Editor’s Letter

Welcome to the Winter 2023 issue of The Journal of Structured Finance. I’m writing this as 2022 draws to a close, so final numbers for the year are not yet available. Nonetheless, it is quite apparent that 2022 was a pretty rough year for nonagency structured finance. Spreads widened across the board (Exhibit 1) and the credit performance of outstanding transactions started to slide.

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EXHIBIT 1

Spreads on Aaa/AAA Selected Securities (bps)

SOURCE: Bank of America Securities.

Issuance was much slower in 2022 than 2021 (Exhibits 2 and 3). Moreover, the pace of new issuance declined markedly as the year progressed and interest rates climbed. Aggregate nonagency issuance dropped to levels not seen in nearly a decade. Among all the major asset classes, auto ABS has shown the best consistency of issuance activity over time. There is much uncertainty about what 2023 has in store.

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EXHIBIT 2

US Structured Finance Issuance Volume ($ trillions)

NOTES: 2022 is through November. The total height of each column shows the annual level of total US non-agency structured finance issuance volume. The segments within each column show the level of issuance for a particular asset class. The red line shows the annual level of agency MBS issuance. As shown by the two rightmost columns, the level of issuance in 2022 (through November) declined markedly from the 2021 level. Moreover, issuance declined in almost all asset classes from 2021 to 2022.

SOURCE: Securities Industry and Financial Markets Association (SIFMA).

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EXHIBIT 3

US Non-Mortgage Structured Finance Issuance Volume ($ billions)

NOTES: 2022 is through November. FAS 166 and 167 were accounting standards that significantly reduced the incentives for banks to issue credit card ABS. The end of the FFELP student loan program significantly reduced the supply of new student loans that could be packaged into student loan ABS.

SOURCE: SIFMA.

An interesting event in early December was a webinar organized by the Urban Institute on the future of loss mitigation. Higher interest rates create obstacles to using loan modifications as a tool for addressing delinquent loans. Panelists discussed a variety of approaches for working in a high interest rate environment. The new year will be a test for whether industry participants and policymakers can act promptly to choose among the available alternatives and roll out effective solutions. This will be an opportunity for the industry to deliver results that matter on Main Street.

In my Editor’s Letter for the Spring 2022 issue of the JSF, I wrote about methodologies for credit ratings and compared them to the process of selecting the best four college football teams to compete in the national championship playoffs.¹ The process is called the CFP Selection Committee Protocol. I observed that the guidelines for picking the best four teams were vague and appeared to lack objectivity; by contrast, methodologies for rating bonds should be clear and objective, permitting replicability of results.² The recent conclusion of the regular college football season in early December vividly illustrated the issues. On December 4 the selection designated the University of Georgia, the University of Michigan, Texas Christian University (TCU), and Ohio State University as the four teams that would enter the semi-finals to compete for the national championship (Exhibit 4).

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EXHIBIT 4

College Football Rankings by Week (2022)

The selection of TCU and Ohio State for the third and fourth slots was not without controversy. Various commentators observed that, although Alabama had lost two games during the season (compared to only one each for TCU and Ohio State), the combined point margin in both games was only 4 points and both games had been lost on their final plays. Meanwhile, when Michigan and Ohio State played during the regular season on November 26, the Michigan Wolverines clobbered the Ohio State Buckeyes by a score of 45 to 23, and completely dominated the game from the middle of the third quarter.³ Still, the selection committee made its decision and football fans can only wonder about the exact reasoning that excluded Alabama from being in the championship playoffs.⁴

Although the financial stakes are lower, judging and ranking in other sports generally delivers greater objectivity than the CFP Selection Committee Protocol. For example, even though qualitative considerations unquestionably apply in judging and scoring gymnastics, there are hundreds of pages of detailed criteria instructing judges on how to score athletes’ performances.⁵ Significantly, the College Football Playoff Board has decided to scrap the current system in favor of a 12-team playoff structure starting in 2024.⁶ The new structure will continue to use committee rankings to seed the 12 teams, but it will place greater emphasis on the coldly objective results of wins and losses in a multi-tiered playoff structure. Teams and players should welcome the change as it will reduce the subjective element of rankings that have affected their funding and career prospects, respectively.

This issue has an exciting selection of articles. The issue opens with a very timely article on the impact of higher interest rates on the housing and mortgage markets by Laurie Goodman, Michael Neal, and Daniel Peng of the Urban Institute. They note that higher rates challenge affordability but are also associated with strong economic growth. They observe that the shortage of housing supply is likely to drive continued home price appreciation. However, higher rates are expected to restrain refinancing activity and to drive an expansion in second-lien lending.

Next comes an article about the use of structured financings for balance sheet management by multilateral development banks (MDBs). The author is Mahesh Kotecha, the president of Structured Credit International Corp. in New York. Kotecha discusses three recent and notable deals that break ground in this emerging area. The issuers are the African Development Bank (two deals) and the International Finance Corporation (one deal). Kotecha addresses the conditions for developing an active market for securitizing MDB loans in CLO structures. He draws a useful comparison to deals by Bayfront Infrastructure Management Pte. Ltd., which securitize Asia-Pacific infrastructure debt.

The issue’s third article introduces the idea of fundamental attributes as predictors of cryptocurrency performance. Authors Dimple Bhojwani and Samik Shome of the Institute of Management, Nirma University identify more than 40 attributes associated with outperformance. They apply their framework to 10 leading cryptocurrencies, including Bitcoin and Ethereum. Of course, the FTX scandal casts a pall on the entire crypto sector. Nonetheless, Bhojwani and Shome offer an approach that adds insight and rigor from a relative value standpoint within the sector.

The fourth article is about applying project finance techniques to develop renewable energy assets. Author Vikas Srivastava of the Indian Institute of Management focuses primarily on the Indian market, but his observations have broader applicability. He advocates for various adjustments to lower the all-in cost of capital for renewable energy projects, including greater use of offtake arrangements and different capital structures.

The next item is my report on the September ABS East 2022 conference in Miami Beach. The event attracted roughly 4,500 attendees. Key themes at the conference included higher interest rates, inflation, the prospect of a recession in 2023, stagnating home prices, the transition from LIBOR to SOFR, NAIC initiatives, student debt relief, and ESG issues. The overall mood was slightly negative. The report covers 12 sessions from the event, including the general sessions on Tuesday and Wednesday, as well as breakout sessions on residential MBS, autos, CLOs, CMBS, and student loans.

The next section is selected highlights from GlobalCapital for the fourth quarter of 2022. The selection was compiled and curated by GC deputy securitization editor, Tom Lemmon. Five stories are featured, covering the following subjects:

• ▪ ESG practices in the US structured finance market,

• ▪ The CLO market in 2022,

• ▪ The impact rising interest rates on residential MBS,

• ▪ Apollo’s acquisition of CSFB’s securitized products group (two stories).

Next comes a selection of industry news items from the Structured Finance Association, also from Q4 2022. The selection includes more than two dozen news snippets covering timely and important developments in the structured finance market.

As always, we welcome your submissions. Please encourage those you know who have good articles or who have made good presentations on structured finance- or project finance-related subjects to submit them to us.

Submission guidelines can be found at https://jsf.pm-research.com/authors. If you have comments or suggestions, you can e-mail them directly to me at m.adelson{at}pm-research.com.

Mark Adelson

Editor

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