Contents

Secondary markets

Cautious optimism for US CLOs

Mezz paper is at the forefront of the current bout of cautious optimism in the US CLO secondary market.

"Over the past three years we've seen the same pattern - the market has sold off from about October and then everyone comes back from Vegas filled with optimism about the relative value of our product and starts buying CLOs," says one trader. "It has happened again this year, but with a great deal more caution than in the past."

For now at least the focus is primarily on mezz, consequently double- and single-B spreads have narrowed significantly, the trader notes. "The bigger players started stepping in just before Vegas in anticipation of the post-conference rally and as the stock market had started to improve. They've been back since too - for example last Friday there were some double-Bs in for the bid, which were low-50s at best in January and they covered in the high 50s."

However, the trader adds: "While there are people willing to put on risk at these levels, it is just a few players getting involved and I don't think there is a real depth to the bids. This is a recovery in sentiment nothing more - there are still difficulties in the underlying loans and while the oil price recovery has helped a bit, it has done so only a bit and there is still extensive tiering."

As a result, the trader argues: "We're still in a CLO bear market and loan downgrades will create more problems. Especially in Triple-Bs, which have not moved as much - the substantial real money participation is no longer in the sector and the large repo lines are also gone, so it's really only the hedge funds that can trade there irrespective of potential rating declines."

Overall, the trader expects any rally beyond single- and double-Bs to be slow moving unless there is a major change to the line-up of market participants. "We keep hearing talk about some of the big private equity guys stepping in. If they do and they start buying in their usual volume in a market as small as ours the rebound across the stack could happen very quickly indeed."

There are currently five BWICs on the US CLO calendar for today. The largest is a ten line $44.7m double-B list due at 13:00 New York time.

It comprises: ADML 2014-1A E1, APID 2015-22A D, AWPT 2014-2A E, BSP 2015-VIA D, DRSLF 2014-31A E, FINNS 2012-1A D, GALXY 2015-20A E, LCM 16A E, OFSBS 2014-6A D and OZLM 2014-9A D. None of the bonds has covered on PriceABS in the past three months.

Secondary markets

Euro secondary sidelined

The improving macro picture has so far failed to encourage the majority of participants back into the European securitisation secondary market.

"Yesterday was mainly dominated by BWICs, which went through OK but a lot of clients are still on the sidelines," says one trader. "While market tone keeps improving in line with broader markets liquidity hasn't moved in tandem with it and a lot of people remain cautious."

The trader continues: "It's another quiet start today, but there is at least one highlight in the form of a UK non-conforming BWIC this afternoon that involves some deeper mezz paper. There's not been a lot of visibility in that sector in that part of the stack of late and a similar list traded last week on the wider side, so today's auction will be watched closely."

There are currently three BWICs on the European schedule for today and first up at 14:00 London time is the above-mentioned UK non-conforming list. The 33.016m euro and sterling original face auction consists of: ALBA 2006-2 D, LGATE 2006-1X C, MPS 4X M2B, RLOC 2007-1X C1A, RMAC 2005-NS2X B1C, RMAC 2005-NS3X B1C, RMACS 2006-NS2X M1C, RMACS 2006-NS4X A3A and RMACS 2006-NS4X M1A. None of the bonds has covered with a price on PriceABS in the past three months.

Then at 15:00 is an Australian dollar, US dollar, euro and sterling mix of prime RMBS. The 24 line 112.9m list comprises: ARENA 2011-2 A2, ARRMF 2011-1X A2B, BRASS 2011-1 A, CHMT 2007-1E A2B, CRGT 2006-2 A1, CRGT 2007-1 A1, DMPL IX A2, DRWBY 2011-1 A2, DRWBY 2012-1 A, DUTCH 2011-16 A2, FMACB 2012-3 A1, FRIAR 2011-1 A2, GFUND 2012-1 A, GMFM 2011-1X 3A, HMI 2011-1X A5, IDOLT 2012-2 A2, IMT 2006-1 A, KENRI 2012-1 A2, LAN 2012-2X 2A, LEOFR 2012-1 A, PEPAU 2012-1X A-A, PERMM 2011-2X 2A, STORM 2011-3 A2 and STORM 2012-2 A2.

Four of the bonds have covered on PriceABS in the last three months, last doing so as follows: BRASS 2011-1 A at 100.4 on 7 January; DRWBY 2012-1 A at 100.921 on 23 February; GFUND 2012-1 A at 100.315 on 10 February; and LEOFR 2012-1 A at 100.85 on 7 January.

Also at 15:00 is a single €1.8m line of PANTH IV-A A1. The ABS CDO has never covered with a price on PriceABS.

Secondary markets

US CMBS still split

The divergence in synthetic and cash spreads continues to pre-occupy the US non-agency CMBS secondary market.

"The big story remains CMBX continuing to tighten significantly while cash keeps going wider," says one trader. "Over the last three weeks triple-A CMBX has come in 35bp and triple-B minus by more than 100bp, whereas triple-A cash spreads have gone out by eight basis points over the same period and triple-B minus by over a 100."

The trader continues: "Some of that widening is deal specific and a result of loans in new issuance that investors aren't so keen on, but overall it's a significant trend. The divergence is obviously hitting conduits, who use CMBX to hedge, hard both ways, but it's also contributing to investor hesitation alongside uncertainty over the world economy."

That hesitation is ensuring that trading volumes remain relatively light. "Secondary activity comes and it goes," says the trader. "We see people stepping in now that CMBS is cheap relative to its own recent past and to other asset classes, but that's not to say it can't get cheaper so many investors are still holding back."

Consequently, the path of future volume and spread movement is unclear, the trader suggests. "Only time will tell - fundamental commercial real estate is fine, so what happens next in CMBS is about investor confidence in both the sector and the overall macro picture."

Secondary markets

Euro secondary stable

The European securitisation secondary market remains stable despite signs of an uptick in volume.

"Yesterday the market was more or less stable despite an increased number of lists," says one trader. "Notably, the large prime RMBS list traded quite well with most of the 24 bonds involved going through in line with recent levels."

At the same time, the trader adds: "The UK non-conforming sector feels a bit better especially in 2.0 deals, though 1.0 paper still looks to be lagging. The sector will also likely be encouraged by the new buy-to-let transaction that is currently being marketed."

Peripherals too are seeing something of an uptick, the trader says. "In the past few days there's been a bit of activity in Spanish paper and there is a new PRADO deal circulating, though that is yet to have any impact on secondary. Meanwhile, Portuguese bonds have been stable for the past couple of days despite a decline in the sovereign."

CLOs continue to lack any guidance from the primary market, but the secondary market is starting to find its own way albeit still based on limited colour and liquidity. "It feels like equity is down a little, while mezz is starting to recover, so the BWIC involving both this afternoon will be closely watched," says the trader. "Liquidity at the top of the stack is better and some trades are going through there."

There are three BWICs on the European schedule for today so far. Two are due at 15:00 London time.

One is a 33.15m euro and sterling four line CMBS list comprising: DECO 8-C2X A2, DECO 2006-C3X A1 B, EMC 6 B and EURO 28X D. None of the bonds has covered on PriceABS in the past three months.

The other 15:00 list is a six line €20m RMBS auction involving: ATLAM 1 B, GRIF 1 A, LUSI 5 A, MAGEL 2 B, MAGEL 4 A and PARGN 13X C1B. None of the bonds has covered with a price on PriceABS in the past three months.

Then at 15:30 there is the above-mentioned 13 line €52.787m mezz and equity CLO list, which comprises: ARESE 2007-1X E, CRNCL 2007-2X E, ARBR 2014-1X SUB, ARESE 2007-2X E1, CGMSE 2015-1X E, CGMSE 2015-2X SUB, CORDA 2006-1X F, CORDA 2006-1X F2, DRYD 2015-39X F, GLGE 1X F, LIGHP 2007-1X SUB, QNST 2006-1X E and QNST 2006-1X F. Only ARESE 2007-1X E has covered with a price on PriceABS in the past three months - VL90s on 15 December.

Secondary markets

US CLO see-saw

Activity and price levels continue to see-saw in the US CLO secondary market.

"Market tone is pretty strong with people trying to be positive after ABS Vegas, but activity and sentiment is up and down," says one trader. "For example, I'm hearing a lot of people saying they're expecting another leg down in lower mezz."

The trader continues: "Overall, the market is still looking for direction so no one wants to step in and make big moves. However, after a very quiet BWIC day yesterday there is a wide range of bonds in for the bid today, which might give us a better picture of where we are, though that picture could of course turn on a dime at the moment."

Meanwhile, there is a noticeable shift towards trading off-BWIC, the trader says. "There have been some redemptions for big hedge funds and they're looking to move bonds quietly because BWIC execution isn't right for them - people can read what they're doing and back-bid. At the same time it suits potential buyers to be able to look extensively and often exclusively at bonds. I expect we'll see more and more of this as it particularly suits the current uncertain macro environment."

There are six BWICs on the US CLO calendar for today so far. The chunkiest is a five line $43.15m mix of 2.0 single-As and triple-Bs due at 14:30 New York time.

The list consists of: BATLN 2014-7A C, BSP 2013-IIIA C, JTWN 2012-1A C, OAKTA 2014-A2 C and TICP 2014-2A B. None of the bonds has covered with a price on PriceABS in the past three months.

Structured Finance

SCI Start the Week - 7 March

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

Pipeline
With many market participants decamped to Las Vegas for the industry conference, pipeline activity last week was muted. There were four ABS and four RMBS added.

US$440m California Republic Auto Receivables Trust 2016-1, US$991.28m Capital Auto Receivables Asset Trust 2016-1, US$664m Conn's Receivables Funding 2016-A and US$122.33m OSCAR US 2016-1 accounted for the ABS. The RMBS were Agate Bay Mortgage Trust 2016-1, €421m FT RMBS Prado 2, A$300m Liberty Series 2016-1 and US$475m STACR 2016-HQA1.

Pricings
The number of deals leaving the pipeline stayed fairly steady with the preceding week. The week's prints consisted of two ABS, four ILS, two RMBS, three CMBS and two CLOs.

A$531m Driver Australia Three and US$551m SoFi Professional Loan Program 2016-A were the ABS. The ILS were US$175m Akibare Re 2016, US$250m Citrus Re 2016-1, US$300m Galileo Re 2016-1 and US$100m Manatee Re 2016-1.

A$1.7bn Medallion Trust Series 2016-1 and US$280m Nationstar HECM Loan Trust 2016-1 were the RMBS, while the CMBS were US$194.8m BAMLL 2016-ASHF, US$470m CARS MTI-1-MTI-7 Series 2016-1 and US$806.2m COMM 2016-DC2. The CLOs were US$358.28m Denali Capital CLO XII and US$407m Highbridge Loan Management 8-2016.

Markets
US CMBS spreads are expected to continue to lag until 'risk-on' sentiment becomes stronger across credit. "As often occurs in securitised products, once CMBS begins to participate in any rally, spreads will likely gap tighter and it will be difficult to source bonds," say Deutsche Bank analysts. Indicative triple-A spreads were at swaps plus 163bp last week, with triple-B minus spreads at 780bp.

The pricing of Highbridge Loan Management 8-2016 brings US CLO issuance to US$3.8bn for the year so far, and JPMorgan analysts see the potential for pricing lower down the capital structure to bounce. The trend of high yield swinging from a loss to a gain and the fact the S&P500 is up 10% since mid-February "will help open up the new issue CLO market," they say.

Editor's picks
Risky business? Capital relief trade opportunities are increasing as more jurisdictions open up. However, with this expansion comes increasing calls for market standardisation...
P2P cut-back: As marketplace lending continues to rapidly evolve in Europe, the fate of small lenders is an emerging theme. SCI's inaugural Marketplace, Direct Lending & Securitisation Seminar in London last month featured a diverse set of views on how consolidation will foster securitisation through a concentration of more sophisticated platforms...
Interest diversion cushions assessed: Jamestown CLO IV is thought to have become the first post-crisis US CLO to fail its interest diversion (ID) test - by 32bp. Wells Fargo figures show that 12 post-crisis US CLOs now have less than 100bp of ID cushion, seven of which are from the 2014 vintage and four are 2013 vintage...

Deal news
• February US CMBS 2.0 remittances show that 15 loans totalling US$103m became newly delinquent during the month, while eight loans totalling US$104m transferred to special servicing and 189 totalling US$3bn were watchlisted. A 2011-vintage loan - the US$12.4m Campus Habitat 15 loan (securitised in WFRBS 2011-C3) - became the first CMBS 2.0 asset to liquidate at a significant loss.
• An early redemption notice has been posted for the Kizuna Re II series 2015-1 catastrophe bond, indicating that the notes will be redeemed on 1 April. S&P expects the issuer to pay the unpaid principal and all interest due on this date, with no prepayment penalty.
• SC Lowy and UOB Asset Management are together launching the first fully Asia Pacific-backed, actively managed cashflow CLO. The CLO will be comprised predominantly by senior secured bank loans from Asia Pacific issuers.
• ISDA's EMEA Determinations Committee has determined that, for the purposes of the 2003 Credit Derivatives Definitions, no succession event occurred with respect to Novo Banco on or about 29 December 2015. It also ruled that, for the purposes of the 2014 Credit Derivatives Definitions, there is no successor to the relevant obligations of Novo Banco.
• Fitch has upgraded five tranches of the Eurohome UK series 2007-1 and 2007-2 transactions, following the discovery of an inconsistent calculation in its UK RMBS surveillance model. The inconsistency had resulted in weighted average foreclosure frequencies that were too high.

Regulatory update
• HM Treasury has opened a consultation on its proposal for a new regulatory and tax framework for ILS in the UK. The proposal covers a range of issues, including the necessity for a Solvency 2-equivalent framework and the authorisation of insurance SPVs.
• The Barr-Scott bill - which seeks risk-retention relief for qualified CLOs (QCLOs) - has passed the House Financial Services Committee by a vote of 42-15, with 10 democrats joining the bill, according to S&P. The bill now passes to the full House of Representatives for a vote. Assuming passage by the House, it would then have to be introduced and passed by the Senate and signed by the president before becoming law.
• A recent ruling by the California Supreme Court affirming the right of mortgage borrowers to continue challenging foreclosures years after a securitisation has closed will be credit negative for pre-crisis RMBS, says Moody's in its latest Credit Outlook. The rating agency warns that the ruling leaves an open door for other borrowers to press similar claims of void mortgage assignments and wrongful disclosures.
• Brian Korn of Manatt Phelps & Phillips has suggested that the marketplace lending industry has "nothing to fear but fear itself" in relation to the Madden vs Midland case. In a recent industry comment, he says that while there is concern that the outcome of the case will have a significant and negative impact on marketplace lending platforms and therefore those invested in the sector, there is no need for panic.
• ISDA has published a classification letter enabling counterparties to notify each other of their status for clearing requirements under Australia's mandatory central clearing regime for OTC derivatives. Counterparties can bilaterally communicate their status by answering a series of questions.
• AFME, the European Fund and Asset Management Association (EFAMA), the International Capital Market Association (ICMA) and Insurance Europe have issued a joint paper backing EU efforts to develop a robust and successful STS framework. The associations believe that STS and the associated CMU could play a pivotal role in enabling non-bank funding alternatives across the region.
• The European Commission has adopted a set of rules which require certain OTC credit derivative contracts to be cleared through central counterparties (CCPs). This implements the clearing obligation under EMIR.

Deals added to the SCI New Issuance database last week:
Ally Auto Receivables Trust 2016-2; Autopia China 2016-1 Retail Auto Mortgage Loan Securitization Trust; Avant Loans Funding Trust 2016-A; BAMLL 2016-SS1; CNH Industrial Capital Australia Receivables Trust series 2016-1; DRB Prime Student Loan Trust 2016-A; Driver Espana Three; Earnest Student Loan Program 2016-A; Flagship Credit Auto Trust 2016-1; Ford Credit Auto Owner Trust 2016-REV1; FRESB 2016-SB13; John Deere Owner Trust 2016; JPMBB 2016-C1; LBTY 2016-225L; Madison Park Funding XX; Magnetite XVII; Nations Equipment Finance Funding III series 2016-1; Neuberger Berman CLO XXI; Quarzo 2016; Rochester Financing No. 2; Rongteng 2016-1 Retail Auto Mortgage Loan Securitization; Station Place Securitization Trust 2016-1; Tidewater Auto Receivables Trust 2016-A; Toyota Auto Receivables 2016-A Owner Trust; WinWater Mortgage Loan Trust 2016-1

Deals added to the SCI CMBS Loan Events database last week:
BACM 2006-3; BACM 2008-1; BSCMS 2006-PW12; BSCMS 2006-PW13; COMM 2013-CR12; COMM 2013-CR9; COMM 2014-LC15; DECO 9-E3; ECLIP 2006-1; ECLIP 2006-2; INFIN SOPR; JPMBB 2013-C14; JPMBB 2015-C28; MLCFC 2007-5; MLMT 2006-C1; MSC 2007-IQ13; TMAN 5; UBSCM 2012-C1; WFCM 2015-NSX2; WFRBS 2012-C7

Structured Finance

ECB looks to provide boost

A new set of measures announced by the ECB could boost ABS supply. The central bank is launching a second TLTRO programme, expanding QE and cutting rates.

The ECB's deposit rate has been cut by 10bp to -0.4%. Its main refinancing rate has been cut by 5bp to zero.

The TLTRO 2 programme will - in contrast to the first TLTRO programme - use a reward structure for banks that are able to increase their loan portfolio relative to lending targets, rather than imposing penalties for failure. This reward structure could result in negative interest rates on the facility, note Rabobank credit analysts, making it an attractive funding tool for banks.

"Covered bond and ABS markets would mostly be affected in terms of supply. A very cheap (currently 0% to -40bp) funding tool could reduce the funding through other instruments," say the Rabobank analysts. "We note, however, that similar to TLTRO, also in this new TLTRO 2 programme residential mortgage lending is excluded from the target."

Should the TLTRO 2 facility prove successful, there could well be an increase in retained ABS transactions for creating collateral. The analysts note that covered bonds are currently less attractive than ABS for this purpose.

The ECB is also expanding QE by €20bn per month, to €80bn per month, although the impact on the ABSPP is expected to be limited. A couple of tweaks will extend the purchase programme to corporate bonds and also allow more purchases of supranational debt.

For ABSPP, the analysts note that there remains a difference between being willing to purchase and being able to purchase. While the ECB appears strongly committed to expanding ABSPP, limited meaningful supply remains a significant hurdle.

JL

CLOs

CLOs cut oil exposure

While the oil and gas sectors have been a relatively small part of the leveraged loan universe, US CLO exposure to these sectors varies greatly across deals. Combined with idiosyncratic issues in other sectors, the impact on CLOs has been significant, particularly at the most credit sensitive tranches of the capital structure.

S&P figures show that loans to firms in the oil and gas sector have been around 2%-5% of outstanding leveraged loans over the last 15 years. That peaked pre-crisis at over 5% and picked up again after the crisis, with especially high activity in summer 2014 - just as oil prices began to collapse.

Deutsche Bank CLO analysts calculate that the average exposure of 637 outstanding post-crisis broadly syndicated loan CLOs to the oil and gas sector is 3.3%-3.7%. One deal has exposure of over 12%, while some have no exposure.

There is also considerable difference across vintages, with 2015 exposure considerably lower than exposure for 2012-2014 CLOs. Managers have generally reduced oil and gas exposure since issuance, with the average CLO that was outstanding at the end of 2014 and still outstanding last month reducing its exposure by half a percent in that time.

"That reduction has, however, greatly varied across deals," note the Deutsche Bank analysts. "There is a strong negative correlation between the change in the oil and gas exposure of deals and their exposure at the end of 2014. The deals with the highest exposure in 2014 have generally reduced their exposure the most and many of the deals with the lowest exposure have added to their exposure."

A basket of 39 loans from 34 issuers that CLOs had more than US$100m nominal exposure to at end-2014 demonstrates the change in loan prices. As of June 2014, the basket had a WARF of just under 2200 (which roughly corresponds to a B1 rating from Moody's), but that has changed to just under 4,400 today (which is around a Caa1 rating).

Of the 10 loans that have fallen most in price since June 2014, four have defaulted. All 10 were trading at or around par in June 2014 and most recent trading prices have fallen as low as 2.2 cents on the dollar.

"While over 60% of non-oil and gas collateral is trading between 95 and par and another 20% is trading between 90 and 95, the prices of oil and gas collateral is widely dispersed from near-zero prices up to par. The distribution is close to being symmetric around 50-60 prices," say the analysts.

There are eight managers with 6% or higher oil and gas exposure and seven with less than 1% exposure. The manager with the highest exposure is Silvermine Capital Management - also the only manager to have had a post-crisis CLO downgraded (SCI 25 February) - and the manager with the lowest exposure is BlueMountain Capital Management.

Those CLOs with most exposure to oil and gas have suffered significant mark-to-market losses. However, the effect on OC tests has been more muted.

"While most oil and gas loans have fallen significantly in price, most of them are still performing and it takes a considerable amount of downgrades to exceed the Caa1/CCC+ limits enough to hit the OC tests," say the analysts.

They add: "As oil and gas defaults grow and more loans generally get downgraded, however, the effect on the OC tests will become more pronounced."

JL

Structured Finance

Increased appetite

European direct lenders moving towards US model

Direct lenders tend to focus on assets that aren't mainstream securitisation candidates and in that sense can be complementary to banks. However, panellists at SCI's inaugural Marketplace, Direct Lending & Securitisation Seminar last month expected European direct lenders to gain more market share as the sector transitions towards the US model.

Richard Green, partner at Venn Partners, anticipates the European direct lending community to begin moving towards the US model, where direct lenders represent a larger share of the market. "Investors in the US are more likely to have a dedicated allocation for direct lending funds. European institutional investors, however, tend to allocate to them from their alternatives or fixed income buckets. But direct lending in the region would benefit from being recognised as a standalone asset class and a permanent part of institutional investor allocations," he observed.

Furthermore, Daniel Sinclair, md in the Ares Credit Group, believes that direct lending in Europe may move to a BDC/permanent capital funding model over the next 10 years, similar to the US. "Our US business is structured as a BDC, so we anticipate that there will be BDC-like structures in Europe, but this hasn't happened yet," he said.

He continued: "In the US, Ares manages the largest BDC as well as a mortgage REIT, and so we clearly appreciate the value of permanent capital vehicles. However, while REITs do exist in Europe, permanent capital for corporate loans doesn't. So, we have adopted a fund-based model to date."

Direct lenders can be complementary to banks, in that they can look at assets that are less loved by banks - such as operating assets - or provide mezzanine finance in deals with them. Indeed, Sam Mellor, partner, real estate at Chenavari Investment Managers, noted that direct lending is more appropriate for smaller cap and transitional assets.

"Private debt funds are needed to provide capital for higher lease-ups: borrowers are often property companies looking for growth capital to reposition properties. The broader structural issue on the real estate side is that banks are reluctant to underwrite developments," he explained.

However, direct lenders can be more responsive than banks. Green noted: "Flatter organisational structures means that direct lenders can be quicker, create more tailored solutions and offer a more client-oriented service. They bring a sharper focus, smaller teams and no legacy assets."

Sinclair said that borrowers are increasingly looking for scale and assurance of closing in securing their financing solutions. "Holding assets on-balance sheet and having the ability to originate and underwrite the credit provides flexibility for sponsors to execute speedily - in under two weeks in some cases - which adds significant value to both them and the management teams," he noted.

Ares, for one, typically targets companies with EBITDA of £5m-£75m with £20m-£250m of financing requirements.

In terms of working with banks, some direct lenders will partner with them to access their large customer base, while others have gone further and acquired bank licences in order to use their cheap deposit funding to support their direct lending business. But in the medium term direct lenders are expected to take more market share from banks.

"In terms of deal flow, we are seeing a large number annually, especially as banks continue to reduce their exposure to originating loans to middle-market companies because of changes in the regulatory schemes, as well as an increased focus on maximising the return on capital," Sinclair concludes.

CS

Structured Finance

Energy boost

Renovate America capital markets md Craig Braun and capital markets svp Adam Garfinkle answer SCI's questions

Q: How and when did Renovate America become involved in the securitisation market?
Braun: We started originating PACE loans in 2012 and we securitised our first HERO bonds in 2014. PACE provides a financing alternative for homeowners when they need to replace aging heating or air conditioning units or make other energy efficiency or renewable energy upgrades.

PACE allows homeowners to pay for these upgrades over time through a voluntary assessment on their property taxes. Around one-in-six homeowners upgrade these home systems each year, but approximately three-quarters of the time they are not doing it with energy efficient products.

PACE provides a financing option that makes these more efficient alternatives more accessible to more homeowners. PACE is authorised by legislation in 32 states and the District of Columbia. Residential PACE is occurring primarily in California, where Renovate America and its HERO programme represents about 90% of the residential PACE market.

Garfinkle: Securitisation has allowed us to scale our platform. Overall, we have generated over US$1bn through six transactions. Our two most recent HERO bond transactions - HERO Funding Trust 2015-3 [SCI 27 November 2015] and HERO Funding Trust 2016-1 [SCI 15 February] - have been verified as 'green' bonds by a third party.

What sets HERO bonds apart is that they are backed by financing for home efficiency upgrades that have been completed, so certified environmental benefits are already being achieved. This is very appealing to investors who want to add green investments to their portfolio and want those investments to have a measurable impact.

Q: What are your key areas of focus today?
Braun: The HERO programme deploys private capital to achieve important public policy objectives - helping to lower utility bills, reducing carbon emissions, saving water, creating clean energy jobs and driving local economies - at no cost to taxpayers. It is the fastest-growing energy efficiency financing option in the US. There's been over US$1bn in funded projects in the programme's first four years.

These projects will save more than US$2bn on energy bills, conserve more than eight billion kWh of electricity, reduce emissions by more than two million tons and save more than three billion gallons of water. It has already created 10,587 jobs across California and has had a local economic impact of more than US$2bn.

Renovate America works with over 8,000 licensed and bonded contractors and maintains the most comprehensive consumer protection programme in the home improvement industry. HERO has created a powerful platform that connects homeowners with contractors, an automated database of over one million products rated as efficient and an underwriting team that can give approvals in minutes. This has helped more than 56,000 homes become more energy efficient and more affordable to power, heat and cool.

Q: How do you differentiate yourself from your competitors?
Garfinkle: Not only are our two most recent deals the first classified green bonds in the market, but they are unique because they are not speculative. What I mean by this is that the improvements made in households are already in place. So, unlike other green bonds which fund future projects and have potential environmental benefits, HERO bonds are backed by projects that are already installed and having a positive environmental impact today.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
Braun: Our latest deal - HERO Funding Trust 2016-1 - pushed over the US$1bn landmark in HERO bond securitisations. The PACE market in general is looking forward with bright prospects and demand is very strong.

The latest HERO bond deal created a real buzz, especially after the recent Paris Climate Summit. It was nearly 3.5 times oversubscribed. One challenge is that there is not enough supply in the market to meet demand.

Q: What major developments do you need/expect from the market in the future?
Garfinkle: PACE is definitely a rising sector in the market and there is a clear demand, but this demand could definitely see more diversification. Investors up until now like the credit quality in these deals and the value that they are getting, so this can be a good selling point.

However, as with any new sector, we need to get the message out. The broader the investor base, the larger the scope for it to grow.

Braun: Also, with risk retention coming in 2017, our compliance will start hitting in December of this year. We will meet European risk retention requirements by December 2016 and expect our transactions in 2017 to be available in Europe. At that point, we will be dual compliant for risk retention in both the US and Europe.

Regarding our timetable, we are bringing a deal to the market quarterly right now. That will stay the same for the foreseeable future.

We are projecting north of US$1bn in issuance this year. We anticipate these transactions will be certified green bonds as well.

JA

Structured Finance

Oaktree targets Aussie growth

Oaktree Capital Group has opened an office in Sydney, Australia. Byron Beath has joined the firm as md to lead investment activities in Australia and New Zealand and will be based in the Sydney office.

Beath was previously at Macquarie Bank. He spent 15 years at the bank, most recently as a director in the corporate and asset finance division.

Structured Finance

Euro opportunistic credit team hired

Crestline Investors has recruited an experienced European opportunistic credit team and opened its first European office, in London. The London office will be managed by Michael Guy, who becomes European cio.

Guy has over 20 years of experience in the investment industry and founded the Tenax Credit Opportunities Fund. He has also worked as co-head of European loans and special situations at Bank of America Merrill Lynch and in a similar role at Credit Suisse/Donaldson, Lufkin and Jenrette.

Sanjeev Sarkar and Andrey Panna join as mds. They both co-founded the Tenax fund with Guy and will focus on sourcing and analysing special situations and distressed debt.

Structured Finance

Promotion due at Och-Ziff

Nim Sivakumaran is set to replace Donald La Vigne as head of European structured credit strategies at Och-Ziff Capital Management Group's London office after the latter's departure in June. Sivakumaran is currently an md and analyst in the firm's European structured credit investment team.

Structured Finance

Real estate investment leader named

Investcorp has appointed Neil Hasson as md to spearhead its European real estate investment initiative, with an initial focus on core-plus opportunities in residential and commercial properties across the UK, Germany, France, Italy and Spain. Based in London, he will report to Investcorp real estate investment head Jonathan Dracos in New York.

Hasson has nearly three decades of experience in real estate investment. He was previously a senior md at Macquarie Group, responsible for the firm's European real estate lending business. Prior to this, he worked at Citi Property Investors, Donaldson Lufkin & Jenrette and Goldman Sachs.

Structured Finance

Distressed debt exec landed

HIG Capital has appointed Giuseppe Mirante as md of its distressed debt and special situations affiliate, Bayside Capital. He will be based in London.

Mirante was previously head of loan and distressed credit research at BNP Paribas in London and has also worked as a European credit and distressed analyst at Cyrus Capital and Trafalgar Asset Managers. He also co-founded Tigon Capital.

Structured Finance

SIV lawsuit concluded

The California Public Employees' Retirement System has settled its case against Moody's for a record US$130m. The lawsuit alleged that Moody's assigned erroneous Aaa ratings to SIVs prior to the financial crisis.

CalPERS sued Moody's and other rating agencies in 2009 after its pension fund sustained losses from investments in three SIVs that relied on the liquidity of assets that turned out to be illiquid, such as subprime RMBS, CDOs and other ABS. In the lawsuit, CalPERS alleged that Moody's made "negligent misrepresentations" by assigning the investments their highest credit rating. This caused significant losses as the market for structured finance securities collapsed in late 2007.

Early in 2015, CalPERS settled with S&P for US$125m, bringing total recoveries from the now-concluded lawsuit to US$255m. In addition to obtaining a substantial recovery for investment losses, the settlements rank as the largest known recovery from Moody's and S&P in a private lawsuit for civil damages. The case also established through a landmark appellate court decision that rating agencies can be liable for negligent misrepresentations under California law for their ratings of privately-placed securities.

Structured Finance

Babson pair poached

Intermediate Capital Group has unveiled what it describes as a major investment in the development of its capital markets capabilities, with the addition of two senior investment team hires from Babson Capital. Zak Summerscale joins the firm to head up its credit fund management business for Europe and Asia Pacific, while Kam Tugnait joins as director, high yield bonds, reporting to Summerscale.

Summerscale has 20 years' experience in managing secured loan, high yield and distressed strategies. Under his leadership, Babson's liquid European high yield AUM increased from €5bn in high yield strategies in 2011 to in excess of €12.5bn today.

Tugnait has over 25 years' experience in managing high yield bonds. He joined Babson in 2011 and was a key player in both launching several high yield bond funds at the firm and growing AUM at the business.

Structured Finance

Fee waivers introduced

TICC Capital Corp, in consultation with its special committee, has agreed to a series of ongoing waivers with respect to its management fee and income incentive fee. The move follows a comprehensive process led by the special committee, including a detailed analysis of best-in-class practices in the industry, conducted with the assistance of the firm's financial advisor Morgan Stanley.

Under the terms of the fee waiver, which will take effect on 1 April: the base management fee will be reduced from 2% to 1.50%; TICC will forgo the payment of any base management fees on funds received in connection with any capital raises until the funds are invested; the calculation of the company's income incentive fee will be revised to include a total return requirement limiting TICC's obligation to pay TICC management an income incentive fee if it has generated cumulative net decreases in net assets due to unrealised or realised net losses on investments; the income incentive fee will incorporate a 'catch-up' provision for net investment income that exceeds the preferred return but is less than 2.1875% quarterly; and the hurdle rate used to calculate the income incentive fee will change from a variable rate of five-year US Treasuries plus 5% to a fixed rate of 7%. Aggregate fees earned from 1 April 2016 by TICC management in any quarterly period will not be higher than they would have been prior to the adoption of these changes.

"We firmly believe that the changes made under the fee waiver have resulted in a fee arrangement that is now best-in-class in the BDC industry and are intended to more closely align the financial incentives of the manager with the interests of TICC's stockholders," comments Steve Novak, chairman of the special committee of TICC's board of directors.

The board also determined to appoint an independent chairman and has assigned the role to Novak, effective 1 March. He has served as an independent director of TICC Capital since 2003 and is chairman and ceo of Quisk, and founder and former chairman of Mederi Therapeutics. Novak was previously president of Palladio Capital Management.

Structured Finance

Strategic review nears completion

In its financial results for the three and twelve months ended 31 December, ZAIS Financial Corp disclosed that its strategic review continues and includes the exploration of merger or sale transactions or a liquidation of its assets. The company last November retained Houlihan Lokey Capital as financial advisor to assist it in evaluating potential strategic alternatives to enhance stockholder value.

ZAIS says it has engaged in preliminary discussions with several potential counterparties and is currently discussing a potential merger or sale transaction, which would be subject to approval by the company's board of directors and its stockholders. If a definitive agreement is not reached, management intends to present to the board of directors for its consideration a plan of liquidation.

In light of the strategic review and in order to reduce current market risk in its investment portfolio, ZAIS has begun selling its seasoned re-performing mortgage loans from its residential mortgage investments segment. A sale of these assets is expected to be completed early in 2Q16. If completed, these sales are likely to result in a reduction of the company's investment income and may therefore result in a decision to curtail dividends in the future.

Additionally, as part of the strategic review, ZAIS has ceased purchasing newly originated residential mortgage loans as part of its mortgage conduit purchase programme and will begin unwinding the mortgage conduit business.

Consistent with these changes to the company's strategy, Brian Hargrave has resigned as cio and is succeeded by its chairman Christian Zugel.

The financial results show that core earnings decreased to US$700,000 (or US$0.08 per diluted weighted average share outstanding) from US$4.1m (US$0.46), as of 31 December 2014. Book value per share declined by US$1.75 or 8.1% compared to 31 December 2014, primarily due to unrealised losses on mortgage loans held for investment. A decline in net interest income was partially offset by GMFS earnings.

Structured Finance

MassMutual affiliates to merge

Babson Capital Management, its subsidiaries Cornerstone Real Estate Advisers and Wood Creek Capital Management, and Baring Asset Management are set to combine under the Barings brand. The combination creates a global multi-asset investment management firm with over US$260bn of assets under management, offices in 20 countries and over 1,700 professionals.

The firm will be led by Tom Finke, current chairman and ceo of Babson, and will be headquartered in Charlotte, North Carolina. "As a unified firm, we will be better able to deliver our diverse and global investment offerings to clients," he comments.

Because of the complementary nature of the firms' investment capabilities across asset classes, no change in investment leadership is anticipated. Further, distribution and marketing capabilities will be combined together to support the new entity.

The firm expects to close the initial phase of the integration during the fourth quarter, subject to required regulatory approval.

Babson, Barings, Cornerstone and Wood Creek are affiliates of Massachusetts Mutual Life Insurance Company.

Structured Finance

PACE provider drives growth

PACE financing provider Ygrene Energy Fund has raised US$30m in operating capital, led by new and existing investors. The firm is set to expand into Georgia, Arkansas, Missouri and Virginia.

The latest investment brings the Ygrene's total operating and project capital raised to over US$530m. The operating capital will fund the firm's expansion of its YgreneWorks programme, including business and call center operations that service the company's high growth in project volume, a new solar operations arm and entrance into new states.

Ygrene is the largest commercial PACE provider in California and Florida, having funded more than 90% of the PACE projects in the Sunshine State. Since its inception, YgreneWorks has approved more than US$1bn in applications for over 21,000 buildings and has completed US$300m in contracts nationally, producing more than US$750m in economic stimulus, 4,500 jobs and 19MW of energy. Together these projects have saved 1.3 billion gallons of water and enough energy to power 300,000 homes for a full year, while also keeping 360K metric tons of CO2 from entering the atmosphere.

Ygrene completed the first PACE securitisation that combines both residential and commercial assets last July (SCI 24 July 2015).

Insurance-linked securities

ILW platform bolstered

Stefano Nicolini has joined Beach & Associates as a vp and will be aid in the development of the firm's ILW and retro platforms globally. He will be based in its New York office, but work closely with the Bermuda and London teams. Nicolini was previously an ILW-focused broker at BMS Group and has also worked at Guy Carpenter and Collins.

Risk Management

Fintech firm expands senior team

Algomi has added former Thomson Reuters ceo Tom Glocer as a strategic advisor. It has also appointed Howard Edelstein, who has been a strategic advisor to the firm for two years, to its board.

Glocer is managing partner of Angelic Ventures and a director at Morgan Stanley, Merck & Co and K2 Intelligence. Edelstein is the chairman of REDI Holdings and was previously chairman and ceo of BondDesk.

Risk Management

Vendor bolsters regional growth

4sight Financial Software has opened a new North American office in New York, as a direct response to increased demand for its products and several recent client wins in the region. Jonathan Cooper, who has been named North American sales director, will be responsible for regional growth at the location.

Cooper has 30 years' capital markets experience. He was previously senior consultant at Finadium Research & Consulting and before that worked at BNP Paribas, Deutsche Bank, Bankers Trust and JPMorgan.

RMBS

MBS REITs to merge

ARMOUR Residential REIT is set to acquire JAVELIN Mortgage Investment Corp for a consideration to be paid in cash, which would value JAVELIN at 87% of its book value, including a reduction of US$1m for JAVELIN's transaction expenses. Under the terms of the merger agreement, a wholly-owned subsidiary of ARMOUR will commence a tender offer to acquire all of the outstanding shares of JAVELIN common stock. Using JAVELIN's latest estimated book value per share as of 1 March, the transaction would value JAVELIN at US$7.14 per share, representing a 19% premium to its closing price on 1 March.

The tender offer does not have any financing condition, as ARMOUR will fund the acquisition with existing cash on hand. JAVELIN's complementary assets provide ARMOUR with investment opportunities in non-agency MBS. Further, the transaction is accretive to ARMOUR's book value upon closing and will drive long-term value for stockholders through stable and diversified risk-adjusted returns.

The merger agreement has been unanimously approved by both ARMOUR and JAVELIN boards, the latter upon the recommendation of the JAVELIN board's special committee. The transaction is the culmination of a review process conducted by JAVELIN's board that explored value-creation options.

The tender offer is subject to customary closing conditions, including the tender of greater than a majority of the total number of JAVELIN's outstanding shares not owned immediately before the expiration of the tender offer by ARMOUR or JAVELIN, or any of their subsidiaries, officers or directors. Following completion of the tender offer, the parties will promptly effect a second-step merger without the approval of JAVELIN stockholders under Maryland law, pursuant to which all remaining shares of JAVELIN common stock not tendered in the tender offer will be converted into the right to receive the same cash price per share as in the tender offer and JAVELIN will become a wholly owned subsidiary of ARMOUR. The transaction is expected to close during 2Q16.

ABS

Auto comparison tool offered

Moody's has launched a global auto ABS market comparison tool, designed to facilitate a comprehensive comparison across the sector. The offering includes over 60 qualitative features - such as securitised products, transaction parties, market history and legal risks - that can be compared across 14 countries, as well as the functionality to analyse transaction performance data across 11 countries and to compare performance with macroeconomic data.

Based on an analysis using the tool, Moody's warns that although simple structures should support auto ABS credit quality, easing underwriting standards in some countries combined with macro pressures could cause headwinds for performance. "Captive originators continue to dominate auto ABS markets globally. While new smaller originators are entering established European markets, the major global auto captives are expanding into the Chinese market. In light of good portfolio performance in recent years, new market entrants are under pressure to loosen their underwriting criteria to achieve certain growth rates," observes Armin Krapf, a vp and senior credit officer at the rating agency.

The similarity in structures across countries stems from the fact that the same international originators dominate many national auto ABS markets, according to Sebastian Schranz, an avp and analyst at Moody's.

ABS

Container ABS to weather conditions

Slowing global trade is a concerning development for shipping container ABS. However, Morningstar Credit Ratings believes certain features and market trends should allay ABS investor concerns.

Global trade is stalling. At 6.9%, Chinese GDP growth last year was the slowest in decades. Meanwhile, the World Trade Organization last September revised down its estimate for world trade growth in 2016 from 4% to 3.9%.

Shipping-container demand is highly correlated with world trade. With steel prices also depressed, the price of new and used shipping containers and their market rates have both suffered, raising concerns about the resiliency of ABS backed by shipping containers.

However, the preponderance of fixed-term leases, long-lived assets and long-date legal final ABS maturities should all work in favour of the asset class. As the ABS are typically structured to pay bondholders monthly to match rent payments, the interest payment is a relatively small component of total monthly cashflow available to transactions and transactions typically have a reserve account to cover nine months of interest payments, the rating agency does not expect transactions to miss timely payments.

The long-lived assets and lengthy final maturities should allow some transactions to benefit from the eventual return of economic expansion. While container ABS transactions can be structured with a legal final maturity of between 15 and 25 years, any recession is expected to last for a comparatively short period.

Another positive factor is that the shift from short-term to fixed-term leases also reduces market shock. The proportion of longer, fixed-term leases has increased from 38% in 2000 to 85% for ABS market stalwart Textainer Group, for example.

Additionally, transactions backed by a higher percentage of either older containers or containers purchased in 2014-2015 are less levered in the current low price environment and so are expected to perform better than those backed by a higher percentage of containers purchased when prices peaked in 2011-2012. This is not least because newer container purchases had stressed lease rates considered in the securitisation.

ABS

Further FFELP bonds extended

Navient has extended the legal final maturity date to 2055 on the senior tranche of SLC Student Loan Trust 2009-1, affecting US$150m of ABS bonds backed by federally guaranteed student loans. The move follows the amendment of transaction agreements for two other Navient-sponsored securitisation trusts last month.

These amendments extended the legal final maturity date to 2045 on the senior tranche of SLM Student Trust 2012-4 and to 2070 on both the senior and subordinated tranches of SLM Student Trust 2012-8. US$2bn of bonds were impacted by the action.

"Navient is committed to supporting a well-functioning, transparent and efficient market for our investors," comments Somsak Chivavibul, cfo at Navient. "We encourage all of our ABS bondholders to visit Navient's online investor communication forum at www.dealvector.com/navient to discuss requested legal final maturity date amendments with fellow investors or contact Navient directly."

ABS

Mitigating factors for revolving structure

Rongteng 2016-1 Retail Auto Mortgage Loan Securitization is originator SAIC-GMAC's first Chinese auto ABS to feature a revolving structure and the second such deal to be issued in China's interbank market, says Moody's. The transaction was issued last month (see SCI's new issuance database).

The revolving structure allows new loans to be added to the securitised pool after the deal closes. While this type of structure poses credit risks to investors that are not posed by static portfolios, the rating agency does see mitigating factors.

The overall credit quality of the loan collateral will be maintained during the 12-month revolving period, says Moody's. Loans must meet various eligibility criteria to be included in the pool and the revolving period will be ended ahead of schedule if certain amortisation triggers are breached.

There are restrictions on the asset yield of loans added during the revolving period to within a tight range of the pool, as well as restrictions on the purchase price of new loans to mitigate against the risk of under-collateralisation. There is also a limit on the geographic concentration of new loans.

Structured Finance

Italian tax exemption boosts market

An Italian law decree introducing a flat tax on auction properties is credit positive for RMBS, ABS and covered bonds of secured loans to SMEs, says Moody's. The stamp duty exemption should attract a larger number of potential buyers, with a particular increase in short-term investors' appetite for auction properties.

Moody's expects that real estate-owned companies and other asset managers, which may have previously refrained from participating in auctions due to the large, upfront stamp duty payment that was required, could now step in. "This is significant for the RMBS, covered bonds and ABS transactions of secured SME loans, because the timeliness of the sale and the price achieved at auction affects their performance; the proceeds of the sale of the property backing the mortgage loans will be treated as a cash inflow that can be applied in the SPV's waterfall to cover inter alia defaults," Moody's says.

The new regime came into effect on 16 February. Under it, a property sold at auction for €300,000 will be subject to a modest flat fee of €200, rather than the standard rate of 9% (€27,000) generally applicable to non-retail buyers.

Structured Finance

PREPA progress reviewed

The extended deadline for PREPA to submit a new rate plan to Puerto Rico's new energy commission (SCI 2 March) suggests that the utility and its creditors are making progress towards an organised debt restructuring, according to Moody's. This development follows the recent enactment of securitisation legislation that will help facilitate a subsequent PREPA debt restructuring.

The submission of a rate plan is a key next step under the terms of the restructuring support agreement (RSA) between PREPA and its creditors. A core component of the RSA is the issuance of new securitisation bonds that will be exchanged for existing uninsured PREPA bonds at a discount.

The new securities will be supported by a separate, non-bypassable surcharge on ratepayer bills, issued by a state-owned SPV. To facilitate the SPV's formation and to create the right to impose and collect the surcharge and to issue the new bonds backed by those charges, the RSA required the enactment of special enabling legislation, which was signed into law on 16 February.

Once a rate plan - referred to as the SPV petition under the RSA - is submitted, the energy commission is expected to review it and hold public hearings. Moody's anticipates that the plan will include the rate calculation methodology and a mechanism to adjust charges periodically to satisfy debt-service payments on the new securitisation bonds.

From a customer rate perspective, the decline in global oil prices - PREPA's primary fuel source - has resulted in lower average electricity rates, which should give the utility some headroom to raise rates or add surcharges if needed to satisfy debt service on the new bonds.

PREPA has a debt-service payment of about US$400m due on 1 July, but Moody's notes that the utility's liquidity profile is weak and the agency does not believe that it has the internal sources to make the payment. Consequently, the payment might require additional funding from the creditor group to avert a payment default.

Structured Finance

Opportunistic credit fund launched

La Française Global Investment Solutions has launched a multi-strategy long/short credit fund, dubbed LFIS Vision UCITS - Credit. The fund will invest opportunistically in a diverse portfolio of undervalued or overvalued credit assets.

The fund is managed by the firm's credit strategies team, led by Renaud Champion, and is run alongside the team's established credit opportunities strategy. Average credit experience within the team is 16 years, covering asset management, investment banking and derivatives experience.

CDO

Deleveraging drives Trups improvement

Moody's reports that the credit quality of Trups CDOs continued to improve in 2015 due to deleveraging of senior notes from redemptions and excess interest diversions, improvements in OC ratios and steady-to-improving collateral credit quality. The agency last year upgraded the ratings on 216 tranches in 59 Trups CDOs and downgraded the ratings on two tranches in one deal after it declared a liquidation.

The senior-most notes in Trups CDOs deleveraged on average by 7.3% of their original balances in 2015, bringing the total pay-down since closing to 48.5% of original par. Senior notes in REIT Trups CDOs deleveraged at a faster pace (11.2% of their original balances) than bank and insurance Trups CDOs (6.4%).

Sooner-than-anticipated redemptions and prepayments of REIT securities and CMBS, as well as material amortisation in interest rate swaps, contributed to the faster deleveraging speed of senior REIT Trups CDO notes. Interest rate swaps in 10 transactions with a total notional of US$670m matured last year.

At end-2015, the average senior OC ratio was 171.5%, up from 150.7% a year previously. Performing par also increased after 60 banks, representing a total par balance of US$518m, that had previously been deferring interest resumed interest payments on their Trups. Indeed, US$61.4m of cumulative deferred interest balance was repaid on mezzanine and junior notes last year.

Trups issuers redeemed US$1.6bn of collateral last year, compared with US$1.2bn in 2014. Although most transactions use redemption and prepayment proceeds to deleverage senior notes, some used principal proceeds to pay hedge payments and senior note defaulted interest.

Further, Trups CDOs last year diverted US$459m of excess interest to pay down the senior notes as a result of OC test breaches, down from US$591m in 2014. At year-end, senior OC tests were failing in only 22 of the 90 Trups CDOs Moody's rate that still had these tests (compared with 42 at year-end 2014), by an average margin of 18%.

However, 84 of the 91 Trups CDOs that the agency rates that have mezzanine and junior OC tests were still failing these tests, by a margin of 22.1%, and continued to divert excess interest to senior notes. In addition, all but 17 (including 10 REIT Trups CDOs) of the 72 Trups CDOs it rates were passing their interest coverage tests comfortably and had sufficient excess interest to deleverage their senior notes.

Finally, exposure to bank failures declined for the fifth year in a row. The FDIC closed only two banks with Trups in CDOs Moody's rates, down from seven in 2014. The total dollar exposure to failed banks also declined, to US$9.5m from US$83m in 2014, and remains well below the peak of US$3.3bn in 2009.

CDS

CDS exposures assessed

A new Office of Financial Research (OFR) working paper uses CDS data to evaluate the impact on banks from a default of their largest counterparties. In addition, it considers from a macroprudential perspective not only the impact on individual banks, but also on the financial system as a whole.

The report finds that banks' exposures in the credit default swap market under stress are concentrated in a small number of counterparties. Banks' indirect exposures to the same counterparties also are potentially much larger than their direct exposures.

The paper uses the same stress test scenarios that the US Fed used for its stress tests in 2013, 2014 and 2015. Known as the comprehensive capital analysis and review (CCAR), the scenarios stress the trading books of the largest US bank holding companies (BHCs). In CCAR, banks must consider the default of the counterparty that would owe the bank the most money on credit default swaps during a stress event.

The OFR paper highlights two potential limitations to the approach of considering only the largest counterparty. First, CCAR considers BHCs' direct counterparty concentrations, not indirect ones.

Access to data on the entire US CDS market allowed the authors of the research to stress CDS positions for both BHCs and non-BHCs. They then compared the direct impact of the default of a BHC's largest counterparty with the impact of indirect losses of the largest counterparty on the BHC's other counterparties.

The authors find that indirect effects can be as much as nine times larger than the direct impact on the BHC. As a result, ignoring indirect effects could understate the stress on banks. There are also instances when the BHC's largest counterparty would not be the source of the largest indirect effects.

Second, the authors compared the risks that BHCs face individually to what they face as a group. The authors used a concentration index that quantifies how much each counterparty would owe to the banking system as a whole under the 2015 CCAR stress scenario. They find that those pay-offs would be highly concentrated: the index reading is similar to a market exposed to just three counterparties.

The paper also points to some changes in the US CDS market. Between 2013 and 2015, BHCs have moved from being net sellers of protection to net buyers, which suggests a shift of risk from the banking sector to non-banks.

The authors also show that the concentration of banks' counterparty exposures has increased.

CLOs

Step-up tranche refinanced

Apollo Credit Management has refinanced the US$120m class A1b notes from its ALM VIII CLO, marking the first refinancing transaction in the sector since September. The tranche was redeemed at par, plus US$272,856 interest, by issuing replacement securities.

Deutsche Bank CLO strategists note that the motivation for the refinancing is unusual in that the refinanced tranche is a step-up tranche. At closing in December 2013, the tranche began paying Libor plus 110bp, but stepped up to plus 165bp last July and was set to step up further to 195bp this July. The replacement tranche will pay 155bp starting in April through the life of the deal.

CLOs

CLO cov-lite limits increasing

Evolving definitions of covenant-lite have reduced the number of leveraged loans that count toward US CLO cov-lite purchase limits, while cov lite purchase limits have also increased, says Moody's. The rating agency considers both trends to be negative.

Moody's bases its conclusions on a review of 419 indentures from CLOs rated between 2012 and 2015. "An increase in carve-outs has weakened cov-lite definitions, resulting in the exclusion of certain loans the market would normally consider to be cov-lite," says Moody's. "This means CLOs can underreport their actual cov-lite exposure, even as cov-lite purchase limits increase."

Cov-lite purchase limits are as high as 80% for some deals. While most CLOs had cov-lite purchase limits of 31%-40% in 2012, that had risen to 51%-60% last year.

CMBS

Sports Authority exposure gauged

Fitch suggests that Sports Authority's withdrawal from some locations, following its Chapter 11 bankruptcy protection filing, may pressure smaller strip malls or neighbourhood shopping centres. However, US CMBS deals that the agency rates aren't expected to be significantly impacted by the store closures.

Fitch has identified 49 transactions with exposure to Sports Authority, 20 of which are CMBS 1.0 vintages and the remainder are CMBS 2.0. Only 11 have exposure to the retailer of 1% or more, based on the loan's percentage of the pool multiplied by the tenant's net rentable area percentage. Additionally, as the majority of these transactions are multi-borrower, the diversification of the properties should minimise the overall impact of problems experienced by one tenant.

A typical Sports Authority store occupies approximately 45,000 square-feet and the firm is either an inline tenant in certain malls or a stand-alone store. In either format, Fitch's analysis indicates the impact of any potential store closures related to the bankruptcy is limited for its CMBS portfolio.

Nevertheless, the loss of a major tenant in smaller strip malls or neighbourhood shopping centres could draw pedestrian traffic away from them, the agency notes. In some cases, the loss of a Sports Authority store could trigger co-tenancy clauses and/or termination options, which come into effect when a major tenant leaves its space.

The bankruptcy does not alter Fitch's overall view that the retail subsector of CMBS is stabilising. In 4Q15, vacancy for neighbourhood malls fell by 10bp to 10% and rents rose by 0.5%, up 2.2% for the year. The regional mall vacancy rate dropped by 10bp to end the year at 7.8%.

The only US region to experience a vacancy increase was the West. However, this region still exhibits the strongest operating metrics, with an average vacancy rate of 8.7% and the highest average asking rate of US$24.57 per square-foot.

The Midwest continues to exhibit the weakest asset performance, with a vacancy rate of 12.5% and average asking rental rate at US$16.49 per square-foot.

Liquidation sales at approximately 140 Sports Authority stores reportedly began last week.

CMBS

Quarterly loss severity spikes

US CMBS liquidations in 4Q15 saw the highest quarterly loss severity since 1Q10, when Moody's began tracking losses across the sector. The agency notes that severities were driven by a number of large loans liquidated at high losses.

"The fourth quarter of 2015 saw 240 loans liquidate with an average loss severity of 58.2%, up significantly from the 210 loans that liquidated with an average loss of 41.9% in the prior quarter," says Moody's svp Keith Banhazl. "Among the loans that liquidated in the final quarter of last year, four liquidated with losses of more than US$100m and loss severities above 70%."

Of the four largest loans that liquidated in the fourth quarter, two were sold by special servicer CWCapital as part of its bulk sale of distressed assets, including the Loews Lake Las Vegas loan (SCI 15 January). The asset liquidated with a US$132.4m loss for a loss severity of 113.1%, the highest loss amount recorded for loans liquidated last year and the sixth highest overall, according to Banhazl.

The other three large loans that liquidated in the final quarter of 2015 were: Citadel Mall, which liquidated with a US$130.9m loss for a severity of 96.2%; DRA-CRT Portfolio I, which liquidated with a US$125.1m loss for a severity of 97.9%; and COPT Office Portfolio (Rollup), which liquidated with a loss of US$109.5m for a loss severity of 73% (see SCI's CMBS loan events database).

Additionally, two CMBS 2.0 loans liquidated with minimal losses in 4Q15: Youngsville Crossing (securitised in WFRBS 2011-C3) and Lockaway Self Storage (GSMS 2012-GC6).

CMBS

Pay-off percentage slips

Trepp reports that the percentage of US CMBS loans paying off on their balloon date slipped modestly in February. Last month's reading is 65.4%, slightly below the January number of 67.2% and close to the 12-month moving average of 68.4%.

By loan count as opposed to balance, 73.2% of loans paid off in February. On this basis, the pay-off rate was above January's level of 64.5%. The 12-month rolling average by loan count now stands at 68.8%.

Insurance-linked securities

Securis launches ILS fund

Securis Investment Partners is launching a fund which will enable investors to participate directly in pure catastrophe event risk. Securis Catastrophe Bond Fund is a sub-fund of Northill Global Funds ICAV and is Securis' first UCITS-compliant fund. The fund will invest in a portfolio of cat bonds, diversified across a range of securities which are exposed to risk in different geographies.

Risk Management

Prudent valuation views sought

The EBA has launched a public consultation on the inclusion of prudent valuation into COREP, the reporting framework through which EU banks report supervisory information. The consultation will run until 30 March.

The EBA's proposed changes would allow the inclusion of the new requirements for reporting information on prudent valuation, as well as some supplementary requirements for reporting credit risk information. The information collected will allow banking supervisors to assess compliance with the prudent valuation requirements set by EU legislation and the EBA's own related technical standards.

Risk Management

Operational risk SMA proposed

The Basel Committee has issued for consultation proposed revisions to the operational risk capital framework. The new standardised measurement approach (SMA) for operational risk builds on the Committee's earlier consultation paper issued in October 2014.

The Committee says the proposed revisions are part of its broad objective of balancing simplicity, comparability and risk sensitivity. The SMA aims to address a number of weaknesses in the current framework.

In particular, the SMA will replace the three existing standardised approaches and the advanced measurement approach (AMA) for calculating operational risk capital, thereby significantly simplifying the regulatory framework. The Committee believes that the AMA has resulted in excessive variability in risk-weighted assets and insufficient levels of capital for some banks.

Further, the revised methodology combines a financial statement-based measure of operational risk - the business indicator (BI) - with an individual firm's past operational losses. This results in a risk-sensitive framework, while also promoting consistency in the calculation of operational risk capital requirements across banks and jurisdictions.

The Committee plans to conduct a quantitative impact study (QIS) to help inform the final calibration of the proposed standard. It expects the proposals to have a relatively neutral impact on capital for most banks.

Comments on all aspects of the consultative document and the proposed standards text are invited by 3 June.

Risk Management

Central margining service introduced

AcadiaSoft reports that 28 banks are participating in industrywide testing of the first-ever two-way central margining service for non-cleared OTC derivatives, which it delivered in collaboration with TriOptima last month. Industry testing of the AcadiaSoft Collateral Hub marks the successful completion of the first phase of an industry initiative around electronic margin management announced last July. The new service aims to facilitate industry compliance with Basel Committee margin regulations coming into effect on 1 September.

"Testing the AcadiaSoft Collateral Hub provides banks with the opportunity to refine and calibrate their margin processes six full months ahead of the implementation of the new margin regulations this coming September," comments Mark Demo, regulatory product director at AcadiaSoft. "We make it possible for industry participants to automate and scale their margin processes to meet the challenges of complying with the new regulations."

The release also marks the first phase in linking AcadiaSoft's platform with TriOptima's triResolve service. The move is designed to enable market participants to calculate and reach agreement for exchanging initial and variation margin amounts, identify and reconcile differences, and prevent disputes.

Risk Management

ESAs publish OTC RTS

The European Supervisory Authorities (ESAs) - EBA, EIOPA and ESMA - have published the final draft regulatory technical standards (RTS) outlining the framework for EMIR. The standards cover margin requirements for non-centrally cleared OTC derivatives.

The RTS concern the risk mitigation techniques related to the exchange of collateral to cover exposures arising from non-centrally cleared OTC derivatives. They also specify the criteria for intragroup exemptions and the definitions of practical and legal impediments to the prompt transfer of funds between counterparties.

For derivatives not cleared by a CCP, the draft RTS prescribe that counterparties have to exchange both initial and variation margins. The RTS also outline the list of eligible collateral for the exchange of margins, the criteria to ensure the collateral is sufficiently diversified and not subject to wrong-way risk, and the methods to determine appropriate collateral haircuts.

Additionally, the draft RTS lay down the operational procedures related to documentation, legal assessments of the enforceability of the agreements and the timing of the collateral exchange. The procedures for counterparties and competent authorities related to the treatment of intragroup derivative contracts are also covered.

Risk Management

Liquidity assessment service offered

Bloomberg has launched a liquidity assessment tool (LQA), which is designed to provide institutional investors with a quantitative approach to calculating liquidity risk consistently across asset classes. The tool combines Bloomberg's financial data and machine learning techniques to calculate the multitude of relevant factors influencing liquidity.

Bloomberg LQA provides users with a standard definition of liquidity and a consistent approach to measuring the expected cost of liquidation for a specific volume of securities and a desired time horizon. It also provides a score designed to indicate security-level liquidity with respect to liquidation cost and its distributions across different volumes.

Bloomberg Professional service subscribers can access Bloomberg LQA data for more than 130,000 global government and corporate securities. While the tool covers government and corporate securities today, the methodology that underpins it can be applied consistently across asset classes, to assess liquidity risk at the portfolio level.

RMBS

Russian law 'RMBS positive'

A Russian law strengthening limited recourse and removing restrictions on repurchasing mortgages on securitised pools is credit positive, says Moody's. For future RMBS transactions which use the limited recourse feature, creditors' claims upon enforcement of the pledged collateral will be limited only to specific assets.

The rating agency believes the new legal framework also provides more flexibility for the arrangers of RMBS transactions to establish revolving structures as the law simplifies the replacement of securitised mortgages. It also allows for single SPV, multi-issuance programmes.

The amended law introduces a legal mechanism for issuing series of notes where each is backed by a separate mortgage pool, which is a development that should contribute to the efficiency of the RMBS market, says Moody's. The introduction of the limited recourse concept also addresses some questions related to cross-collateralisation issues, which arise in cases when one single mortgage agent will be used to issue many series of RMBS notes.

RMBS

Dutch origination platform debuts

Venn Partners has launched its own Dutch mortgage brand and origination platform. Called Venn Hypotheken, the firm says it is designed to be efficient, cost-effective and reliable, allowing Venn to offer competitively-priced mortgages in direct competition with banks.

The new lender is expected to target an annual production volume of €2bn and offers annuity, linear and interest-only mortgage loans. Its pricing is most competitive in the higher LTV segments, without NHG guarantees, according to a Rabobank research note.

Venn's experience in the Dutch mortgage market includes the acquisition of a pool of GE Artesia Bank loans, which it securitised in the Cartesian Residential Mortgage 1 RMBS in 2014.

RMBS

Deleveraging drives UK RMBS

Deleveraging will be the main driver of UK non-conforming RMBS in 2016, says Moody's. Collateral performance will be supported by the nation's economic recovery and robust housing market.

"Deleveraging will drive the UK non-conforming sector's performance in 2016, cushioning against losses in a hypothetical severe recession scenario," says Moody's. Last year, 80% of UK non-conforming RMBS upgrades were due to deleveraging and improved collateral performance.

The rating agency says servicer disruption risk will still constrain most senior tranches' creditworthiness, on the back of lowly or non-rated servicers and/or insufficient back-up arrangements. A disruption in servicer performance can significantly affect transaction performance.

Deterioration in collateral performance would have more of an impact on junior and mezzanine tranches. This is due to deleveraging mitigating the impact on senior notes.

RMBS

AnaCap makes Dutch purchase

AnaCap Financial Partners and Arrow Global have acquired a portfolio of Dutch residential and commercial mortgages with a face value of €127m. AnaCap also recently acquired a pair of Italian NPL portfolios (SCI 4 March).

The Dutch portfolio has been acquired by vehicles owned by AnaCap Credit Opportunities III and Arrow Capital. It is AnaCap's first such transaction in the Netherlands and represents a granular mix of seasoned loans, mainly consisting of residential mortgages.

RMBS

RFC issued on Indian RMBS

Moody's has published a request for comment on its proposed approach to rating Indian RMBS. The agency proposes using its residential mortgage collateral analysis model MILAN, which is a key element of its approach to loan and portfolio level evaluation. In addition, it will publish a methodology supplement outlining the country-specific values for the assumptions and adjustments that the methodology uses.

The calibration of MILAN for India is primarily driven by benchmarking the Indian residential real estate market to other jurisdictions that also use MILAN. Specifically, the changes are due to differences between India and other new markets in terms of macroeconomic characteristics, Moody's observations of the Indian property and residential mortgage market and regional differences within India when compared with other countries. In its proposed approach, the agency uses jurisdictions such as Russia and Turkey for benchmarking various aspects of the Indian market.

Although India's housing and mortgage markets are still developing, they evolved rapidly between 2006 and 2015 against a backdrop of strong economic growth for the country. Moody's notes that data on house-price volatility and mortgage book performance through a full economic cycle is consequently limited. It therefore uses parameters from its new securitisation market settings of MILAN for Indian residential mortgage pools, with a few additional calibrations to reflect India-specific elements.

The proposed approach does not affect any outstanding transactions and therefore no rating changes will result from the publication of the India MILAN settings, if adopted as proposed.