Navigating the new normal – Q&A with Ocorian’s Sonal Patel and Sinead McIntosh
The last six months have been unprecedented times for the global capital markets, and securitization has not been spared the volatility. In both the US and Europe, structured finance sectors have had to navigate worsening economic conditions, widening spreads and a deeply uncertain outlook for the rest of 2020 and beyond. With the help of central bank and government support measures, the worst of the crisis may have been avoided, but securitization may also have a role to play in the coming recovery. GlobalCapital spoke with Ocorian’s Sonal Patel and Sinead McIntosh on the outlook for capital markets, the state of securitization and the prospects for 2021.
GlobalCapital: Sonal, can you provide a synopsis of how the capital markets and the securitization industry has dealt with the past six months of the pandemic crisis?
Sonal Patel: This has been a hugely impactful time around the globe, especially for the US and its credit cycle. I think leading into 2021, it will be interesting to understand the trajectory of the securitization space, especially across CLOs and any other leveraged loan type instrument. Currently, the entire market is under stress and that will continue, probably until the latter part of 2021.
In terms of the pandemic, I think people are trying to capitalize on some of that distress, but as it relates to the amount of new issuance, we’ve seen a slowdown, though hopefully there are other types of structures being created as a result of this period. Asset managers are trying to figure out diversification tools to create palatable structures for investors and the demands in terms of assets is getting smaller and smaller. We’ll have to see what transpires in the coming months as the implications of the pandemic affects the credit cycle, the capital markets and the securitization market, especially in the US.
Sinead McIntosh: I would echo a lot of what Sonal has said. It’s been an unprecedented economic fallout but it has also been very apparent that the debt capital markets have fared better than equity or unsecured corporate debt, and securitization has performed strongly. Securitized structures, particularly in public issuance, are holding up well because they are designed to withstand a certain amount of stress on their cash flows, whether through cash reserves, liquidity facilities or subordination. With Covid continuing to be a real problem, those cash reserves are being depleted and some tranches are on negative watch or have already been downgraded, so we are seeing impacts regardless of how well structured they are.
We're seeing more vulnerable areas in private asset-backed securitizations where they commonly feature triggers on defaulted receivables. These are the transactions where we’re seeing increased activity between borrowers and lenders, where borrowers are asking for forbearance from lenders and it’s really those lenders having to take a view on the situation. I suppose the upside, is that it's easier to get that consent from a private issuer compared to a major public issuer. While securitization is a very robust product which has coped well, whether it will continue to cope so well with prolonged shock will be seen next year.
GlobalCapital: Speaking of payment holidays and forbearance, have we seen the full effects of that on securitizations?
McIntosh: From our perspective in Europe, we are still seeing forbearance and payment holidays that are anything up to nine months or even a year in length. So that will continue for a while longer. What we are seeing in terms of forbearance is that lenders are scrutinising the amendments and waivers now, being much more demanding, and we’re definitely seeing that earlier, very charitable approach to forbearance is starting to dry up.
Patel: It is something that is obviously still evolving. Data is still coming in and the forbearance schedule is still developing. It could even be longer than the timeframe we are looking at today.
GlobalCapital: What is your view on how central bank and government support measures have shaped the experience of the capital markets and securitization in the last six months?
McIntosh: I think if we take a step back, the rules in Europe put in place following the financial crisis have made banks more resilient, better able to handle shocks and therefore more able to be flexible with their counterparties. In April this year, the European Commission adopted a banking package which was echoed across all other non-EC European governments that enabled banks to lend to households again. Now what we’ve seen in another summer package - the capital markets recovery package - is really targeted at encouraging investment in the economy, and allowing banks flexibility in terms of their own recovery. Initially what we saw in the market was that new issuance had completely dried up and the only issuance was in investment grade, and that was in small windows of market stability. What we’re hoping for now with this additional stimulus is that with changes to securitization regulations, MiFiD II and prospectus regulation in Europe, is that those specific targeted measures in the capital markets will give people comfort again that securitization is robust and can help regenerate the market. We fully expected a massive shock, but there has been a very sensible reaction from the central banks in supporting these structures.
Patel: In March and April, the US government passed three main stimulus packages totalling $2.8tr. This was one of the largest stimulus packages in the history of the US. I think that most securitizations are linked to consumer receivables and I think the stimulus really softened that pressure but a lot of it has yet to be seen.
I think that this particular stimulus was very different than what we saw in 2008. This was to soften the pressure on all markets, not just the bigger financial institutions. The difference in the US is that the banks still have deep pockets. When you see how it differs, there is still a fallout effect for the securitization market so I would say it is yet to be seen in terms of what’s in store for 2021. It remains to be seen how these stimulus measures are being implemented by larger institutions that probably don’t need the funds, but also how the normal consumer is capitalizing to make their payments and how all of that affects the credit cycle and securitization.
GlobalCapital: The Federal Reserve revived the Term Asset Backed Securities Loan Facility in the early days of the pandemic. Do you feel like this has had a meaningful impact?
Patel: I do. I think that TALF 1.0 was a very different bailout, and this particular version is out there for institutions that need it and has allowed securitization to stabilize. But for new issue and new collateral, the effects are yet to be seen. There are still warehouses in place that have been pushed to 2021. In terms of payments though, I think stimulus like TALF has definitely helped.
GlobalCapital: In terms of areas of the market that are holding up, where are you seeing pockets of opportunity versus pockets of potential weakness in European securitization?
McIntosh: There are some obvious sectors that have been hit harder than others – travel, transport and energy have struggled and those that have fared well are tech, food and pharma. What is really interesting is that ESG compliant structures are faring much better, and that is across ESG compliant corporate debt and ESG funds, they’re both outperforming across debt and equity.
I find it very interesting and quite telling that this relatively new investment strategy is performing so well in such unprecedented, stressed times where you would expect the natural course of behavior - the majority of investors falling back to what they know. It's something we're hearing from every corner of the market, that this is not just window dressing, but it is of fundamental importance to their investment strategies.
Patel: Yes, I do. I think the US has looked at ESG a little more hesitantly but in the midst of a pandemic and with climate warnings and environmental disasters well publicized, ESG strategies will continue to gain traction; ESG is certainly more prevalent in the conversations we have with bankers.
GlobalCapital: Where are you seeing pockets of opportunity and vulnerability in the US market?
Patel: The sectors that have performed well are those already mentioned by Sinead. The difference for the US in terms of securitization, is that the asset backed market, mortgage market, aircraft market, all of those industries have been impacted and I think that’s just a little more prevalent in the US, especially in assets like CLOs. Any kind of securitization instrument has been impacted differently, so that’s what we’re watching.
GlobalCapital: Comparing this crisis to 2008, securitization had a very different reputation. Do you think securitization this time around has an opportunity to prove its worth as a tool that can clean up the mess left by the pandemic?
Patel: Yes. I think that there are some similarities to both crises, with stimulus packages and some form of bailout, but the impact has been very different. The credit crisis was an extremely challenging time for institutions that may have been over leveraged. This time it is not about that. This crisis has impacted every type of industry and consumer. As time goes on the securitization market can help refinance or help with balance sheet programs for a range of industries, including autos, hotels or airlines, and we’re seeing that already. There are various receivables creating tax neutral structures that are prevalent for investors. So, there is a lot going on in terms of concepts and I think through this crisis we’re going to learn a lot and the securitization market is actually going to be even more impactful going forward.
McIntosh: I think we’re looking at two very different scenarios. Banks were in very different shape and were the main player at the time of the global financial crisis. Since then, there has been a huge amount of regulation on those banks to make sure they can withstand significant shock or correction. A lot of that bank position has also been taken up by private equity, so the players are different, as is the liquidity situation. Banks were hammered at the beginning of Covid as every facility was being drawn upon. Then there was the government stimulus that they also had to deliver, and so the stress on banks has been significant but handled completely differently compared to the global financial crisis.
GlobalCapital: How has Ocorian been helping clients during this period? What are some of the big issues that you have had to help with?
Patel: We’re uniquely positioned as a global administrative services provider. Dynamic, cutting-edge technology and bespoke reporting are just two elements that we're able to deliver much more seamlessly than some of our counterparts, as well as really understanding the instrument. Being a neutral party allows us to have an independent view that makes sure investors are getting the types of reports and transparency related to the vehicles we service globally. Those are the needs managers and investors are coming to us with to really provide a level of bespoke service.
McIntosh: Our clients had this initial shock of having to work from home basically overnight. Depending on the scale of the organization, the operational and organizational impact was incredibly draining for many clients. They had that to contend with on top of the preexisting regulatory issues including Libor transition and Brexit. All of these things are still happening and our clients need solutions while they’re trying to cope with this massive shock to their own processes.
Our approach is to really embed ourselves with our clients to really understand their markets, their problems and their products so we can service them as seamlessly as possible. By making sure we are at the forefront of all regulatory changes, we can be a consultative service provider for our clients, and come up with solutions in terms of reporting, regulatory oversight and governance best practices. The fact that we’ve lived through credit cycles and our team has such a wealth of experience means we can provide solutions rather than just ticking a box, and we can consult with them to build solutions tailored to their specific needs. Whether it is something as seismic as Covid or something more predictable such as ECB regulations, we are able to provide them with a best course of action.
GlobalCapital: What is your outlook for the market from this point, and what is the legacy of this event on the capital markets?
Patel: The markets had already become resilient and I think they will be even more so going forward. The covenants, disclosures and such, these are things that will be part of agreements and discussions as investors and managers underwrite any kind of loan to securitize, this crisis is going to be part of those discussions and default scenarios that folks may not have ever thought of before. This will be a part of the new normal as we enter 2021, especially relating to new deal flow.
McIntosh: I don’t think this sort of event was at the top of anyone’s mind. I think there is definitely more distress to come. If you look at where we were prior to Covid, we were due for a credit correction and a lot of companies were barely keeping the lights on as it was. Now, there has been a global government stimulus where they are basically now supporting these zombie companies even further along. Realistically, when that government stimulus falls away, we are going to see a lot of companies that were just barely keeping the lights on unable to generate any revenue at all and they’ll start to fall over.
Our clients are going through a very stressful period, and that stress is only likely to increase. We are very fortunate that our capital markets team globally have a huge amount of experience through numerous credit cycles and numerous shocks across industries. They are able to help clients navigate through distress, whether it is corporate restructuring or debt restructuring, whether real estate or airlines, we have that experience to help people come through the other side. The implosion that you would have expected to happen with an event like this actually hasn’t happened, and I can only imagine that at some point governments will have to step back and that is when we’ll see a bigger fallout. We’re very fortunate to have a really experienced team and offer a broad range of solutions to our clients.