Contents

CLOs

Equity gap

CLO equity approaches diverging

A two-tier system is emerging within US CLO equity as large investors competitively expand their mandate while smaller players move out of the market. This emerging gap is also manifested in a wave of manager consolidation, as risk retention remains a dominant concern.

"BDCs are providing the most interesting story in the equity market right now," says Oliver Wriedt, co-president at CIFC Asset Management. "The gap between platforms trading at a premium to book versus those trading at a deep discount is widening. Investments in CLO equity have become a particular battleground between the pure-play middle market lenders and the managers pursuing more of a hybrid strategy."

BDCs are confined to a 30% bucket for non-qualifying investments, which includes CLO equity. American Capital has responded by recently launching a new US$450m standalone off-balance sheet fund focused on investments in CLO equity tranches. Approximately US$300m of the American Capital CLO Fund I will purchase the firm's existing CLO equity portfolio, freeing up space for it to add new equity investments to its book.

"You also have Prospect Capital, which has publicly announced that it is looking to shift some of its CLO equity to a new pure-play fund," says Wriedt. The new fund, Prospect Yield Corp, is being used by the investment firm to spin off part of its CLO book through a rights offering. The process is intended to free up capital, enabling Prospect to make fresh investments in CLO equity.

Fair Oaks Capital has also been an active investor this year, through its Fair Oaks Income Fund. Its most recent investment involved an acquisition of US$28m in equity note notional (representing 73% of the total equity) and US$8.6m notional of class F notes of the Alcentra-managed Shackleton 2015-VIII CLO (SCI 25 August).

In contrast, a number of BDCs have recently announced plans to exit the equity market. Following its agreement to acquire TICC Capital, Benefit Street Partners signalled its intent to shift strategy from CLO equity to private debt (SCI 5 August). In addition, THL Credit announced in its Q2 earnings call that it will be exiting its CLO equity positions over time to redeploy capital to senior secured loans, having already sold two CLO equity positions after quarter-end (SCI 12 August).

"A theme we saw in the first half of the year was the drop in equity investment by BDCs," Wriedt adds. "This has now reached the next step where some managers are shedding exposure altogether."

Strategy changes have been communicated through strongly worded messages, exhibiting a firm stance on their planned departures. Management for the BDCs have explained that their CLO equity have lower valuations than other comparable BDCs, thus justifying their attempts to move out of the market. It has also been speculated that the decisions were based more on how BDC investors perceive CLO equity than actual CLO equity performance, viewing the asset as too complex (SCI 12 August).

In TICC's Q2 earnings conference call, the firm's ceo Jonathan Cohen described how 'the market had spoken', and that the response was negative to CLOs as an investment opportunity for BDCs. As BDCs are expected to play a more limited role in CLO formation, smaller CLO platforms are expected to struggle to raise equity capital, while current market dynamics favour larger firms.

"The average small issuer takes around four to six months to get a deal done now in the current market. Deal lead times are getting longer and longer," adds Wreidt.

Outside of the top 20 CLO managers, the ability to complete additional deals is tough. Dodd-Frank risk retention requirements have created a clear divergence between compliant and non-compliant deals, with the 5% retention rule proving too high a hurdle for some managers.

Additionally, the arbitrage is still proving to be challenging for market players. Triple-A and mezzanine bonds have experienced widening, while the wait for loan prices to drop continues.

"Players are waiting to see if loan prices cheapen up," says Wriedt. "Top-tier managers have been able to print triple-As in the mid-140s, but the rest of the market has been forced to accept pricing in the high-150s to low-160s. A 15bp-20bp difference in senior debt liability costs is hard to absorb."

With the industry conference in Miami due later this month, a number of deals are expected to be announced. However, Wriedt believes current circumstances suggest the results may be underwhelming. "The current dynamics suggest a drop in Q4 issuance," he concludes.

JA

CMBS

CMBS loans enter special servicing

The US$61.8m Phoenix Airport Marriott loan has returned to special servicing, having previously gone into special servicing last year (see SCI's CMBS loan events database). The loan is securitised in BACM 2006-3.

The Phoenix Airport Marriott loan has enjoyed improved performance. It is now covering debt service - DSCR NOI is 1.21x in the 12 months to March 2015 - while occupancy has increased to 57%.

However, despite this improved performance, the risk of imminent default is considered to be high. Barclays analysts note that the property has not been renovated since it was built in 1999. There is also an upcoming balloon maturity, although this is more than nine months away.

"Considering that the sponsor has supported the loan even though the property did not cover debt service for five years (2009-2013), and despite the low appraisal, we think a modification is the most likely option, with an extension also likely. For BACM 2006-3, any extension could extend the A4 tranche, while any potential losses or shortfalls would threaten the AJ and first loss B tranche in a deal that has already realised significant losses," the analysts say.

The US$45m Maxtor Campus loan in CSMC 2006-C4 has also moved into special servicing. Seagate Technology, which is the only tenant, intends to vacate at the end of its lease next March.

"Once the lease expires in March, the performance drop-off will be steep as revenue will go from US$7.3m and 1.73x DSCR NOI a year to zero and we would expect the loan to quickly turn delinquent at that point. Once the loan becomes delinquent, an appraisal reduction would likely increase shortfalls, which currently reach the C tranche in CSMC 2006-C4. If the property ultimately becomes REO and is liquidated, the vacant property could generate losses above 50% severity," warn the analysts.

JL

Structured Finance

Trade credit chief hired

Aon Risk Solutions has hired Pieter van Ede as head of business development, global trade credit. Ede's responsibility will be to deliver the firm's strategy and service proposition to global clients, with an area of focus that includes structured trade finance. He will work closely with Stuart Lawson, ceo of Aon Credit International EMEA, and Steve Keogh, chief administrative officer - Americas.

Prior to Aon, Ede was head of global clients at Marsh Trade Credit, where he led the development and execution of their global client strategy. He also directed the firm's global lenders solution group for credit, surety and structured credit.

Structured Finance

Ex-US business head hired

Shaun Curry has joined Prytania Investment Advisors as head of business development. In this role for the specialist structured credit firm, Curry will be responsible for institutional business development across the globe, with the exception of the US.

Prior to joining Prytania, Curry has been senior business development executive at Stenham Asset Management and director of marketing at Gottex Fund Management. Previous to his work on the buy-side, Curry worked in sales and trading at Credit Suisse First Boston, as well as research and sales at Merrill Lynch.

Structured Finance

SF practice recruits trio

Schulte Roth & Zabel has expanded its structured finance practice by adding Boris Ziser and Thomas Weinberger as partners. The law firm has also brought in Stephen Schauder as an associate.

Ziser will co-head the firm's structured finance and derivatives group, with his experience ranging across ABS, warehouse facilities, secured financings and commercial paper conduits. His practice encompasses a variety of asset classes, including life settlements, equipment leases, loans and cell towers.

Weinberger focuses his practice on ABS and corporate finance, with an emphasis on insurance and risk-linked securities and specialty finance companies. His expertise extends to life settlements, reserve funding transactions, premium finance, marketplace lending and other non-bank finance products.

CDO

Dock Street steps in for CDO

Dock Street Capital Management is taking over as collateral manager for Kleros Preferred Funding. Vertical Capital gave notice of its intention to stand down as collateral manager in the summer (SCI 12 June).

Moody's says there will be no impact on ratings. For other recent CDO manager transfers, see SCI's CDO manager transfer database.

CLOs

TICC terms revised

TICC Capital has revised the terms over its agreed acquisition by Benefit Street Partners (BSP). The revisions include a permanent annual base management fee reduction to 1.5% from 2%, as well as a commitment by various members and affiliates of BSP and TICC Management to purchase a minimum of US$20m of TICC's common stock within twelve months following entry into the agreement.

BSP previously announced that it intends to transition TICC's investment strategy from syndicated loans and CLO investment vehicles to primarily focus on private debt investments (SCI 5 August). The most recent revisions are the result of a review undertaken by a special committee of TICC's board of directors and was concluded in agreement with BSP.

Steve Novak, chairman of both TICC's audit committee and special committee says: "The change will have an immediate and ongoing benefit to our distributable earnings and dividends. It is worth noting that the permanent reduction in the annual base management fee will provide the company with an immediate and substantial benefit on a net present value basis."

CLOs

CLO co-head appointed

Natixis has appointed Alex Zilberman as co-head of US CLOs and structured credit in its global structured credit and solutions (GSCS) Americas operations. He will jointly manage the group alongside Mike Hopson, with both reporting to deputy head of GSCS Americas, Hank Sandlass.

Zilberman will focus on increasing Natixis' presence in the CLO broadly syndicated loan market. His experience ranges across CLO origination, advisory and structured credit sales, most recently in a number of roles at Credit Suisse.

CMBS

Real estate legal pro tapped

Allen & Overy has appointed Lucy Oddy to its real estate finance group. Joining from Latham & Watkins, Oddy is a structured finance specialist who advises on a broad range of transactions, with a particular focus on CMBS and RMBS.

Oddy's clients include financial institutions, funds and private equity firms. She focuses on employing new funding structures for real estate assets across Europe, as well as searching for value in distressed legacy structured finance transactions and loan portfolios.

CMBS

Servicer integration announced

Värde Partners has acquired Trimont Real Estate Advisors as it plans to integrate operations between Trimont and subsidiary FirstCity Financial (FCSC). Värde will create a new Dallas office for Trimont as part of the process, and will retain the brand name for the acquired firm.

Under the agreement, Värde will be majority owners while Trimont will hold a minority investment in the new entity, paving the way for Värde to take over the US$85bn of client capital under management at Trimont. The integration will incorporate Trimont's financial services in real estate, including asset management, asset servicing, construction loan administration and services, and underwriting.

The consolidation of FCSC's servicing portfolio and employees into the new Trimont entity is expected to occur over the next six to nine months, according to Fitch. The agency has subsequently withdrawn its special servicer ratings for FCSC but does not expect this to impact Trimont's primary or special servicer ratings.

Trimont principal Greg Winchester and founding partners John Charles and Ernie Davis have agreed to stay with Trimont through a transition period and will be meaningful shareholders in the company. Financial terms of the deal have not been disclosed.

Insurance-linked securities

CATCo assets sold

Markel is set to acquire CATCo Investment Management's assets in a deal that is expected to close in 4Q15. The new business will operate under the name Markel CATCo Investment Management and will see the transition of the existing CATCo management team, led by ceo Tony Belisle, into commensurate roles for the new firm.

The management team will operate the business from CATCo's current Bermuda headquarters, under Markel's ownership. The completion of the deal will combine Markel's traditional reinsurance capabilities with CATCo's focus on ILS.

Insurance-linked securities

Non-cat ILS vehicle launched

Vario Partners and Guy Carpenter have teamed up to form a new ILS investment vehicle and fund that focuses on non-catastrophe products. Vario Global Capital has been established to serve long-term investor interest specifically in the insurance risks of property and casualty insurers.

The joint venture will function on a combination of Vario Partner's portfolio modelling technology and analytical expertise and Guy Caprenter's strategic advisory and global reinsurance capabilities. For insurers, Vario Global Capital will provide consistent access to capital markets funding for non-cat risk portfolios through single class, multi-class and whole account transactions, with the intention of raising its own dedicated fund over time to directly participate in such arrangements.

"Our strength lies in a new, proprietary modelling approach which allows us to structure and analyse non-peak risks, and even whole insurance portfolios, to deliver reliable return projections for investors," says James McPherson, founding partner for Vario and director of Vario Global Capital. "The technology opens an entirely new area of insurance risk to institutional investment."

Insurance-linked securities

UK insurer set to be sold

Mitsui Sumitomo Insurance is set to acquire Amlin for approximately £3.47m. As part of the agreement, MSI will also gain the 75% stake that Amlin has in ILS manager Leadenhall Capital Partners.

Under the terms of the agreement, Amlin shareholders will be entitled to receive 670 pence per Amlin share, which is a 36% premium over yesterday's closing price. Amlin shareholders will additionally be entitled to receive a previously announced interim dividend of 8.4 pence per Amlin Share. MSI's offer represents a multiple of 2.4x to Amlin's net tangible book value per share as of 30 June.

The proposed acquisition is conditional on the Amlin shareholders' approval, as well as their passing of the proposed resolutions at a general meeting. Amlin's directors view MSI's proposal as 'fair and reasonable', and intend to recommend that its shareholders vote in favour of the deal.

Insurance-linked securities

Reinsurer hires for ILS push

Sequant Re has hired Victor Baillargeon as chief underwriting officer. He is tasked with leading the development of the firm's underwriting strategies as the company pushes to provide greater access for investors to ILS.

Baillargeon's expertise includes the casualty and specialty lines of business. The company plans to use his presence as a support for its strategy of building customised and diversified ILS portfolios to meet increasing interest in reinsurance.

RMBS

Traders charged with RMBS fraud

The SEC has charged three traders over lying to customers with regard to pricing information on RMBS. Ross Shapiro, Michael Gramins and Tyler Peters allegedly generated millions of dollars in additional revenue for former employer Nomura Securities as a result of their supposed misconduct.

The charges say that the three traders misrepresented the bids and offers being provided to Nomura for RMBS as well as the prices at which Nomura bought and sold RMBS and the spreads that the firm earned intermediating RMBS trades. In addition, the traders are accused of creating a "corrupt culture" within the firm's trading desk arena by training, coaching and directing junior traders to engage in the same misconduct.

The SEC says that customers sought and relied on market price information from these traders due to difficulties in obtaining accurate price information in the related RMBS market. In this respect, the regulator stresses that there was added importance in the responsibility of the traders to act honestly. However, Shapiro, Gramins and Peters allegedly went so far as to invent phantom third-party sellers and fictional offers when Nomura already owned the bonds the traders were pretending to obtain for potential buyers.

SEC figures state that an additional US$5m was generated for Nomura on the back of the lies and omissions. This is on top of an additional US$2m in profits produced by the subordinate traders.

Nomura's determination for bonuses for Shapiro, Gramins and Peters included, among several factors, revenue generation. The firm paid total compensation of US$13.3m to Shapiro, US$5.8m to Gramins and US$2.9m to Peters during the years that misconduct was supposedly occuring.

In a parallel action, the US Attorney's Office for the District of Connecticut announced criminal charges against the three traders. The SEC also separately entered into deferred prosecution agreements with three other individuals who have extensively cooperated with its investigation and provided enforcement staff with access to critical evidence that otherwise would not have been available. The investigation remains ongoing.

ABS

Aussie auto loss rise anticipated

Fitch expects Australian auto portfolio losses to increase over coming quarters as rising unemployment and delinquencies converge by year end. This follows higher recorded auto arrears in 2Q15, with 60 plus days and 30 plus days arrears reaching 0.56% and 1.34% respectively - an increase of 7bp and 9bp over the quarter.

The annualised loss rate remained almost unchanged at 0.6% though, which is 2bp above 1Q15 levels and in contrast to what has been seen historically. During the past five years, delinquency rates in the second quarter have been similar to that of the first quarter while the net loss rate has been higher, specifically, by 8bp on average. Fitch believes that a lengthening of repossession timing is a key factor for higher arrears.

The agency has also noticed a reduction in recoveries during 2Q15, with the average recovery rate at 39.2% - down from the average of 44.9% in the past five years. However, Fitch notes that the fall in recoveries was specific to a few well-seasoned transactions, as transactions issued in 2015 are performing with above-average recovery rates.

Higher losses and repossessions are expected in 3Q15, due to arrears increasing and losses not yet materialising. Moreover, as the agency expects unemployment to reach 6.6% by the end of 2015, higher delinquency rates and losses could follow throughout the rest of the year, going into 2016.

Fitch-rated auto ABS issuance was modest at A$0.9bn in 2Q15, down from the record-high of A$2.05bn in 1Q15.

ABS

UK card ABS remains strong

The collateral performance of UK credit card ABS has remained strong in 1H15, according to S&P. A favourable UK macroeconomic environment has resulted in low delinquencies and charge-offs, while payment and yield rates have been fairly steady from quarter to quarter.

Charge-off rates were fairly low and stable at 3.03% at the end of 1Q15 and 3.04% at the end of 2Q15 - compared with 3.16% at the end of 4Q14. S&P expects UK credit card receivables' performance to remain strong, given the agency's forecast of modest economic growth, lower unemployment and rising real wages over the coming years.

S&P rated two new issuances from the Penarth Master Issuer (series 2015-1 and 2015-2) and affirmed the outstanding issuances from the trust as part of its surveillance process in the first half of this year. One new issuance from the Delamare Cards MTN Issuer PLC (series 2015-1) was also rated, with the agency simultaneously affirming its ratings on the outstanding issuances from the trust.

ABS

Mobile carriers tapping into ABS

US mobile carriers are boosting their liquidity by tapping into account receivable securitisation to finance equipment instalment plans, reports Moody's. The agency notes that these facilities bolster the reported results of mobile carriers because the cash proceeds from the securitised receivables are reported as operating cashflow.

As a result of the net proceeds, AT&T and Verizon both reported higher free cashflow and improved payout ratios in 2Q15. Moody's expects T-Mobile USA to pursue securitisation as well.

Sprint has also used receivable securitisation facilities to finance its capital needs, and has announced high-level plans to create a special-purpose entity for financing device securitisations. Depending on the structure, Moody's suggests that this could improve the company's credit profile.

However, the agency warns that these securitisations, as a form of secured debt, can increase a company's leverage and affect credit metrics. Moody's says that receivable securitisation accelerates future period cashflows into the current period, creating a future headwind because the receivables sold are no longer recognised in reported results.

ABS

Marketplace lending ABS on the up

US marketplace lenders are increasingly looking at ABS as a viable funding source, according to Fitch. Nonetheless, key challenges need to be addressed before the product moves into the mainstream.

Fitch says the rising popularity of marketplace lending among consumers and small businesses is due to the ability of marketplace lenders to connect with their customers directly. Borrowers in turn find the ease of use and bypassing traditional banks appealing. Cost savings are passed on to borrowers via lower interest rates as these platforms benefit from more efficient online operations and fewer regulatory burdens.

That said, the industry lacks an extensive track record. "Credit performance so far has been stable across most marketplace lending platforms, though it has yet to be tested through a full economic cycle," says Fitch senior director Tracy Wan. "The rapid growth of marketplace lending is also drawing increasing attention and scrutiny from various regulators like the CFPB."

Non-balance sheet marketplace lenders in particular face more regulatory uncertainty due to the concern of 'true lender' status. Further, the recent ruling with Midland Funding (SCI 21 July) also highlights the risk that exemption of usury laws may be challenged when accounts change hands.

ABS

Madden impact put to test

The recent Madden Ruling by the US Court of Appeals for the Second Circuit could have a limited, but negative, credit impact on Moody's-rated securitisations backed by bank-originated consumer marketplace lending loans. The ruling holds that non-bank debt collectors that purchase written-off credit card accounts from a bank cannot benefit from the bank's federal pre-emption of state usury laws (SCI 21 July).

The ruling applies to the states of New York, Connecticut and Vermont, which Moody's states as a credit negative. However, if the courts in these states were to apply the reasoning of the case to consumer marketplace loans, the agency says that the marketplace loan securitisations it rates would have credit enhancement in excess of the loan losses.

Moody's rates two securitisations of unsecured consumer instalment loans originated by a bank through an online marketplace lending platform - Consumer Credit Origination Loan Trust 2015-1 (CCOLT) and Citi Held for Asset Issuance 2015-PM1 (CHAI). Both transactions are backed by loans originated through the Prosper platform by WebBank, a state-chartered bank located in Utah. Both pools represented roughly pro-rata slices of recent Prosper originations.

In a scenario where the pools of these transactions violated usury laws, approximately 3.2% of the loans in the CHAI pool and a similar proportion of the CCOLT pool would be uncollectable. All CCOLT notes, including the most junior ones, benefit from 5% overcollateralisation (OC) at closing, increasing to a target OC of 15% through build-up via excess spread.

Meanwhile, the CHAI notes benefit from 10.5% OC at closing, increasing to a target of 15.5% through build-up via excess spread. As a result, Moody's notes that the OC would shield the loans from being made void or enforceable during an application of the Madden ruling.

Moody's cautions that the assumptions are made only on the Madden ruling affecting loans originated by borrowers in the three affected states, but courts in other states could make similar future rulings. Nonetheless, the senior notes' credit enhancement from the two deals and a very short WAL of approximately only 0.7 years should mitigate exposure to the Madden risk.

Structured Finance

New lender challenges surveyed

A new survey by the University of Edinburgh Business School has found that 75% of experts believe alternative lenders pose a threat to banks and traditional lenders. The survey covered 200 delegates from 40 countries, with 19% describing the entrance of alternative lenders as a 'big threat'.

Nonetheless, a majority of the respondents welcome the challenge, as 55% say that the entrance of alternative lenders will make the market for finance more competitive. Meanwhile, 53% also believed alternative lending models are likely to increase access to finance in the next five years.

The survey revealed a fear over the risk of new lender models, with 73% responding that there are dangers to how lenders are deciding who to lend to and how much to lend. In addition, 26% state that alternative lenders are relaxing controls on lending too much, and the same proportion felt these companies could be circumventing regulations in order to operate. One in five (20%) also believe that the newer lenders may be more open to fraud.

The respondents were broadly optimistic about the impact of the new breed of challenger brands for consumers and small businesses, with nearly half (48%) believing credit will become more available in the country they live in during the next six months. However, nearly three quarters of respondents (73%) believed financial stability can be improved by keeping lending criteria as they are, or tightening controls.

"In a market where a small difference to an interest rate can make all the difference in attracting a good customer's business, banks that don't push ahead with technological advancements in the way that newer challengers are could really begin to suffer," adds Jonathan Crook, director of credit research at the University of Edinburgh Business School.

Structured Finance

SME lending deal boosted

Prospa has brought to the market the first Australian securitisation of unsecured, online business loans. The firm secured A$60m in capital as proceeds to help both fund the loans to Australian SMEs and support Prospa's expansion in the local financial technology market, making it the largest capital raising to date by an Australian online lender.

The co-investment is led by Carlyle Group, which contributed A$50m. Ironbridge Capital, Entrée Capital, Airtree Ventures and private investor David Fite were the other contributors.

Structured Finance

Revolving deal sets China precedent

Revolving structures can help Chinese banks securitise SME loans because they resolve the mismatch between the short tenor of the underlying loans and the long-term maturity of the securitisation scheme, says Moody's. The agency believes that the recent launch of the first securitisation with such a structure in the interbank bond market may have set a precedent for future transactions to follow.

The Bank of Ningbo's credit card ABS deal integrates a structure that adds new loans to the securitisation pool to replace those that mature. The deal closed in July and is structured through a senior tranche (rated triple-A), a mezzanine tranche (single-A) and a subordinate tranche (unrated), all ratings of which were issued by local rating agencies. The underlying loan pool comprises of 34,130 consumer loan contracts, each of which does not exceed CNY500,000. 

"Prior to the Bank of Ningbo's deal, uncertainty had persisted in China on whether deals with revolving structures could qualify for off-balance sheet accounting treatment," says Jerome Cheng, Moody's svp.

Shifting assets off their balance sheets allows banks that are governed by regulatory capital adequacy requirements to hold less capital, meaning that they can invest any capital that is released to improve the potential returns on assets. A combination of this key consideration and the aforementioned uncertainty surrounding off-balance qualifying prevented banks from previously issuing SME securitisations with revolving structures.

In comparison, Moody's explains specialist non-bank SME lenders view securitisation primarily as a source of funding, rather than as a means of shifting assets off their balance sheets. Therefore questions over off-balance sheet accounting treatment did not prevent them from using revolving structures, making way for deals such as the Alibaba Group's Ant Micro Loan.

Regulatory framework differences have also been an impediment to bank sponsored SME securitisation, however current lending to this area of the market accounts for about 30% of all corporate lending by Chinese banks, with an expectation to rise. The Chinese Banking Regulatory Commission (CBRC) has given a clear policy directive to banks to boost lending to SMEs and micro-enterprises. To fund these loans, both the CBRC and the State Council have raised the need for SME securitisation.

In addition, securitising SME loans could be potentially attractive for banks because of the typically higher interest rates on these loans, adding incentive for further issuance. Moody's notes that higher rates increase the prospects for excess spread, thereby improving credit enhancement, which in turn could increase demand from investors and potentially boost the profits of originators.

CDO

CDO settlement 'credit positive'

Taberna Capital Management's recent settlement with the SEC in relation to charges made over its fraudulent management practices of 11 CDOs (SCI 3 September) is credit positive for the transactions, according to Moody's. The agency says that settlement proceeds for the CDOs - which have a par of around US$5.2bn - along with other diverted interest and principal proceeds, will pay down the notes as a result of the transactions' overcollaterlisation (OC) test failures.

Moody's states that all but two of the 11 Taberna CDOs are currently failing their senior OC tests, which requires the deals to divert all available proceeds, including both interest and principal, to pay down the senior notes. Taberna Preferred Funding I and VIII are passing their senior-most OC tests, but failing their mezzanine and junior OC tests, which also requires the diversion of all proceeds to repay the notes.

CMBS

CRE outlook 'tempered'

Moody's is advocating caution for the European CRE sector against the backdrop of a nascent recovery on the continent. The agency warns of potential headwinds in the form of market volatility, interest rate hikes and rising development costs.

Following the rise in CRE activity, Moody's has rated €1.5bn of European CMBS this year so far. "Commercial property companies have also sought ratings, as they want to diversify their funding base and take advantage of current low interest rates being paid on senior unsecured debt," says Daniel Kolter, Moody's md - structured finance.

However, Moody's is taking a tempered, yet cautiously optimistic view on European CRE. The agency says that its stance was echoed by attendees to its recent commercial property briefing, citing market volatility as a main driver behind the general caution.

"Although CMBS deal volume has been higher than in 2014, we find there is uncertainty around issuance levels for the rest of the year owing to capital market volatility, amid developments in the Chinese capital markets and uncertainty around interest rate increases," observes Oliver Moldenhauer, Moody's vp and senior credit officer.

Moody's believes that the broader mix of lenders, the increase in deal volumes and improved market liquidity have changed the game and put the ball in the borrowers' court. However, the liquid lending market is considered by the agency to be supportive of strong European property investment.

"The diversification of the lender base has contributed to this positive trend in liquidity, as non-bank lenders like insurance companies and debt funds have materially increased their market share in CRE loan origination, especially in the UK," adds Moldenhauer. "Recently, most of the loan sponsors in deals have been opportunistic US private equity firms."

RMBS

SFR servicing scarcity underlined

The limited number of special servicers available to administer US single-family rental (SFR) properties in the event that the operator defaults is a risk to SFR securitisations, says Moody's. The limited near-term incentive for other servicers to enter the market presents an added issue.

There are 22 SFR transactions outstanding with two entities, Midland Loan Services and Situs Holdings, assigned to specially service the loans that fall into default. The servicers take care of 11 transactions each.

Although the two servicers' experience in CMBS provides them with a solid platform to manage SFR transaction defaults, Moody's believes that their ability to manage volumes could become stretched if concurrent operator defaults require them to work out many loans backed by a high number of properties at once. As a result, the ability of the servicer to produce the highest possible recoveries on defaulted loans would be strained.

In addition, Moody's notes that the potential financial issues that the servicers may face could make them unavailable to service SFR securitisations, thus putting the transactions at greater risk. Of the two entities, Midland has more solid financial grounding due to the backing of a strong financial partner in PNC Bank.

As long as the housing market outlook is stable though, the existing special servicing fee structure discourages other entities from entering the special servicing market. Under the current fee structure, special servicers get paid only when loans become distressed or default.

Furhter disincentivising factors include potential costs and investments outweighing the profit that coincides with servicing SFR deals, while SFR defaults are also unlikey to default in the near term due to strong rental growth. Servicers may also be wary that a potential downside on CMBS could affect capacity constraints, if they did indeed choose to work in both markets.

RMBS

Dutch RMBS delinquencies drop

The Dutch RMBS market saw a continued decrease in delinquencies but a modest increase in cumulative defaults during a three-month period ending in June, says Moody's. The 60-plus day delinquencies of Dutch RMBS fell to 0.81% in June from 0.85% in March, while defaults moved up to 0.76% from 0.65% in the same time - in comparison to 0.43% in June 2014.

In addition, 90-plus day delinquencies also continued to decrease in the market, moving down to 0.62% in June from 0.66% in March. However, cumulative losses made a slight increase to 0.15% from 0.13%.

Moody's has assigned definitive credit ratings to two new transactions since 20 May, including one class of notes issued by Orange Lion 2015-11 RMBS and one class of notes issued by Orange Lion XII RMBS. The agency has also upgraded the ratings on five classes of notes and affirmed the ratings on five classes of notes issued by two Dutch RMBS transactions - Lowland Mortgage Backed Securities 1 and Green Lion I.

Moody's adds that an increase in housing market activity should boost the Dutch housing market's recovery and raise recovery prospects in RMBS deals. As of the end of June, the 113 Moody's-rated Dutch RMBS transactions had an outstanding pool balance of €218.9bn, representing a year-over-year decrease of 5.3%.

RMBS

MBS guide rules updated

Ginnie Mae has made a number of updates to its issuer business status criteria in its MBS guide. The GSE says that the changes are in response to recent changes in the economic and regulatory environments, as well as an increase in the volume and complexity of issuer requests for approval of certain changes.

Among the changes made, the required five days written notice that issuers must provide to supervisory or regulatory agencies - in the event of a change to their relationship with the agency - has been extended to include banking agencies too. Additionally, notification of a potential merger has been extended from 30 days to 60 days for approved issuers, while non-approved issuers have been granted a 90-day mandate.

The GSE also previously defined 'change in ownership or control' as a change in ownership of 20% or more of the stock or other ownership interest in the issuer or an issuer's guarantor. In the event of a change in ownership, the issuer must now provide 30 days written notice. Issuer notice for a plan execution of a transfer of assets has also been given the same time for a written notice requirement.

Ginnie Mae says its has worked to streamline the documentation process, which should help mitigate any added time consumption or pressures that have resulted from the new guidelines.

RMBS

Rates masking RMBS risk

Moody's suggests that low interest rates are currently masking key drivers of Australian mortgage defaults. The agency notes that mortgages used for investment purposes and interest-only (IO) repayments will remain key drivers of future defaults, despite their strong performance in the current prolonged low rate environment.

The default rate of investor and IO loans is currently lower than that of owner-occupied principal and interest loans - a reversal of the historic trend. However, Moody's states that investor and IO loan performance remains more volatile and dependent on interest rate levels than their counterparts.

"Investor and IO loans will therefore continue to act as default drivers in  RMBS pools over the longer term, despite their current outstanding performance," says John Paul Truijens, Moody's avp and analyst.

The agency believes the current performance of investor and IO loans is also increasing risk, as it has prompted an increased volume of origination over the last few years. The outperformance of these loans in comparison to the more benchmark loans began in 2012 and improved into 2014, coinciding with the beginning of rate cuts made by the Reserve Bank of Australia towards the end of 2011.