Slideshow Best of SFIG Vegas 2019

From financing driverless cars to dealing with Libor's demise, here are the highlights from the Structured Finance Industry Group's annual conference.

Removing the implicit guarantee for Freddie Mac's unsecured debt would have consequences for the housing finance system, according to CEO Don Layton.

Layton said that Freddie, along with sister company Fannie Mae, relies on unsecured debt to fund its purchases of delinquent loans out of pools of collateral for mortgage bonds. Loans that are subsequently modified stay on Freddie's balance sheet, rather than in a securitization trust.

The two government-sponsored enterprises could not continue to do this if it had to issue unsecured debt without the implicit guarantee; they would not be able to issue debt cheaply enough.

"People should understand that zero as a policy reaction has consequences that I don’t think the system would like," he said.

Libor’s demise poses significant problems for outstanding floating-rate securities that are pegged to the benchmark.

Issuers can incorporate language in new deals that spells out the process for switching to a new benchmark. But existing deals may require an amendment that is approved by 100% of holders. And locating investors is no easy feat, since financial assets are held “in street name” by a brokerage firm, bank or dealer on behalf of a purchaser, obscuring their true ownership.

Faced with amending several hundreds of billions of dollars of outstanding asset-backed securities, the Structured Finance Industry Group has formed a task force to look at commissioning a better way of communicating with bondholders, and potentially among bondholders.

“There’s a desire as an industry to come up with a solution,” Kristi Leo, a member of SFIG’s operating committee. “We’re going out to the marketplace to see if we can put it together.”

GM Financial's role as a captive lender has grown considerably in the eight years since it was acquired by General Motors. Now the Fort Worth, Texas, lender is ready to go along for the ride as its parent expands into electric cars and managed fleets of driverless and ride-sharing vehicle fleets, CEO Dan Berce said.

All three programs are central to GM's long-term corporate mission of achieving "zero crashes, zero emissions and zero congestion,” or "zero/zero/zero." GM Financial has a key role to play, Berce said.

The finance company is already underwriting and managing leases for GM electric cars in China (where government subsidies are encouraging production). The lender is also buying and managing fleets for GM’s Maven ride-sharing program launched in 2016 in a handful of U.S. and international urban markets, and plans to do the same when GM introduced driverless car fleets later this year through its Cruise Automation division.

For now, this financing is being kept on balance sheet, however

Tapping the capital markets for reinsurance does more for mortgage insurers than just reduce their exposure to a downturn in the housing market. It also provides them with information about how others view this credit risk.

One day, this information could be used to adjust premiums.

Arch Capital Group, the largest private mortgage insurer, comes to market twice a year with notes whose performance is linked to insurance policies underwritten over the previous six months. Pricing of these notes provides information about investors views of credit risk that flows back to Arch's premium pricing team.

"To date, there have not been any actual adjustments on the front end, [credit risk transfer] execution has been good," Jim Bennison, executive vice president for capital markets, said at the Structured Finance Industry Group's annual conference in Las Vegas. "But at some point that will likely change as we go through a normal housing cycle."

Recent rating agency downgrades do not appear to have dented enthusiasm for bonds backed by franchise fees.

In February, S&P Global Ratings issued a one-notch downgrade to two series of notes issued in TGI Friday's 2017 whole-business securitization. The agency cut both the Class A-1 and Class A-2 notes issued by the $425 million transaction by one notch, to BB+ from the original BBB-, citing the chain's declining debt-service coverage ratio as well as same-store sales and average unit volume.

The action came two months after S&P completed a ratings watch review of the $785 million Arby's Funding LLC securitization, although it concluded by affirming the existing ratings.

Participants at the Structured Finance Industry Group's annual conference in Las Vegas seem to view those events as outliers in a sector that continues to gain in popularity with investors. Since early 2017, more than $13 billion in whole-business securitizations have taken place, more than doubling the amount of securities outstanding.

“It’s somewhat unusual for us to have credit watches in this asset class," Kate Scanlin, an analyst and senior director at S&P, said. S&P currently rates 29 series of notes from 16 corporate securitizations of franchise- and royalty-fee payments.

When Verizon issued its debut handset securitization in 2016, it generated some buzz. There were expectations that other U.S. carriers would follow suit, resulting in a new asset class with significant size.

Yet three years later, Sprint, T-Mobile and AT&T have yet to securitize device plan purchase agreements, despite the potential benefits.

“Across the industry, there are other priorities,” said Chris Jonas, the direct of ABS banking for Bank of America Merrill Lynch. “Some of the carriers are focused on managing their debt load, so it probably is incongruent to say we’re going to add a new debt product as part of the process.”

The first step toward getting a handle on blockchain technology is not to get bogged down in how it works.

Think instead of what it can do, experts say.

“When you look at these technologies, don’t start from the ground up, thinking, 'Oh my god, these distributed ledgers, how does all that work?'” said Lewis Cohen, a co-founder of startup legal outfit DLx Law.

Instead, “Start from the top down; what are we trying to achieve here and are these blockchains a tool set that will allow us to doing something much, much more effectively,” he said. “When you start looking at it that way, you’re going to come back and participate and be much more engaged.”

Being too forgiving to borrowers to borrowers with temporary cash flow problems proved to be the undoing of Honor Finance. But most other subprime auto lenders are using extensions much more effectively, according to S&P Global Ratings.

Most of the lenders the rating agency has surveyed reported extension rates between 2%-8% of the loans they service. “It’s an effective loss mitigation tool,” said Rahel Avigbor, an S&P credit analyst.

Extensions are usually granted no earlier than six months after a loan is originated, according to S&P, with no more than one or two a year, and a maximum four to eight extensions over the life of a loan.

Circumstances for extending loans have included allowing borrowers to wait for income tax refunds, or assisting borrowers under emergency circumstances – such as those affected by Hurricanes Harvey, Irma and Maria in 2017 across the Gulf Coast and Puerto Rico.

Replacing Libor as the benchmark for outstanding securities is so challenging that an industry working group may ask the New York legislature to lend a hand, David Bowman, special adviser to the Federal Reserve Board of Governors, said Tuesday.

Since most U.S. securities transactions are subject to New York law, it could be expedient to pass legislation defining the London interbank offered rate as the secured overnight financing rate plus a spread, Bowman said at the Structured Finance Industry Group conference in Las Vegas. This would obviate the need to amend documents governing $1.1 billion of leveraged loans and $800 billion of collateralized loan obligations, most of which never anticipated that Libor might cease to be published.

Expect even more actively managed CRE CLOs to be issued this year as investors get more comfortable with the idea of managers using proceeds from the repayment of collateral to acquire new bridge loan.

Unlike longer term commercial real estate loans, bridge loans can be repaid early. And when one of the loans in a CRE CLO prepays, the economics of the deal quickly deteriorate unless the manager can replace it.

While static CRE CLOs are similar in many ways to CMBS, actively managed deals "take a while to be understood and accepted" by investors, according to Steven Kolyer, a partner at Sidley Austin. They have various features designed to offset the risk that the composition of the pool will change over time, potentially resulting in a deterioration in credit metrics. For example, any new asset that is purchased is subject to numerous criteria.

CleanFund and other providers of Property Assessed Clean Energy financing for commercial building are increasingly focusing on larger projects. While this should boost underwriting volume over time, it may have slowed the growth of the industry in the short term, according to CEO Greg Saunders.

Saunders said that the sponsors of larger commercial developments are starting to see all kinds of advantages to PACE, which creates a lien on a property that is senior to a first mortgage and is repaid alongside property taxes. It is generally less expensive than some other means of financing energy and water efficiency improvements, such as mezzanine financing.

CleanFund has provided quotes for PACE financing as large as $350 million on a multibillion-dollar developments. "We see larger PACE financing happening at the expense of smaller projects, those of $500,000, partly because of the cost and time involved in getting commercial mortgage lenders to consent," Saunders said.