Contents

RMBS

Reissue, renew, reprint

Big banks focus on retention in German RMBS

The reissuing, renewing and reprinting of retained structures seems to be the name of the game in German RMBS, as covered bonds remain the preferred secured wholesale funding tool of German banks as TLTROs disappear. However, with higher all-in coupons and widening covered bond spreads, the relative pricing differential is narrowing and the funding diversification argument may become stronger.

“In the last few years, we’ve only seen retained RMBS in Germany, partly because of TLTROs – but with maturities on the horizon, banks are finding the next best terms in instruments like covered bonds. Still, banks are expected to maintain retained programmes as ECB eligible collateral for contingency purposes,” states Kevin Kroke, director on the asset securitisation team at ING Germany.

Investors value the strong protection from the long standing and solid local covered bond law, which explains German issuers’ historic preference for covered bonds. “Most large German banks active in the mortgage market have covered bond programmes - it’s a traditional German product,” confirms Kroke.

“In comparison, ING-DiBa AG priced a benchmark 4.25Y triple-A EUR Green Mortgage Pfandbrief in Germany at 22bp versus ING Bank N.V.’s recent 4.88Y triple-A EUR Green RMBS at 45bp in the Netherlands. Hence you could deduce a key argument for the preferred instrument,” he adds.

Currently, covered bond spreads are widening but are still being issued at a meaningful discount to RMBS, which have widened as well. Therefore, covered bonds are expected to remain the issuer-favourite following the exit from TLTROs.

Kroke notes: “There is a downside to covered bonds in terms of lower collateral to funding efficiency. But this is no bother for German banks, as what matters most is price and liquidity required to contend in the competitive loan market.”

Recent RMBS issuance has been dominated by repeat deals from the big banks – including ING. “We will continue to see this because the large banks aim to maintain collateral for contingency purposes - and retained RMBS is still the most efficient in terms of collateral and effective in terms of volume. Moreover, sharp rate hikes have weakened borrowers’ capacity and originations are plateauing,” Kroke states.

He adds: “As banks weight between repricing and market share, we observe further compression in loan margins. Further, with Basel 4 on the horizon, higher capital cost from the output floor will force repricing. This will potentially create room for non-bank lenders and perhaps new RMBS issuers.”

With higher all-in coupons and widening covered bond spreads, the relative pricing differential can get smaller and the funding diversification argument may become stronger. “Banks may actually be willing to pay-up for that,” Kroke concludes.

Claudia Lewis

Structured Finance

SCI Start the Week - 13 November

A review of SCI's latest content

Last week's news and analysis
A global market
Man GPM answers SCI's questions
Canadians coming
Scotia back in the CRT market
Esoteric explosion
Data centre securitisation seeing strong fundamentals
Glass half full?
PRA publishes discussion paper on capital requirements for securitisation transactions
Global Risk Transfer Report: Chapter two
The second of six chapters surveying the synthetic securitisation market explores regulatory developments
Job swaps weekly: ESG debt-swap pioneer transitions to UBS
People moves and key promotions in securitisation
Motor Securities 2023-1 prices
Santander completes UK capital relief trade
Scope sees ratings drift reverse in Q3
Agency provides update
Securitisation due in H1 for international student loan provider
Goldman, Deutsche and Värde backed MPOWER's latest debt funding round
Plus
Deal-focused updates from our ABS Markets and CLO Markets services

Free Special Report available to download

SCI Global Risk Transfer Report 2023: New frontiers in CRT
Capital relief trade issuance witnessed another record-breaking 12 months in 2022, yet a number of regulatory challenges remained outstanding by the end of the year. SCI’s latest Special Report examines how the risk transfer community is addressing these issues – whether through regulatory fixes or structural enhancements – and the fallout from the turmoil in the bank sector in March. It also explores the new frontiers that are emerging across jurisdictions and asset classes, including by highlighting the potential of the Canadian and the CEE CRT markets.

Sponsored by Arch MI, Man GPM, Mayer Brown and The Texel Group, the report is available to download here.

Regulars
Recent premium research to download
Data centre securitisation – November2023
Insatiable demand for connectivity is fuelling a rise in data centre securitisation issuance. This Premium Content article tracks the market’s development.

(Re)insurer participation in CRTs – October 2023
(Re)insurer interest in CRTs is rising, but execution of unfunded transactions remains limited. This Premium Content article outlines the hurdles that still need to be overcome.

Utility ABS – October 2023
An uptick in utility ABS is expected as US utilities seek financial solutions for retiring the country’s aging fossil fuel fleet. This SCI Premium Content article explores how the proceeds from these transactions can be used to facilitate an equitable energy transition.

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

SCI In Conversation podcast
In the latest episode, Matthew Bisanz, a partner in Mayer Brown’s bank regulatory practice, outlines how the Federal Reserve’s update on 28 September of the FAQs on Regulation Q is likely to impact the US capital relief trades market. The long-awaited guidance clarifies the definition of a synthetic securitisation and, crucially, states that a reservation of authority can be requested for direct CLNs. Bisanz, for one, anticipates an increased willingness – especially among larger CCAR banks – to enter into CRTs as a result.

The episode can be accessed here, as well as wherever you usually get your podcasts, including Apple Podcasts and Spotify (just search for ‘SCI In Conversation’).

SCI Markets
SCI Markets provides deal-focused information on the global CLO and Australian/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 Tauseef Asri 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
European CRE Finance Seminar
28 November 2023, London

Capital Relief Trades

Risk transfer round-up - 16 November

The week's CRT developments and deal news

Market news
Freddie Mac last week priced the high-LTV STACR 2023-HQA3 deal, its first CRT transaction since the end of June, introducing a new deal structure. The trade included an A1 class structured as a three-year bullet-like bond, which is pro-rata to the senior retained AH class from day one, but receives all AH cashflows at the three-year mark and is subsequently paid off. Additionally, the GSE sold an M1 tranche instead of M1A and M1B classes, but continues to retain the B notes.

According to JPMorgan securitised products research analysts, issuing the A1 class better aligns the CRT deal structure with the GSEs’ Enterprise Regulatory Capital Framework (ERCF). Under the ERCF, loan level risk weights change due to HPA and seasoning. As loan pools delever and season, the GSEs are required to hold less capital.

The seasoning multiplier decreases from 1 to 0.95 for two to three years of seasoning, and to 0.8 for over three-year seasoned loans. “At the three-year mark, loan level RWA modestly declines. As the loan capital declines, so does the amount of CRT needed to receive maximum capital relief - hence why the new A1 class is structured to pay off at the three-year point,” the JPMorgan analysts explain.

The class A1 notes priced at 185bp DM, with 4.3% of credit support.

Separately, Fannie Mae is in the market with its latest CRT deal – CAS 2023-R08 – which offers US$573.48m of notes. The reference pool comprises 60,345 loans with original LTV ratios greater than 60% and less than/equal to 80%, for an outstanding principal balance of approximately US$18.9bn.

Pipeline update
Although SRT market conditions remain broadly stable, investors highlight a quieter Q4 year-on-year.

In the UK, Lloyd’s latest synthetic securitisation of UK SME loans from the Salisbury programme is, according to one SRT investor, “definitely going ahead.” Similarly, Natwest’s project finance SRT (SCI 3 November) is described as being in its “second phase and set to close soon.”

Joining the pipeline is Bank of Ireland, with a transaction referencing a portfolio of large and mid-cap corporate loans. Regarding the trade’s timeline, the investor notes: “I think the deal is in the second stage. However, I don’t think they have received fund bids yet.”

In respect of current SRT market conditions, the investor describes a combination of stable pricing conditions and smaller volumes in terms of the number of deals coming through. He says: “I think the market has quietened down towards the end of the year. Looking back at the deals we have had over the last few months, I feel the market has been broadly flat, with no meaningful movement - up or down. And the same goes for the Q3 and early Q4 deals.”

He continues: “I don’t expect any movement by year-end either. It doesn't look like last year-end, where some trades didn't close because there were just too many deals in the market and insufficient investor appetite. I think there are fewer trades in the market for Q4 than last year; however, they seem to be getting sufficient traction.”

Another SRT investor notes that “pricing is tight” at the moment, before concluding: “If you look at the spreads across the board, in effect, you’ve been paid the same spread for the last 10 years. If you take away the rates element, the spread is the same, which is crazy. Banks are having a really good time.”

CRT new issue pipeline

SCI SRTx indexes

For more information on the Significant Risk Transfer Index (SRTx), click here.

Capital Relief Trades

Stand by, CRT

CRT boom but adverse regulations loom, say SCI conference speakers

Echoing what is now a familiar refrain, speakers at SCI’s inaugural esoterics conference in New York Last week said that the US CRT market is set to get very big.

“Every bank is now looking at assets that don’t justify a 100% risk weighting,” said one.

The rise of subscription credit facilities means that CRT deals that offer synthetic exposure to this class of assets are likely to become seen more widely, said another.

Subscription credit facilities, or capital call lines, often offer low yields but are popular with banks as they are an entrée to more lucrative business lines with the same clients. There have already been a number of CRT deals in Europe and the US which have referenced this asset class.

More worryingly for banks, the regulatory horizon is clouded. The SEC, for example, has embarked on an aggressive agenda. The so-called “conflict of interest” ruling, proposed in January of this year, would prohibit so-called ‘securitization participants’ from engaging in certain transactions connected with ABS deals. This includes, for example, CDS trades and short sales for one year after the closing of the ABS deal.

The phrase “securitized participant” is “very broad”, noted a speaker, and covers the issuer, arranger and all the affiliates thereof. If enacted, this rule would have a profound impact on the operation of the securitized market. It means, in effect, that parallel trades to the ABS deal, would be prohibited.

There is as well, of course, the Basel III endgame, the comment period for which has been extended to January next year. Most observers believe that the proposed increase to capital requirements will go forward as planned, which means securitized assets will require more capital. “Securitized exposure will be goosed up a lot,” commented a speaker.

Delegates also discussed the rise and rise of the infrastructure and communications ABS market. Transactions are getting “larger and larger,” said one. The quality of the contractual cash flow is a key component of the attractiveness of these deals. “The payments have to be made; these deals will perform,” commented another.

The enormous use of electricity made by data centres was debated as well. One investor said they ask issuers to disclose “plans” for conversion to non-fossil fuel energy generation.  

Given the meagre contribution to the power grid currently made by renewable energy, its relative expense and the colossal demands made by data centres, it seems unreasonable to expect these “plans” to amount to anything substantive in the near term.  Indeed, said a delegate to SCI, the limitations of the current power grid is an obstacle to growth of data centres, irrespective of a putative move to greater use of renewables.

The fact that data centres extend broadband to parts of the USA which hitherto lacked it, with the consequent fillip to business and employment, is a fulfilment of ESG objectives, said another delegate.

Simon Boughey

Capital Relief Trades

Global Risk Transfer Report: Chapter three

In the third of six chapters surveying the synthetic securitisation market, SCI explores recent structural developments in SRT

IACPM’s latest risk-sharing survey notes that 2022 highlighted not only a substantial growth in SRT product utilisation by banks, with €200bn in new issuance, but also some structural changes in the risk-sharing activity of banks. Nevertheless, a number of regulatory challenges remain outstanding.

SCI’s Global Risk Transfer Report examines how the risk transfer community is addressing these issues – through regulation or structural enhancements – and the fallout from the turmoil in the US bank sector in March. It also explores the new frontiers that are emerging across jurisdictions and asset classes.

Chapter 3: Structural developments
The CRT market is dominated by direct CLN structures, which some market participants believe are the simplest and most cost-effective transactions to execute. But the recent pause in US issuance is attributed in some quarters to the Federal Reserve’s dislike for these structures. Now SPV structures appear to be gaining traction as an alternative among some issuers.

“I have not heard anything beyond the Fed’s cryptic FAQs that would indicate that US banking regulators are publicly softening their stance on CLN structures. The conflicts proposal from the SEC shows that some US regulators have no direct objection to CRT, including the CLN variations. But also it shows how some US regulators have not considered CRT as closely as the industry has and, therefore, there is a continuing need to educate regulators on its important, risk-mitigating function,” says Matthew Bisanz, a partner in Mayer Brown’s bank regulatory practice.

Jon Imundo, md and co-head of credit risk sharing at Man GPM, confirms that on the question of CLN structures, market participants are focused on understanding whether US regulators are softening their stance. “It’s something that comes up in almost every meeting,” he says. “What is clear, however, is that regulators globally appear to recognise the benefits of this market to the banking system. We hope that at some point there will be a framework that allows banks to issue in a more programmatic way.”

In the US, three main CRT structures are utilised: credit default swap structures, bank-issued CLN structures, and bank-sponsored SPV-issued CLN structures. Sagi Tamir, partner at Mayer Brown in New York, notes: “From an economics perspective, the market finds the CLN structures to be the most capital relief favourable because they typically involve a cash collateral element for optimising capital relief.”

He continues: “With credit default swap structures, you don’t always optimise capital relief and you also start to get into more complicated questions, such as US insurance law, US derivatives law, margin calculations and so on. It certainly can be done. But they require a higher level of sophistication on both sides.”

Imundo points out that the decision to undertake bilateral, club or syndicated transactions is often driven by the issuer, rather than the investor. “A lot is down to how the issuer wants to run its programme. There are pros and cons to bilateral, and pros and cons to syndicated transactions. There are different motivations. For our part, we are agnostic across bilateral, club or syndicated transactions.”

He adds: “What’s important is that a transaction meets the thresholds that we deem appropriate; in particular, around concentration limits. There's a whole list of metrics that we have in terms of how we think about a transaction, both on a standalone basis and as an aggregate, with respect to a given portfolio.”

Different CRT structures offer different levels of comfort for different banking tiers, according to Tamir. “Some participants have been willing to give up some level of capital relief in exchange for certainty. You might see a bilateral deal where credit protection is provided by way of a credit default swap, or a deal where you would have an intermediary in the middle. The idea of those structures is providing a greater level of comfort around recognition of the capital relief.”

Regulatory certainty
Ultimately, banks want certainty from their regulator. If one bank learns that a similarly situated bank has been given the nod from their regulators for a slightly different structure, they might change their structure in turn.

“I've seen flexibility both at the bank level, to meet a given regulator’s preference, and at the investor level, to accommodate the applicable bank,” Tamir says. “In the US, my experience is that investors focus more on economics and are flexible in the structure that a bank chooses, because they fully understand that the main driver of the deal is capital relief.”

In Europe, the IACPM reports that usage of SPVs in the CRT market has been decreasing year after year. The main risk transfer instruments are collateralised guarantees, CLNs with embedded guarantees and unfunded credit insurance.

A bilateral guarantee is an option if the guarantor is of a sufficient credit quality required by the regulations. “With these structures, you're trying to substitute the quality of the credit protection provider for the quality of the debtors in the reference portfolio. So, you need both the counterparty and the guarantee to be of sufficient quality,” observes Edmund Parker, partner and global practice head of derivatives and structured products at Mayer Brown.

The advantages are that the legal documentation is relatively simpler because there is just a guarantee and an administration agreement, thereby avoiding the broader infrastructure arising from a note issuance. “For bilaterals, it can be easier from an issuer's perspective to deal with one counterparty negotiating documents. Of course, sourcing the size of the transaction is a key issue. Bilaterals naturally bring in larger investors, as well as allowing negotiations with a single counterparty,” Imundo notes.

He continues: “The flipside is that doing a more open option or syndicated, or flip transaction, allows the issuer to drive a bit more discovery and there are times where that can be more beneficial. As the market has grown, price discovery is less of an issue generally speaking, but there are still cases where that approach may be preferred.”

While individual deal format remains largely issuer-dependant, the trend has been for more club deals and bilateral deals than were seen in the market a decade ago.

Parker says that direct CLN structures come with other downsides. “The trouble for an investor with direct CLN structures, where the originating institution issues a note credit-linked to the reference portfolio, is that you are getting credit exposure to the institution issuing the notes in addition to the reference portfolio. So, if you're looking at one of the major financial institutions in Europe, as an investor, you might be quite comfortable with that. But if you're looking at lower credit quality institutions, then this will have a greater impact on pricing - which may give you more of a push towards an SPV issuance, to isolate against the credit risk inherent in the originator.”

Some market participants believe that direct financial guarantees are the most straightforward to execute. Their utilisation is seen as less complex, with less set-up needed and a reduced cost. The downside is that there are fewer protection providers who can execute them.

“Many investors want a CLN because they need to be able to demonstrate liquidity and theoretical tradability of their instrument, even if they don't intend to sell it. For them, the downside of the direct financial guarantee is that you don't get a CLN. For some investors, that's fine; for many, it’s not. Those investors able to execute direct guarantees, however, can use this to their advantage when banks for some reason prefer not to issue a CLN,” says Robert Bradbury, md and head of structured credit execution at Alvarez & Marsal.

Ultimately, by utilising a direct CLN, an issuer can avoid the need for certain regulatory permissions that would otherwise be required in a more conventional SPV structure. “An SPV-issued CLN structure has proved a useful way for issuers to navigate tax, regulatory, licensing and other issues in the context of European SRTs. It is not, however, of universal applicability. For example, we’ve worked with new entrants and would-be issuers who have the balance sheet to make capital relief trades desirable, but lack the requisite regulatory permissions to execute such trades via an SPV,” concludes Jack Thornber, a broker in Texel’s structured and bespoke solutions group.

SCI’s Global Risk Transfer Report is sponsored by Arch MI, Man GBM, Mayer Brown and Texel. The report can be downloaded, for free, here.

Capital Relief Trades

Inflection point?

Dennis Heuer, partner at White & Case, discusses the drivers that could facilitate a more commoditised SRT market

Q: Having historically been secretive and opaque, is the SRT market likely to transition from highly private to increasingly more syndicated deals? Are we witnessing an inflection point? 
A: I wouldn’t describe it as a clear shift but rather something I can foresee happening. Currently the market is divided between small club (often anchored by one lead investor) or bilateral deals – with one or two investors – and the syndicated deals.

More credit heavy, less granular portfolios work better with small club or bilateral deals. The syndicated trades are usually done by frequent issuers with more granular portfolios and good history of performance that are definitely getting more proficient in this exercise.

However, many issuers still opt for small club and bilateral trades. And as this market matured, more investors have emerged - notably from the private credit space - and as such, there is still no need for issuers to engage in more syndicated transactions. Additionally, I believe issuers appreciate these type of small club (preferably anchored) and bilateral relationships for reasons of transaction certainty, confidentiality and the absence of potential conflicts between many investors that you would otherwise have if you have a more broadly syndicated deal.

However, could we envision a shift in this sector moving forward? I believe that there are three factors which could lead to an increase towards more syndicated deals.

The first is that these SRT trades have been picked up quite favourably by EU regulators. What regulators do not want to see though is credit underperformance, liquidity constraints in difficult times and lack of transparency.

It has been reported that there was a functioning secondary market also in more difficult times, such as in 2020, where primary issuance had slowed down (SCI 28 April 2020). And assuming credit performance and liquidity will remain positive for the foreseeable future, I expect no specific requirement from a regulatory perspective for more syndicated deals with better tradability.

The second point is that we have a clear trend where banks, to the extent they can, are using direct issuances off their balance sheet. So, banks do the unsecured CLNs off their balance sheets, where investors are increasingly relying on their creditworthiness and their corporate rating for the CLNs to be repaid (but always subject to performance of the reference pool).

Therefore, for some banks, SRTs are becoming more of a classic DCM product - where there is, I believe, more standardisation in the areas of structure, documentation, data, but also distribution. This might incentivise banks to use more syndication to do larger deals; e.g., for consumer loans or SMEs from established platforms.

And the third point relates to SRTs in the context of the green transition. Reports are suggesting the need for a synthetic platform to assist mid-size and smaller banks that will have capital constraints under the energy transition (SCI 9 August).

It is suggested that they may build on an anchor investor or support from public institution (e.g. the EIF) and, on the back of that, there would be more private investors joining the boat. And they would also likely be okay with lower initial investments based on the idea that you can then do repeat deals of platform issuances. And that, again, shows me that it may become a bit more commoditised.

This is certainly only true for very established and more homogenous asset classes, namely consumer loans or SMEs. Consequently, we may end up with some SRTs with a different placement structure in, say, two years.

Q: Do you think the SRT market has truly been tested? How are investors likely to approach SRTs when faced with a significant downturn in the credit cycle?
A: It is hard to tell, given the opaque nature of this market. However, I do not feel that we have experienced a period of increased testing, where things were truly challenged. I believe that so far, performance has been surprisingly good on these deals, even during more difficult times as through the pandemic.

That being said, there are private investors in this market that also invest in CLOs. Generally, CLOs are much more sensitive during a crisis and need to be marked down by investors much more quickly. I heard rumours during the pandemic that certain investors considered trading their recap positions, in order to deal with the marking down of their CLO positions.

Therefore, if we were to navigate through a period where things are really difficult, or a prolonged period of stress potentially combined with negative credit performance, it may be in the industry’s interest to have a functioning secondary market for these positions.

Q: On the regulatory front, do you expect Basel 4 to be a game-changer for the SRT market?
A: I would not call it a game-changer for SRTs, but I know that the industry is expecting Basel 4 to lead to further issuance and growth of the SRT market. In my personal view, the energy transition and the global need to improve capital ratios of banks to stem the energy transition for corporates will be a much bigger market driver for SRTs.

Raising new capital is extremely expensive and also uncertain, with a volatile market [making it] difficult to achieve. From an economic perspective, the cost of capital in SRTs is reported to be below the banks’ implied cost of equity. Therefore, bringing down RWAs (which have been inflating quite a bit in the past three years) and using SRT transactions is something many institutions have realised they will need to do sooner or later.

Vincent Nadeau

Structured Finance

Value covered

LibreMax Capital cio Greg Lippmann and ABS head Kevin Tyler outline the asset-based private credit opportunity set

Q: How has the evolution of the banking system and regulatory environment over time shaped private credit markets?
GL: Before the global financial crisis (GFC), there were certain aggressive financial products which enabled consumers to become overleveraged, as well as light bank capital charges for investment bank holdings of structured products, which ultimately brought Lehman Brothers to default and spurred the Great Recession. Following the GFC, the government instituted a multitude of changes, including changes to bank participation in lending. The capital charge for securitised products increased significantly, as did the capital charge for deep mezzanine lending.

The tightening of capital requirements through the Dodd-Frank Act, now exacerbated by the Federal Reserve's aggressive rate-hiking cycle, has put the US banking system under considerable strain. This has led to reduced lending and diminished earnings power for banks.

In response, banks are strategically offloading assets, cutting back on consumer lending and engaging in credit risk transfer trades to minimise their risk exposure. As traditional banks retreat, a significant gap in credit supply is emerging. Private credit firms like LibreMax are stepping in to fill this void, particularly in sectors like specialty finance and commercial real estate, which are most affected by the pullback in traditional bank capital.

Q: How does the public credit market compare to the private credit market? Does investing in the former inform investing in the latter?
GL: Because of the aforementioned regulatory dynamics and the reticence to raise more capital on the part of the finance companies, private credit investors can get spreads that are well in excess of the spreads of the publicly traded reference security. When coupled with our team's ability to underwrite both the collateral and the originator to structure a transaction, we are able to identify extremely attractive private opportunities relative to the public counterparts – which we know well, as we are deeply involved in our public credit funds. These opportunities are illiquid and therefore require vehicles that can hold these types of assets.  

KT: Not only are we getting at least a few hundred basis points more in spread than the public market equivalent, but private credit investments are also usually accompanied by a better collateral and structure package – such as lower leverage, stronger covenants, tighter triggers and cleaner collateral selection.

From a structural perspective, particularly these days, the dynamics have shifted quite dramatically towards lenders in the sense that public markets have become less reliable for borrowers over the last 18 months, given the rate and spread volatility. As such, in a lot of cases, companies are looking for customised solutions to provide them with certainty of execution, which gives private credit players extra bargaining power. The pipeline today versus prior years is much more robust, with the ability to cherry pick opportunities.

Q: Why does LibreMax find today an opportune time to invest in asset-based private credit?
KT: Today we are seeing a myriad of opportunities to put capital to work in the specialty finance sector, where companies are struggling to access funding following a difficult fundraising environment in 2022 and 2023 and a tightening of lending standards across the board. A lot of specialty finance businesses that were on solid footing in a lower interest rate world were shaken in late 2021 and early 2022, when we started to see increasing credit losses in the subprime consumer cohort, driven by FICO score inflation, the fading of stimulus money and lax lending standards from the 2020-2021 period coming to roost. As those losses rolled through the system in tandem with the Fed’s aggressive hiking cycle, many specialty finance companies focused on subprime borrowers struggled to raise capital - be it through public market ABS programmes or private market activities - leading to where we are today.

Since the events involving Silicon Valley Bank earlier this year, another growing theme where we have been focused is constrained bank balance sheets.

GL: We are also seeing a lot of opportunity on the residential side, particularly in second liens and lending against that, because of how high rates have risen and the amount of equity that people have in their homes. Historically, many individuals and families would have moved into new homes or executed some sort of cash-out refinancing. But with rates so high, a better way for homeowners to get cash out while staying in their homes is to take out a second mortgage.

Q: How do you view the outlook for asset-based private credit in the context of the current macroeconomic environment?
GL: The macro debate in the US has centred around three possible scenarios: a hard landing; no landing, where the Fed will have to keep raising rates; or a soft landing. We believe the third scenario is least likely, but if there is a soft landing to the economy, the assets underpinning our investments will perform well.

In the hard landing scenario, where we have a recession directly, we believe that our assets are going to bend, not break. We underwrite our collateral to significant stress scenarios; we assume losses are nearly double what our base case is, and we are still whole. We therefore trust in our private credit team to underwrite the originator, the collateral and structure appropriately, so that even in a recessionary environment, we could be value covered.

Conversely, should there be no recession, but rates stay high because the economy remains strong and inflation remains higher than forecasted, we would expect the collateral backing a lot of our loans to maintain value, as such an environment is generally positive for real assets. If the economy is strong, defaults and unemployment should remain low. Plus, we benefit from higher rates, given the floating rate nature of most of our positions. 

KT: To Greg’s earlier “stress scenarios” point, we underwrite our investments assuming a recession is coming shortly, and we seek to appropriately consider potential economic weakness. Generally speaking, we expect a full repayment of principal under stress scenarios. From a relative value perspective, when you consider the macro environment and compare the potential yield one can earn in an asset-based type of investment to the dividend yield in the S&P 500, we think private credit and its downside protection are quite attractive.

Alternative assets

Ares flies high

Top alt credit investor predicts CRT boom

Ares Management, founded in 1997, is a leading investor in alternative credit products. It has US$395bn under management, of which some US$32bn, or a little under 10%, is invested in alternative credit. It recently closed Pathfinder II, one of its alternative credit funds devoted to illiquid instruments, with US$6.6bn in commitments, measurably more than the US$5bn target. It is also almost twice the size of its predecessor, Pathfinder I, which had total commitments of US$3.7bn.

SCI caught up with Joel Holsinger, portfolio manager and co-head of alternative credit, based in both New York and Atlanta, last week.

SCI: Joel, thanks for finding time to speak to us and good to meet you. So, what are the features that, in your opinion, make Ares different from others in the field of alternative credit investing?

Joel: Nice to meet you too, Simon. We have two big advantages. One of them is our flexibility. We do all alt credit products in one bucket. If you only do aircraft leasing, you’re looking at only relative value within aircraft leasing. For us, if it’s not interesting, we’ll say ‘why are we looking at this? There’s nothing to do here, so we should do something else.’ We did almost nothing in fund finance three years ago, and recently we’ve been very active. We’ve done nothing in credit risk transfers (CRT) in the last several years, yet we’ve recently been very active in this space and Ares’ view is that we’re only going to get more active. When it’s not interesting you rotate. We have relative value skills and capacity across asset classes, and we walk away from things when they’re not interesting.

SCI: You’re also a pretty big shop as well, aren’t you?

Joel: That’s right. That goes to our second big advantage, which is scale.   If you have a US$50m investment, you might meet 30 competitors. When you get to a US$100m cheque, you’ll see fewer. When you get to US$200m or US$300m, you see less than five, and there are some pretty well-known names in there. We can do scale, and we couldn’t do it if we didn’t sit on this platform because one-third of what we do is sourced from other parts of Ares.

SCI: You mentioned that you have been very active in the CRT space and are going to get bigger. Could you tell me a bit more about this.

Joel: Well, we did a US$5bn portfolio of super-prime auto loans from a US regional bank at the end of Q3, for example.

SCI: I know JP Morgan has been in the CRT market with a reputed US$25bn pool of assets in the last few weeks. Have you taken a piece of that?

Joel: We’ve been very active across all markets. We see the potential for record levels in CRT for this year and next year.

SCI: We’re hearing this a lot, of course. What’s your take on it?

Joel: Look, if you’re a bank, your liability costs have gone up because of rates. They rose 80bps between Q1 and Q3. But asset yields aren’t going up because they’re mainly fixed rates or floating rates that have peaked. If I have short duration high quality assets, and you can sell it at a good price, it makes sense. (As an example of this, Ares bought a $3.5bn specialty loan finance portfolio from PacWest in June).

But if it’s a longer duration portfolio of fixed rate assets, it’s tough to sell it so you can either securitize it or do a CRT. But if you have a low weighted average coupon, you can’t find the debt service ratio and can’t get the rating agencies on board, so a CRT makes more sense. For legacy assets like consumer loans, mortgages or auto loans, this is the better option. Remember that these are low-yielding assets but still carry 100% risk weighting, and you’re facing Basel III endgame as well. The fact that JP Morgan is out there should tell you something. The healthiest of healthy banks needs to do a lot. What does that say about everyone else? Unless we have a collapse in rates, we believe that CRT is going to get bigger.

SCI: What other areas are you looking at?

Joel: Our big areas are bank portfolio purchases, CRT, fintech and funds finance at the moment. We’re also looking at digital infrastructure, like data centres. We believe these are great assets, with great contractual cash flow, and great diversity. The downside is that there is huge amount of capex in these projects, and the borrowers are highly levered. But CRT is our biggest area, not perhaps by number of deals but by size of deals.

SCI: Do you look at deals outside the US?

Joel: Yes, we do. We do European deals and have recently added an Australian component. But the US is our biggest market by a long way.

SCI: How has the alt credit space changed in your career?

Joel: Twenty years ago, it was all run off the prop desks of big investment banks like Goldman, Deutsche, Morgan Stanley. You had players like GE Capital as well, which financed it through commercial paper. But then the crisis happened, a lot of new regulations came in, like the Volcker Rule, and it was pushed out of banks. GE Capital lost access to their cheap liability, which was commercial paper. So, specialty alt credit funds arrived, but they were generally small players that did one asset class, like aircraft leasing and fund finance.

We acquired Indicus Advisors in 2011, which was our big start in the business, but Ares has been organically evolving and growing the business over the last 12 years.

SCI: What else makes Ares special?

Joel: The charitable component of what we do is very important to us. Ten percent of Pathfinder I carried interest profit is being given to global health and educational charities, half from the house and half from the team. We partner with non-profits that have an identified track record of delivering high value per charitable dollar contributed.

SCI: That’s great Joel. It’s not all about profit for Ares then. It’s been great to chat to you and let’s keep in touch.

Joel: It’s been a pleasure, Simon.

Simon Boughey

ABS

Angel Oak ABS-focused ETF reaches US$100m in AuM

Market updates and sector developments

Angel Oak Capital Advisors, based in Atlanta, has announced its Ultra Short Income ETF, chiefly invested in ABS, has grown to over US$100m in assets under management in the year since launch. Most ultra short ETFs with assets of a year or less in duration are invested in commercial paper and Treasury bills, but Angel Oak perceived a gap in the market for such a fund mainly devoted to ABS.

Up to 50% of the fund is invested in investment grade consumer credit ABS, such as prime auto loans, credit cards loans and online loans. The remainder is variously distributed into mortgages, CLOs and corporate credit.

“We saw a huge opportunity in the short duration ETF space,” says Clayton Triick, senior portfolio manager at Angel Oak. “There are very few ultra short ETFs in ABS and we’ve seen a dramatic yield pick up in securitized instruments this year.”

The Ultra Short Income ETF was also Angel Oak’s debut in the ETF market.

Structured Finance

Job swaps weekly: BNP bulks up in Americas

People moves and key promotions in securitisation

This week’s roundup of securitisation job swaps sees BNP Paribas building out its Americas-focused advisory and solutions teams, with two senior securitisation-focused appointments among a number of hires. Elsewhere, American Century Investments has appointed two industry veterans to its securitised markets team, while Academy Securities has snapped up a senior Citi exec as md and head of RMBS capital markets and origination.

BNP Paribas has made two senior appointments in its New York office, amid a hiring spree aimed at building out its advisory and solutions capabilities in the Americas. The bank has promoted Adnan Zuberi to co-head of global capital markets and hired former Deutsche Bank md Richard Meth as head of CRE Americas.

Zuberi will focus primarily on asset finance and securitisation across its real assets and securitised products group. He has been with the bank since 2008 and is promoted from his role as md, head of credit solutions and head of CLOs.

Meth joins BNP Paribas seven months after leaving his role in Deutsche Bank’s New York office, where he led US CRE financing. He will oversee the launch of the bank’s CRE financing and securitisation activities in the region. Meth previously spent 17 years at JP Morgan.

Mark Lynagh has also been appointed co-head of global markets alongside Zuberi, with a focus on investment grade finance, leveraged finance and equity capital markets.

Meanwhile, American Century Investments has recruited industry veteran, Paul Norris, to lead its securitised markets team. Norris joins the firm as vp and senior portfolio manager from Conning Asset Management, and will be based in its New York office. Norris will co-manage nine strategies and 11 funds as well as serving the US multisector, government and income portfolio construction teams as a new member of the global fixed income investment committee.

Academy Securities has appointed Susan Mills as md and head of RMBS capital markets and origination. She joins Academy from Citi, where she held numerous senior leadership positions related to residential mortgages, including whole loan transactions, securitisation, warehouse lending and contract finance.

Whitehorse Liquidity Partners has expanded its distribution capabilities with two new hires in its capital management team. Joe Gallitano joins the firm as senior principal, head of private wealth, and Pramit Sheth joins as senior principal, head of structured products.

Gallitano has more than 18 years of experience working in private wealth and institutional fundraising. Most recently, he was principal, investor relations with AlpInvest. Sheth has over 18 years of experience in credit ratings. He comes to Whitehorse from KBRA, where he was a senior md and global head of its investment funds group.

abrdn has named Andrew Dennis head of private placements, with a focus on private credit, structured credit and real estate. He was previously head of private placement research at the firm, which he joined in August 2013. Before that, Dennis was executive director - head of EMEA ABS/structured finance sales at UBS.

Andrew Jacobs has joined Valitana as director of analytics, based in New York. He was previously head of structured finance - product management at Trepp.

Saadia Ghazi has joined Seyfarth Shaw as a partner in its servicing and special servicing practice within the firm’s real estate department. Based in New York, Ghazi comes from Bryan Cave Leighton Paisner, where she worked closely in its corporate and finance transactions group with Katie Schwarting and Amy Simpson, who moved to Seyfarth in August. Ghazi’s practice focuses on securitisation, commercial real estate finance and general corporate matters.

Bryan Cave Leighton Paisner has recruited David Holmberg as a partner in its global tax practice, based in the New York office. With a focus on private equity real estate and direct lending, Holmberg’s practice includes advising investment funds and REITs on the tax aspects of CMBS and CRE CLO investments, in particular distressed loans. He joins BCLP from Akin Gump.

NLC Capital Partners has hired a new partner, Tim Steele, to its practice in London. Steele will work with the portfolio management and the capital and deal execution teams on the firm’s fund finance and loan portfolio and investor funding channels. He joins NLC from AIG where he supported its structured products business, and most recently served as head of structured alternatives and non-US residential investments.

Newmark Group has promoted Sharon Karaffa to president for multifamily debt and structured finance, based in McLean, Virginia. Karaffa joined the commercial real estate advisory group in 2017 and is promoted from the role of vice chairperson and co-head of production. She previously spent 13 years at Fannie Mae.

Credit insurance broker Impello Global has added Cole Augustine to its structured finance advisory team in Portland. Augustine has a background in infrastructure and renewable energy and rejoins the business eight months after leaving his position as product manager at Alkami Technology. He previously spent six months as a market executive at Impello before leaving the firm in mid 2021.

Moody’s has promoted Ana Arsov to global head of private credit and co-head of its global financial institutions group. Among her new responsibilities, Arsov will promote engagement across the agency’s financial Institutions, corporate finance, and structured finance groups. Moody’s said she will also be responsible for deepening analytical capabilities for business development companies, CLOs and other private credit-related assets. Arsov joined Moody’s from UBS in 2013 and is promoted from global md and co-head of global banking.

And finally, Capcora has increased its focus on the energy transition sector with the hire of renewable energy expert, José Joaquín Muñoz Osuna. As director and head of the consulting firm’s team in Hamburg, Osuna will work to develop its debt and M&A advisory team and boost capabilities in the Iberian markets. Osuna joins Capcora from ib vogt where he served as head of project finance and PPA where he led the teams responsible for structured finance, M&A processes, non-recourse financing and PPA origination and negotiation.

Structured Finance

Manulife acquires CQS

Market updates and sector developments

Manulife Investment Management is to acquire London-based alternative credit manager CQS. The transaction will see CQS’s investment team continue to operate autonomously, though Manulife will take ownership of the firm’s brand and credit platform.

Following completion of the deal, CQS will benefit from exposure to new investors and the scaling of its distribution footprint, according to a statement. The business will continue to be led by ceo Soraya Chabarek, credit cio Craig Scordellis and ABS cio Jason Walker.

CQS has US$13.5bn in AuM and invests in CLOs, ABS, regulatory capital, structured credit and convertibles, in addition to corporate credit.

Michael Hintze, who founded CQS as a hedge fund manager in 1999, will launch a new firm following the deal. The new firm will continue to manage the hedge fund Directional Opportunities Fund and certain other mandates, which have not been included in the transaction.

Piper Sandler & Company acted as financial advisor and Simmons & Simmons was legal counsel to CQS on the deal. The transaction is due to close in early 2024.

Capital Relief Trades

CAS and out

Fannie Mae prints 8th and final CAS of 2023

Fannie Mae has printed its US$609m CAS 2023-08, the eighth and final CAS offering of 2023.

Morgan Stanley was the lead structuring manager, and joint bookrunner. Wells Fargo is the co-lead and also joint bookrunner.

There are three tranches to the trade. The A-/A- US$278m M1 has been priced at 30-day SOFR plus 150bp, the BBB/BBB+ US$206m M2 at SOFR plus 250bp and the BB/BBB- US$125m B1 at SOFR plus 355bp.

Fannie Mae retains a portion of all three tranches.

The reference pool for the deal consists of around 60,000 low LTV single family loans acquired between October and December last year with an outstanding unpaid principal balance of US$18.9bn.