Contents

ABS

US ABS activity accelerates

SCI's PriceABS data shows a mix of auto and railcar bonds circulating on bid-lists yesterday as US ABS secondary market activity picked up. BWIC volume for the session reached around US$125m.

Among the auto tranches out for the bid was AMCAR 2013-3 D, which was covered at 103. That was the first time the tranche had appeared in PriceABS, but the deal's C tranche was spotted last month and the A2 tranche was covered in both November and December.

The auto non-prime SNAAC 2013-1A B tranche was also out for the bid. It was covered at 100.89, while the C tranche had been covered last month at 101.57.

Much of the activity was in the railcar space and there were a couple of tranches from Flagship Rail Services' FRS 2013-1A deal. A US$4m piece of the first, FRS 2013-1A A2, was talked in the mid-130s and at around plus 130.

The second Flagship tranche was FRS 2013-1A B. A US$6m piece of that tranche was talked in the low-190s and at around plus 200.

Trinity Rail Leasing's TRL 2012-1A A1 tranche was talked in the high-120s and at around plus 120. The tranche was covered last April at plus 105, when price talk ranged from 105 to plus 115.

Other TRL tranches which have previously been captured by PriceABS include TRL 2006-1A A1, which was talked at 108 handle in January, and the TRL 2012-1A A2 tranche, which was talked at 94 handle in January. When that latter tranche appeared in June 2013 it was talked at around 135.

Another railcar equipment tranche was also out for the bid yesterday: a US$1.71m piece of the ARLFR 2012-1A A1 tranche was talked in the mid-130s and at Libor plus 130s. A much larger US$11.159225m piece of the same tranche was previously talked in the 150s in August.

JL

CLOs

CLO market gauges Vivarte impact

The European CLO market continues to feel the effects of the recent Vivarte default (SCI 18 March) as new deals struggle to ramp up. Secondary market activity has also been affected.

"New issue CLOs, such as CVC Cordatus III and Holland Park were quite tight, but there are currently big question marks hanging over a few other deals. The market is really scrutinising the impact of Vivarte at the moment because a few deals look like they will struggle to ramp up," reports one trader.

He continues: "The Vivarte default is making it much harder for deals that have not yet finished ramping. Managers may now be forced to buy lower quality loans in order to reach their effective targets."

Vivarte has also triggered concerns in the secondary market. "Last week there was an equity tranche from St Paul's CLO III on a bid-list where the seller was actually looking to sell it below where he had bought it," says the trader. "In December this tranche closed in the 90s, but it covered lower than that print price last week."

SCI's PriceABS data shows that price talk for the SPAUL 3X SUB tranche was in the low-90s, but the cover was only in the mid-80s.

Elsewhere, secondary market activity has generally been subdued. The trader suggests that at least part of this is simply seasonal.

"The market is certainly a bit softer at the minute, but that is not surprising, with traders away for the holidays. Even when everyone was still at their desks though the bid was just not that strong and the number of BWICs over the last couple of weeks has been lower than it was earlier in the year," he says.

PriceABS picked up a few names out for the bid yesterday, including tranches from Gillespie CLO, Gresham Capital CLO 4 and Harbourmaster CLO 7. HARBM 7X C was talked in the mid-50s and traded during the session, having been recorded as a DNT in both January and February.

The GLSPE 2007-1X D bond was covered in the very high-80s. Price talk had been in the high-80s, 90 area and low-90s during the session, with the tranche having previously been covered on 19 March.

As for GSHAM 2007-4X D, it too was covered in the very high-80s. Price talk had similarly been in the high-80s, 90 area, low-90s and mid/high-90s.

JL

CMBS

'Cheap' Euro CMBS lacks buyers

There was a lot of price talk on European CMBS tranches in the secondary market yesterday, but a lack of trades as the market winds down for Easter. CMBS looks cheap compared to RMBS but investors remain reluctant to get involved.

"The Street has been a bit more active over the last couple of weeks but we are still seeing a lack of client activity. Seniors remain too tight for hedge funds and even second-pays have seen interest fall away," reports one trader.

He continues: "There is still good interest in low cash price mezzanine tranches but the problem is that there is not very much of that paper around. Where there is activity is for either the high quality names or the ones trading wider, but not in between."

That lack of activity surprises the trader. While CMBS remains at tight levels post-crisis, compared to other sectors he notes that it looks attractive.

"Last week in particular there was very good interest in Spanish and Italian paper. Peripheral and UK non-conforming RMBS have widened out but CMBS looks cheap," he says.

The trader notes that BWICs have been trading at "very good" levels, even if volumes may be down. However, the majority of trading still appears to be going to the Street and not on through to clients.

SCI's PriceABS data picked up a score of unique European CMBS tranches out for the bid yesterday, including the Italian FIPF 1 A1 tranche, which was talked at 92 handle, 92.25 and 92.5. The tranche first appeared in the PriceABS archive in May last year, when it was talked in the low/mid-80s, at around 83 and at around 84.

DECO 2007-C4X A2 was talked at various levels between the mid-90s and 98, while the ECLIP 2006-2 B tranche was talked between 98 and 99.8. When the latter tranche first appeared in PriceABS in June 2012 it was talked in the mid-80s.

OPERA GER² A was talked between 98.5 and 99, having been covered late last month at 98.75. The tranche was also covered on 27 January at 98.86, on 24 January at 98.98 and on 16 January at 99.091.

Price talk was also recorded on a trio of Talisman tranches, including TMAN 7 B. That tranche was talked at 96.5, 96.75 and at the high-96. The tranche was covered at the start of the month at 96.58.

JL

RMBS

US RMBS stays subdued

The US RMBS secondary market was quiet once again yesterday as bid-list volume dipped to around US$335m. SCI's PriceABS data recorded a number of DNTs for the session, although a number of successful covers were also seen.

Supply was up slightly for fixed-rate and hybrid bonds, with the focus for each segment on senior current-pays. Subprime supply was light, however, with activity mainly concentrating on names with longer WALs.

Many of the tranches picked up by PriceABS came from 2005- and 2006-vintage deals, although paper issued as long ago as 1999 was also circulating. In addition, post-crisis paper - such as the GNR 2011-163 NS tranche - was covered at very high-22.

The 1999 tranche was SAST 1999-3 BF1A, which was covered at 95.75. The bond had only appeared in PriceABS once before, when it was covered in the high-80s last May.

A couple of BSABS tranches were out for the bid yesterday, with BSABS 2003-1 B covered at 86 handle. BSABS 2005-HE3 M2, meanwhile, was talked in the high-90s and covered at 99 handle.

The CWHL 2004-HYB1 M tranche was talked in the 40s, while price talk on CWHL 2004-HYB2 B1 was in the low/mid-70s. CWALT 2005-J12 2A4 was talked in the low-50s and covered in the mid/high-60s, while CWALT 2006-OA1 2A1 was covered in the mid-70s.

ACE 2006-ASP5 A2B traded during the session. That bond was covered in the low-50s on 20 March and first appeared in PriceABS in August 2012, when it was talked in the mid-30s.

FFML 2006-FF1 2A3 was talked in the mid/high-90s and covered at 98 handle, while IMM 2005-6 1A1 was both talked at and covered in the low/mid-80s. The former tranche had not been seen since 2012, when it was covered three times.

Also of note was the SASC 2005-11H B1 tranche, which was talked at 7 handle. Finally, DNTs were recorded for AABST 2003-3 M2, MLMI 2004-WMC3 M3, POPLR 2005-A M3, JPMAC 2006-CH2 MV1 and HASC 2007-HE1 2A3.

JL

ABS

Punch proposes securitisation waivers

Restructuring negotiations for Punch's securitisations continue and both  have requested DSCR waivers. Punch A is non-compliant with its DSCR covenant, while Punch B will be non-compliant at its next testing date.

Punch's results for the first half of the 2014 financial year show continued progress in its core portfolio. Like-for-like net income growth is up 1.4% as the group has benefited from a mixture of previous rental adjustments, targeted capex and improvements in consumer confidence, say Barclays Capital analysts.

Bondholders are expected to vote for the waiver on 29 April to avoid the costs and downside risks associated with the appointment of an administrative receiver. The revised restructuring proposal deadline is for 30 June, when the proposed wavier terminates.

For junior principal to be written off there would have to be significant dilution in the group's equity value in the securitisations, say the analysts. They expect that if a restructuring proposal is not agreed on 30 June then a further waiver will be requested and granted, considering the current performance of the business versus the costs of administration.

Punch A class B bonds provide yield of 15% and are leveraged at 10.4x debt to EBITDA including swap breakage costs, which is similar to the EV EBITDA multiple of Enterprise Inns. "Given that these bonds can already PIK at the current coupon which is again 15% based on the cash price of the bonds, the offer of a new PIK instrument by the company at a lower rate would not be attractive by itself," the analysts say.

The Punch A A2Rs yield 5% and the Punch A A1Rs yield 5.75%. Without a waiver there would be a small fall in price because of concerns that around a quarter of them would be prepaid at par following an event of default.

"However, we would expect the bonds to trade subsequently back to current levels given the yield and relatively low leverage. In the event that a restructuring is agreed we see potential upside to at least 110 given a spread of 340bp (although dependent on new cash flows following restructuring), which compares well against the ETI 6.5 18s at c.350bp given lower leverage in the Punch A class A bonds," the analysts add.

JL

Structured Finance

SCI Start the Week - 14 April

A look at the major activity in structured finance over the past seven days

Pipeline
A number of new deals were announced last week. In total, eight ABS, three ILS, three RMBS and six CLOs were added to the pipeline by the end of the week.

The newly-announced ABS were: US$151.739m BCC Funding VIII Series 2014-1; US$777.87m Capital Auto Receivables Asset Trust 2014-2; US$215m MMCA Auto Owner Trust 2014-1; US$912.423m Spirit Master Funding Series 2014-1, Series 2014-2 and Series 2014-3; €400m Voba No.5; and US849.15m World Omni Auto Receivables Trust 2014-A.

The ILS consisted of US$400m Everglades Re Series 2014-I, US$250m Kilimanjaro Re Series 2014-1 and €150m Lion I Re. The RMBS, meanwhile, comprised A$300m AFG 2014-1 Trust, A$300m Liberty Series 2014-1 Trust and A$500m Pepper Residential Securities Trust No.12.

Finally, €415m Avoca CLO XI; US$500m Benefit Street Partners IV; US$550m Halcyon Loan Advisors Funding 2014-2; US$400m Marathon CLO VI; US$400m Telos CLO 2014-5; and US$520.625m Washington Mill CLO joined the pipeline.

Pricings
It was an even busier week for completed issuance. There were 16 ABS prints, as well as one ILS, two RMBS, one CMBS and six CLOs issued.

Many of the ABS pricings were auto-related, including: US$1bn BMW Vehicle Lease Trust 2014-1; US$299m Credit Acceptance Auto Loan Trust 2014-1; US$288.76m DT Auto Owner Trust 2014-2; US$340.347m Element Rail Leasing I Series 2014-1; US$266.09m Flagship Credit Auto Trust 2014-1; US$850m Harley-Davidson Motorcycle Trust 2014-1; US$1.025bn Motor 2014-1; US$47.2m Santander Drive Auto Receivables Trust 2014-S1; US$45.2m Santander Drive Auto Receivables Trust 2014-S2; US$57.8m Santander Drive Auto Receivables Trust 2014-S3; US$80.6m Santander Drive Auto Receivables Trust 2014-S4; US$90.8m Santander Drive Auto Receivables Trust 2014-S5; and US$87.8m Santander Drive Auto Receivables Trust 2014-S6.

The non-auto ABS prints were: US$925m Chase Issuance Trust 2014-4; US$760m OneMain Financial Issuance Trust 2014-1; and £650m Penarth Master Issuer 2014-1. Additionally, the US$100m Citrus Re Series 2014-1 ILS and the €705m Claris RMBS 2014 and £564m Darrowby No.3 RMBS priced. The US$1.304bn FREMF K-F03 CMBS also completed.

The US$421.5m B&M CLO 2014-1, US$700m CIFC Funding 2014-II, US$812m Dryden 33, US$410.5m Golub Capital Partners CLO 19(B), US$359m Great Lakes CLO 2014-1 and US$627m Shackleton 2014-V transactions rounded the issuance out.

Markets
Much of the activity in the European CLO market was focused on the recent Vivarte default (SCI 18 March), as SCI reported last week (SCI 10 April). New deals are struggling to ramp up, while the secondary market has also been affected.

"The Vivarte default is making it much harder for deals that have not yet finished ramping. Managers may now be forced to buy lower quality loans in order to reach their effective targets," says one trader.

Meanwhile, European RMBS peripheral secondary spreads once again outperformed the rest of the market. "Italian, Spanish, Greek, Irish and Portuguese spreads all tightened on the back of increased primary and secondary activity, while the rest of the market closed the week broadly unchanged," note JPMorgan ABS analysts.

US ABS spreads were mostly unchanged over the week, as trading volumes picked up from the week before. "In contrast with the prior week, fixed-rate ABS total returns performed extremely well [last] week, rising 36bp as rates rallied," Barclays Capital ABS analysts add.

However, the US non-agency RMBS market has remained quiet, as SCI reported last week (SCI 11 April). Bid-list volume remained subdued, with SCI's PriceABS data recording a number of DNTs during Thursday's session.

More activity was seen in US CMBS, with BWIC volume reaching US$287m in Tuesday's session (SCI 9 April). Supply was skewed towards AM and AJ bonds, while a large list of 2006- and 2007-vintage multifamily-directed A1A tranches dominated on Wednesday.

In the US CLO market, secondary activity increased slightly over the week. Bank of America Merrill Lynch securitised products analysts note that US$490m BWIC supply was split evenly between 1.0 and 2.0 deals. "US 2.0 saw strong demand at the top of the capital structure and also further down in credit," they comment.

Deal news
• H/2 Asset Funding 2014-1, which closed last month, could represent a watershed for the CREL CDO market. The transaction harks back to the flexibility seen in legacy deals, which is expected to become increasingly prevalent in future issuances.
• A group of 18 institutional investors has reached an agreement with Citigroup under which it will make a binding offer to the trustees of 68 RMBS trusts issued by Citi to settle mortgage repurchase claims. The investors support the agreement and have asked the trustees to accept it.

Regulatory update
• The US Fed says it intends to give banking entities two additional one-year extensions to 21 July 2017 to conform their ownership interests in and sponsorship of CLOs covered by the Volcker Rule. The move is disappointing for the industry, which had called for comprehensive relief for CLOs under the rule.
• The OCC, the US Fed and the FDIC have adopted a final rule that strengthens the supplementary leverage ratio (SLR) standards for US bank holding companies (BHC) with more than US$700bn in total consolidated assets or more than US$10trn in assets under custody and any insured depository institution (IDI) subsidiary of these BHCs. Under the final rule, an IDI that is a subsidiary of a covered BHC must maintain a SLR of at least 6% to be well capitalised under the agencies' prompt corrective action framework.
• The US CFTC has issued No-Action Letter 14-46, replacing No-Action Letter 14-16 from 12 February. Subsequent to the issuance of the latter letter, CFTC staff continued to engage in dialogue with the European Commission and the UK Financial Conduct Authority - as well as with facility operators and market participants - concerning certain terms and conditions in the letter.

Deals added to the SCI New Issuance database last week:
ARI Fleet Lease Trust 2014-A; Avalon IV Capital; BlueMountain CLO 2014-1; BPHA Finance; Canyon Capital CLO 2014-1; Capital One Multi-asset Execution Trust 2014-2; Capital One Multi-asset Execution Trust 2014-3; Catamaran CLO 2014-1; CFIP CLO 2014-1; Chase Issuance Trust 2014-2; Chase Issuance Trust 2014-3; China Real Estate Asset Mortgages; Citibank Credit Card Issuance Trust 2013-A7 (re-open); COMM 2014-CCRE16; CVC Cordatus Loan Fund III; Dolphin Master Issuer series 2014-1; First Investors Auto Owner Trust 2014-1; Fortress Credit Opportunities III CLO; GE Equipment Small Ticket series 2014-1; GM Financial Automobile Leasing Trust 2014-1; GSMS 2014-GC20; H/2 Asset Funding 2014-1; Hertz Fleet Lease Funding Series 2014-1; Holland Park CLO; John Deere Owner Trust 2014; JPMCC 2014-FL4; LCM X Partnership; Mercedes-Benz Auto Lease Trust 2014-A; MSBAM 2014-C15; Oak No.1; ORES 2014-LV3; Pinnacle Park CLO; Porterbrook Rail Finance; Quadrivio RMBS 2011; Riverfront Re series 2014-1; Sequoia Mortgage Trust 2014-1; SNAAC Auto Receivables Trust Series 2014-1; SolarCity LMC Series II 2014-1; Sound Point CLO V ; THL Credit Wind River 2014-1 CLO; Thrive Homes Finance; Trinitas CLO I; Volta II Electricity Receivables Securitisation Notes; WFCM 2014-TISH.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2005-2; BACM 2006-3; BACM 2006-4; BACM 2007-1; BACM 2007-5; BRUNT 2007-1; BSCMS 2007-PW18; CD 2005-CD1; CGCMT 2007-C6; COMM 2006-C8; CSFB 2004-C5; DECO 2006-C3; DECO 2006-E4; DECO 2007-E5; DECO 6-UK2; DECO 7-E2; DECO 9-E3; ECLIP 2006-2; ECLIP 2006-3; ECLIP 2007-1, 2006-4, 2006-3, 2006-1 and 2005-4; EMC IV; EPICP CULZ; EURO 28; FOX 1; FREMF 2013-K712; GCCF 2007-GG9; GCCFC 2003-C1; GCCFC 2003-C2; GCCFC 2005-GG3; GCCFC 2007-GG11; GECMC 2007-C1; GMACC 2004-C1; GSMS 2007-GG10; JPMCC 2005-LDP1; JPMCC 2007-LDP11; JPMCC 2007-LDPX; LBUBS 2002-C4; LBUBS 2004-C7; LBUBS 2006-C3; LBUBS 2006-C6; LBUBS 2006-C7; LEMES 2006-1; MESDG CHAR; MLCFC 2007-9; MLMT 2005-CIP1; MLMT 2007-C1; MSBAM 2013-C7; PCMT 2003-PWR1; PPCRE 2006-1; PROUL 1; SOVC 2007-C1; TESCO 6; TITN 2006-3; TMAN 4; TMAN 5; TMAN 6; TMAN 7; WBCMT 2005-C19; WBCMT 2006-C24; WBCMT 2006-C25; WBCMT 2006-C27 & BACM 2006-4; WFCM 2010-C1; WINDM VII; WINDM X; WINDM XI; WINDM XII; WINDM XIV.

Top stories to come in SCI:
Evolution of NPL deals

CDO

CRE CDO embraces flexibility

H/2 Asset Funding 2014-1, which closed last month, could represent a watershed for the CREL CDO market. The transaction harks back to the flexibility seen in legacy deals, which is expected to become increasingly prevalent in future issuances.

There have been 15 CREL CDOs issued since the start of 2012, with eight of those coming since June 2013. Specialty finance lenders have been looking to fill a gap in the market, as over US$1trn of commercial real estate loans are scheduled to mature in the next few years, many of which will be difficult to refinance without bridge or mezzanine financing.

Many post-2012 deals have little in common with legacy CREL CDOs, but Morgan Stanley CMBS analysts note that the situation is now changing. Deals have started to exhibit more flexibility and more closely resemble legacy CREL CDOs and traditional CLOs.

Until recently, CREL CDOs have differed from legacy deals in several respects. Whereas legacy deals would ramp up over three to nine months, post-crisis transactions have been fully funded at closing.

And while legacy deals were actively managed and had reinvestment periods of up to six years, the more recent CREL CDOs have been static transactions, so principal proceeds have been used to immediately pay down notes. Trading has also been very limited or strictly prohibited in these deals, whereas in legacy deals the manager could sell credit risk and credit-impaired assets, as well as actively trade collateral.

Another change is in coverage tests, where legacy deals previously used numerous tests and triggers to maintain timely payment of principal and interest. The more recent deals, by contrast, have had no diversion triggers.

"Along these same lines, most subordinate legacy CREL CDO bonds were PIK'able, meaning that unpaid interest was deferred and capitalised as part of the balance of the bonds. By comparison, many new issue CRE CDO bonds are not PIK'able and instead any unpaid interest results in an interest shortfall to the bonds," note the Morgan Stanley analysts.

Managers on newer deals also retained as much as 50% of the capital structure. This is in stark contrast to legacy deals, where the senior 90% would typically be sold.

There have also been changes in credit enhancement. The analysts contrast the recent RSO 2013-CRE1 deal, which has 55.5% credit enhancement, with ARMSS 2006-1, which had only 45% original credit enhancement.

Unlike other recent deals, the US$516m H/2 Asset Funding 2014-1 - managed by H/2 Targeted Return II Manager and originated by Citi and Deutsche Bank - includes a six-month ramp-up period to purchase around 20% of the pool. The notes are collateralised by 26 assets, mainly consisting of single asset CMBS, senior corporate loans and bank loans. The reinvestment period of four years is twice as long as the reinvestment period of the ARCLO deals and similar to the standard reinvestment period of traditional CLOs secured by leveraged loans.

"This is the first deal that we are aware of where a ramp-up period, reinvestment period and coverage tests have been combined together," the analysts observe. "This deal represents the next evolution of the CREL CDO market, with other managers likely to bring similar deals to market, in our view."

Where these CDOs help to facilitate business rather than serving as ends in themselves the analysts believe the more flexible structures should not be viewed negatively. The performance of legacy CREL CDOs has been strong and they note that the H/2 Real Estate 2006-1 transaction, for example, did not breach a single coverage test or collateral quality test.

However, the analysts are more concerned by unproven managers that are issuing CREL CDOs for the sole purpose of growing assets under management and to enhance yield. "With no underlying business purpose, we caution that a proliferation of such deals could potentially contribute to another bubble in commercial real estate prices as systemic leverage increases," they conclude.

JL

CLOs

CLO tail risk 'not excessive'

Single-B loans appear to represent the sweet spot for US CLO 2.0 assets, given risk and reward considerations. At the same time, exposure to the widest margin assets varies across deals and managers.

CLO 2.0 deals are significantly overweight single-B loans compared to the rest of the loan universe and are underweight every other rating, according to a JPMorgan analysis of 267 broadly-syndicated pools with a closing date from July 2010 to December 2013. Since 2013, 70% of gross US institutional loan issuance has been refinancings or re-pricings to tighter spreads due in part to limited call protection. The assets with the highest margin should therefore represent higher risk names and industries.

The majority of loans have margins in the Libor plus 250bp to Libor plus 400bp range, the JPMorgan analysis suggests. A further 32% of loan assets in CLO 2.0s are at or above Libor plus 400bp, including 13% that are at or above Libor plus 500bp.

An upward sloping relationship is evident between weighted average rating factor (WARF) and average margin, which JPMorgan CDO analysts note is to be expected. But tiering also occurs, even at the same WARF or average margin.

The top-50 held issuers with assets at or above Libor plus 450bp account for 6.5% of the entire US 2.0-held loan universe and around a third of loans at or above Libor plus 450bp, the analysts add. Nearly all of them have a 1%-1.5% Libor floor and many are small facilities, with a trade-off of illiquidity risk in return for boosted spreads.

The top-five loans held at Libor plus 450bp or greater are Avaya, Harland Clarke, RedPrairie, Ocean Rig UDW and Caesars. They represent 1.31% of loan assets at that margin range.

The top-five most widely-held names in CLO 2.0s overall are Asurion, First Data, Tribune, Valeant and Calpine. They represent 3.8% of all loan assets.

Out of the 88 managers surveyed, the analysts report that 29 have only one deal in their sample of Libor plus 450bp assets, which is "not excessive". "Still, it is evident that the exposure to widest spread assets varies significantly across deals and managers. In measuring the tail risk distribution, we note 10% of the most exposed US CLO 2.0s hold 20% of these L+450bp or greater assets," they conclude.

JL

RMBS

Resets hasten Dutch RMBS CPRs

European DataWarehouse (ED) loan-level data for Obvion's STORM programme suggests that forthcoming resets may affect Dutch RMBS CPRs significantly. This holds true even if those resets are up to two years away, according to Bank of America Merrill Lynch analysts.

Dutch RMBS pools are generally dominated by fixed-rate mortgages that normally feature a reset period, during which the rate remains fixed. Loans that are approaching their reset date show markedly higher repayment rates as they approach the point at which they can be refinanced.

ED data for 2013 shows the impact of resets on repayments in STORM RMBS on performing, 30-90 day delinquent and 90-plus day delinquent loans. Repayment rates can then be compared by their reset year.

The impact of approaching resets is the most pronounced for performing loans, the BAML analysts observe. Repayment rates during 2013 for loans with resets the same year were 23%, and were 32% for loans with 2014 resets.

Performing loans with resets in 2015 or later repaid at a rate of 5%-6%. This difference was seen in all 12 deals the analysts examined, with STORM 2010-3 standing out as having the lowest repayments among loans with 2013 or 2014 resets.

The impact on 30-90 day delinquent loans is similar. Loans with 2013 and 2014 resets had repayment rates of 42% and 35% in 2013, compared to around 15% for loans with resets in 2015 or later.

For 90-plus day delinquent loans, the repayment rate for 2013 resets was 26% and for 2014 resets was 41%. That compares to around 10% for loans with resets in 2015 or later.

However, the impact for delinquent loans is not uniform across deals, with 30-90 day delinquent loans in STORM 2010-2, 2011-2 and 2012-1 failing to exhibit a clear bias towards repayment preference for loans resetting soon. The analysts believe this may be a result of using a limited sample size.

The data supports the view that upcoming resets can impact CPRs even if they are a couple of years away. Investors using CPR vectors rather than fixed CPR may therefore be interested in incorporating the timing of resets into their assumptions.

A sub-sample of 33 Dutch deals shows a large variation in resets, including among transactions within the same programme. Loans resetting in the next three years - and therefore impacting CPRs in 2014 and 2015 - constitute around 22% of the pool on average, but can vary from just 1% up to 42%.

Deals where loans resetting in the next three years are below 10% of the pool include SAEC 8, 11-13 and PHEHY 2010-1 and 2011-1. Deals where loans resetting in the next three years are above 30% of the pool include STORM 2010-2, STORM 2010-3, STORM 2011-4, STORM 2012-1, CANDI 2012-1 and DUTCH 2013-18.

STORM RMBS have higher than average resets in the next three years. By contrast, SAEC and PHEHY have resets that are much lower than average.

JL

Structured Finance

Decisive action

Katie Skeels, associate at Hogan Lovells, examines current trends and solutions in cross-border disputes

Hogan Lovells recently published a report - entitled 'Global Currents - Trends in Complex Cross-Border Disputes 2014' - which surveys current trends in cross-border disputes. The results suggest that senior executives and in-house counsel are proactively developing their dispute management strategies, including for securitisations, to suit the increasingly global business landscape.

In an increasingly globalised economy, there are significant benefits to be reaped from tapping into an international market. However, when relationships turn sour - which a number of high profile securitisation cases in recent years suggest is now more of risk than may have been the case previously - the combination of multiple jurisdictions in any given deal can substantially increase the level of complication in managing, and eventually extricating oneself from, the resulting dispute.

Hogan Lovells' new survey examines the experience of 148 senior executives and in-house lawyers across 18 industries in dealing with cross-border disputes, and highlights a number of key trends coming out of the global nature of many of the respondents' businesses. Some of the most exciting emerging markets, such as China, India and Brazil, are conversely seen to be the most challenging jurisdictions in which to bring or defend a dispute. However, perhaps surprisingly, it is the US that is seen as the most difficult place to litigate - despite its status as an established global economy.

Thirty percent of respondents' daily caseloads consist of cross-border rather than domestic disputes, and over half expect that proportion to increase even further over the next two years. Most cross-border disputes involve two or three jurisdictions, but many involve substantially more and some particularly complex cases can involve as many as 50 jurisdictions.

Annual legal spend on cross-border disputes averages US$6.6m, but in many cases the cost to companies is significantly more than that. Consequently, effectively budgeting for international disputes is now seen as an important and established part of many respondents' businesses.

These trends show that cross-border disputes can be very expensive, time-consuming to manage and navigate and show no signs of abating. However, the findings from the survey also suggest that - notwithstanding these serious challenges - senior executives and in-house counsel are increasingly deploying a number of different techniques to manage these disputes more effectively - which, in turn, is allowing them to reduce their impact on business and ultimate cost to the company.

Thinking ahead
Putting one's head in the sand is a common (and perhaps understandable) initial reaction from companies when complex cross-border disputes first emerge - sometimes in the courts of a far-flung jurisdiction - and taking an ad hoc and generally reactive approach to dealing with these cases may often seem like the best way of dealing with them. However, the survey reveals that many corporates - including in the structured finance world - are increasingly seeking to grapple with the issues posed by cross-border disputes head-on by planning ahead.

The survey identifies a number of different strategies. First, companies are looking backwards by thinking more proactively about the lessons that can be learned from past disputes or regulatory investigations.

Some companies, for example, are initiating their own reviews of processes and paperwork to root out any issues which generated past disputes, so that they can identify similar risks that might exist in other parts of the business. This is particularly so in the context of investigations instigated by financial regulators, where 'cross-fertilisation' of issues from parts of a business already under inquiry to others that were originally outside of the scope of investigation is becoming increasingly typical.

Second, companies are looking forwards by thinking about how they can be better prepared for cross-border disputes once they do emerge, so that they can be handled on their own terms rather than those of the opposing party. One way of doing this, as confirmed by the survey, is by the careful use of arbitration and dispute resolution clauses in contracts to control the jurisdiction in which a dispute may ultimately be decided and, in particular, to avoid jurisdictions that might be seen as difficult or unfavourable.

This could be said to be of particular importance in the structured finance industry, where 'forum shopping' is rife and parties race against each other to bring the dispute in their chosen court. This often leads to complex and expensive satellite litigation, while the competing courts determine where the matter should be heard.

Jurisdiction clauses in finance agreements can reduce this risk, although history has shown that they are not necessarily fool-proof. For example, the English courts have accepted that clauses providing for the courts of one country to have 'non-exclusive' (rather than exclusive) jurisdiction over a dispute may not necessarily prevent proceedings from being initiated elsewhere, such as the counterparty's home jurisdiction. However, with careful drafting, these clauses can significantly narrow the risk of a company becoming embroiled in a dispute in what may be perceived as an undesirable and legally challenging jurisdiction.

A further interesting development - given the financial crisis and its effect on headcount - is the increasing willingness of international companies to invest in their in-house compliance and legal functions, with the aim of building up their internal expertise in dealing with complex, cross-border disputes when they inevitably come through the door. This would suggest that companies are recognising that having experienced in-house lawyers at hand to manage disputes can be invaluable and ultimately result in a cost benefit to the company.

Local and global counsel
While cross-border deals in the structured finance industry can involve a wide number of different jurisdictions, the harmonisation of laws and regulations governing them has tended to lag behind. A series of running battles between structured finance counterparties have revealed how these divergences in law and regulations can create significant difficulties for parties faced with a cross-border dispute - for example, where a Hong Kong bank books a deal for a German public authority with a US counterparty, even the basic starting point of "which law applies?" can seem less than clear.

In the wake of the financial crisis, governments and regulators came under significant pressure to overhaul their derivatives markets to make them 'safe'. Legislation, such as the Dodd-Frank Act in the US and EMIR in Europe, was enacted for this purpose - but there are key divergences among the different rules.

The 2009 G20 mandate has encouraged governments to take steps to harmonise their laws, but that is still some way off. It is also worth remembering that it is not just securitisation-specific laws that a company might be subject to in a given dispute, as in some jurisdictions sanctions against any infringement of domestic criminal laws may well be just around the corner. Significant territorial legal differences are therefore likely to remain for a good deal longer.

In light of this complex cross-border legal and regulatory environment, detailed country-specific knowledge of each relevant jurisdiction can be crucial - without which parties to a dispute are likely to face significant disadvantages. What is also important is having an understanding of the cultural idiosyncrasies of the given jurisdiction, particularly in the emerging markets - as failing to recognise and safely navigate these may have even more serious consequences than failing to get the local law right. It is perhaps no surprise, therefore, that over a third of respondents to the survey say that finding experienced local counsel to handle their cross-border disputes - particularly in challenging jurisdictions - is their greatest concern.

Companies are also turning to their main legal counsel to provide them with a more holistic service - with over two-thirds of respondents opting to instruct a single global legal counsel to manage cross-border disputes for them. This would seem to make commercial sense; enabling companies to channel instructions through a single point of contact minimises management time, and using a single firm facilitates a coordinated strategy and - it would be hoped - ensures better cost and quality control.

Thinking about settlement
When a dispute emerges, there is often little that can be done to stop the wheels of justice from turning - however slowly and in whatever jurisdiction that may be. However, the survey findings show that some companies are seeking to wrestle back control by pursuing a deliberate strategy of identifying and - if necessary - settling problem cases early on in the process.

Gathering information and interviewing witness as the start of a dispute may seem like unnecessarily front-loading a case - in terms of time and, especially, costs. However, this strategy can often pay dividends in the long run by ensuring that only cases with a good chance of success are fought, weaker cases which could otherwise lead to a raft of further disputes are nipped in the bud and management time is freed up to devote to building the business, rather than being taken up with dispute management.

It is clear, then, that companies have a number of challenges on their hands in dealing with an increasing number of complex cross-border disputes. However, companies are starting to deploy a range of strategies for making these disputes more containable and more manageable - and can even see this as an opportunity to protect and promote their market position through decisive legal action. The survey highlights that many senior executives and in-house counsel are aware of these challenges - and are consciously and proactively looking to develop their dispute management strategies to suit the ever-increasingly global business landscape.

CLOs

Credit picking

CLO investing in an evolving regulatory environment discussed

Representatives from Thomson Reuters, Prudential Fixed Income and Guggenheim Securities discussed the CLO investment landscape in an evolving regulatory environment during a live webinar hosted by SCI last month (view the webinar here). Topics included the impact of risk retention requirements and the Volcker Rule, as well as current drivers of relative value. This Q&A article highlights some of the main talking points from the session.

Q: How has the regulatory environment impacted new issue volumes and secondary supply?
A: Matthew Rose, head of CLO pricing at Thomson Reuters: The US CLO new issue market started the year off slowly, with just US$2.6bn priced in January, compared to US$4.4bn in December while the market awaited clarity on the Volcker Rule. Since then, volume has picked up strongly, with US$8.4bn issued in February and US$10.8bn in March as the market begins to implement structural alternatives that are Volcker-compliant.

Although geo-political events caused a slow-down in secondary markets earlier in the year, BWIC activity has also picked up recently, focusing on US and European senior bonds with shorter average lives. Also making the headlines is the refinancing of CLO 2.0 deals as 2012-vintage transactions exit their non-call periods.

Mario Verna, md at Guggenheim Securities: Some players are predicting full-year issuance of US$55bn in 2014, compared to US$85bn last year, which sounds somewhat pessimistic - especially considering the run-rate we've seen so far, albeit at a compressed arbitrage. There is an active pipeline, especially later on in the year when the number of transactions expected to be refinanced spikes.

Q: How are spreads likely to react if the regulatory uncertainty lifts?
A: Verna: If the situation is resolved with a positive outcome, triple-A CLO spreads at least in the US are likely to tighten by 10bp-15bp, as there will be less pressure for banks to divest their triple-A rated holdings. Mezzanine bonds probably won't come in that much because they've already seen significant tightening.

There are no fundamental reasons for spreads to tighten by more than 10bp-15bp. However, we've seen different investors entering the market to take advantage of repo financing - for example, repoing triple-A and triple-B bonds by putting up a 20% margin. More investors results in more capacity, which tends to drive rates lower.

Indeed, insurance companies are increasingly participating in US managed CLOs and now account for around 30% of the buyer base, compared to 10% previously. These players seem to be filling in many of the gaps that the banks have left, although some large US banks have indicated that they're looking to get back into the market.

We're also seeing a rise in warehouse providers entering the sector, which is indicative of the drive in the market a present. Warehouse terms are now more advantageous to the borrower, typically featuring longer terms, with fewer market value triggers or perhaps no market value triggers.

CLOs remain an attractive alternative to other asset classes, such as investment grade bonds and CMBS, which trade about 60bp-65bp tighter.

It remains to be seen what impact the Volcker Rule will have, if any, on loan spreads. While Volcker may not have a direct impact, Fed action more generally will.

If rates rise within the next year, as many expect, the beneficial effect of the Libor floor will diminish. However, in a rising interest rate environment, floating rate product is advantageous.

Q: What are the latest developments with respect to the skin-in-the-game debate?
A: Rose: The risk retention requirement under Dodd-Frank allows for the exemption of CLO-eligible loan tranches, where the lead arranger agrees to retain 5% of the entire notional tranche. They would be prohibited from selling or hedging the exposure for the life of the transaction. But this arrangement seems unworkable for banks, which face new capital restrictions.

The LSTA has introduced an alternative concept - the 'qualified CLO' - which would be subject to six criteria around asset quality, portfolio composition, structural protection, alignment of interest between managers and investors, transparency and disclosure, and regulatory oversight. If a CLO were to meet all these criteria, then the manager could meet the risk retention requirements by holding 5% of just the equity tranche, rather than 5% of the entire deal.

One of the key points to remember here is that - unlike other securitised products - CLOs are not originate-to-distribute deals, but are diversified credit portfolios that are actively managed by asset managers, most of whom are registered advisors.

Edwin Wilches, senior associate and portfolio manager at Prudential Fixed Income: Not being an originate-to-distribute product, it's unfortunate that CLOs have been caught up in the broader effort to address the shortcomings of structured products. The qualified CLO route is a positive step forward for the industry, as a 5% vertical slice would be quite cumbersome for many managers to retain.

Verna: The LSTA has been vocal about alignment of interest occurring through the subordinate fee structure for managers, but somewhat surprisingly this hasn't been met with a lot of enthusiasm from the regulators. They seem unconvinced that this would provide enough alignment of interest, despite managers being incentivised to manage CLOs properly with respect to investor interests. Risk retention is necessary in any structured transaction, but the point that the industry is trying to make is that such alignment exists by virtue of the manager's fee structure.

The fixes suggested so far aren't ideal; for example, the open market approach where banks retain the risk goes counter to the need for them to syndicate the risk. And the qualifying loan proposal seems to be more suited to MBS. It's frustrating that, despite all of the industry's efforts, there is still a lot of discussion around how risk retention requirements will play out.

Q: Continuing the risk retention theme, how is the implementation of CRD Article 122a progressing in Europe?
A: Verna: Article 122a has been in effect in Europe since January 2011 and was revised in May 2013 to the Capital Requirements Regulation. Under the CRR, the 5% risk retention needs to be held by one of three participants - the originator, the sponsor or the original lender. The burden of proof is on the investor.

CLO volume in Europe picked up in the second half of 2013. In most issuances, the sponsor was a large manager that was able to finance the risk retention piece itself. But this would be a significant burden for smaller managers.

One change that occurred in December allows US managers to qualify as the risk retention provider; previously only EU or MiFID institutions could qualify. The definition was revised to allow any manager of a securitisation programme to qualify.

Under the revision, the originator purchases the loans for its own account and sells them to the CLO or otherwise securitises them. This also provides for other investors in the capital structure to qualify.

Article 122a seems to offer more flexibility than Dodd-Frank; for example, it allows a participant to further leverage/finance the vertical slice. A manager can, for instance, borrow 80% say against the 5% - effectively creating an equity-like return. However, the 80% financed also needs to be retained for the life of the deal, thereby satisfying the 5% requirement.

This probably applies more to the US, but if the 5% needs to strictly be held by a manager, the risk is that there will be a further consolidation of asset managers and ultimately a reduction in issuance and funding for corporates.

Q: The passage last month of the Barr bill shows that there is broad bipartisan support for relief for CLOs under the Volcker Rule. This was followed by the regulatory agencies announcing an extension of the compliance period until 21 July 2017. Where do these developments leave CLO market participants?
A: Wilches: The Barr bill was a little mixed. Although it demonstrated the House's agreement on the importance of CLOs, much of the original grandfathering language was eliminated from the bill to achieve bipartisan support.

But I believe grandfathering remains the number one issue. US banks hold an estimated US$75bn of legacy CLOs, while Asian accounts hold another US$25bn-US$50bn. What happens to these portfolios now remains to be seen - I think this is what is really keeping spreads back.

The Barr bill has addressed some market concerns with regards to the 'ownership interest' definition, however, CLO 3.0 transactions are doing a good job of complying with the ownership interest piece and there is a place for the market to exist just by doing loan securitisations.

Ultimately banks have a few options available to them. One option - and we're already seeing this being implemented - is for them to waive the right to replace managers under certain outcomes.

If this is something that their credit departments will not allow or the bank is unwilling to accept, it's difficult to see how deals can be amended. In these cases, when the call periods come up, banks may take a lower spread to where the market is just to get a fix and make the transaction Volcker-compliant retrospectively.

Verna: It's doubtful that other types of investors could fully replace banks if they were precluded from the CLO market entirely. But this is an extreme scenario, since banks can give up control language to make deals compliant.

The type of exemption used under the investment act - whether it's 3c7 or 3a7 - also dictates whether a CLO respectively falls under or is exempt from Volcker. Historically, most deals were done under 3c7, which allows for active trading of the underlying loans. But 3a7 deals have been done by managers that are comfortable with a somewhat more restrictive trading covenant. It depends on the intention and style of the asset manager.

Q: How are managers compensating for the loss of spread from eliminating bond buckets?
A: Wilches: Managers are compensating for the loss of bond buckets in a variety of ways. The natural place to look for extra juice outside of bonds is in second-lien loans. An alternative is to move down in liquidity by looking at smaller facility sizes.

Equity has also capitulated a bit on the required return, while management and dealer fees have compressed. Credit enhancement in many pre-Volcker CLOs is in the high-30%/low-40% range, but - given the lack of bond buckets - rating agencies are allowing managers to lever some of the more recent deals a little more, so that credit enhancement now stands at around 35%.

Verna: Eliminating bonds doesn't seem to have impacted many managers. Across all CLOs, the bond bucket was only utilised to the extent of 1.2%-1.5% of the traditional 10% for US deals. The figure is higher for European transactions, at 9.7%.

Many managers are including second-lien loans, but they have lower recoveries, so cushions need to be added with respect to the rating agency test. We're seeing other managers raising financing privately or via managed accounts as a way to earn fees and increase AUM, and either retaining the equity or syndicating it. This is a way of effectively creating the economics of a CLO, potentially with less regulatory impact.

Other financings are done almost as an extension of the warehouse facility, with the senior lender providing a TRS, for instance. It remains unclear whether these transactions are really CLOs and therefore should fall under Volcker.

Q: In terms of relative value, which factors influence investment in middle market versus broadly syndicated loan CLOs?
A: Verna: Middle market deals represent a strong relative value proposition. A middle market loan is generally made to a US$50m EBITDA company and the facility sizes tend to be US$150m or lower.

Yields tend to be higher than for broadly syndicated loans, at around 535bp margin, with a higher Libor floor. For equity providers, the returns tend to be one point higher than for broadly syndicated CLOs.

Middle market loans also tend to be less levered, while covenants tend to be stricter and historical recovery and default rates have been more advantageous. Structures usually result in higher credit enhancement due to the rating agency assumptions around recovery rates.

Middle market CLO debt trades around 25% wider than broadly syndicated loan CLO debt. There is a fair amount of liquidity for these deals in the secondary market, but not as much as for broadly syndicated loan CLOs.

We're expecting around US$15bn of middle market CLO issuance this year, up from US$11bn last year. Growth is being driven by BDC originations, as well as new money coming into the sector.

Wilches: I think broadly syndicated loan CLO triple-A and double-A bonds are cheap relative to the risk. Based on underlying loan spreads of 350bp-375bp and CLOs yielding 150bp-160bp, the spread capture of 35%-50% is significant, considering the credit risk-remote nature of the deals.

The floating rate nature of broadly syndicated loan CLOs means that they are more attractive to banks than insurance companies or pension funds. I would expect there to be a floor to spreads until a deeper investor base emerges or a mechanism is developed that makes CLOs more attractive to fixed-rate buyers.

Q: How do European and US spread levels compare for CLO 2.0 deals?
A: Verna: European spreads are tighter at the triple-A level. But this is difficult to justify, given that there is less liquidity and less collateral available.

Wilches: European spreads are tighter on a nominal basis and is likely due to the scarcity value, given the paucity of supply. That being said, when buying a US CLO, there is a loss of spread for European-based investors when the cross-currency swap is executed.

Q: How significant is manager style when analysing CLO investments?
A: Wilches: Assessing a CLO manager is one of the first screens we make, in order to ascertain their character, as well as their style. If those two aspects don't match up for us, we won't be able to get comfortable with the structure.

In terms of character, the past actions of a manager and their interpretation of the indenture are paramount because it shows how they treat amend-to-extends and long-dated buckets and so on. This is very indicative of potential future action.

Another important factor is franchise value and how much CLO managers are willing to put at risk to eke out extra returns to the potential detriment of debt holders. The depth of the team is another factor.

Initial portfolios are telling in terms of what a manager intends to do - albeit we understand that underwriting on day one is challenging, given the revolving nature of the pools. Our general philosophy is high quality, high yield investing, so we tend to focus on managers who fulfil that requirement.

Q: How have CLO calls, refinancings and repricings impacted the market?
A: Wilches: CLO refinancings have been healthy for the market in the sense that investors in the refinanced tranches are typically new accounts coming into the asset class, such as managed short-duration or floating rate funds. One interesting technical is that the term structure of triple-As has become clearer: anything with a WAL of under 3.5-4 years is eligible for these funds. Investors are almost rolling their deals and perhaps losing a few basis points in coupon, but receiving an extra two years of call protection.

Verna: Refinancings are mainly driven by equity investors, who can achieve a pick-up of a point or 1.5 points. I expect this trend to accelerate further as spread compression continues.

Rose: We're seeing a lot of focus on refinancings in the secondary market, where there appears to be sensitivity to trading as deals approach the end of their non-call periods. Investors buying into the refis seem to be attracted to the short duration and seasoned portfolios on offer.

Q: How should investors approach tail risk in CLO portfolios?
A: Wilches: Tail risk is a function of a deal's vintage and the opportunities a manager has to buy into the credit market as we move deeper into the cycle. Tail risk will vary depending on a manager's philosophy and risk appetite. The one potential unintended consequence of the past cycle and the recovery post-crisis is that it has emboldened some managers to take more risk than is appropriate.

Verna: TRS and market value triggers exacerbated the losses in the downturn. As fewer triggers are out-of-the-money now, there is less pressure on worst-case scenarios. This, in turn, opens up the possibility for managers to roll into new deals or refinance through a different facility with a portfolio that has a shorter remaining duration and is presumably less levered.

Structured Finance

Annaly boosts management group

Annaly Capital Management has made a series of additions to its management team. The additions include key RMBS and CMBS roles as well as a push into middle market lending.

David Finkelstein has joined the agency portfolio team as an md. He was most recently in the markets group at the Federal Reserve Bank of New York and has also traded agency RMBS for Barclays and Citigroup.

Jessica LaScala has joined the agency portfolio team as a director. She too was at the Federal Reserve Bank of New York and before that spent over a decade on Citi's agency RMBS trading desk.

Allison Werry has joined Annaly's financial and risk teams as a director, focusing on commercial real estate investments. She was most recently head of CMBS surveillance at Kroll Bond Rating Agency.

Annaly has also added Sarah Fowlkes and Krista Patterson to its CRE legal team. Michael Quinn will further boost CRE origination capabilities, while David Frost joins the middle market lending platform.

Pete Koukouras and Konstantin Pavlov are promoted to head of repo trading and head of alternative financing, respectively. Meanwhile, Francine Bovich has also been nominated for election to Annaly's board of directors at next month's annual meeting.

Structured Finance

Bank brings in trio

Lloyds Bank Commercial Banking has made three additions to its capital and financial markets team. Caroline Jennings, Robert Gaspar and Kristan Gochee will each be based in New York.

Jennings joins as credit sales svp. She has particular structured products expertise and was previously at Raymond James & Associates, having also worked for JPMorgan, Bank One Capital Markets, Barclays Capital and Cohen & Company, where she was structured product sales md.

Gaspar joins as credit trading svp. He has experience trading multiple sectors in the investment grade space and was most recently at Jeffries & Co, having also worked in fixed income trading at RBS.

Gochee also joins as credit trading svp. She was most recently responsible for structured products trading and sales at CastleOak Securities and has previously worked at Conning Asset Management and UBS.

Structured Finance

Asset manager enhances offering

TIAA-CREF is set to purchase Nuveen Investments, significantly expanding the products and services it can offer customers. Nuveen, meanwhile, will benefit from the enhanced resources and scale TIAA-CREF can provide.

The transaction provides clients with additional investment choices and access to new products. Enhanced investment capabilities will span traditional and alternative investments, including a range of fixed income and credit strategies.

Nuveen is being acquired for an enterprise value of US$6.25bn, inclusive of outstanding debt. It will operate as a separate subsidiary within TIAA-CREF's asset management business with John Amboian continuing to serve as ceo and the rest of the leadership and investment teams also staying in place.

CDS

ISDA elects new directors

ISDA has elected 12 directors at its latest AGM in Munich. This includes four new directors as well as eight who were re-elected.

The new directors are Jonathan Hall, Kieran Higgins, Ciaran O'Flynn and Koji Sakurai. Hall is advisory director at Goldman Sachs and Higgins is head of EMEA fixed income trading at RBS, while O'Flynn in co-head of fixed income electronic trading at Morgan Stanley and Sakurai is svp at Mizuho Bank.

The re-elected directors are: Guillaume Amblard (BNP Paribas); Biswarup Chatterjee (Citigroup); Elie El Hayek (HSBC); Diane Genova (JPMorgan); Richard Prager (BlackRock); Will Roberts (Bank of America Merrill Lynch); Eraj Shirvani (Credit Suisse); and Emmanuel Vercoustre (AXA Bank Europe).

CMBS

Key vet to lead real estate group

KeyCorp has appointed Angela Mago to lead KeyBank Real Estate Capital and Community Development Lending. She will report to Christopher Gorman, Key Corporate Bank president.

Mago has been at Key for 26 years, most recently leading the real estate capital markets team which has responsibility for originating, underwriting and distributing permanent mortgage financing through Fannie Mae, Freddie Mac and CMBS. She succeeds EJ Burke, who has moved to become Key's community bank co-president for commercial and private banking.

Insurance-linked securities

Willis boosts Europe, Asia teams

Willis Capital Markets & Advisory has hired Quentin Perrot in London and Rui Huang in Hong Kong. The pair will significantly boost the firm's capabilities in Europe and Asia.

Perrot joins as ILS vp, moving over from BNP Paribas, where he led the origination and structuring of ILS on a global basis. Before that he worked at the bank as a credit analyst.

Insurance specialist Huang joins as svp and will continue to develop Willis' capital markets and strategic advisory business in Asia. He was most recently at Temasek and has previously worked at Morgan Stanley, Rothschild, Dresdner Kleinwort and Bank of America.

ABS

Tiering emerging in aircraft ABS

Airlines and lessors appear to have ample access to liquidity, with many having recently issued debt across various sectors - including the term-loan, ABS and corporate bond markets. Indeed, following strong issuance last year comprising four deals, momentum in the aircraft ABS primary market has continued with two deals issued year to date in 2014.

The deals - RISE and Castlelake - featured different collateral profiles, Wells Fargo ABS analysts observe. Marking a departure for the sector, the Castlelake portfolio had an initial weighted average age of 17.5, with a lower A tranche LTV of 52% (SCI 13 February).

Meanwhile, the ACAP 2003 deal was called and the notes paid off in full last month. This marks the second post-2001 vintage deal to be called in 2014, following the redemption of Aircastle 2006 (SCI 4 February).

The Wells Fargo analysts note that tiering in the aircraft ABS market is emerging for single-tranche 2006-2007 vintage deals, with Aircastle 2007-1 trading at tighter levels than comparable bonds. "For the most part, older vintage deals continue to pare portfolios. Many of these bonds trade at, or above, the estimated market value of the collateral," they add.

ABS

Energy efficiency programme launched

A US public-private partnership has been formed to facilitate lower-cost loans for home energy efficiency improvements. Dubbed the Warehouse for Energy Efficiency Loans (WHEEL), the aim is to open up the sector to large institutional investors by harnessing securitisation technology.

WHEEL is the product of a years-long collaboration between Citi, the Pennsylvania Treasury Department, Renewable Funding, the Energy Programs Consortium, National Association of State Energy Officials and the US Department of Energy. The Commonwealth of Kentucky has also joined the initiative as a charter member, with key financial support provided by Energy, Ford, Rockefeller, Surdna and William Penn Foundations.

The partnership is designed to simplify financing programmes for states, utilities, contractors and homeowners. Approved local contractors will offer low-cost financing directly to consumers; the loans will then be purchased by Renewable Funding (with a credit facility provided by Citi and the State of Pennsylvania Treasury), aggregated into diversified pools, securitised and sold to institutional bond investors. Citi is set to provide an initial warehouse facility for Renewable Funding to purchase loans to facilitate a US$100m ABS MTN programme.

WHEEL builds on Pennsylvania's successful Keystone HELP Loan programme. These loans - originated by AFC First Financial Corporation - have helped more than 13,000 homeowners reduce their energy use and provided the robust performance data necessary to launch the national WHEEL initiative.

McKinsey & Co reported in 2009 that the US could reduce energy consumption in homes by 28% by 2020, with an upfront investment of US$229bn. States and utilities are expected to double spending on energy efficiency rebate and incentive programmes by 2025 to approximately US$15.6bn.

That leaves more than US$200bn in unmet need for financing to make homes more energy efficient. By tapping into the ABS market, it is hoped that WHEEL will help meet that need.

ABS

Chinese leasing ABS eyed

Amendments to rules for financial leasing companies in China look set to make leasing ABS deals possible in the jurisdiction, Fitch suggests. The rules should strengthen the operating environment for leasing companies and limit the risk of originator/servicer default.

The China Banking Regulatory Commission (CBRC) recently released amended 'Administrative Measures for Financial Leasing Companies', which aim to encourage new entrants into financial leasing - such as overseas commercial banks and financial leasing companies - and enable them to draw on a wider range of sources of capital, including securitisation. Fitch notes that the regulatory framework for securitisation in China continues to develop and this may bring new asset classes to the market, including equipment leases and aircraft leases.

The new rules include general measures for the leasing sector, such as tighter supervision and management of capital adequacy ratios. They also make leasing ABS deals more feasible by emphasising the importance of title management. They contain improved provisions for lease administration, bolstering the ability of leasing companies to administer and service leasing assets.

Verifying that these provisions were implemented in leasing companies' day-to-day operations would be important in rating new deals, Fitch observes. This would take place during originator/servicer reviews, which look at underwriting and servicing procedures and policies to ensure ongoing credit quality of the securitised assets.

Additionally, the new rules attempt to limit originator/servicer default risk by insisting that a financial leasing company's articles of association include provisions for shareholders to provide liquidity support to the company if necessary and that if operating losses eroded capital, the shareholders would make up the shortfall in timely fashion. Fitch believes that this would reduce originator/servicer default risk if the shareholders had higher ratings than the leasing company and injected capital in line with the rules, which require at least one eligible commercial bank, large domestic manufacturer or overseas financial leasing company to own no less than 30% of the leasing company.

The Chinese government has promoted securitisation via measures, such as allowing securitised products backed by high quality assets to be traded on exchanges and increasing the issuance quota under its pilot programme, including the quota allowed for auto loan securitisations (SCI 1 April).

ABS

SLM split scheduled

Sallie Mae's board has formally approved the separation of its loan servicing business line from its consumer banking business. The loan servicing entity will be called Navient, while the consumer banking business will retain the Sallie Mae brand.

The split is scheduled for 30 April, with the separation achieved via a dividend distribution to Sallie Mae shareholders on 22 April. Navient's servicing book is expected to total US$300bn after the split.

Barclays Capital ABS analysts believe that the split should have no material impact on existing Sallie Mae student loan securitisations, as Navient will service all of the loans in the outstanding ABS. Navient will also adopt Sallie Mae's existing servicing infrastructure, as well as some of the senior leadership team currently at Sallie Mae (SCI 6 January).

Structured Finance

Sovereign ceiling criteria finalised

Fitch has published its criteria detailing how ratings of structured finance (SF) notes and covered bonds (CVB) are constrained by the credit quality of the sovereign to which the SF transaction or CVB programme is exposed. The methodology is consistent with the one presented in the exposure draft published on 22 January (SCI 23 January).

The criteria provide details of Fitch's current approach to assigning SF and CVB ratings that are higher than the relevant sovereign local currency issuer default rating and outline how the agency embeds sovereign default risk in its rating stresses. It also details the methodology applicable to ratings of multi-jurisdictional SF notes or CVB.

As detailed in the criteria, the ratings of SF notes and CVB issued in foreign currency cannot exceed the country ceiling (CC) of the country of the assets, unless the transfer and convertibility (T&C) risk is mitigated. Where T&C risk is mitigated, ratings cannot be higher than four notches above the CC. In addition, Fitch SF and CVB ratings are capped at a maximum of six notches above the sovereign LC IDR.

Fitch believes that it is not possible to completely de-link SF and CVB ratings from the credit quality of the relevant sovereign, as a high level of sovereign default risk raises the prospect of extreme events occurring in a country and reduces the certainty of performance projections for SF and CVB assets. CVB are also further affected by sovereign risk through its impact upon the issuing bank and liquidity of the cover pool.

These criteria are not expected to affect ratings assigned to SF notes or CVB whose assets are concentrated in a single jurisdiction, as they reflect Fitch's current global analytical practices with respect to rating caps. Similarly, no major revision of the base-case and stress assumptions currently applied by the agency is expected, due to sufficient cushion being embedded in transactions.

However, a limited number of ratings assigned to multi-jurisdictional SF notes and CVB may be downgraded by one or two notches upon implementation of the criteria.

Structured Finance

Housing reform bill weighed

Several provisions in the comprehensive housing finance reform bill introduced by US Senators Tim Johnson and Mike Crapo would help spur issuance of private-label RMBS (SCI 12 March), according to Moody's. At the same time, the bill is expected to modestly dampen prices of multifamily properties and increase CMBS refinance risk.

Under the framework proposed in Johnson-Crapo, fewer residential mortgage loans would be eligible for inclusion in government-guaranteed securities because of changes in criteria establishing which securitisations can receive government guarantees. "Under the bill, a new agency - the Federal Mortgage Insurance Corporation (FMIC) - would provide a government backstop for eligible mortgage pools that have secured a private first loss piece of 10% through FMIC-approved risk-sharing mechanisms," says Moody's vp Sang Shin. "Loans would only be eligible for the FMIC backstop if they meet the CFPB's qualified mortgage standards, among other requirements."

The new requirements would be more stringent than the GSEs' current eligibility criteria, which do not mandate that loans meet QM standards to be eligible for securitisation. Increased issuance would be driven - both in the private-label and government-guaranteed securitisation markets - by the introduction of a common securitisation platform, as outlined under the legislation. Further, the new system could provide investors with added confidence in the securitisation market as a result of increased transparency and standardisation, and encourage originators/aggregators that had been on the sidelines to participate in the secondary securitisation market.

However, several factors could partially offset this growth in the initial transition period of housing reform, including investor uncertainty regarding the wind-down of the GSEs and its impact on mortgage rates, as well as the bill's provision keeping the existing conforming mortgage loan balance requirements. "The conforming loan provision is a shift from the Obama administration's stance and previous housing reform proposals, such as the bill introduced last year by Senators Corker and Warner. Maintaining the existing maximum conforming loan balance would limit the potential increase in private-label RMBS issuance," says Shin.

Meanwhile, with respect to CMBS, Moody's suggests that the bill will modestly dampen prices of multifamily properties and increase refinance risk. The bill proposes creating a multifamily office within the FMIC that would insure MBS to facilitate the availability of multifamily loans.

"If this bill becomes law, higher loan coupons on the FMIC-backed share of debt will exert downward pressure on multifamily property prices and increase refinance risk, but the impact would be moderate," says Tad Philipp, Moody's director of commercial real estate research. "US government backing for multifamily debt that had been implicit and free would become explicit and bear a guarantee fee. While GSE-backed multifamily debt often had pricing advantages relative to private market debt, loan spreads on FMIC-backed debt would more closely align with those of private market originators."

Structured Finance

Peripheral country caps lifted

Fitch has taken positive rating action on 150 tranches of 113 structured finance transactions that are capped relative to the sovereign ratings of Ireland, Portugal and Spain. The move follows the revision of the caps on structured finance (SF) ratings to align them with the country ceilings of those countries, six notches above the respective sovereign issuer default ratings (IDR). The SF cap for each country was previously set at five notches above the IDR of the sovereign.

Selected RMBS tranches rated at the respective sovereign caps have been placed on rating watch positive (RWP) pending further review, due to sound asset performance. The ABS and structured credit tranches rated at the respective sovereign caps have been upgraded by one notch to the country ceilings.

Further, the outlook on Portuguese ABS and structured credit transactions has been revised to positive, following a similar action on the sovereign IDR.

Structured Finance

Stable rating outlooks for APAC

Fitch reports that over 97% of its Asia-Pacific structured finance rating actions in 1Q14 were affirmations, with eight upgrades and two downgrades accounting for the remaining rating actions. Of the 364 affirmations, 347 were from Australia and New Zealand.

Australia also contributed all eight of the upgrades - to auto loan ABS, prime RMBS and non-conforming RMBS bonds - during the quarter, where a build-up of credit enhancement supports the higher ratings. Asset performance was supported by continued strong economic performance in both Australia and New Zealand.

Both downgrades were to a Japanese CMBS transaction, where Fitch downgraded two tranches to single-D from double-C and single-C following principal loss in the remaining defaulted loans. The agency's other rating actions in Japan were 11 affirmations across two prime RMBS, two CMBS transactions and two CLN transactions.

In non-Japan Asia, meanwhile, all six tranches reviewed were affirmed. Three Korean credit card bonds and one Singapore CMBS bond were affirmed, based on the stable economic performance in these jurisdictions. The other two affirmations were of the short-term ratings on two Taiwanese structured credit transactions.

Most long-term ratings in the region had stable outlooks, as of 31 March - with the exception of two positive outlooks in Australia, as well as five positive and two negative outlooks in Japan.

However, the performance of collateral in Indian commercial vehicle transactions continues to deteriorate on the back of increased fuel costs and reduced freight rates squeezing the margins for operators. Fitch maintains a stable outlook on the transactions due to significant build-up in credit enhancement and continued excess spread that currently covers losses, even though delinquencies and defaults of underlying loans are deteriorating.

Structured Finance

Royal Decree impact examined

DBRS says that changes to Spain's insolvency law, introduced last month (SCI 18 March), will not immediately impact its assumptions regarding defaults and recovery rates in the jurisdiction. However, the agency notes that the Royal Decree 4/2014 raises several questions as to how structured finance transactions will be impacted.

In particular, DBRS points to a number of questions raised by the regulation changes around potential extension risk, voting rights and default/loss calculations. The new framework allows loans to be extended for up to ten years from their original maturity.

If there are loans outstanding at the legal maturity of the SPV, the issuer will be left with three options: sell the assets back to the originating bank, sell them in the market to any interested party at a price that would likely be below par or lose the right to those assets. For new transactions, this risk can be addressed by extending the legal final maturity of the SPV by more than ten years beyond the longest maturing asset in the portfolio, according to DBRS.

An analysis of existing Spanish SF transactions rated by the agency finds that while 22 transactions contain loans at risk of extension beyond legal maturity, the exposure amounts are small. Of those 22 transactions, the percentage of original outstanding balance at risk of extension ranges from 0.01% to 1.75%. Only three transactions have over 1% of their loan balances with maturities less than ten years before the legal maturity of the notes.

With respect to voting rights, DBRS says it is important to distinguish the voting direction of the fund versus the voting direction of the bank at the moment of establishing the qualified majorities. It is therefore necessary to clarify in the transaction agreements how the right to vote on any restructuring plan is given back to the management company.

In terms of default and loss calculations, it is possible that certain performance triggers embedded in transactions may lose their effectiveness if management companies take a lenient approach to recognising the change in value caused by a restructuring of the debt they hold. DBRS anticipates that management companies will provide guidance in the coming months on how they plan to treat these scenarios.

Overall the agency still expects that a considerable proportion of delinquent borrowers will end in insolvency proceedings. "Only those that are considered to have the potential to remain a going concern and received support of at least 51% of creditors will be considered for entering this new process. Entry into the process must then be voted on by creditors," it explains.

Finally, for lenders, the main uncertainty under the new law relates to control during the insolvency process. In certain circumstances, lenders may be unable to enforce collateral or be forced to accept a restructuring/recovery plan as approved by creditors and validated by the court.

Structured Finance

Fundamentals index remains stable

The Fitch Fundamentals Index (FFI) remained stable for 1Q14 on trends including a bottoming-out of consumer credit delinquencies, a decline in the CDS outlook and an increase in corporate earnings and banking scores that are unlikely to be sustained in the longer term. Quarter-over-quarter, positive FFI component scores outweighed the negative by four to one, with five remaining at neutral.

For instance, the FFI credit card performance component score remained at +5, while year-over-year scores fell from +5 to zero, indicating a market bottom. "Year-over-year the prime credit card performance score moved to neutral from positive, signalling that delinquencies may have hit historical lows. With the delinquency rate at half the 2005 rate, there is little room for future improvement," comments Jeremy Carter, Fitch md.

He adds: "Credit card ABS collateral performance should start receding in the latter half of 2014 as originators begin loosening lending standards and less-seasoned, lower-quality accounts are added to securitisations."

Meanwhile, the FFI CDS outlook component score fell to zero from +5, driven by a slight decline in the pace of tightening risk spreads in early 2014. However, the year-over-year score remains in positive territory at +5.

Fitch notes that risk appetite remains strong, despite Fed tapering, with the Fitch Solutions CDS index tightening for seven consecutive quarters. High investor demand - notably in high yield, leveraged loans and less creditor-friendly structures - has also fuelled heavy debt issuance.

Structured Finance

NSFR framework critiqued

The Basel Committee's amended proposal for a minimum standard ratio for bank funding would introduce globally harmonised requirements that would potentially reduce funding mismatches, according to S&P. The agency adds, however, that the proposals contain some potential inconsistencies and gaps - and that the planned timeline for their implementation in January 2018 is slow.

These observations form part of S&P's response to the Basel Committee's consultative document on its net stable funding ratio (NSFR). "From a credit perspective, we believe that the NSFR framework and the principles the paper sets out are a pragmatic step that set a regulatory floor to monitor and reduce funding mismatches," comments S&P credit analyst Stefan Best. "The framework supplements several regulatory initiatives that have been, or will be, introduced over time. This, in turn, could reduce the risk of idiosyncratic or systemic stress or at least the negative implications of stress for the economy."

The agency also believes that globally harmonised funding measures could significantly augment the analytical tools used by market participants to make comparisons among banks and track changes in their funding positions over time - assuming that there would be appropriate and timely disclosure. It expects that smaller, deposit-funded retail banks would find it easier to comply with more stringent requirements than larger wholesale-funded institutions with extensive trading operations. The latter will likely need to make more significant changes to their balance-sheet structures or business models, possibly because the new liquidity and funding requirements could make holding illiquid assets less attractive or because of limited long-term wholesale funding capacity.

With respect to the proposed timeline for implementation, a number of banks already report the new ratio. "In our view, the committee could have partially addressed these concerns had it opted for a phase-in approach that had started earlier, similar to the implementation of the liquidity coverage ratio," Best concludes.

Structured Finance

QE impact weighed

If the ECB were to buy senior tranches of SME securitisations - for example, under a quantitative easing (QE) programme - it could help revive private investor interest in the sector and provide additional funding to banks for business lending, Fitch says. However, this would depend on the price the ECB is willing to pay for senior tranches.

European SME CLO spreads have tightened significantly over the last two years and a handful of transactions were able to sell the senior tranche to private investors. However, despite significant tightening, the spreads over Euribor paid to place these deals with investors remain at levels where placing mezzanine and equity positions would not make economic sense for the originator.

For instance, in February Quadrivio SME 2014 paid investors a spread of 168bp over Euribor on the senior tranches, versus a spread on the floating rate assets of 3.3%. In contrast, retained Italian SME securitisations used to obtain ECB repo financing have had spreads as low as 30bp over Euribor. If the ECB were to buy senior tranches at that level, mezzanine and junior parts of the capital structure of SME securitisations may become attractive to private investors.

In European leveraged loan CLOs with similar capital structures that have been entirely placed with private investors the spread over Euribor on the senior notes is around 140bp. The asset spread on the underlying loans is 400bp, leaving enough spread to compensate the mezzanine and equity investors. Recent CLOs have been oversubscribed, especially on the mezzanine and junior notes.

If the ECB were to buy the senior tranches of SME securitisations at 30bp, Fitch estimates that a break-even asset spread of 360bp would be needed to match the economics of a fully placed European leveraged loan CLO, compared with the 410bp needed if the senior notes were sold to private investors. The cost of borrowing for SMEs would therefore still have to increase, but to a much lesser extent if the ECB were to purchase the senior notes.

It remains to be seen what spread the ECB would demand if it did start buying, but it could well be lower than that demanded by private investors, who tend to demand a liquidity premium relative to RMBS while disregarding the credit enhancement that Fitch believes compensates for the higher risks in SME lending and which is a multiple of that in RMBS at the same rating level. For example, the senior tranches in Quadrivio SME benefited from 45% credit enhancement.

SME securitisations are often backed by static portfolios of amortising loans with sequential pay-down structures and significantly shorter weighted average lives than mortgages. The WAL for the senior notes in Quadrivio SME 2014 was 2.9 years under 0% prepayment assumptions, compared to a WAL of 12.1 years for Quadrivio RMBS 2013.

Recent comments by ECB officials indicate that QE is becoming less contentious. Bundesbank president Jens Weidmann said last month that the ECB might consider buying "private or public assets", while Mario Draghi confirmed last week that QE was under discussion. Separately, the central bank has increasingly voiced its desire to support securitisation to boost lending.

Structured Finance

Direct lending fund closed

Benefit Street Partners (BSP) has announced the final closing of its middle market direct lending fund, Providence Debt Fund III. The fund was substantially oversubscribed, with demand surpassing its US$1.75bn hard cap.

The fund received commitments from many existing and new investors, including state and corporate pensions, sovereign wealth funds, family offices and other high net-worth individuals. "We believe that a combination of regulatory and structural changes is resulting in a sustained significant funding gap for middle market companies," comments BSP president Richard Byrne. "With the fund, corporations benefit from our flexible financing solutions and the deep operational and strategic expertise we can provide management. We have already begun deploying capital from the fund and are excited to help a wide range of companies grow their businesses and achieve their full potential."

BSP previously raised Fund II in 2010, which also focused on middle market private debt and direct lending, and Fund I in 2008. Since the inception of this strategy in 2010 through 4Q13, it has generated a gross internal rate of return of approximately 18% (14% net).

Structured Finance

Call for action on 'high quality' ABS

The ECB and the Bank of England (BoE) last Friday published a joint paper, which concludes that securitisation is an important complementary funding tool to support the real economy. In their analysis of the European ABS market, the central banks observe that current regulatory treatment of securitisation has been unduly conservative and recommend accelerating the promotion of 'high-quality' securitisation in regulatory treatment and adjusting regulations to be commensurate with the reduced risk of such transactions.

The ECB's and BoE's existing eligibility criteria is recommended as a "useful guide" for defining high-quality transactions. Specifically, the two central banks recommend that the Basel Committee and IOSCO review developments in the securitisation markets and reconsider the existing 'catch all' regulatory treatment.

As well as differentiating between high-quality ABS and more complex structures, another issue highlighted as a roadblock to a full recovery of the European securitisation market is reliance on rating agencies. In particular, the central banks argue that sovereign caps do not always reflect the underlying collateral quality and structural strength of the transactions.

The central banks conclude that revitalising publicly-distributed ABS issuance on any meaningful scale would require "concerted policy action in various fields, involving a range of official entities". For instance, standard-setters can change incentives to participate in the ABS market.

They call for efforts to promote the concept of high-quality securitisations to be reinforced and accelerated "without delay" to reduce the current regulatory uncertainty that is impeding the reactivation of the market. "The high-quality segment of the securitisation market should aim to be more resistant to market stress, thereby providing banks with a resilient form of funding. But it is also important to support more junior tranches of safe and robust securitisation markets. In this regard, authorities should continue to help improve the availability of data and analytics and seek to ensure that these are delivered as efficiently as possible."

DBRS notes that the European securitisation market has shrunk by €750m to €1.5bn, one-quarter the size of the US securitisation market. The majority of new issuance is still failing to reach the public markets and is largely structured and retained, the agency adds.

Structured Finance

Noteholder communication facilitated

Broadway Financial Corporation has leveraged DealVector for distributing its proposal to extend the maturity of its debentures. Using DealVector has allowed Broadway to deliver its proposal directly to the inboxes of front office decision-makers, avoiding the delays that typically accompany notifications that pass through DTCC.

"We are pleased to report that the requisite investors of the trust that holds our floating rate junior subordinated debentures have approved our proposal, which was facilitated by DealVector's platform and helpful personnel," comments Wayne Bradshaw, ceo of Broadway Financial. "Their ability to connect us directly to investors in the trust that holds our debentures helped us gain the approval we needed in a very short timeframe."

CDS

Credit event for Kazakh bank

ISDA's EMEA Credit Derivatives Determinations Committee has resolved that a failure to pay credit event occurred in respect of JSC Alliance Bank. The move follows JSC Alliance Bank's failure to make an interest payment on its discount notes, part notes and subordinated notes outstanding on 25 March. The grace period has now expired.

A meeting has been scheduled for 14 April to discuss the matter further, including whether a CDS auction is to be held.

CDS

Bankruptcy credit event called

ISDA's Americas Credit Derivatives Determinations Committee has resolved that a bankruptcy credit event occurred in respect of Momentive Performance Materials Inc. The move follows the firm's commencement of a pre-negotiated reorganisation under Chapter 11 of the US Bankruptcy Code, with a view to restructuring its balance sheet. The DC is set to vote on whether a CDS auction should be held with respect to the reference entity.

CDS

Clearing due for Euro sovereigns

ICE Clear Europe is set to introduce clearing for Western European Sovereign Credit Default Swaps on 28 April, following receipt of regulatory approval. Becoming the first clearinghouse to clear such contracts, ICE Clear Europe will begin clearing US dollar-denominated CDS on Ireland, Italy, Portugal and Spain.

The clearer has extended its existing CDS risk model and margin methodology to clear sovereigns, including additional risk model considerations for country-specific exposure. Over 400 single name and index CDS instruments based on corporate and sovereign debt are now available for clearing at ICE.

CLOs

New manager variation examined

Moody's reports in its latest CLO Interest publication that it assigned ratings to deals from another six managers that are new to the US CLO market between July 2013 and March 2014, bringing the total number of new managers that issued deals post-2011 to 24 and the count of deals under their management to 52. The agency notes that new managers' experience with CLO and leveraged loan management varies, however.

"Some new managers have an edge over others because they have more substantial credit experience relevant to the CLO business or a more established infrastructure to support the CLO platform. Managers backed by large sponsors with substantial leveraged loan experience, managers with entire teams of investment professionals that have worked together at CLO 1.0 management firms, and established European CLO managers who have recently ventured into the US CLO market are generally well positioned for the CLO management business," Moody's explains.

AXA Investment Managers, Credit Value Partners, Hildene Leveraged Credit, ICG Debt Advisors, TPG Institutional Credit Partners and Zais Leveraged Loan Manager are the latest new entrants to the US CLO market. Most of the top-seven new managers by issuance - each of which has brought three to six CLO 2.0 deals - are backed by or affiliated with a large sponsor.

When AXA IM and ICG branched out into the US CLO management business, they established a separate management team in the US, headed by a portfolio manager and credit analysts with CLO experience in the US. The move acknowledges that key differences between US and European CLOs could affect their management approach, Moody's observes.

The prospects for smaller, independent entities are considerably more varied, according to the agency. "Some entities have very seasoned investment professionals with substantial experience managing CLOs and leveraged loans, whereas others have investment personnel with less experience. In the latter case, manager evaluation requires greater scrutiny in our rating analysis - although management replacement provisions and trading limitations in CLO documentation, for example, could to some extent mitigate concerns about the manager's relative lack of in-depth or extensive experience."

New managers Valcour Capital Management and Highbridge Principal Strategies hired teams from Aladdin Capital and Stanfield Capital respectively. In this case, Moody's notes that although the CLO platform is new, the investment professionals have a proven track record of working together on CLOs and leveraged loans, including through the last credit cycle. They can also leverage best practices from their previous CLO platform to optimise their investment strategies and processes at the new firm.

Investors continue to demand additional returns or protections in new managers' deals. Since early 2013, the length of the reinvestment period in new managers' CLOs has converged with the market norm of four years. However, purchases after the end of the reinvestment period are still either prohibited or often subject to tighter restrictions in new managers' CLOs than those in established managers' CLOs.

New managers also appear to be more flexible in accommodating investors' requests with respect to other CLO structural features. Additionally, investors are better compensated for investing in new managers' CLOs, because their liabilities typically have somewhat higher-than-average spreads and are sometimes sold at a discount.

CLOs

Volcker impact weighed

The provision of extra time to comply with the Volcker Rule provides few opportunities to banks and CLOs, Fitch says. Nevertheless, the methods CLOs are using to avoid being labelled as covered funds are largely viewed as credit neutral.

The US Fed last week extended the deadline for banks to divest their CLO holdings to 21 July 2017 (SCI 8 April). In Fitch's view, the extension could provide banks with more time to shop their investment portfolios and potentially diminish the losses that could result from the forced sale of their CLO holdings. It also provides more opportunities for the banks to restructure some of their holdings to be in compliance with Volcker.

Small banks could benefit from the extension more as they have higher portions of their securities allocated to the sector than larger banks. But while the largest banks - JPMorgan and Wells Fargo - have smaller percentages, they could incur larger losses.

Fitch suggests that CLOs launched pre-financial crisis are likely to be called or otherwise paid out before a forced sale occurs, while those created during 2014 are Volcker-compliant. However, the majority of CLOs structured between the beginning of 2010 and the end of 2013 are unlikely to be converted into Volcker-compliant structures, as it is neither practical nor feasible to gain approval from all the parties.

Opportunistic investors are expected to absorb most of the CLO senior notes at prices much lower than par, with expected losses for the tranche if forced sales occur. "We expect this to have a negative impact on banks that made the initial investment in these CLOs, as forced sales prices will likely be significantly lower than the expected credit losses on the notes. We also expect a potential disruption in the CLO secondary market to affect the CLO primary market, as evidenced by the current spread widening amid a benign credit environment," Fitch observes.

Meanwhile, Moody's notes in its latest CLO Interest publication that the methods CLOs are using to avoid being labelled as covered funds under the Volcker Rule are largely credit neutral. However, the agency says that methods that subject a CLO to market value risk by forcing it to sell investments by the Volcker Rule's effective date and waiving investors' rights to terminate a manager are credit negative.

Thus far, these methods include: eliminating non-loan investments, whether by preventing investments in such assets or requiring the divestment of such assets by the Volcker Rule's effective date; structuring a CLO to use different exemptions under the Investment Company Act of 1940; and eliminating or changing what have been typical CLO senior investor rights to replace a CLO manager under certain circumstances. Moody's says that underwriters have structured most of the CLOs it has rated in recent months to avoid the effects of the Volcker Rule by addressing one of these three features, with credit implications that are largely neutral.

The most common Volcker Rule-induced provisions in CLO 2.0s prohibit CLOs from purchasing non-loan assets, the credit effect of which depends on what replaces those non-loan assets in the CLO's collateral pool. The effect will be credit negative if CLOs substitute loans with lower recoveries and credit positive if it substitutes loans with higher recoveries. These provisions often come with a caveat that allows for some non-loan investments, in conjunction with investor consent and counsel's written opinion that the investment will not result in covered fund status.

In other instances, CLOs are allowed to purchase non-loan assets initially, but must sell them once the Volcker Rule becomes effective in July 2015 - a credit negative for the deals because the forced sale of assets subjects CLOs to market risk, impeding their ability to preserve par.

Another, less common approach that some CLO 2.0s are taking to avoid Volcker Rule restrictions is to use the Rule 3a7 exemption from the Investment Company Act of 1940, which Moody's says is credit neutral. CLOs qualifying under Rule 3a7 are not subject to 1940 Act regulations, are not covered funds under the Volcker Rule and thus are eligible to buy non-loan assets.

Rule 3a7 requirements are consistent with typical CLO structures and operations, with some exceptions. In particular, under Rule 3a7, a CLO cannot acquire or dispose of assets for the primary purpose of recognising gains or decreasing losses. Although the purpose of CLO trading is to prevent deterioration of portfolio credit quality rather than realise the benefits of short-term market fluctuations, proving this purpose places some small administrative burdens on managers.

But waiving investors' rights to terminate a manager could have a negative effect on transaction performance because the manager no longer has the incentive to perform to the noteholders' satisfaction, according to Moody's. An alternative credit-neutral approach to avoid ownership interest in CLO is to tie the termination of the manager with cause to an EOD trigger.

CLOs

CLO repacks emerging

Transactions tailored to CLO senior tranche investors' specific currency needs are beginning to emerge, Moody's notes in its latest CLO Interest publication. Last month, for example, the agency rated a repackaging transaction that effectively converted the US$250m class A tranche issued by JFIN CLO 2014 into a note making payments to the ultimate investor in Japanese yen.

Dubbed Repackaged Asset-Backed Securities Series 2014-2, the triple-A rated ¥25.59bn repack provided the investor with a Yen-denominated note that has the same level of creditworthiness as the underlying US dollar-denominated CLO tranche. Moody's says that a pass-through rating is possible for this type of transaction if the repack addresses certain overlying credit concerns - namely, swap-related risks and risks associated with the status and operation of the repack issuer as a separate entity.

The repack involved an SPV issuing a Yen-denominated note and then using the proceeds to purchase the senior CLO tranche. At the same time, the repack issuer entered into a balance-guaranteed swap, in which a counterparty agreed to make the Yen-denominated payments at a pre-determined exchange rate for the US dollar-denominated payments from the underlying CLO tranche.

BNP Paribas arranged the deal.

CMBS

CBD office prices outperform

The growth of central business district (CBD) office prices outpaced that of suburban office prices post-crisis in major US metro areas. CBD office prices appreciated by 106.5%, compared with 54.2% for suburban office prices, according to the latest Moody's/RCA CPPI report.

"After hitting their post-crisis troughs, central business district office prices far outperformed prices of their suburban office counterparts by more than 50 percentage points," comments Moody's director of commercial real estate research Tad Philipp. "CBD office has been the best performing core commercial property type, with prices up 9.8% over the last three-month period and 26.2% over the last 12-month period."

Both CBD and suburban office prices peaked in 4Q07 and experienced a post-peak decline of approximately 47%. CBD prices currently stand at 8.6% above their pre-crisis peak, while suburban office prices are 18% below peak.

Meanwhile, the national all-property composite index increased by 0.9% in February. Apartment and core commercial prices each increased by 0.9%.

The index has now recovered 85% of its post-crisis loss. All property sectors, besides suburban office in non-major markets, have recovered at least 40% of their peak-to-trough loss.

CMBS

Loan defaults hit post-2008 lows

US CMBS loan defaults dropped for the fourth consecutive year and to their lowest level since 2008, according to Fitch's annual US CMBS loan default study. The agency reported an annual default rate of 0.9% for CMBS in 2013, compared with 1.2% in 2012.

"The broader commercial real estate markets are stabilising and healthy new CMBS issuance volume is providing ample liquidity," comments Fitch md Mary MacNeill.

Annual CMBS defaults dropped by 26% in 2013 and finished the year 75% lower than peak levels in 2010. In total, 353 loans with a balance of US$5.4bn defaulted in 2013, compared with 557 totalling US$7.3bn in 2012 and 950 totalling US$13.8bn in 2011.

"Office defaults topped all property types in 2013 and will remain under pressure due to high unemployment, slow job growth and tenants requiring less space per employee," says MacNeill.

Cumulative defaults in 2013 were 13.5% (totalling US$84.2bn). Fitch expects the rate of cumulative CMBS defaults to hold fairly steady, with less than 50bp movement by year-end.

CMBS

CMBS criteria updated, back-tested

Fitch has published a criteria exposure draft for rating CMBS and loans in EMEA secured on investment property, including multifamily apartment blocks. The exposure draft includes a widening of criteria to include loan ratings, enhanced disclosure on the setting of key real estate assumptions, guidance ranges for those key assumptions and greater insight into Fitch's analysis of contracted income.

The proposed rating criteria are not expected to lead to changes in ratings assigned to CMBS in EMEA. The market cyclicality embedded in the key rating drivers outlined in the report has already been factored into the current ratings, Fitch says.

In the exposure draft, Fitch details the qualitative and quantitative factors it considers in its rating analysis. Specifically, the report addresses how the agency assesses collateral value under various rating stresses, how both loan and transaction-level features can impact the distribution of funds from the commercial real estate portfolio to bondholders, and how legal and operational risks may affect the underlying loan performance.

Accompanying the criteria exposure draft is a special report covering Fitch's back-testing of its key EMEA real estate assumptions, applied retrospectively to a sample of legacy deals as if at note issuance. The findings indicate that under the proposed criteria - which are strongly counter-cyclical - ratings will be more stable over future market cycles than over the past one.

The study suggests that key drivers of EMEA CMBS credit risk are appropriately screened for using Fitch's proposed criteria: CMBS that performed well through the recession would have been rated considerably higher at closing than those that eventually suffered losses. Fitch's ratings are based on a wide variety of factors that correlate with the point-in-cycle and collateral quality, neither of which is captured in commonly-quoted loan-to-value and debt service coverage ratios.

The findings indicate that for the sample of deals tested, had Fitch's proposed EMEA CMBS methodology been in force, none of the notes that suffered a loss through the recession would have been rated at investment grade. The seven CMBS in the sample were selected in order to cover a range of deal types, regions and vintages, with exposure to assets undergoing varying levels of distress. These include: UK regional offices and industrial (Alburn REC and Epic (Industrious)); a long-dated debt profile on high quality UK assets (Broadgate Financing); a UK multi-loan pool (Cornerstone Titan 2005-1); a Dutch single-borrower retail deal (Leo - Mesdag); and two pan-European multi-loan pools (Quirinus (ELOC 23) and Cornerstone Titan 2007-1).

Feedback on the exposure draft is invited by 14 May.

CMBS

Pay-offs decline further

The percentage of US CMBS loans paying off on their balloon date was 64.6% in March, according to Trepp, marking the fourth straight month in which the rate declined. The March pay-off percentage was also lower than the 12-month moving average of 69.5%.

By loan count as opposed to balance, 64.8% of loans paid off last month. March's rate was a decrease from 74.6% on this basis in February. The 12-month rolling average by loan count is now 70.2%.

Trepp suggests that the decline could be a result of adverse selection from the loans that remained outstanding until maturity. A large percentage of the loans due to mature in March came from the 2004 vintage.

"With interest rates and spreads so low in 2013, it is quite possible that the higher quality loans paid off as soon as they came out of lockout, which could have left the more marginal properties outstanding. Those properties, of course, would have the hardest time refinancing," Trepp explains.

CMBS

Asset sales drive delinquencies lower

US CMBS delinquencies fell sharply again last month as more CWCapital bulk asset sales were booked and delinquency rates for the major property types converged, according to Fitch's latest index results for the sector. CMBS late-pays fell by 27bp in March to 5.16% from 5.43% a month earlier, while just 1.59 percentage points separated the property type with the lowest delinquency rate - retail, at 5.15% - from the highest, industrial at 6.74%.

"This is a stark contrast to over three years ago, when the gap between property type delinquency rates peaked at nearly 16 percentage points. Hotel late-pays topped 21%, while office stood close to its current rate of about 5% in September 2010," the agency notes.

Approximately US$800m in stated balance of CWCapital bulk asset sales in Fitch-rated deals were reported in March, with close to US$700m backed by office properties. Further, the overwhelming majority of the asset sales (US$532m) were from GSMS 2007-GG10.

In total, resolutions of US$1.8bn in March outpaced new additions to the index of US$611m. The largest resolutions last month include: the US$468m Two California Plaza, securitised in GSMS 2007-GG10 (at a US$204m loss); US$159m StratReal Industrial Portfolio II, securitised in JPMCC 2007-LDP10 (US$35m); and US$100m Westin Aruba Resort & Spa, securitised in Wachovia 2006-WHALE 7 (US$35m) (see SCI's CMBS loan events database).

Meanwhile, the largest new delinquency was the US$89.5m Gateway I loan (MSCI 2007-IQ13), which fell 60 days delinquent in March. Fitch-rated new issuance volume of US$2.1bn failed to keep pace with US$4.9bn in portfolio run-off during the month, causing a decrease in the index denominator.

Office delinquencies fell by 69bp, thanks mostly to the Two California Plaza sale. Similarly, industrial improved by 64bp, largely as a result of the StratReal Industrial Portfolio II sale.

The hotel sector improved modestly due to the Westin Aruba Resort & Spa sale, though the improvement was partially offset by the US$54m Sheraton at Newark International Airport loan (JPMCC 2006-CIBC17) falling 60-days delinquent. Multifamily delinquencies were mostly flat month-over-month, while the retail rate was completely unchanged.

Current and previous delinquency rates are: 6.74% for industrial (from 7.38% in February); 6.03% for multifamily (from 6.07%); 5.36% for office (from 6.05%); 5.35% for hotel (from 5.42%); and 5.15% for retail (from 5.15%).

Risk Management

RFC issued on bilateral margining

The European Supervisory Authorities (ESAs) have launched a consultation on draft regulatory technical standards (RTS) outlining risk management procedures for counterparties in non-centrally cleared OTC derivatives, the criteria concerning intra-group exemptions and the definitions of practical and legal impediments under EMIR. The draft RTS prescribe that counterparties apply robust risk mitigation techniques to their bilateral relationships, which will include mandatory exchange of initial and variation margin.

The draft RTS also elaborate on the risk-management procedures for the exchange of collateral and on the procedures concerning intra-group exemptions, including the criteria that identify practical and legal impediments to the prompt transfer of funds. Additionally, they lay down methodologies for determining the appropriate level of margin, the criteria that define liquid high-quality collateral, the list of eligible asset classes, collateral haircuts and concentration limits. The ESAs are proposing not to allow re-hypothecation of collateral collected for initial margin.

The ESAs have launched a public consultation on the draft RTS, with the aim of ensuring that margin requirements are implemented in a proportionate fashion. Comments are invited by 14 July, with a public hearing scheduled for 2 June.

Risk Management

CCP capitalisation rule finalised

The Basel Committee has issued a final standard for calculating regulatory capital for banks' exposures to central counterparties (CCPs), replacing the interim capital requirements that were published in July 2012 (SCI 26 July 2012). The Committee says it has sought to simplify the underlying policy framework and to complement relevant initiatives undertaken by other supervisory bodies, including the CPSS-IOSCO 'Principles for financial market infrastructures'.

The final standard will take effect on 1 January 2017, with the interim requirements continuing to apply until then. Although retaining many of the interim requirements, the final standard also: includes a single approach for calculating capital requirements for a bank's exposure that arises from its contributions to the mutualised default fund of a qualifying CCP (QCCP); employs the standardised approach for counterparty credit risk to measure the hypothetical capital requirement of a CCP; includes an explicit cap on the capital charges applicable to a bank's exposures to a QCCP; specifies the treatment of multi-level client structures, whereby an institution clears its trades through intermediaries linked to a CCP; and incorporates responses to frequently asked questions posed to the Basel Committee in the course of its work on the final standard.

Risk Management

Collateralisation trends highlighted

The estimated amount of collateral in circulation in the non-cleared OTC derivatives market decreased by 14% from US$3.7trn at end-2012 to approximately US$3.17trn by 31 December, according to ISDA's 2014 Margin Survey. Much of this decrease can be attributed to the rise of mandatory central clearing, the association says.

The number of active collateral agreements supporting non-cleared OTC derivatives transactions totalled 133,155 at end-2013, 87% of which are ISDA agreements. Responding firms indicated that 90% of non-cleared OTC derivatives trades were subject to collateral agreements at end-2013.

According to the 2014 Margin Survey, the use of cash and government securities continues to account for roughly 90% of non-cleared OTC derivatives collateral. As in the past, participants indicated that the majority of portfolios they transact consist of fewer than 100 trades.

Eighty-seven percent of non-cleared OTC derivatives collateral agreements relate to such portfolios. Only 0.3% involve portfolios of more than 5,000 trades, as of 31 December 2013.

The 2014 Margin Survey also demonstrates that portfolio reconciliation is widely used and considered a best market practice. Larger-sized portfolios (of 100-499 trades) show a 5% increase in daily reconciliation at end-2013 compared to 2012.

Dodd-Frank and EMIR regulations involving more rigorous and frequent portfolio reconciliation are expected to continue driving this trend. Eighty-four percent of large firms surveyed indicated that they reconcile their portfolio mix on a daily basis.

Of the 61 firms responding to the survey, 87% were banks and broker dealers. The remaining participants consisted of asset managers, hedge funds, insurance companies and others. Participants were based in 20 different countries across three regions: EMEA (52%), the Americas (33%) and Asia (15%).

Risk Management

MTF relief clarified

The US CFTC has issued No-Action Letter 14-46, replacing No-Action Letter 14-16 from 12 February. Subsequent to the issuance of the latter letter, CFTC staff continued to engage in dialogue with the European Commission and the UK Financial Conduct Authority - as well as with facility operators and market participants - concerning certain terms and conditions in the letter.

No-Action Letter 14-16 provided no-action relief for: qualifying MTFs from the SEF registration requirement; parties executing swap transactions on qualifying MTFs from the trade execution mandate; and swap dealers and major swap participants executing swap transactions on qualifying MTFs from certain business conduct requirements. Seeking to build upon the progress achieved to date towards harmonising a regulatory framework for CFTC-regulated SEFs and EU-regulated MTFs, the CFTC issued No-Action Letter 14-46, which generally tracks the conditional relief provided in No-Action Letter 14-16. However, No-Action Letter 14-46 features several notable clarifications, as well as new and amended conditions.

These include: an MTF must report all swap transactions to a Commission-registered or provisionally-registered swap data repository as if it were a SEF, as a condition subsequent to qualifying for relief; an MTF must certify that it is subject to and compliant with regulations that require all MTF participants to consent to the MTF's jurisdiction, thereby enabling the MTF to effectively enforce its rules; qualifying MTFs must submit monthly reports to the CFTC summarising levels of participation and volume by US persons; and clarifications regarding the reporting obligations for counterparties to swap transactions executed on or pursuant to the rules of a qualifying MTF.

Risk Management

Collateral management tool offered

Broadridge Financial Solutions has launched CollateralPro, an enterprise-wide solution designed to help investment banks, asset management firms and service providers transform their regional or global collateral management functions. The offering delivers end-to-end collateral management capabilities, as well as an advanced optimisation module that can assist clients in improving liquidity and profitability via efficient asset allocation. Building on Broadridge's alliance with Lombard Risk (SCI 17 March), the solution is available as a hosted or licensed technology, integrated as a holistic solution with Broadridge or other platforms, or offered as a managed service.

Risk Management

Large exposure controls finalised

The Basel Committee has published a final standard that sets out a supervisory framework for measuring and controlling large exposures, which will take effect from 1 January 2019. The framework is designed to protect banks from significant losses caused by the sudden default of an individual counterparty or a group of connected counterparties.

In cases where the bank's counterparty is another bank, large exposure limits will directly contribute towards the reduction of system-wide contagion risk. In addition, by extending the scope of coverage to exposures to funds, securitisation structures and collective investment undertakings, the framework is expected to help strengthen the oversight and regulation of the shadow banking system.

The standard includes a general limit applied to all of a bank's exposures to a single counterparty, which is set at 25% of a bank's Tier 1 capital. This limit also applies to a bank's exposure to identified groups of connected counterparties.

A tighter limit will apply to exposures between banks that have been designated as global systemically important banks (G-SIBs). This limit has been set at 15% of Tier 1 capital.

The final standard takes into account comments on the Committee's March 2013 proposals (SCI 27 March 2013). The initial proposal has been revised to raise the reporting thresholds to 10% of the eligible capital base from 5%.

Additionally, the treatment of a limited range of credit default swaps (CDS) used as hedges in the trading book has been modified to be more closely aligned with the risk-based capital framework. The initially proposed granularity threshold for exposures to securitisation vehicles has also been replaced with a materiality threshold related to the capital base of the bank (calibrated at 0.25% of the capital base).

The Committee will by 2016 review the appropriateness of setting a large exposure limit for exposures to qualifying central counterparties related to clearing activities, which are currently exempted. It will also review the impact of the large exposures framework on monetary policy implementation.

Risk Management

EBA work plan expanded

The EBA has released an addendum to its work plan for 2014, following a series of calls for advice from the European Commission. The additional work will mostly consist of technical advice on a number of topics related to provisions in the CRR/CRD, informing the Commission in the preparation of reports to the European Parliament and the Council.

The technical advice will mostly build on work already being conducted by the EBA. In particular, it will cover: capital requirements on exposures to transferred credit risk (Article 512 of the CRR); longer-term refinancing operations (Article 161(9) of the CRD); prudential filter for fair value gains and losses arising from an institution's own credit risk related to derivative liabilities (Article 502 of the CRR); implementing acts on third country equivalence decisions (Articles 107(4), 114(7), 115(4), 116(5), 132(3), 142(2) of the CRR); appropriateness of the definition of eligible capital applied for the purposes of the large exposures regime (Article 517 of the CRR); and long-term financing (Article 505 of the CRR).

RMBS

Post-crisis RMBS delinquencies 'near zero'

Delinquency rates on recently issued US RMBS remain near zero nearly four years after the first post-crisis transaction was completed, according to Fitch's new US prime jumbo RMBS monthly trends report. Of the roughly 20,000 loans securitised since the start of 2010, only two loans are currently over 60 days delinquent. When loans that are only one payment behind are included, the total delinquency as a percentage of the remaining loans is only 18bp.

"The exceptionally strong credit performance for post-crisis RMBS reflects the unusually high credit quality and tight loan underwriting of the mortgage pools," explains Grant Bailey, md at Fitch.

Volatile prepayment behaviour has also been a distinguishing characteristic of the recent transactions. After spiking to annualised prepayment rates above 60% in 2012, most transactions are currently prepaying at rates of below 10%.