Contents

Structured Finance

SCI Start the Week - 17 April

A review of SCI's latest content

Last week's news and analysis
Benchmarking commitments
Importance of private securitisation to real economy underlined
Canadian wave continues
CIBC debuts synthetic securitisation
CLO pros take volatility in their stride
IMN European CLOs and Leveraged Loans conference recap
SPV structures eyed
US SPV CRT prospects raised

For all of last week’s stories including ‘Market moves’ and ‘Risk transfer round-up’ click here.

Recent premium research to download
CRT 2022 review – March 2023
CRT issuance volumes broke all-time records last year and the pipeline continues to build. The only potential blots on the horizon are the regulatory pause in the US and the fallout from the collapse of Credit Suisse and Silicon Valley Bank, as this Premium Content article suggests.

CLO ESG reporting – March 2023
CLO managers are increasingly investing in their own methodologies and disclosure processes to provide investors with helpful ESG information. However, as this Premium Content article shows, the subjective nature of this data remains an issue.

Digitisation and securitisation - February 2023
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.

All of SCI’s premium content articles can be found here.

SCI In Conversation podcast
In the latest episode, Arrow Global principal John Pellew discusses the evolution of blockchain technology in the securitisation market. We highlight the milestone achievements in the space, as well as the challenges that still need to be overcome.

The podcast can be accessed wherever you usually get your podcasts, including Apple Podcasts and Spotify (just search for ‘SCI In Conversation’), or by clicking 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.

SRTx benchmark

SCI has launched SRTx (Significant Risk Transfer Index), a new benchmark that measures the estimated prevailing new-issue price spread for generic private market risk transfer transactions. Calculated and rebalanced on a monthly basis by Mark Fontanilla & Co, the index provides market participants with a benchmark reference point for pricing in the private risk transfer market by aggregating issuer and investor views on pricing. For more information on SRTx or to register your interest as a contributor, click here.

Upcoming SCI events
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

ESG Seminar line-up finalised

Securitisation awards to debut

SCI’s 2nd Annual ESG Securitisation Seminar is taking place in-person on 25 April at the offices of Clifford Chance in London. Chaired by Pemberton Capital Advisors’ Naomi Prasad, the event will cover the latest regulatory developments, key trends and emerging opportunities within the sustainable securitisation market.

The seminar begins with a pair of panels exploring ESG regulatory developments from the perspective of issuers and investors. The following panels examine which metrics to use for determining whether a securitisation is ESG-compliant, as well as standardisation, transparency and verification issues.

Next, a panel on supply and demand discusses the ‘use of proceeds’ paradigm. There is also a fireside chat between European Leveraged Finance Association’s Sabrina Fox and Clifford Chance’s Simi Arora-Lalani.

Rounding off the event is SCI’s inaugural ESG Securitisation Awards ceremony, which will be followed by a cocktail reception.

SCI’s 2nd Annual ESG Securitisation Seminar is sponsored by the EIF, European DataWarehouse, Fidelity International, Fitch Ratings, Intesa Sanpaolo and Linklaters. Panelists also include representatives from ABN AMRO, Angel Oak Capital Advisors, auxmoney, Chenavari, Deutsche Bank, European Mortgage Federation, Federated Hermes, IACPM, Investec, Kensington Mortgages, Obvion, PCS, PGGM, Polus Capital, Sustainable Fitch and Sustainalytics. For more information on the event or to register, click here.

Capital Relief Trades

Test case

JP Morgan said to be targeting SPV structure

SCI understands that JP Morgan is eyeing an SPV structure for an alleged synthetic securitisation that is expected to close in the second half of the year. The choice of an SPV structure coheres with what seems to be a regulatory preference towards the format although clarity on this issue is still pending (SCI 13 April).

According to market sources, the transaction is a test case for the bank's future CRT issuance especially following a stellar first quarter for JPMorgan. Indeed, JP Morgan led the pack in 1Q23 with net earnings up 52% on the back of higher profits from lending due to rising interest rates. Moreover, the CET1 ratio increased to 13.8%, compared to a regulatory requirement of 12.5% and the lender’s 13% target for 1Q23. Nevertheless, JPMorgan raised provisions for credit losses reflecting a deteriorating economic outlook.

US regulators put the CRT market on hold last year given alleged concerns over direct CLN structures and the presence of call features. Consequently, JPMorgan’s transaction would be the first deal for capital relief purposes in over a year.

US capital relief trades were typically structured as CLNs with an embedded CDS but there have been a few CDS trades under an ISDA. The latter benefits from a pledge over an account which fully collateralizes the CDS and doesn’t involve the issuance of any securities. Financial guarantees are another option, but they were never the preferred format given potential withholding tax implications and avoiding them requires the counterparty to be based in the US or otherwise in a country with a double tax treaty with the US, which can complicate matters. Hence, US originators have generally opted for direct CLNs given their simple and cost-effective nature. Now, to the extent that banks move away from direct CLNs, market participants note that US banks could consider either direct CDS or SPV structures where notes are issued to investors.  

US supervisors seem to be moving in the direction of SPV structures, but questions remain from a supervisory standpoint as to whether the SPV has ownership of the collateral and pledges to fully repay the notes to the bank and then the investors. Another question more salient for originators is whether banks must comply with swap regulations since the SPV can be considered as a commodity pool. Nevertheless, there is some legal ambiguity here over the definition of a commodity pool that could tilt the balance in favour of US banks. The direct CDS format is the other option, but these structures would have to be marked to market.  

The JP Morgan transaction is expected to close in the second half of the year.

Stelios Papadopoulos

Capital Relief Trades

Risk transfer round up-20 April

CRT sector developments and deal news

Klarna is believed to be readying its second ever synthetic securitisation following the consumer lender’s debut capital relief trade last year (SCI 11 July 2022). Meanwhile, Unicredit is allegedly prepping a synthetic ABS referencing corporate loans for 2Q23.  

Stelios Papadopoulos

Capital Relief Trades

Canadian boost

BNP Paribas said to be arranging another Canadian CRT

BNP Paribas is believed to be readying a synthetic securitisation for an undisclosed Canadian bank that is expected to close in 2H23. The transaction is the fourth Canadian capital relief trade this year as risk transfer issuance in the country continues to gather steam.

The latest trade follows the recent execution of a corporate CRT from CIBC where BNP Paribas acted as the arranger. The transaction featured a junior mezzanine tranche with an approximately 6% thickness that was priced at less than 10%. The portfolio was backed by US$4.5bn investment grade corporate loans and was upsized from an initial US$3bn. The deal was finalized on the back of another synthetic risk transfer trade from Toronto Dominion that was executed in February (SCI 13 April).

The rise in issuance in the Canadian market marks a significant break with the past given that the only active originator until now has been Bank of Montreal. The bank itself has experienced a record year for its own risk transfer issuance with a total of ten synthetic securitisations last year. Issuance was driven by BMO's acquisition of Bank of the West. The pickup in the Canadian market is perhaps not surprising given that the Canadian supervisor, the office of the superintendent of financial institutions (OFSI), stipulated in an official letter that was published on January 31, 2022, that the Basel output floor would have to be effectively frontloaded this year.

Stelios Papadopoulos

CLOs

DDEs surveyed

'More favourable' outcomes for participating CLOs

Fitch has examined the holding outcomes of two leveraged loan issuers - MLN US HoldCo (Mitel) and Envision Healthcare - that underwent out-of-court restructurings last year. The analysis finds that recovery outcomes vary widely across CLOs, with more favourable outcomes achieved for CLOs that participated in the restructurings.

Indeed, CLO vintages as old as 2017 were able to participate in new money debt issued for the obligors, demonstrating the flexibility and discretion available under documentation. “Participation in the relevant obligor’s restructured debt was most likely permitted under CLO indenture provisions that carved out allowances for current pay obligations or distressed/bankruptcy exchanges and otherwise qualified as an eligible collateral obligation. Even so, classification of credit risk obligations can depend on manager’s discretion, and the new debt may have even qualified as performing collateral obligations if not considered to be a defaulted obligation,” notes Fitch.

Deal documentation alone does not appear to be the key determinant of CLOs’ participation in the restructurings, however. The ability to invest new money in restructurings has also depended on collateral quality test cushions or lack thereof.

Prior to Mitel’s uptiering transaction on 18 October 2022, the CLOs monitored by Fitch were primarily holding the first-lien loan issued by the obligor, and a few also had exposure to the second-lien loan. Bid levels on the original first-lien loan dropped by almost 50% pre- to post-restructuring, when the loan was reduced to the fourth-out position for non-participating CLOs, which could be realised as a trading loss if the CLO manager decides to sell the loan. For participating CLOs, their first-lien holdings were rolled into a new second-out loan, with minimal discount, while other participants retained 94% of their original par amount.

“Although participating CLOs realised some par loss on the exchange, bid levels were in the low 80s after a month of the distressed debt exchanges - which offered higher recovery potential in the event of a sale, compared to the fourth-out position that was trading in the low 30s. Bids on the original first-lien (now fourth-out) and second-out loans fell an additional 8 and 13 points respectively by January 2023,” Fitch observes.

Meanwhile, Envision experienced two major restructurings in 2022 involving drop-downs and uptiering. The company moved its ambulatory surgical business to an unrestricted subsidiary, AmSurg, which issued secured loans that were structurally senior to the remaining company’s debt. The issuer then proceeded with an uptiering transaction at the original issuer level, which left non-consenting lenders in a fourth-out position, behind a substantial amount of debt.

In the first restructuring in April 2022, one participating manager exchanged half of its original first-lien par amounts for the new loans under AmSurg at roughly a 35% discount. Bid levels for the original first-lien holdings dropped to the high 30s range in May from 60s in April, while bid levels on the uptiered loan for AmSurg were roughly in the mid-90s, according to Fitch.

Based on the total notional amounts held in the Envision/AmSurg loans after the first DDE, the participating manager had realised a par loss of approximately 18% from its original par value, while other non-participating CLOs did not realise any par losses. However, the participating manager was able to keep the WA bid level on its combined Envision/AmSurg exposure at approximately 61, higher than non-participating CLOs that saw lower bid levels.

“This illustrates the trade-off managers face for different recovery experiences,” Fitch notes.

Many CLOs that did not participate in the first DDE participated in the second DDE in August 2022 by adding new money debt and converting a large portion of their original first-lien par amount to second-out positions at a 17% discount and the remaining first-lien amounts to third-out loans at par. Participating CLOs effectively realised approximately 12% par losses from the original par value from the uptiering transaction.

Bid levels on the second- and third-out loans ranged from the mid-40s to mid-20s respectively by the end of September. Bids on the original Envision first-lien loan also dropped further to range in the 20s, comparable to the bid range for the third-out tranche.

While non-participating CLOs did not realise significant par losses over the year, Fitch suggests that the expected recovery on their original first-lien loan is now comparable to the expected recovery on the third-out tranche, based on bid levels.

Corinne Smith

CLOs

Cautious optimism

Moody's Analytics Chief Economist Mark Zandi shares his views

SCI talked with Moody’s Analytics Chief Economist Mark Zandi ahead of his economic outlook keynote at Information Management Network’s 12th Annual Investors Conference on CLOs & Leveraged Loans in New York on April 17-18, 2023.

In general, the financial market mood is one of caution, but there is also room for some optimism, especially in the CLO and leveraged loan space. “There’s a lot of nervousness around the state of the economy, the global economy, the US economy, and what that might mean for corporate borrowers, which ultimately is critical to the CLO market, and the leveraged loan market,” Zandi explains.

Although the CLO market continues to do well, there is concern that this may not be the case in 6-12 months, according to Zandi. “However, I make the case that while the economy is struggling with high inflation and high interest rates as the Federal Reserve continues to push on the brakes, there's a reasonable probability the economy can make its way through the next 12-18 months without experiencing outright recession,” he says.

One reason for the relative optimism is because corporate balance sheets are in good shape, Zandi notes.

“Leverage is low, debt service is low. There clearly are businesses that have over levered and over extended, and there will be some problems, but broadly speaking, I think the corporate world is in pretty good financial shape and can face whatever economic storm is headed that way.”

“And this is really critical to avoiding recession because if businesses are able to manage their leverage, their debt, then its less likely that you need private investment which is the key to not going into recession,” Zandi adds.

Zandi also believes that as long as a recessionary risk is looming, it is difficult for the market to move into a higher gear. “The key here is getting to the other side of these macroeconomic issues that are weighing on and most significant those is inflation,” he says.

He continues: “Inflation has to come back down to something that everyone feels more comfortable with, including central banks and the Federal Reserve. Once it's clear that inflation is back in the bottle, and interest rates have peaked, I think that's when the market will find its footing again and can rebound.”

Despite the concerns, the market is doing pretty well, Zandi points out. He observes: “Leveraged loans outstanding of lease leveraged loans that go into CLOs, which is about three fourths of all leveraged loans outstanding, are still growing through early this year. The latest data shows it’s growing at almost double-digits year-over-year, which is meaningful growth. And even though credit conditions are starting to weaken, there's downgrades and you're starting to see some increased delinquency and default, it is quite modest in the grand scheme of things.”

Indeed, despite the macroeconomic conditions there is still huge value of investing in CLOs, according to Zandi. He says, “If you look historically through different stress periods such as the financial crisis and the pandemic, CLOs have navigated through them very well compared to other types of financial investments and other structured investments. So, I think there's a lot of evidence that CLO structures are durable, resilient against different economic environments and different conditions in the financial markets.”

As result, Zandi says: “I sense growing appreciation of CLOs among global institutional investors based on that historical experience of it being a safe investment. Especially in the context of these current concerns about the global macro economy, I think there's particularly a growing interest in the triple-A tranches, which should help support activity across the CLO market more broadly.”

Overall, Zandi believes that market regulators are unsurprisingly currently focused on the US banking system, following the collapse of Credit Suisse and Silicon Valley Bank.

“It’s unnerving to see several banks fail. That set off a bank run and significant deposit outflows and really highlighted some of the vulnerabilities in the banking system. So, I suspect the Federal Reserve and other major US regulators are going to be focused on the banking system at this point than what is currently happening in the CLO market,” he concludes.

Ramla Soni

About Mark Zandi
Dr. Zandi is on the board of directors of MGIC, the US’s largest private mortgage insurance company, and is the lead director of PolicyMap, a data visualisation and analytics company, used by policymakers and commercial businesses.

He is a trusted adviser to policymakers and an influential source of economic analysis for businesses, journalists and the public. Dr. Zandi frequently testifies before Congress and conducts regular briefings on the economy for corporate boards, trade associations, and policymakers at all levels.

Dr. Zandi is the author of two books: ‘Paying the Price: Ending the Great Recession and Beginning a New American Century’ and ‘Financial Shock: A 360º Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis’. He is also host of the Inside Economics podcast.

Dr. Zandi earned his BS from the Wharton School at the University of Pennsylvania and his PhD at the University of Pennsylvania. 

Structured Finance

'Meaningful' layoff exposure for TAMI CMBS leases

Sector developments and company hires

‘Meaningful’ layoff exposure for TAMI CMBS leases
KBRA has identified 266 US CMBS lease exposures to 45 large companies that have recently announced combined layoffs of 216,905 white-collar employees. The rating agency focused on companies announcing layoffs of at least 1,000 employees from 2022 through mid-March 2023, among the universe of nearly 5,700 office and mixed-use properties in CMBS 2.0 conduit and single asset-single borrower/large loan transactions.

Together, these leases account for 33.3 million square-feet across 245 properties, or an average of 29.6% of the respective property square-footage. The properties secure US$35.4bn of CMBS loans on an allocated property balance basis, equating to approximately 5.6% of the currently outstanding CMBS 2.0 balance.

The analysis reveals that tech, advertising, media and information (TAMI) industries represent a meaningful portion of the layoff companies. Large tech companies - such as Amazon, Google, Meta and Microsoft - account for 18.6 million sf (55.8%) of the exposure.

The largest exposure is to Amazon, representing 38 leases across 33 properties totaling 7.5 million sf of leased space and collateralising US$3.2bn of property allocated loan balance. The largest single lease exposure is to Warner Bros Discovery, which leases 100% of the 1.5 million sf of 30 Hudson Yards, securing a US$1.4bn loan collateralising HY 2019-30HY.

Given the heavy TAMI exposure, the San Francisco, Silicon Valley and Seattle markets represent 15.8 million sf (or 47.5%) of the overall exposure to layoff companies.

In other news…

APAC
K&L Gates has appointed King & Wood Mallesons’ Stuart Broadfoot as a Sydney-based partner in its tax practice. Broadfoot has a background of working on cross-border taxation related to mergers and acquisitions, structured finance, restructurings and project finance.

The new recruit leaves his role as special counsel at KWM, after four years with the firm. He previously worked at Clifford Chance and EY Law Perth - then known as Norton & Smailes.

Prestige steps in to support auto ABS
The deteriorating performance of US subprime auto ABS PART 2022-1 has prompted the sponsor Prestige to make a capital contribution to support the deal. According to JPMorgan securitised products research analysts, Prestige plans a one-time contribution of US$3.1m (equating to 75bp of the original collateral amount) for the 17 April distribution date - covering the March collection period - to help build credit enhancement. In addition, Prestige will continue to forgo its monthly servicing fee – which it began doing in February – through the September collection period or until overcollateralisation is attained, whichever is earlier.

S&P stated that it will not take any rating action on the transaction at this time. However, it noted that while hard credit enhancement has increased from initial levels for 22-1, there has been little to no excess spread remaining after covering losses in recent months and that the lowest rated class E is heavily dependent on excess spread. The rating agency says it will continue to monitor the transaction.

Structured Finance

Surge in refi SLABS predicted

Sector developments and company hires

Surge in refi SLABS predicted
The US Supreme Court is expected to render its decision regarding the legality of President Biden’s student loan forgiveness programme (SCI 31 August 2022) by the end of June. A resolution will provide borrowers with more clarity about their federal student loan debt balances and obligations - which is anticipated to spark further refinance activity, in turn benefitting the refi student loan ABS sector by increasing the collateral eligible to securitise.

“With more than US$100bn of federal student loans originated per year and the strong likelihood that the fixed interest rate for federal student loans disbursed for the next academic year (2023-2024) will exceed the current rate, the addressable market of refi borrowers should continue to grow,” notes Jon Riber, svp, US ABS at DBRS Morningstar.

If the forgiveness programme goes ahead as planned, borrowers with federal student loans will receive debt cancelations of up to US$20,000. Additionally, federal student loan payments - which were frozen in March 2020, due to the Covid-19 crisis - are expected to resume 60 days after the court’s ruling or after August. DBRS Morningstar anticipates that the resumption of interest and principal payments should result in a significant portion of federal borrowers seeking more favourable terms via the private student loan refinance market.

“As interest rates have increased, we have observed a significant supply of newly originated private student loans and federal loans that carry relatively high interest rates. These underlying borrowers are beginning to make up a large pipeline of potential customers that that the refi lenders will target,” Riber observes.

The student loan refinancing market has suffered from sharply higher interest rates, which have eroded the value proposition between the rates on the loans that borrowers currently hold and the latest rates offered by refi lenders. Additionally, weak investor sentiment against the backdrop of economic uncertainty has resulted in increased securitisation cost of funds, further dampening refi ABS volumes. Refi ABS issuance dropped to three transactions in 2022 from 11 transactions in 2021, according to DBRS Morningstar.

“While there are several factors that influence origination volumes for consumer loans in general - including the economic environment, interest rates and the availability of credit - we have identified several converging events specific to the student loan market that bode well for the refi sector and will benefit those holding federal student loans. Furthermore, if market conditions and general ABS investor sentiment improve, DBRS Morningstar anticipates a surge in refi ABS new issuance volume,” the agency concludes.

In other news…

EMEA
Arrow Global Group has appointed Gabi Cohen as md, Nordics, client and product solutions (CPS). The CPS team is responsible for setting Arrow’s capital formation strategy and broadening the firm’s investor set by enabling global capital pools to access the opportunities presented by a growing investor landscape.  
Cohen joins Arrow Global from ICG, where she worked for 10 years as part of its business development function, including leading the firm’s Nordic investor activities. She also spent two years at ESO Capital, as well as in various banking roles at UBS and HSBC.
Based in London, Cohen will report to Charlotte Gilbert, md, CPS.

Greg Campbell has joined O’Melveny’s London office as a partner in its corporate finance practice group, strengthening the firm’s cross-border capabilities while also expanding its capacity in London and across the European market. Campbell brings more than 25 years of experience advising on leveraged finance, real estate finance, restructuring, distressed and special-situations transactions. He was previously a member of Gibson Dunn’s global finance and business restructuring practices.

North America
Cadwalader has appointed Ryan McNaughton as a partner in its securitisation and structured finance practice in New York. He joins from King & Spalding, where he was a partner. McNaughton has a particular focus on esoteric ABS, including whole business and other operating asset securitisations, music and media royalty transactions and specialty real estate lending transactions.

PacWest synthetic downgraded
Fitch has downgraded the class M1 and M2 notes issued by PacWest 2022-1 from triple-B minus to double-B plus. The agency’s ratings watch negative has been removed and a negative ratings outlook has been assigned.

The move follows its decision to place the CLN on ratings watch negative on 20 March, in the wake of the collapse in confidence in a number of US regional banks.

The deal represents PacWest’s single foray into the capital relief trades market.

The long-term issuer ratings of Pacific Western Bancorp and Pacific Western Bank were downgraded from triple-B minus to double-B plus at the end of last week. The short-term rating were also downgraded from B to F3.

The decision was taken, says Fitch, due to the “bank’s funding and liquidity profile, specifically reliance on non-core funding in the wake of the failure of Silicon Valley Bank.” The agency notes that the performance of PacWest 2022-1 has been stable over the last six months and 30-day delinquencies remain below 1%. There have been no losses incurred within the pool, which has paid down by about 2.5%.

RFC issued on NPL servicer guidelines
The EBA has launched a public consultation on its draft guidelines on the assessment of adequate knowledge and experience of the management of credit servicers under the Non-Performing Loans Directive. The objective of the guidelines is to ensure that management is suitable to conduct the business of the credit servicer in a competent and responsible manner, including that it has adequate knowledge and experience.

The guidelines specify the criteria for assessing collective knowledge and experience, taking into account the principle of proportionality. They also set out the main requirements of the credit servicer assessment process and specify when such an assessment has to be performed. Where shortcomings are identified, the credit servicer must take appropriate corrective measures, including to provide training or to replace members of the management body.

The consultation runs until 19 July and a public hearing will take place on 12 June.

Capital Relief Trades

RFC issued on synthetic STS criteria

Sector developments and company hires

RFC issued on synthetic STS criteria
The EBA has launched a public consultation on its draft guidelines on the criteria related to simplicity, standardisation and transparency and additional specific criteria for on-balance sheet securitisations. The aim is to ensure a harmonised interpretation of STS criteria, in alignment with the EBA guidelines for traditional securitisations.

With the introduction of STS criteria for synthetic securitisations, on-balance sheet securitisations are eligible for preferential risk-weight treatment under the CRR. The draft guidelines clarify aspects with a potential level of ambiguity, thus both ensuring a harmonised understanding of the criteria, but also a harmonised implementation in terms of capital requirements.

During the development of the guidelines, the EBA says it has been mindful to ensure consistency with existing guidelines for traditional securitisations, which has provided a single point of consistent interpretation of the STS criteria to the relevant stakeholders throughout the EU. For a limited number of these criteria, the guidelines for non-ABCP and ABCP securitisation have been updated to ensure further clarity and to reflect the practical implementation of the criteria.

Responses to the consultation are invited by 7 July and a public hearing will take place on 30 May.