News Analysis
Structured Finance
The affordability conundrum
Impact of alternative credit scores explored
The GSEs are under considerable political pressure to extend credit to the underserved. But what does this mean for CRT investors, issuers and rating agencies? This Premium Content article investigates.
In October of last year, Sandra Thompson, director of the FHFA, unveiled potentially far-reaching policy changes with the aim of making US homes more affordable. All involve a radical reordering of how creditworthiness of potential borrowers is assessed.
Under the changes, the FICO 10T and VantageScore 4.0 scoring systems replace classic FICO, both of which Thompson said at the time are not only “more accurate” than classic FICO, but also “more inclusive.” In addition, she announced that henceforth mortgage originators would require two credit reports from national consumer reporting agencies, such as Experian and Equifax, rather than three.
Finally, upfront fees - or loan level price adjustments (LLPAs) in certain categories of loans, for which the credit threshold is lower - will be abolished. To compensate for the loss of income, upfront fees for cash-out refinance loans were increased.
The categories of borrowers for whom fees would no longer be applied include Housing Finance Agency (HFA) Advantage and Preferred loans, as well as first-time borrowers at or below 100% of the area median income (AMI) or below 120% AMI in high-cost areas.
The fee elimination will benefit “borrowers with limited income, borrowers with limited resources for down payments and borrowers in underserved communities,” Thompson stated.
Fee changes were further amplified on 19 January, when, in essence, LLPAs were decreased for low credit borrowers and increased for better credit borrowers. The industry has not responded with unalloyed enthusiasm (SCI 26 January).
The GSEs have announced changes to their underwriting processes to align with the FHFA’s priorities. Fannie Mae further unveiled “innovative enhancements” to “simplify the borrowing process for loans where homebuyers do not have a credit score”, adding that “millions of people in the US are credit invisible, with Black and Latino/Hispanic people disproportionately represented.”
As such, Fannie Mae’s automated underwriting mechanism Desktop Underwriter would update its eligibility criteria for borrowers without any credit score. Other forms of assessment will be used, such as an evaluation of a monthly cashflow over a 12-month period using bank statements.
One issue that these new measures have precipitated is accurate assessment from credit rating agencies, whose methodologies for rating MBS are centered around traditional FICO scores. “The issue that the industry is running into is that our models are based on the classic FICO, which is also what prior GSE data is based on. So now we’re introduced to these new FICO scores and we need to find a new mapping system that says, for example, ‘Vantage score X equates to FICO score Y.’ No one in the industry has come out and said ‘This is the mapping,’” says Susan Hosterman, senior analyst in North American RMBS at Fitch in New York.
There appears to be no straightforward way to establish an equivalence between one method of credit scoring and traditional FICOs. “We have looked into this, but there is not a simple method of mapping between FICO and other scoring methodologies. It’s a completely new scoring set. You can’t just say that 700 Vantage is equal to 750 FICO,” says another analyst.
Fitch has asked originators that want to use non-classic FICO scores to provide data for both non-classic FICO and FICO, says Hosterman. The differences are alarming.
“We’re seeing differences of up to 200 points between classic FICO and non-classic FICO,” she says.
Calculating a blended credit score between numbers as divergent as this raises a whole new vista for the MBS industry. The agencies have their work cut out, as indeed do investors.
Beyond the technical difficulties of credit assessment is the elephant in the room: by widening - or at least - redefining the credit box, could US regulators be courting the same type of financial hurricane seen in 2008/2009? Through the National Homeownership Strategy of 1994, the Bill Clinton administration took more than 100 executive orders to relax bank lending and also enlisted federal agencies to enforce new underwriting guidelines to help low-income borrowers. In this context, Fannie Mae and Freddie Mac were enjoined to double the underwriting quota of ‘affordable loans’.
Products designed to help borrowers have always featured in the GSEs’ books and from Q3 onwards last year have made a resurgence. This includes such products as 40-year loans when years 10 to 20 are interest rate only (IO), 30-year loans with a 10-year IO period and short-term adjustable-rate mortgages (ARMs) with balloon payments at the end.
“Our losses on these products are significantly higher than they were before and during the financial crisis. For example, for a 30-year IO, the losses are 1.15 times higher than for our basic 30-year mortgage; for a 40-year IO, the losses are 1.5 times higher and for a short-term ARM, the losses have increased by around two times,” says Hosterman.
The MBS market has, of course, changed a lot since the pre-financial crisis days. Underwriting standards and due diligence are markedly better and more rigorous, stress sources.
The market has changed in another key respect, with the emergence of credit risk transfer products. For the last almost 10 years, Fannie Mae has issued CAS transactions and Freddie Mac has issued STACR transactions, alongside reinsurance products - the express purpose of which has been to cover the GSEs from losses they may incur on triple-A rated government-backed TBA issuance.
This market has been remarkably successful. When Fannie Mae’s CAS 2023-R01 was priced in the second week of January, it represented the fifty-fourth deal of this kind, with total volume of US$59bn and total risk transfer of US$1.98bn.
There is seemingly some incentive for the GSEs to push loans acquired with the new underwriting standards into the CRT market or risk a repeat of 2008 and a government bailout. No losses have ever occurred to CAS or STACR bonds, but could the new underwriting standards poison the well?
In its credit report on CAS 2023-R01, for instance, KBRA notes that the borrowers had a weighted average (WA) credit score of 747, a WA debt to income ratio of 36.3% and a WA loan to value of 74.4%. “I do think CRTs are very credit levered, particularly comparing them to other triple-A RMBS without government guarantees. There are few credit enhancements and adding in potentially risky collateral is going to be of concern to investors. The credit enhancement in these deals is so low that it doesn’t take a high percentage of loans to create a problem,” says a credit analyst.
Roelof Slump, md and senior RMBS analyst at Fitch, agrees: “The CRT market is highly sensitive. There could be a major impact felt depending on the magnitude of inclusion of this.”
So, how might investors react? “The CRT market should refuse to accept paper with these loans in them and they should require the agencies to keep them on-balance sheet and require taxpayers to observe them. I bet most investors express a similar view to me off-the-record,” says one investor.
It is, as everyone concedes, a very politicised topic. At the very least, pricing in the CRT market should provide a clear signal to the GSEs whether CRT trades incorporating these types of credits are economically viable.
The changes to the fee structure that the FHFA announced in October are likely to drive a greater proportion of low FICO credits away from the FHA and towards the GSEs. In the past, as the GSEs charged fees for these categories of borrowers - which were included in monthly mortgage payments - they would invariably choose FHA loans. This was positive for GSE loan quality, but the incentive to take an FHA loan has been reduced.
“The pricing dynamic that drove the weakest credits to FHA loans and away from GSE loans is changing as result of recent FHFA actions. The GSEs will be more competitive for lower FICO borrowers, but less competitive for higher DTI. What this means to portfolio credit quality is uncertain,” says Tim Armstrong, an md for mortgages and structured credit at Guy Carpenter.
There are caveats to be made, however. When the impact of the changes take effect is at some point in the future. The most recently issued CAS 2023-R01 securitised loans that were put on in January and February of last year, so it will likely be at least a year until any impacts manifest themselves.
Nor is it clear how much and how many of these new loans will actually be originated. It could be that they will represent a small portion of loans that the GSEs buy.
The GSEs have always been mandated to increase affordability and currently CRT transactions include a small amount of loans without FICO scores, but they are too few to have any bearing on the overall performance of a bond. A credit analyst points out that the recently issued CAS 2023-R01 contained 21 loans without FICO scores, but this was only 21 out of 67,000 loans in the reference portfolio – a small enough sample to register as a data error.
“The GSES have always allowed underwriting to borrowers who don’t have FICO scores or when no FICO scores are provided and in those we make assumptions. But it is a very small proportion and doesn’t move the needle much,” he says.
Freddie Mac has also begun retaining the bottom 200bp of CRT deals, rather than 25bp as in the past. This move is solely related to the affordability of CRT transactions to the issuer rather than to increase affordability, but it does have the effect of creating an extra layer of buffering between CRT buyers and troubled loans.
There is also another wrinkle to be considered. As a result of the November 2022 elections, there have been changes to the leadership and composition of committees in the House of Representatives and the GOP is now in the driving seat.
The new chairman of the House Committee on Financial Services is Patrick McHenry, Republican Representative for the tenth district of North Carolina, while the Sub-Committee for Housing and Insurance - which oversees the FHFA - is headed by Warren Davidson for the eighth district of Ohio.
So far, neither have said anything about the GSEs and in his initial comments upon taking up his new role, McHenry safely covered all the bases, saying that the mandate was to increase economic prosperity for all Americans: “Whether that is increasing opportunities for all investors, expanding access to innovative financial products, or ensuring the safety and soundness of our financial system…”
However, some sources suspect that the safety and soundness aspect of the governance of the GSEs will loom rather larger than affordability to the new personnel.
Others wonder if the GSEs are currently making all the right noises about extending a hand to less creditworthy borrowers, but in the end what they actually do won’t make much difference to the credit profile of their debt. “We are seeing a lot of headlines, but we haven’t seen an impact on portfolio credit quality,” says Armstrong.
Slump suggests that the material inclusion of this type of debt in a CRT deal is many months away. “If it is going to happen, we need to think about these things more deeply, what concentration it represents, what our comfort level is and how we calculate default risk. We may need to come up with something new,” he says.
He adds that the GSEs are such a big and influential part of the market that these practices may slip into the non-agency space. “Because of the size and dominance of the GSEs, as they take a certain position, it becomes an industry fact that the non-agency market decides to adopt or not, depending on if they see an opportunity.”
If it is to become a bigger part of CRT debt, then it might appeal to impact funds, which have a mandate to invest in assets that align with ESG priorities. Whether they will earn a decent enough return alongside social objectives remains to be seen.
Other close watchers of the CRT space also speculate whether this new generation of products will achieve the desired result, as it will increase demand for mortgages and thus elevate prices. “This is the wrong solution. The solution to affordability is to lower prices, not credit. And it is the worst time to do it,” one source concludes.
Simon Boughey
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News Analysis
Structured Finance
Growing pains?
Blockchain, digitisation addressing securitisation inefficiencies
Blockchain and digitisation are increasingly being incorporated into the securitisation process. This Premium Content article explores the benefits and challenges that these new technologies represent.
Blockchain and digitisation are increasingly being incorporated into the securitisation process, with the aim of facilitating market efficiency. It is hoped that these new technologies will also help overcome some of the issues highlighted by the financial crisis and address new ones potentially still to come.
Traditional methods of conducting transactions are reliant on outdated technologies - such as email, excel and standard telephone calls – which throw up several challenges throughout the securitisation process. On top of this, the US CLO market, for instance, has more than doubled in size since the financial crisis and such growth demands either larger teams of people to conduct existing structures of business or fundamental changes in workflows to improve inefficiencies.
Octaura’s digital CLO trading platform, for one, seeks to enhance the workflows of existing trading platforms (SCI 14 June 2022). A principal aim of the platform is to reduce the BWIC auction process to 10-15 minutes by eliminating the telephone relay and providing users with integrated abilities to offer and receive instant feedback on a transaction.
Blockchain technology is also being adopted to address inefficiencies in the securitisation market. John Pellew, principal of distribution and securitisation at Arrow Global, argues that the use of digital technologies - including blockchain - can be a fundamental tool for addressing issues brought to light in 2008-2009.
“I would argue that difficult times like we saw in the financial crisis are actually the driver of changes like this and the introduction of new technologies like this too. Alongside this current blockchain movement, we are also seeing another potential economic crisis and while it’s not for the same reasons as seen in 2008-2009, it could have the same impact on the macro environment,” he says.
He continues: “When considering buying securitisations - or any other products that involve pools of underlying assets – you want to be sure that what you’re buying is what you expect. Blockchain definitely gives you the ability to look into the data and be able to rely on the fact that data has not been manipulated once it has been put into the system.”
The integration of data analytics is key for most digitisation strategies, as it helps to address matters of transparency and efficiency. Brightvine and Liquid Mortgage are examples of fintechs working to bring those benefits to securitisations through the use of blockchain – in their case, beginning with the mortgage space.
“We are currently focused on data and compliance – so we create underlying digital assets for every single loan we onboard,” explains Ian Ferreira, Liquid Mortgage’s founder and ceo.
At present, investors typically wait 55 days for loan-level reporting to be released for a given month, to check whether a borrower makes a payment. However, Liquid Mortgage can offer investors insight into payments on a daily basis, so investors can make more informed decisions.
By onboarding single loans and creating a digital asset replica that sits on the blockchain, contributors can add data and documentation to the asset while maintaining anonymity for the borrower, property and loan attributes. Further, Liquid Mortgage ingests servicer data on a daily basis and then replicates any payments from the previous day on-chain.
Ferreira states: “When you ingest information from multiple sources, all of the data is structured differently. What we are doing by putting it on the blockchain is creating structured data – meaning we, or other companies, can come in and build AI/ML or other analytical tools that sit on top of the blockchain.”
Thus far, Liquid Mortgage has been involved in eight different securitisations, six of which were prime jumbo and the other two single-family rental. “Because we are written into the securitisation itself as distributed ledger agent, we create all of the digital assets and capture payment data on the loan level, then report that information directly to investors on a daily basis,” comments Ferreira.
The firm perceives its role in the market as an intermediary between the ‘real’ world and the blockchain universe. “We post information on-chain and we also pull that information off of the blockchain for reporting purposes, so we really see ourselves as that intermediary where a traditional bank or asset manager doesn’t want to have to deal with direct interaction,” Ferreira adds.
Meanwhile, Brightvine perceives itself as an instigator for fundamental structural changes. “It is going to take some time to get the entire traditional financial industry to move on to the blockchain, and anyone who is in this space is going to experience that whenever they are innovating. I think the main challenge right now is that we are dealing with the convergence of traditional finance with blockchain and distributed ledger technology – so there is just this inertia,” says Joe Vellanikaran, ceo and founder of Brightvine.
Infrastructure is high on the list in terms of what the securitisation market needs, in order to support further digitisation. “In our industry, a lot of companies are focused on the origination side and not focused enough on post-close infrastructure. And that is the piece that is really broken and needs to be fixed,” Ferreira observes.
Pellew agrees that there are many moving parts within the blockchain ecosystem. “A lot of it has to do with regulatory aspects,” he explains. “But other parts of it have to do with the ecosystem and whether your counterparties are ready to deal with the complexities of holding digital assets.”
He argues that the primary challenge facing the blockchain space remains the issue of interoperability. “The reality is that there are thousands of blockchains and thousands of permutations of blockchains, and at some point you have to accept that the ecosystem will not make a singular technology choice. From my experience, this misunderstanding is one of the biggest barriers I’ve encountered in the market – and is the thing stopping people from investing in blockchain. As a business, we should essentially be able to do a transaction into an interoperability network layer that would be able to connect to anybody that wants to do business with us, and we should be able to deliver our own digital assets, data, cash, origination across the network from anyone to anyone, and from anywhere to anywhere.”
Another issue is resistance from both regulators and issuers. On the regulatory side, Ferreira suggests that it is not a question of regulators’ openness to learning more, but rather the lack of regulatory clarity that exists for the blockchain market at present.
He explains: “There is a hesitation from firms right now who are waiting for clarity from regulators on how digital assets should be treated. For example, are digital assets securities if they are backed by loans? Or if you fractionalise a loan-backed digital asset, does that mean you are creating a security? The large banks we have spoken with are open to tests and pilots right now, but full integration requires further clarity.”
Meanwhile, some issuers believe they don’t need to provide transparency, as bond investors currently don’t require it. “Our theory is that once you get a critical mass of investors asking for the data or for processes to work a certain way, then everybody will be more open to change,” Ferreira says.
Looking ahead, Liquid Mortgage is focused on onboarding loans earlier in their lifecycle - whether at origination, warehouse financing or diligence. “We have structured the business model to reduce risk from boom-and-bust origination cycles and to focus on solving problems at any point during the lifecycle of the loan,” explains Ferreira. “We are having conversations with both new origination channels and firms invested in non-performing loans and reperforming loans because we can provide solutions to both.”
He continues: “We believe a key point in the loan lifecycle sits with warehouse providers and therefore have focused conversations on these institutions to onboard loans at the point of financing. While warehouse providers play a key role in the non-agency market, our current focus, we believe this is also a way for us to move our technology into the agencies.”
Vellanikaran is optimistic about growth in the use of blockchain in the structured finance market in the future. “I think everyone in structured finance is now aware of all the benefits of blockchain, so I think you’re going to see over the next few years a movement with large institutions using blockchain systems that allows for the sharing of information like what we do at Brightvine. Our goal is to continue working with Angel Oak and other large issuers to put tokenised assets on Brightvine and work with getting all the stakeholders involved in the structured finance market to be using our platform,” he concludes.
Claudia Lewis
News
Structured Finance
Time to shine
Multi-sector structured credit 'top performer'
Gapstow Capital Partners’ composite credit hedge fund index last year posted its lowest annual return – having declined by 3.9% - since its inception in 2009, with no peer group within the index producing a positive average return. Nevertheless, the multi-sector structured credit peer group - the funds of which invest across CLOs, MBS and ABS - was the top performing strategy of the year.
Rapidly rising interest rates, widening spreads and technical headwinds resulted in weak performance among alternative credit strategies in 2022. However, the structured credit peer groups within the Gapstow Alternative Credit Index (GACI) generally performed in line with their respective indices, showing a decline of 3.5% overall.
The MBS peer group, for example, declined by 1.9% - in line with -2.6% for a 50/50 blend of GSE credit risk transfer securities and legacy non-agency RMBS, although the peer group’s underlying funds ranged from +8% to -17%. The corporate structured credit peer group (which returned -7.6%) lagged the CLO B Debt index (-6.4%), although Gapstow notes that the peer group consists primarily of funds that focus on CLO equity and the Flat Rock CLO Equity index was down by 11.7% through 30 September. Meanwhile, the multi-sector structured credit peer group outperformed both the MBS and corporate structured credit peer groups with a -1.3% return, albeit the range of returns was +6% to -15%.
Gapstow attributes such outperformance primarily to the higher proportion of relative value and/or short strategies within the multi-sector peer group, given that the other two peer groups tend to be more long-biased.
Notably, the GACI public fund composite - which reflects the performance of listed BDCs, mortgage REITs and credit-centric closed-end funds - declined by an eye-watering 23.3%, as portfolio performance was compounded by diminishing prices per share. Such underperformance begs the question of whether public funds trading at well below book value indicates over-selling or whether it portends future credit deterioration, especially in private loans.
“Personally, while I think private funds are slower to mark down than you may otherwise believe, it’s difficult to understand why the public funds trade well below book value. There may have been a bit of credit deterioration, but not to an extent that justifies a 10%-20% discount to book value,” suggests Chris Acito, Gapstow ceo.
Looking ahead, he says the alternative credit market continues to face both fundamental and technical challenges. “For the managers that work in this community, it is their time to shine. Trading will become increasingly more important as opportunities emerge.”
GACI comprises 12 peer groups and three aggregate sector-level sub-indices - corporate credit, structured credit and multi-strategy credit. Compared to the -3.9% and -3.5% returns posted in 2022, GACI and the structured credit sub-index respectively posted 12.6% and 14.3% returns in 2021.
Corinne Smith
News
Capital Relief Trades
Expanding east
Raiffeisen grows CEE foothold
Raiffeisen has boosted its foothold in Central and South Eastern Europe with three new synthetic securitisations as the pickup in the region continues following the opening of the Polish market last year (SCI 6 January)
The first transaction, dubbed Roof Hungary 2022, is an unfunded mezzanine guarantee with a 12% thickness that references a €570m Hungarian residential mortgage portfolio.
The capital relief trade was priced in the single digits and amortizes on a pro-rata basis-with triggers to sequential-over a five-year weighted average life. The deal features a time call that can be exercised after the WAL and the 24-month replenishment period.
The tranche is somewhat thick for residential mortgages but that was because the structuring considered legacy data and the implications that this would have for model risk.
The deal is another example of how insurers can help open the private market in the CEE region. However, ‘’for less granular pools insurers would prefer higher attachment points and the participation of a first loss investor below them. Yet this isn’t applicable to all’’ says Oliver Furst, head of active credit portfolio management at Raiffeisen.
The second trade, dubbed Roof Croatia 2022, is a €25.6m unfunded mezzanine guarantee with the European Bank for Reconstruction and Development (EBRD). The €367m portfolio consists of Croatian Corporate and SME loans and features a 2.2 year weighted average life and an 18-month replenishment period.
The third transaction is a Romanian SRT with the European Investment Fund (SCI 3 January). The securitisation references a RON1.52bn portfolio of non-retail loans and comprises senior, mezzanine, and junior tranches.
Looking forward, Furst concludes: ‘’All three transactions combined allowed us to release a total of €500m of RWAs at the local level and thus provide additional headroom for lending going forward. We don’t have plans to add new jurisdictions but are considering additional transactions in these three countries with corporate and SME loans as well as commercial real estate.’’
Stelios Papadopoulos
News
Capital Relief Trades
Default boost
Corporate defaults rise in 2022
Global corporate defaults increased by 15% last year compared to 2021 levels. However, the deterioration in credit conditions is starting from a high base, given that corporates built financial buffers after the pandemic, which is why the increase in the proportion of negative rating outlooks has been modest.
According to the latest research from S&P, the US led defaults in December, but the region’s year end tally was at its lowest since 2014. Meanwhile, defaults in Europe were more than 20% above 2021 levels.
'’We believe the U.S. speculative-grade corporate default rate could reach 3.75% by September 2023, while the European corporate speculative-grade default rate could reach 3.25% in the same period’’ says S&P.
Consumer products, home builders and real estate sectors together accounted for nearly one-third of defaults in 2022, compared with just over 25% of total defaults in 2021.
S&P notes: ‘’defaults from consumer-driven sectors are expected to continue in 2023, given the high number of weakest links--issuers rated 'B-' and below with either a negative outlook or CreditWatch placement--as consumers' budget-conscious behaviour, price inflation, and supply chain constraints are affecting some lower rated issuers in the sector. For the homebuilder and real estate sector, all defaults have been from Asia-Pacific based issuers driven by persistent issues affecting China's property developers.’’
Distressed exchanges led in December with five defaults and in 2022 comprised 45% of total defaults. Distressed exchanges have become more prevalent last year as distressed companies used them to restructure out of court and negotiate directly with investors to address liquidity or solvency needs. S&P expects this trend to continue into 2023, as economies slow, financing conditions tighten, and speculative-grade credit quality deteriorates.
However, according to Fitch, the deterioration in credit conditions is starting from a high base, given that corporates built financial buffers after the pandemic. The latter applies, in particular, to European corporates-the bulk of the CRT market-and explains why the increase in the proportion of negative rating outlooks has been modest at around 15% as of the end of 2022.
Credit profiles of European corporates could be affected by a combination of waning demand, increasing input costs and higher interest rates, compounded by sustained, albeit moderating, supply-chain issues, and major uncertainty around macroeconomic developments in 2023. Energy-intensive sectors and industries exposed to discretionary spending are most vulnerable to these factors.
Yet again, Fitch qualifies that ‘’corporate issuers have increased financial headroom in recent years and are in a better position to face these challenges in 2023.’’
Additionally, ‘’high inflation is putting pressure on profitability, although the impact on cash generation from increasing costs can be partly offset by cost pass-through mechanisms and the ability to flex capex and restrain dividend payments’’ concludes Fitch.
Stelios Papadopoulos
News
Capital Relief Trades
CRT expansion continues
BBVA taps private market again
BBVA and PGGM have finalized a synthetic securitisation that references a €2bn portfolio of Spanish, European, US and APAC Corporate loans. The synthetic ABS is the bank’s second ever with a private investor as it continues to test waters in the private market.
The transaction allows the Spanish lender to free up to 80% of the portfolio’s capital and it complies with EU STS criteria. Although the bank transfers a significant portion of the credit risk of the loan portfolio to the investor, there’s a percentage of the portfolio that has been retained by the lender.
The significant risk transfer trade follows the execution of a project finance SRT early last year with PGGM (see SCI’s capital relief trades database).
BBVA has traditionally tapped the European Investment Fund for its synthetic ABS trades but last year’s project finance deal with PGGM marked the first with a private investor.
Last year proved to be a stellar one for PGGM with the closing of transactions in Germany, Poland, APAC, the Nordics, and France. One reason for this was the ability of the Dutch investor to be more aggressive on pricing as evidenced for example from BNP Paribas’s latest Resonance nine transaction (SCI 10 January).
Indeed, PGGM was able to offer single digit pricing for the mezzanine tranche even though such pricing has become increasingly rare for mezzanine deals and the pricing barely budged from Resonance seven despite the widening that was observed for most deals.
Stelios Papadopoulos
News
CMBS
Mind the gap
Euro CRE refinancing risk gauged
European commercial real estate borrowers currently face a tripartite risk of tightening credit standards, rising debt costs and pressure on property values. Against this backdrop, new AEW research suggests that the debt funding gap (DFG) for the sector grew to €51bn in 4Q22 from €32bn the previous quarter.
AEW measures the DFG as the shortfall between the original amount of secured debt originated in 2018-2020 and the amount available for refinance at loan maturity in the next three years across all CRE sectors in France, Germany and the UK. The research shows that Germany accounts for 45% of the DFG, while the UK accounts for 33% and France 22%.
The widening of the DFG is driven by a combination of capital value decreases that have resulted in higher LTVs and higher interest rates pushing down ICRs. All-in interest rates doubled in 2022, reaching 6.3% for the UK and 4% for Europe by year-end. At the same time, ICRs for legacy loans due to refinance in 2023 halved to 1.6 from their 10-year average of 3.25 across all sectors.
Against this backdrop, Scope notes that almost 20% of the loans securitised in European CMBS maturing this year and next face very high refinancing risk, as their expected cashflows are too low to meet higher anticipated requirements from lenders. Another 14% face high risk if swap rates rise by another 100bp.
Of these securitised loans, 20 mature in 2023 and 18 in 2024. Of those falling due this year, around 7% denominated in euros have debt yields less than Scope’s estimated refinancing rate. The estimated refinancing rate is the relevant five-year swap rate, plus the actual loan margins, topped up by 50bp to reflect ongoing debt repricing.
The situation is more severe in sterling because interest rates have risen faster: as many as one-third of sterling-denominated loans maturing in 2023 fall into the very high risk category. For loans maturing in 2024, 18% of euro-denominated loans and 43% of sterling-denominated loans are heavily exposed to refinancing failure.
In aggregate, as much as 33% of all loans in CMBS (representing €500m and £1.1bn of senior real estate debt) maturing in 2023 and 2024 are facing very high to high refinancing risk if interest rates rise by up to 100bp. In total, just over €2bn of CMBS debt falls due this year and a little under €2bn in 2024, accounting for around half of all outstanding euro-denominated CMBS debt of €7.9bn. In sterling, £978m matures this year and £1.8bn in 2024, accounting for more than a third of the £8bn outstanding.
Nevertheless, financings with weak covenants still appear healthy and are not triggering forced deleveraging, given that most borrowers are not yet in breach of LTV or interest-coverage covenants based on the latest valuations and low interest-rate cap. Scope points out that most property valuations are holding up for now, due to time lags in revaluation and anchor value bias. However, the rating agency expects valuations to gradually adjust as the anchor value bias weakens, with more borrowers failing to refinance and being forced into fire sales.
“Borrowers are generally in wait-and-see mode or are seeking loan extensions, hoping in the meantime that the dust settles before they are forced into the less attractive alternatives of injecting fresh equity or considering asset sales into a weak market,” it suggests.
AEW argues that bridging the widened DFG and reaching sustainable LTV and ICR levels will require more than the usual maturity extensions, covenant waivers, cash traps and partial restructuring of existing loans before they can be refinanced. While the legal and organisational infrastructure to deal with these challenges has improved in the aftermath of the financial crisis, the luxury of lower interest rates and other fiscal responses are unavailable in the current circumstances, the firm adds.
“Lenders and borrowers will need to adopt a far more proactive approach as the market is faced with a different set of challenges than during the GFC in respect to inflation, higher interest rates and new regulations. The regulatory requirement for banks to hedge loans could be the trigger the market needs to bridge the mounting bid-ask spread in the current downcycle. This is likely to force a quicker work-out of upcoming loan maturities compared to the GFC, since extending maturing loans without fixing the rate at higher swap rates is unlikely to be an option this time around,” concludes Hans Vrensen, head of research and strategy at AEW.
Corinne Smith
The Structured Credit Interview
Structured Finance
Book building
Peter Polanskyj, senior md and head of structured credit at Obra Capital, answers SCI's questions
Q: Vida Capital recently rebranded to Obra Capital (SCI 16 December 2022). Could you explain why this signifies an important milestone for the firm?
A: Rebranding was a natural step for the firm. Vida – which means ‘life’ in Spanish - was historically a life settlements investment firm. However, the firm is now focusing on diversifying its investment mandate, so it made sense to reflect that in its name. Obra translates as ‘construction’ or ‘work’ and we are working hard to build a further diversified firm and to putting focus on new (for us) parts of the market that themselves require hard work to be successful.
Q: What are the drivers behind the firm’s expansion into structured credit strategies (SCI 6 April 2022)?
A: Our approach to life settlements involves both quantitative and qualitative aspects, including the origination and servicing of assets ourselves. We hope to bring this approach to other spaces as well. Given our experience in insurance special situations, liquid structured credit is a natural add-on to our capabilities.
Q: Which structured credit sectors are currently attractive from your perspective and why?
A: We’re deploying across a variety of sectors, including prime consumer ABS, single-asset/single-borrower CMBS and CLOs – predominantly at the top of the capital structure, although we’re beginning to look further down the capital stack. We’re seeking opportunities where credit fundamentals play out at wider levels and could potentially start looking at subprime and esoteric ABS too. We’re seeing dispersion of loan pricing and performance, due to the current macroeconomic environment, and expect more to come there.
There are many asset classes where we believe we can differentiate ourselves in terms of underwriting and/or origination, especially in underserved areas where there is a lack of capital. Our aim is to be thoughtful and build out different views on risk, based on our own methodologies. Even in more liquid segments like CLOs, we’re hopeful we can differentiate ourselves around structural details like call optionality, for example.
We have a US$500m book of investment grade multisector structured products and ABS, which means we can easily navigate the market and reallocate where necessary. As a smaller firm, we focus on areas where we can go a bit deeper to generate alpha and face less competition. We expect this type of AUM to grow considerably over the coming quarters and given our deep experience and relationships, we feel comfortable that our approach is scalable.
Q: In which other ways does Obra seek to differentiate itself in the structured credit space?
A: The press release announcing our recent acquisition – via a joint venture with R&Q Insurance Holdings – of the legacy liabilities of MSA Safety is one example. The JV won the tender for the transaction because it can provide both sides of the equation: R&Q will provide claims and management services for the portfolio, while Obra will provide investment management services.
We have an insurance-type balance sheet with a multi-year investment horizon. As such, we can achieve better returns with patient capital and are paid a liquidity premium.
We’re looking to repeat similar transactions to the one with R&Q, in which we can bring opportunistic capital to bear, as well as asset management expertise.
Q: What is your outlook for the structured credit market in 2023?
A: The major driver of performance in 2022 was the re-rating of the risk-free rate and the consequent repricing of liquidity premiums. The spread action reflected the change in market liquidity, which became more precious.
Strong price action to start the year seems to be a function, among other things, of the markets’ expectation of a reversal of the risk-free rate. With that being said, we remain cautious as the effects of deteriorating consumer balance sheets and top and bottom line pressures on corporates will likely cause volatility in credit spreads as the year progresses.
We like approaching the current market environment from a structured products lens, as securitisation structures generally allow for a more tailored approach to market views. The ability to adjust duration or add varying levels of credit enhancement offer extra elements of security over non-structured markets.
For us, it’s simply identifying the best valuations across the capital stack and figuring out the right risk/reward profiles. We benefit from having a capital base that offers the flexibility to pick the right spots and pivot accordingly.
Corinne Smith
Market Moves
Structured Finance
Life ILS partnership inked
Sector developments and company hires
Life ILS partnership inked
Twelve Capital has joined forces with Farsight Partners in a bid to boost their provision of life ILS opportunities. The two firms believe that ILS can offer capital and risk capacity to the life insurance industry – ultimately promoting the growth and efficiency of the industry. The new strategic partnership will allow the pair to combine their complementary skillsets to focus on long-term trends and market inefficiencies, as well as offer investors a more stable, long-term, lighter tail and more diversified source of return.
In other news…
EMEA
Kieran Sharma has rejoined Sidley Austin’s global restructuring group as a partner in London. Sharma joins the firm from Strategic Value Partners (SVP), where he was a director in its European investment team, focusing on credit, distressed debt and private equity opportunities. Prior to joining SVP, he worked for three years in Sidley’s restructuring group as a senior associate.
Simmons & Simmons has named Tommaso Canepa a partner in its risk-sharing and synthetic securitisation practice, as well as co-head of its structured finance group in the Milan office. He previously worked at Cappelli RCCD.
North America
Madhur Duggar has joined KBRA as an md, based in New York. He was previously a vp, credit risk management at New York Life Insurance Company. Before that, Duggar worked at Moody’s, KPMG, Barclays, Citi and Lehman Brothers in roles that included structured finance research and CLO strategy.
Notice surveilling service launched
Oakleaf has launched a new investor notice tracking service, which aims to streamline and reduce the time it takes to collect and analyse investor notices on public RMBS transactions. The service seeks to address the long-neglected inefficiencies in surveilling notices by buy-siders in terms of both time and resources. It offers investors twice-monthly reports and analysis on the importance and urgency levels of each notice by sorting through every deal upon sign-up for the service.
Market Moves
Structured Finance
Electronic loan trade completed
Sector developments and company hires
Electronic loan trade completed
Octaura has completed its first entirely electronic syndicated loan trade. The news comes after the official launch of Octaura Holdings last year, which was founded with the intention to improve efficiency, liquidity and transparency in the CLO and syndicated loan trading processes (SCI 14 June 2022).
At present, the US$1.5trn syndicated loan market functions predominantly on a manual basis, which Octaura aims to help modernise via its digital trading platform for syndicated loans. Users of the platform seek to benefit from a boost in the efficiency of its automation of old methods, which many participants believe could play a fundamental role in the future growth of the overall leveraged finance markets.
Backed by eight leading global financial institutions, Octaura has thus far successfully completed several trades with 10 different buy-side investors – including funds advised by T. Rowe Price Associates, Invesco, Lord, Abbett and Co, Investcorp Credit Management and Steele Creeke. Octaura plans to launch a beta version of the platform for use in loan trading sessions prior to the platform’s official launch.
In other news…
ABS CDOs transferred
Dock Street Capital Management has assumed collateral management of ACA ABS 2006-1 and ACA ABS 2007-3 from Solidus Capital, which in turn succeeded ACA Management as collateral manager for the ABS CDOs. Moody’s has confirmed that the appointment won’t impact any ratings on the notes issued by the transaction.
EMEA
Audrey Ambre Vire has started a new position at Aegon Asset Management as ABS/CLO junior portfolio manager. She was previously a junior portfolio manager at AXA Investment Managers and worked at Amundi, BNP Paribas and Banque de France before that.
Amundi has appointed Amadou Loum portfolio manager, securitised assets, based in Paris. He was previously head of ABS credit research at the firm, based in London. Before joining Amundi, Loum worked at Fitch, AXA Investment Managers, Societe Generale and Exane.
Global
Swiss Re is streamlining its organisational structure with the aim of improving efficiency and client experience. Effective from 3 April, subject to regulatory approvals, the current reinsurance business unit will be split into P&C Re and L&H Re - with each having full authority over the respective underwriting and claims management processes.
Urs Baertschi, currently ceo reinsurance EMEA, will lead P&C Re, while Paul Murray, currently ceo reinsurance Asia Pacific, will lead L&H Re. Moses Ojeisekhoba, currently ceo reinsurance, will assume leadership of the global clients and solutions business unit. Corporate solutions will continue as a business unit under the leadership of Andreas Berger.
Meanwhile, the responsibilities of the group chief underwriting officer (cuo) will be reallocated, most importantly to the cuos of P&C Re and L&H Re, as well as to group risk management. The tasks of the regional presidents will be reallocated as the roles will no longer exist in the new set-up.
Minerva 3 inked
BNL BNP Paribas and the EIB Group have closed a synthetic securitisation referencing a portfolio of the bank’s performing loans. Under the transaction, dubbed Minerva 3, the EIF has provided security for a €86.8m mezzanine tranche - with an EIB counter-guarantee - which will enable BNL to provide new low-interest loans up to a ceiling of €434m. The bank has committed to dedicate at least 20% of the total ceiling to investments by Italian small businesses designed to promote green energy production, reduce CO2 emissions and improve energy efficiency. This funding aims to help support Italian small businesses as they seek to relaunch investment and meet post-pandemic working capital requirements against an uncertain macroeconomic backdrop.
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