Surveying the global structured finance landscape in the Covid era
The pandemic has been a time of immense difficulty for financial markets globally. The period of stress in the corporate sector has led to intense stress on economies large and small and the recovery following the 2020 coronavirus crisis will be long. But will also be a window of opportunity for market players. This is particularly true of the structured finance market, which may have a significant role to play in helping to clean up after a period of unprecedented distress. GlobalCapital and Vistra gathered a roundtable of market experts to discuss the state of securitization sectors in Europe, Asia and the US and the role of the product helping the market get back on its feet following months of pandemic stress.
Participants in the roundtable were:
Weili Chen, head of commercial ABS, Standard Chartered
Rob Ford, portfolio manager, TwentyFour Asset Management
Gaganpreet Kalra, director, Vistra
Martin Sharkey, partner, Dentons
Nicholas Tan, chief operating officer, Bayfront Infrastructure Management
Navita Yadav, managing director, Vistra
Moderator: Max Adams, GlobalCapital
GlobalCapital: Navita, the non-bank and fintech space has had an interesting experience through the Covid‑19 crisis. Can you tell us a bit about what you are seeing in that space?
Navita Yadav, Vistra: Fintech, as we all know, has tremendous potential. The increased use of digital payments are the key drivers for fintech in the region, and we have seen a renewed focus. Even before Covid, we saw a massive push to cashless payments and digital identification, with banks making that a particular area of focus, and governments moving to adoption of e-signatures. With fintechs being smaller in size and many in start-up phases, many are susceptible to short‑term disruptions in their business. The landscape during Covid and even post-Covid will create new winners and losers. It will also lead to consolidation across payments, AI, software as a service and challenger banks.
Another trend we are seeing is that central banks are now pushing to hasten the process of central bank digital currencies. This was already under examination and Covid accelerated that process, though there are policy and regulatory considerations that need to still be addressed there. This is all on the trend side in terms of demand and acceleration of trends due to Covid. At the same time, the financing remains a question mark for these fintech companies. Generally they are smaller; but with fintechs, innovations can help develop a model for financing which is not necessarily reliant on financials — but a model which allows you to establish credibility of these SMEs and P2P lending platforms.
Whether in Europe, which has been a hotbed of fintech activity, in the UK, or in Asia, there is big demand for fintech solutions and a push from governments to support solutions for SMEs, though it remains to be seen whether this support is enough to keep them afloat during Covid. So we do see great demand, consolidation and innovation happening in the space.
GlobalCapital: Rob, can you talk about the fintech experience in the UK and Europe during this time? There has been some concern that non-bank lenders don’t get access to central bank funding. What is your outlook for the space?
Rob Ford, TwentyFour Asset Management: I think Navita is right, there is big demand for non-bank finance across Europe, with fintech lending one of the dominant sources of that. I think to a certain extent the funding issues have been less acute in mainland Europe than they have been in the UK. The really big issue, particularly for UK non-banks, was that the banks were given access to huge central bank funding programmes but the non-bank lenders were pretty much ignored and abandoned. Yet, at the same time they were obliged to follow the same payment holiday and forbearance measures that were particularly large in the UK — and because their typical customer base targets less prime borrowers, the non-banks saw a much bigger take-up than any other lenders. I suppose there might have been a perception that the banks would pass on some of that funding support to the non-banks, but it really wasn’t quite so simple. Most of that lending is done through warehouses, which generally have pre-agreed terms, limits and restrictions.
The reality was that many non-bank lenders were forced to pull most or all of their lending products and many are still not yet ready to resume lending, at least not in any meaningful way. To be fair, it’s no doubt that there is a huge amount of uncertainty, so it’s certainly a time to take risk off the table. Banks themselves have reduced their product ranges as well, and they are only just starting to dip their toes back in the water with limited higher LTV products — and only to very clean borrowers. But the non-banks don’t typically lend to the very clean borrower segment, but to those less able to access funds from the banks and those borrowers have had their choices massively cut or removed entirely. I’m sure that wasn’t the intention of regulators, but if these businesses can’t restart lending they will have to shrink, shed staff or shut down altogether.
It has been a really tough time, although there are some signs of a recovery. The UK housing revival has helped, as the cut in stamp duty has led house prices to rally sharply. But many of these lenders have big tails of payment holidays sitting on their books. We haven’t come to the end of that yet. We have seen the numbers come down a lot from the peak, but the residual amounts are still pretty high and I would have some concerns that some of those bank warehouses in the future are going to start to hit triggers that were put in place before an event like the pandemic was even a consideration. So it is quite a worrying time and it will be a tough few months, particularly if we go into more constrained environments that will curtail lending again.
Weili Chen, Standard Chartered: I think in the US, in the SME space, Kabbage and OnDeck, for example, certainly mirror the theme of consolidation. Kabbage, a very cutting-edge SME lender, was acquired by American Express. I think that really speaks to the dependence of this space on securitization and the difficulties for these businesses when that market goes through a challenging time — but with Amex coming in, it is also a validation of their business model and technology.
The second area I am following quite a bit that I think is exciting is on the investor side. We are speaking to the issuers regarding using fintech for asset origination, and trends I am also following have to do with how to get more investor participation. And what I mean by that is a continuation of what we see in equities, where fintech enables retail investors to come in and participate in very small ticket sizes. This year we have seen in the US, an issuer using blockchain to drive down the initial cost of securitizations of a much smaller deal. I have seen an acceleration of these trends.
In this part of the world, in Singapore in 2018 there was a successful first issuance of a securitization placed in the retail market and that was with the active encouragement of the regulators in that market. I think the motivation there is to diversify the products offered to retail investors. I can see some very interesting and high quality securitizations finding their way to retail investors, which I think is an exciting development worth watching.
GlobalCapital: Turning to Asia specifically, Gagan, what have you seen in the Asian structured finance market in recent months?
Gaganpreet Kalra, Vistra: I think Weili has made a really valid point when he talks about using securitization and structured finance as a funding tool. On the demand and supply side, there are variables affecting this and how it is going to play out in the future. I think the current situation created an opportunity for issuers, and it goes without saying that banks and non-banks are having these discussions to be able to extend out their capital for safe and high yielding assets.
Another thing driving Asia at the moment is consumption. There are estimates that China and India will comprise 50% of the middle class population globally by 2050, and we all know how ecommerce and tech is driving a new type of securitization market in China. If we were to look at how capital markets have fared, I think today Asia accounts for approximately 30% of global capital markets and by 2030 we are looking at 40% of capital markets being covered by Asia. More than half of this growth is expected to come from China. But the writing on the wall has been that it is very difficult to get a homogeneous product for Asian markets, given different regulators in each jurisdiction and how they deal with these products, which is visible in terms of how there is an Asia risk premium. But I think investors would be more than happy to look at slice and dice portfolios available in the market.
Coming back to the cross-border part of securitization in Asia, I think that is an area that has potential to grow a lot. These are the nuances from a very high level; and moving on to the Covid situation, the NPLs in this part of the world is something we have to look out for.
There are some estimates that at the end of Covid we might see upwards of $600bn of NPLs, of which $300bn will come from China, and another $150bn‑$200bn will come from India. And its very visible because we have seen governments doing a lot in the past six months to support the market with various measures. I think that going forward we will see more and more off-balance sheet structures focused on securitization.
GlobalCapital: Nicholas, can you talk about what the path has been like for alternative assets in Asia, such as project finance securitizations?
Nicholas Tan, Bayfront Infrastructure Management: For us, our core focus is the infrastructure finance market in Asia. The Asian Development Bank estimated $455bn of market gap in infrastructure financing in Asia, so that is where we see a lot of potential for securitization because the project finance market in this part of the world still tends to be dominated by banks, export credit agencies and multilaterals. Hence, we would like to address that gap by mobilising a new source of liquidity in the form of more participation from institutional investors in this space.
Our focus is to create a product that is suitable for them, given a lack of suitable investor format in Asia at the moment. A number of the jurisdictions here are sub-investment grade, resulting in the credit ratings of these projects being capped by the sovereign rating. That’s why we think utilising a securitization structure can create an investment grade product that insurance companies, pensions or bank treasuries can really look into.
We started off looking at a pilot transaction in 2017 to test if there is indeed appetite for such a product and we have proven in 2018 that there is appetite. Through the performance of the pilot over the past two years, we have been able to show this asset class is very resilient. One challenge that we had was to find appropriate comparables for investors, because, looking at the space, there is very little cross-border market and US dollar denominated investments. Here, we are trying to explain to investors this is a different asset class, but they tend to benchmark to something liquid such as the US CLO market.
The opportunity with the Covid situation for us is to demonstrate through this crisis that this asset class is highly resilient; hence it should warrant a separate discussion around benchmarking.
Yadav, Vistra: The only other thing to comment on is the green ABS market in Asia. China has been a major green bond issuer, particularly of green covered bonds. So that’s the upcoming space: whether it is for infrastructures, energy efficiency companies, property assessed ABS, there is a pent‑up demand we are seeing. Green labels are not standardised and different regions have different guidelines and Asia broadly is still a laggard in the green space, so we see potential there as more awareness spreads among investors.
The private debt environment is another interesting sector to watch. Financing by PE houses through securitization has led CLOs to be the biggest buyers of leveraged loans.
This is another area we are watching closely, as well as the securitization of trade receivables, which starts with bridge financing and then shifts into permanent securitization financing.
GlobalCapital: That leads us nicely into our discussion of ESG. Martin, can you give us your views on the development of that market?
Martin Sharkey, Dentons: My own specialism is focused on CLOs and in that space we’ve had ESG elements for many years, driven by the involvement of ethical or religious investors in transactions and as part of that they have required the inclusion of eligibility criteria, such as restrictions on acquiring loans from gambling, firearms or fossil fuels industries. More recently, though, managers have been marketing their CLOs as ESG to generate interest among investors that way.
But we should look at what ESG really is — ‘E’ for the environmental aspect could be anything green, solar ABS is a good example; ‘S’ for social, speaking to the impact of the financing in things like transactions that promote diversity, strong labour relations; and finally ‘G’, which is the governance of transactions — are they equitably managed, free of conflicts of interest?
Certainly we see ESG very much as a growth area and a focus going forward. When you look at ESG, what makes it ESG? For a lot of securitizations, people will look at what the assets backing the deal are, but also look at where cashflows are going. If you have a deal backed by fossil fuels but the cashflows are going toward the issuer improving their green credentials, is that ESG? Although you might give plaudits to the overall intention there, I don’t think you can really label that deal as ESG.
The label can cover the whole gamut of securitized assets, autos, CMBS, CLOs — anything can be looked at from an ESG perspective — but you should also consider who determines what is considered ESG or not. I think there has been a lot of noise from the rating agency space, but they are also trying to make clear that they are looking at credit quality and it is not for them to determine whether a transaction is green. What they will look at is how ESG in a transaction impacts credit quality. So the market is still looking for an independent kind of third party verification.
GlobalCapital: As an investor, Rob, do you feel like ESG is of growing importance and are you factoring it into investment decisions?
Ford, TwentyFour Asset Management: It is massively important. As an asset manager, it is a topic that has moved from somewhere near the bottom of the list to very top or number two on every potential investor questionnaire. As a firm we have been launching sustainable type products to not just attract new money, but to make sure that our investor base can see the products we are aiming to invest in with a specific focus on sustainability and responsibility. We have an ESG assessment on every investment we make, not just those that go into sustainable focused funds.
From an ABS side, it isn’t just about the asset classes. As securitization people, we naturally categorise things — categorise the asset classes into green and non-green, for example. But for me, it makes it too easy to focus everything on the ‘E’ and forget about the ‘S’ and ‘G’. You can have an originator with a pool of lovely green assets, whatever they are, but if that originator doesn’t behave in a responsible way in their lending or how they manage their staff, then I don’t want to buy their assets. So I want to analyse transactions in the whole and make investment decisions on all the factors.
We also look very carefully at what we call momentum. You might have an originator who is originating assets that aren’t as clean as you would like them to be — diesel cars loans, say — but if they are moving in a better direction, towards electric cars, then that is a big positive and we can commit more capital to those investments than to those who aren’t developing and evolving to take account of ESG. That’s a really important part of the way we approach it.
Kalra, Vistra: Globally, in the past eight months we have surpassed the entire previous year’s issuance of ESG assets. This has been the year of ESG, and where some asset classes have seen a year of stagnating growth, ESG and specifically green bonds have seen a large increase.
I think in Asia, China is the clear leader when it comes to ESG and green issuance. The second largest market would be Japan, followed by Australia. In Singapore, where I am based, it is the largest market in the region. This year we have seen Singapore contribute 55% of issuances. Another thing to highlight is that we have two very large sukuk markets in the region, those being Malaysia and Indonesia, and both have seen green sukuks in terms of their assets in the past eight months.
I would conclude by talking about the role of fintech in green finance. We have in the past six months seen a lot of peer-to-peer lending platforms trying to come up with a workable model for crowd-sourced opportunities for ESG exposures, where private investors can come in and take part in the higher yielding parts of these investments.
GlobalCapital: I’d like to move on to a discussion of the CLO market. Covid for some has felt like an inflection point in that space. Weili, could you tell us about what you are following in that market?
Chen, Standard Chartered: I happened to be around rating agencies when 2.0 was recalibrated. These designations have to do with some external forces, like the global financial crisis which led rating agencies to have to wholesale recalibrate the asset class and eliminate something entirely — for example, CDO. CLO version 3.0 in the US context has a lot to do with the Volcker Rule and regulation.
So the good news is that we are not seeing the inputs of such wholesale changes thus far. Right now, I think it is around 4% of ratings that are affected by Covid. Going back to the last crisis, that number was 10 times as high, around 30%-40%, and the rating impact this time around is mostly focused on junior tranches. So, if you look at the difference, I have to give credit to the post-crisis calibration. The structures have held up well, and the differentiating factor is the massive amount of central bank and government support. On paper, if you look at the sheer economic impact, it may exceed that of the financial crisis, but I think equally important are the different measures this time around.
There are early signs that the worst of Covid impact on collaterals may be behind us. If the current trend continues, I think any wholesale change to CLO structures at this point does not look quite likely, so we may end up with status quo or with modest change.
Sharkey, Dentons: I think I would agree with Weili. Certainly Covid has had a big impact, but if you look at the technology changes in CLO documentation after the financial crisis, things like risk retention, prohibiting investment in CDS and structured finance securities, introducing the refinancing and repricing concept — those changes when the CLO market re-opened in Europe were just seismic. If you look at the impact Covid-19 has had, in the short term, yes we’ve seen an impact, with less leverage, smaller deals, pricing on triple-A notes increased, a lot of stress on warehouses, pressure from ratings downgrades and on cashflows. But as for lasting changes on CLO documentation, I think in Europe they are still carrying on with the existing technology, except for the addition of the loss mitigation loans concept, so I think it might be hard to justify a 3.0 label.
GlobalCapital: Navita, you’ve been looking at trade finance and supply chain receivables securitizations. What is going on in that market?
Yadav, Vistra: 80% of global trade is financed through some form of trade credit. Covid obviously led to a freeze or near freeze of supply chain financing and subsequent securitizations. Even pre-Covid, the unmet demand for global trade financing has been about $1.5tr, so we can imagine the increase now.
Generally, central bank support has been aimed at SMEs. Having said that, it is a very gradual process and the trade finance market lacks external standardization. Europe has been very active, and it matters a lot for the European market that supply chain finance continues without hiccups. Trade receivables securitization is something which has been right up there in importance during the Covid crisis, and we have been getting many queries in this space. Especially, if you are sub-investment grade, a trade finance securitization would get you better cost and diversification.
We do believe this near freeze would need to be lifted, as disruptions have caused massive impact on both large corporates and their lenders. Demand has seen 2019 levels, but it remains largely unmet. Matching the demand, while getting the financing at the right time, whether through securitization or not, is important.
Kalra, Vistra: If you look at this market, this space was primarily driven by large banks in Asia, which have strong commercial teams and structured finance desks. Most of the securitization that was happening was bespoke and at the same time there were some portfolio-based approaches for particular markets.
What we see now as the largest change in this ecosystem, is that currently the supply chains in Asia predominantly revolve around China. With the geopolitical tensions that are going on between China and the US, a lot of clients, specifically those who have been using supply chains linked to China, are looking at options in Vietnam, Thailand or the Philippines. So there would be a reconfiguration of supply chain dynamics in the region, and once things are realigned the money will flow along with that. So this is a sign we will see more localised securitization structures, and banks that are active in smaller markets will start looking to realign their strategies and I think it might be right to say that regional banks with a presence in all of these regions will start seeing some divergence of demand to their side. It’s early days to make firm estimates, but these are the signals that are coming in from the region and I think, once we are looking at a more certain environment, we can come to a conclusion as to how much this has impacted money flow from China to other markets.
GlobalCapital: To close out our discussion, could you all give your thoughts on the macro level situation? The past six months have been highly unprecedented and the various government and central bank support measures have had big impact on these markets. What is your outlook for the macro environment six months on from the start of all this?
Chen, Standard Chartered: I view various jurisdictions to be accretive or productive for securitization. One way is that you have direct support. In the US, you have Talf 2.0 and for the first time have included CLOs as eligible collateral, and ECB’s covered bond purchase has been credited with making a very attractive covered bond market for some of even the non-EU issuers, including from Asia and North America. So I think central bank policy has been helpful and there is a recognition that securitization has become more stable, mature and reformed to be a mainstay in these programmes.
On the margins, some policies that come to mind in terms of making things easier for banks have really created less of an incentive to do securitization. This makes room for non-bank issuers, which I think in many regions are the big drivers of securitization.
Longer run, when I look at low or negative rates, I think eventually there will be some reckoning with this massive growth in balance sheets. In that context I think that securitization, which is based on asset quality and cashflows, will emerge as an attractive alternative to more investors.
Ford, TwentyFour Asset Management: Undoubtedly we’re going to see ongoing central bank stimulus. I’m not 100% sure it will be in the form of lower or negative rates. I think the asset purchase route is very powerful, and with regard to non-banks we saw the ECB buy some non-banks deals quite recently. So I think that is a real positive and balances the slightly more negative outlook for non-banks more broadly. Given what we’ve seen in Europe, you do have to question what negative rates really achieve and what they were supposed to do.
There are some technical points from the standpoint of securitization, too. Banks can’t really lend to consumers at zero or negative rates, so you have to ask how big or small that margin can really get and what issue does that create for securitization. What is the impact on excess spread levels in Europe, where we already have negative rates. It is a big challenge for securitization and I do hope we continue down a more asset purchase route. I think the question, ultimately, is how low can yields go.
Tan, Bayfront Infrastructure: Returns is a big consideration, given where rates are. It’s not just around absolute returns for investors, but also for us as equity holders. Investors have to recalibrate their expectations around what kind of returns are appropriate for the next couple of years, especially those that have fixed return hurdles. So how they react to the current environment will be something very interesting to test and see.
Sharkey, Dentons: I think it is worth looking at what we have on the horizon. We have elections in the US, you’ve got a potential second wave of Covid, you have the end of the transitional period with Brexit, and so all of those will be something for global and local economies to deal with.
Kalra, Vistra: I had read that this year global debt may jump by $9.3tr, but, that said, we have still not really hit the road on where this will lead us. Governments in Asia have given support to SMEs and individuals by offering a moratorium on interest, which is something in play this quarter and the next. But that has also brought discussions about when that support is no longer available, and there will be an increase in defaults and an increase in NPLs. From a business perspective, the vantage point you are looking at is that we are expecting restructuring and refinancing to quicken by early next year or second half. And we have seen a lot of debt funds and opportunity funds raising a lot in Asia, and we have seen other funds do a fresh round. And their interests have been across the region, from China, Malaysia, Singapore, Indonesia, Thailand, India, so that is something we anticipate driving activity in the region until at least early next year.
Yadav, Vistra: This has been a crisis of solvency. Until some time back, global debt was already 1.3 times equity levels. And now, to solve the problem of debt, we’ve simply gone about adding more debt in the world. So it only goes on to conclude that the global debt market size is going to explode, which in turn means that solving the problem of solvency for companies will lead to problems of solvency for governments. It will be interesting to see the emerging standards for risk and return in face of the new reality of unprecedented defaults, non-performing loans and assets changing hands worldwide.