Contents

Capital Relief Trades

On the up

Nordic reticence towards SRT "less pressing"

The Nordic and Baltic countries are expected to experience a “not-insignificant” increase in SRT issuance in 2024, with their somewhat self-imposed supervisory reticence towards the instrument taking a back seat amid other market drivers. Indeed, the implied supervisory concerns across the region appear less pressing now, given greater regulatory transparency around synthetic securitisation and the designation of SRTs as a strategic area by the ECB.

Jonas Bäcklund, head of group structuring at Nordea, says SRT deal volumes in the Nordic region could possibly even double compared to previous years. “Nordea kicked this off in 2016 with our inaugural transaction, which has been followed by additional deals in the previous few years, while also acting in a capacity as arranger for other Nordic banks. We expect to remain active in this space to the benefit of our customers and shareholders alike, possibly broadening the scope of referenced assets.”

One of the key concerns regarding SRT transactions from the region was so-called flowback risk, a term for risk and related capital returning to bank balance sheets at deal maturity. In this spirit, in 2017, Sweden’s financial supervisory authority released guidelines on this, voicing its discomfort.

The move hampered securitisation activities in the region, despite rising capital requirements and the emergence of shared regulation between Sweden and much of Europe, with local banks sticking to more traditional means of raising funding (via covered bonds) and capital rather than through SRTs.

Bäcklund observes that flowback risk per se is not controversial; on the contrary, it’s commonsense banking. “If you use SRT, you have to make sure you have a check on these maturity profiles, so you don’t try and rollover these transactions when the market may not be open. It might be unusual in a European supervisory context, but I don’t think it’s controversial,” he explains.

He adds that these initial concerns may have also “resonated” across the Nordic landscape, including Denmark and Finland - although explicit guidance of this kind wasn’t issued in those jurisdictions. Meanwhile, Finnish banks have worked with the ECB, which in turn hopes to reduce the stigma around and increase the issuance of SRT. Finnish banks have also been slow to issue synthetic securitisations. 

Finally, Norwegian adoption of the EU Securitisation Regulation - which would set out a general framework for securitisations within the EU and the specific STS framework - is still ongoing. Implementation is currently expected in Q2 or Q3, with the delay believed to be due to the EEA implementation backlog for financial regulations, which has become quite substantial in recent years.

Bäcklund gives other reasons for the Nordic region’s sluggish uptake of SRT. He says in addition to Nordic countries’ resilient economies also in the face of the 2008 financial crash, banks remain well capitalised and had (and still have) above average profitability and valuations. This meant they were less motivated to use SRT.

He adds: “In my opinion, the authorities were very happy with the gold-plated regulations in the Nordics too.” Bäcklund is overall keen to emphasise, however, that the market is moving in a positive direction.

Joe Quiruga

ABS

CMBS slide

Commercial real estate values falling with no bottom in sight

Collapsed commercial real estate values, which will not recover for perhaps half a decade, will drive expected losses in office loans within its rated US CMBS conduit portfolio of 7.7%, according to a new report by Fitch.

This is more than double the expected losses at time of issuance, and also well above the overall average loss of 5.2% for all property types.

The CMBS sector constitutes about 10% of the market for office financing, with traditional bank lending making up about half and the non-bank lending from insurance companies, REITS and others the remainder.

Office values have fallen about 35% since the start of the Covid 19 pandemic compared to the drop of 47% seen in the global financial crisis of 2008/2009. But it is now 47 months since the start of the pandemic and values are still dropping, whereas 47 months after the start of the financial crisis values had already recovered to about 80% of their pre-crisis levels.

The figure of 35% is an average, of course, and some markets have seen markedly higher losses. San Franciso, for example, is trending at much deeper losses than this.

Nor is the bottom in sight. About half the number of current office leases were signed pre-pandemic before the working from home phenomenon, and as these leases roll over the next several years tenants will likely downsize and pay reduced rents, points out Melissa Che, senior director, structured finance and CMBS at Fitch Ratings in New York.

"Fitch projects US CMBS delinquencies in 2025 will surpass what was seen in the global financial crisis. Defaults haven't peaked yet. This cycle is different from the global financial crisis in that it isn't just driven by interest rates but also by secular changes in the office sector itself," she says.

According to the report, Fitch expects the CMBS office delinquency rate to more than double from 3.6% as of February 2024 to 8.1% in 2024 and 9.9% in 2025, surpassing the post-financial crisis peak.

CMBS loans generally have 10-year maturities, and 2014/2015 loans were originated at 4% - 4.5% coupons. Borrowers face refinancing these loans at current 6.75% - 7% mortgage rates. "Making up this delta has been a sticker shock to some borrowers. Even if your property cash flow hasn't gone down since origination, you have already eroded some or all of your equity," says Che

In fact, the cash flow is also likely to have been impaired by higher real estate taxes, higher insurance premiums and higher costs in general due to inflation.

The commercial real estate sector may not show signs of recovery until the end of the decade, and even then it is unlikely to recover all the ground lost during the seismic shifts in the dynamics of office financing seen since the start of the 2020s.

Simon Boughey

Capital Relief Trades

Nordic SRT prepped

SRT Market Update

Nordea is believed to be on the brink of closing an SRT transaction. The move comes amid expectations that synthetic securitisation issuance volumes in the Nordic and Baltic regions could increase meaningfully this year.

The deal, which could close as early as this week, references a portfolio of mortgages. Munich Re is understood to be the protection seller.

One source observes: “If the issuer is looking for duration, (re)insurers with more durability are a natural home for this kind of risk. Especially if you think about draw down.”

Five years is the typical duration for this type of deal. While no specific details on pricing have come to light, another source suggests that a “very low number” was shown in terms of spread and the tranche thickness is “very thin” at just over 2%.

SRT activity in Denmark, Finland and Sweden has historically been relatively low. This was principally due to concerns about flowback risk, the term for risk returning to bank balance sheets at deal maturity.

Joe Quiruga

Capital Relief Trades

CRAFT 2024-1 prints

DB's latest corporate SRT unveiled

Deutsche Bank has executed the latest synthetic securitisation from its CRAFT programme. The significant risk transfer transaction – named CRAFT 2024-1 – references a US$4.6bn portfolio of global corporate loans. 

Structured as a CLN, the trade features a US$368m first-loss tranche (0%-8%), which priced at SOFR plus 9.25%. Consequently, the print is materially tighter than last year’s trade, which landed at SOFR plus 11.75%. The replenishable transaction has an approximately 7.5-year scheduled maturity and is structurally broadly similar to prior CRAFT trades. 

“CRAFT 2024-1 is part of our flagship CRAFT synthetic securitisation programme, under which we issue regularly for risk management purposes. The transaction was substantially oversubscribed, and we again experienced strong interest from accounts that have historically not invested in our SRT programmes. We remain focused on broadening and diversifying our investor base across our SRT shelves and plan to issue further transactions during this year,” says Oliver Moschuering, global portfolio manager for strategic corporate lending at Deutsche Bank.                                                                                                                   

Vincent Nadeau

Capital Relief Trades

Capital call exposures on offer

SRT Market Update

NatWest is understood to be in the final stages of executing a synthetic securitisation of capital call facilities.

Two investors are said to be left in the running for the deal, which references a portfolio composed of facilities to investment funds, mostly located in Europe and the US.

An early version of the deal is believed to have featured a 0%-4% tranche thickness, with a 700bp spread. One source suggests that the spread may have since been reduced to around 600bp, but that any level below that “would seem too tight”.

Joe Quiruga

Capital Relief Trades

More of the same, only more so

SRT market update

Deutsche Bank printed its latest Craft synthetic securitization, NatWest is about to print a securitization of capital call facilities while Nordea is believed to be on the brink of closing an SRT in what was another brisk week of business in the European SRT market.

Meanwhile, across the Atlantic, additional details emerged about the US$346m auto CLN from Bayview Opportunity Master Fund VII 2024-CAR1 which printed at the end of last week. This note references a pool of US$2.7bn auto loans originated by Huntington National Bank. The latter is also rumoured to be looking at the market in its own name.

Craft 2024-1, which references a US$4.6bn portfolio of global corporate loans, printed at SOFR plus 9.25%. Once again, this is inside what investors were used to last year, but spreads have narrowed appreciably this year.

Not only is Deutsche a high quality name and this is a portfolio of high quality assets, there are more investors clamouring for a slice of the pie than hitherto and European banks also seem to selling narrower spreads as well.

As a market source says, “I don’t know if the US spreads are as tight as Europe as the tranches are thicker. I think spreads are wider in America compared to Europe – European banks seem to selling very thin tranches.”

In fact, the narrowness of spreads in US deals have also raised eyebrows lately. The recent US Bank was much richer than would have been the case in Q4 2023, say.

NatWest is expected to sell a 0%-4% tranche – which is thin by anyone’s estimation – at plus 700bp though there have been rumours it may test the waters at plus 600bp.

As an indication of the more competitive conditions, last year’s Craft deal sold at SOFR plus 11.75%, fully 250bp wider than this week’s transaction.

The Nordea trade could well be the herald of “not insignificantly increased” SRT issuance by Nordic borrowers, SCI reported this week. Synthetic securitizations tended to carry a “Beware” labelling in Nordic countries due to flowback risk, but this stigma is diminishing.

Eastern Europe is also looking like it might take off. “Poland will see more activity. We have heard from some banks that they are considering. I think Unicredit did something. I think Santander did too,” says a source this week.

US issuance is to a certain degree constrained by the waiting game for the Fed and its possible softening of the highly controversial Basel III Endgame rules. However, the market has by no means closed. Issuance in the US is expected to pick up in Q3, says a market watcher.

As we move into Q2, market conditions and deal business is expected to remain unchanged to busier. “More of the same is expected deal wise. We expect banks to do about the same as last year and a bit more. I expect more deals that last year, but subject to macro economic conditions. Pricing will be more and more of a challenge because more investors are entering the market,” summarizes a London source.

Joe Quiruga    Simon Boughey

Structured Finance

SCI Start the Week - 25 March 2024

A review of SCI's latest content

Last week's news and analysis
Job swaps weekly: ARMOUR reveals successors to Gruber
People moves and key promotions in securitisation
Motor finance review sparks RWA optimisation
Close Brothers plans plus updates on Enpal’s warehouse & a Redwood-CPPI JV
NCSLT found to be 'covered persons'
CFPB ruling plus updates on an RWA breach, Non-neutrality & Scope’s fine
Regional clamour
Fed approves Truist, Huntingdon in the market as regionals seek SRT balm
Tight print for Broadway
SRT Market Update
Plus
Deal-focused updates from our ABS Markets and CLO Markets services

SCI In Conversation podcast
The latest episode is a special for International Women's Day in which SCI deputy editor Kenny Wastell speaks to Ruhi Patil, a counsel in Dentons' London office, about gender diversity and inclusion in the structured finance industry.
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 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
ESG Leaders’ Securitisation Summit
16 April 2024, London

2nd Annual Esoteric ABS Seminar
30 May, New York

Emerging Europe SRT Seminar
18 June 2024, Warsaw

CRT Training for New Market Entrants
14-15 October, London

Women In Risk Sharing
15th October, London

10th Annual Capital Relief Trades Seminar
16 & 17 October 2024, London

2nd Annual European CRE Finance Seminar
November 2024, London

Capital Relief Trades

Bayview bonanza

Spreads for HNB via Bayview auto loan CLN

Further details have emerged about the US$346m auto credit-linked note from Bayview Opportunity Master Fund VII 2024-CAR1, which was reported at the end of last week.

The transaction, issued by SPV Bayview Opportunity Master Fund VII, references a $2.8bn pool of car loans, which were originated and serviced by Huntington National Bank (HNB). It was arranged by Bank of America, say sources.

Payments on the notes are linked to a CDS transaction between HNB and the issuer, with HNB as the protection buyer. The deal, notes Moody’s, is different compared to other bank issued CLN transactions referencing auto loans, in that the notes are issued by an SPV and not the bank buying the credit protection. As such, HNB does not retain any part of the residual risk in this transaction.

Bayview is an investment platform which specializes in mortgage and consumer credit. It is a regular issuer in various ABS markets through SPVs. It appears it acquired the original portfolio from HNB at the end of last year.

The auto-linked note consists of six classes, rated Aaa to B3. Sources say the A tranche was priced at SOFR plus 110bp, the B tranche at plus 130bp, the C tranche at plus 150bp, the D tranche at plus 205bp, the E tranche at plus 360bp and the F tranche at plus 700bp. Bayview was unavailable for comment.

Huntington Bank is also rumoured to be in the market with another trade in its own name, though there is no confirmation of this. It has also been unavailable for comment.

Simon Boughey

ABS

Navigating market volatility

Mike Nowakowski, md and head of structured products at Conning, outlines the opportunities for yield and portfolio diversification offered by esoteric ABS

Institutional investors navigating market volatility increasingly seek asset classes offering unique yield opportunities and portfolio diversification. One such asset class garnering attention and capital is esoteric ABS.

Esoteric ABS are very similar to traditional auto and credit card ABS, but the collateral may be less familiar. Most esoteric ABS deals can be divided into three large categories based on their collateral: consumer, commercial and/or digital infrastructure.

Benefits to institutional investors
Since the pandemic, rotation into structured products has grown as investors diversify into asset classes that offer structural protections with shorter duration. Esoteric ABS offers investors a similar (or higher) spread level to longer duration investment-grade corporate bonds, but at a fraction of the duration exposure.

Not only are esoteric ABS alternative choices from an investment product perspective, but they also offer a diverse set of collateral options, including prime consumer, subprime consumer, the shipping industry, construction equipment, digital infrastructure and others. Additionally, esoteric ABS currently offer yields at a premium to traditional ABS, as well as other assets of similar quality and duration.

Both from a spread-tightening perspective, as well as a fixed-rate, duration-additive perspective, esoteric ABS will serve a useful purpose for investors’ portfolio allocations going forward. For investors that are also invested in other structured credit asset classes like CLOs, adding fixed-rate duration on the front end of the curve in an environment where the Fed is poised to cut rates should be a good complement.

Changes since the GFC
Many may remember esoteric ABS from the 2008-2009 financial crisis. However, much has changed since then.

When most of us think of the deals of that era that experienced heavy losses, we think of over-levered consumers with subprime mortgages at high debt-to-income ratios. But esoteric ABS are very different from legacy RMBS products.

For starters, the collateral backing esoteric ABS deals is not mortgage-related. In addition, the underwriting process has become more efficient, and lenders have done a much better job at managing the risk within their respective credit boxes. Most importantly, the structural protections in esoteric ABS deals issued after the financial crisis have higher levels of credit enhancement.

Levels of credit enhancement at the single-A level across various subsectors more than account for the level of 60-plus day delinquencies currently seen in the market. Even if all those delinquencies came through as defaults, there would be sufficient credit enhancement to enable these tranches to continue to pay principal and interest to investors. Additionally, rating upgrades are common in esoteric ABS, as many deals amortise over time and build credit enhancement in the process.

Navigating the current market
Present day, the current interest rate environment has affected the asset class, but opportunities persist. Performance for esoteric ABS was challenged in 2022 as the Fed embarked on an aggressive rate hiking campaign and spreads widened into the broader risk-off environment.

Consequently, the inverted nature of the Treasury curve at present makes the front-end of the duration spectrum very attractive. Add wider spreads on top of that, and esoteric ABS offers a very attractive entry point and an appealing yield per unit of duration.

There are a few dynamics driving the esoteric ABS market, but two are currently commanding a lot of attention from investors and managers alike.

One is the Red Sea conflict, which has global ramifications for the shipping industry. Container ships are rerouting around the Horn of Africa, adding 20%-30% to travel time, which is causing shipping rates to reprice significantly higher.

This is a challenge for the shipping industry, but it’s great for container lessors (who issue ABS deals) because operators will need more containers and more container ships to make up for the delay in deliveries. As a result, container utilisation and demand will rise, improving the fundamentals of container deals.

The second dynamic concerns the aircraft industry, which has also been in the headlines. However, there are reasons to be optimistic about lessors in the space.

There is a global shortage of aircraft, particularly engines, now that air and passenger traffic is back to pre-pandemic levels. Narrowbody aircraft and engine lease transactions offer solid fundamentals and typically come at very attractive spread levels.

What to expect in 2024
For the remainder of 2024, there are two items on the radar that are significantly affecting the esoteric ABS market. They include the evolution of the US consumer and the rise of digital infrastructure and artificial intelligence (AI).

The health of the consumer has been a big topic of conversation during the past 18 months, but it is more nuanced than the US consumer en masse; data show that it has been a story of the prime consumer versus the subprime consumer.

The prime, homeowning consumer has enjoyed rising home prices and equity markets as well as an increase in wages. As a result, delinquencies for prime-related ABS collateral have been well contained.

On the other hand, delinquencies are rising above 2008-2009 levels for subprime auto and unsecured consumer loans as inflation has affected the lower-FICO-score, paycheck-to-paycheck borrowers to a greater extent. However, the market is approaching an inflection point in delinquencies and can expect better consumer metrics into 2024.

The recent rise in AI has led corporations and individuals to demand greater computing power. This has led to an increase in corporate capital expenditures in digital infrastructure.

As a result, there has been significant growth in digital infrastructure-related ABS in the form of data centre and fiber network deals. Data centres offer cashflows backed by the leases on the centre’s tenants, which can vary by scale in the form of colocation, wholesale and hyperscale. As the need for computing power (and more importantly, space) expands, growth and subsequent issuer tiering in this sector will continue to develop.

With borrowing rates poised to come down this year, we anticipate a good year of issuance in the ABS space and are optimistic about the fundamentals. Through ongoing evolution and adaptation to market conditions, esoteric ABS are poised to play a significant role in institutional investors' portfolios, offering both stability and yield in an ever-changing financial landscape.

Capital Relief Trades

Hot, hot, hot!

Four takeaways from IMN's SRT Symposium

SCI attended IMN’s SRT Symposium at Clifford Chance last week. Based on our takeaways from the conference, here are the four things every SRT enthusiast needs to know:

1. Investor interest

“SRT is seriously hot!” Kaikobad Kakalia, cio of Chorus Capital Management and a speaker on the first panel of the day, told audience members. “Taylor Swift was asking for due diligence just the other day!”

While significant risk transfer may still be a tad too esoteric for popstars, the quip alluded to a serious point. Audience numbers at the event had swelled compared to previous years, due to an influx of new investors to the SRT market attending.

The draws to SRT are three-fold. Increasing RWAs and capital requirements have made the technology an attractive prospect, and a necessary one, given that last year the entire European banking sector was only as profitable as JPMorgan (a single bank).

ESG concerns and the pressing need for an energy transition also play a role. Harry Noutsos, md at PCS, observed: “We realise we need to change our economy – that took 100 years last time, but we need to do it in 15-20 years.”

But one concern with a flood of new investors (as Taylor Swift will have told bankers in their negotiations) is that a bigger entourage means a greater number of non-serious actors. While Kakalia insisted “Covid investors stayed” because the market scaled to support them, other market participants said privately that many of these new investors could be “tourists”, who only stick around while the market is hot.

Charis Edwards, portfolio manager at Orchard Global, asked: “Will investors still be as interested when the spreads continue to go down?”

2. Squeezed spreads

Recent deals have seen spreads tighten, with supply and demand dynamics altering due to the flood of investors in the market. One participant recently estimated that deal spreads are 200bp-400bp tighter than last year, although others dispute this.

Kaelyn Abrell, a partner at ArrowMark, pointed out: “We have US$20bn-US$25bn in the US SRT market – but the banking sector is a trillion dollar market, so we need to keep in context that this is still a growing market with too much money chasing too few assets.”

She advised issuers to have a core group of investors who will “be with you through market problems”.

James Parsons, partner at PAG, added: “The issue is not too many investors, but too many investors for the supply that there is. In the past, supply and demand has been fairly well balanced.”

3. The Endgame

Negotiations over the Basel 3 Endgame drag on, but conference-goers believed that more clarity on the proposals will emerge soon, with the effects less stringent than initially feared. Its conclusion should also offer some clarity to those concerned about tourist investors.

Alastair Pickett, portfolio manager at Chenavari Investment Managers, said: “There are new investors, but the market does tend to find an equilibrium through time. Maybe we are reaching that point where we can find a balance. We need to keep our eyes on the US: the Basel endgame will decide how interested the market is.”

4. Where’s hot?

Finally, panellists provided some indications as to which geographies are the most exciting for SRT investors right now.

Central and Eastern Europe is of interest. Alongside the well-established SRT activity in Poland, issuers in Czechia, Slovakia, Estonia, Hungary and Romania have all started to gear up.

Xavier Jordan, cio at IFC, observed: “CEE will not be as big as western Europe, but it will be very interesting, particularly if you already have a presence with banks in other markets.”

Matteo Palumbo, a vp at Intesa Sanpaolo, said existing markets may also include new areas on investment: “In Italy, we see the local banks have a presence in tourism and other sectors – but we also see a lot of portfolios with space for SRT.”

Further afield, Latin America is also showing signs of life. Ed Parker, partner at Mayer Brown, revealed he had worked on Santander transactions in the region with two unfunded, large portfolio SME deals in Mexico and Brazil, with the latter closing in December.

David Saunders, Parker’s fellow panellist and an executive director at Santander, added: “LatAm came back to the table. We were actually working on a transaction in Chile last year, which we’re hoping to close this year.”

Joe Quiruga