2020 Year in Review - Structured Finance Canada
By almost any measure, 2020 was a tumultuous year. The emergence of the coronavirus pandemic resulted in social, political and economic upheaval around the world. In Canada, widespread lockdowns aimed at slowing the spread of the virus brought the economy to a near standstill in March and April and resulted in the Canadian economy suffering its largest three-month decline on record during the second quarter. Despite the economic challenges created by the coronavirus pandemic, the Canadian structured finance market demonstrated its resiliency in 2020 and provided the Canadian economy with a reliable and invaluable source of funding.
Our Firm’s leading structured finance practice in Canada was very active in 2020 and played central roles in many of the year’s significant Canadian transactions and developments.
As we turn the page on an unprecedented year and look forward to brighter days ahead, the following is a review of the Canadian structured finance market in 2020, including key developments and trends that may be of interest to you.
Prior to the onset of the coronavirus pandemic, 2020 was shaping up to be a busy year for term asset-backed securities (“ABS”) issuances by Canadian issuers. Transactions in early 2020 included successful residential mortgage-backed securities
(“RMBS”) and commercial mortgage-backed securities (“CMBS”) private placementssponsored by leading Schedule I banks under the Bank Act (Canada). However, the arrival of the coronavirus pandemic and government responses to curb the spread of the virus led to a shut-down of the Canadian economy in the second quarter. As a result, Canadian term ABS issuance all but dried up and only a handful of transactions were completed after mid-March. Of these term ABS issuances, our Firm was involved in the Ford Auto Securitization Trust Series 2020-A ABS and Fairstone Financial Issuance Trust I Series 2020-1 ABS issuances, which were privately placed in Canada and the U.S., and the Glacier Credit Card Trust Series 2020-1 ABS issuance, which was publicly offered in Canada. Glacier Credit Card Trust ABS is secured by a co-ownership interest in a pool of credit card receivables originated by Canadian Tire Bank, a Schedule I bank under the Bank Act (Canada).
While the term ABS market in Canada became relatively quiet after the coronavirus pandemic, the Canadian asset-backed commercial paper (“ABCP”) market grew significantly in 2020 as originators sought access to cost-effective financing. A number of new programs were added to Canadian bank-sponsored ABCP conduits, with retail auto loan receivables, consumer loan receivables and trade receivables comprising a significant percentage of these new programs. Like the United States, the response by Canadian originators to the pandemic’s economic challenges included offering payment deferrals to underlying obligors – particularly in the consumer finance, residential mortgages, credit cards and auto loans asset classes. Our Firm assisted numerous Canadian ABCP conduits and originators in restructuring transactions to address structural issues resulting from payment deferrals provided by servicers to underlying obligors in the spring and summer of 2020. Provisions relating to cash reserves, spread maintenance tests, servicer advances and deemed collections were either amended or utilized in connection with addressing payment deferrals. As well, in some cases, amortization events, events of default and servicer termination events were amended in order to avoid any of these events from occurring solely as a result of payment deferrals. These actions allowed many securitization programs to continue during the pandemic without triggering program defaults, early amortizations or terminations. By the fall of 2020, many servicers had suspended or wound down their payment deferral programs. By contrast, some programs were unable to avoid triggering amortization events as a result of the effects of the coronavirus pandemic and we have assisted originators and investors in navigating the consequences. Of particular note, we have acted as Canadian securitization and bankruptcy counsel to Hertz in connection with its Chapter 11 proceedings and the related effects on its Canadian securitization programs.
Our Firm’s structured finance group was very active in a variety of cross-border (Canada-U.S.) financings of Canadian assets in 2020. We regularly act for financial institutions, private equity firms, originators, issuers and sponsors in cross-border structured finance matters, and 2020 was no exception. During 2020, we were involved in a number of term ABS issuances that involved Canadian and U.S. private placements, including the widely distributed offerings from the Ford Credit and Fairstone Financial sponsored issuers noted above, as well as other term ABS transactions in the RMBS and CMBS spaces. Over the past several years, Canadian Schedule I banks have been frequent issuers of credit card term ABS deals that have been offered primarily (and in some cases, exclusively) into the U.S. As the large and deep U.S. ABS market provides Canadian ABS issuers with an alternative source of cost-effective liquidity, we expect that this cross-border trend will continue.
In 2020, our Firm’s structured finance practice also acted on several widely distributed U.S. term ABS deals that included Canadian assets (such as data center rents, cell tower revenue, etc.) in which we addressed Canadian regulatory and asset disclosure matters with respect to the unique Canadian legal regimes applicable to the Canadian assets.
In addition to ABS transactions, U.S. banks and private equity and capital firms were very active in financing Canadian financial assets in 2020. Our group acted on a number of cross-border transactions involving whole loan sale structures, warehouse funding structures and multi-jurisdictional securitization transactions relating to a variety of asset classes - particularly in the Fintech, consumer loans, point of sale financing (buy now, pay later), trade receivables and auto loans spaces.
These cross-border deals give rise to unique Canadian tax and other Canadian regulatory and legal issues. U.S. entities acquiring and/or funding Canadian assets need to be aware of Canadian regulatory requirements pertaining to various types of Canadian assets in light of the kinds of activities that the U.S. entities might perform in a whole loan purchase or securitization transaction (including restrictions on banking activities and collection activities, licensing requirements, etc.). U.S. entities should also be aware of privacy requirements with respect to Canadian obligors, which in some cases differ materially from those in the U.S., such as in the case of consumers. When structuring cross-border deals, it is imperative to ensure that the structure does not inadvertently result in the U.S. entities being deemed to be doing business in Canada for Canadian income tax purposes and that cross border payments, to the extent possible, do not attract Canadian withholding or other taxes. U.S. dealers participating in note offerings into Canada by U.S. issuers may be eligible for the “international dealer exemption” in Canada. This dealer exemption may also available, but in a more limited fashion, for U.S. dealers participating in Canadian offerings by Canadian issuers where the deal is denominated in a foreign currency or the deal is offered substantially outside of Canada. In addition, U.S. issuers conducting a private placement in Canada may be eligible for an exemption from the requirement to use a “Canadian wrap” of the offering document. However, the availability of this exemption is a factual determination that is to be made on a deal-by-deal basis.
Following the onset of the pandemic, market regulators and market participants introduced a wide array of relief measures that have had significant impacts on the Canadian structured finance market.
On March 18, 2020, the Bank of Canada (the “BoC”) announced a temporary expansion to the list of eligible securities for its term repo operations, including the addition of own-name covered bonds, term ABS and ABCP. Shortly thereafter, on March 27, 2020, and on March 31, 2020, the Office of the Superintendent of Financial Institutions (OSFI) and the Authorité de Marchés Financiers (AMF), respectively, announced a temporary increase in the legislative limit on covered bond issuances to 10.0% of an issuer’s balance sheet assets (up from 5.5%), in order to allow issuers to access the BoC term repo facilities. The expansion to the list of eligible securities and the increase in the issuance limit resulted in strong covered bond and ABCP issuances over the balance of 2020, which made up for a notable decrease in term ABS transactions by Canadian issuers.
Similarly, on March 17, 2020, the big six Canadian banks announced plans to extend financial relief to consumers affected by the coronavirus pandemic, including up to six months of deferrals on mortgage payments, as well deferrals for other credit products including credit cards and auto loans. Payment deferrals, in conjunction with government aid programs such as the Canadian Emergency Response Benefit (CERB), contributed to relatively low loss rates in structured finance transactions across the consumer credit spectrum over the balance of 2020. As deferral periods and government relief programs began to expire toward the end of 2020, some market commentators were forecasting that delinquencies, defaults and write-offs would begin to increase. The extent of the pandemic’s impact on the performance of structured finance transactions in 2021 and beyond will likely depend on how quickly the broader Canadian economy recovers, and whether further relief measures are introduced.
Electronic Chattel Paper
Long-awaited amendments to the Personal Property Security Act (Ontario) (the “PPSA”) came into force in 2020 creating a regime for perfection by way of control of electronic chattel paper. The provisions are substantially the same as the corresponding UCC provisions, so should be familiar to securitizers with operations on both sides of the border. There is one nuance in the new PPSA provisions, however, which does not exist in the UCC: a priority rule to deal with the scenario where rights under tangible chattel paper are purported to be transferred both in the form of tangible and electronic chattel paper. Another wrinkle that should be kept in mind is that because each Canadian province and territory has its own personal property security legislation or equivalent legislation, and to date Saskatchewan is the only other jurisdiction to proclaim into force similar amendments, for the moment these new perfection rules will only apply if the debtor is located in either Ontario or Saskatchewan as determined under the personal property security legislation in these provinces. To learn more, please refer to our article, Timely Modernization of Ontario PPSA Chattel Paper Provisions
While much ink has been spilled on the subject of LIBOR transition globally the market impetus to move towards alternative risk free rates is also true in respect of the Canadian dollar CDOR rate. Compared to LIBOR and its anticipated end dates as recently announced by the ICE Benchmark Administration, there is no set timeline in Canada in respect of which CDOR rates will no longer be published or continue to be available. The adoption of the Canadian Overnight Repo Rate Average (“CORRA”) as the key Canadian dollar interest rate benchmark to ultimately replace CDOR is supported by the Canadian Alternative Reference Rate Working Group (“CARR”), formed in March, 2018 with the mandate to ensure that Canada’s interest rate benchmark regime is robust, relevant and effective. CARR issued a consultation paper on November 24, 2020 with draft benchmark fallback language, as well as a methodology for calculating CORRA in arrears, for floating rate notes that reference CDOR. Such methodologies and proposed benchmark fallback language in respect of the replacement of CDOR are not as advanced in comparison to the work of the Alternative Reference Rates Committee in respect of LIBOR transitioning and its recommendation to use robust hardwired fallback language. Market participants can therefore expect that CDOR will continue to be referenced in Canadian dollar transactions in 2021, but with the increased use of benchmark fallback amendment language which has yet to be standardized across the Canadian market. To learn more, please refer to our article, FSB’s Global Transition Roadmap from LIBOR and How it Impacts Canadian Market Participants
In conclusion, 2020 was a year unlike any other that we have experienced. The way we work, live and connect has undergone fundamental change. With any luck, we will return to a more familiar world in 2021. We look forward to connecting with you in the future and hopefully seeing you in person at structured finance events. We wish you a very happy New Year and all the best in the year ahead.