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New world old credit events

As Europe's newly minted insolvency regimes are tested in courtrooms, synthetic risk transfer deals face a reckoning over how to treat defaults in a legal landscape still taking shape.

SRT deals are fundamentally about protecting against losses, and usually losses on corporate credit debt. They're a financial instrument of high abstraction, of synthetic guarantees, regulatory artifice, and complex structuring.

But they're fundamentally tied to the mechanics of insolvency. In the EU and UK, these have been through a total revolution in the past five years, a period which has overlapped with huge growth in the SRT market.

The European Restructuring Directive, approved in 2019, mandated EU member states to rethink their insolvency processes, cleaning up some of the idiosyncrasies and oddities that governed restructurings, and promulgate a process that was more creditor-driven and kicks in at an earlier point, with the aim of preserving the value of a firm.

As the Directive was implemented in member states, that resulted in new regimes. These include the German StaRUG, Dutch WHOA, new laws in Spain and France, and even the UK's Restructuring Plan (the UK incorporated the ideas of the directive pre-Brexit).

It's not quite the case that Europe is one homogeneous area with one process, but it's moved in that direction.

Case law is coming through, but there have still been few large cap processes done under these regimes, so there’s a lot of precedent still to be worked out.

Even the UK, traditional home of the European capital markets and the English law loan agreement, is still in a period of transition — judgments on Thames Water and Petrofac have been breaking new ground (9fin has covered both in depth here and here).

The mechanics tying these processes to SRT deals are complex.

There are generally three credit events in an SRT: bankruptcy, restructuring or failure to pay, with losses determined by negotiated deal-dependent provisions.

Which brings us to BayWa, the German agricultural supply and renewable energy conglomerate. Economically, it's been through a fairly consensual restructuring, with senior lenders pushing out maturities in return for more equity coming in underneath, giving more runway to sell assets and turn around the business.

For the purposes of at least one SRT deal, though, it's been through bankruptcy, using a StaRUG process in the Munich court to push through the plan against a particular holdout creditor.

That implies a different tree of loss determinations from a restructuring event, and possibly an inferior tree (again, deal dependent). Issues include the initial loss determination (there's no par loss implied by the BayWa process, but bankruptcy events start from a lower point than restructuring), the length of the period over which calculations occur, and how (and if) the true-up process occurs at the end.

Celeste Tamers has taken a deep look at it here (behind paywall). But the broad lesson to draw is that the territory of European insolvency is only just beginning to be charted.

Some of the deals referencing BayWa were placed before StaRUG hit the statute book! As insolvency evolves, SRT deals and trigger mechanics must move with it. But it won't necessarily be easy.

The market is fundamentally based on CDS mechanics and corporate single name CDS is basically trying to achieve the same goal — use financial technology to abstract from messy local laws and court processes to likely outcomes, and provide an effective hedge to credit losses.

But in practice, it hardly ever works that way. CDS auctions do what the docs say they ought to (though there are plenty of conspiracy theories about the Determinations Committees out there) but they rarely deliver an accurate hedge that ties smoothly to the eventual loss debt holders experiences.

One might hope the bespoke negotiations over SRT documents can deliver better, more accurate hedging (changing ISDA regimes is much stickier than adding provisions into a single SRT document) — but European insolvency law is a still-moving target, with more surprises to come.

Hammer time

Goldman Sachs might have been relegated to risk retention on Project Flamenco, as we discussed last week, with Pimco providing most of the money and unwilling to share the economics, but that doesn’t mean it’s been standing idle.

A notice this week reveals that it’s bought the portfolio in Parkmore Point 2022-1, originally a deal from… Goldman Sachs!

Goldman bought the original book (legacy mortgages of 16 years seasoning, securitised in RMS 29, 30 and 31) from Kensington in August 2021, as part of a package called Project Hammer. GS teamed up with Starling Bank, which bought the clean end of the pool, with GS taking the NPL/RPL collateral.

But it was very much in the business of recycling its principal risk at the time, and it shipped out the equity to US-headquartered hedge fund a year later. The backdrop wasn’t the best — the tail-end of the marketing process ran into the ill-fated UK premiership of Liz Truss and associated market tanking, and, although the equity sale went ahead, the debt placement was put on pause until February 2023.

The deal featured some fairly hairy collateral — 74% arrears at the pool cut date, 63% in arrears of more than three months — though it had some specific strengths. The collateral is nearly all floating rate, and borrowers have a ton of equity (indexed LTV was 54.7%). So with a little macro tailwind, there were sound reasons to think some of the borrowers could get current and even refinance out; they don’t want to be stuck on SVRs if they can possibly help it.

UK macro hasn’t been particularly kind in the intervening period, and the deal underperformed original expectations, with S&P and KBRA downgrading the junior notes in March and October 2024, respectively (though it seemed like things turned around this year, with deferred interest on the class Ds cleared and Es starting to clear).

It had some of the usual structural mechanics seen in low WAC RPL pools, such as the ability for principal to pay interest — good for the original tranching and leverage point, but a problem if you’re reliant on said principal at the bottom of the stack.

The call date is this very Friday (25 July), and happily for debt investors, it will be exercised — but not by the original equity holder, which sold the rights back to Goldman. As we’ve discussed, GS is keen to get its European loan trading / portfolio buying activities firing again, and has brought in a new loan trading head, Pratik Gupta, to help make it happen.

It might seem a bit circular to buy back deals it already underwrote and sold down, but that’s probably better than fighting it out in a competitive portfolio auction (and losing to Pimco). Sometimes the best off-market trades are the deals you’ve already done?

Faster

Propel Finance serves as a fine example of how to build a securitisation-fuelled lender — something of a speciality for sponsor Cabot Square, which counts Blue Motor Finance, MSP Finance, JBR Finance, Lendco, and Simply Asset Finance among its portcos.

It recently announced the next stage in its evolution, a £1.5bn funding package comprising a big forward flow with Barclays, a new warehouse with Bank of America, extensions to its main warehouse with Citi and a facility with the British Business Bank, a longtime backer of the asset finance lender.

Most excitingly, it procured a mezzanine NAV facility, believed to be with Castlelake, taking the leverage point to a very tasty high-90s level. Castlelake beat intense competition to win the deal (Propel had 26 proposals on the table), reflecting what any asset-based fund will tell you — mezz is pretty hot right now!

The mezz structure is interesting — it’s similar to that used by Capital on Tap in 2024, which at the time was possibly the largest single mezz position in the European market. Instead of slotting into the warehouse facility below the senior debt and signing up to the intercreditor, a specialist lender can instead put all of its equity positions in a funding vehicle and sell debt secured against the value of these, effectively adding mezzanine leverage across every facility all at once.

This is cheaper to do, and more attractive — going to the effort of structuring and originating private warehouse mezz only to deploy a £10m ticket isn’t a particularly rewarding activity, especially for the larger asset-backed funds out there.

The new funding round sets Propel up for a public markets debut in 2026 to recycle capacity in the BofA and Citi facilities, which will be a welcome addition to the securitisation market landscape. Asset finance is one of the most fundamental lending activities around, and yet there’s only Haydock’s Hermitage shelf active in the UK. France’s Leasecom made its debut earlier this year, with FCT Ponant 1 (which included some leases of non-tangible assets) but it’s pretty sparse out there.

Actually, any kind of SME financing in true sale distributed securitisation format is rare, despite all the lobbying and think pieces on this topic.

Aside from these equipment lease deals, there’s basically Funding Circle’s unsecured personal guaranteed loans, which only show up in public in Waterfall Asset Management’s SBOLT deals, and Capital on Tap’s SME credit cards, in London Cards No. 1 and 2, and soon available in master trust format.

Asset finance in particular is lumpy, often slightly odd collateral — fairground rides, cranes, photography kit, portaloos, classic cars, oil rigs and much more — meaning that lenders need their funding facilities to have maximum flexibility, and care need to go into structuring both product and deal.

Residual value risk, for example, can be modelled well across a portfolio of new cars, but how much is a five year old dodgems ride worth? Someone knows, but it’s probably not a securitisation credit fund or bank. That doesn’t matter too much — asset finance leasing tends to be underwritten on the basis that it will fully amortise and with less lessee optionality than you’d expect in autos.

But, at least in the deals so far, Propel has some encouraging prints to take comfort from. Hermitage 2025's senior notes placed at 87bps, and placed down to 95%, with a blended cost of roughly 107bps. That’s about 5.3% all in, based on Sonia in early June, against an asset portfolio paying 11.5%.

This securitisation thing could be pretty good!

School’s out

Summer holidays are here, the regulators are heading to the beach, and they’re clearing their desks. So we have a smorgasbord of policy statements to look through from EU and UK authorities.

The most consequential of these concerns Solvency II, the European insurance regulation. The European Commission published a review of the regulation last Friday (18 July), including a whole swathe of amendments (treatment of insurers’ investment in long term funds, alternatives and venture capital, treatment of dividends, treatment of national insurance schemes) alongside the securitisation piece.

The mood music is excellent. The proposals aim to align the treatment of STS senior tranches with that of covered bonds, and it highlights that, unlike in the case of covered or corporate bonds, STS securitisations have their own detailed due diligence and transparency requirements.

Parity with covered bonds has been a dream of the industry since the crisis — BofA’s research team, which heroically crunched the numbers last weekend, described this as “welcome and justifiable (as we have argued for years), but nonetheless a very positive surprise”.

Solvency II capital is fiercely complicated, and calculated by combining different “modules” for e.g. counterparty risk, interest rate risk and, the most relevant for credit assets, spread risk, which in turn is a function of the modified spread duration and the credit quality of the underlying assets.

Therefore it’s hard to read off a table and say “this is how much equity capital an insurer needs to hold against XYZ asset” — the numbers need to be crunched thoroughly, though the BofA team have had a good go, and note the capital treatment for banks is still favourable, as well as pointing out that the proportional reduction for non-STS deals for insurers is greatest.

But will it work? A fly in the ointment is the other package of proposals on the Securitisation Regulation, which were published in June.

This tweaks the responsibilities for investor due diligence in such a way that end-investors in funds (for example insurers allocating to securitisation) remain legally responsible for this diligence, with hefty fines if it goes wrong — potentially enough to scare off some insurers considering dipping their toes into the asset class.

There’s an element of market structure to consider as well. European securitisation is generally short-dated and floating rate, and lifers in particular tend to like fixed-rate and long-dated assets.

This is partly a chicken-egg situation: issuing longer-dated fixed rate securitisation is perfectly possible, but with few insurance buyers out there, why would you? We note in passing that Rothesay won Project Tampa, a €6.7bn book of French mortgages, and holds its other French mortgage book, from Orange Bank, in a private on-balance sheet securitisation FCT Morisot. But that’s very different to doing a public deal!

So if the Solvency II package is approved, does the actual demand run ahead of the deal structures on offer?

The other big regulatory package unveiled last week was much less high level, but the implications are clear and substantial. The UK’s PRA announced “PS12/25 — Restatement of CRR and Solvency II requirements in PRA Rulebook — 2026 Implementation”, some of which is very dry (a reworking of rating agency mapping) but some of which shakes up the execution of UK SRTs, by opening the door to self-assessments and multiple deal permissions.

Instead of case-by-case applications, which can be refused (the PRA will not preauthorise transactions), in certain circumstances banks will be able to make their own SRT assessments, and use this across multiple transactions. That opens the way for a more programmatic, low cost execution template, where the deal terms don’t change much but a bank can issue more deals more cheaply.

As it stands, Barclays is likely to be the main beneficiary, being the largest PRA-regulated SRT issuer, and an institution which already takes a fairly programmatic approach to its flagship large corporates shelf. But it might encourage other banks to go further down this route.

Other changes include the explicit acceptance of unfunded SRTs in the UK — these were not banned before, but the treatment was ambiguous and the PRA won’t give a priori approval, limiting activity in the market; you don’t want to spend months baking a deal only for the regulator to reject it.

This, like pro-rata amortisation, will be considered a 'complex feature', so the streamlined permissions won’t apply, but it’s still an encouraging sign.

The PRA also set out its expectations for management oversight of SRT programmes (it’s the CFO’s job, though parts can be delegated) as well as capitalisation of synthetic excess spread (capital deduction), and excess spread in traditional securitisations, where this has been created by selling the assets in too cheap (also capital deduction).

The PRA’s statement Solvency II: illiquid unrated assets will also be of interest to portions of the securitisation market, as it deals with the largest hidden securitisation market in the UK — the internal securitisations of equity release mortgages on UK lifer balance sheets.

The regulator wants stronger checks on firms’ internal credit assessments, and it’s willing to bring in the rating agencies.

“Having sample assets assessed by a credit rating agency will additionally help demonstrate broad consistency between a firm’s internal credit assessment outcomes and comparable CRA issue ratings. Nevertheless, firms should not solely or mechanistically rely on credit ratings for assessing the creditworthiness of an entity of financial instrument”.

Other parts in the paper deal with the 'no negative equity guarantee' seen in some equity release mortgages, and with other aspects of structuring these transactions. The PRA is keen to make sure the risks of these fully retained ERM securitisations are properly recognised — while structuring a tranche to be matching-adjustment eligible should indeed provide a capital benefit, the securitisation process and internal risk assessments shouldn’t make risk disappear entirely.

The paper also lays out expectations for insurers investing in Income Producing Real Estate lending (effectively CRE exposures), including for valuations, underwriting methodologies, spread modelling, and matching adjustment eligibility.

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