transactions and market data, DBRS Morningstar finds that on average year-over-year early-stage delinquencies doubled across European portfolios. Although such change is notable in terms of proportions, the absolute nominal level sits at a low 0.3%.
The rise of macroeconomic pressures in Europe at the start of 2022 marked the beginning of deteriorating trends in early-stage leasing performance, with DBRS Morningstar data showing increasing delinquencies across European countries of 31- to 60-days in arrears. But early-stage delinquencies continue to vary broadly across Europe, with German collateral outperforming other sectors and UK portfolios having weakened.
There also appears to be sensitivities for borrowers with loans with longer-than-average terms – typically offered to student and unemployed borrowers – and especially when financed amounts are considerably high. Concern also lies with the volatility in the data supporting transactions with higher exposures to corporate borrowers, and those which report information quarterly.
DBRS Morningstar also reports a shift in loan and lease profiles amid rising vehicle prices, noting increases in used vehicle mix, further growth of non-captive and non-bank lenders, and continuing product migration to usage from ownership. Increases in used vehicle mix also appear more evident within some non-captive portfolios with risk-based pricing strategies and tend to target obligors with lesser credit profiles.
The rating agency considers a fundamental cause for current trends seen in European auto ABS to be the persistent pressures on households, as the cost-of-living crisis continues to deplete disposable incomes and chip away at pandemic-acquired savings. Ultimately, these pressures leave numerous obligor cohorts with the decision of which debt repayments to prioritise and that is beginning to appear in early-arrears performance reporting.
Further, as a result of the short supply and aftermath of disruptions in global supply chains through the pandemic, auto ABS transactions now have an increased exposure to used vehicle financing – up from representing 40% of vehicles in auto ABS portfolios in 2019 to 45% in 2020 and 2021. This could prove to be a concern as, historically, a mix of originations in respect of used cars within auto ABS pools have performed worse. Negative equity positions could also rise for those who have purchased used vehicles in the last two years, as reductions in used vehicle prices after supply-chain issues and changing customer preferences towards alternatively fuelled vehicles are resolved.
Nevertheless, the comparatively high underwriting standards of European lenders and few high-risk obligors should continue to keep fundamentals strong. DBRS Morningstar concludes that any downstream increase in defaults will likely remain limited to used vehicle financing, longer contract terms, unemployed and student obligors, and higher interest rate contracts.
In the case where actual performance exceeds predicted levels and tranches do not benefit from deleveraging, subordinated notes could be affected. However, marginal changes are unlikely to lead to any credit rating downgrades for senior notes.
Claudia Lewis
News
Structured Finance
SCI Start the Week - 23 January
A review of SCI's latest content
Last week's news and analysis
Different speeds
Legislative advances driving C-PACE momentum
Generating impact
Banco BPM executes project finance SRT
Italian boost
Intesa ramps up CRT issuance
Rabobank returns
Rabobank launches synthetic securitisation
Seeking stability
Jersey Finance discusses international finance centres
Where's the money?
Top agency MBS buyer talks value at the start of 2023
For all of last week’s stories including ‘Market moves’ and ‘Risk transfer round-up’ click here.
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.
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
Talking Point
ABS
Diversification possibilities
Pawel Turek, counsel at DLA Piper, outlines how trade receivables securitisation is an innovative form of alternative financing compared to factoring
In most cases when economic entities need financing, they use traditional methods of obtaining funds. They take out loans, borrowings or issue bonds. But companies that issue invoices and have a very large number of contractors can also consider factoring.
Factoring allows for the sale of receivables before the maturity date and in exchange for an agreed discount to immediately obtain funds without waiting for the invoices to be paid on time. There are, of course, different types of factoring, including full, non-full, advance and so on. However, regardless of its form, it may not always be able to meet all the expectations of the company.
If the company operates in a market with a very dynamic upward trend or is rapidly increasing its portfolio level, it may need a relatively high level of financing. In such a situation, economic entities may consider choosing securitisation of trade receivables (trade receivables securitisation (TRS)) - especially in these demanding times, where diversification of financing sources seems to be necessary.
TRS is a well-recognised method of financing - particularly in the US and Western Europe, but increasingly developing in other parts of Europe - that allows companies to develop much faster than other traditional forms of financing, due to the fact that the analysis of the subject of financing and addressing the risks associated with it are approached in a completely different way. To better understand its mechanism, it is worth comparing it to factoring, whose subject is also trade receivables. Securitisation does not replace factoring, but it provides different possibilities.
The securitisation scheme
In the most simplified securitisation model, three entities are involved in the transaction. The company that sells the receivables (the originator), the SPV that acquires these receivables and issues bonds to raise funds to purchase them, and the investor who purchases these securities.
Compared to factoring, a purpose-made company is involved in the scheme. This is necessary due to the segregation of receivables from the originator. In this situation, the financing entity has the comfort that in a negative scenario – for example, the originator’s bankruptcy - the bankruptcy estate will not include the securitised receivables.
Five differences between securitisation and factoring
First and foremost, the main difference between securitisation and factoring is that through securitisation, illiquid assets (receivables) are converted into liquid assets (securities). Such securities can be purchased by banks, but also by private or public investors. Consequently, the seller has access to capital markets, along with all the benefits associated with it.
Second, in securitisation analysis, the quality and granularity (concentration) of the portfolio is more important than the seller itself. Disclosure to investors can be based on aggregate and average portfolio data; no disclosure of receivables on individual debtors is required, providing the debtor does not exceed a concentration ratio of usually 2%.
Credit risk for the investor is mitigated by applying a discount based on a multiple of actual losses. This multiple is called overcollateralisation. So, on a portfolio of €50m with a 5% loss rate, a multiple of 2x would create an overcollateralisation of 10% or €5m: on the collateral of €50m, €45m is advanced and €5m is overcollateralisation.
Third, in securitisation, for financial institutions, indicators related to portfolio quality are more important than financial indicators directly related to the seller, such as debt/EBITDA. As a result, securitisation may also be available to smaller entities if the analysis of the portfolio and its prospects is positively evaluated.
Fourth, as a rule, securitisation does not interfere with the status of the seller and it does not impose obligations prohibiting further borrowing or prohibiting the sale of assets, other than those that are the subject of securitisation (unless the documentation of other borrowing facilities prohibits the sale or assignment of trade receivables).
Finally, securitisation is a form of financing that is more flexible and adaptable to the specific needs of the portfolio than factoring. For instance, the amount of financing derives from the quality, historical data and prospects of the portfolio, rather than the data of the originator itself, and therefore it may be much larger and more favourable financing than if it were granted in the form of factoring directly to the originator, as long as the collections on the receivables can be effectively separated from the originator’s estate.
What receivables?
It is standard that the parties to the transaction agree on the eligibility criteria for receivables that are to be the subject of the sale in the sales agreement. These criteria determine the receivables that will be the subject of the sale at the time of the transaction and which will be able to be sold later during the transaction, where the SPV will be obliged to purchase them – providing they comply with the financing limit agreed by the parties and other eligibility criteria, like concentration ratios, are met.
Receivables should be generated in the entity’s normal course of business, as a result of the sale of goods or services by the entity. Receivables must be saleable and confirmed by invoices.
There are no strict requirements for payment terms, but in most cases the term should be in line with normal business practices in the jurisdiction. The portfolio should not comprise overdue receivables.
Receivables should not be disputed, but they may be subject to dilution, such as being associated with discounts. Depending on how the risk of diluting the invoice amount has been assessed, investors may expect the creation of a special reserve addressing this risk.
For which entities?
Securitisation of trade receivables is aimed at any entity generating trade receivables. Examples of transactions carried out in recent years include securitisation of receivables of telecom providers, as well as shipping, logistics, chemical, metal and fuel industry companies.
In summary, on the one hand, securitisation is a more complex transaction than factoring and requires significantly more operational effort from the seller. It also requires more engagement and the dedication of more human resources and time. However, on the other hand, it offers opportunities for development that are not possible using traditional financing methods.
Market Moves
Structured Finance
Alternative credit acquisitions hit record AUM
Sector developments and company hires
Alternative credit acquisitions hit record AUM
The AUM of acquired alternative credit managers hit a record US$326bn across 37 transactions in 2022, according to Gapstow Capital Partners figures, with acquisitions of private lending firms accounting for nearly half of this activity (15 acquisitions at US$161bn in target AUM). In comparison, the tally for the prior two years was US$140bn in 2021 and US$150bn in 2020, while 2018 was the previous largest year on record (at US$278bn).
“These levels of activity were well above historical averages and significantly account for 2022 being a record year. Among the acquired private lenders, the biggest increase in activity was in those specialising in corporate lending, which saw eight deals for US$133bn target AUM, as compared to two deals for US$4bn last year and the annual average of US$37bn from 2017 to 2021,” Gapstow notes.
CLO-centric acquisitions also dwarfed the historical average last year. While the number of acquisitions (six) was in line with the historical average, acquired AUM of US$33bn far exceeded the historical average of US$5bn - largely as a result of Carlyle’s acquisition of CBAM (US$15bn), as well as Investcorp’s acquisition of Marble Point (US$8bn) and Owl Rock’s acquisition of Wellfleet (US$7bn).
Overall, the Gapstow analysis shows that the three largest transactions accounted for over 40% of 2022’s target AUM: Guardian Life’s minority purchase of and partnership with HPS (at US$80bn of AUM); Franklin Templeton’s acquisition of Alcentra (US$39bn); and First Eagle’s acquisition of Napier Park (US$19bn).
Meanwhile, minority ownership purchases accounted for about 32% and 25% of deal count and acquired AUM respectively. Gapstow believes this level of acquisition activity should continue in 2023, as alternative credit managers will be under pressure to build scale and scope, with more managers with current minority owners considering new partnerships.
“Growth in demand for alternative credit, while slowing, is still exceptionally strong relative to other asset classes. Both traditional and alternative investment managers believe that gaining and/or building exposure here is a strategic imperative. We predict an increase in acquisitions of firms who currently have minority owners, with the minority owners being bought out in the process,” the firm observes.
Over the last 11 years, it has tracked over 445 minority purchases, with most of the firms considered unlikely to be purchased because the managers had used the proceeds of the sale to address critical strategic issues. “In fact, to date, only four of these 44 firms have been subsequently sold outright. However, to reach their next set of strategic goals, many more will consider a re-sale,” Gapstow suggests.
The Gapstow analysis is based on the firm’s proprietary acquisition database, which begins in 2012 and covers 284 transactions, for which the target firms had over US$1.6trn in AUM.
In other news…
EMEA
Channel Capital Advisors has appointed Bhoomika Kesaria as head of investor relations, responsible for the firm’s fundraising efforts across all products, including its fintech lending strategy. With over 13 years of experience in capital introductions, private debt and structured finance, she joins from Lendable and will report to Channel cio Paul Wilson.
Vedanta Bagchi has joined Revolut as portfolio manager and global head of structured credit, based in London. He was previously director and portfolio manager within Commerzbank’s investment office, having joined the bank as vp - M&A advisory in January 2012. Before that, Bagchi worked at UBS.
Market Moves
Structured Finance
ECON votes on output floor
Sector developments and company hires
ECON votes on output floor
The European Parliament's Committee on Economic and Monetary Affairs (ECON) has voted to apply the capital requirements output floor at the consolidated EU level under CRR3, in order to engender comparable risk weights and avoid variations in capital levels. Additionally, the Committee has agreed transitional adjustments for low-risk exposures secured by residential mortgages to mitigate the negative impact the introduction of the output floor would have, until a wider review of the securitisation framework is undertaken. An extension of the transitional period is possible, but will be no longer than four years.
MEPs agreed that a competent authority should be able to address inappropriate distribution of capital among banking groups and propose a capital redistribution.
The stated aim of these proposed changes under the CRR and CRD is to implement Basel 3, while avoiding “a significant increase in overall capital requirements for the EU banking system”. AFME, for one, has welcomed the ECON Committee’s recognition of the important role securitisation plays in financing of the economy.
The European Parliament has also proposed an interim treatment to apply a 1,250% risk weight to crypto assets until 31 December 2024. However, AFME notes that there is no definition of crypto assets in the CRR and therefore the requirement may apply to tokenised securities, as well as the non-traditional crypto assets the interim treatment is targeted at.
“The scope of application should be clarified in the trilogue process to ensure a faithful implementation of the finalised Basel standard to avoid any unintended impact on securities markets during the interim period,” the association comments.
Separately, taking into account the EU’s objective to achieve carbon neutrality by 2050 and the relevant sustainability goals, MEPs agreed to strengthen reporting and disclosure requirements for ESG risk. The CRD makes it compulsory for banks to adopt transitional plans to address ESG risks in the short, medium and long term.
In other news…
EMEA
Marialaura Aymerich has joined MUFG as director, structured finance syndicate. She was previously head of loan sales at SEB, which she joined in January 2003. Before that, Aymerich worked at Bankgesellschaft Berlin and Banca Commerciale Italiana.
North America
Investcorp has appointed Suhail Shaikh as co-head of its private credit business, alongside existing co-head Mike Mauer. Based in New York, Shaikh brings with him approximately US$200m of assets under management and three team members from his previous firm Alcentra, expanding the private credit team to 14 professionals and team-managed assets to approximately US$500m. He replaces Chris Jansen, who will take on an advisory role and retire later this year after ensuring a smooth transition.
Shaikh has over a decade of private credit investment experience and previously led Alcentra’s US private credit business. Prior to that, he worked at SLR Capital Partners, Bank of America, CIBC and JPMorgan.
Market Moves
Structured Finance
Panagram CLO ETF debuts
Sector developments and company hires
Panagram CLO ETF debuts
Panagram Structured Asset Management has launched its first ETF - the Panagram BBB-B CLO ETF (CLOZ). The portfolio will primarily comprise triple-B and double-B rated CLO bonds and is expected to pay a monthly dividend.
The firm says its goal is to provide investors with a liquid alternative to traditional fixed income, with attractive structural features and competitive yield. "The historical outperformance of CLO tranches versus other corporates led us to create this innovative floating-rate product for the retail investor,” comments John Kim, ceo of Panagram and portfolio manager of CLOZ.
CLOZ is listed on the NYSE and has an expense ratio of 0.50%.
In other news…
North America
Comvest Partners has recruited Charles Asfour as a partner, based in the firm’s Chicago office. Asfour assumes a key leadership role within the Comvest special opportunities investment platform, where he serves on the strategy’s investment committee and is responsible for originating, structuring and managing special opportunities investments.
Prior to joining Comvest, Asfour founded Aves Capital Management, a Chicago-based manager of special situation-oriented structured capital investments and funds. Before that, he spent nearly a decade at Victory Park Capital Advisors and has also worked at Code Hennessy & Simmons and JPMorgan.
Market Moves
Structured Finance
ABS conflicts of interest eyed
Sector developments and company hires
ABS conflicts of interest eyed
The US SEC has proposed a rule intended to address conflicts of interests in the securitisation market. Specifically, the rule would prohibit securitisation participants from engaging in certain transactions that could incentivise a securitisation participant to structure an ABS in a way that would put the securitisation participant's interests ahead of those of ABS investors. The rule would implement Section 27B of the Securities Act of 1933, a provision added by Section 621 of the Dodd-Frank Act, which the Commission originally proposed in September 2011.
If adopted, the new Securities Act Rule 192 would prohibit an underwriter, placement agent, initial purchaser or sponsor of an ABS - including affiliates or subsidiaries of those entities - from engaging in any transaction that would involve or result in any material conflict of interest between the securitisation participant and an investor in the ABS. Under the proposed rule, such transactions would be ‘conflicted transactions’. They include, for example, a short sale of the ABS or the purchase of a credit derivative that entitles the securitisation participant to receive payments upon the occurrence of specified credit events in respect of the ABS.
The prohibition on conflicted transactions would commence on the date on which a person has reached an agreement to become a securitisation participant with respect to an ABS, and it would end one year after the date of the first closing of the sale of the ABS. The proposed rule would provide certain exceptions for risk-mitigating hedging activities, bona fide market-making activities and certain commitments by a securitisation participant to provide liquidity for an ABS. The proposed exceptions would focus on distinguishing the characteristics of such activities from speculative trading and would also seek to avoid disrupting current liquidity commitment, market-making and balance sheet management activities.
A public comment period is open for 60 days following publication of the proposing release.
In other news…
API collaboration inked
Howden CAP and AXA XL in the UK have collaborated on a structured credit API, representing Howden CAP’s third API collaboration with an underwriting partner in the last 12 months. It follows Howden CAP’s successful integrations with Mosaic and Allianz Trade, as the firm seeks to create the world’s first comprehensive API network for any specialty insurance product in the market.
The development reflects Howden CAP and AXA XL’s commitment to utilise digital platforms to enhance efficiency and market integration, and to provide seamless insurance solutions for institutional clients. By collaborating with underwriters, Howden CAP clients and their broking teams can obtain offers and execute business, delivering a data-driven method of trading and placement of insurance.
BVAL disclosure charges settled
Bloomberg Finance has settled charges brought by the US SEC for misleading disclosures relating to its fixed income valuations service, BVAL. The SEC’s order finds that from at least 2016 through October 2022, Bloomberg failed to disclose to its BVAL customers that the valuations for certain fixed income securities could be based on a single data input, such as a broker quote, which did not adhere to methodologies it had previously disclosed. The order finds that Bloomberg was aware that its customers may utilise BVAL prices to determine fund asset valuations and that BVAL prices therefore can have an impact on the price at which securities are offered or traded.
The SEC’s order finds that Bloomberg violated section 17(a)(2) of the Securities Act. Without admitting or denying the findings, Bloomberg agreed to cease and desist from future violations and to pay a US$5m penalty. The SEC’s order notes that Bloomberg voluntarily engaged in remedial efforts to make improvements to its BVAL line of business.
NPA ABS framework mooted
The Reserve Bank of India has released a discussion paper on the introduction of a framework for the securitisation of stressed assets (SSAF), in addition to the existing asset reconstruction company (ARC) route. While the country’s Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) provides for securitisation of non-performing assets (NPAs), such transactions have to be undertaken by ARCs licensed under the Act. Based on market feedback and stakeholder consultations, RBI is seeking to enable securitisation of NPAs through the existing special purpose entity route.
The discussion paper broadly covers nine relevant areas of the framework, including asset universe, asset eligibility, minimum risk retention, regulatory framework for SPEs and resolution managers, access to finance for resolution managers, capital treatment, due diligence, credit enhancement and valuation. It draws upon similar frameworks introduced in other jurisdictions, while trying to keep it structurally aligned with the framework for securitisation of standard assets in India.
The RBI is seeking comments on the discussion paper by 28 February.
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