Weekly Wrap: GAO sees no systemic risk with CLOs

December 23, 2020 9:00 PM

Collateralized loan obligations have taken criticism for bringing the U.S. financial system to the “cusp of calamity.” Or described as a Wall Street-created leviathan churning out capital to junk-rated, highly leveraged companies under increasingly lax standards – thus fueling even more risk into a trillion-dollar sized leveraged loan market.

Most commonly, these corporate-loan portfolios have been compared (despite robust objections from the structured-finance industry) to the notorious collateralized debt obligations fed by the untamed subprime mortgage industry that fomented the “Great Recession” financial collapse of 2008 amid rampant borrower defaults.

But this month, the U.S. Government Accountability Office noted that CLOs this year were met with their first post-crisis stress test - and were “largely resilient” when it came to facing down the COVID-19 economic calamity that brought record levels of delinquencies and downgrades across several sectors of corporate borrowers.

“Present-day CLO securities appear to pose less of a risk to financial stability than did similar securities during the 2007–2009 financial crisis, according to regulators and market participants,” the GAO concluded in an 85-page report. “For example, CLO securities have better investor protections, are more insulated from market swings, and are not widely tied to other risky, complex instruments.”

The GAO also reinforced the widespread industry mantra that CLO capital structures are particularly hardy when it comes to protecting investors in senior-rated tranches (the “AAAs”). That follows an October analysis by the Securities and Exchange Commission on the systemic impact of coronavirus-related economic shocks. As highlighted by the Structured Finance Association in a news brief this week, the SEC held that triple-A senior tranches would not lose principal even in the event of corporate defaults rising to 35% and recoveries falling to zero.

While new issuance of CLOs sputtered in March and April, volume recovered as the broader economy improved during the summer on the heels of $2.3 trillion in government stimulus and emergency lending facilities to businesses and capital markets. So did pricing, from an issuer standpoint, as the payouts to investors that spiked early during the outbreak retreated to pre-pandemic levels in the fourth quarter.

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Indoor business conference for managers.

SFA makes plans for in-person Vegas confab

The capital markets industry is ready to shake hands again.

The Structured Finance Association announced last Friday it has scheduled its 2021 securitization industry conference as an in-person confab for next July, banking on a successful rollout of COVID-19 vaccines to stem the coronavirus pandemic and again allow for large public gatherings.

The Washington, D.C.-based trade group said the three-day SFVegas 2021 show would return to Las Vegas on July 25-28, in the same venue (the Aria Resort & Casino) where the SFA hosted its 2020 conference this past February.

That gathering attracting 8,200 attendees prior to the COVID-19 outbreak in the U.S. that brought a halt to global business travel and shifted subsequent industry gatherings this year to online virtual symposiums.

“We are eager to get together again,” said Michael Bright, chief executive officer of the SFA, in a press release statement. “With Covid-19 vaccines coming online fast, we are very hopeful that will be possible in mid-2021.”

The conference was originally slated for May 2-5.

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Aerial view of of a residential neighborhood in LA

Aerial view of of a residential neighborhood in Hawthorne, in Los Angeles, CA

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Provident's 'unique' RMBS boasts super-prime pool

The next residential mortgage securitization co-sponsored by Provident Funding Associates may be the Cadillac of post-crisis RMBS deals.

The $258.42 million Provident Funding Mortgage Trust 2020-F1 is a pool of 649 agency-compliant loans that Kroll Bond Rating Agency describes as one of the most high-end credit quality deal of any RMBS transaction that has closed in the past decade.

The nonbank lender’s deal is “somewhat unique” in that it is backed solely by 15-year fixed-rate conforming mortgages, issued to a coterie of “underlying borrowers [who] on average are of notably high credit quality,” according to a presale report published Monday by Kroll.

“PFMT 2020-F1 comprises loans which have the highest [weighted average] FICO score as well as the lowest WA original CLTV of any of the more than 400 RMBS 2.0 transactions issued to date," the report stated.

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Upstart aims to push boundaries of AI-based lending

Credit modeling is still an imperfect science, even with the use of artificial intelligence, acknowledges Dave Girouard, co-founder and CEO of the online lender Upstart.

There's still room for a better understanding of human behavior and the impact of external factors on a person's ability to repay, he said in an interview after his company raised $240 million in an initial public offering last week.

Upstart has stood out since its inception in 2014 for several reasons. The San Francisco company takes a distinctive approach to lending — its software considers 1,600 data points to determine creditworthiness, including the college an applicant attended, the degree obtained and the profession he or she is entering.

Second, it’s the only fintech to have received a no-action letter from the Consumer Financial Protection Bureau, getting the bureau's blessing to pursue AI-based lending provided Upstart sends it data about loan applicants, approvals and loans rejections on a regular basis. Upstart's IPO was a rare event among online lenders, too. Affirm delayed the one it had planned for 2020; SoFi is rumored to be thinking about doing one.

In the interview, Girouard discussed why his company decided to go public at this time, how it has evolved in partnership with banks and how it has maintained a special relationship with the CFPB.

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Penny Crosman