Contents

Secondary markets

Euro secondary hesitant

It was an unsurprisingly quiet day yesterday in the European securitisation secondary market as participants appear hesitant to return to the fray.

As a result of the US holiday and continuing broader market volatility it was a quiet session yesterday even for a Monday. Many investors remained sidelined and appear to be waiting for some signs of broader credit stability or at the very least a first move from other participants.

Nevertheless, there continue to be pockets of activity across ABS/MBS. Yesterday saw most action around prime RMBS, but elsewhere, particularly in higher beta sectors, there was little trading and tone, if not spreads, is weakening.

Meanwhile, CLOs, and deeper mezz in particular, are still being hampered by wider market volatility and lack of price transparency, albeit with a solitary new issue pricing reasonably well on Friday. Yesterday saw a sole BWIC in the sector where its four double-B lines DNT'd and the other, a triple-B, trade but with no colour released.

There are six BWICs on the European calendar for today so far. Four are one or two line RMBS lists and two focus on CLOs, which are both due at 15:00 London time and once again involve mezz.

The smaller of the two CLO auctions amounts to €15.65m across five line items - CRNCL 2015-5X D, CRNCL 2014-4X D, HEC 2007-3X C, OHECP 2015-3X D and TIKEH 2015-1X DV. Two of the bonds have covered with a price on PriceABS in the past three months - CRNCL 2014-4X D at H97s on 16 December and OHECP 2015-3X D at M90s on 13 January.

The other CLO BWIC consists of seven line items totalling €30.7m - BABSE 2014-2X E, CGMSE 2013-1X D1, CGMSE 2013-2X C, CGMSE 2014-2X D, DRYD 2013-29X E, GLGE 1X D and SPAUL 3X E. Only DRYD 2013-29X E has covered on PriceABS in the past three months - at LM90s on 13 January.

Secondary markets

Euro secondary story unchanged

Yesterday's improvement in broader markets did not change the story in the European securitisation secondary market and this morning's macro weakness is likely to keep it that way.

"Yesterday things were a bit better overall and credit indices came in some way," says one trader. "However, little changed in our sector."

Instead, recent trends continue, the trader says. "Senior prime continues to perform well with good support and two-way flows across the board in both eligible and non-eligible bonds. Consequently spreads are stable to slightly tighter."

However, it is different story elsewhere. "Off-the-run assets are struggling," the trader says. "In particular, low CLO mezz remains under pressure and now most of the UK non-conforming space is getting a bit more difficult and liquidity is scarce, though senior 2.0s are resisting quite well."

There are currently seven BWICs on the European schedule for today. They involve ABS, CLOs and RMBS across a variety of jurisdictions and parts of the capital stack, but highlights involve the above-mentioned sectors under pressure.

The largest ABS/MBS auction is a nine line 43.186m euro and sterling UK buy-to-let and non-conforming list due at 14:30 London time. It comprises: AIREM 2006-1X 2B3, EHMU 2007-1 M1, ESAIL 2006-4X B1A, ESAIL 2007-1X C1A, GHM 2007-2X BA, GHM 2007-2X CA, GHM 2007-2X CB, PRS 2006-1X D1A and RLOC 2007-1X C1A. Two of the bonds have covered on PriceABS in the past three months, last doing so as follows: GHM 2007-2X CB at 73H on 3 December and RLOC 2007-1X C1A at MH77 on 11 November.

The biggest of the three CLO auctions amounts to €28.3m across six 2.0 mezz line items and is due at 14:00. It involves: CGMSE 2014-3X C, DRYD 2013-29X D, DRYD 2014-32X DV, HARVT 9X D, HARVT 12X C and JUBIL 2014-14X D. Only one bond has covered on PriceABS in the past three months - HARVT 12X C at 97.27 on 13 November.

Secondary markets

US CLOs light

The holiday-shortened week has not produced the usual boost to activity and volumes in US CLO secondary market continue to be light.

"Especially with the lack of primary activity you'd expect an uptick in secondary, but total visible BWIC volume is light," says one trader. "Prices are falling, which is making sellers reluctant, but month-end is coming and that will only make things worse."

The trader continues: "Hedge funds are trying to avoid taking a big hit so for now they're stuck and we're not seeing much from them. However, there is one relatively sizeable list from a hedge fund today, but I'm not sure what they expect to achieve in this market."

The remainder of the visible BWIC calendar stems from real money and is in small size. "That tells you all you need to know about current market sentiment," says the trader.

That sentiment is not helped by trends in the underlying, the trader notes. "The loan market just keeps on going down - it's dropped 10 points in the past week."

For the CLO market, the current pattern could continue for some time, the trader suggests. "The drivers behind this year's decline are different to what was behind the rallies in the past two Januarys - they were technically driven so were always going to be finite, but this decline is based on fundamentals and there is a real sense of everyone bracing themselves for worse to come."

There are currently four US CLO BWICs on the calendar for today, after a four line $29.94m 1.0 and 2.0 equity mix was postponed this morning. The largest of the lists due is a seven line $39.1m mezz and equity auction due at 13:00 New York time.

The BWIC is the one from the above mentioned hedge fund seller and comprises: ARES 2014-32A E, CVPC 2013-CLO1 E, KVK 2013-2A E, OAKC 2013-9A SUB, SNDPT 2014-1A F, SNDPT 2014-2A F and SYMP 2014-14A F. None of the bonds has covered on PriceABS in the past three months.

Secondary markets

Euro ABS/MBS turns

After two weeks of insulation from broader market volatility the positive tone in the European ABS/MBS secondary market has turned.

"It's become challenging, to put it mildly, now that macro volatility is impacting our space and drying up liquidity," says one trader. "The last two sessions have been risk off and I don't see that changing today with most investors sitting on the sidelines and bids becoming increasingly defensive."

However, the trader adds: "We're continuing to see a fair number of BWICs and while there's not a lot of colour coming from the line items that do trade the results we are seeing are mixed rather than all bad. Overall, though, secondary spreads are wider across the board."

There are five BWICs on the European ABS/MBS schedule for today so far. Three of which involve CMBS.

The largest CMBS auction is due at 16:00 London time and involves a nine line m mix of euro and sterling tranches - DECO 2014-BONA A, DECO 2014-BONA E, DECO 2014-GNDL A, GRF 2013-1 A, INTULN 4 1/4 09/17/30, RTLY 2015-1 A1, TAURS 2013-GMF1 A, TAURS 2013-GMF1 B and TAURS 2015-IT1 A. Two of the bonds have covered on PriceABS in the past three months, last doing so as follows: DECO 2014-GNDL A at 99.63 on 7 January and TAURS 2013-GMF1 A at 100.95 on 12 January.

In addition, there is a large Spanish seniors OWIC due by 14:00 today. It involves up to €80m each of 19 line items - AYTCH II A, AYTGH IX A2, AYTGH VIII A2, BCJAF 8 A, BCJAM 4 A3, BFTH 10 A2, BFTH 13 A2, BVA 2 A, BVA 3 A2, CLAB 2006-1 A, COMP 2012-3 A, KUTXH 2 A, PENED 1 A, RHIPG I A, RHIPO 6 A, RHIPO 9 A2, SABA 1 A2, TDA 29 A2 and TDAC 4 A.

Secondary markets

Euro CLOs suffer

The European CLO secondary market is suffering under heavy selling pressure.

"Activity is almost entirely driven by selling from accounts," says one trader. "The only demand we are seeing is for short-dated bonds and there is none whatsoever for 2.0 paper."

Consequently, the trader continues: "We're seeing BWIC after BWIC in the 2.0 space. However, we're seeing no colour from the lists, so levels have got to a breaking point for dealers and they don't want to disclose prices."

The trading pattern is being driven primarily by current macro volatility, but the trader suggests the trend also goes back further. "The market was weak into year-end, which was put down to the usual causes, but ever since January began people have been willing to sell CLO paper they acquired in December or November at a loss."

There is one European CLO BWIC on the calendar for today so far. Due at 14:00 London time, it involves four 1.0 line items totalling €2.4m - AVOCA III-X C, BOYNE 1X C1, LOMBS 2006-1X B and SKELL 2006-1X D.

Two of the bonds have covered on PriceABS in the past three months, last doing so as follows: AVOCA III-X C at 97.657 on 16 December and SKELL 2006-1X D at 96.97 on 23 November.

Secondary markets

Euro secondary improves

Better wider markets have improved European securitisation secondary tone once more.

A combination of a return to form in stocks/broader credit, the ECB press conference and the successful execution of the Spanish OWIC boosted the secondary market across the board yesterday and that has continued into this morning. Nevertheless, it is only the prime and ECB-eligible peripheral sectors that are receiving any pricing benefit so far.

Off-the-run bonds remain weighed down by a selling bias. However, more buyers could begin to step in if the wider recovery continues, though thus far liquidity is still very thin.

There are currently three BWICs on the European schedule for today. At 13:30 London time there is €200k each due of LEEK 17X A2C and LEEK 18X A2C. The bonds last covered on PriceABS on 19 January 2016 at 106.45 and 104.45, respectively.

At 15:30 there is a €7.5m three line CLO list, consisting of: AVOCA 15X D, CGMSE 2015-1X D and HPARK 1X D. None of the bonds has covered with a price on PriceABS in the past three months.

Then at 16:00 there is a seven line €29m CLO auction comprising: ALPST 2A E, CELF 2007-1X D, HARBM 9X E, HEC 2006-2NX D, HSAME 2007-IX D, WODST IV-X E and WODST V-A E1. Two of the bonds have covered with a price on PriceABS in the past three months, last doing so as follows: HEC 2006-2NX D at 90A on 14 January and HSAME 2007-IX D at 87 on 15 December.

In addition there is a 24 line Dutch RMBS OWIC due by 14:00. It involves up to €50m each of: ARENA 2011-2 A2, ARENA 2012-1 A2, ARENA 2014-1NHG A2, ARENA 2014-1NHG A3, ARENA 2014-2NHG A1, ARENA 2014-2NHG A2, ARENA 2014-2NHG A3, DMPL X A2, DRMP 1 A1, DRMP 1 A2, HYPEN 3 A1, HYPEN 3 A2, HYPEN 4 A1, HYPEN 4 A2, LUNET 2013-1 A2, ORANL 2015-11 A, PHEHY 2013-1 A2, SAEC 12 A2, SAEC 13 A1, SAEC 13 A2, SAEC 14 A1, SAEC 14 A2, SAEC 15 A1 and SAEC 15 A2.

Structured Finance

SCI Start the Week - 18 January

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

Pipeline
The pipeline continued to build last week as a number of new deals were added. At the final count there were eight new ABS, one ILS, three RMBS, one CMBS and two CLOs.

The ABS were: US$188.5m ACAR 2016-1; US$1.05bn Ally Auto Receivables Trust 2016-1; US$340m CPS Auto Receivables Trust 2016-A; US$750m Drive Auto Receivables Trust 2016-A; US$1.05bn Ford Credit Auto Owner Trust 2016-A; €1.47bn Siena Lease 2016-2; US$161.75m United Auto Credit Securitization Trust 2016-1; and US$663m Volvo Financial Equipment Series 2016-1.

US$200m Vitality Re VII was the sole ILS, while the RMBS were US$400m ASFR 2016-1, US$500m Home Partners of America 2016-1 and Puma Trust 2016-1. The CMBS was US$1.03bn COMM 2016-CCRE28 and the CLOs were US$400m Babson CLO 2016-I and US$500m Voya CLO 2016-1.

Pricings
The week's prints were concentrated in ABS and RMBS. There were six of the former and three of the latter.

The ABS were: US$1.2bn AmeriCredit Automobile Receivables Trust 2016-1; CNY2.79bn Driver China Three; US$340m DT Auto Owner Trust 2016-1; €663.8m Globaldrive Auto Receivables 2016-A; US$185m SolarCity FTE Series 1 Series 2015-A; and US$450m Westlake Automobile Receivables Trust 2016-1.

The RMBS were €750m IM BCC Cajamar 1, £1.55bn-equivablent Gosforth Funding 2016-1 and US$996m STACR 2016-DNA1.

Markets
A surge of US ABS issuance brought the market to life, aided by the first subprime auto ABS to hit the market since before Thanksgiving. Barclays analysts comment: "Despite the continued macro sell-off, spreads in the traditional ABS asset classes were stable or tightened week-over-week, as investors reallocated to shorter duration triple-A assets. As a result, it was a heavy week of ABS secondary market activity, with US$1.2bn traded on average each day during the first four days of the week, making it the busiest trading week since mid-October."

By contrast, secondary trading activity in the European CMBS market was subdued, as bid-lists totalled a mere US$20.4m by original face, all from CMBS 1.0 deals. "As we see it, there is limited supply of 2.0 paper outstanding, which is exceeded by the volume of investors keen to buy 2.0 paper at a price below par. Now that the would-be sellers of 2.0 have sold we do not see anyone willing to sell 2.0 paper below par," say Bank of America Merrill Lynch analysts.

Editor's picks
Finalised FRTB 'still punitive': The Basel Committee has released the final version of its fundamental review of the trading book (FRTB). While the final ruling remains punitive for securitisation, it is not as harsh as earlier drafts suggested it might be...
Distressed resolutions gather pace: January US CMBS remittance reports show that several larger loans from CWCapital's bulk liquidations have been resolved. JPMCC 2006-CB17, MLMT 2006-C1 and CD 2007-CD4 have so far been the main beneficiaries of the auctions, with the disposal of US$395m, US$231m and US$934m respectively across 60 loans...
US CLOs still searching: The US CLO secondary market is still searching for pricing clarity, but Trups CDOs are generating some interest. "We're still in an exploratory phase," says one trader. "There's a bit more activity today in terms of BWICs, but most players are still trying to figure out where things are going to go longer term. Shorter-term it's obviously difficult to ignore the macro headlines, so values are falling for now..."

Deal news
• MLCFC 2007-5 has become one of the first CMBS to report distributions from the pay-off of the US$3bn Stuyvesant Town/Peter Cooper Village loan, resulting in the largest liquidation in the market's history with no loss (SCI passim). However, Barclays CMBS analysts note that the remittance report fails to answer key questions about excess proceeds and the amount paid for a mezzanine debt settlement.
• Home Partners of America's (HPA) unique tenant-driven property acquisition and rent-to-own business strategy will benefit the performance of its first single-family rental (SFR) securitisation, Home Partners of America 2016-1, says Moody's. HPA 2016-1 hit the market on 12 January.
• XXIII Capital has launched its inaugural securitisation - a US$72.9m ABS backed by nine receivable purchases and loans tied to European football clubs. Kroll Bond Rating Agency has assigned a single-A rating to the US$64.2m of class A notes in XXIII Capital Financing I.
• Country Garden has brought a new ABS transaction to the market that packages part of its contract receivable rights, a deal that the Chinese property developer claims to be the first of its kind in the industry. The CNY2.95bn deal was issued via Zengcheng Country Garden and was approved by the Shanghai Stock Exchange on 25 December.
• In adjourned meetings, subordinate noteholders of Panther CDO III, IV and V last week passed an extraordinary resolution seeking to allow the issuers to pay legal costs in connection with a suit against Hayfin Capital Management. Class B and C noteholders of Panther CDO III and IV also passed the resolution.

Regulatory update
• A proposal by the French Ministry of Finance to modify the hierarchy of claims in liquidation during 2016 could boost the ability of French banks to issue loss-absorbing instruments, according to S&P. The agency says that the process would also subsequently protect more senior obligations.
• The US SEC has prohibited Steven Cohen from supervising funds that manage outside money until 2018 in order to settle charges that he failed to supervise a portfolio manager who engaged in insider trading while employed at his firm. Cohen's family office firms will also be subject to SEC examinations and must retain an independent consultant to review their activities.
• ISDA has voted to make a number of changes to its Credit Derivatives Determinations Committees (DC) rules. The trade organisation says the move is part of an effort to strengthen its process for determining whether a credit event has occurred in the credit derivatives market.

Deals added to the SCI New Issuance database last week:
ALM XVII; Driver China Three Trust; Globaldrive Auto Receivables 2016-A; MarketPlace Loan Trust series 2015-OD4; Palmer Square Loan Funding 2016-1; SCOF-2; STACR 2016-DNA1; Venture XXII CLO

Deals added to the SCI CMBS Loan Events database last week:
BACM 2004-6; BACM 2005-6; BSCMS 2005-PW10; BSCMS 2007-PW16; CD 2007-CD4; CMLT 2008-LS1; COMM 2006-C7; DECO 2006-C3; DECO 2006-E4; DECO 2007-E2; DECO 6-UK2; ECLIP 2006-1; ECLIP 2006-2; ECLIP 2006-4; EPIC (Premier); EPICP DRUM; GECMC 2005-C4; GSMS 2007-GG10; JPMCC 2006-CB17; JPMCC 2007-LD11; JPMCC 2008-C2; LBUBS 2006-C6; MLCFC 2007-5; MLCFC 2007-6; MLMT 2006-C1; MSC 2007-IQ14; WBCMT 2007-C32; WFRBS 2011-C4; WFRBS 2014-C21; WINDM VII

CMBS

Vulcan CMBS prospects eyed

The EuroCastle Office Portfolio in Vulcan (ELoC28) has been sold at a level sufficient to repay the securitised loan in full. Progress on the other loans securitised in the deal suggests that the class F and class G notes will suffer total losses.

The €24.9m EuroCastle loan contains six office properties in Germany and accounts for 10% of the CMBS. A full repayment of the loans should repay 52.5% of the outstanding class A note amount, which Bank of America Merrill Lynch analysts calculate will reduce the class A note factor from 0.0554 to 0.0263.

The special servicer - Mount Street Loan Solutions - declared in November 2015 that it intended to sell the 12 properties backing the Babcock French loan, although it is not clear whether that can be achieved before the CMBS's final maturity date in May 2017. If the properties are not disposed of in time there could be a note event of default. In the long term, a principal loss of 6% is expected on the loan.

A sale and purchase agreement for the Tishman German office property was signed last year at a price which would repay the securitised loan in full, but that sale is conditional on the completion of development works and other conditions and the agreement may be rescinded if those conditions are not met. The loan has been extended to 8 August and is expected to ultimately repay in full.

Enforcement proceedings are being pursued against the borrowers for the H&B Retail loan. Default interest is accruing and not being paid on the loan, although Mount Street says this is subordinate to the payment of principal on the loan, so it should not exacerbate principal losses.

In November 2015, the H&B debt was assumed by a new sponsor, Panther Grip (see SCI's CMBS loan events database), which is now the owner of the 14 properties and has a business plan to sell or refinance the properties. While the portfolio could probably be sold for a price which repays the loan, the special servicer's liquidation fee will most likely create a small loss.

Safeguard proceedings were initiated in 2011 for the Beacon Doublon loan just one month before the loan maturity date. The French commercial court ruled that the loan would remain in safeguard until 31 December 2015, although the BAML analysts have seen no update on its status and believe the property is currently worth less than the amount owed, with little time to increase value.

The analysts forecast losses of €19m for the Vulcan (ELoC28) CMBS from losses on the H&B Retail, Beacon Doublon and Babcock French loans. This would enable the class A, B, C and D notes to recover par.

The class E notes are expected to recover around 61% of principal. The class F and class G notes, however, are unlikely to recover any principal at all.

"The class F and class G notes are likely to continue to receive coupons until they are written down by principal losses realised in May 2017, in our view," comment the analysts.

JL

RMBS

FHLB rule impact gauged

The FHFA has released a final rule which amends its guidelines for Federal Home Loan Bank (FHLB) membership. The rule adds to the woes of leveraged RMBS investors by excluding captive insurers from the list of entities eligible for FHLB membership.

An increasing number of new members over the last few years have been reeled in by the temptation of low-cost, reliable funding from the programme. In addition, FHLB members are not subject to the same capital and reporting requirements as repo dealers.

Many of the new entrants come from subsidiaries of mortgage REITs and hedge funds that would otherwise be ineligible. In total, the FHLB has admitted 27 new captive members since mid-2012, 20 of which would now be ineligible under new membership rules.

To minimise disruption to current members and to the FHLB system, the new rule will allow captive insurer members that joined prior to its proposed changes in September 2014 up to five years to terminate their membership. For those captive insurers that joined after this date, the rule will allow them to remain FHLB members for another year.

Repo funding for REITs has been slowly drying up since 2013, but Barclays analysts saysthat the new rule will likely only have very limited effect on agency RMBS in the base case. The mortgage REIT market is already small to begin with, standing at only 5% of total agency RMBS holdings. In addition, only 42% of REITs fall under the one-year grace period - with about 9% of their funding sourced from FHLB lines - adding up to about US$9.5bn in FHLB funding as of 3Q15.

Assuming an expansion of these FHLB lines in 4Q15 in accordance with prior quarters would still only see an additional US$7bn of FHLB funding accumulated by year-end. This would translate into roughly US$17bn of total advances from the FHLBs. In addition, the analysts believes that some of the FHLB funding will be replaced by other repo providers, albeit at a slightly higher rate, thus reducing the risk of forced deleveraging.

However, a greater risk to mortgage REITs could lie in the potential for dealer repo providers to continue shrinking their balance sheets, possibly forcing some asset sales out of REITs. These FHLB lines have been considered so far to be a form of insurance in the event of disruption in regular repo funding levels. In that context, this increases the tail risk of forced sales from REITs in the event of further declines in repo availability.

"There are more negative developments on the repo front lined up for the rest of the year. European banks currently managing leverage ratios to quarter-end reporting will move to daily average reporting by Q3. Additionally, inter-bank (Chase - BONY) GCP is also going away on July 1, which may have further effect on repo availability and pricing. Finally, bank balance sheet positioning into rising short rates may also play a role in dictating repo availability," say the analysts.

The new FHLB rule will become effective 30 days from publication in the US Federal Register.

JA

RMBS

Oil slump is CRT concern

Oil prices last week hit their lowest mark for 12 years, with significant implications for CRT deals. Should oil prices remain depressed over the coming quarters, Barclays analysts expect the underperformance of oil-affected areas to worsen.

Oil prices began to fall in 2H14 and have been on a downward trajectory for much of 2015-2016. While oil areas had been outperforming the rest of the country in terms of always current-to-delinquent rolls up until 3Q14, when the price of oil started to fall, so did the performance of these areas.

"While the data remain somewhat noisy and still relatively well controlled in absolute terms, we believe that continued lower prices will likely start to affect jobs," say the analysts. Eventually, default rates will also be affected.

The analysts add: "Oil areas underperformed across most seasoning buckets. This seems worst for the most seasoned loans, with 24-30 WALA loans running at close to twice the roll rate in oil-affected areas, but the data in this bucket are somewhat sparse."

House values shot up in oil areas over the last few years, so there are currently very few loans in the low LTV CRT deals with updated LTVs above 80%. Looking only at rolls for below-80% updated LTV, oil-affected regions have underperformed meaningfully across the board, with some further worsening at higher LTVs.

Roll rates for oil areas below 35% DTI were well constrained below 1bp and were in fact even lower than non-oil areas across the 25%-35% bucket. However, leverage to DTI increases sharply for oil areas where DTI is above 35%, driving the roll rate of loans with 40%-45% DTI to 5.3bp, compared to only 2.3bp for non-oil areas.

"If the oil prices stay at current levels or drop even further for a longer time, we would expect higher collateral loss in CRT deals," say the analysts. "The deals with the heaviest concentrations have 7-8% exposure, and most deals with the heaviest oil exposure are high-LTV deals. With the high oil exposure and amplified negative effect due to the high LTV, the default risk in these high exposure deals could be much higher than base case scenarios."

The analysts predict that the B tranches in these deals would take the highest loss. Even M3s would not be spared from the headline risks and could see widening, should the prolonged oil crisis drag the default rate low enough.

"In general, we maintain our strongest recommendations on the seasoned last cash flow bonds, and while we believe that the new issue rated M3s and M2s continue to offer attractive spreads, there could be some near-term adverse effects if the oil and gas producing regions continue to worsen," say the analysts.

JL

Structured Finance

Alignment of interest

Marketplace lending regulatory scrutiny discussed

Representatives from Kaye Scholer, Fundation Group and PeerIQ recently discussed the impact of heightened regulatory scrutiny on the US marketplace lending industry during a live webinar hosted by SCI (view the webinar here). This Q&A article highlights the main talking points from the session, including the fall-out from the Madden versus Midland Funding ruling and the US Treasury's request for information on the sector. For an in-depth exploration of the European marketplace and direct lending landscape, attend SCI's alternative lending and securitisation seminar on 10 February.

Q: The Madden vs Midland Funding case hit the headlines in May 2015, when the US Court of Appeals for the Second Circuit ruled that a non-bank debt collector that purchased written-off credit card accounts from a bank could not rely on the pre-emption of State usury laws. If interpreted broadly, the decision could affect a wide array of bank-originated loans that are subsequently sold to non-bank entities. How is the Madden case expected to impact the marketplace lending industry specifically?
Lawton Camp, partner at Kaye Scholer: A typical marketplace lending structure involves a national bank or federally chartered institution originating loans based on criteria established by the bank and the marketplace lender. The bank transfers that loan to the marketplace lender or to investors that are funding the loan after a certain period of time has passed.

Pursuant to the National Bank Act and Section 27 of the Federal Deposit Insurance Act, a bank that is federally insured may impose fees in accordance with the usury laws of the State in which it is located. Web Bank, for example, is located in Utah; therefore, you would look to Utah's usury law - regardless of the location of the borrower. Before Madden, it was assumed by marketplace lenders and investors that if the loan was enforceable at the time of issuance, it would be enforceable by any subsequent assignee.

The Madden case involves a collection action with respect to a charged-off credit card account. The credit card was issued by a bank in Delaware related to Bank of America. The charged-off account was purchased by Midland Funding, who attempted to collect on the outstanding balance. Midland continued to charge interest on the outstanding balance after it purchased the charged-off account at the original default rate.

Madden sued in the District Court of New York, claiming - among other things - that as Midland isn't a bank, it may not rely on the federal pre-emption relied on by the Delaware bank. This pre-emption had allowed the Delaware usury laws to be exported to New York, where Madden resided.

The District Court upheld the exporting of the interest rate, but the Second Circuit subsequently overturned the ruling and stated that once the Delaware bank had sold the entire account to a non-bank, the non-bank holder of the account could not rely on the federal pre-emption relied on by the Delaware bank. However, the Second Circuit remanded the case to the District Court to determine whether the law of the State of the consumer or the governing law of the underlying contract would apply.

In the context of marketplace lending, the decision creates concerns by non-bank holders of marketplace loans that they may not be able to enforce collection on a loan if the interest rate on the loan is above the relevant State usury rate.

Henry Morriello, chair of the finance practice at Kaye Scholer: The Madden ruling has the greatest impact in the consumer sector, where civil usury limits come into play. The ruling has implications for everyone involved in marketplace lending, especially as loans move from platforms to investment vehicles to securitisation vehicles. It has precipitated a good deal of proactive structuring to allow issuers to get comfortable that the ruling won't interfere with cashflows, nor subject them to any sanctions.

LC: With respect to Madden, the district court will need to determine which State usury rate applies. Beyond the specific facts in Madden, the appropriate State usury limit may depend on the law of both the State where the loan was originated and the State in which the borrower resides. It will be interesting to see if the Supreme Court decides to review the decision.

Kevin Reed, coo and evp at PeerIQ: Most platforms and institutions appear to be adopting a 'business as usual' attitude, at least with respect to the primary market - in other words, purchasing loans from platforms. Most participants feel that the Madden ruling is a questionable decision and contrary to precedent.

Nevertheless, there is a sense that sponsors have a fiduciary duty to exclude Second Circuit loans from securitisations, given the potential risk of discharge. With respect to warehouse lines, some credit providers are asking for covenants that exclude loans originated within the Second Circuit - either full exclusions or only those loans that are in excess of the usury rate.

Marketplace lending securitisation is a non-standard, nascent industry. Representations and warranties aren't standardised and most sponsors don't have long histories, and Madden has brought the specter of unenforceability. But we haven't seen any movements on existing securitisations yet and there isn't a secondary market, so we can't tell how the potential legal risk of Madden is being priced in.

The impact could worsen if the decision is adopted by other States, but at the moment it is somewhat contained - assuming the attributes of warehouse lines and so on remain unchanged. We are yet to see a slow-down in originations; nor have we seen a specific move away from lower FICO originations.

The actual impact of the ruling within the Second Circuit has been marginal. In terms of Lending Club and Prosper originations, only 3% of their loans within New York, Vermont and Connecticut have interest rates above State usury caps.

Q: What are the ramifications of the Madden decision being adopted by other States?
KR: It would likely have the biggest impact on California, which is the largest market in terms of marketplace loan originations. While New York has a 16% usury rate, for instance, California's is 10% - meaning that three-quarters of consumer loans originated in the State would be affected by the ruling. However, there is a precedent in California that runs fairly contrary to Madden and so there is a bit of a 'wait and see' approach at present.

LC: A number of other States also have precedents that are the contrary to Madden. But there are cases in other States, such as West Virginia, that are not as favourable.

HM: Generally speaking, usury is a matter controlled by State law and, therefore, the outcome of situations like the Madden case will likely vary State-to-State. For States that have adopted the Uniform Consumer Credit Code (UCCC), the law of the State in which the consumer resides will generally control. However, in States that aren't subject to the UCCC, a further analysis must be made as to whether the controlling law will be the law in which the consumer resides or the governing law of the contract.

Against this backdrop, during the aggregation phase prior to tapping the capital markets, various provisions are being inserted in financing documents for loans to become ineligible if Madden spreads to jurisdictions beyond those located in the Second Circuit.

Q: How can the industry gain clarity around 'true lender' status of online lending platforms?
Samuel Hu, evp - head of legal, compliance and operations at Fundation Group: There are three ways that the industry can potentially gain clarity around the issue that the Madden case has raised.

The first is for a platform to become the 'true' lender; in other words, the platform would actually originate the loans in the first place. This solution would typically require each platform to obtain licences in each State that they want to lend in and then abide by the applicable State laws, including any usury limits in those States. But sometimes the usury limits may be too low to be a viable option, based on the borrowers they are trying to attract, or the licencing requirements may be too difficult or costly to satisfy.

The second option is to simply do nothing and wait to see what choice of law the District Court ultimately applies in the Madden case. If the District Court determines that Delaware law applies, there may be less scrutiny around the issue since there is no criminal usury law in Delaware. Marketplace lending platforms may also just wait to see if a Supreme Court ruling brings more clarity, given the fact that there is substantial precedent that is contrary to the Second Circuit's decision in Madden.

The third approach could involve an industry response to develop a standardised set of policies and procedures that need to be adopted by an 'originating bank' (such as WebBank), so that it would be clear that the originating bank is in fact a 'true lender' and, as such, can rely on laws such as the National Bank Act and Section 27 of the Federal Deposit Insurance Act. Such policies and procedures could require the originating bank to conduct its own know-your-customer (KYC) due diligence on each borrower, a credit analysis of each borrower and/or require the originating bank to retain the risk of each loan that it originates for a certain length of time.

Q: The Madden case has focused attention on reps and warranties and enforceability in connection with marketplace lending securitisations. What should investors look for when assessing these features?
SH: The Madden case focuses on one particular representation and warranty; that is, whether the underlying receivable is enforceable with respect to the borrower. If it is unclear as to whether or not the securitised receivables are enforceable, investors should focus on the remedies available to them if the enforceability representation turns out to be invalid.

The remedies available in a typical securitisation include a put-back right or an indemnity claim against the platform. However, remedies are only as good as the ability of platforms to honour them.

Many smaller or less capitalised platforms may not have the capital to remedy significant put-back claims or honour indemnity provisions. Consequently, investors need to analyse both a platform's practices to gauge whether there may be an issue regarding enforceability or the loans and a platform's ability to provide adequate remedies in the event that there is an issue.

Q: Regulatory scrutiny of the marketplace lending model increased in July 2015 when the US Treasury issued a request for information aimed at ensuring both that the industry grows in a safe manner and that Treasury officials fully understand it. How has this RFI been received by the industry?
KR: The context in which the RFI was introduced was that the Treasury is gathering information and isn't contemplating any additional regulation. The primary focus is how marketplace lending can address underserved credit markets and how the technology can be leveraged for more efficient underwriting and better borrower penetration.

The slowest recovery has been in consumer and small business lending. The Treasury sees P2P lending as a great way of plugging the gap, but it wants to ensure that the sector grows in a responsible way.

A primary topic of the debate is how to create alignment of interest in a way that doesn't kill innovation. This has spurred a lot of discussion about risk retention and how it would affect platforms that don't have balance sheets.

There may be ways of partnering up with another institution to satisfy risk retention requirements, but it may also force many lightly capitalised platforms out of business. Such consolidation is probably premature, however.

Our view is that there needs to be alignment of interest, but it doesn't have to be in the form of risk retention. Many alternative mechanisms could be used; for example, standardisation of data in a useable format is a great source of alignment of interest.

Q: In its RFI, the Treasury asked if marketplace lending platforms should be required to have skin in the game for the loans they originate. How is this issue likely to play out?
HM: Our view is that there needs to be alignment of interest among participants in the market, but that the Dodd-Frank provisions are adequate to cover ABS investors that aren't 'at the table' to negotiate risk retention into their own contracts. Generally under these provisions, the sponsor in a securitisation is required to hold 5% of the risk associated with the ABS.

That 5% can be achieved in various formats - through a horizontal tranche, a vertical tranche or an L-shaped tranche, which is a combination of both the horizontal and vertical tranches. The idea is to encourage sponsors to issue responsibly because they're retaining 5% of the risk.

Marketplace lending securitisation participants generally include the originating bank, the platform, the aggregator (which buys the loans from platforms to then securitise) and the ABS issuer (which is normally an affiliate of the aggregator). The view of many trade organisations is that these parties are able to negotiate for themselves the appropriate level of risk that they should take and that regulation isn't necessary to protect them.

SH: The skin-in-the-game question primarily arises where the platform itself simply facilitates a loan, but never holds any part of the risk. It's debatable whether that kind of business model will ultimately be successful, given that it only allows platforms to earn fees from origination and servicing, but no interest income.

Based on the financial information that is publicly available, it is clear that in order to be profitable, platforms that rely only on origination and servicing fees for revenue need to operate on a large scale. On the other hand, platforms that originate and hold assets on their own balance sheet clearly have skin in the game. My view is that the skin-in-the-game question might be a little premature to ask from a regulatory perspective, as it could resolve itself in how the marketplace lending industry develops and what business models ultimately prevail.

Q: Given the heightened scrutiny of the sector, how should investors in marketplace loans and related securitisations assess the regulatory risks of holding these assets?
SH: Apart from enforceability of the underlying assets and the related issues, other regulatory risks that could be concerning for investors include reputational risk - whether they want to be associated with an industry that typically charges high interest rates (albeit with the intent of providing credit to underserved borrowers) and offers products that may be in some people's view predatory. Another risk is information security: to the extent that investors obtain personal information on underlying borrowers, they need to ensure that they adequately protect this information, so that the data isn't leaked or accessed fraudulently. Investors also need to ensure that platforms are complying with KYC/AML requirements so that they are not inadvertently participating in any illegal activities.

Q: How can marketplace lending platforms differentiate themselves in light of heightened regulatory scrutiny?
KR: While many larger incumbents are based on a P2P model, newer players are adopting a balance sheet model and obtaining funding for their loans from a number of large institutions. Increasingly platforms are embracing other methods too.

Many are trying to grow rapidly, so it's about how they can differentiate their capital markets strategy - especially in terms of securing long-term, stable and passive funding. There is a lot of retail interest in the sector at the moment, but that money can be fickle, so platforms are considering which mechanisms and products can allow institutions to hold marketplace investments through a credit cycle - whether that would be via risk transfer or owning particular parts of a security.

Capital markets strategies are driven by how platforms can achieve the lowest cost of capital. If they have a lower cost of capital than their competitors, they can offer better rates to the end-user and originate loans more efficiently.

SH: Platforms can also differentiate themselves by highlighting which steps they're taking to go above and beyond what's necessary from a regulatory perspective. For example, although there is no specific stipulation regarding data security, a marketplace lending platform can adopt guidelines published by the Federal Financial Institutions Examination Council and design their IT infrastructure accordingly. Other examples include employing specialised anti-money laundering officers to identify suspicious activity and adoption of robust compliance management systems to address issues such as fair lending and consumer complaints.

SCI's Marketplace, Direct Lending & Securitisation Seminar is being held on 10 February at The Royal College of Surgeons of England, 35-43 Lincoln's Inn Fields, London. The conference programme consists of panel debates covering the investor perspective, risk management and underwriting, bank partnerships, structuring and credit considerations, regulatory challenges, disintermediation and lending strategies.

Speakers include representatives from: Beechbrook Capital Partners, BNP Paribas Investment Partners, Bondora, Chenavari, Crowdnetic, East Lodge Capital Partners, ESF Capital, EuroCredit Exchange, 400 Capital Management Europe, GLI Finance, Godolphin Capital, Liberum, Proventus Capital Partners, Ratesetter, Venn Partners, Victory Park Capital, Whitehorse and Zopa.

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

Structured Finance

Mid-market platform bolstered

Kayne Anderson Capital Advisors has hired James Hunt as managing partner and ceo of its middle market credit platform. He will lead this arm of the asset manager as it continues to provide debt capital solutions to mid-market clientele with first and second lien secured debt, last-out financing, unitranche and mezzanine financing.

Previously, Hunt was the founding chairman, ceo and cio of THL Credit and THL Credit Advisors. Prior to that he was co-founder, managing partner and ceo of Bison Capital. Hunt has experience across high yield investments, including CLO management and structured finance.

Structured Finance

BlueCrest fund changes management

JPMorgan is set to take over the management of the US$1.2bn BlueCrest AllBlue Fund, which will pave the way for it to invest into a hedge fund managed by Highbridge Capital Management. The move follows the announcement last month that BlueCrest Capital Management will transition to a private investment partnership and return to clients the US$8bn that it currently manages (SCI 2 December 2015).

The proposed move to hand its mandate to JPMorgan and subsequently invest in Highbridge comes after the BlueCrest AllBlue Fund reportedly received a significant number of approaches from third-party investment managers to take on the management of its assets. The appointment of JPMorgan will be subject to shareholder approval as part of a broader re-organisation. BlueCrest AllBlue Fund says its shareholders will be able to receive a full cash exit at net asset value (NAV) less costs, with the intention to introduce a quarterly redemption facility for up to 20% of the prevailing NAV of the company.

Structured Finance

Magnetar poaches SF pro

Aidan McKeown has joined Magnetar as part of its fixed income team, focusing on structured credit and specialty finance investments. He joins after a stint as director at Lloyds. McKeown has also been a structurer at StormHarbour, as well as working in derivatives and structured products as an associate at Linklaters.

Structured Finance

Risk manager switches shops

Fitch Solutions has poached Justin Revelle from Moody's Analytics to serve as regional business manager for the Americas. In this role, he is responsible for strategic growth initiatives and sales support in North America and Latin America, and will report to md and global product head Brian Filanowski.

Revelle undertook a number of roles for Moody's, most recently focusing on fixed income regulatory and risk management solutions. He has also worked in the fixed income division at Morgan Stanley.

CLOs

Manager invests in structured experience

Alberta Investment Management Corporation (AIMCo) has strengthened its relationship with DFG Investment Advisers through the acquisition of a minority ownership stake in the asset manager's holding company. DFG's expertise is in structured credit and leveraged corporate debt markets and has an institutional client base in North America and Asia.

CMBS

Multifamily expert added

Walker & Dunlop has beefed up its multifamily finance group by hiring Hal Reinauer as vp. In this role, he will focus on originating Fannie Mae and Freddie Mac loans out of the firm's Boston office.

Reinauer moves from his role as director at Holliday Fenoglio Fowler, where he similarly concentrated on multifamily financing. He also previously served as an originations director at Arbor Commercial Mortgage and senior underwriter for Fannie Mae.

Insurance-linked securities

ILS portfolio manager tapped

Butch Agnew has been brought in by Tokio Solution Management as vp, ILS portfolio management. He moves from Dyna Management Services, where he was also vp, and has previously held other senior roles at AQR RE Management, Aon Risk Solutions and ATB Financial.

ABS

UK card performance 'strong'

The collateral performance of transactions in S&P's UK credit card ABS index remained strong on the back of economic growth in 3Q15, says the rating agency. The UK economy's growth exceeded any of the G7 or large European economies' growth over the past two years.

Charge-offs increased from 2.9% in 2Q15 to 3.1% in 3Q15, which S&P attributes to a one-time acceleration by an issuer rather than an industry-wide trend. Charge-offs were generally stable year-on-year.

Delinquencies fell during the quarter from 2% to 1.8%, suggesting that overall credit quality continues to improve. The payment rate declined from 21.5% to 21.3% and is down from 22.7% year-on-year.

ABS

Prime auto LTV losses compared

Pools of prime US auto loans with high LTV ratios perform more than three times worse on a cumulative net loss (CNL) basis than those with low LTVs, Moody's reports. Average LTVs in auto loan ABS deals issued since 2010 have been generally low too, but losses could rise as competition in the auto lending industry increases and props up the average.

Moody's notes that the lifetime CNL of high-LTV loan pools is on average 3.7x higher than that of low-LTV loan pools. Further, losses on high-credit-tier, high-LTV loan pools - while quite low on an absolute basis - are 6.1x higher than losses on high-credit-tier, low-LTV loan pools.

In contrast, lower credit quality pools are far less sensitive to increases in LTV. Low-credit-tier, high-LTV loan pools incur losses that are 2.5x higher than losses on low-credit-tier, low-LTV loan pools.

Moody's says that the vulnerability of high LTV loans to increased loss probability is explained in a sample 100% LTV loan, which reaches positive equity in the agency's study when the loan balance crosses below the vehicle market value in its 38th month. In comparison, a 90% LTV loan reaches positive equity in 30 months, leaving eight additional months in which the 100% LTV loan can default with negative equity and experience a loss.

Nonetheless, despite the competitive auto loan market, LTVs remain steady in auto loan ABS deal. The LTVs of the prime issuers, Ford Credit and Ally Bank, have remained stable at around 95%, while LTVs for subprime issuers AmeriCredit Financial Services and Santander Consumer USA continue to be in the 110% to 113% range.

However, although average LTVs in auto loan securitisations have held flat, the LTV distribution of loans in some pools has become more barbelled. To maintain stable average LTVs, some issuers have securitised loans with lower LTV loans along with loans with higher LTVs. The risk of barbell securitisations are high though, due to the overall average higher percentage of high LTV loans.

ABS

Marketplace ABS guidelines provided

Marketplace loans are "the most exciting securitisation asset class to emerge since credit cards and student loans," says K&L Gates. The law firm has drawn up a report with 10 guidelines which market participants should keep in mind.

First, the report notes that it is important to be aware of how marketplace loan securitisations can differ from other ABS. One way a marketplace loan ABS can differ is in terms of repurchase obligations, because the online lending platform often retains recourse only in very limited circumstances. This means that the sponsor may not be able to look to the marketplace lending platform or the originator to satisfy repurchase demands.

While marketplace loan securitisations have the attributes of a fixed-income security with a relatively low default risk, there are issues around consumer protection laws and assignee liability. Platform bankruptcy, violations of lending laws and the potential unavailability of federal preemption of state usury and consumer protection laws should also be considered.

The second major consideration is whether a marketplace loan ABS should be rated. Ratings are useful in lending an asset class authority and so making it more investable, but there are significant costs involved in employing a rating agency as well as large time and effort commitments in gathering and disclosing the required information.

Other considerations are also applicable to securitisations generally. The report underlines the importance of making the deal bankruptcy remote to de-link the risk inherent in the assets from the operating and credit risk of the sponsor, as well as the importance of a deal being SEC compliant.

The report's fifth note is that US platforms will need to hold skin in the game when the SEC's credit risk retention requirements become applicable to marketplace loan securitisations. Any marketplace loans securitised after 24 December 2016 will have to comply with credit risk retention requirements under Section 15G of the Securities Act and Rule 15G.

Regulation is also the key consideration for the sixth guideline, which refers to disclosure to the SEC, and the seventh guideline, which relates to the JOBS and FAST Acts, which concern whom securities can be sold to and the provision of a non-exclusive safe harbour for private resales of securities.

The eighth consideration is also regulatory and concerns Regulation AB, which addresses the registration, disclosure and reporting requirements for ABS. For a marketplace loan ABS it may be advisable to use Regulation AB as a template for disclosure on the basis that it provides a standard of the SEC's view of what constitutes material disclosure, says the report.

The ninth guideline concerns the Volcker Rule, under which bank investors cannot have an ownership interest in an SPV if it is considered to be a covered fund (SCI passim).

The final guideline covers the importance of the Madden ruling, which creates a risk that the effective rate of interest on marketplace loans that have not been originated by a bank or licensed lender affiliate of the marketplace lending platform may be capped. This risk can be addressed through representations and warranties and repurchase obligations and may also be mitigated through structural features such as initial over-collateralisation.

Structured Finance

STS securitisation supported

The European Economic and Social Committee (EESC) has added its voice to calls for the introduction of a simple, transparent and standardised (STS) securitisation regime in Europe. It says securitisation can still be a secure system and can create growth through the unlocking of additional credit.

"The risks involved in such transactions should now be clearly understood and responsibilities well established before launch, following the whole chain from the issuer to the investor. This will unlock significant credit potential, representing an additional amount of credit of €100bn-€150bn, and growth opportunities for households and SMEs who currently suffer from reduced access to bank funding," the EESC says.

However, the EESC says securitisation should not be targeted at small investors and consumers. It is requesting a formal, explicit prohibition against this to be included in legislation.

Structured Finance

Europe credit conditions surveyed

The European securities financing and OTC derivatives markets saw less favourable credit terms being offered to counterparties between September and November 2015, according to the ECB's latest survey. Respondents cited less favourable price and non-price credit terms, with hedge funds particularly suffering.

The maximum amount and maturity of funding in securities financing transactions have decreased for many types of collateral, and was most evident where government bonds and high-quality corporate bonds were used. Meanwhile, the use of central counterparties has increased somewhat.

However, the market also saw an accelerating deterioration in market liquidity and functioning, with the issue pervading across many types of collateral. The survey also finds that banks have decreased their market-making activities over 2015 and expect further cutbacks this year. Compared with previous years, fewer banks characterised their ability to make markets in times of stress as 'good', while more characterised it as only 'moderate'.

Structured Finance

China, India seeking alternative finance

The development of domestic securitisation markets in India and China can boost the countries' financial systems and help serve affordable credit to underprivileged areas that are often excluded from the conventional banking system, reports Moody's. In particular, the rating agency highlights the importance of non-bank finance companies (NBFCs) in serving such segments of society by combining securitisation with their ability to offer more tailored and flexible products.

"In both countries, in this context, NBFCs are key providers of credit to individuals and small businesses that would otherwise have limited access to bank loans or would incur high interest costs for such loans," says Moody's avp Georgina Lee. "While there are various funding avenues open to NBFCs in India and China, securitisation has proven to be reliable and competitively priced, and is therefore an important source of the funds the NBFCs use for lending."

Among the advantages, NBFCs have quick turnaround times from loan application to disbursement. They are also recognised for their strong knowledge of local industries and submarkets, as well as the ability to understand the credit profiles of their borrowers - despite a lack of information - who would otherwise be ineligible for bank loans. This enables financially weak businesses to access cost-competitive funding.

Moreover, Moody's says that, as repayment of securitisation notes rely on the asset pool instead of repayment capability of the originator, securitisation could offer lowly-rated originators an opportunity to issue transactions at a higher rating and lower costs than unsecured borrowings.

Securitisation is already beginning to have a positive effect in both India and China. The Reserve Bank of India in September 2015 granted approval to 10 entities - including eight micro-finance institutions (MFIs) - to operate as small finance banks. With the aim of promoting financial inclusion to under-served segment, these small finance banks will accept deposits and extend credit to marginal farmers and small business units.

Moody's notes that securitisation will continue to be instrumental for these small Indian finance banks, as it will take time for them to develop a retail deposit franchise. At the same time, NBFCs and MFIs will continue to fund through securitisation as the sector grows.

In comparison, innovative transactions in China have enabled smaller scale small loan companies to capture competitive capital market financing opportunities. This is irrespective of the size of their balance sheet or the volume of their business.

Moody's stresses, however, that the dynamics are uniquely different for the two countries. In India, there are regulatory requirements in the form of the priority sector lending targets that the Reserve Bank of India has imposed on banks, thereby continuing support for the uptake of securitisations issued by NBFCs. Such a regulatory mandate on the investor-side of securitisation is absent in China though.

Structured Finance

APAC ratings stable

Structured finance transactions remained stable in Japan, Australia and New Zealand in 4Q15, according to Fitch. The agency affirmed 210 APAC tranches during the quarter, with one upgrade and two downgrades.

Of the affirmations, 188 from 65 transactions came from Australia and New Zealand. Six of the affirmed ratings were simultaneously withdrawn as an Australian RMBS warehouse was restructured. Fitch says that a variation of strong and stable asset performances in the two countries reflected the local economic environment, which has seen positive market outlooks, continued property price appreciation and stable interest rates helping reduce volatility in mortgage performance.

The sole upgrade was given to the class D notes of L-MAP One Funding and reflected growth in credit enhancement. The downgraded notes were the A2s and ABs in Interstar Millennium Series 2005-3E Trust, where remedial action following the downgrade of the currency swap provider, RBS, was not in line with current Fitch criteria.

Meanwhile, an account bank for eight Japanese structured finance transactions was downgraded in December. Under Fitch's counterparty criteria for structured finance, account banks rated below single-A and F1 are deemed ineligible to support notes rated triple-A, thus placing the relevant notes in affected transactions at risk of downgrade.

Structured Finance

Swaps allow for higher ratings

Cross-currency swaps that mitigate the effect of foreign exchange controls have enabled Moody's to assign ratings above the applicable foreign currency bond ceilings to foreign currency-denominated securitisation transactions, says the rating agency. Without these features such ratings would not be attainable.

"To mitigate the transferability and convertibility restrictions, an offshore swap counterparty typically receives local currency payments from an onshore issuer, and pays the requisite amount of foreign currency into an offshore bank account," says Moody's svp Jose de Leon.

"Since the counterparty is located offshore, its payments are not affected by foreign exchange controls that may otherwise prevent the issuer from servicing its foreign currency debt," he adds.

Without cross-currency swaps that mitigate the effect of exchange controls, the ratings of foreign currency securities are constrained by the applicable foreign currency bond ceiling. The imposition of exchange controls in an issuer's home country may affect its ability to service its foreign currency securities. Exchange controls may also require the issuer to repatriate any foreign currency that it holds offshore, says Moody's.

The offshore bank account to which the swap counterparty makes its payments is typically under the control of an offshore trustee, as one way of mitigating the risk of repatriation by the issuer. Legal arrangements that seek to restrict an issuer's rights as an account holder are governed by an appropriate foreign law rather than the law of the issuer's home country.

Structured Finance

Global SF growth predicted

The global structured finance market could reach up to US$2trn by 2020, according to a report by market research firm Technavio. This would see an annual growth rate  of over 16% between 2016 and 2020.

The report shows that asset performance and regulatory initiatives in the US and Europe have heightened the issuance of structured finance products. In particular, credit cards and auto loans are expected to rise over the forecast period.

"A strong focus on the ECB's asset purchase program should help restore investor confidence and help them diversify their portfolios," says Bharath K, lead research analyst at Technavio. "This should generate higher yield for investors over the next four years. We also expect the issuance of CLOs and SMEs to continue to grow in the coming years."

In line with its growth, the European market in particular is expected to evolve to different products, such as project financing tools. The report suggests that corporate borrowers will likely undertake structured and secured financing techniques to avoid long-dated loans for large corporations, as well as the top vendors.

CDS

Novo Banco meeting set

ISDA's Determinations Committee will reconvene on 19 January to further discuss the Novo Banco potential credit event. The Committee failed to reach a conclusion last week over the conundrum and subsequently sent the process to external review (SCI 14 January).

CLOs

CLO structural tweaks emerging

Moody's expects more multi-currency deals to emerge within the European CLO market in 2016, with sterling-denominated exposures becoming the preference. The agency also predicts that new CLO structures overall will adapt to market changes in a strong fashion.

For example, many of the new structures will share similar characteristics to their 2015 counterparts, with subordination likely to remain around 41% - compared with 33% for 1.0 deals at their origination. In addition, Moody's believes that ramp-up, trading and reinvestment provisions for new deals will also resemble earlier 2.0 vintages.

Limited collateral supply is a risk in forcing CLOs to overpay or move down the credit scale. Nonetheless, established managers are expected to keep issuance stable, while new entrants are also expected in the market. Moody's says that European CLO debutants or re-entrants will mostly be confined to larger name US firms that are seeking the opportunity to scale economies and diversify their revenue streams.

In contrast, US CLOs issuance is expected to drop, driven by sparse loan supply and the consolidation of certain managers feeling the effects of risk retention. The former issue follows on from a 28% contraction in 2015 of leveraged loan issuance.

However, credit quality is expected to remain strong in US CLOs, while riskier instruments could also make a push. Typical portfolios should remain with at least 90% first-lien senior secured loans, but an increasing excess spread in a low-yield environment could spurs riskier assets to pop up, such as SME credits, last-out loans and lower-rated loans.

In China, Moody's predicts a similar issuance volume to 2015 - which stood at CNY202bn on 30 September - while noting that rural and city commercial banks should continue to be the core CLO originators. The agency believes that the rest of Asia will also continue to perform well, owing largely to low corporate default rates and continued regional diversification.

CLOs

CLO issuance set to drop

The pace of new US CLOs coming to market could be set to decline as looming risk retention takes a stranglehold, according to Fitch. The rating agency's observation comes despite a December flurry which saw 15 new deals.

However, new issuance overall for 2015 was down from the previous year, at US$93.1bn in 2015 from US$116.2bn in 2014. There are also fewer managerscoming to market with new deals as a total of 28 managers who issued new deals in 2014 did not return again in 2015.

Approximately 65% of Fitch-rated CLOs in 4Q15 were either explicitly risk retention compliant or the manager or its affiliate at least had 5% 'skin in the game'. The remaining CLOs were issued by managers that investors viewed as having a high likelihood of satisfying risk retention when necessary.

"Any organisational structure changes and any risk retention financing that may transpire will be more closely scrutinised as more CLO managers seek to comply with the forthcoming risk retention rules," says Fitch senior director Derek Miller.

CMBS

Hudson loses another anchor

Hudson Valley Mall is set to lose another anchor chain when Macy's closes shop in April 2016. Kroll Bond Rating Agency warns that the regional shopping mall in Kingston, New York, is exposed to the 'debilitating effects' of co-tenancy clauses.

The shopping mall backs US$49.6m (12.8%) of pooled debt in CFCRE 2011-C1. However, Macy's looming closure, the loss of JC Penney last April and the continued struggles of Sears have exacerbated investor concern. KBRA listed the loan on the mall as a concern in February 2015 and saw it transferred to special servicing for imminent default only two months later.

Despite such concerns, the loan remained current in payment through the December 2015 remittance period. Special servicer commentary between October and December, however, indicates a joint sale of the property is being discussed, which signals acknowledgement of the asset's depressed value.

KBRA recently valued the property at US$32.3m, which resulted in a US$20.5m loss projection, or 41% severity. The agency says that this loss forecast is significantly higher than other loss observations in the market. Even in its conservative loss scenario, it still projects a US$26.8m loss, at a 54% severity.

CMBS

New highs for CMBS repays

Two-thirds of European CMBS loans maturing in 2016 will repay as a result of high prepayment levels, according to Moody's. This will be a dramatic increase on the average 38% repayment rate that has been recorded since 1Q12.

"These high repayments are a product of improved lending conditions and stabilising occupational market fundamentals for secondary quality properties, which started 12 to 18 months earlier," says Andrea Daniels, associate md at Moody's.

In total, 34 loans have original scheduled maturity dates this year at a securitised balance of €4.72bn. Roughly 38% of the loans with original maturity dates set for 2016 have already prepaid, which is substantially higher than the long-term average of 11%.

"LTV ratios are the main predictor of maturity default. All loans with Moody's LTV ratios lower than 100% either prepaid or repaid, whereas the loans with high LTV ratios that repaid did so because they had strong sponsors," adds Radostina Atanasova, avp and analyst at Moody's.

The agency's research shows the quarterly repayment rate for European CMBS has varied between 22% and 66% since 1Q12. Figures have depended on the quality of the loans maturing in each quarter and the real estate lending conditions at the time.

In comparison, 26 loans with a combined securitised loan balance of €4.38bn were originally scheduled to mature in 2015. Of these loans, 66% either prepaid or repaid at maturity. UK loans comprised two thirds of the loans that matured in 2015 and had a similar repayment rate as the overall rate for 2015. Meanwhile, 42% of maturities in 2015 comprised large loans of over €100m.

Insurance-linked securities

ILS market hits milestone

The ILS market reached a new height for issuance in 2015, hitting US$70bn and exceeding the previous record of US$65bn in 2014. The figures come from a new report by Willis Capital Markets & Advisory (WCMA), which says that reinsurer interest and investor confidence continued to grow last year as new products and perils were brought to the table.

In particular, products such as sidecars, industry loss warranties and collateralised reinsurance showed considerable growth during the year. There was also a continuation of the gradual move towards a broader array of risks transferred, with increasing interest beyond natural catastrophe perils to life, accident and health, and casualty risks.

In contrast, non-life catastrophe bond issuance - which had seen continued year-on-year growth since 2011 - dropped to US$6.2bn in 2015. This is down from the record US$8bn level issued during 2014. WCMA says that the fall is mainly due to one-off factors such as multi-year deal inception dates and does not signify a decline in appetite for such transactions.

"Looking at the headline catastrophe bond figure, a decline in issuance appears to be the case," says Bill Dubinsky, head of ILS at WCMA. "However, this general picture fails to account for the huge US$1.5bn transaction completed in 2014 - Citizens' Everglades Re - which skews any prior year comparison."

Dubinsky expects continued growth in ILS assets under management in 2016, including growth in catastrophe bonds. Investors are showing pricing discipline in the current soft market, yet there also remains clear appetite to deploy capital across a broader array of risks and products as investors continue to become more comfortable with the asset class.

Risk Management

EBA consults on 'implicit support'

The EBA has launched a consultation regarding its guidelines on implicit support for securitisation transactions. The guidelines were drafted to provide clarity on what constitutes 'arm's length conditions' and when a transaction is not structured to provide support for securitisations.

The capital requirements regulation (CRR) foresees restrictions on implicit support to securitisations due to significant supervisory concerns and the belief that it undermines the achievement of significant risk transfer. If originator or sponsor institutions fail to comply with the relevant requirements, they shall hold funds against all of the securitised exposures as if  they have not been securitised.

The EBA's guidelines underline the elements that should be considered when assessing whether a transaction is not structured to provide support and on the notification requirements applicable to such transactions. They also include provisions to avoid a scenario whereby support is provided on behalf of the originator by another entity.

A public hearing will take place at the EBA on 18 February. Responses to the consultation are invited by 20 April.

Risk Management

Canadian OTC proposals published

The Canadian Securities Administrators (CSA) is seeking comment on its proposed approach to OTC derivatives. It has set out certain requirements for the treatment of customer collateral, record-keeping and disclosure for clearing intermediaries and regulated clearing agencies.

The CSA intends to ensure that the clearing of customer OTC derivatives transactions will be done in such a way that customers' collateral and positions will be protected and clearing agencies will be resilient to default by a clearing intermediary. The 90-day comment period expires on 19 April.

The CSA's proposed framework contains requirements for the treatment of customer collateral by clearing intermediaries and regulated clearing agencies, including requirements relating to collection and segregation of customer collateral, record-keeping requirements to identify customers' collateral and positions, and restrictions on the use and investment of customer collateral. It also creates a framework for customer clearing that promotes stability and efficiency of the OTC derivatives market by facilitating the transfer of customer positions and collateral in the event of a clearing intermediary's default or insolvency.

RMBS

Small balance RMBS RFC issued

S&P is requesting feedback on proposed changes to its surveillance of US RMBS backed by small-balance commercial loans. These securitisations are backed by mortgages on properties that have commercial characteristics - such as mixed-use, multifamily or retail - but also have underwriting and transaction structural features aligned to RMBS.

The agency warns that the proposals would bring higher loss projections across all related transactions and consequently lead to downgrades. This is because of the higher roll-rate assumptions that would be applied to current, reperforming and delinquent loans under the criteria. Approximately one third of the 70 outstanding ratings above single-D may be lowered by an average of six notches, it says.

S&P requests comments on the proposals be received by 12 February.

RMBS

More scrutiny on SFR managers

Certain operational risk fundamentals for property managers in the single-family rental space are only now being addressed, says Morningstar. This is largely due to the lack of an extensive operating history.

"As the rush to acquire large numbers of rental houses has slowed, institutional property managers are turning their attention to stabilising their platforms and focusing on documenting policies, strengthening controls and auditing their operations. While the SFR property-management sector continues to experience growing pains, it appears to be turning its attention to developing and improving its operational risk management," says Morningstar.

The rating agency expects more activity in the coming months as industry participants consider mergers and acquisitions to realise operational cost efficiencies. Market growth is expected to be driven by multiborrower rentals, with four multiborrower SFR securitisations issued last year. As multiborrower transactions lead the growth in the market, Morningstar expects sound property management practices to be all the more important for investor confidence in the asset class.

RMBS

Fresh mortgages rap for Ocwen

Ocwen has settled US SEC charges that it misstated financial results by using a flawed and undisclosed methodology to value complex mortgage assets. Ocwen has made a string of settlements (SCI passim) and under this latest one will pay the SEC a US$2m penalty.

The SEC found Ocwen inaccurately disclosed to investors that it valued assets independently at fair value under GAAP, but actually it just used a valuation from a related party. Ocwen's audit committee did not review the methodology used by that party, which in fact deviated from fair value measures.

Ocwen also failed to prevent conflicts of interest involving its executive chairman, who played a dual role in many related party transactions. He was wrongly able to approve transactions from both sides, including a US$75m bridge loan to Ocwen from another company where he also served as chairman.