Overview – Capital Markets – Securitization
The United States securitization market has continued to be very active over the last year. Issuers of registered asset-backed securities (ABS) have successfully adapted to the many additional regulatory requirements enacted in response to the financial crisis. Registered offerings of ABS have primarily consisted of ABS backed by automobile loans and leases, and commercial mortgage-backed securities. Registered offerings of residential mortgage-backed securities (RMBS) have been nonexistent, primarily due to the difficulties related to compliance with the 2016 amendments to Regulation AB that required the provision of asset-level data. Other sectors of the ABS market, including securitizers of marketplace loans and single-family rental loans (SFR), have also chosen to pursue unregistered offerings. The scope of one of the primary regulatory responses to the financial crisis, the risk retention rules which apply to both registered and unregistered offerings of ABS, was limited by the U.S. Court of Appeals for the D.C. Circuit in early 2018. The Court held that CLO managers were not securitizers, and thus were not subject to the risk retention rules. Many CLO managers had adapted to the risk retention rules by employing a variety of structures to make compliance with those rules economically feasible, and the ruling may usher in a new wave of CLOs without such structures. It remains to be seen whether investors will be willing to invest in CLOs which no longer include risk retention features in the same volume and at the same price levels as those CLOs which may continue to include such features. Other asset classes may also attempt to structure securitizations in a similar manner to open-market CLOs, but as of this writing, the authors are not aware of any such transactions.
Throughout the latter half of 2017 and into 2018, the volume of securitization has increased to the highest level since the financial crisis. Spreads have fallen, most notably in RMBS, although it seems unlikely that the remainder of 2018 will experience dramatically lower spreads than those that have existed during the early part of 2018. There continue to be concerns over the underwriting standards for subprime auto loans as well as commercial mortgage loans.
Below are specific observations on a few asset classes. Given the breadth of the asset classes in the ABS market, we have selected only a small number of the many possible asset classes.
Alternative Energy ABS. One of the faster growing areas in the ABS market is the securitization of alternative energy assets, typically loans and leases that are made to support renewable energy products like solar loans, energy efficiency washers, dryers and windows and similar products. Sponsors can be specialty finance companies or municipal agencies and entities, and lenders have included banks and government agencies. The warehouse and term transactions that have been done to date have been structured in similar fashion to consumer asset securitizations. Most of these transactions are private placements and do not have to comply with the public offering asset-level disclosure requirements.
Auto ABS. Given the large number of issuers in the auto ABS sector that issue publicly registered ABS, this particular sector was significantly affected by the regulations enacted in the aftermath of the financial crisis. The industry has successfully adapted to the new regulations, including the asset-level data requirements in public transactions and risk retention. As noted above, concerns still remain over future loan performance, especially deeper subprime auto loans, given evidence of slowing automobile sales. However, in spite of these concerns, the vast majority of auto ABS are performing within expectations.
CLOs. CLO issuance was positively affected by the upturn in the leveraged loan market in the last quarter of 2017 and early 2018. Consequently, the amount of issuance over the past several months was considerably more than during the year-earlier period. Recently, a large number of refinancings and re-pricings of existing CLOs has also contributed to higher levels of issuance. Finally, the decision of the U.S. Court of Appeals for the D.C. Circuit mentioned above, which held that managers of open-market CLOs are not subject to the U.S. risk retention rules, is likely to have a significant and positive impact on the CLO industry.
CMBS. The CMBS market is commonly divided into a large publicly-registered conduit component; a single asset/single borrower privately offered component; and a private floating rate component. Each of these sectors was strong in 2017 and the first few months of 2018 after digesting a few years’ worth of new federal regulation arising from the Dodd-Frank legislation. Those issuers that have compliant shelf registration statements have been active in the public market refinancing many previously securitized ten year mortgage loans. High real estate values and continuing historically low interest rates continue to drive a busy single asset/single borrower market. Each market has largely resolved the issues inherent in the risk retention rules and a number of horizontal, vertical and L-shaped retention deals have already been done in the first three months of 2018. The type of risk retention that is most economically attractive in any particular deal depends on any number of factors, including the identity of the sponsors, the regulatory capital treatment of the retention interests, and the identity and structure of the third party purchasers themselves.
Marketplace Lending. After a slow first half of 2016, the marketplace lending securitization market has grown uninterrupted from the latter half of 2016 through the beginning of 2018. Volume in 2017 was the highest yet in this asset class and spreads have tightened. Rated securitizations of marketplace loans are now commonplace. The market now consists almost entirely of 144A private placements sponsored by the marketplace lending platforms, many of which aggregate loans previously sold to third-party purchasers on their platforms. The marketplace lending platforms hold the risk retention on these transactions. Signs of credit deterioration in certain vintages, as well as a rising interest rate environment, raised some concerns as to whether growth can continue at its current rate. In addition, certain court decisions and state regulatory challenges that call into question the bank partnership model used by many marketplace lending platforms continue to raise risks in this asset class. Marketplace lending platforms have implemented structural changes intended to distinguish their loans from those challenged by these court decisions and regulators, and legislative fixes to some of these issues have been proposed in Congress. The proposed OCC FinTech charter did not materialize in 2017, and faced challenges from community banking groups, but it is a development worth watching in 2018 and beyond.
RMBS. While whole loan sales of residential mortgage loans remains an attractive exit option, pricing for RMBS was extremely favorable in the latter half of 2017 and early 2018, resulting in a marked increase in the issuance of RMBS of all types, including RMBS backed by newly originated loans (both QM and non-QM) and reperforming mortgage loans. Several new issuers of RMBS have entered the market over the past several months, and it appears several more may enter the market prior to the end of 2018. However, the difficulty of complying with the regulations associated with registered offerings continue to make private placements more attractive to issuers.
Single Family Rental. SFR is divided into single asset/single borrower transactions, and transactions backed by multiple SFR loans to different borrowers, both of which are privately offered. Both types of transactions continued to be prevalent in 2017, with the first GSE wrapped transactions for single and multi-loan transactions taking place in 2017. Consolidation in the large owner/operators of SFR decreased the number of issuers in the single asset/single borrower space in 2017. Risk retention requirements have been satisfied using both horizontal and vertical options.