Contents

Structured Finance

Capital clarity

CMU securitisation package receives market approval

The release of the European Commission's Capital Market Union (CMU) action plan has been hailed for reducing capital requirements and outlining a succinct and centralised definition for simple, transparent and standardised (STS) securitisation. However, key concerns remain over Solvency 2 capital recalibrations.

The action plan introduces amendments to the Capital Requirements Regulation and a new overall securitisation legislation. The latter outlines a clear set of criteria for identifying STS transactions, which are broken down into two separate groups and include a number of attributes from previous legislative proposals. Among the main proposals are a minimum 5% originator loan retention rule and a requirement to package assets homogenously (SCI 30 September).

"The presentation of the legislation is very well done and it helps put clarity to a number of definitional issues before," says Rob Ford, portfolio manager and partner at TwentyFour Asset Management. "There may naturally have to be some tweaks along the way, but it is nice to see that the criteria has been shortened down somewhat and simplified to a number of key points."

In particular, Ford notes that the Commission's pull-back on an overload of transparency criteria is a positive development. "Transparency had to be cut down because it had been pushed to an extreme. For example, the type of loan level data you would have to provide for a credit card ABS transaction was just not viable."

Another area that has witnessed a major change is due diligence, where requirements have been lowered for investors. In particular, the responsibility of asserting compliance with risk retention requirements is now firmly on the originator of a transaction.

However, Ford explains that the guidelines provide too much detail. "An investor is happy to perform their duty of due diligence and should not have to be told everything they must do," he says. "We already have internal checks within the institutions we work in, so holding the hand of the investor throughout the whole process is really unnecessary."

He continues: "When an investor can instead go buy into equity or a government bond without having to follow this much detail, there becomes the risk that new investors will be put off from the red tape involved in securitisation."

CLOs have also been granted relief from originator risk retention obligations under the current regime, allowing the approach used by many CLO issuers to remain. However, the originator definition now includes a 'purpose test', in which an originator will not be considered as such if the entity it is linked to is 'established or operates for the sole purpose of securitising exposures'. Ashurst describes the additional test as an improvement on the definition standards, explaining that the test ensures that securitising exposures should be construed to include any activity relating to purchasing or originating loans and then selling them to a securitisation SPV.

The law firm notes that the next stage in the process is for clarification to be given on deals with multiple issuers or sponsors. It also expects the Commission to apply its terminology for originators to specific jurisdictions.

The second part of the Commission's action plan is its amendments to the Capital Requirements Regulation (CRR). As anticipated, the Commission proposes to introduce a lower risk floor for STS securitisation at a 10% risk weight. The risk floor for other securitisations remains 15%, which is line with the Basel Committee's guidelines.

The risk weights under the external ratings-based approach have also been adjusted for STS securitisations. One-year tranches will have a 10% risk weight, whereas the risk weight for five-year tranches is set at 15%.

JPMorgan European ABS analysts note that the proposals lead to increased risk weights and capital charges for securitisation investments compared to the current treatment under the CRR in Basel 2, as well as a commensurate fall in return on capital for banks. However, they suggest that investment in the securitisation markets remains economically viable current spread levels - particularly towards the top of the capital stack.

"We believe that while yesterday's proposals are unlikely to unleash a wave of additional bank investor demand, they go some way to support and further encourage long-term participation in the securitisation markets by European banks," the JPMorgan analysts note.

There is also a bid to boost SME securitisations through capital recalibration, with lower risk weights proposed for senior tranches. Rabobank securitisation analysts note that this is subject to mezzanine tranches being guaranteed by specific third parties. An implementation date has not yet been mentioned for the amendment, but the new Basel framework for securitisation foresees implementation by 2018.

AFME welcomes the Commission's plan as a "key building block" for securitisation. However, the association's ceo Simon Lewis believes that EU legislators must move forward as soon as possible with capital recalibrations for securitisation under Solvency 2, which he describes as a remaining area of "complexity and uncertainty".

The Commission is expected to wait until official implementation of the STS framework before providing a recalibration outline for Solvency 2 capital charges for securitisation holdings. "It would have been nice for institutions to have been given a scale as to the Commission's plans, because it would have given them the opportunity to anticipate and plan around this," says Ford.

The Rabobank analysts suggest that recalibration of non-senior STS tranches could result in lower capital charges for insurers, as a look-through approach is likely to be applied. Technical calibrations for senior STS tranches are also anticipated.

"However, the reality is that there will likely be more consultations as the current draft goes through the European Council and Parliament," Ford concludes. "Insurance firms may have to start paying higher capital charges when January comes. Consequently, they may just choose to start selling off their portfolios before the market simmers down in December."

JA

Secondary markets

Euro secondary stays thin

Liquidity remains thin in the European securitisation secondary market.

Last week ended as anticipated with many players staying on the sidelines as a selling bias prevailed and bid-offers moved ever wider. Even flows in CLOs diminished as the relatively hectic BWIC schedule saw a flurry of DNTs. Overall, away from prime assets, secondary spreads have edged out further.

Today currently sees three European BWICs on the schedule. First up at 10:00 London time is a slice of VW paper in the form of €25m DRVON 13 A, which last covered on PriceABS at 100.053 on 22 July.

Then, at 14:00 are three large blocks of CLO triple-As - €105m ALME 2013-1X A-1, €45m AVOCA 13X A2 and €45m DRYD 2014-32X A1AV. None of the bonds has covered on PriceABS in the past three months.

At 15:00 is a two line CMBS list - £5.5m ECLIP 2006-4 B and £2.25m ECLIP 2006-4 C. Only ECLIP 2006-4 B has covered on PriceABS in the past three months - at 95.59 on 21 July.

Secondary markets

US CLOs put to the test

Continuing seller-heavy activity is testing the US CLO secondary market.

"We're approaching month- and quarter-end so the flurry of lists of the past few days is continuing," says one trader. "Broad market volatility is of course a factor, but it's more about sellers testing the market and re-pricing risk."

The trader continues: "A lot of the lists circulating today are concentrated down in mezz - triple- and double-Bs. That's where there's been the most differentiation in bonds depending on the sectors involved - in triple-Bs there's a 50bp gap for those deals with higher energy exposure and in double-Bs the range is even wider."

There are also a few line items from either end of the capital structure due today. "There are some equity pieces today too and they could be interesting as we've seen very little equity actually change hands lately thanks to the same pressures the mezz is suffering from," says the trader. "Hopefully, today's large number of lists will provide some price discovery for the CLO market overall."

There are currently seven US CLO BWICs on the schedule for today. The chunkiest auction comes at 11:00 New York time and involves seven 2.0 triple-B tranches.

The $32.5m list comprises: ALLEG 2013-1A C, AMMC 2013-13A B1L, CIFC 2014-2A B1L, CRMN 2015-1A D, HLDN 2013-1A D, KKR 2013-1A C and TICP 2014-1A C. Two of the bonds have covered on PriceABS in the last three months - ALLEG 2013-1A C at 94.877 on 6 August and CRMN 2015-1A D at M90s on 8 July.

Meanwhile, the trader highlights a Trups CDO on the schedule for tomorrow. "The Trups sector can always do with extra data points, but particularly now as it has followed the traditional pattern of being less active when macro volatility is high. Sure, there have been some REIT Trups lists lately, but tomorrow's large block auction of bank front pays will be watched closely."

The three line BWIC is due at 14:00 tomorrow and consists of: $35.51m ALESC 9A A1, $21.809m ALESC 16A A and $16.95m PRETSL 25 A1. None of the bonds has traded on PriceABS in the last three months.

Secondary markets

Euro secondary weakens

The European securitisation secondary market has weakened further on the back of broader market sell-offs and continuing VW concerns.

"Equity and credit markets are weaker and so are we," says one trader. "In particular the weakness in VW ABS has filtered through into the whole of the low beta space and with that weak it's extremely difficult to get anything done."

Consequently liquidity remains very thin and secondary spreads have widened across the board. However, a small number of auto ABS buyers for selected names are emerging this morning.

There are currently four BWICs on the European calendar for today. They involve a two piece MANSD 06-1X residual list, a mixed bag of small clips, five lines of euro CLOs as part of a larger auction also including US CLOs and the largest visible auction so far due at 15:00 London time.

The latter, a 32.65m six line combination of sterling and euro RMBS, comprises: AZOR 1 B, IMPAS 4 A, MAGEL 4 A, MPS 4X A1A, PAST 3 C and UCI 17 B. None of the bonds has covered with a price on PriceABS in the past three months.

Secondary markets

US CLOs still searching

Amid broader market volatility and commodity concerns the US CLO secondary market is still searching for some price transparency.

"There's a lot of focus on deals with a lot of commodity exposure for obvious reasons," says one trader. "Consequently buyers are shying away from CLOs with metals and mining exposure, but stuff without appears to be trading fairly realistically."

As the same time, yesterday's hoped for greater pricing clarity was masked by a large number of DNTs and line items where no colour was released. However, the trader is more optimistic for today: "We should get greater pricing transparency as a couple of the sellers today historically have always provided good colour."

There are six US CLO lists on today's BWIC calendar so far. Of those that remain, the largest is a six line collection of triple-As due at 13:00 New York time.

The $50.25m list consists of: AIMCO 2014-AA A, CGMS 2012-4A A, DRSLF 2013-26A A, DRSLF 2014-33A A, INGIM 2013-2A A1 and SHSQR 2013-1A A1. Two of the bonds have covered with a price on PriceABS in the last three months - AIMCO 2014-AA A at 99.811 on 20 August and DRSLF 2014-33A A at H99H on 11 September.

Secondary markets

Euro secondary drifts

European securitisation secondary spreads are continuing to drift wider.

"Yesterday was very quiet and today looks to be the same," says one trader. "Clients are definitely sidelined as market sentiment weakens."

The trader continues: "There are a number of factors impacting sentiment both internal and external to ABS - there's the broader macro picture obviously, combined with our US equivalent markets selling off to an extent and the VW story continues to play a big role. At the same time, it's month- and quarter end, which both typically reduce activity. Consequently, we're drifting wider across the board."

There are two BWICs on the European calendar for today so far. At 10:00 London time is a two line €7.4m CLO auction involving HARVT IV D1 and WODST V-X D. Then, at 14:00 there is three line £6.75m ABS and CMBS list - GNKLN 0 06/15/31, MABLN 0 12/15/33 and TELSEC C1 09/10/31.

None of the bonds in for the bid today has traded on PriceABS in the last three months.

Secondary markets

US CLOs stay tough

Times are still tough in the US CLO secondary market.

"The focus has primarily been on double- and triple-Bs, but even there liquidity has been very thin," says one trader. "In particular, it's been really tough for double-Bs across 2.0, but 1.0s have held up relatively well."

Nevertheless, the trader adds: "Overall, we're wider across the board in double- and triple-Bs, but the bifurcation of the higher commodity holding deals continues. At the same time, pricing colour remains very limited."

The top of the stack is attracting attention as well. "Everyone's also looking to see where triple-As are going but again there's little price transparency," says the trader. "Yesterday's triple-A BWIC was difficult as it involved some non-Volcker deals, but overall they look to be 7-8bp wider than the start of September."

The end of the month is making for a quieter day in terms of supply, but the trader suggests there could be more to it. "The full impact of quarter-end, which always brings its own issues, remains to be seen - so far a few lists have been moved around, but we're not seeing any forced selling yet."

There is currently now only one US CLO BWIC due today. "It's a nice list of triple-Bs, but they're going to be 50-75bp from where the seller priced them, so expect price talk to be wider across the board," says the trader.

The six line $34.914m triple-B list is due at 13:00 New York time and comprises: ATCLO 2014-1A D, BSP 2014-IVA C, CIFC 2014-2A B1L, OCT20 2014-1A D, SNDPT 2013-3A D and TICP 2014-2A C. only TICP 2014-2A C has covered with a price on PriceABS in the past three months, last doing so at MH92H on 25 September.

Secondary markets

Euro secondary improves

Tone in the European securitisation secondary market is improving in line with broader market sentiment, but activity remains limited away from VW.

"Yesterday was very quiet again, but that is typical of quarter-end," says one trader. "However we did start to see bids back in VW ABS and it had stabilised at its wides by the close. This morning it has improved further and euro VW paper is now being quoted in the 60area - around 20 points tighter - so ABS is following the same path as the corporates."

Elsewhere in ABS/MBS activity remains patchy and in small size leaving spreads unchanged. In CLOs, the trader adds: "We saw a few trades yesterday at close to recent wides, but the market isn't moving a great deal as many people are still hanging back waiting for new issues to come through."

There are currently four BWICs on the European calendar for today. All involve either CLOs or CMBS.

At 14:00 London time there is a €12m line of EUROC V-X SUB. The bond hasn't covered on PriceABS in the past three months.

At 14:30 there is a six line mixed CLO and CMBS list - €1.5m BACCH 2007-1 B, €37.85m ECLIP 2007-2X A, €1m HARVT III-X B, €1m NWEST III-X C, €7.64+m UTREF 1X A and €55.5m WINDM X-X A. Two of the bonds have covered on PriceABS in the past three months - ECLIP 2007-2X A at 98.17 on 10July and HARVT III-X B also at 98.17 on 18 September.

Then at 15:00 there is a single £10m line of DECO 8-C2X A2. The bond hasn't covered with a price on PriceABS in the last three months.

Also at 15:00 there is an eight line €35.1m 1.0 CLO mezz list comprising: ALPST 1 D, DALRA 4-X C, DALRA 4-X D, DUCHS VII-X C, ELEXA 2006-1X C, HARBM 9X A2, LEOP V-X C1 and NWEST III-X C. None of the bonds has covered with a price on PriceABS in the past three months.

Secondary markets

US RMBS cautious

Caution is prevailing in the US non-agency RMBS secondary market.

"It's been a very quiet week with only about $800m in for the bid in total so far, which is highly surprising for quarter-end," says one trader. "The low volume is leading people to question whether paper is trading in significant volume privately, but I think it's just players being cautious in the current environment."

The trader continues: "Accounts are distracted by other structured products widening and the fear that those moves are the canary in the coal mine and there will be worse to come for sectors such as ours. As a result, no one is looking to add, but at the same time RMBS hasn't been hit as hard, so people are willing to hold for now; hence the lack of trading."

There are however still notable lists emerging, the trader notes. "Today's highlight is a re-REMIC list that was due at 10:30. It only amounted to $21m current face, but given the widespread involvement in such bonds it's being watched closely - talk was a bit lower than we've seen in the past and if colour is released it will be used as a benchmark."

Overall, the trader says: "We're 25-50bp wider than a month ago, which isn't major, but if prices keep heading this way we will start to see opportunistic buying once bonds get cheap enough. But for now people don't want to do anything."

ABS

FFELP reform to affect payments

The CFPB, US Department of Education and Department of the Treasury have issued a joint statement on student loan servicing principles to provide a framework to improve servicing practices, promote borrower success and minimise defaults. The CFPB has also released its student loan servicing analysis of public input and recommendations for reform, which has direct implications for FFELP ABS through higher potential adoption rates in income-based repayment plans.

The government agencies note that different types of student loan currently come with different levels of consumer protection. They intend to strengthen protections for all student loan borrowers and ensure servicing is consistent, accurate and actionable, accountable and transparent.

The analysis released by the CFPB will affect FFELP ABS due to two main factors, say Wells Fargo analysts. These have the potential to increase use of income-based repayment plans and exposure to cash flow extension risk.

First, current servicing failures may contribute to millions of distressed borrowers defaulting, with CFPB figures showing that 70% of federal Direct Loan Program borrowers which were in default would have met the income requirements for lower monthly payments under an income-driven repayment plan. Borrowers also reported servicers steering them into payment options which were not in their best interest.

Second, there are currently certain practices boosting costs and causing distressed borrowers to lose protections. Consumers enrolled in an income-based repayment plan must recertify for the programme on an annual basis, while data suggests that three in five borrowers in income-driven repayment plans do not recertify in time even though they are eligible.

"The points highlighted by the CFPB suggest that income-based repayment plans have the potential to experience higher adoption rates in the future. With the CFPB focusing on servicing practices, it seems that a higher percentage of student loan borrowers are likely to enrol and remain in an income-based repayment plan going forward," say the analysts.

The analysts note that it is not unusual for 40% or more of the current collateral balance in Sallie Mae and Navient FFELP deals to be slow-pay accounts. They believe more delinquent loans and loans in forbearance will have the potential to enter into an income-based repayment plan, which - by helping to avoid defaults - could keep principal collections slow in FFELP ABS.

JL

Structured Finance

SCI Start the Week - 28 September

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

Pipeline
The pace of deals joining the pipeline continued to slow last week. In all, there were three new ABS as well as one RMBS, one CMBS and one CLO.

US$220m American Credit Acceptance Receivables Trust 2015-3, Canadian Credit Card Trust II Series 2015-2 and Hertz Vehicle Financing II Series 2015-3 accounted for the ABS. The RMBS was Hypenn RMBS IV, the CMBS was US$170m MSJP 2015-HAUL and the CLO was US$800m Octagon Investment Partners 25.

Pricings
Many more deals left the pipeline than joined it. In total there were four ABS, five RMBS, three CMBS and two CLO prints.

The ABS were: US$1bn Drive Auto Receivables Trust 2015-D; €750m Driver Espana Two; C$250m Eagle Credit Card Trust Series 2015-1; and US$290m OneMain Financial Issuance Trust 2015-3.

The RMBS were: US$310.39m Agate Bay Mortgage Trust 2015-6; US$425m California Republic Auto Receivables Trust 2015-3; US$340m DRB Prime Student Loan Trust 2015-B; A$500m Light Trust No.6; and US$1.3bn Towd Point Mortgage Trust 2015-4.

US$1.57bn FREMF 2015-K48, €150m Taurus 2015-3 EU DAC and US$814.5m WFCM 2015-NXS3 made up the CMBS. Meanwhile, the CLOs were US$400m JFIN CLO 2015-II and US$456m THL Credit Wind River 2015-2.

Markets
US ABS primary activity was reduced due to the industry conference in Miami, while secondary spreads were mostly stable. Barclays analysts say: "An average of US$1bn in ABS traded each day during the first four days of the week, bringing average daily volumes in September up to US$806m, still well below the US$1.6bn during September 2014."

Over three quarters of the week's US CLO secondary market supply came from 2.0 and 3.0 deals, report Bank of America Merrill Lynch analysts. They add: "Bidding activity was somewhat muted and we saw a repeat of some of the same themes from the last few weeks, where triple-A notes continued to hold up and mezz trading stayed thin. The generic spread levels we track for 2.0/3.0 deals pushed wider by 5bp wider in double-A and single-A, and by 35bp and 25bp wider in double-B and single-B."

The weakness that had been feeding into secondary levels for European ABS and RMBS over the last few weeks finally slowed down, particularly for UK non-conforming and buy-to-let, which only shed 1bp-2bp last week. "The auto ABS sector however reversed, when its broadly stable spreads leaked 2bp-3bp wider during the week on concerns surrounding Volkswagen. Moving south to the periphery, Portuguese senior RMBS paper came under a degree of stress - widening 10bp generically, while its Spanish and Italian peers held ground relatively well, shedding 1bp-2bp only," say JPMorgan analysts.

Editor's picks
New frontiers? Recent US RMBS transactions have increased expectations about the dawn of a 3.0 market. However, while their innovations may open new territory, a true 3.0 environment appears to remain a way off...
VW 'rule breach' impact weighed: The US Environmental Protection Agency's issuance of a notice of violation of the Clean Air Act to Volkswagen has direct implications for securitisations backed by Volkswagen vehicles. Volkswagen's auto loan (VALET), auto lease (VWALT) and dealer floorplan (VWMT) transactions will all be affected...
Euro market looks liquid: European ABS BWIC activity was high over the summer, while the traded percentage also surprised to the upside. From this perspective, at least, European liquidity appears healthy, with UK RMBS proving particularly liquid...

Deal news
• The One & Two Prudential Plaza loan has been refinanced in such a way as to avoid paying proceeds to the modified B-note. Barclays CMBS analysts describe it as "the worst case of hope note strategic refinancing to date". The modified loan was split pari passu between JPMCC 2006-LDP7 and JPMCC 2006-CB16.
• Ford Motor Credit last week priced the first Reg AB 2-compliant ABS - the US$1.05bn Ford Credit Auto Owner Trust 2015-C prime auto loan transaction. New data disclosures under the filing include weighted average LTV, subvented receivables and commercial use percentages, delinquencies, losses and prepayment charts, according to JPMorgan ABS analysts.
• Freddie Mac has priced its first STACR actual loss offering with original LTV ratios ranging from 80% to 95%. The transaction is the GSE's sixth in 2015 and fifteenth since the programme began in 2013.
• Following reports that proceeds from a mortgage loan securitised in Velocity Commercial Capital 2015-1 were misused by the related borrower to purchase a home as a primary residence, Kroll Bond Rating Agency has undertaken a thorough review of Velocity's credit policies, underwriting guideline, sample loan documentation and loan sale representations. As a result of this review, the rating agency is satisfied that Velocity is acting properly and is not making any consumer loans to residential buyers.
• Dock Street Capital Management is set to replace Chotin Group as collateral advisor to Saturn Ventures 2004 - Fund America Investors III. Under the terms of the appointment, Dock Street agrees to assume all the responsibilities, duties and obligations of the collateral advisor under the applicable terms of the indenture.
• ISDA's EMEA Credit Derivatives Determinations Committee has resolved that a potential repudiation/moratorium has occurred in respect of the Republic of Ukraine. The move comes after Ukraine agreed to a restructuring deal with creditors that includes a 20% write-down to the face value of about US$18bn of Eurobonds.

Regulatory update
• AFME has published a model clause for contractual recognition of bail-in. It provides model wording designed to assist banks in complying with obligations under the Article 55 of the EU's Bank Recovery and Resolution Directive (BRRD).
• ISDA has published an Australian single-sided reporting letter, allowing certain market participants to take advantage of the Australian single-sided reporting regime for Phase Three entities. The letter provides necessary representations to allow Phase Three entities to take advantage of an exemption from reporting.

Deals added to the SCI New Issuance database last week:
American Homes 4 Rent 2015-SFR²; Ares XXXV CLO; BACM 2015-UBS7; Benefit Street Partners CLO I (refinancing); CGCMT 2015-GC33; CPS Auto Receivables Trust 2015-C; Driver Espana Two; Dryden 41 Senior Loan Fund; Ford Credit Auto Owner Trust 2015-C; FREMF 2015-K48; Liberty Series 2015-1 SME; Light Trust No. 6; MAD 2015-11MD; Ocwen Master Advance Receivables Trust series 2015-T1; Series 2015-1 REDS EHP Trust; Taurus 2015-3 EU DAC; Ursa Re series 2015-1; Warwick Finance Residential Mortgages Number Two

Deals added to the SCI CMBS Loan Events database last week:
COMM 2012-LC4; COMM 2013-LC13; COMM 2013-LC6 & COMM 2013-CCRE6; COMM 2014-CR14; CWCI 2007-C2; GCCFC 2007-GG9; JPMCC 2010-C2; LBUBS 2006-C3; MLCFC 2007-5; MSBAM 2012-C5; MSC 2005-HQ5; WBCMT 2004-C12; WBCMT 2005-C22; WBCMT 2007-C32; WFCM 2015-C26; WFRBS 2011-C4; WINDM X

CDS

New index rules roll

The Markit CDX High Yield index rolls from Series 24 to 25 today (28 September), marking the implementation of new composition rules (SCI 20 August). The updated rules aim to bridge the gap in sector composition between the cash and synthetic indices, which has partly driven the performance divergence in the two markets since the summer of 2014.

Since the tights in June 2014, the HY cash index spread has widened by nearly 300bp, whereas CDX HY has widened by only around 100bp. For investors looking to use CDX HY as a risk management tool, the basis risk has meant that hedging via the index has been inefficient.

Introducing 10 name changes, the new rules have had a meaningful impact on index membership in this roll. At the sector level, energy is the biggest beneficiary, with the addition of four new names (California Resources Corp, MarkWest Energy Partners, Sabine Pass Liquefaction and Whiting Petroleum Corp).

The sector now accounts for 8% of the HY25 index, bridging the gap relative to the iBoxx HY index (11.6%), according to Morgan Stanley credit derivatives strategists. However, they note that broader high yield benchmarks still comprise a higher proportion of energy entities (14.6%), implying that there is still some disparity versus the market.

One name (Windstream) has been split into two entities, both of which were liquid enough to be part of the new index. As a result, only nine new entities have been added to HY25 (DaVita HealthCare Partners, Dynegy, HD Supply, T-Mobile USA and Valeant Pharmaceuticals account for the remainder). The weighting of the healthcare sector consequently increases in HY25 to 6%, although it also remains under-represented compared to iBoxx HY at around 11%.

Meanwhile, the consumer goods sector sees the biggest fall in weighting (from 23% to 14%), with nine of the 10 names removed belonging to this sector (Brunswick Corp, Constellation Brands, Cooper Tire & Rubber Co, Dean Foods Co, General Motors Co, HJ Heinz Co, Levi Strauss & Co, Norbord and Smithfield Foods). Three of the removals are driven by defaults (Sabine Oil & Gas Corp) or upgrades (GM and Heinz), whereas the others are driven by the new rules around liquidity and sector composition. This sector now comprises 14% of HY25 compared to 23% in HY24, but remains heavily represented relative to the cash market (7.5%).

The average spread of the nine names added is roughly 504bp, whereas the average of names removed is 162bp. In terms of NAV, the Morgan Stanley strategists expect HY25 to trade roughly 55bp wider than HY24, with single name CDS changes contributing around 35bp and the rest driven by the six-month maturity extension.

Together with the 10 removals, the strategists note that taking into account the sector composition of the synthetic market relative to the cash market has had a meaningful impact on the index's make-up. "Under-represented sectors in CDX HY are potentially compensated for by the removal of the least liquid names from the over-represented sectors. With regards to inclusion of new names, the rules now take into account the size and liquidity of the cash bond complex for a given entity, in addition to pure CDS liquidity," they explain.

They conclude: "While the new index rules only partially address the cash-synthetic spread disconnect, in our view they are a step in the right direction. Bigger challenges for the market are the general lack of liquidity in the single name CDS market, especially in high yield, and index-inclusion of large names that don't have an existing CDS might actually help in this regard."

CS

CLOs

Fund liquidity proposals weighed

Last week, the US SEC voted to propose tighter liquidity rules for open-end funds, including mutual funds and ETFs. While the rules would lead to several changes, the most significant one for CLO investors could be regarding liquidity buckets.

The SEC's proposed rules would formalise the 15% limit on illiquid assets which currently serves as a guideline, classify assets into buckets based on liquidity and establish a three-day liquid asset minimum. It would also require periodic review of liquidity risk and provide a framework for mutual funds to elect to use swing pricing, which would effectively pass on the costs stemming from shareholder purchase or redemption activity.

Wells Fargo analysts believe CLOs will be most affected by the need for funds to classify the liquidity of each position. In doing so, a fund must consider: the existence of an active market for the asset; the frequency of trades or quotes for the asset and average daily trading volume of the asset; the volatility of trading prices for the asset; bid-ask spreads for the asset; whether the asset has a relatively standardised and simple structure; maturity and date of issue (for fixed income securities); restrictions on trading of the asset and limitations on transfer of the asset; the size of the fund's position in the asset relative to the asset's average daily trading; and the relationship of the asset to another portfolio asset.

"The liquidity buckets would be defined based on 'the number of days in which the fund's position would be convertible to cash at a price that does not materially affect the value of that asset immediately prior to sale'," note the analysts. A fund would have to classify each asset into categories that could be converted to cash either within one business day, two to three business days, four to seven calendar days, eight to 15 calendar days, 16-30 calendar days or over 30 days without materially affecting the value of the asset immediately prior to the sale.

A fund might, therefore, conclude that different portions of the position in a particular asset could be placed in different liquidity classifications. For the periodic review requirement, liquidity risk would be defined as the risk that a fund could not meet redemptions under normal and stressed conditions without a material effect on the fund's NAV.

"Currently, there are more questions than answers, but the risks are in the implementation, and - more important - how funds approach any required portfolio re-shaping," say the analysts. "Based on the considerations for liquidity classification, and the number of CLO tranches in the market, a risk is that fund managers may list specific individual CLO tranches in a 'less liquid' bucket."

JL

CMBS

Crowdfunded properties transfer to special

September remits show that three CMBS 2.0 loans totalling US$71m sponsored by the same borrower - Colony Hills - have been transferred to special servicing. According to Morgan Stanley CMBS strategists, the five properties securing these loans received financing via crowdfunding, which is an untested ownership structure in CMBS.

The affected loans are the US$25.26m Colony Hills - Sandpiper and Cabana Apartments (securitised in COMM 2013-CR9), US$23.35m Colony Hills Portfolio Loans - Yester Oaks Apartments (JPMBB 2013-C12) and US$22.37m Colony Hills Portfolio Loans - Windsor Place and Pathways Apartments (JPMBB 2013-C12). Servicer commentary indicates that the transfers were due to a pledge of interest to a restricted party.

The three loans are secured by five multifamily properties in Mobile, Alabama. The Morgan Stanley strategists found that these properties comprise a portfolio that received US$12m of financing via crowdfunding on EarlyShares.com.

They note that the fundraising page described the project as an "est. +27% IRR opportunity to invest in a high-performing, diversified portfolio of multifamily assets in a booming market". NOI was said to have increased by over 24% since the portfolio was acquired in May 2013, with local cap rates also decreasing in the period, resulting in "a 28% increase in portfolio value". The minimum investment was US$25,000, with an expected hold period of 3-5 years.

Massolution dubbed commercial real estate as the fastest-growing industry segment of crowd capitalism. This form of capital-raising received a boost after an SEC rule went into effect on 19 June, which broadened the potential reach of crowdfunding platforms to include non-accredited investors that have a net worth of less than US$1m.

CS

CMBS

First significant Freddie K loss

A US$5.3m loan securitised in FREMF 2011-K12 has been liquidated at a loss severity of 55%. It is the first Freddie K loan to be liquidated at a significant loss.

The loan was secured by University Courtyard Apartments and was liquidated at a loss of US$2.92m. Class C notes have been written down from US$90.8m to US$87.9m as a result.

"According to our Deal Comp Database, this is the third Freddie K loan to realise a loss, but the first at a significant severity. The other two loans realised losses of around 10% or less - The Retreat at Stonebridge Ranch (FREMF 2011-K704) at a 1% severity and Green Meadows Apartments (FREMF 2010-K6) at a 10.2% severity," say Morgan Stanley analysts.

The property was appraised at US$8m in September 2010, at US$4m in August 2014 and at US$3m in August 2015. The loan was transferred to special servicing in July 2014 (see SCI's CMBS loan events database).

"The liquidation of this property and the resulting loss shouldn't come as a surprise, given its history. However, what is surprising is the size of the loss relative to the significant increase in multifamily valuations since 2010, up nearly 90% since December 2009 according to the CPPI. This reinforces the potential idiosyncratic risks inherent in commercial real estate," note the analysts.

JL

CMBS

CMBS bulk sale planned

CWCapital Asset Management is marketing US$2.12bn of distressed CRE loans and properties, most of which are from the company's specially serviced CMBS portfolio. There are 15 US CMBS transactions affected.

The assets are slated to be auctioned in early November, although Bank of America Merrill Lynch analysts believe that the auction date may be updated over the next month. The two deals with the most exposure by balance to the assets listed for auction are MLMT 2006-C1 and CD 2007-CD4.

"Of the 34 loans in the CD 2007-CD4 deal that are currently in special servicing, 16 of the assets with a UPB of almost US$138m are included in the list to be auctioned. Although the US$225m Riverton Apartments loan is not, as of this writing, included in the list of assets to be sold, we can't rule out a sale," say the analysts.

While there have been several smaller auctions since, the US$2.6bn bulk liquidation almost two years ago (SCI 14 October 2013) makes for an interesting comparison. The composition of underlying assets is more diversified this time around, with a 44% concentration in office properties, followed by 21% in retail and 20% in multifamily.

A final list of assets listed for sale is expected tomorrow (30 September). CWCapital is using various brokers for the majority of the liquidations, with the remainder managed through Auction.com.

As well as MLMT 2006-C1 and CD 2007-CD4, the other deals with assets slated for auction are: BACM 2006-3; CGCMT 2005-C3; CSFB 2005-C5; CWCI 2006-C1; CWCW 2007-C2; CWCI 2007-C3; GCCFC 2005-GG3; JPMCC 2003-C1; JPMCC 2006-CB17; JPMCC 2008-C2; MLCFC 2007-6; MSC 2005-HQ5; and WBCMT 2006-C28.

JL

CMBS

Underwriting push-back?

Concerns over the US$115m Prudential Plaza loan are believed to be behind COMM 2015-CCRE26 pricing this week at a significant concession across the capital structure. Morgan Stanley CMBS strategists suggest that underwriting of the loan, the largest in the deal, provides little margin for error and that it may be a future modification candidate under certain scenarios.

The COMM 2015-CCRE26 last cashflow triple-A tranche priced at swaps plus 125bp, compared to the plus 115bp seen for WFCM 2015-NSX3 that priced three days prior. Additionally, the triple-B minus tranche priced at 525bp, compared to 460bp for WFCM 2015-NXS3.

"This is among the greatest tiering that we've observed in the market. This reinforces that the performance of loans in legacy CMBS is an important consideration and that credit quality matters more than ever," the Morgan Stanley strategists note.

The legacy One & Two Prudential Plaza CMBS loan - securitised in JPMCC 2006-LDP7 and JPMCC 2006-CB16 - was transferred to special servicing in October 2012 and subsequently modified, splitting the first mortgage into a US$336m A-note and US$74m B-note (see SCI's CMBS loan events database). The loan prepaid in August, returning full principal to the A-note, but wiping out the B-note.

The property was subsequently refinanced with a US$415m first mortgage. Coupled with an 'as-is' appraisal value of US$642m and an 'as-stabilised' value of US$787.5m, this loan amount suggests that there may have been sufficient value to pay off the legacy CMBS loan in full (SCI 23 September).

The most recent NOI for the property of US$19.6m is in contrast to an underwritten NOI of US$33.5m. The offering documents state several factors for the increase, including leasing activity since June 2015, rent step-ups and free rent concessions that are rolling off. The strategists note that it's reasonable to assume that these factors were known when the loan refinanced in August.

The as-is and as-stabilised values of the property imply an average price per square-foot of US$280 and US$344 respectively, according to the strategists. By comparison, Illinois Center - which is located 0.2 miles away - was financed in CGCMT 2015-GC33 with an appraisal value of US$390m, or US$186 per square-foot.

"We believe US$225 to US$250 per square-feet may be more appropriate for Pru Plaza, implying a valuation ranging from US$514m to US$572m," the strategists observe. "The US$642m 'as-is' appraised value is driven by an off-market cap rate of 5.2%. If we apply a 6% cap rate consistent with Illinois Center, then the value of Pru Plaza is US$554m - in the middle of the cost per square-foot estimated value."

The underwriting of Pru Plaza appears to leave little margin for error, with a rising interest rate environment and slower than anticipated NOI growth posing potential challenges. "While Moody's notes in its presale report that default risk is 'partially mitigated by the change in ownership, the sponsor's recent investment of US$30m in capital expenditures and US$26.6m in tenant improvement costs', we nonetheless believe the loan may be a future modification candidate under certain scenarios," the strategists conclude.

CS

Structured Finance

Wash trading charges settled

The US CFTC has settled charges against TeraExchange over its failure to enforce prohibition on wash trading and prearranged trading on its SEF platform. Tera allegedly offered for trading on its SEF a non-deliverable forward contract based on the relative value of the US dollar and Bitcoin, without indicating that it was a wash sale.

The charges states that, in October 2014, the only two market participants authorised at that time to trade on Tera's SEF entered into two transactions in a Bitcoin swap. The transactions were for the same notional amount, price and tenor, and had the effect of completely offsetting each other. At the time, these were the only transactions on Tera's SEF.

Tera supposedly arranged for the two market participants to enter into the transactions. One of the market participants was alleged to have been told that the trade would be 'to test the pipes by doing a round-trip trade with the same price in, same price out', with no profit or loss consequences required.

However, subsequent to the transactions, Tera is believed to have issued a press release and made statements at a meeting of the CFTC's Global Markets Advisory Committee (GMAC) announcing the transactions, thus creating the impression of actual trading interest in the Bitcoin swap. Neither Tera's press release nor the statements at the GMAC meeting indicated that the transactions were pre-arranged wash sales executed for the purpose of testing Tera's systems.

Tera is required under the certain SEF regulation to enact and enforce rules prohibiting certain types of trade practices on the SEF, including wash trading and prearranged trading. The CFTC adds that Tera's rulebook also prohibits such practices, thus leading to the charges.

Structured Finance

Gleacher pay-outs continue

Gleacher & Company's board has decided to make a third liquidating distribution to the firm's stockholders in the amount of US$4 per share of its common stock - approximately US$24.7m in aggregate. The record date for the distribution is 12 October, with the anticipated payment date on or about 23 October. Since Gleacher's dissolution announcement last year (SCI 29 July), its distributions now total US$52.9m, at US$8.55 per share of the firm's common stock.

Structured Finance

RBS reshuffles corporate division

RBS has appointed Scott Satriano to its new head of financing and risk solutions role as the bank looks to simplify the structure of its corporate and institutional banking (CIB) division. Simultaneously, Kieran Higgins becomes head of trading and flow sales, while Richard Bartlett has stepped down from his position as head of coverage and debt capital markets.  

Satriano was previously head of sales at RBS, with his new group combining the bank's derivative solutions, structuring technology, debt capital market origination, and product and syndication capabilities with its ratings and risk advisory teams. Higgins, who was previously head of trading at RBS, will now head a new group that focuses on rates, currencies, credit sales and trading. Both will report to CIB ceo Chris Marks.

CDS

CDS settlement details disclosed

Further details have been revealed about the settlement of an antitrust class action case that involved a dozen banks allegedly rigging CDS markets in collusion with ISDA and Markit (SCI 15 September). The accused have agreed to pay a final recovery figure of US$1.86bn, in addition to providing injunctive relief for enhancing competition in the CDS trading domain.

As part of the settlement, ISDA has agreed to changes in its licensing procedures that will make it easier for exchanges and other electronic trading platforms to enter the CDS market. ISDA will also ensure that class members are represented in its decision-making processes.

Plaintiffs for the case - which was originally filed in 2013 - accused the investment banks, ISDA and Markit of coordinating to prevent the rise of efficient and transparent trading platforms. The accusations claimed that the goal of the defendants were to prevent competition and preserve their favoured position in the OTC CDS trading market.

Representatives for the plaintiff class are: Los Angeles County Employees Retirement Association; Salix Capital US; Value Recovery Fund; Delta Institutional; Delta Onshore; Delta Offshore; Delta Pleiades; and Essex Regional Retirement System.

Quinn Emanuel Urquhart & Sullivan, the legal representation for the plaintiffs, adds that the US Department of Justice and the European Commission have investigated the same claims since 2009, but have not yet secured relief on any findings.

RMBS

WaMu appeal approved

An appeal by the FDIC of the June ruling in the WaMu rep and warranty trial (SCI 4 June) was approved last week. Proposed schedule changes are due to be submitted by both parties this week, which may shed more light on the timing of the subsequent process.

Bank of America Merrill Lynch RMBS analysts note that for reference purposes, the Countrywide appeal process took almost a year to resolve - albeit the case involved different issues. "An outcome of this appeal in favour of FDIC would be a positive for the RMBS investors; however, it is too early to judge its likelihood," they add.

The 3 June ruling by the US District Court of Columbia held JPMorgan responsible for mortgage repurchase liabilities that were only either: reflected on WaMu's balance sheet, as of 25 September 2008; or where WMMSC is the responsible party. For every other deal, including Long Beach transactions, the rep and warranty liability was judged to remain with the FDIC.

The BAML analysts suggest that the decision consequently: limited the recovery on the RMBS R&W claims to recoveries on the WaMu estate; and excluded all the non-WMMSC US Bank deals, as they had not filed the proof of claim against the WaMu estate by the deadline.

ABS

Utility sponsored ABS debuts

AES Distributed Energy has launched its inaugural securitisation, making it the first solar ABS deal to be backed by a utility company. Aurora Master Funding 2015-1 is secured by 15 limited purpose solar power distributed energy project companies, comprising 12 commercial, industrial, municipal and small utility companies (CIMU) and three that are residential.

The transaction comprises two tranches and is rated by Kroll Bond Rating Agency. The senior tranche consists of US$92.5m in class A notes, rated triple-B, while the US$7.5m in class B notes are rated single-A. The transaction is structured so that interest and principal are paid sequentially.

The tranches have an anticipated repayment date of December 2025, with the maturity date set at December 2045. The weighted average original tenor of the portfolio is approximately 289.3 months, with a weighted average remaining term of approximately 266.9 months.

In total, the portfolio contains 1,548 CIMU and residential solar distributed generation assets that are located throughout six US states and the US Virgin Islands. The pool totals approximately US$128m from leases, revenues and power purchase agreements (PPAs).

The CIMU companies earn revenue through PPAs with 12 corporate entities on 97 project sites and are therefore dependent on the energy generation of each project. The residential companies earn revenue through 1,451 lease agreements with homeowners, the terms of which include a fixed fee independent of energy generation.

KBRA says that the deal benefits from a number of credit enhancements, including overcollateralisation, excess spread, an interest reserve account, a major maintenance reserve account and a non-covered services reserve account. Negative credit attributes include the lack of historic static pool data and the limited geographical diversity of the pool.

AES has maintained a strategic partnership with two affiliates of the sole bookrunner Morgan Stanley for the development and ownership of the assets. These companies are MS Solar Holdings and MS Solar Investments. Prior to the closing of the transaction, they will transfer ownership of the project companies to the Aurora Master Holdings, which will then transfer ownership to Aurora Master Funding on the closing date.

ABS

PACE approach finalised

DBRS has finalised its US PACE securitisation methodology, which it will use to rate and monitor property assessed clean energy transactions. The agency's approach to the asset class entails focusing on the quality of the originator and other parties involved in the transaction, evaluation of the collateral pool and historical collateral performance evaluation techniques. DBRS says it typically evaluates both qualitative and quantitative factors when assigning ratings for US PACE assessment securitisations.

PACE programmes are designed to enable local governments to finance renewable energy, energy efficiency and water conservation improvement projects - either directly or through private sector capital - for privately owned residential and commercial properties. Some form of PACE legislation has so far been adopted by 31 US states and the District of Columbia, and PACE financing is being offered and utilised in 10 states and DC.

PACE utilises the 'land-secured financing district' (or 'energy financing districts') structure, which results in property owners paying their assessment as part of their property tax bill. Payments are secured by a priority lien on the subject property.

Under a PACE programme, the property owners receive PACE financing through their county or municipality's programme to fund the purchase of eligible improvements and then repay the related financing over a five- to 20-year period via a special assessment on their property. The assessment remains with the property in the event of a sale (unless prepaid), thus the property owner (obligor) may change prior to final repayment.

Under most programmes, the levy is senior to any other non-tax liens and has the same priority as ad valorem taxes. However, some programmes facilitate structural subordination of the assessments.

ABS

VW auto ABS risks outlined

The current Volkswagen scandal may be felt in auto ABS transactions primarily through its impact on used car values, says Fitch. The agency notes that transactions are exposed to used car values either directly through residual value or indirectly via recovery proceeds from the sale of the car when a borrower or lessee defaults.

Fitch rates 25 Volkswagen-originated transactions globally, with 15 securitised in EMEA, six in the US and four in APAC. Only five Fitch-rated transactions originated by Volkswagen are exposed to residual value risk - one in the US and four in EMEA.

The full impact on car prices remains uncertain as of now, but a recall could be a potential challenge for affected diesel vehicles. If the remediation results in lower fuel economy and performance, resale values may decline. In turn, this could bolster owners' civil cases against Volkswagen, resulting in longer lasting reputational damage.

Additionally, more customers may 'turn back' their vehicles than anticipated, which could exert pressure on auction or dealer prices due to higher supply. If Volkswagen's brand image is permanently damaged, used car prices of all Volkswagen cars could see some impact.

Nevertheless, Fitch is not expecting a direct and immediate impact on transaction performance from potential reduced used car prices. Most transactions are only indirectly exposed to used car prices following a borrower or lessee default, and the expectation is that the default risk will not change in the short run.

Price impact is expected to be largely limited to the affected vehicles even in the event of permanent damage to Volkswagen's image. While the car manufacturer will likely clarify the portion of affected vehicles in each transaction in due course, Fitch believes the impact will be lower in the US, given the lower diesel penetration than in Europe.

The agency also says that if the allegations are found to present a breach of the representations and warranties, Volkswagen could be obliged to repurchase the affected contracts, mitigating this risk. In addition, European transactions with residual value exposure include a direct obligation from Volkswagen or a connected entity to purchase the vehicle at the residual value at contract maturity.

Other possible risks for potential losses include the invalidation of loans or lease contracts, or cars being declared not road worthy. Over the medium term, there could also be legal challenges by some jurisdictions with environmental agendas taking more aggressive actions against Volkswagen. As of now, Fitch expects that Volkswagen will be able to satisfy its obligations in the ABS transactions, but awaits further developments.

ABS

VW outlook 'negative', agency confirms

Moody's is the latest rating agency to warn that the US Environmental Protection Agency's findings that Volkswagen used engine management software in its diesel cars to evade emissions standards (SCI 23 September) are credit negative for outstanding auto ABS the company sponsors in the US and Europe. Brand damage could lead to lower recoveries on ABS loan and lease transactions while a sales freeze threatens the company's dealer floorplan ABS.

Approximately half a million Volkswagen and Audi vehicles are affected in the US, while 11 million vehicles could be affected worldwide. Moody's has changed its outlook on Volkswagen's ratings from stable to negative.

"The EPA's findings are credit negative for the outstanding ABS transactions that Volkswagen sponsors largely because reduced consumer confidence in the Volkswagen brand risks hurting sales of all vehicle types the company produces," says Moody's vp and senior analyst Corey Henry. "Reduced demand for VW vehicles will result in lower recoveries on ABS loan and lease transactions when the vehicles are resold."

Most immediately affected will be Volkswagen Credit Auto Master Owner Trust floorplan notes. The principal payment rate to the trust could drop to 40% of the outstanding receivables balance, says the rating agency, which compares with an average payment rate of about 55% since 2013.

Exposure to diesel vehicles in European auto ABS pools is higher than in the US owing to the large number of passenger vehicles in Europe that are equipped with diesel engines. Approximately half of all vehicles in Germany have diesel engines, while in Spain and France nearly two thirds of cars run on diesel.

"The recent news will have a negative effect on market values and thus recoveries on the vehicles in VW's outstanding transactions," says fellow Moody's vp and senior analyst Johann Grieneisen. "That is, at least until there is clarity on which models are affected, VW's ability to fix the vehicles, and the effect of the required fixes on vehicle performance."

Moody's expects Volkswagen to fix the affected European vehicles and support its dealer network as necessary, so lessees and loan borrowers should not have an incentive to rescind on their obligations. However, a stressed case scenario of higher vehicle return rates and defaults in a lower recovery environment could result in higher losses, increasing tail risk.

ABS

RFC issued on railcar approach

S&P is requesting comments on its methodology and assumptions for rating North American railcar ABS. The proposed criteria provide more transparency into the agency's approach and the cashflow assumptions used when reviewing transactions backed primarily by lease rental payments from a portfolio of railcars leased to various lessees.

The criteria would apply to all new and outstanding North American railcar ABS transactions. Typical ABS are backed by railcar portfolios that are sufficiently diversified in terms of railcar type and lessee. Should a transaction have larger concentrations, S&P says it would consider applying more stressful parameters to address the concentration risk, such as lower utilisation rates, lease rates and/or residual values.

The approach provides for stress assumptions up to and including the double-A rating category. The agency caps railcar-backed securities at this level because it believes the railcar leasing business has high operational risk.

If adopted, the proposed criteria aren't expected to impact outstanding ratings. Comments on the proposed criteria are invited by 15 October.

ABS

Lack of data limits marketplace ratings

Fitch states that it would struggle to assign a high investment grade rating to securitisations of marketplace lender consumer and SME loans. While recognising that marketplace lenders are not necessarily focusing on riskier borrowers, the agency notes that higher rates being charged to SMEs suggest they have previously been rejected by retail banks, implying a higher degree of risk.

The agency says that while marketplace lenders may have performance data comparable to other SME lenders, this has yet to be tested in a downturn. Furthermore, a closer comparison of marketplace lenders with larger existing banks is challenging, especially without a centralised credit bureau covering individual UK SMEs.

Fitch adds that it would therefore cap ratings and assume more volatile asset performance for securitised marketplace SME loans unless a marketplace lender can show their portfolio is of comparable credit quality to those of UK banks. However, ratings could be higher outside of the UK, in countries that have centralised data on SME credit scores, such as Germany.

In terms of consumer loans from marketplace lenders, the agency states that the cap could be higher, due to greater amounts of both positive and negative consumer lending data, as well as a greater amount of data from marketplace lenders in terms of their own information and underwriting tools.

Fitch emphasises that the difficulty in rating UK consumer marketplace ABS is primarily in lack of performance data for meaningful origination volumes, especially when typical loan terms are of 3-5 years. As such, it says that this would be insufficient to establish a performance benchmark, with data from comparable non-marketplace lenders also being an ineffective proxy.

However, the agency suggests that marketplace lenders may be able to improve on this by bridging the information gap through their advanced IT systems, and in time they may be able to provide more thorough data on loan characteristics and performance to investors.

Structured Finance

Agency seeks above-currency comments

S&P is requesting comments on proposed changes to its methodology for assigning ratings above the foreign currency ratings on the sovereigns in a multijurisdictional structured finance transaction. The proposed criteria would constitute a global framework.

Few rating changes are expected if the proposed criteria are adopted. From a test on CDOs, CMBS, ABS and covered bonds, the rating agency expects one- to two-notch downgrades on less than 2% of transactions, with a limited number of one-notch upgrades.

S&P requests comments by 31 October 2015.

Structured Finance

ESMA reports on rating agencies

ESMA has published two sets of technical advice and a report on the regulation of credit rating agencies in the EU. These papers consider measures to provide stronger controls around credit ratings for structured finance instruments and to reduce reliance on credit ratings.

The report finds that regulation has improved the governance and operation of rating agencies but that it is too soon to comprehensively assess the impact of measures regarding competition and conflicts of interest included in the CRA Regulation of 2013. ESMA says it would benefit from further supervisory powers regarding the appointment of independent non-executive directors by rating agencies and that its enforcement powers would be more effective if fines better reflected a rating agency's turnover.

ESMA says the ratings industry is more complex than initially foreseen as most rating agencies focus on a particular asset class or member state and that the high fees charged suggests there may be little effective competition. Regulation has not increased competition in the provision of structured finance ratings and references to credit ratings still remain in national and EU legislation, as well as within the collateral frameworks of some central banks.

The European Commission will consider ESMA's findings and issue its own reports to the European Parliament and Council on whether all references to credit ratings should be removed from EU law for regulatory purposes and on the implementation of regulation relating to competition, conflicts of interest and structured finance products. ESMA will reassess rating agency regulation in the next three to five years.

Structured Finance

New regulations 'unnecessary' for marketplace ABS

The Structured Finance Industry Group (SFIG) yesterday released its response to the US Treasury's recent Request For Information on the marketplace lending industry. The response covers securitisations of marketplace loans, regulations that are currently in place and what challenges the industry faces in the near future.

SFIG notes that the marketplace lending industry has the potential to play a major role in the provision of funding to consumers and businesses alike, which will benefit the wider economy as a whole. Taking this in to account, the association is also supportive of securitisation of marketplace loans, highlighting that it will promote "increased access to credit for consumers and small businesses, thereby benefiting not just industry participants but also the broader economy".

The response stresses that though marketplace lending may be seen by many as an innovative industry, it has yet to result in any new asset classes, and the only thing that truly distinguishes it from other traditional forms of lending is that "a marketplace loan is merely the provision of credit by means of an e-commerce platform".

As such, SFIG believes that in discussing the potential for any new regulations of marketplace lending and securitisation, an analysis of recent and existing regulations needs to be undertaken. The association highlights that the new rules set out by the Dodd-Frank Act and in Final Regulations already provide a robust set of requirements pertaining to traditional ABS and ABS investors.

SFIG particularly highlights the existing and incoming stipulations relating to risk retention and transparency, which are also broad enough to cover marketplace lending securitisations, it says. In conclusion, the association states that no new regulations need to be developed specific to marketplace lending and that doing so may negatively impact the industry's ability to generate funding - which could, in turn, inhibit its ability to provide credit to consumers and small businesses and potentially negatively impact the economy as a whole.

It points out that going forward, the "combination of risk retention and appropriate disclosures" - as set out by the Dodd-Frank Act, Final Regulations and other legal frameworks - "should form the cornerstone of industry standards".

Structured Finance

SCI conference line-up unveiled

Panellists have been confirmed for SCI's 8th Annual Securitisation Pricing, Trading and Risk Seminar, which is being held on 7 October in New York. The event is being held at Bank of America's offices at 250 Vesey Street (formerly Four World Trade Center).

The conference programme consists of a series of roundtables and panel debates focusing on issues affecting the investment in, and trading of, securitised bonds. Panel sessions include a regulatory update, the evolution of the IPV desk and many more. There will also be a pricing and valuation workshop and a new Ask The Experts working group feature.

Speakers include representatives from: Bank of America; Brean Capital; Christofferson Robb; DBRS; Duff & Phelps; Ernst & Young; FHFA; FTI Consulting; George K Baum; Grenadier Capital; Guggenheim; Houlihan Lokey; Janney Montgomery Scott; Katten, Muchin Rosenman; KGS Alpha; McGladrey; Milbank; Morningstar; NewOak; PartnerRe; PriceServe; Prism Valuation; PwC; RBS; RJM Consulting; Tetragon; Thomson Reuters; and Tiedemann.

Please email SCI for a conference registration code or click here and follow the link to register.

Structured Finance

CMU proposals laid out

The European Commission has launched its Capital Markets Union action plan to build a single market among EU member states. The proposal provides specific criteria  to differentiate simple, transparent and standardised (STS) securitisation products, while also making amendments to capital requirements regulations.

The Commission's introduction of a clear set of criteria to identify STS is broken down into two groups. According to the proposal, 'simple securitisation' entails that assets packaged in a securitisation must be homogeneous. For example, residential mortgages must only be packaged with other residential mortgages.

In addition, loans must have a credit history long enough to allow for reliable estimates of default risk. The ownership of a loan must also have been transferred to the securitisation issuer.

With 'transparent and standardised securitisations', 5% of the loan must be retained by the originator. There will also be precise disclosure requirements from the originator, the sponsor and the issuer. This includes ongoing publishing of data on packaged loans, as well as relevant transaction details with regard to contracts, structure and payment cascade.

The Commissions adds that many synthetic securitisations often carry additional legal and counterparty risks, with the additional higher losses generated pushing them outside of its STS framework. However, it notes that precise criteria to identify more simple synthetic securitisations are being developed by the EBA, with the Commission standing ready to consider the inclusion of any such criteria.

The proposals also recognise the different risk profiles of STS and non-STS securitisations. As a result, the Commission will amend the current prudential treatment for both banks and insurance companies in order to establish a closer relationship between the riskiness of a securitisation and the prudential capital required from banks and insurance companies investing in it.

The securitisation framework proposed today will be transmitted to the European Parliament and Council for adoption.

Structured Finance

Agency proposes new rating type

S&P has issued a request for comment on its proposed criteria for assigning a new rating type. It would be specific to the financial obligations which structured finance special-purpose entities enter into with banks or other entities on the issuer's credit risk under a contract such as a swap or liquidity facility.

The new counterparty instrument rating (CIR) would address an issuer's capacity to meet its financial obligations to a counterparty on an ultimate payment basis as funds become available, without regard to any specific repayment date that may be stated in the terms of the contract. A CIR rating could apply to any financial obligation that an issuer enters into with a counterparty which falls within the proposed criteria.

S&P says that where a financial obligation to a counterparty has the same seniority in the priority of payments as a note the agency rates, it would likely assign a CIR no higher than the rating on the note. Where a financial obligation to a counterparty ranks above a rated note, the proposed criteria may assign a CIR that is higher than the note rating, subject to further asset-specific analysis.

As a new rating product, there is no impact on outstanding issue credit ratings. Comments are sought be 2 November 2015.

Structured Finance

New fund targets SF investment

Franklin Templeton Investments has launched the Franklin K2 Long Short Credit Fund, which will invest in a variety of credit strategies. It aims to provide investors with access to a select group of hedge fund managers in a single diversified portfolio, while providing daily liquidity.

Franklin Templeton acquired hedge fund solutions provider K2 Advisors in 2012. The new fund aims to provide attractive risk-adjusted returns with a lower correlation to traditional long-only fixed-income strategies.

The fund will allocate to a variety of hedge fund managers selected by K2 Advisors through a proprietary due diligence process. Structured credit will be one of the strategies employed by the initial underlying hedge fund managers, with ABS, MBS, CDO and CLO products all eligible for investment.

The fund will be managed by K2 Advisors founding md David Saunders, as well as colleagues Robert Christian, Jeff Schmidt and Charmaine Chin. The fund's initial set of sub-advisors includes Apollo Credit Management, Candlewood Investment Group, Chatham Asset Management and Ellington Global Asset Management.

CLOs

Loan ratings, CLO defaults correlated

Default rates for leveraged loans in US CLO portfolios from 2007 to 2012 varied considerably across major CLO managers, though they did reflect the ratings of those loans, Moody's reports. Pro forma default rates came in somewhat higher than realised default rates during the same period, while the US speculative grade corporate default rate came in between the pro forma and realised default rates of leveraged loans in CLOs.

Moody's findings are based on a study of trustee-reported defaults within the broadly syndicated loan CLOs it rates. The agency restricted its 2007-2012 analysis to managers that managed five or more deals a year and considered default rates only, not total returns.

"The average annual pro forma default rate of US CLO collateral over the 2007-2012 period varied from 5.2% to 8.5%, with two-thirds of the defaults over this span taking place during the crisis in 2008-2009," says Moody's vp Julian Sieler. "Although default rates can reflect the success - or otherwise - of a manager's credit strategy, high default rates are not necessarily indicative of worse deal performance."

Aside from their ability to pick credits, there are several possible reasons why default rates differed among managers, Seiler adds. Some managers chose riskier credits in the hope of higher returns and ended up having higher default rates during the 2008-2009 period. Additionally, the deals outstanding at the beginning of any year represent a range of vintages, with the collateral pools for these deals partly reflecting market collateral characteristics at the time of origination.

Though default rates vary substantially by manager, they are correlated with the average ratings of the loans in their portfolios, Moody's analysis shows. The US CLO collateral default rate pattern over the 2002-2014 period largely followed that of the universe of speculative grade credits.

On average, the speculative grade default rate was between the pro forma and realised CLO collateral default rates, with a deviation of less than 1%. Each default rate measure declined after 2002, then spiked during the 2008-2009 crisis.

CLOs

Euro CLO growth continues

European CLO issuance continues to show strong growth, with Fitch counting 38 new transactions in the 12 months to July 2015. This is 36% higher than the same period a year earlier and includes 10 new post-crisis managers, with manager strategies varying.

Loan supply has been 47% lower so far in 2015 than it was in the same period last year. Fitch estimates total loan issuance of €40bn this year, down from €65bn last year, which may lengthen ramping periods for transactions currently ramping up and closing in the near future. Ramp times for Fitch-rated transactions have varied from three weeks to 29 weeks.

The limited loan universe leads to significant asset overlap for CLOs. For different managers, overlap is around 48% - significantly higher than in the US.

Managers have made limited use of their risk buckets and fixed-rate buckets and losses have remained limited, with par built through manager trading typically absorbing any losses experienced to date. Of the 44 post-crisis CLOs Fitch rates that have gone effective to date, only six have a par balance below target.

Annual turnover and trading rates have varied significantly between transactions as managers pursue differing strategies. Equity distributions have begun at levels lower than pre-crisis CLOs due to the increased cost of liabilities and annualised equity returns vary between 12% and 22%.

CMBS

Delinquencies drop lower

After four months of negligible movement, the Trepp US CMBS delinquency rate dropped significantly lower in September, falling by 17bp to 5.28%. The rate is now 75bp lower than the year-ago level and 47bp lower year-to-date.

US$1.4bn in loans became newly delinquent last month, which put 26bp of upward pressure on the delinquency rate. Almost US$700m in loans were cured, which helped push delinquencies lower by 13bp.

Meanwhile, CMBS loans that were previously delinquent but paid off with a loss or at par totalled almost US$1.3bn in September. Removing these distressed assets from the numerator of the delinquency calculation helped push the rate down by 25bp.

CMBS

CMBS liquidations move back up

Trepp reports that US CMBS loan liquidation volume rose back above US$1bn after lower summertime totals in July and August. In total, US$1.02bn across 70 loans were liquidated with losses in September, with the majority of the increase due to a jump in average loan size to US$14.56m from US$11.48m and US$9.44m in August and July respectively.

Seven loans totalling US$55.67m took 100%-plus losses, three of which were relatively small class B notes. The US$25.7m 1604 Broadway retail loan in New York was the only large loan to take 100%-plus loss, but the US$50.68m Shoreview Corporate Center in Minnesota was close behind with a 95.71% loss.

The headliner in September was the US$134.25m Westin Casuarina Hotel & Spa loan, which has been on the delinquent rolls for over five years. The loan finally resolved in September with a US$66.64m loss - a 49.64% severity. In addition, the struggling US$72.16m Norden Park office loan in Connecticut took a 79.3% loss.

Loss severity for September was 43.48%, down slightly from August's 45.56%. Looking only at losses greater than 2%, volume was US$819.71m with a 53.81% loss severity.

CMBS

Bridge resolution exceeds valuation

Hatfield Philips International has negotiated the successful resolution of the Bridge loan, securitised in the Windermere X CMBS, via a highly targeted marketing process for the underlying properties. The gross disposal proceeds from the sale of the portfolio are in excess of €330m - a price that is greater than the latest public valuation - and net proceeds are expected to fully repay the amount of principal and interest outstanding on the senior loan and partially repay the amount outstanding on the junior loan.

The portfolio consists of six office buildings aggregating approximately 190,000 square-metres and produces €28m in gross rental income per year. The properties -which are located in key German metropolitan markets - are primarily let to high credit quality tenants.

Blair Lewis, HPI/LNR Europe ceo, comments: "Working with a dedicated and interest-aligned asset manager and two highly regarded brokers allowed us to target the most logical buyers; and the comprehensive dataroom we established enabled those targets to make quick, informed investment decisions."

HPI was appointed special servicer on the loan after the borrowing entities failed to repay it in full on its 15 January 2014 maturity date. Shortly thereafter, HPI took control of the borrowing entities through enforcement on Luxembourg share pledges and appointed a new asset manager - Valad - to enhance the value of the portfolio.

After engaging in regular dialogue with Valad, the borrowing entities, controlling class representative and noteholders, a highly targeted sales process was agreed as the most appropriate resolution strategy. This decision led to NAI Apollo and PricewaterhouseCoopers being appointed to strategically market the properties to potential buyers. To maximise proceeds, the sale was split into two transactions, with five assets being acquired by affiliates of a global private equity fund in a share deal and one asset being acquired in a direct asset deal by Publity.

The resolution marks the third large German portfolio HPI has managed to sell in excess of €250m over the last 24 months. HPI previously announced the successful sales of the Margaux portfolio and Treveria Silo E portfolio in December 2013 and 2014 respectively.

Insurance-linked securities

'Limited' cat bond growth forecast

Fitch reports that the global catastrophe bond market experienced strong issuance through the first nine months of 2015, despite a modest decline from the record level reported in the prior year. The agency calculates that US$5.5bn of cat bonds were issued during the period, down from US$6.2bn in 2014.

"Repeat sponsors have replaced maturing issues and taken advantage of current favourable market conditions, but new sponsor issuance has been limited, as other alternative risk transfer outlets remained strong options for cedants," Fitch notes.

Issuance is likely to remain strong into 2016 as more than US$7bn of outstanding cat bonds will mature and are likely to be replaced in the next 15 months. Conditions remain favourable for new and returning sponsors, but growth in total outstanding issuance is expected to be limited as maturities offset much of the new issuance.

Fitch rated 12 separate tranches across nine catastrophe bond transactions in the 15-month period between April 2014 and July 2015, representing over US$3bn in par value, with a range of ratings between single-B and double-B plus. The agency expects that peak tail risks within sponsors' reinsurance programmes will continue to remain of interest to investors and a source of growth in the industry, but that cat bonds will continue to be structured with risk profiles consistent with non-investment grade ratings.

NPLs

Trevi 3 portfolio acquired

AnaCap Credit Opportunities III has acquired €1.2bn of non-performing loans from UniCredit Group. Under the terms of the agreement, the AnaCap fund will acquire 100% of the Trevi 3 portfolio, which comprises Italian secured and unsecured bankruptcy and other enforcement claims against primarily SME borrowers.

AnaCap funds previously acquired a similar portfolio of NPLs from UniCredit in October, totalling claims of €1.9bn, which was the largest transaction of its kind in Italy. AnaCap funds have now purchased circa €6bn of Italian NPLs over the past three years, as well as a €550m performing portfolio of Italian salary guaranteed loans. The firm says it maintains a large current pipeline of comparable transactions from other Italian financial institutions.

The sale of the Trevi 3 portfolio is part of UniCredit's ongoing non-core asset disposal strategy, aimed at strengthening the bank's credit profile. Justin Sulger, a partner at AnaCap Financial Partners, comments: "The strong partnerships we have forged with institutions like UniCredit have cemented our reputation as one of the most trusted counterparties for banks in Europe. With close to €800bn of NPLs still on the balance sheets of European banks, there is a continuing need for specialist institutions such as ourselves to help ease the pressure on banks and encourage renewed lending across the continent."

NPLs

Toro buys into NPL portfolio

Toro has invested approximately €31.25m in instruments that are backed by the performance of a granular NPL portfolio of SME loans and secured residential loans. The company says that the co-investment will be junior to any senior financing of the portfolio, and backed proportionately by loan exposures to 1654 SMEs and to 2283 secured residential loans originated by Bancaja, Bankia and Caja Madrid.

The expected WAL of the portfolio is 2.8 years, with the portfolio expected to be serviced by Copernicus. The transaction represents approximately 8.5% of the company's net asset value and leaves Toro now approximately 83% invested. The expected return of the investment is in line with Toro's target gross return for private asset backed finance of approximately 15%.

Risk Management

MiFID 2 standards finalised

ESMA has published its final technical standards on MiFID 2, revealing how the legislation will apply in practice to market participants, market infrastructures and national supervisors. The standards are broken down into how they will help increase transparency, safety and investor protection.

In promoting fairer and safer markets for OTC and non-equity products, ESMA says that there will be tests to determine whether a non-financial firm's speculative investment activities are so great that it should be subject to MiFID 2 regulation. In addition, MiFID 2 will include ranges for the new EU-wide commodity derivatives position limits regime, as well as a set of organisational requirements on investment firms and trading venues that are subject to high frequency trading.

Provisions will also be included to increase competition by regulating non-discriminatory access to central counterparties, trading venues and benchmarks. Additional provisions will also include trading venues to offer disaggregated data on a 'reasonable commercial basis'.

In order to promote greater transparency, the final MiFID 2 standards include thresholds for pre- and post-trade transparency regimes that include derivatives and structured finance products. The regulations also introduce both a liquidity assessment for non-equity instruments and trading obligations for certain derivatives to be traded on regulated platforms instead of OTC.

The final standards also promote stronger investor protection principally through improving disclosure to 'strengthen the best execution regime'. In accordance with MiFID 2, ESMA has also provided its final standards for Market Abuse Regulation and Central Securities Depositaries Regulation.

Risk Management

KRIS models updated

Kamakura Corp has updated its Kamakura Risk Information Services (KRIS) models. Version 6.0 of the offering includes what the firm describes as a state-of-the-art Jarrow-Chava reduced form model, a modern implementation of the Merton model and a Jarrow-Merton hybrid model in the reduced form model framework. The KRIS version 6.0 models were in development for four years and reflect the full credit crisis experience and its aftermath.

Kamakura founder and ceo Donald van Deventer comments: "The new version 6.0 KRIS models raise the level of accuracy of the models to new heights, thanks in large part to suggestions and advice from the many KRIS clients world-wide."

Risk Management

Risk-weighted assets report released

The Basel Committee on Banking Supervision has released findings from a hypothetical test portfolio exercise to examine variability in banks' modelling of derivatives. The report focuses on the internal model method (IMM) and advanced credit valuation adjustments (CVA) risk capital charge for OTC derivatives trades.

The Basel Committee's report analyses the variability of risk-weighted assets outcomes, highlights good practices and identifies areas where additional attention from banks and supervisors is required to mitigate unwarranted RWA variability. It aims to support implementation and supervision of counterparty credit risk (CCR) models.

The results show considerable variability in the outcomes of CCR models, which is typically higher for CVA models than for IMM models. The overall level of variability is similar to the variability of other market risk model outcomes observed in previous exercises. Key drivers for the variability include differences in banks' modelling choices, as well as differences in supervisory practices.

RMBS

RMBS settlement progress tracked

JPMorgan paid US$3.555bn in consumer relief to 158,107 borrowers through 31 March 2015, according to figures from US National Mortgage Monitor Joseph Smith. The settlement payments are due to claims that Chase, Bear Stearns and Washington Mutual packaged and sold bad RMBS.

JPMorgan is required to provide a total of US$4bn in credited consumer relief by 31 December 2017. JPMorgan self-reported a further US$126m in consumer relief as of 30 June.

RMBS

FNMA brings actual loss deal

Fannie Mae has completed its latest credit risk sharing transaction, CIRT 2015-3. For the second time since the credit insurance risk transfer (CIRT) programme's inception in 2014, an international reinsurer participated in the RMBS. Coverage is provided based upon actual losses for a term of 10 years.

Under the securitisation, Fannie Mae retained risk for the first 50bp of loss on a US$7bn pool of loans. If this retention layer were to be exhausted, reinsurers would cover the next 250bp of loss on the pool, up to a maximum coverage of approximately US$176.2m.

Depending upon the pay-down of the insured pool and the amount of insured loans that become seriously delinquent, the aggregate coverage amount may be reduced at the three-year anniversary and each anniversary of the effective date thereafter. The coverage may be cancelled by Fannie Mae at any time after the five-year anniversary of the effective date by paying a cancellation fee.

The reference pool for the transaction consists of 30-year fixed rate loans with loan-to-value (LTV) ratios of greater than 60% and less than/equal to 80%. The loans were acquired by Fannie Mae from September through December of 2014.

Through both its CIRT and CAS programmes, Fannie Mae has sold a portion of the credit risk on approximately 60% of recent acquisitions and on approximately US$419bn of loans in recent years.

RMBS

Greek RMBS paying 'on time'

The capital controls that the Greek government imposed in June have had no impact on the timing of interest payments for Greek RMBS, with all issuers paying noteholders on time, Moody's reports. Themeleion II Mortgage Finance was the first to successfully pay (on 13 July), while Grifonas Finance No. 1 was the last (on 28 August).

"All Moody's-rated Greek RMBS transactions paid their first coupon after the introduction of the capital controls, the forced bank holiday and the spring/summer market disruptions. Furthermore, despite Greece's fragile economic environment, portfolio deterioration has been moderate," says Carole Bernard, a Moody's vp - senior analyst.

Capital controls can affect Greek structured transactions in two ways. Administrative delays can disrupt the payments from the collection accounts to the off-shore issuer account, as time is needed to separate the interest payments from ordinary deposit transfers. Second, bank closures and restrictions on cash withdrawals can disrupt collections of interest and principal from borrowers.

The recent rise in redenomination risk from the capital controls - which could have led to deposits losing value - may have pushed borrowers to use that cash to pay down their mortgage loans, increasing the prepayments rates for Greek RMBS. Moody's prepayment index for Greek RMBS performance increased by 30% over the past six months, albeit from a low level.

"If this trend continues, it could suggest that borrowers are prepaying their loans to avoid losses in value on their deposits. High prepayment rates are positive for senior notes, as they would be allocated towards their amortisation. However, Greek RMBS performance will likely deteriorate further amid weak economic conditions, which will gradually strain the debt service capability and affordability of borrowers," explains Bernard.

RMBS

Actual loss ACIS inked

Freddie Mac has obtained another actual loss insurance policy under its ACIS programme, which is tied to its previous STACR 2015-DNA1 offering (SCI 8 April). The new transaction transfers much of the remaining credit risk associated with the deal to insurance and reinsurance companies around the globe.

The policy transfers up to a combined maximum limit of approximately US$132.5m of losses on a pool of single-family loans acquired by Freddie Mac in 4Q12. The GSE has acquired more than US$1bn in additional insurance coverage this year with six ACIS transactions and almost US$2bn since the programme's inception in 2013, according to Kevin Palmer, vp of Freddie Mac's single-family strategic credit costing and structuring.

Freddie Mac has now provided 15 STACR offerings and 10 ACIS transactions since mid-2013. The GSE explains that it has subsequently laid off a substantial portion of credit risk on more than US$333bn of UPB in single-family transactions.