Susan L. Hodges 2016-07-29 03:21:18
New Rules add obstacles to securitizing. Will issuers get by unscathed?
WHERE THERE IS A WILL, so often there is a way. Like stream water trickling around a mound of stones, post-recession equipment securitizations began in 2010 and by 2013 reached record-setting issuance amounts. Last year saw 23 equipment deals and four new securitizers.
But stones in the form of federal regulations continue to gather, posing new challenges for both issuers and investors. As of mid-June this year, no new issuers had come forth, and according to Harrison Scott Publications’ Asset-Backed Alert newsletter, 12 equipment lease- and/or loan-backed transactions had been registered in the United States. Thus the question: Is securitization here to stay, or will this funding method be choked off by outside forces?
Among the mandates already imposed or now in process:
SEC Rule 17g-5, effective June 2015, which requires issuers, sponsors or underwriters of structured finance to post on a secure website any third-party due-diligence reviews and disclosures;
SEC Rule 17g-7, effective June 2015, requiring rating agencies to compare representations/warranties offered in a specific transaction to comparable transactions;
SEC Regulation RR (Risk Retention), effective Dec. 24, 2016, for nonmortgage-backed securities, requiring issuers or sponsors to retain at least 5% of the credit risk for assets that are conveyed;
SEC Rule 15ga-1, in effect for several years now, requiring securitizers to disclose fulfilled and unfulfilled repurchase requests on a quarterly basis (or annually if no repurchase activity); and
CFTC (Commodity Futures Trading Commission) Rule on Interest-Rate Swaps for Clearing Requirement, proposed June 2016, which would require, if implemented, that certain interest-rate swaps be submitted for clearing to a derivatives-clearing organization.
Compliance Happens
Mike Herzberger, Treasurer of GreatAmerica Financial Services in Cedar Rapids, Iowa, says his firm is monitoring the proposed rules on interest-rate swap clearing. “This is very much an issue in the securitization warehouse marketplace,” he says. “It’s not that we can’t comply, but it’s another rule being implemented that will undoubtedly increase the cost of securitization for GreatAmerica with little or no value-adds, from my perspective.”
For Herzberger, the broader issue is that equipment ABS [the asset-backed securities market] was so solid throughout the Great Recession. “To my knowledge no equipment ABS transaction ever got into trouble during the last recession, as contrasted to other asset types,” he says. “Equipment securitizations are getting caught up in all these new rules.”
Evan Wilkoff, Executive Vice President of Capital Markets for Ascentium Capital LLC in Charlotte, North Carolina, says his firm is monitoring regulators’ consideration of another rule that would require additional collateral disclosures for broadly distributed private offerings.
Increasingly, the advantages of securitization— access to the lowest cost of capital, the spread of risk and the diversification of funding sources— are available only to those firms with the size, scale, margin and expertise to control the process.
“This means that if you have a collateral pool, you’d have to disclose a lot of individual information about those contracts,” says Wilkoff. “But there is a push-pull in the marketplace.
Certain stakeholders want more disclosure; others want less.” The rule has yet to be finalized, but Wilkoff believes the SEC needs to choose carefully the information it will ultimately require issuers to disclose. “Certain information, such as vendor names, residual assumptions and contract yields, could be deemed proprietary,” he says. “If issuers are required to disclose trade secrets, they might choose or be forced to fund in alternative marketplaces.”
Under another rule, Regulation RR, the originator or sponsor of a transaction must hold, while the ABS are outstanding, at least 5% of the credit risk for the assets that are transferred, sold or conveyed through the issuance. “It could have been worse,” says Stephen Whelan, Partner at Blank Rome LLP in New York City and author of the 2015 Equipment Leasing & Finance Foundation study “Securitization: A Renaissance for Equipment Finance?” “An earlier version of the rule would have prohibited transaction sponsors from receiving their share of equipment residual proceeds if those receipts would have disturbed investor/sponsor proportionate shares established at closing.”
Even so, says Whelan, as with disclosure of collateralrelated due diligence, the concern with Regulation RR is not compliance but disclosure. “Sponsors will now have to reveal much more data about their internal operations,” he says. This includes the method used to calculate the fair value of the retained interest and of the balance of the ABS interest that will be securitized in the form of the asset-backed securities.
No Newcomers?
Not surprising, then, that thus far, 2016 has seen no new issuers in the equipment securitization market. “It’s not because of a dearth of investment bankers who want to do these deals,” says Whelan. “What may deter first-time issuers is sticker-shock.”
A company may be so unfamiliar with the process, for example, “that it doesn’t know what it doesn’t know, and asks 100 questions to establish a structure and a rating with the rating agencies,” Whelan explains. First-time issuers also usually spend a great deal of time creating documents, which can also add to the cost of a first issue. Once the first transaction has been completed, however, “There’s less backand- forth or asking what to do next,” says Whelan. “And documents are largely duplicated or revised for future securitizations instead of being heavily redrafted.”
Wilkoff points out that securitizing was expensive even before new regs were imposed. “Compliance with these rules has added to already-high transaction costs,” he says. Out-ofpocket costs for issuers include placement agency fees, investor and sponsor counsel, trustee fees, rating-agency costs and charges levied by other entities that perform required services on top of these. These fees can easily top $500,000. “Whether you have a $10 million or a $1 billion securitization, the fixed costs are roughly the same,” Wilkoff says. “So it makes securitizing much more challenging for the smaller issuer.”
Along similar lines, Herzberger believes costs are starting to define a minimum deal size. “It’s one thing for a company like GreatAmerica to spread the costs over a half-billiondollar ABS transaction like our last securitization, and for bigger players, it’s even less of a burden,” he says. “But for companies trying to do a smaller deal, increased costs of securitizing could prove to be prohibitive. Size is becoming much more important going forward.”
Vincent Belcastro, Managing Director/Group Head of Corporate Equipment Finance at Santander Bank Equipment Finance, in Short Hills, New Jersey, agrees that securitization floors are indeed moving higher. “Someone willing to do a $50 million transaction five years ago may now have to wait until they have $100 million or $150 million now,” he says.
Belcastro doesn’t believe rising overhead has forced companies to back off from the market, but rather to wait until they have a bigger pool to go forward. He says, “You have to look at pools of $100 million or greater to be seriously thought of as being able to launch a transaction.”
As a result, not everyone can play. Adhering to new rules and paying all transaction costs—which include costs of compliance—“definitely keeps securitization funding out of the hands of the lower-volume or tighter-margin issuers,” says Wilkoff . “A lot of leasing companies that lease equipment to large corporate entities do so in deals that are thinly priced without a lot of spread,” he adds. “And if your spread is too thin, you can’t afford to securitize. You have fixed costs and investors who demand a certain return, and you can’t do it. That’s where banks have an advantage—their low cost of funds allows them to pursue this type of financing without regard to private cost of capital.”
Increasingly, the advantages of securitization—access to the lowest cost of capital, the spread of risk and the diversification of funding sources—are available only to those firms with the size, scale, margin and expertise to control the process.
Interest-Rate Influence
Belcastro sees the 2016 market in a different light. “The slowdown is really a function of the fact that quite a few securitizations got done last year, and interest rates have picked up a bit, so the market is generally constrained as whole,” he says. Although just eight firms had issued transactions as of mid-June, Belcastro says an array of firms are participating overall and launching securitizations that range from trucking opportunities to automotive leases to office automation. “The market moves in tandem with where interest rates are going,” he says. “As a whole, with banks being regulated to the degree that they are, securitization markets will continue to be popular and growing.”
At the same time, he acknowledges pressures. “Markets are demanding more to launch a successful securitization and investors are demanding higher returns,” he notes. As a result issuers are making less spread, sometimes below 3%.
Still, Belcastro doesn’t expect big changes in the securitization market anytime soon, in part because equipment securitizations generally carry less risk than other types of ABS. “When you compare a collateralized mortgage securitization with an automotive securitization, for example, the automotive deal contains much smaller tickets that are well diversified across buckets of credit-risk profiles,” he says. “You’d need many more defaults in such a deal to cause the same damage as a mortgage securitization with defaults.”
What’s more, Belcastro thinks today’s deals are less about the equipment and more about credit profiles. “Investors are just more focused on overall credit ratings of pools and average ticket size than on certain types of equipment,” he says. “They want to know what type of credit quality they’ll get for their return.”
Whither Tomorrow?
Focus on credit quality could be due to investor concerns about a future downturn, or it could just be good business practice. “Yet, secondary trading support requires sponsors to have more equity in these transactions than before, so they have more capital than ever,” says Belcastro. “And companies are still actively issuing, so if a deal meets the parameters of good credit and good overall diversity in credits, the market is still good.”
Whelan also sees deals continuing to be done, in business equipment, aircraft and energy equipment—and he believes there’s room for growth, particularly in alternative energy receivables. Whether new issuers will come forth, though, he’s unsure. “To be a player, you have to have a good track record in terms of losses and delinquencies and be able to show management stability,” he says. “Companies issuing now have securitization teams that have been in place for several years.”
Wilkoff believes the market will hold, too, but he has reservations. “I still view equipment securitization as a viable funding tool for higher-volume issuers, although not without concern,” he says. “The equipment subsector is small, a lot of fixed-income investors have a hard time justifying spending the time to learn about the space due to its limited investment potential relative to other asset-backed securities, and broader market forces concerning price transparency and secondary trading support temper my enthusiasm a bit.”
Herzberger thinks similarly. “I also believe the market will hold, although the weight of regulation is becoming increasingly burdensome,” he says. “Additionally, as noted, we operate in a rather small subset of the overall ABS universe, so continued investor interest in equipment ABS is crucial to its continuing viability for equipment issuers.”
The biggest unknown in Herzberger’s mind is how the recent Wells Fargo acquisition of GE Capital’s commercial distribution finance business will impact the equipment sector. The deal was completed this past March 1. “GE Capital was a large securitizer in this space, very visible, and that was beneficial to the entire equipment market,” says Herzberger. “It’s unclear how their departure will impact this space, if at all.”
Susan Hodges writes about equipment finance and other business topics from her office in Wilmette, Ill.
For more on this topic, download “Securitization: A Renaissance for Equipment Finance?” from the Equipment Leasing & Finance Foundation at www.LeaseFoundation.org. The report reviews the current environment and analyzes the future of securitizations.
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