New EU ABS Guidelines…. Talk About Tone Deaf!!

Just as the EU Securitisation Industry is about to limp into its annual industry gathering in Barcelona next week, along comes the EU Parliament to stomp on the few green shoots that are keeping this industry relevant in the EU capital markets!

You have to ask, what are the bureaucrats thinking?

Most glaring in the proposed regulations released by the EU Parliament’s Committee on Economic and Monetary Affairs released last week are the requirements for a 20% risk retention level and the possibility that all investors may need to be regulated entities (we assume that may mean banks, insurance companies, etc.).  Not that the other major elements of the proposal are positive.  It’s just that these two really stand out as having the potential to add gas to a fire that has the potential to burn down the entire securitisation house in EU zone.

For a very long time, we have suspected that the regulators and bureaucrats that have been tasked with revising the regulations for securitisation, simply do not understand the topic or the market.  Nothing we have seen makes that case better that this insane level of risk retention (where are the economics?) and a requirement for the securities to trade only among the very same institutions that are looking to move assets off their balance sheet.  The whole idea behind securitisation is to create an orderly market which will allow non-financial institutions to invest in financial assets.  A significant by-product is the ability for the experts at underwriting and structuring these assets and securities (banks and insurance companies) to continue to leverage their capacities and expertise and to make credit available to more borrowers (both institutions and consumers), all while providing a mechanism for them to properly balance their own portfolios (a good thing for both their own shareholders and creditors).

If these new proposals become law, you might as well shut the door on securitisation in the EU.  It will be too costly to issue and there will never be enough investors.  Even in the best of times, it was always costly to raise capital via securitisation.  Nevertheless, it was competitive enough to attract enough companies to utilize it as one of several capital formation tools available to them.  In some cases, it was the only viable tool available to some issuers.

Shutting out non-regulated institutions from investing in securitisation is about as self-defeating a proposal as you could dream up.  The global capital markets need more capital, not less!  Just ask any middle market company how hard it is to get credit.  Have a look at the rapid growth of marketplace lending platforms.  Do you think the timing for this growth over the past few years has been a coincidence?  Of course it is not!  Borrowers will look where they can and these platforms have begun filling a very important need; one that probably existed before the Credit Crisis but has been illuminated with at least a little help from the failure of the EU government and regulators to get the regulations right.

There are some rumors that the egregiousness of some of the proposed elements may be a political stunt (to be traded later for other elements).  However, we can’t see the logic in that hopeful theory.  Even if it is true, this is simply too important a topic, to be playing politics.

We are certain that this topic will dominate the discussion these next few days in Spain.

Maybe, we will all wake tomorrow to hear that the EU parliament was just kidding!

MERS Posts Yet Another Court Victory

The New Hampshire State Supreme Court handed down the latest in a string of victories for Mortgage Electronic Registration Systems (“MERS”), continuing a trend which has bolstered the legitimacy of the MERS framework, as the primary tool for the recording of residential mortgage files in the United States.

The latest court decision in favor of MERS came this week from the same court which upheld a July 2015 decision that the language in a mortgage granted to MERS as the mortgagee as nominee for the lender and the lenders successors and assigns, evidences an agency relationship between the note holder and the assignee of a MERS mortgage.

In the case of Castagnaro v. The Bank of New York Mellon, the borrower filed a wrongful foreclosure action, claiming that BNY Mellon lacked the authority to foreclosure non-judicially under New Hampshire state law without also proving that it was the holder of the borrower’s note.  The Supreme Court referred the First Circuit Court to its opinion in Bergeron v. N.Y. Community Bank, issued in July 2015, which involved answering similar questions on the law pertaining to foreclosure.  Both cases involved mortgages creating an agency relationship between MERS and the noteholder and granted expressly to MERS (or whomever MERS assigns) “the power of sale and the right to foreclose and sell the mortgaged property,” according to an announcement made by MERSCORP Holdings, Inc.

MERS has won a number of court decisions over the past year, in cases that challenged its right to act as mortgagee.  Last fall, MERS won similar decisions in Montana, Georgia, New York, Texas and Kentucky.  This has had the affect of further solidifying the credibility of this industry authorized platform for enhancing the efficiency of what was historically viewed as a very cumbersome process.

Chalk this up as another victory for rationality!

STC Comments due to Basel Committee by February 5th

With some degree of fanfare, last summer EU regulators introduced proposed rules for Simple, Transparent and Comparable  (STC”) securitisations.  One theme was to create a platform for more favorable capital treatment for STC compliant securitisation programs.  If you have taken the time to read through these rules or guidelines, you might conclude that they are anything but simple.  Nevertheless, given the seemingly bottomless quagmire that EU regulators seemed to be in at the time (they have for years struggled to find a way to re-open the EU structured finance markets), this news seemed like a breath of fresh air.  For the first time in several years, issuers, bankers and investors began to feel like there was real hope for a much stronger revival in issuance levels.

However, if you speed ahead to November of 2015, the Basel Committee on Banking Supervision (“BCBS”) weighed in on the conversation with their views on how the proposed STC rules would impact capital requirements for both originators and investors.  These views came in the form of a “Consultative Document” which begins to shed light on the potential benefits (lower capital ratios) for securitisations which comply with the STC rules.  Comments are due to the BCBS by February 5th.

Based on our read through the Consultative Document, we are not sure if the BCBS makes the picture any clearer, as it relates to establishing a clear understanding of the real benefits associated with putting the hard work into ensuring a securitisation is issued as STC compliant and remains that way.   We will leave that interpretation to others with better insight but you could be left wondering if the benefits of the capital reductions could be overtaken by the costs of compliance with STC rules.

We are wondering if others may be coming to the same conclusion.

 

2016: The Year of Risk Retention

As the markets lift off for the new year, we suspect that 2016 might wind up becoming best known as the year when the dust and clouds surrounding risk retention for a securitization structures, all began to clear.

Over the years, there has been no shortage of prognostications for exactly how the “skin-in-the-game” rules, coming on the back of the structured credit market’s collapse (now more than eight years ago), would ultimately affect the long term prospects for a healthy and vibrant global structured finance marketplace.

Much attention has been focused on three major topics; the general impact of proposed new rules for the euro-securitization market, the global CLO market and the US residential mortgage-backed market.  Some have predicted complete disaster for one or all of these markets.  Others have loudly applauded these changes (although it is hard to understand how anyone can see clearly ahead yet to the long term impact).

For many years, we have been on the record with our view that it would be unproductive to paint all structures and all markets with the same brush and it would appear that many others feel the same way, as witnessed by the good progress being made across the industry to focus on the benefits or additional value to be derived from risk retention, on an asset class-by-asset class or market-by-market basis.  Particularly over the past two years, there has been lots of good work done by lots of smart people from both within the industry and within the various legislative and regulatory bodies that have worked hard over the past several years to get up to speed on the workings of these complex, yet systematically vital, instruments.

As we turn the corner into the first months of 2016 and these rules either start to come on line or as we get closer to key implementation dates, we should be able to see exactly how the risk retention rules for CLOs and US RMBS hold up, for good or for worse.  The impact on the euro market will probably continue to lag behind, consistent with the general lack of regulatory clarity and the resulting weakness in the that market’s recovery.  Nevertheless, there seems to be enough momentum among European regulators to suggest that we should also see some tangible finality to their approach to risk retention sometime soon.  We only hope that they too will acknowledge the need to drill down into individual asset classes and structural types, to match the progress we have already witnessed in other markets.

In any event, we suspect that by the time we get to end of 2016, we will all know much more about how risk retention helps or hurts the global structured finance markets.

Important Decision Affecting Safe Harbor for CMBS That You May Have Missed

An important recent ruling by the Northern District of Illinois District Court in connection with a preference claim by a bankruptcy trustee which involved CMBS securities.  Could become a very important standard for the future and ongoing recovery of reputation and legitimacy of securitization structures.  Certainly seems to restore some rationality to what most investors, trustees, bankers and originators thought they were getting into when they put these structures together.

Here is a very good summary of the decision which was handed down in April and posted by The National Law Review earlier today, authored by Mark Salzberg of Squire Patton Boggs……..

 

Commercial Mortgage-Backed Securitization Investors Given “Safe Harbor” Protection

How far do the Bankruptcy Code’s “safe harbor” provisions extend in the commercial mortgage-backed securitization (CMBS) market? Do these safe harbor provisions protect financial institutions that act merely as conduits for CMBS payments? These questions were addressed recently by the Northern District of Illinois District Court, and the court’s decision provides ammunition for CMBS investors in clawback claims brought by a bankruptcy trustee.

In Krol v. Key Bank, N.A., the chapter 7 trustee filed preference and fraudulent transfer claims against Key Bank and LaSalle Bank. At issue were payments made by the debtor on a loan (the “Loan”) extended by a trust (the “Trust”) to an entity related to the debtor. Prior to the bankruptcy, the note evidencing the Loan had been transferred to the Trust as part of a securitization process. Key Bank was the master servicer for the Loan, and held the payments temporarily before transferring them to the Trust. LaSalle Bank was the trustee under the Trust

The defendants moved to dismiss the bankruptcy trustee’s claims arguing, among other things, that the payments were shielded by the safe harbor provisions of section 546(e) of the Bankruptcy Code. Section 546(e) provides a safe harbor from preference and constructively fraudulent transfer claims where the transfers (1) were made by and to a financial institution, and (2) were made in connection with a securities contract. The purpose of these safe harbor provisions is to minimize the displacement caused in the commodities and securities markets by a bankruptcy filing affecting those industries. The safe harbor does not extend to intentionally fraudulent transfers (those transfers made with an actual intent to hinder, delay or defraud creditors).

The first question before the court was whether Key Bank was a “financial institution” for purposes of Section 546(e) since Key Bank acted as a mere conduit for payments on the Loan. The bankruptcy trustee argued that Key Bank’s status as a mere conduit required the court to determine whether the Trust, the ultimate recipient of the money, was a financial institution. The court rejected these arguments and refused to read into the statute an additional requirement that the financial institution receive some financial benefit or acquire the funds for its own use. This reasoning is consistent with the approach taken by most of the federal circuits that have addressed the issue.

The second question was whether payments made to Key Bank on the Loan were made in connection with a “securities contract.” The bankruptcy trustee argued that the payments were made in connection with the Loan which was not a securities contract. However, looking to the economic realities of the transaction, the court found that the Loan had been securitized as a CMBS. In a CMBS, securities are collateralized pursuant to a pooling and servicing agreement (PSA) by a pool of mortgages on commercial real estate in which all principal and interest from the mortgages flow to certificate holders in a defined sequence or manner. Here, the Loan had been transferred to the Trust and that the Trust had issued certificates representing investors’ interests in multiple bundled loans. Writing that “in connection with” as used in Section 546(e) should be construed broadly, the court held that the payments to Key Bank, which Key Bank then transferred to the Trust, were made “in connection with” the PSA. The court rejected the bankruptcy trustee’s “novel proposition” that any two-tiered transaction precludes a finding that a securities contract is involved.

Based on this analysis, the court dismissed the bankruptcy trustee’s preference claims and recommended dismissal of the constructive fraudulent transfer claims.

The Krol decision is an important decision for participants in the CMBS market. First, the decision is further support that Section 546(e)’s safe harbor provisions apply where financial institutions act simply as a mere conduit for funds. Under the majority approach, as adopted by the Krol court, a financial institution does not need to acquire any ownership interest in the funds in order to qualify for the safe harbor protections. Second, the Krol decision recognizes the economic reality of CMBS transactions, and brings within the protection of Section 546(e) loan payments where the loan has been collateralized. Third, the decision provides more security for CMBS investors since it increases the scope of the safe harbor protections of Section 546(e).

Seward Kissel Event Kicks off the Holiday Season in NYC

Last night was the unofficial kickoff of the holiday season for structured professionals in New York with Seward & Kissel hosting their traditional event at Brasserie 8 1/2.  It is always a stretch to put too much emphasis on the vibe at these events but with well over 600 professionals in attendance and the conversations lively and positive, it is hard not to feel very optimistic for the securitization industry as we head into the final stretch of the year and look ahead to 2015.  Lots of conversations about new transactions and structures in the works, all around the room.

Euro CLO Market Breaks Out and This Time it Looks Sustainable

Several recent article’s about CLO market activity in the Eurozone all point to that long awaited rebound.  Several factors including a increasing level of comfort among issuers for regulatory constraints, growing enthusiasm among investors for yield opportunities and the continued strength of the US CLO market are all having a positive influence on the Euro market.

LeveragedLoan.com produced a useful chart which shows this important uptick in Euro CLO activity over the summer of 2014.  It may take some time before we see a level of consistent activity which mirrors recent  US trends but the road ahead does look very good.