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Merganser Capital Management, LLC

PRI reporting framework 2020

You are in Direct - Fixed Income » ESG incorporation in actively managed fixed income » (C) Implementation: Integration

(C) Implementation: Integration

FI 10. Integration overview

10.1. Describe your approach to integrating ESG into traditional financial analysis.

In an effort to understand the full set of material ESG risks that could impact our holdings, we emphasize sector specific ESG considerations which inform how much compensation we demand as a lender.

10.2. Describe how your ESG integration approach is adapted to each of the different types of fixed income you invest in.

SSA

An examination of the past and current political backdrop is the number one criteria we consider when assessing ESG materiality. Underlying this is a number of other factors such as international relations, labour standards and energy resource management. In general, we feel that social factors and governance tend to be more relevant to this sector of the fixed income market due to the need for political stability and a consistent tax base.

Corporate (financial)

Financial issuers make up a large portion of the investible universe within investment grade fixed income. To assess the full spectrum of risks relating to money center banks and other financial institutions, we consider each of the following in our underwriting:

  • Balance sheet management
  • Risk management and overall regulatory 
  • Reporting practices and the degree of disclosure/transparency
  • Product responsibility, customer relations and employee relations
  • Loan mix and concentration to certain demographics

Corporate (non-financial)

Within non-financial corporate credit, we tend to place more emphasis on potential event risk which can arise from regulatory or litigation against a public company. Additionally, governance is weighted more heavily in the risk assessment of corporate borrowers given the heightened risks associated with incentive structures, Transparency and audit practices.

Securitised

For securitized issuers, we focus our lens on origination practices, servicing capabilities and potential ESG risks associated with the underlying collateral value (i.e. automobiles). 

10.3. Additional information [OPTIONAL]


FI 11. Integration - ESG information in investment processes

11.1. Indicate how ESG information is typically used as part of your investment process.

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
Securitised
ESG analysis is integrated into fundamental analysis
ESG analysis is used to adjust the internal credit assessments of issuers.
ESG analysis is used to adjust forecasted financials and future cash flow estimates.
ESG analysis impacts the ranking of an issuer relative to a chosen peer group.
An issuer`s ESG bond spreads and its relative value versus its sector peers are analysed to find out if all risks are priced in.
The impact of ESG analysis on bonds of an issuer with different durations/maturities are analysed.
Sensitivity analysis and scenario analysis are applied to valuation models to compare the difference between base-case and ESG-integrated security valuation.
ESG analysis is integrated into portfolio weighting decisions.
Companies, sectors, countries and currency and monitored for changes in ESG exposure and for breaches of risk limits.
The ESG profile of portfolios is examined for securities with high ESG risks and assessed relative to the ESG profile of a benchmark.
Other, specify in Additional Information

11.2. Additional information [OPTIONAL]


FI 12. Integration - E,S and G issues reviewed

12.1. Indicate the extent to which ESG issues are reviewed in your integration process.

Environment
Social
Governance
SSA

Environmental

Social

Governance

Corporate (financial)

Environmental

Social

Governance

Corporate (non-financial)

Environmental

Social

Governance

Securitised

Environmental

Social

Governance

12.2. Please provide more detail on how you review E, S and/or G factors in your integration process.

SSA

At Merganser, we have decided not to assign risk weightings or rankings based on ESG criteria, so there is no automated alert system or programmatic feedback loop. Based on our review of third-party research services and rating agency reports, we find that much of the analysis is subjective and based on unaudited company information which is difficult to apply across geographies and different legal jurisdictions. Instead, we empower the sector specialist who initially recommended the security to continually assess and challenge which ESG factors they feel are most likely to impact the long-term value of the investment. This thought process is integrated across the different sectors in which we invest.

Corporate (financial)

At Merganser, we have decided not to assign risk weightings or rankings based on ESG criteria, so there is no automated alert system or programmatic feedback loop. Based on our review of third-party research services and rating agency reports, we find that much of the analysis is subjective and based on unaudited company information which is difficult to apply across geographies and different legal jurisdictions. Instead, we empower the sector specialist who initially recommended the security to continually assess and challenge which ESG factors they feel are most likely to impact the long-term value of the investment. This thought process is integrated across the different sectors in which we invest.

Corporate (non-financial)

At Merganser, we have decided not to assign risk weightings or rankings based on ESG criteria, so there is no automated alert system or programmatic feedback loop. Based on our review of third-party research services and rating agency reports, we find that much of the analysis is subjective and based on unaudited company information which is difficult to apply across geographies and different legal jurisdictions. Instead, we empower the sector specialist who initially recommended the security to continually assess and challenge which ESG factors they feel are most likely to impact the long-term value of the investment. This thought process is integrated across the different sectors in which we invest.

Securitised

Merganser has found that governance factors can present a meaningful risk as it relates to credit underwriting for asset backed securities. We have not developed a formal scoring system for ESG categories as it relates to subsectors and issuers in the asset backed market, however, we do integrate qualitative judgements in our decision-making process. This is because there is no clear framework to apply across asset classes and  approaches we’ve studied tend to be highly subjective and not particularly useful. Furthermore, the lack standardization of reporting by issuers, sponsors and servicers make development of a quantitative framework difficult. The net result of this is our integration of a qualitative approach to ESG in evaluating opportunities and assessing risks in the asset backed sector which are generally applied at the issuer/sponsor/servicer and trustee levels. The key metrics in evaluating the securitization begins with a review of loan origination and servicing practices which directly factors into governance practices. The structure of the securitization also plays a key role in the evaluation process to ensure proper alignment of interests. We avoid those securitizations where inadequate governance creates unquantifiable risks or where assets have been originated and serviced in a predatory manner. To a lesser degree, we have also found that environmental factors can present idiosyncratic risk to asset backed securitizations, particularly within the auto and equipment subsectors, and we remain mindful of this during the underwriting and ongoing monitoring of our holdings.  

We believe that a well governed company with a diverse, ethical, and an experienced leadership team in place is arguably the most important aspect to consider. With such a management team in place, a company will be able to effectively run their business while evolving to societies changing standards around environmental and social impacts of their business. We would support the standardization of data reporting but will continue with our bottom-up approach to risk management and incorporate ESG factors where appropriate. 

Multi-borrower conduit transactions have historically (and continue to) face criticism over Governance issues.  We favor conduit transactions with a “vertical” risk retention on the hypothesis that originators who retain risk for the life of a transaction should have better performance over time; but acknowledge it is too early to know if this holds true (risk retention began in 2017).  Environmental data on “conduit” transactions is limited.  Known contamination issues should be disclosed in the prospectus; and may be discussed in greater detail for the largest loans.  The presence of LEED certifications may be disclosed in commentary that is provided on only the largest assets.  Single Asset/Single borrower transactions on the other hand offer greater transparency and therefore offer relatively stronger Governance; often with 100% LEED certifications.  Another sub-sector with relatively strong Governance is the Agency CMBS market.  Fannie Mae’s “DUS” (Delegated Underwriting and Servicing) program, founded in 1987, was the original risk-retention model and has experienced very modest losses over time.  This sub-sector offers consistent underwriting, with a strong social purpose in facilitating the ownership of affordable housing. Further, Agency CMBS pools often contain large “Green” loan components, where the borrower has committed to quantifiable energy/water/waste utilization improvement targets which are monitored by Freddie/Fannie.  Loans originated under various “green” programs are disclosed in the annex/data tape.  On a Social issue, Freddie Mac discloses in multi-borrower transactions the number of units that are deemed affordable to “low income” and “very low income” tenants.   Fannie Mae makes this data available on individual DUS loans, but the data does not flow through to the annex/data tape on multi-borrower transactions (e.g. GEMS/MEGA issuance).  

However, the worthy social goal of providing affordable housing has led to unintended consequences and generated losses for investors.  King County, WA (Seattle metro area) has recently been utilizing eminent domain to acquire multifamily properties to preserve affordable housing; which has resulted in early prepayments without penalty. This is achieved by utilizing the condemnation process to exercise eminent domain thereby avoiding paying a penalty.   This may have the unintended consequence of limiting capital for affordable housing in an area that is underserved, highlighting these issues are not black and white, but rather grey.

For all CMBS deal types we consider unique location attributes (i.e. floodplain or earthquake zone).  We recognize that over time increased costs (all else equal) from environmental risks should reduce the value of real estate and increase risk of loss to lenders.  We also believe that as increasing numbers of investors begin to focus on and better understand these risks, improved risk-based pricing may make refinancing (and/or selling) more difficult for certain assets.  We are hyper-sensitive to idiosyncratic geographic concentration risks in areas that have seen significant natural disasters.  Concentrations in California, Houston, or Gulf Coast areas will warrant closer scrutiny and lead us to require higher levels of compensation.

12.3. Additional information.[OPTIONAL]


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