Primary pause

It’s hard to write about markets when there’s a real and horrifying human crisis unfolding, and geopolitical news tearing up the last 30 years of foreign policy assumptions.

Structured finance is a relative backwater in relation to the Russian invasion of Ukraine, with no direct exposure in consumer asset classes, and limited exposure through the corporate obligors in CLO portfolios.  If you’re an FX guy, or a payments infrastructure geek, or, god forbid, an EM shop, these are extraordinary times and you have to step up and figure out how to parse the situation; in ABS land, the last week has mostly been a time to hunker down, sit on the sidelines, and grit your teeth through the mark-to-market. It’s risk-off for now, and caution is advised in catching any falling knives.

That approach, though, has a definite shelf-life — there are plenty of deals waiting in the wings for an acceptable backdrop. At this point the various “Outlook 2022” pieces in December seem wildly out of date, but most funding teams probably started this year expecting a decent window for pretty much all of Q1, and so there are certainly deals waiting to be done. 

We haven’t seen Kensington in the market yet, and, based on a quick look at the list of SPVs out there, we’d also expect Lendable, Lendco, Lendinvest, Oodle and Close Brothers to have issuance ready in the near future.

We’re interested in how warehouse terms have evolved as market conditions have soured and latterly puked. If you’re a fintech lender locking in terms for the next year or two of origination, war in Ukraine shouldn’t make that much of a difference — none of the likely endgames for the situation other than nuclear war should make a big difference to western European mortgage credit — but equally, asking banks to write big cheques when the screens are red is rarely a good idea.

Still technically live in the market is Morgan Stanley’s Shamrock Residential 2022-1, a €600m Irish RPL deal announced the day before the Russian invasion. The four investment grade tranches were listed as ‘offered’ at deal announcement, with three sub-IG tranches and the reserve fund note set up as “call desk”, following the full preplacement of Warrington Residential 2022-1, another MS-led RPL trade for Mars Capital a couple of weeks before.

We’d expect to see Shamrock get done, but wouldn’t be surprised to see it come in club format. Irish RPL/NPL deals are already something of an acquired taste, distributed to a subset of the broader securitisation investor base — the collateral is more difficult than most deals out there, and deal structures tend to be garlanded with various bells and whistles designed to compensate for the low portfolio yield and squeeze a more efficient structure out of the rating agencies.

This particular transaction, for example, includes a Yield Supplement Overcollateralisation feature (essentially, reclassifying some principal to interest), and a net WAC cap, which defers and subordinates excess interest payments. If you like your cash flows simple, this may not be the deal for you.

It’s a credit to Morgan Stanley that the bank generally tries to syndicate these issues publicly, and that policy has probably helped develop the market (in which MS has a huge share) over the years. But when the chips are down, it’s easier to get a deal over the line in a more private process.

We also saw that Generation Home (a brand of Imagine Mortgages), a  UK fintech lender focused on first time buyers, struck a warehouse deal with Morgan Stanley earlier this year. The facility was signed, according to Companies House, in the happier times of mid-January.

It might signal a change in emphasis for Morgan Stanley’s securitised products business. MS is certainly one of the Street’s top shops, with a fondness for the refinements of structuring, but it has been less present in the front book mortgage warehousing business than the likes of BNP Paribas, Bank of America, Citi — RMBS deals emanating from 20 Bank Street tend to lean towards bespoke NPLs and RPLs, legacy portfolios, and principal deals.

We might well be behind the times here — maybe MS has been shipping out vanilla warehouse balance sheet for some time, just with no bond takeouts to show for it — but we’re excited to see the competitive landscape evolve, especially with JPM making moves in a similar direction.   

Secondary markets have been active, with some fairly sizable BWICs out there — plus some small ticket lists populated by mostly <1m lines, likely to be price discovery exercises.

Still trucking?

In CLOs, we ran a study last week looking at the various leveraged issuers (primarily in bonds) with a strong Russia or Ukraine nexus — the most worrisome names, including Frigoglass, YIT and Maire Tecnimont, aren’t held by European CLOs, according to our data.

The biggest impacts in CLO land will be indirect (the team at BofA research did some nice work on this last week) but potentially large, with chemicals firms struggling with spikes in oil and gas prices, for example. Aluminium prices and scarcity could have impacts in packaging, auto components, aerospace and defence, all substantial sectors in the CLO market, though it remains to be seen how this flows through.

For some names, Germany’s massive commitment to rearmament (€100bn special fund, and >2% of GDP going forwards) will undoubtedly have a beneficial impact. Two relevant credits include Hensoldt and Aernnova, both fairly widely held across European CLOs — we looked at the impact of this military expenditure in leveraged credit for 9fin subscribers. If you are not a subscriber but would like to request a copy of the report, please complete your details.

Loans are structured to be instruments with minimal upside, so CLOs are probably not the right way to play this trade — Hensoldt (partly owned by German govt, makes sensors and optics) shares were up nearly 90% on the news of the German military spending, but the ‘best case’ for the loan is probably popping a couple of points and then a repricing or refi down the road. 

Scaling up military expenditure this fast might even mean extended capex in the short term — which could mean more debt coming down the line, or at least a hit to free cashflow — so the effects are going to be complex.

ESG considerations for defence are also…nuanced. The understandable burst of enthusiasm for the embattled Ukranian regime, which allowed the sale of a one year “war bond”, has been accompanied by commitments from many countries to arm Ukrainian troops in their fight against the invaders. This seems unambiguously good, but military financing still sits uncomfortably in so-called ESG portfolios. 

CLO managers almost all now prohibit “unconventional” weapons — cluster bombs, anti-personnel mines, chemical and biological weapons — and some also prohibit manfacturers of weapons more generally. But if we’re talking about a company like Ultra Electronics, which makes components, not complete weapons systems….does that count too? 

Primary CLO pricings have taken a breather this week, with general sentiment being more of a driver than a nuanced view of the underlying individual credits on a deal-by-deal basis. In a risk-off environment, steer clear of high beta products like CLO junior mezz — it’s that simple. 

But there are still some deals in the market, with CVC Credit and Napier Park marketing deals. Indicative levels have moved a fair bit wider, in line with broader risk asset conditions, but certainly haven’t collapsed — senior notes might come in the high 90s or even break 100, but that’s no worse than, say, last October. Managers with new issues nearly ready are probably anxious to get on and ramp, and may see few medium term catalysts to bring levels back to early Jan levels. If you’re going to go at some point in the next couple of months, why not now?

Judgment Day

Wednesday finally saw the judgment handed down in Rizwan Hussain’s contempt of court case, Business Mortgage Finance 4 PLC and others v. Hussain and others (FL-2020-000023).

It turns out he’s guilty! Not on all of the counts, but three of the seven, with others proved in part or substantially proved. Only Count One was considered “not proven”. Read the judgment for all the details. The case basically turned on whether the various parties which continued to attack the Business Mortgage Finance deals following Rizwan’s 2021 release from prison were controlled by, or actually were, Rizwan himself, and therefore he was in breach of an earlier injunction telling him to stop. 

There was no show-stopping smoking gun uncovered by the Simmons & Simmons team and their investigators, but there was plenty to satisfy the judge. Even on some of the counts which were not proven, the judge was satisfied Rizwan was directing proceedings, just not that these were necessarily a breach of the injunction (e.g. a request to Barclays for info on issuer accounts for BMF).

Rizwan himself remains elusive, however. The judge did tell him (via his representatives) to show up to the sanction hearing on March 11 (which will determine the punishment for the contempt judgment), but the judge has told him a lot of things over the years, and he has not followed through. The arrest warrant issued last month remains in force, and was actually strengthened from its original version to allow forcible entry — the police tried to find him at various addresses, without success, and even his solicitors (he applied, somewhat late, for legal aid representation) don’t know where he is.

He does have the right to appeal, and his past preferences seem to indicate a fondness for any possible delaying actions, but it seems unlikely that an appeal judge would look kindly on his continued evasion of the arrest warrant. 

Separately, it’s also possible that one of his preferred routes of attack will be closed down in future — UK Companies House is supposed to be cleaning up its act, with a 124 page white paper on “Corporate Transparency and Register Reform” published this week.

The target is really money laundering through UK companies, rather than Rizwan’s rather niche shenanigans, but it should speed up the response of Companies House to false claims of director appointments.

As the white paper says, “It is time-consuming to remove fraudulent appointments from the register – under the existing legislation a victim must prove to Companies House that they are not the director and wait 28 days before the appointment is removed from the register. In the case of Person with Significant Control registrations, a court order must be obtained by the victim in order to remove a fraudulent registration – this can be costly and stressful for the victims.”

Under the white paper proposals, Companies House will have the power to reject and query new filings, and query existing filings. It will also be required to verify the identities of those filing at Companies House. Given I need to show my passport to register with a doctor, you might think something similar was needed to set up a company. But you would be wrong.

This wouldn’t stop all of Rizwan’s schemes — several appointments were in his own name — but a further requirement that “corporate directorships be restricted to entities registered in the UK” would have blocked his Marshall Islands or BVI vehicles.

Just like everything else

The European Banking Authority published its report on “Developing a Framework for Sustainable Securitisation” on Wednesday, and the big headline is…..it doesn’t recommend a separate framework out of the gate, but an adaptation of the EU green bonds standard.

That’s basically good news for the industry in short term — instead of a complex parallel piece of regulation which requires green reporting, due diligence in greenness, and adds to the cost and obstacles to issuance, the standard basically just requires issuers to say “we’ll use this piece of funding for green purposes going forward”, the same basic idea as in a corporate, financial or government green bond.

PCS, a third party verifier, said that the EBA should be commended for its “logical, coherent and fair approach”, and described the document as a “a well thought through and excellent report that deserved to be a building block on the path to mobilising the securitisation market in financing the desperately needed ecological transition”.

If the upside to the report is “it’s quite easy to do green securitisations”, that’s the downside as well.

Securitisation, with full transparency to the underlying assets, is arguably the best placed capital market to go really deep green, and structure instruments where investors can be 100% confident their cash is flowing into green assets. 

Even the most robust corporate green bond runs up against the issue that money is fungible; green bond proceeds just go into corporate treasury exactly the same as anything else. Earmarking or ring-fencing green use of proceeds says nothing about the broader impact of a company, if it continues to run a “brown” funding shelf in parallel.

Structured finance is different — the assets in the SPV back the deal, nothing else, so the money raised is, in a very literal and theoretical sense, not fungible. It has to be used to purchase the SPV assets, so investors in green securitisation notes know they’re getting something really green. As it’s also capable of offering capital relief, this capital can additionally be earmarked for recycling into new green assets, so it’s possible to evidence direct, as well as indirect support for green lending.

In another sense, though, the EBA approach honours the practical use of securitisation by banks and corporates. It really is just another funding tool, so why treat it differently from a green covered bond or a green unsecured bond? This is explicitly part of the EBA’s reasoning — according to the report, its approach “would also ensure that securitisation is treated in a consistent manager as per other types of asset-backed securities” (presumably covered bonds).

This model implicitly assumes front book securitisation from an entity of substance — bank or specialist lender deals, for example — rather than one-off legacy deals sponsored by financial investors. But these older portfolios are unlikely to be seeking a green label in any case, and probably don’t have the environmental data that would be needed for a collateral-based version of sustainable securitisation.

Perhaps a more serious omission is in the CLO market, where the focus on the “originator” being able to redeploy the “green securitisation” proceeds into other green assets a la green bonds doesn’t make a lot of sense. Despite the “entity of substance” requirements, CLO originator vehicles don’t do a lot other than acquire leveraged loans to securitise, so a green bond use of proceeds approach just means….it will be able to acquire green loans. And if it could do that, why not just use them to back the first CLO?

But this doesn’t necessarily matter — given their managed nature, CLOs taking a different route to ESG branding, aligning themselves towards the fund management sustainability regulations of Article 8, and pushing ahead with their own ESG screening approaches for underlying assets. Unless some capital benefit crops up down the road, CLO managers are unlikely to care about doing labelled green deals. We’ve talked already about the excellent work White & Case has done covering these developments, but in the interests of balance, we also found this study from Millbank, published last week, pretty useful and worthwhile.

The EBA is explicitly recommending its approach for the transition — a full-blown green securitisation scheme might come down the tracks later. Tantalisingly, this might also come with a capital benefit….but not any time soon. The regulator is looking at a “dedicated prudential treatment for sustainable securitisation”, but the report isn’t due until 2025.

We suspect the same kinds of issues will crop up in three years time — lack of good quality data, a desire to avoid adding new and burdensome disclosure rules, and a lack of clearly “green” underlying collateral — but let’s park it for now.

Motherhood and apple pie

SME financing is the capital markets equivalent of motherhood and apple pie — every regulator and every lobbyist is in favour, and it can be used to justify all kinds of measures, including lunacy like the SME Supporting Factor (that’s the bit in European capital requirements rules that says “imagine SME loans are only 75% as risky as everything else with the same credit characteristics”).

The securitisation industry has been masterful at using the SME argument, despite the fact that very little of the actual securitisation dealflow is backed by SMEs.

But there is a real issue at the heart of the SME obsession — lots of SME loans are basically too small to do proper corporate credit work on, so small business owners end up having to do personal guarantees or collateral, or pay excessively high spreads, or simply fail to get the credit they need.

Securitisation is also uniquely well-placed to help — even if in practice, there isn’t very much SME securitisation, it is the only capital markets instruments that can, in theory, connect institutional investors directly to SME lending.

So new attempts in this direction are always worth a look. Last week, a deal called Aquisgran was funded for the first time — a new structure set up by the Spanish regional SME guarantee funds, the SGRs. 

These public bodies have a longstanding programme of guaranteeing SME loans on bank balance sheets, but have been trying to find a way to break out of the banks and fund their loans directly in the capital markets.

The Aquisgran deal doesn’t do that, exactly — the €150m in notes from the new securitisation, of which €35m is drawn so far, will be subscribed by ICO, the Spanish development credit agency, and guaranteed by the European Investment Fund — but it does point the way to developing a bigger market down the road.

For the first deal, though, there are four layers of state-supported capital involved here — regional guarantees on the underlying loans, counter-guaranteed by the national guarantee scheme, Cersa. The region guarantee schemes also credit enhance the deal, subscribing for the 17% junior piece. The guaranteed loans are packaged up and the senior tranche is bought by another govt-guaranteed entity, ICO, which is counter-guaranteed by an EU-level institution, the European Investment Fund.

Cersa isn’t rated or explicitly supported by the Spanish government, so the notes are not credit-linked to Spain, at least for rating purposes — hence the credit enhancement.

The EIF has been….enthusiastic in its deployment of capital into SME securitisations, pretty much sewing up the synthetic SME guarantee sector. “Firehosing money” and “buying the entire market” are comments we’ve heard, but isn’t that the point of public sector support? If you just do deals that someone else would have done, at prices in line with the market, it’s not really going to make much of a difference.

The point of the EIF’s involvement here is to support a proof of concept — once there’s a track record to look at, and experience of the regional guarantee schemes paying out promptly and in full, then similar deals can be sold out into the market.

At the levels on offer in this deal, the bonds look like a bargain — they pay a fixed 85 bps spread to Bonos, for senior notes with 17% credit enhancement backed by collateral already guaranteed by the Spanish public sector. There’s a liquidity premium vs govvies of course, but it sure looks like free money, if ICO can spare any bonds…

The EIF is unlikely to stop at Spain — it’s got a broad European mandate, and there are plenty of other national guarantee schemes that might be watching with interest…