Market Wrap

Excess Spread - Mortgage shakeup, Rizwan (again), funding car subscriptions

Owen Sanderson's avatar
  1. Owen Sanderson
16 min read

Release the prisoners!

The Bank of England dropped a minor bombshell in its December Financial Stability Report, with a promise to consult on withdrawing the “affordability test” recommendation early in 2022. 

This technical-sounding tweak could mean big changes for UK mortgages.

The “affordability test” stresses UK owner-occupied mortgage repayments as though interest rates were 300 bps higher than the reversion rate in the mortgage contract. 

So a prime-ish borrower such as myself might sign a two-year fixed deal at 1.24%, reverting to 3.59% once the fixed term is up (I’m using Nationwide’s numbers for, uh, refinancing my house). But Nationwide has to underwrite making sure I can cover a rate of 6.59%, thanks to the affordability test.

Making sure borrowers can afford their mortgage is a laudable financial stability aim but….Bank Rate hasn’t been over 1% since the financial crisis, and the UK Gilts curve suggests rates aren’t going near 6% in a hurry — despite Thursday's rate hike to 0.25%.

The Bank of England isn’t changing other hard limits to lending though, such as the loan-to-income cap (don’t lend more than 4.5x income) — which would likely remain the binding constraint for certain categories of borrower, like the single first-time buyer looking to buy a pricey London flat.

Lower income borrowers buying cheaper properties, though, are likely to find the changes makes mortgage-hunting easier, because their constraint is not absolute debt quantum but assumptions about how easy it will be to service that debt. The Bank of England estimates that 6% of mortgagors could have borrowed more money without the 300 bps affordability stress.

The biggest beneficiaries of all could be the “mortgage prisoners” — pre-financial crisis borrowers stuck on relatively high reversion rates, and unable to refinance because their loans have been sold to an inactive lender or financial investor, such as Pimco or Cerberus, and because they do not meet affordability criteria introduced in 2014. Change the affordability assumptions, and some of these borrowers could happily refinance out of their loans, perhaps accelerating the paydown of legacy RMBS deals.

Much depends on the magnitude of the change. Buy-to-let loans include a 200 bps stress test, and there’s no very good reason why the stress should be lower for BTL than for owner-occupied. 

But the Bank of England is in the business of financial stability, not particularly of supporting mortgage markets or house prices, so it seems likely that some kind of interest coverage stress will remain in place, even if it’s smaller than the 300 bps in place at the moment.

The next generation of CRE CLO?

European CRE CLOs are a small market of, uh, one deal so far. And not an especially large one either. We’ve already written a bunch about Starz Mortgage Capital, and about the likely follow-on pipeline, from some of the bigger beasts in CRE debt — the likes of ApolloStarwoodBlackstone and Brookfield.

The first generation of European deals will likely all be static — simply applying leverage to a portfolio of smaller CRE loans, with the manager/originator holding the equity in the deal. This effectively competes with private loan-on-loan financing, which offers asset-level leverage on CRE debt exposures.

But a step beyond that is to bring in third parties to provide the equity, as frequently occurs in the leveraged loan CLO market. Equity and manager are usually a partnership, at least to some extent, but may be set up in different ways, with equity funders looking across high yielding alternative fixed income, while managers specialise in leveraged loan credit picking.

Copy that model across to CRE, and you have something a little bit like the new deal Linus Digital Finance and Bain Capital have just struck (alongside an unnamed German bank). 

All we know from the press release is that it’s a €183m “funding line” which will “accelerate the growth of its real estate financing business in the UK and Germany”, with Bain also acting as “a strategic partner for the expansion of LINUS' successful real estate private debt business into other European markets”.

Essentially, Bain is providing the capital for Linus’s origination warehouse, with the bank taking a senior position — just like a CRE CLO warehouse with third party equity.

Asking around, it seems like this market has been rumbling away behind the scenes for some time, with the crucial difference here being that Linus is listed, and so has an interest and an obligation to press-release the transaction. It's not so much the first deal, as the first to poke its nose out in public.

Funds playing in the real estate and alternative credit space have been willing to contribute equity into CRE warehouse lines for capital-light lenders for years — though these run the gamut from smallish development loans, which tend to be in true securitisation structures, to the €10m-€40m loans which are the sweet spot for CRE CLOs, and may be in more bespoke, discretion-based vehicles.

Still, it’s another solution adding to the toolkit of lenders looking for leverage, and further cements the role of non-banks in providing traditionally bank-like facilities.

Fun with Finn

Sitting down with one of the top securitisation bankers in Europe the other day, we got to talking about new products, and they seemed pretty excited about the evolution of auto finance promised by the car subscription services. 

These are essentially short leases, promising that customers will get to drive new cars, regularly refreshed, with high flexibility over models and all the costs of ownership bundled together. Cars-as-a-service, if you buy the hype.

Several of these services are currently run by the car manufacturers themselves — Jaguar Land Rover has a service called Pivotal, for example — but some are separate fintechs, such as the UK’s Cazoo or Germany’s

Finn is what we’re interested in here, because Credit Suisse and Waterfall Asset Management have just struck a €500m deal to fund Finn’s inventory. We couldn’t get the deal terms, but it’s safe to assume Credit Suisse is senior, Waterfall junior, with Finn (which raised a $20m Series A in December 2020) probably contributing as little as it can get away with.

From the funder’s point of view, it’s basically a lease-like auto ABS with a ton of residual value in place (the value of the car at the end of a lease term). Usually residual value is total pain — including it in an auto lease ABS means a lousy advance rate and wider pricing — but that’s partly the case because lease terms for the Original Equipment Manufacturers tend to be pretty long.

That means it’s hard to gauge the condition of the cars at the end of the term, and hard to guess the state of the used car market years into the future. Investors and rating agencies alike tend to be conservative in the absence of hard data, and hence RV risk is a massive annoyance.

But for short leases, some of those issues fall away — there’s much more transparency into the likely residual value of a year-old vehicle, and, given current supply shortages and consequent strong used car prices, it’s probably a good time to do a deal like this.

A term takeout is probably a little way off — Finn needs to scale and firm up its track record for rating agencies and investors before it would make sense for Waterfall to go looking for capital markets funding — but it’s good to see the securitised products industry tapping up new sectors.

Fully automated luxury securitisation

From the frontiers of FinTech and the mountains of Lichenstein comes GreyPeak 2021-1, which, according to Cadeia, the fintech firm which did the deal, is the “first fully blockchain-based loan securitisation”.

Various other blockchain firsts — a non-agency RMBS for Redwood Trusta HELOC deal for Tilman Park Capital, an EIF synthetic risk transfer for BBVA — appear to be “blockchain supported” or “leveraging blockchain technology”, while this deal is blockchain all the way down - not just turning the bonds into blockchain assets, but replacing trustees, SPV administrators, account banks, calculation agents, offering circulars, cashflow waterfalls, investor reporting and so on with blockchain-based smart contracts.

It’s not a huge deal (less than CHF5m), and functions more as a proof-of-concept than a real piece of financing. Bank Frick hasn’t been active in securitisation in the past, but is holding itself out as a “blockchain bank”, helped partly by Lichenstein’s supportive legal framework for the technology — and it is an investor in Cadeia.

The blockchain piece might have the most Silicon Valley pizzaz, but the heart of the deal is a platform Cadeia has built which is supposed to link up the various systems that form the building blocks of a securitisation, bringing loan data, servicing data, contractual terms and structuring documents together, simplifying deal structuring and, if desired, eliminating counterparty roles such as paying agent, calculation agent and trustee.

That seems like a worthwhile product blockchain or no blockchain, though it will mean shaking up some entrenched habits. The technology has existed to pull various securitisation systems together for years, and yet still the PDFs and Excel files circulate, suggesting a certain inertia in the market, or simply pointing to the brain damage required to bring multiple actors into agreement around a single platform. The only fully successful standardisations have been imposed by regulatory dictat, in the shape of the ESMA data templates and the loan data repositories before that.

The blockchain layer is kind of a second step — once a deal is structured and the loan data in place on the Cadeia platform, it can be encoded in “smart contracts” which self-execute. So when a loan pays interest, for example, it could  flow through the transaction waterfall automatically. Contracts encoded on the blockchain can be positioned on a private chain such that confidential information stays out of public view.

Many market participants might feel a little queasy about moving all the way to fully automated “smart” processing — having a human involved somewhere along the line is handy if something comes up which wasn’t contemplated in the documents like….Libor cessation, or Rizwan Hussain (see below). 

But the Cadeia system is agnostic over these issues — if deal parties want the fully-automated blockchain maximalist version, they can have it, but humans can have the final say too.

Off the deep end

I’ve written probably more words about Rizwan Hussain than he really deserves, but…..the story just keeps getting more and more surreal. If the definition of insanity is doing the same thing over and over again and expecting different results…

His basic MO, if you haven’t been following the long and tortuous tale, is making various attempts to sell assets inside securitisations and unwind the vehicles themselves. This is, on one level, a reasonable commercial activity, but usually it requires….money, the idea being to buy low and sell high.

Rizwan’s basic innovation is to try doing this without ever having any real money, through such gambits as pretending to appoint administrators, pretending to be the corporate director of various SPVs, pretending to enforce security, pretending to tender and vote securitisation bonds, and veritable clouds of litigation.

These tactics are….legally controversial, let’s say. But to general amazement in the securitisation market, Rizwan was only actually sent to prison for contempt of court, following non-payment of rent on an apartment, thanks to a sustained campaign by his landlords - the Vaswani family.

On emergence from his stay at Her Majesty’s pleasure, he pretty much jumped right back into securitisation attacks, trying once again to take control of the Business Mortgage Finance deals, and having a go at Bluestone Mortgages’ Clavis Securities. He even branched out into public equities, trying to insert himself in Hurricane Energy and Symphony International Holdings.

At this point, I’m going to hand over the tale to Mr Justice Miles, in his latest judgement concerning Rizwan. Emphasis mine throughout.

“To give an idea of the volume of litigation there have been some 26 separate sets of litigation concerning [Business Mortgage Finance]. They have caused the Issuers to have to spend millions of pounds and have taken much judicial time”.

Latest in the long line of litigation is an attempt by corporate services provider Sanne (the legitimate director of the BMF SPVs) and its representatives to get Rizwan back in prison, with a contempt of court trial set for early in 2022 — and an attempt by Rizwan and associates to stop this, trying once again to claim that they are the directors of the BMF vehicles and launching a counter-suit.

The judge describes these attacks as “Legally absurd or unmeritorious steps have been taken to seek to assert that various entities or individuals have become in some way capable of being involved in the management of the affairs of the securitisation vehicles”.

Given the existing injunctions stopping Rizwan and a variety of previous associates and corporate vehicles from holding themselves out as directors of the BMF vehicles, this required new SPVs, incorporated in the Marshall Islands, and a new frontman.

Enter Andreou Artemiou (real name Artemakis Artemiou)!

From Mr Justice Miles: “There is also uncontroverted evidence that Mr Artemakis Artemiou met Mr Hussain in prison when Mr Hussain was in prison for contempt of court. The person who appeared before me today was given an opportunity to comment on that allegation and declined to do so. Indeed, he almost immediately invoked a right of silence and the privilege against self-incrimination. This was notwithstanding that Mr Artemiou claims to have caused the application to have been brought, or at least was one of the people who allowed it to be brought, and he was the person who appeared in court today to present it.”

He continues: “He is not properly appointed as a legal representative of any of the other claimants. I should also record that it was entirely apparent that he lacked even the faintest understanding of the contents of the skeleton argument served in the name of "Andreou Artemiou". He read out a prepared statement and then said he was unwilling to answer any questions about the skeleton argument “

The good judge wasn’t terribly happy with the evidence either

“The problems go beyond the failure to provide sources of information; the two versions of events that I have described are entirely inconsistent with one another…The two sets of documents relied on for these two different versions of events are dated on their face at about the same time, possibly a matter of one or two days apart. The people responsible for making the current application have not even attempted to explain this and the other glaring inconsistencies in the two stories.”

To continue: “I have major doubts about the authenticity of the documents that have now been put before the court. Not only are the people who are said to be directors different but the route by which they are said to have been made directors is entirely different.”

Sanne, the SPV administrator, and Simmons & Simmons, its law firm, also applied for an order to try to stop Rizwan plus his various associates and front companies, from continuing to try to take over the BMF deals.

A question that keeps coming up for me is why? Early-stage Rizwan gambits had some rationale, some possibility of success, some potential commercial payoff. But late-stage Rizwan deals have achieved nothing but wasting countless legal hours and racking up the costs for his unfortunate targets.

My working theory is that it’s the gambler’s fallacy, the belief that soon his luck will change, and the big payout is just around the corner. The ever-changing cast of associates attached to the various Rizwan projects suggests he’s got a compelling sales pitch, at least for those with no knowledge of securitisation (and no willingness to google my old articles). 

Let’s see what 2022’s contempt of court case brings — one is unfortunate, but two starts to look like carelessness.

UK disappoints

The UK finance ministry has published a report on its review of the Securitisation Regulation, a piece of EU legislation ported over before Brexit, and now under review. 

It’s pretty weak tea, at least so far, with the report saying that “some areas of the Regulation that may benefit from targeted and appropriate refinement”, with potential action to tweak disclosure requirements and take non-UK hedgies out of scope.

The spicier stuff, such as a review of capital requirements, wasn’t in the scope of the review, but may come up later on — “considering the high interest in this topic shown by respondents to the call for evidence, HM Treasury and the Prudential Regulatory Authority will consider certain points related to the prudential treatment of securitisations in due course.”

According to PCS, a third party verifier for securitisations in both UK and EU, “The overall impression is that the UK government is broadly happy with the current regime and is certainly not evincing any wish to tear up the rule book or effect radical changes to the regime inherited from the EU Securitisation Regulation. This report is about tweaking not transforming.”

There are a few promising hints on risk retention — some changes to the non-performing loan risk retention regime, basically in line with the EU “Quick Fixes” package, which came out after the Brexit date, plus a promise to look at “L-shaped risk retention” and using excess spread as part of risk retention.

The last point would be a much-appreciated goodie for the market….but much depends on the detail. Presumably to work as a risk retention piece, the excess spread in question would need to come out pretty high in the waterfall, otherwise it would be at risk of dipping below 5% if the deal didn’t perform — and so issuers that were looking to maximise their leverage wouldn’t really be interested (they’d want their retention piece as subordinated as possible).

Other points include support for “Simple Transparent and Standardised” equivalence — so that EU and UK STS securitisations get the benefits in each jurisdiction — and a potential “green securitisation framework” down the road, though “not in the immediate future”.

The report was lukewarm on any changes to capital or liquidity rules for bank and insurance investors in securitisation — one of the big prizes the industry is hoping for — in part because this would go against Basel Committee commitments.

“HM Treasury does not currently see sufficient evidence to support significant changes to the capital treatment of securitisation, which is consistent with the Basel standards. For example, allowing CMBS and CLOs to be STS-eligible would not be justifiable deviations from the Basel standards.”

But there are further consultations to be had — a UK review of “Basel 3.1” (the industry generally calls this Basel IV but who’s counting?) and of Solvency II, as well as the Prudential Regulatory Authority’s review of liquidity rules.

Most disappointingly, for the big UK banks, is a decision against including synthetic securitisations in the STS regime — something which is already a feature of the EU market. The UK institutions are some of the largest and most active synthetic securitisation issuers, so would have no doubt appreciated any easing of the capital treatment that might come with the STS label.

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