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Weathering the storm

March 2020

With global uncertainty increasing, triggered by the coronavirus threat, leaders of the financial services industry assembled at the SFVegas conference from 23-26 February to discuss what could stem the tide

“News was made, and positive, forward-looking plans were developed,” wrote Michael Bright, CEO of the Structured Finance Association (SFA) in his blog about the SFVegas conference. “With such a dramatic backdrop, it clearly makes sense to gather a few key takeaways, especially as Covid-19 begins to thrust the global financial markets into a tailspin of confusion and fear.”

Once a year those who are at the forefront of structured finance gather in Las Vegas for a conference that captures the mood of the industry and sets the tone for the year. Despite Bright’s foreboding, a check on how delegates at the event regarded the outlook showed that a tone of optimism exists across the industry even as the backdrop of Covid-19 (coronavirus) began to cast shadows. Had the event taken place just a couple of weeks later, the mood would likely have been much more pessimistic.

 

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More than 8,000 market participants who assembled for the SFA’s annual conference on 23-26 February shared their expectations for a robust new issue supply during the first half of 2020, as issuers capitalise on the current low yield and tight spread environment.

What was perhaps most compelling this year was the focus on the Environment, Social and Governance (ESG) sector, with the SFA corralling the industry to develop its own framework in the absence of any regulatory guidelines for ESG investing in the US. Various panellists at the conference also painted a healthy outlook for collateralised loan obligations and residential mortgage backed securities. Both sectors look poised to benefit from opportune supply conditions and technological innovations such as digitisation, artificial intelligence and electronic contracts.

 

Going green

Amidst growing demands from investors for companies to be more proactive in adopting ESG policies and putting sustainability at the heart of their operations, market participants are driving a collective activism to get frameworks adopted.

ESG took up four panel discussions and working groups, which comprised investors, money managers, issuers, rating agencies, and accounting firms. The event illuminated the uncertainty around what ESG requirements are and how they affect businesses.

This uncertainty stems from the lack in the US of a common ESG framework. At the conference, multiple perspectives were covered on who should drive its implementation.

ESG evaluations in North America tend to be more organic and investor-driven in comparison to Europe. Since regulations mandate the adoption of ESG frameworks and nonfinancial reporting, one panel noted the US has divergent pathways towards ESG compliance.

The conference also heralded some early moves towards ESG frameworks in the area of non-agency/private securitisations.

Some investors believed that adoption should be driven by the ratings agencies and accounting firms. In this regard, the SFA is leading a Taskforce responsible for putting together a common ESG framework within structured finance. At this point parties are looking to the United Nations-supported Principles for Responsible Investment (PRI) and the SFA ESG Taskforce to help develop a common ESG Framework, which they continue to work on unaided in the meantime.

As to agency-led securitisations, other delegates at the event expected government-sponsored enterprises (GSEs) to drive a single ESG framework within residential mortgage-backed securities. They touted GSE green bonds as an ESG success story, noting that two securitisations last year attracted interest from investors who do not typically invest in GSE bonds.

 

Home talk

In the residential mortgage sector, the mood among issuers and investors was generally optimistic, with substantial growth noted for non-qualified mortgage (non-QM) loans that fall outside strict qualifications of the standard mortgage lending box. While credit fundamentals remain stable in RMBS, there was some collective concern over slowing home price growth.

This sector is also getting behind the ESG theme, with SFA devoting more of its agenda to the take-up of green mortgages, which provide homebuyers and owners with discounted mortgage rates once they have upgraded the energy rating of their home. One session heard how in July 2019, the UK government launched its Green Finance Strategy designed to reduce mortgage rates, bills and emissions through new green mortgages1.

 

Digitising mortgages

Another RMBS panel discussed recent advances in the effort to digitise the mortgage process. Panellists noted that the move to more widely adopt digital promissory notes, or eNotes, has been accelerating, with the GSE’s playing a key role. In total, over 120,000 eNotes were registered in 2019 alone, with future volume expected to increase dramatically.

The eNote is created, signed and managed digitally through eVaults. The infrastructure requires the Mortgage Electronic Registration System (MERS) and eVaults to store the “authoritative” copy of the eNote. Its digital make-up is said to reduce the time taken to complete a typical mortgage.

MERS – a US national electronic database that tracks changes in servicing and beneficial ownership interests in residential mortgage loans on behalf of mortgage lenders and originators has become market standard in RMBS and the MERS eRegistry identifies the owner and location of eNotes as well as records transfers to subsequent purchasers.

The role of custodians was the focus of a discussion covering automated verification, certification and eNote transfer procedures. Panellist member James Macmillan, Deutsche Bank’s Document Custody co-head, highlighted several Deutsche Bank eNote initiatives. The most recent of these is the bank’s partnership with mortgage giant Freddie Mac to launch an automated eNote certification and safekeeping solution2. A press release issued in January 2020 describes the initiative as the industry’s first automated eNote certification solution to be run by a 3rd party Document Custodian.

 

CLOs move forward

CLO investors at SFVegas also shared the structured finance industry’s optimism. They appeared to be unfazed by credit fundamentals or the need to transition away from the Libor benchmark rate to some alternative rate by the end of 2021, noted Kroll Bond Rating Agency in its conference report.

New issue volumes for 2020 were expected to lag behind 2019. Deutsche Bank Research’s 2020 Securitisation Outlook2 projects US$90bn in US new issuance for this year, a 20% decline from 2019, and 29% lower than 2018. But recent market reaction, triggered by the coronavirus threat, would temper this.

 

Looking ahead

Gary Vaughan, Head of Americas, Corporate Trust at Deutsche Bank noted an overall positive outlook and tone from a record number of conference attendees. However, shortly after the conference, Covid-19 began to accelerate across global markets. “While there has been a small impact on issuance to date on the structured side, time will tell as to the impact on issuance in the medium term,” he said. “On a positive note, the significant drop in the 10-year treasury rate will lead to a large increase in document custody volumes in the short to medium term as the markets look to transact with increasing ferocity.”

Deutsche Bank’s Corporate Trust team wishes clients and industry colleagues health and well-being during these turbulent times and continues to help clients navigate complexity in capital markets. For further information on how the team can support issuers and investors, click on the client navigator app and choose a solution that best meets your needs.

 

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