By Sayed Kadiri, Creditflux
Thursday, 06 April 2017
Prytania Investment Advisors has got off to a strong start in 2017 with the manager’s Athena Fund gaining 8.4% through February. The London-based firm runs a diversified asset pool with Athena invested in CLOs, CMBS, CRE CDOs, RMBS and trups CDOs, and its outperformance has come on the back of contributions from many different parts of its portfolio.
Chief executive officer Mark Hale says that trups CDOs have been rallying in recent months and this has boosted Athena, which was up 5.90% in January and 2.49% in February. “Trups CDOs are benefiting from strong fundamentals in the bank sector at the moment, while rising real estate prices and hopes for deregulation in Washington have also boosted sentiment towards these US lenders,” says London-based Hale.
But the star performer for Prytania was a special situation investment relating to a European CMBS position. The fund manager purchased the asset for Athena in December at around 57 cents and has seen its value rise in to the high 70s. “The servicer in this deal became more proactive and this has resulted in higher and quicker realisations on certain loans than the market expected. As a result, the class A notes Prytania owns in its Galene Fund have almost fully paid down and our Class Bs have rallied strongly on the back of this,” says Hale. He adds that the Class Bs are now expected to return par.
In Europe, CLO spreads have reached their tightest levels since the financial crisis in 2008. Prytania has been an active buyer of junior European CLO debt over the last 18 months or so, but Hale says that the firm more recently bought into the equity of a new issue CLO with the lowest cost of funds since the crisis.
He reasons that CLO equity can benefit from optionality if there is renewed volatility and a sell off in loans.
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By Structured Credit Investor, 30 June 2016
Brexit hits European ABS recovery, capital markets reform
The UK’s vote to leave the EU has caused untold damage to the recovery of the European securitisation market. Not only will issuance volumes suffer, but reform of the European capital markets via the CMU has also been set back significantly – both of which could limit the role that securitisation can play in economic regeneration and the reshaping of the financial system.
Mark Hale, cio of Prytania Investment Advisors, says that there are three key aspects to consider in connection with the impact of Brexit on the securitisation market – the UK-specific effects, the effect on Europe and policy developments relating to the future of the sector. The most immediate impact on the UK securitisation market is that the flood of issuance that had been expected post a Remain vote and prior to the summer holidays has been put on hold, due to the combination of uncertainty and market volatility.
Gordon Kerr, head of structured finance research in London at DBRS, confirms that a few deals have been delayed in the aftermath of the referendum result. “A surge of retained issuance could also occur as banks batten down the hatches. In the long term, we expect issuance to remain relatively muted,” he says.
While the European securitisation market has been dominated by UK RMBS issuance this year, this dynamic has now been stymied, according to Hale. “Originators that do not rely on securitisation issuance for funding and can afford to wait for spreads to recover – not that UK prime RMBS has seen very significant widening – will be fine. It will be more difficult for challenger banks and specialty lenders, whose business models are more substantially built on securitisation, as accessing the market will likely become more expensive for some time and the whole loan market may also be affected.”
Brexit may also deter cross-border investment in UK issuance, although anecdotal evidence from recent days suggests that US investor demand is increasing in some cases, due to the cheapening of UK assets and the sense that a wider market dislocation will yield more opportunities. More caution can be expected from Japanese investors, who are typically more sensitive to political changes, but there appears to be no reason why – should signs of stabilisation emerge – the dynamics that were driving them offshore couldn’t resume.
At this stage, it is assumed that spread levels will eventually stabilise. “The overall driver is low returns in other asset classes and limited supply, which suggests that primary activity can pick up in time, providing deals are sensibly priced,” Hale notes. Nevertheless, given the expectation of a more limited UK presence in the market, JPMorgan European securitisation analysts have revised their international ABS issuance forecast for 2016 to €60bn from €85bn.
Notably, secondary market activity appears to be weathering the Brexit fall-out better than expected, to the extent that bids declined somewhat and offers often did not move much. Hale continues: “There hasn’t been much visibility, but we’ve seen a number of BWICs circulate and prices have held up well. There hasn’t been any panic or forced selling – just more of a spill-over effect from the turmoil in FX or equity markets. The securitisation market typically reacts quite slowly and there has been a sense of measured calm since 2009, in the case of UK assets, which is reinforced by the limited supply and stronger fundamentals in the last seven years.”
Indicative spreads on sterling-denominated UK credit card ABS and prime RMBS are 22bp-23bp wider on the week (at one-month Libor plus 80bp and three-month Libor plus 110bp respectively) in the wake of Brexit, while ‘riskier’ non-conforming and buy-to-let bonds have widened by 32bp-33bp (to plus 185bp and 175bp respectively), according to JPMorgan figures. In comparison, Dutch RMBS and European auto ABS were each 5bp wider, and Spanish and Italian RMBS 18bp-19bp wider.
The JPMorgan analysts expect a more extensive re-pricing of UK and, to a lesser extent, peripheral risk to materialise over the next few weeks. In addition, credit curve and quality curve steepening could occur as higher quality senior risk outperforms.
Only a modest challenge to credit quality is anticipated in the short-term, but in the medium-term a more serious impact could materialise if there is a sustained rise in unemployment. “While the UK currently has a strong level of total employment and has been enjoying real wage gains, demand for labour is likely to slow and household incomes can be squeezed by higher inflation. A prolonged recession and weakened labour market would raise corporate defaults, constrain the level of consumer spending and cause a more material drop in house prices,” Hale suggests.
Prytania projections continue to show the strong prime and buy-to-let RMBS that the firm favours can sustain a repeat of the last two serious downturns in the economy and house prices with ease. However, it remains cautious on more junior, non-conforming paper.
The analysts remain neutral on UK prime RMBS, UK credit card ABS and UK BTL across the capital structure, as well as UK NCF seniors, as they believe that better entry points to add risk will emerge. “However, newer vintage UK NCF subordinate bonds will be most adversely impacted by the outcome of the referendum, both from an initial technical and longer-term fundamental performance perspective. Accordingly, we recommend an underweight position in UK NCF subs and continue to prefer the BTL sector, which in our view remains better insulated from performance deterioration relative to NCF,” they concur.
Should a prolonged period of economic weakness cause house prices to fall, mortgage market churn rates could decline and CPRs slow across the UK RMBS market, although performance is expected to remain tiered by programme type. UK prime RMBS in master trust format, with scheduled amortisation or bullet repayment structures, should remain most immune to slowing prepayment speeds.
In contrast, the European (ex-UK) securitisation market should see a continued slow recovery based on fundamentals and the support provided by the ECB. Kerr suggests that European collateral could also potentially be supported if jobs migrate from the UK to the continent. Similarly, while Brexit is expected to have a negative impact on UK commercial real estate – especially the London office segment – it again presents opportunities for Europe as businesses relocate.
On the political front, however, Hale suggests that secessionist and separatist movements in other countries had not been properly ‘priced in’ for both periphery and core countries in the run up to the Brexit vote. But, as with the UK, there is scope for policymakers to implement further monetary easing and other support measures if conditions demand them.
Meanwhile, from a long-term perspective, the recent moves towards more securitisation-friendly European capital markets has been badly hurt by the UK exit and by the associated resignation of Financial Services Commissioner Jonathan Hill. “The unintended consequence of Brexit is a set-back in reforming the European capital markets. This is most concerning, given that securitisation can play a significant role in economic regeneration and the reshaping of the financial system,” says Hale.
He adds: “There could eventually be a cathartic change of heart across Europe. But, for the moment, the referendum result has provided more power to those that are anti-reform and anti-securitisation. Having said that, there are a number of countries – such as Ireland, Holland and Sweden – that do not share the hostility to Anglo-Saxon capitalism in countries like France, and which may have to pick up the mantle of pushing the EU forward.”
Kerr suggests that Brexit creates the potential to introduce new regulations that are supportive of UK issuance. “EU risk retention requirements will be in place until the UK actually leaves,” he says. “If the UK adopts an alternative risk retention regime, issuers may still want to meet EU investor requirements. But there will always be demand from UK and US investors that wouldn’t necessarily have such stringent requirements.”
Specifically with regard to CLOs, it is unclear whether UK-based CLO managers can still be authorised under MiFID as sponsors after the country leaves the EU. This has raised questions about how to achieve EU risk-retention compliance for European CLO managers and whether the ‘sponsor’ route will remain viable.
One solution being discussed is for European CLO managers to relocate from the UK and to an EU member country. It is also possible that European managers will increasingly consider using the originator route to achieve compliance, according to Morgan Stanley CLO strategists.
The common presumption is that the UK will pull out of the EU completely and find itself in the worst of all scenarios, akin to Switzerland and Norway’s situation (but without the gold and the oil). However, Hale counsels that it is unclear whether the UK will fully leave the eurozone and negotiations could ultimately lead to the country enjoying an ‘EU-lite’ status.
“The UK’s flexibility to ‘go it alone’ and improve its competitive position in financial markets is limited: the regulatory environment is constrained by the need to accede to certain demands of the single market, such as passporting, and international regulatory initiatives like Basel 3 and Solvency 2,” he explains. “However, if an accommodation isn’t reached, regulatory arbitrage could emerge to some degree. The UK was the banking centre for Europe before the eurozone era and it could conceivably compete more aggressively, if necessary, potentially sucking business away from other over-regulated and over-taxed jurisdictions.”
As yet, there is no clear political thought on what is feasible in the UK, but the policy outcome largely depends on the new government that will be formed by October. There could be displacement of activity to the UK if a reform-minded government takes over that, for example, cuts the corporate tax rate significantly further and lightens the regulatory burden on financial entities here. This may offset the damage that will inevitably result from EU efforts to ‘repatriate’ business from London to Frankfurt and Paris.
“At the margin, prudential and supervisory policy adjustments could be made available to soften a severe downturn. The UK government will have a hole in its finances post-Brexit, which – coupled with policy reconfigurations and regime change – could allow more creativity to emerge and some of the more damaging rules and regulations to be toned down,” Hale indicates.
By contrast, a new government with a more ‘Establishment’ leadership may perpetuate what are seen as the often misguided policies of the last three administrations and be too timorous to deviate meaningfully from policies driven by Brussels.
Hale warns that the extent to which the UK’s financial sector in general and trading in securitisation in particular is ‘hollowed out’ could also lead to a permanent lack of liquidity in Europe. “We’ve already lost significant financial and human capital since 2008 and further negative forces on liquidity would be extremely unwelcome.”
He points out that a number of factors could positively impact liquidity, including supportive policy action in terms of the Bank of England cutting interest rates or resuming QE. “Additionally, longer-term dynamics could lead to more efficient intermediation of investor and borrower capital, some of which could find its way into the securitisation market. Online marketplaces and fintech platforms could continue being a growth story as bank activity remains limited. While this may not be the way all regulators would ideally like the market to evolve, they could have a passive tolerance of such disintermediation if it helps to address the constraints on bank balance sheets and concerns over their levels of leverage.”
By Structured Credit Investor, 30 June 2016
Mark Hale discusses in The Local Authority Pension Fund magazine the options in structured finance for investors in search of yield.