Contents

Consolidation concerns

M&A may compromise pricing vendor choice and innovation

The consolidation of evaluated pricing firms poses a number of concerns for the securitisation and derivatives markets. A diminishing number of independent pricing points, the potential for higher service charges and a possible threat to innovation are at the top of the list.

M&A activity within the evaluated pricing business is rife. Last month ICE bought from McGraw Hill Financial S&P Securities Evaluations (SPSE) and Credit Market Analysis (CMA), which join IDC and SuperDerivatives in the exchange's portfolio. Also in March, Markit acquired Fitch Solutions' CDS Pricing Service.

"From our perspective, the biggest concerns we've seen from our clients is potential reduction in vendor choice and what that means to them," says Ian Blance, md at Voltaire Advisors. "The market power that now resides with ICE has implications."

He continues: "On the face of it, restriction in choice is not that obvious when you look at the overall market structure. There's still Bloomberg, Thomson Reuters, JPMorgan, Markit, for example. But when you dig a little bit deeper, specifically in some of the asset classes such as CDS, there are potential problems."

A detail that is yet to be clarified is whether the different pricing firms that have been purchased will continue to operate as independent pricing sources or merge into one. SCI contacted relevant parties, but no further information other than the official press releases was supplied.

In those releases, ICE said it was positioned to expand coverage in derivatives and offer a "multi-asset class, comprehensive source for pricing and reference data". Markit and Fitch Solutions will meanwhile "integrate Markit CDS Pricing as a critical component of its risk analytics, implied ratings and other derived services".

"One of our primary questions when we do our due diligence on the pricing vendors will be whether the merged firms will remain as stand-alone entities or merge into one," says Adam Bareham, director of forensic and valuation services at Grant Thornton. "It would be especially important for us that even if they are merged, they retain some sort of independence in their pricing."

For many clients, the operational implication of the mergers comes down to the need for primary and secondary sources; in other words, using one vendor as a primary pricing point and the other as a back-up. "SPSE was positioned, in many cases, as a back-up to IDC," explains Blance. "Now that they are owned by the same company - even if it intends to run them as different businesses - they will still share a corporate identity."

Questions over regulatory approval of the mergers have also been raised. It is understood that regulatory bodies are looking carefully at some of the deals in question and it is anticipated that there will be industry comment, especially from those that are susceptible to a restriction in pricing sources.

Another concern in relation to vendor consolidation is the threat to innovation. "This is an industry that has not been known, historically, for its innovation," says Blance. "During periods of integration, innovation tends to suffer as work is focused on synergy and cost-saving. The pricing industry doesn't have a reputation for proactive responses to products, so it is worth asking if the firms that provide the data are going to be able to cater to the changing needs of their clients."

However, according to Keldon Drudge, ceo at Prism Valuation, there's still a healthy amount of competition, even if it is restricted to the large vendors of valuations. "I don't think we've hit a stage where one major player dominates it," he says. "The vendors will still have to compete for the business, so I don't think we're at the point where we're going to see innovation or efficiency threatened."

The main question, according to Drudge, is whether this set of vendors adequately serves the market. "We find that the large vendors still have gaps in coverage. Asset coverage is far better that it was, but it certainly isn't being fully met yet," he says.

Bareham adds that although he is not particularly concerned about agency bonds, munis or corporates, his concern would lie with the esoteric assets or the newer non-agency RMBS deals for example, where there are fewer experts who are able to price them. "That's my concern in this environment," he says.

According to Brian Sciacca, a leading advisor in the valuation space, the problem with vendor consolidation is not just fewer companies and fewer data points. "You have to question the quality of pricing data that banks are contributing to consensus services," he says. "For example, a number of banks are backing away from complex products. Yet they continue contributing to these services. The illiquid nature of highly structured products exacerbates this particular issue."

Of particular concern, according to Sciacca, is the potential for conformity in pricing vendors' algorithms. "As different vendors compete for market share, no company wishes to be perceived as a weak outlier," he says. "This presents an incentive to modify and independently converge pricing algorithms. That is worrying as two matching prices may be interpreted as corroborating evidence, when perhaps they are simply echoing the same information."

He notes that he prefers to utilise multiple vendors, thereby gathering data from different information sources. "Bank efforts to cut costs (stream-line their approved vendor list), as well as capital requirements under prudential valuation standards may inadvertently increase pressure for conformity among algorithms," he adds.

Another potential concern, according to one UK IPV head, is that vendor clients start acting like a flock. "Rather than trending towards the right prices from the actual data experts, we start trending towards the sources that we know the regulator approves of," he says. "The large data providers tend to get regulatory approval."

Does the diminishing number of pricing sources create an opportunity for a new vendor to enter the scene? It seems unlikely: there would have to be a very compelling reason for a firm to switch to another provider, even if a fully-fledged, competitive evaluated pricing option became available.

"There is a lot of inertia to swap from one provider to another," explains Blance. "The amount of work that would go into migrating from one source to another is really quite large. There would need to be a massive commercial reason to change provider; i.e. the source is a lot cheaper - which justifies the change - or because it was some sort of risk-related exercise."

Bareham agrees. "It would be a tall order for a new pricing vendor to enter the market, given the service these merged companies are going to offer - i.e. a one-stop-shop, where every single structured product will be priced," he says. "Some will do a fine job, others not. Some firms will price an asset just because they want to be able to price the entire market."

That is somewhat problematic, he explains, as different people with different expertise are required. "It takes time to build up that expertise and a larger corporation may not consider esoteric assets as important. They may spend more time synergising than on innovation," he adds.

However, it is becoming easier for clients to swap between vendors if they are not satisfied with the service they are providing. Drudge notes that vendor clients are adapting their technology processes to make the transition less complex.

"In the past incumbent vendors were at a huge advantage because infrastructure was built around them," he says. "Clients of valuations services, particularly on the buy-side, are now better able to change those switches without having to do so much work. That forces vendors to be more competitive on price and service. It's still a big process to change from one vendor to another, but it's getting easier."

As the new evaluated pricing environment continues to evolve, pricing vendor clients will likely be looking closely at their licence fees and potential price rises. "They will expect the prices to rise," says Blance. "Given the vendors' business models, it's difficult to see how that is going to change. This is one of the more intractable issues of the evaluated pricing market - elsewhere, data and information costs are tending to fall as a result of efficiency and technology, but with evaluated pricing, costs remain high."

AC

CLOs

On the rebound

US CLO spreads, issuance rallying

The December to February period was the worst experienced by the US CLO market since the financial crisis, but the subsequent rally in commodities and high yield has enabled most of the returns lost during that period to be regained. Cleaner portfolios of new deals, together with tightening spreads, are expected to support a growing primary market for the rest of the year.

The first quarter saw the lowest quarterly US CLO issuance since 1Q12: only US$8.2bn of new deals printed, compared with an average US$25.3bn per quarter over the previous three years, according to Deutsche Bank figures. Over half of the quarter's issuance was in March, when US$4.9bn of new paper priced.

Matthew Natcharian, head of structured credit at Babson Capital Management, says that the CLO market reacted rationally to the volatile beginning of the year. "Junior tranches widened, reflecting increased likelihood of loss at the bottom of the stack, but double- and even single-A tranches have been immune as a function of stronger structures. CLOs are an illiquid asset class, but what liquidity there is in the market remained throughout the volatility, demonstrating the health of the sector."

At the beginning of 2016, generic double-B tranches were trading at discount margins of 800bp-950bp over Libor, but by late-February most were trading in the 1000bp-1400bp range. Spreads recovered during March to the 800bp-1200bp range.

Similarly, triple-B tranches started the year trading with DMs in the high-400s and 500s, which widened to 600bp-800bp by end-February. But by the end of last month, triple-Bs were generally trading at 550bp-700bp, according to Deutsche Bank.

Against this backdrop, some managers outperformed, especially at the bottom of the capital structure. "We're seeing significant dispersion around spreads and performance based on composition of portfolios. Prices plummeted so quickly at the beginning of the year that it limited the ability of some managers to sell, while others traded out of their commodity exposures early and they are now benefitting from cleaner portfolios," Natcharian observes.

He adds: "Investors should always know the manager and their investment style, and understand their strategy. If a manager is overweight energy names, investors need to understand the actual exposures because although some loans are clearly under stress, others are not. This presents an opportunity, as any portfolios comprising energy names have wider spreads, enabling investors to take a view."

While Wall Street cost-cutting and scaling back of trading capabilities should also provide opportunities to find interesting CLO paper, forced selling isn't expected as a result of recent ratings watches and downgrades in the sector (SCI 25 February). "Rating agencies are being more proactive these days, but ratings mean more when a deal is new and have less importance once it has closed. Besides, most of the recent rating activity is at the double-B level and the majority of buyers at this part of the stack are hedge funds and aren't ratings-sensitive," Natcharian explains.

Both established and first-time investors have found the wider spreads on offer attractive. However, it remains unclear whether new investors at the triple-A level are natural buyers. While CLO equity is typically preplaced, the missing piece appears to be triple-A demand.

"The tug-of-war between triple-A and equity buyers continues, and the pace of new issuance has been very slow," Natcharian says. "The CLO secondary market rebounded quickly; higher prices should facilitate more secondary supply, which should in turn kick-start the primary market. New deals will be clean and so should trade tighter than secondary paper."

Assuming no big macro impact, he expects new issuance to keep building for the rest of the year. "Deals are increasingly being structured as risk retention-compliant to attract debt investors. There is more flexibility in the US regulatory structures, but this variety will naturally reduce as the market settles and standards are agreed."

CS

Secondary markets

Euro secondary solid

The European securitisation secondary market remains solid but fairly quiet.

Tone remains firm across the board though activity is still patchy. An uptick in flows and secondary supply in the middle of last week fizzled out by Friday and yesterday was no different with only very select pockets of activity, which is keeping spreads range-bound.

Notably, Italian paper did manage to catch a bid yesterday on the back of the country's bank recapitalisation plans. The sector also saw a flash BWIC involving a mix of seniors, which traded well.

There are currently three BWICs on the European schedule for today. One involves some small clips of 1.0 triple-A CLOs and the other two are more sizeable lists both consisting of triple-A RMBS.

The first of the RMBS lists is due at 14:00 London time. It is a five line 38m original face euro and sterling mix comprising: AIREM 2006-1X 2A1, AIREM 2007-1X 2A2, GHM 2007-1 A2B, PARGN 15X A2A and RLOC 2007-1X A3A. Two of the bonds have covered with a price on PriceABS in the past three months - AIREM 2006-1X 2A1 at 97.522 and AIREM 2007-1X 2A2 at 97,08, both on 19 February.

At 14:30 there are six lines of Dutch RMBS totalling €73.3m. The auction involves: EMACP 2008-NL4 A, SAEC 12 A2, STORM 2012-1 A2, STORM 2012-2 A2, STORM 2014-3 A2 and STORM 2015-1 A. Two of the bonds have covered with a price on PriceABS in the past three months - STORM 2014-3 A2 at 100.33 on 20 January and STORM 2015-1 A at 99.921 on 19 January.

Secondary markets

US CLOs continue

The positive trend in the US CLO secondary market is continuing.

"Demand for bonds continues and consequently they continue to trade well," says one trader. "It's very noticeable that the number of line items that actually trade is much higher than it was even a month ago."

The trader continues: "We're now into the fifth week of this rally and yesterday saw us move a little tighter even though activity was relatively low. There are already quite a few lists on the schedule for this week but not involving massive volumes - certainly last week TRACE volumes slowed a little on the previous few weeks but sellers are going to continue to sell into this bid as long as it remains deep."

Activity continues to surround the middle of the stack, the trader notes. "The market is still very much mezz focused. Nevertheless, there are a couple of double-A lists scheduled and some 1.0s, but in very small size."

There are currently seven BWICs on the US CLO calendar for today. The largest is a collection of 2.0 triple- to single-Bs due at 11:00 New York time.

The nine line $45.45m list comprises: ARES 2013-3A F, CIFC 2014-1A E, CRNPT 2013-2A B2L, FLAGS 2013-7A D, GALL 2013-1A E, OCT20 2014-1A E, REGT4 2014-1A E, VENTR 2013-14A E and WSTC 2014-1A D. Only CIFC 2014-1A E has covered with a price on PriceABS in the past three months, last doing so at M70S on 30 March.

Secondary markets

Euro secondary selective

Trading continues to be selective across the European securitisation secondary market.

"Yesterday we saw some action in prime," says one trader. "On BWIC there was a reasonably large Dutch RMBS list that traded at very tight levels - four-year STORM in the +25 area, for example. At the same time, UK prime saw two-way flows and having been under a little pressure looks to be stabilising."

Meanwhile, the trader continues: "There were practically no flows in peripherals yesterday. The only exception was Portugal, but even there bid-offers continue to be quite wide."

CMBS is similarly very quiet, the trader reports. "We're seeing some accounts looking for seniors but that's about it. Even in German multifamily there's not a lot happening despite the widespread expectation that we are nearing a number of call dates."

Meanwhile, CLOs are seeing some, albeit limited, action. "The market as a whole appears to be functioning a bit better and while the new issue pipeline is long, deals are printing so the arb is working, which was previously a worry, and giving the maret some pricing direction," says the trader. "However, secondary is still a bit sticky and liquidity remains quite thin with only pockets of activity - we saw some selective buying in 1.0s yesterday, for example."

There are currently two BWICs on the European schedule for today. One is a 12 line 11.2m CLO and RMBS mix due at 13:00 London time.

The list comprises: AUBN 9 D, EGLXY 2015-4X C, GHM 2007-1 BB, LEEK 17X MC, LEEK 19X CC, LEEK 19X DC, NGATE 2006-1 BB, OHECP 2015-4X D, RMAC 2005-NS2X M2C, RMACS 2006-NS2X M2C, WARW 1 C and WARW 2 C. Two of the bonds have covered with a price on PriceABS in the past three months - EGLXY 2015-4X C at 97H on 8 April and LEEK 17X MC at 98.55 on 21 January.

Then, at 15:00 there is €3m each of JUBIL 2015-15X SUB and ORWPK 1X SUB. Neither CLO equity piece has covered with a price on PriceABS before.

Secondary markets

US CLOs add variety

It looks set to be another busy day in the US CLO secondary market with today's auction schedule involving more than mezz paper for once.

"People keep putting out lists and they continue to trade well, we're even seeing some decent size triple-As today," says one trader. "Primarily it's still all about the bottom of the stack where, for example, we saw a good name double-B with 4% credit enhancement trade at 825DM yesterday, which is a 100DM move in over the past week or so."

Six of the eight BWICs currently on the US CLO calendar for today involve mezz, but the other two exclusively focus on triple-As. "Those large lists are both from big money managers," says the trader. "I'm not sure it's necessarily a sign of a widespread shift beyond mezz, but one of the lists could be a strategic move, while the other seems more like they're moving stuff around."

The first of the triple-A lists is due at 12:00 New York time and comprises 11 line items totalling $47.102m - AMMC 2015-16A A1, BABSN 2014-IA A1, BABSN 2014-IIA A, BHILL 2013-1A A, CLRCK 2015-1A A, DRSLF 2014-31A A, FLAT 2014-1A A1, LROCK 2014-3A A1, MAGNE 2014-11A A1, MAGNE 2015-12A A and VOYA 2014-2A A1. None of the bonds has covered with a price on PriceABS in the past three months.

Then, at 14:00 there is a three line auction consisting of: $18.47m DRSLF 2014-33A A, $18.82m MAGNE 2014-9A A1 and $51.5m OZLM 2014-6A A1. Only MAGNE 2014-9A A1 has covered with a price on PriceABS in the past three months, last doing so at 98.701 on 19 February.

Secondary markets

Euro CLOs stay active

The recent uptick in activity in the European CLO secondary market is continuing.

"There's more activity across the board thanks mainly to primary continuing to tighten, which gives people comfort that primary and secondary are more aligned," says one trader. "Consequently, the secondary market appears to be getting back to normal."

However, the trader continues: "That said, it can still be tough to win bonds and tough to sell. A lot of players are still absent - it will take them a very long time for some to forget the impact of the volatility in Q1 and be willing to dip their toes back in the water."

Overall, though, volumes are increasingly healthy, the trader reports. "2.0s are generally trading consistently strongly with single-Bs perhaps the exception, while 1.0s are trading completely differently - the mix of callable and non-callable bonds is making for a bifurcated market."

There is one European CLO BWIC on the schedule for today so far - a five line €18.8m double-A and double-B list due at 14:00 London time. It comprises: ARBR 2014-1X E, ARESE 7X A2A, EGLXY 2015-4X B2, NEWH 1X E and PENTA 2015-2X B. None of the bonds has covered on PriceABS in the past three months.

Secondary markets

US CMBS shaped by primary

New issuance pricing and trends are shaping what's happening in the US non-agency CMBS secondary market.

"Primary is driving a lot of what's happening in secondary right now," says one trader. "New issuance spreads have come back a long way from recent wides - triple-As peaked at 173 and the latest JPM deal priced at 129 - and secondary levels have followed suit."

The trader continues: "Consequently, it was very busy last week as people took the opportunity to sell via bid lists. This week is much quieter as most profit taking has been completed for now."

Nevertheless other primary market factors could cause further secondary tightening, the trader suggests. "Risk retention is coming but a lot of originators probably won't be able to take 5%, so will have to sell a bigger B-piece instead, which will mean B-piece buyers will end up taking triple-B-minus and possibly even single-A paper. That will bring the available volume down and those bonds are already attractive to secondary buyers."

The trader explains: "At the end of 2014 triple-B-minus spreads were 320 they are now 650-700. So, you're getting a good return yet are unlikely to take a loss - subordination is now 7-9%, not like the old days when it was 2% - on an asset that's going to become scarce. As a result, triple-B-minus paper will increasingly attract buyers who can take the inherent mark-to-market volatility and that will only push prices up."

At the same time, new issues are likely to become scarcer more broadly, the trader says. "Origination was estimated to be $100bn-$110bn at the beginning of the year - it's now expected to be in the $50bn-$75bn region. One of the main reasons why spreads blew out in Q1 was too much supply, but that's clearly no longer an issue."

Overall, the trader concludes: "I think the market will continue to trend towards tightening in the long-term, despite that meaning shorter-term a lot of people will have the instinct to sell once they've made sizeable gains. We still have a long way for the market to go to return it to properly functioning normality - triple-As were at 92 at the end of 2014, for example."

Structured Finance

SCI Start the Week - 11 April

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

Pipeline
Pipeline activity picked up again last week. There were 10 ABS additions, as well as an RMBS, two CMBS and two CLOs.

The ABS were: US$220.33m American Credit Acceptance Receivables Trust 2016-2; €549.1m Bumper 7; US$1.175bn CarMax Auto Owner Trust 2016-2; US$751.6m Chrysler Capital Auto Receivables Trust 2016-A; US$342.69m CPS Auto Receivables Trust 2016-B; A$500m Crusade ABS Series 2016-1 Trust; Hertz Fleet Lease Funding Series 2016-1; Master Credit Card Trust II 2016-1; Penarth 2016-1; and SPE PSB SME 2015.

£6.2bn Towd Point Mortgage Funding 2016-Granite 1 was the RMBS, while the CMBS were US$694.7m CGCMT 2016-GC37 and US$1.4bn FREMF 2016-K54. The CLOs were US$248m BlueMountain CLO 2016-1 and US$255m Regatta VI Funding.

Pricings
There were fewer deals departing the pipeline, however. Last week there were seven ABS prints.

These were: US$1.2bn AmeriCredit Automobile Receivables Trust 2016-2; US$300m DT Auto Owner Trust 2016-2; US$438m Hyundai Floorplan Master Owner Trust Series 2016-1; US$497m Navient Student Loan Trust 2016-2; US$382m Utility Debt Securitization Authority Restructuring Bonds Series 2016A; and €750m VCL 23.

Markets
The US CLO bid shows no signs of fading, as SCI reported last week (SCI 7 April). "The secondary rally continues to strengthen - this wave now really seems to have some power to it," says one trader.

European secondary activity is patchy, although the European CLO sector continues to attract strong interest, as SCI reported last week (SCI 7 April). "We're seeing a strong client bid for triple-As, but what little BWIC activity there is focuses on mezz where spreads remain firm - the bonds that traded on yesterday's single-B list went through in the low 1,000s," comments one trader.

The tone in the European RMBS secondary market continues to improve, say JPMorgan analysts. They add: "Spreads in the periphery continued to firm, with benchmark Italian, Spanish, and Portuguese senior RMBS spreads 3bp-5bp tighter, ending the week at 160bp, 220bp, and 330bp, respectively."

Editor's picks
Special forces: Credit Suisse's recent decision to exit securitised trading in Europe highlights the reshaping of the ABS frontier that is underway across the region. Against the backdrop of regulatory pressures and capital constraints, many dealers are adopting a narrower, more specialised approach...
Reckless driving?: Concern is mounting over rising US subprime auto ABS delinquencies. However, issuance in the sector remains vibrant and ratings are generally expected to remain stable to positive this year...
Granite resurfaces in unique RMBS: Cerberus European Residential Holdings is bringing to market a deal which is essentially a refinancing of the Granite portfolio it bought late last year (SCI 13 November 2015). Towd Point Mortgage Funding 2016-GR1 is the largest new issue in its sector since before the financial crisis, which is seen as widely positive for UK non-conforming RMBS, particularly so close to the Brexit referendum...
China NPL rules mooted: Chinese authorities are pushing to incorporate NPLs as a fully-fledged product within the country's growing securitisation market. The National Association of Financial Market Institutional Investors (NAFMII) is leading the initiative with a new set of guidelines for an NPL framework, which were opened for feedback last month...

Deal news
• A severance order and partial final judgment was last week filed in the New York State Supreme Court that would permit allocable shares under the Countrywide RMBS settlement to be distributed to 515 'initial release trusts'. The remaining 15 transactions - 12 CWALT and three CWHL deals - involved in the case continue to be contested.
• The final price of Pacific Exploration & Production Corp CDS has settled at 20 (SCI 24 March). At an auction held on 6 April, 11 dealers submitted initial markets, physical settlement requests and limit orders to settle trades across the credit derivatives market referencing the entity.

Regulatory update
• A list of potential pitfalls in the European Commission's STS framework has been published in a letter by 32 signatories, including some of the EU's largest banks. The signatories argue that the STS framework would not, in its current form, provide the solution for the securitisation market that it is intended to.
• The EBA has launched a public consultation on draft amending regulatory technical standards (RTS) on credit valuation adjustment (CVA) proxy spread, which aim to ensure a more adequate calculation of own funds requirements for CVA risk. The RTS propose limited amendments to the European Commission's Delegated Regulation (EU) No 526/2014 based on two policy recommendations contained in the EBA's CVA report published on 25 February 2015.
• The Basel Committee has released a consultative document on revisions to the Basel 3 leverage ratio framework, as well as responses to a third set of FAQs. The consultative document's proposals are the result of feedback from market participants and stakeholders and cover four key issues.
• The California Attorney General Kamala Harris has filed a lawsuit against Morgan Stanley over RMBS that it allegedly misrepresented when selling to California public pension funds. The complaint was filed in the San Francisco Superior Court. The funds lost millions of dollars on the RMBS investments.

Deals added to the SCI New Issuance database last week:
ALM VIII (refinancing); AMMC CLO XI (refinancing); Apollo Aviation Securitization Equity Trust 2016-1; Avis Budget Rental Car Funding Series 2016-1; Berica PMI 2; BlueMountain EUR CLO 2016-1; Bosphorus CLO II; Canyon CLO 2016-1; Chesapeake Funding II Series 2016-1; Citi Held For Asset Issuance 2016-PM1; Contego CLO III; DBJPM 2016-C1; Fastnet Securities 11; FREMF 2016-KLH3; Harvest CLO XV; Hyundai Auto Receivables Trust 2016-A; LCM XXI; MarketPlace Loan Trust series 2016-LD1; Merna Re series 2016-1; Mill Creek CLO; Octagon Investment Partners 26; Telos CLO 2016-7; Upland CLO; ;

Deals added to the SCI CMBS Loan Events database last week:
BACM 2006-3; CGCMT 2014-GC25; ECLIP 2006-1; ECLIP 2006-4; EPIC (Premier); EURO 26; EURO 27; EURO 28; FHSL 2006-1; GSMS 2007-GG10; JPMCC 2007-LDPX; JPMCC 2013-C10; MSC 2006-IQ12; TITN 2006-3; TITN 2006-5; WBCMT 2007-C31; WINDM X

Structured Finance

Appetite strong for marketplace loans

A poll of 300 institutional investors suggests that appetite for marketplace loans remains strong. The second survey conducted by Richards Kibbe and Orbe, in partnership with Wharton Fintech, finds that a greater number of institutional investors are invested in the asset class than a year ago.

The survey also highlights that optimism has grown among institutional investors, with 80% indicating high or medium levels of optimism for continued growth of marketplace lending, compared to 71% last year. This is supported by the finding that 50% of respondents have capital allocated to the marketplace lending space, compared with only 29% a year ago.

With a slow-down in securitisation activity, there has been some concern that the industry may be contracting. The survey paints a different picture, however, suggesting that the these worries may have arisen from the industry simply not growing at the explosive and unsustainable rate that it had previously enjoyed.

Many institutional investors are also more familiar with marketplace lending as an asset, with 82% being somewhat or very familiar with marketplace lending compared to 75% a year ago. Additionally, investors reported being familiar with a number of ways to invest in marketplace loans.

Most notably the most common investment in marketplace lending was via equity in privately-held platforms, with 19% of respondents accessing the market that way. Second was direct lending to a platform (18%) and third was purchase of whole loans via an agreement with a platform (15%).

Of the institutional investors polled, 8% invest in securitised marketplace loans, with 12% of those surveyed expressing an interest in investing in marketplace lending ABS in the near future.

In terms of concerns about the future of the industry, the biggest concern related to market-wide credit events, with 85% of respondents somewhat or very concerned. Transparency and disclosure of credit and interest rate risk was cited as the most important way to reduce concern about the industry. Over a third (39%) said that a liquid secondary market would assuage their concerns, while 33% also stated that a mature securitisation market would boost their confidence in the sector.

In terms of the future of marketplace lending, 47% of institutional investors believe real estate loans are the best investment opportunity and 72% believe that consolidation of marketplace platforms is somewhat or very likely.

One of the more alarming results of the survey is that 40% of legal and compliance professionals at institutional investors said they are either not or just a little familiar with the regulatory framework for marketplace lending.

Of the respondents, 15% work at funds of US$10bn or more in AUM, 36% with over US$1bn and 47% with less than US$200m. Among respondents whose funds invest in whole loans or borrower payment-dependent notes through a platform, 73% have less than 10% of their portfolios invested in such assets, while 15% have more than 90% of their portfolios in such assets.

RB

Structured Finance

Marketplace challenges weighed

Expanded access to the ABS markets will be important to the industry's growth, according to a new survey of marketplace lending regulations compiled by Chapman and Cutler. The study also highlights several difficulties that are unique to marketplace loan ABS.

The report suggests that while the first marketplace ABS only closed a few years ago, securitisation has quickly become an important source of funding for many platforms and that this will become more important to platforms over time. However, it outlines several of the challenges peculiar to marketplace loan ABS - one such example being in relation to the obligations of servicers after securities are purchased by the SPV.

In marketplace loan securitisations, the marketplace lender or platform is typically appointed as servicer and the lender will still collect payments on the loans, pursue delinquent borrowers and interact with borrowers, much as they would regardless of the securitisation process. However, with the lender itself appointed as servicer, investors could be left exposed to lender credit risk since the lender's ability to perform its duties as servicer will largely depend on its continuing solvency. While the market will determine back-up servicing requirements for marketplace loan ABS, 'hot' back-up servicing arrangements is expected to become increasingly common, especially with respect to an ABS of loans from a platform with a short history.

In terms of credit enhancement, as the long-term performance of marketplace loan securitisations has not yet been proven, investors will also require higher credit enhancement levels than for similar asset classes.

Additionally, the paper suggests that this lack of performance history has led to hesitancy from rating agencies to rate marketplace loan ABS. Once more marketplace loan ABS are rated, the institutional investor base will likely broaden. Similarly, as a result of some of these challenges, ratings assigned at least in the short term will likely be lower than those assigned to more traditional consumer loans of an equivalent credit quality.

Another unique challenge surrounds the sponsor in the deal: in marketplace loan ABS, the sponsor is usually a bank, investment fund or other institutional investor with no affiliation to the platforms. This complicates the documentation involved in the transaction, according to Chapman and Cutler.

One such example of this surrounds disclosures provided as part of the ABS, which typically covers risk factors specific to the or originator, as well as the lender's underwriting policies, servicing practices, regulatory status and loan performance information. Unless agreed in the loan purchase agreement, the aggregator (because it is not a lender affiliate) cannot require the lender to provide information needed to prepare the offering materials or to certify that the offering materials are accurate.

Despite not being affiliated with the aggregator, marketplace lenders have often been willing to partake in many of the same obligations as a typical ABS, as aggregators often will reinvest the proceeds of the securitisation in further marketplace loans. However, the terms agreed upon between lenders and aggregators can vary significantly between transactions.

In particular, the marketplace lender's obligation to repurchase ineligible loans, or to pay related indemnities, has not been uniform. The result of this is potentially a reduction in secondary market demand, which could therefore "impair the industry's overall access to the securitisation markets".

Also of note is that sponsors of marketplace loan ABS will need to file periodic reports to the US SEC disclosing amounts demanded from investors to repurchase ineligible loans and of any repurchases made.

RB

NPLs

Italian policy changes welcomed

The Italian government is proposing to create a €5bn fund capitalised by the strongest financial institutions in Italy, together with the government-owned entity Cassa Depositi e Prestiti. The move is part of new measures to support the banking market and legislation changes to enhance the underlying infrastructure.

Dubbed Atlante, the fund is intended to backstop any required equity capital raising by the banking sector and will also purchase junior tranches of securitisations of non-performing loans. It is expected to invest directly in the first-loss of securitisations backed by Italian NPLs, thereby allowing the deconsolidation of these loans from lenders' balance sheets, according to a recent TwentyFour Asset Management client memo.

"The big question is whether the €5bn-€6bn size will be sufficient for the scale of the challenge. Total NPLs in Italy is estimated at around €370bn, with the worst of these 'sofferenze loans' held by the largest listed banks totalling around 25%," it notes.

The memo continues: "Clearly the plan as it stands will require a significant amount of private sector involvement if it is to truly clean up the Italian bad loan problems. This is a good start to a long-overdue cleansing of the system, but all the moving parts need to be implemented for success."

TwentyFour AM believes that changes to the Italian foreclosure framework are essential: the foreclosure process can take 3-5 years for individuals and up to 10 years for commercial borrowers, mainly because those borrowers have the ability to challenge and elevate settlement disputes to a higher ranked court. As well as shortening the life of the NPL overhang, the changes - which are expected to be made in October - could increase the price that buyers are willing to pay for NPL pools, as the yield would increase (assuming speeding up the recovery does not increase the loss).

The firm suggests that UniCredit's recent agreement to sell approximately €420m of non-performing unsecured consumer, overdraft and personal loan assets to AnaCap Financial Partners is a sign that such transactions may have found a clearing price.

"Atlante and, more importantly, policy change have the potential to be catalysts in clearing the NPL backlog and moving Italy towards a better functioning banking system in the long term. It does, however, rely on Matteo Renzi achieving changes to the legislation and the constitution - which may still prove to be more challenging than he hopes," the memo concludes.

CS

Structured Finance

Mortgage REITs merge

Annaly Capital Management is set to acquire Hatteras Financial Corp for a consideration to be paid in cash and shares of Annaly common stock, which values Hatteras at US$15.85 per share of its common stock based upon the closing price of Annaly common stock on 8 April. The value of the consideration represents a premium of approximately 24% to the 60-day volume-weighted average price of Hatteras common stock ending on 8 April and a multiple of 0.85x Hatteras' estimated book value per share, as of 29 February.

Subject to the terms and conditions of the merger agreement, a wholly-owned subsidiary of Annaly will commence an exchange offer to acquire all outstanding shares of Hatteras common stock. For each share of Hatteras common stock validly tendered in the exchange offer or converted pursuant to a second-step merger, Hatteras shareholders may elect to receive: US$5.55 in cash and 0.9894 shares of Annaly common stock; US$15.85 in cash; or 1.5226 shares of Annaly common stock. Hatteras shareholders that elect either of the latter two options will be subject to proration, in each of the exchange offer and the subsequent second-step merger, so that the aggregate consideration will consist of approximately 65% of Annaly's common stock and approximately 35% in cash.

In addition, Annaly would assume the existing notional US$287.5m in Hatteras 7.625% Series A cumulative redeemable preferred stock.

The merger is expected to expand and further diversify Annaly's investment portfolio. Hatteras' portfolio - which consists of agency RMBS, residential whole loans and mortgage servicing rights - is complementary to Annaly's existing businesses and will position it as the largest, most liquid and diversified mortgage REIT in the world.

CMBS

CRE firm adds Bay Area director

Holliday Fenoglio Fowler has appointed John Churchward to its San Francisco office as a director focused on debt and equity placement transactions in the Bay Area. He was most recently at Palmer Capital, where he was a structured finance partner. Churchward has also worked at iStar Financial in both Boston and New York.

Insurance-linked securities

Bermuda law firm beefs up

Harneys has recruited corporate and insurance lawyer Michael Skrbic as counsel in its Bermuda office. He joins from Kennedys, where he was partner.

Skrbic's practice includes ILS, reinsurance, derivatives, regulatory compliance, ISDA documentation and credit restructuring. His experience ranges to Asian-based issues too and has seen him hold senior positions at ACE Group, Zurich Financial Services, Dresdner Kleinwort, Commerzbank and CMS Cameron McKenna.

Risk Management

ISDA directors elected

ISDA has announced the election of 10 directors at its 31st Annual General Meeting in Tokyo. A further 14 directors are continuing on the board.

Three new directors were elected: John Feeney, head of pricing and conduct coordination at NAB; Benjamin Jacquard, global head of credit at BNP Paribas; and Hideo Kitano, md, head of credit trading department, head of global markets structuring, Japan, and deputy global head of structured fixed income at Nomura. Seven directors were re-elected: Keith Bailey, md, market structure at Barclays; Biswarup Chatterjee, global head electronic trading & new business development, credit markets at Citi; Elie El Hayek, md, global head of fixed income at HSBC; Diane Genova, general counsel, corporate and regulatory law at JPMorgan; Dixit Joshi, md, head of institutional client group - debt and listed derivatives and markets clearing at Deutsche Bank; Will Roberts, head of global rates, structured credit trading and counterparty portfolio management at Bank of America Merrill Lynch; and Guy Saidenberg, head of EMEA emerging markets trading, global head of securities division sales strats and structuring, Goldman Sachs.

RMBS

RMBS settlement bumped up

Credit Suisse will pay the NCUA a revised US$50.3m sum for a case settled last month surrounding the bank's role in the sale of faulty pre-crisis RMBS (SCI 29 March). The original agreement had Credit Suisse paying out US$29m, but this has now been increased following prejudgement interest determined by a ruling court in Manhattan.

The case concerns substantial losses incurred on transactions bought by Members United and Southwest corporate credit unions. The NCUA has acted as liquidating agent in the case for the credit unions. It says that Credit Suisse will also be liable for attorneys' fees and expenses in an amount still to be determined.

Further, the agency is pursuing federal court litigation against Credit Suisse in Kansas - also for the alleged sale of faulty RMBS. This case involves investments from US Central, Southwest and WesCorp.

The agency has additional lawsuits pending against several other firms.

RMBS

Goldman settles over deceptive practices

US Attorney General Eric Schneiderman has announced a US$5bn settlement with Goldman Sachs over the bank's deceptive practices leading up to the financial crisis. The settlement was negotiated through the RMBS Working Group.

The settlement provides for US$670m - comprising US$480m worth of creditable consumer relief and US$190m in cash - to be allocated to New York State. The resolution requires Goldman Sachs to provide significant community-level relief to New Yorkers, including resources that will facilitate the expansion of the New York State Mortgage Assistance Program, as well as first-lien principal forgiveness and funds to spur the construction of more affordable housing. Additional resources will be dedicated to helping communities transform their code enforcement systems and invest in land banks and land trusts.

New York has now received US$5.33bn in cash and consumer relief from the National Mortgage Settlement (NMS) and all five RMBS Working Group settlements. The combined US$3.2bn in cash and consumer relief from RMBS settlements is more than for any other state.

The settlement includes an agreed-upon statement of facts that describes how Goldman Sachs made multiple representations to RMBS investors about the quality of the mortgage loans it securitised and sold to investors, its process for screening out questionable loans and its process for qualifying loan originators. Contrary to those representations, the bank securitised and sold RMBS backed by large numbers of loans from originators whose mortgage loans contained material defects.

In the statement of facts, Goldman Sachs acknowledges that it securitised thousands of Alt-A and subprime mortgage loans and sold the resulting RMBS to investors for tens of billions of dollars. In certain circumstances, the bank re-evaluated loan grades and directed that such loans be waived into the pools to be purchased or securitised. In many cases, 80% or more of the loans in the loan pools Goldman purchased and securitised were not sampled for credit and compliance due diligence.

The settlement includes a menu of options for consumer relief to be provided, with different categories of relief credited at different rates towards the bank's US$480m obligation.

ABS

FCC auction 'positive' for tower ABS

A current spectrum auction overseen by the US Federal Communications Commission (FCC) has positive credit implications for wireless tower ABS, according to Moody's in its latest Credit Outlook. The auction allows television broadcasters the opportunity to sell their unused 600-megahertz spectrum to the US government.

Moody's notes that American Tower, Crown Castle International and SBA Communications will use the sale as greater incentive to spend more on upgrading or installing new equipment at tower operators' sites. These upgrades will likely increase revenue and cashflows available to the ABS bonds tied into these companies.

Industry analysts estimate that the auction to wireless carriers could fetch gross bids in the range of US$15bn to US$35bn. An additional auction will be held in May or June, in which the FCC will sell the spectrum to wireless carriers.

The spectrum is often referred to as the 'beachfront spectrum' because its band stands at a lower frequency that travels farther. This is better for rural areas with sparse wireless tower coverage.

Further build-out of the spectrum could benefit tower operators because the average incremental increase in revenue per tower driven by carriers' deployment acquired at auction can total US$500 to US$800 a month. This revenue growth from the deployment equals a monthly revenue increase of 9% to 18% per tower.

However, because it will take at least two or three years for carriers to begin building out the spectrum, Moody's does not expect the auction to trigger an increase in tower operators' organic revenue growth in 2016 or 2017. Revenue could increase in 2018 and beyond as the winning carriers begin to deploy the spectrum and comply with the FCC's mandate to offer service to at least 40% of the US population in each of their license areas.

In addition, ABS deals sponsored by tower operators will benefit from increased spending by carriers on renting tower space. Cashflows in wireless tower ABS are highly concentrated among the four largest US wireless carriers - AT&T, Sprint, Verizon and T-Mobile USA - with securitisations having the largest exposure to AT&T. All but Sprint are participating in the auction.

ABS

First UK marketplace ABS launches

Funding Circle is in the market with its inaugural rated securitisation, the first ABS of marketplace loans originated in Europe. The £130m deal, dubbed Small Business Origination Loan Trust 2016-1 DAC, is backed by marketplace loans to UK SMEs.

Moody's and S&P have assigned provisional ratings of Aa3/BBB to the £88.4m class A notes, A2/BBB to the £6.17m class B notes, Baa2/BB- to the £7.8m class C notes and Ba2/B to the £6.3m class D notes. The £14.8m class E and £6.5m Z notes are unrated.

As of February 2016 the portfolio comprised 2,497 loan contracts to 2,464 individual entrepreneurs and SMEs. The loans were originated between November 2014 and February 2016, with a weighted average seasoning of 6.5 months and a weighted average remaining term of 3.7 years.

"The P2P loan market is getting bigger and bigger, and is already too important to ignore in some countries, including the UK," comment Rabobank credit analysts. They expect further issuance to follow as the marketplace lending market grows.

Considering US marketplace ABS are already on ratings watch, the analysts also note that "with a Brexit being a real scenario, a possible economic recession that could follow is likely to affect asset performance".

Structured Finance

Counterparty risk revisions proposed

Fitch has released an exposure draft that outlines proposed changes to assessing counterparty risk in structured finance transactions and covered bonds. Although largely unchanged, the agency is introducing derivative counterparty ratings (DCR), as well as considerations to counterparty eligibility.

The introduction of DCRs would see them replace long-term issuer default ratings. This would work in accordance with Fitch's definition of eligible derivative counterparties.

The agency is also proposing to introduce optionality between minimum long- and short-term ratings. For example, a counterparty rated single-A or F1 will be considered eligible for triple-A notes, as Fitch deems counterparty risk for the majority of structured finance deals as inherently short term.

Remedial actions upon downgrade are meant to prevent sudden deteriorations in credit quality, as envisaged by the short timeframe in which these actions are expected to be implemented. Special considerations would be given to highly rated banks, with the proposal to extend the expected remedial period to 60 days from 30 days for banks rated at least double-A or F1+.

Other proposals include reducing the collateral amounts available for structured finance notes and stressing the importance of collateral posting for derivatives counterparties.

The revisions are expected to have a limited positive effect on the existing ratings of structured finance transactions. Ratings currently capped for counterparty eligibility or payment interruption risk could be subject to some upgrades. In total, the changes could have a positive rating impact on up to 10 tranches across nine transactions globally and a negative impact on one tranche of an Australian ABS transaction.

Fitch is inviting feedback on its proposals until 16 May.

Structured Finance

PREPA fee sent to Commission

PREPA filed a petition with the Puerto Rico Energy Commission on Thursday seeking approval for a new rate fee for its bond restructuring programme. The Commission now has 75 days to respond to the proposal.

The fee would be a separate charge on the bills of the utility's rate-payers and will be issued by a state-owned SPV. Legislation was passed in February to bring the charge into legal formality and ensure the creation of the SPV (SCI 7 March).

It is understood that under PREPA's proposal, residents will pay a fixed charge, with non-residential clients paying a kilowatt per hour rate. The fee would be revised at least every three months to ensure payments are made on the bonds, both through principal and interest.

The restructuring is part of a plan to reduce the utility's US$9bn debt burden by agreeing to exchange outstanding uninsured bonds from its bondholders for new securitisation notes. The Commission's period for consideration on the proposed rate fee will include public hearings and an opportunity for Puerto Rican citizens to submit their opinions in writing.

CLOs

Retail heads CLO fears

Retail is seen as the most troubling non-commodity sector for the global CLO market, according to the results of JPMorgan's latest quarterly client survey. It stands way ahead of the healthcare and technology sectors in joint second, receiving 3.3 times more votes from respondents.

The question surrounding non-commodity sectors emanates from recent volatility in high yield credit markets and broader macro concerns. JPMorgan CLO analysts note that retail, healthcare and technology account for a respective average of 6.7%, 11.6% and 11.2% of post-crisis CLO collateral concentrations. The healthcare sector in particular has had to deal with recent troubling credit concerns surrounding Valeant (SCI passim).

On a cross-sector perspective, respondents view CLOs as offering the best relative value, given its higher yields over other asset classes. However, the outcome of the results can be partly attributed to a potential bias from the survey's respondent base - many of which could be CLO-specific funds.

Meanwhile, the survey outlines surging primary and secondary interest in US CLO mezz in 1Q16, both in double-B and triple-B tranches. Elsewhere, the number of investors interested in US secondary equity dropped by half but remains reasonable. Primary triple-A and single-A received less votes in the US than the previous quarter, while the votes received for European CLO equity in both primary and secondary held steady.

Responses on current cash balances show that the proportion of low cash declined and moderate cash nearly doubled, adding more funds for risk. However, overall cash is not near mid-2014 levels, when few investors reported low cash.

Finally, the survey reveals that the ratio of buyers to sellers slightly deteriorated but still sees the former outnumber the latter by 11 to one. More of these buyers want to invest in CLO mezz or subordinate debt than at any point in the prior year.

CMBS

WINDM VII case dismissed

Justice Snowden last week handed down judgment of the English High Court in the Windermere VII Part 8 proceedings case. The plaintiffs' arguments have been dismissed.

Under the dispute, the WINDM VII class X noteholders and a holder of the class B notes commenced proceedings in November seeking a number of declarations as to the proper construction of the transaction documents (see SCI's CMBS loan events database). A recent Reed Smith memo notes that these declarations were broadly in connection with the basis on which payments of class X interest had been made historically (specifically, as a result of the application of the intercreditor agreements), whether this underpayment constitutes an EOD and whether any underpayments accrue interest at the class X interest rate.

The plaintiffs asserted that there had been historical underpayments of class X interest, that there had been an EOD and that these unpaid amounts should accrue interest at the class X interest rate - which, at various points in the life of the transaction, had been as high as 6,001%. In the judgment, Justice Snowden ruled that there had not been an underpayment of class X interest for the January 2015 or October 2015 payment dates, or that any further interest at the class X interest rate would have accrued under Condition 5(i) of the transaction documents or that any note EOD has occurred.

CMBS

CRE fund closes

Venn Partners has secured £185m of institutional investment for the second close of its CRE debt fund. Venn Commercial Real Estate Fund I targets direct lending opportunities in the UK and Western European CRE market, focusing on value-add loans in the mid-market.

Within a close-ended structure, loans will be offered at up to 75% LTV and will include maturities for a period of six months to five years. Venn says that the fund's current investment portfolio is defensively positioned with a conservative LTV metric, which provides strong downside protection. A final close is expected to take place during 3Q16.

To date, £140m of loan investments have been made by Venn's team for the fund. This is headed by Venn managing partner Paul House.

The latest commitments for the fund have been sourced primarily from UK and North American pension funds, of which 80% are high quality CRE loans. Investors are expected to benefit from the fund's regular cash distributions and low double-digit total return.

CMBS

Euro CMBS delinquencies down

The 12-month rolling loan maturity default rate for European CMBS rated by S&P remained stable at 10.3% at the end of March, the rating agency reports in its latest monthly bulletin. The senior loan delinquency rate decreased from 46.5% to 45.3%.

Breaking down the delinquency rate, the decrease for continental European senior loans was from 58.8% to 58.4%. The decrease for UK loans was from 22.4% to 20.3%.

CMBS

CMBS 2.0 delinquencies inch up

While the overall US CMBS delinquency rate remained relatively unchanged in March, CMBS 2.0 delinquencies saw a modest up-tick, according to Fitch's latest index results for the sector.

Loan delinquencies last month fell by 1bp to 2.90% from 2.91% a month earlier. Fitch-rated new issuance volume of US$6.9bn in February (across seven transactions) exceeded the portfolio run-off of US$5.1bn, causing an increase in the index denominator. New delinquencies of US$467m slightly edged out resolutions of US$440m.

Meanwhile, the CMBS 2.0 delinquency rate stood at 0.10% in March, compared to 0.08% in February, 0.07% in January and 0.05% at year-end 2015. Twelve CMBS 2.0 loans (totalling US$79.2m) entered Fitch's delinquency index in March, compared to two in February.

The agency notes that property type composition of current outstanding CMBS 1.0 and CMBS 2.0 delinquencies are vastly different. CMBS 1.0 delinquencies consist primarily of retail (39% of total CMBS 1.0 delinquency balance) and office (32%), while CMBS 2.0 delinquencies consist primarily of multifamily (48% of total CMBS 2.0 delinquency balance) and hotel (17%). The 2.0 delinquencies are mostly in energy-dependent markets, where in many cases the properties and the communities were recently built.

Overall, current and previous delinquency rates by property type are: 4.45% for retail (from 4.67% in February); 4.08% for office (from 4.03%); 3.20% for hotel (from 3.11%); 0.92% for multifamily (from 0.84%); 3.49% for industrial (from 3.48%); 3.25% for mixed use (from 3.25%); and 0.78% for other (from 0.73%).

The largest new delinquency in March was the US$50.9m Babcock & Brown FX 3 loan (securitised in CSMC 2006-C4). The loan was transferred to special servicing due to the bankruptcy of the parent entity and bankruptcy of the borrower. A liquidation plan is currently being reviewed.

The three largest resolutions last month - the US$77.5m St. Louis Mills (MSCI 2007-IQ13), US$51.8m Ariel Preferred Retail Portfolio (GSMS 2006-GG8) and US$43.5m Gallery at South Dekalb (CSFB 2005-C5) assets - were all retail properties, which helped to drive the retail delinquency rate down by 22bp (see SCI's CMBS loan events database).

Insurance-linked securities

Firms form collateralised ILS fund

Plenum is launching a new ILS fund to invest in collateralised reinsurance transactions to be sourced and underwritten by Sequant Re. The fund will complement Plenum's current ILS offering.

The new fund will benefit from Plenum's management expertise and the efficiency and flexibility of Sequant Re's segregated cell structure, as well as Sequant Re's expertise in sourcing, underwriting and modelling a broad range of lines of business and types of reinsurance contracts that are not commonly accessible to many ILS managers, the firms say.

A common investment committee will set out underwriting guidelines under which Sequant Re will operate. Plenum will remain in control of selecting and funding transactions.

"The biggest opportunity for ILS in the future lies in opening up more of the reinsurance market to collateralised solutions and increasing the diversification of risks becoming available to ILS investors," says Guy Cloutier, ceo, Sequant Re. "The reinsurance landscape is changing rapidly and this partnership will allow the two fully independent firms to bring more investment options to investors."

Insurance-linked securities

Cat bond fund launched

Lombard Odier IM has launched its first catastrophe bond fund, following its recruitment drive last year of Gregor Gawron, Simon Vuille and Marc Brogli to form an ILS team (SCI 10 August 2015). The LO Funds - CAT Bonds fund will target regions with a high concentration of insured wealth, including the US, Western Europe and Japan.

Lombard Odier says that the UCITS-compliant fund will target returns of Libor plus 2%-4%. The fund seeks to provide stable returns through a high floating rate coupon and yield, in light of projected low economic growth and volatility affecting the broader markets.

The fund will be managed by Gawron, Vuille and Brogli, along with Stephan Gaschen. Gawron says: "We expect the market for ILS and cat bonds to continue to grow as the insurance industry looks to cope with the ever-increasing concentration of wealth in urban areas and the continuing pressure from regulators."

NPLs

Further NPLs up for bid

Fannie Mae has announced its latest sale of non-performing loans, including a third Community Impact Pool. This smaller pool of loans is geographically-focused, high occupancy and is being marketed to encourage participation by smaller investors, non-profit organisations and minority- and women-owned businesses (MWOBs).

The four larger pools of approximately 8,200 loans totalling US$1.527bn in unpaid principal balance (UPB) and the US$20m Community Impact Pool of approximately 80 loans focused in the Miami area are available for purchase by qualified bidders. This sale is being marketed in collaboration with Bank of America Merrill Lynch, First Financial Network and Castle Oak Securities as advisors.

"The non-performing loans that are included in [this] sale announcement have been previously solicited for loss mitigation opportunities by Fannie Mae servicers, but they unfortunately remain seriously delinquent. We believe other investors will offer additional opportunities for these borrowers to avoid foreclosure," says Joy Cianci, Fannie Mae's svp for single-family credit portfolio management.

Bids are due on the four larger pools on 5 May and on 19 May for the Community Impact Pool.

Risk Management

Non-cleared derivatives doc published

ISDA has published the first in a series of documents to help market participants to comply with new margining requirements for non-cleared derivatives. The 2016 Credit Support Annex for Variation Margin for use with New York Law will allow parties to negotiate collateral terms that comply with variation margin requirements under the new rules.

The margining framework for non-cleared derivatives has been developed by the Basel Committee and IOSCO and will become effective for the largest derivatives users from 1 September. Initial margin requirements for other entities will be phased in over a four-year period. Variation margin obligations will come into force from 1 March 2017.

US prudential regulators published their final version of the margining rules last October (SCI 23 October 2015), as did the CFTC in December (SCI 17 December 2015). European and Japanese regulators released their final standards last month.

ISDA intends to publish a series of further documents. It is also assisting the industry with its implementation of margining requirements through other initiatives, such as the development of a standard initial margin model - ISDA SIMM (SCI 11 December 2013).

Risk Management

Call for entity-based approach

In partnership with 12 other trade associations, ISDA has published a paper that recommends an entity-based approach to derivatives trade reporting in a bid to cut costs and complexity for end-users. The report argues that global adoption of an entity-based reporting framework - where sole responsibility for reporting is assigned to a single counterparty via an automated hierarchy process - would help promote greater consistency in reporting standards and lead to improvements in data quality. The approach would also significantly reduce the operational complexity associated with current reporting requirements, cut costs and eliminate the reporting burden on end-users.

The associations say that a lack of consistency in the reporting rules between jurisdictions and variations in data reporting formats have hampered the ability of regulators to aggregate exposures and spot possible systemic risks - a key objective of the G20 derivatives reforms. Some jurisdictions have opted for dual-sided reporting, with the rationale that requiring both parties to a trade to report will improve the quality of the data. In reality, pairing rates at trade repositories used in dual-sided regimes are around 60%, well below confirmation execution rates using existing confirmation processes.

Other recommendations made in the paper include: existing processes, and not dual-sided reporting, be used to identify mismatches in trade terms; a tie-breaker methodology for determining the responsible reporting party be implemented consistently; legal responsibility for non-reporting counterparties to verify trade reports be removed; and greater focus be placed on global data harmonisation efforts.

The associations that have published the paper alongside ISDA are: the Alternative Investment Management Association, the Association of Corporate Treasurers, the Australian Financial Markets Association, the US Chamber of Commerce's Center for Capital Markets Competitiveness, the Coalition for Derivatives End-Users, the global FX division of the Global Financial Markets Association, ICI Global, the Investment Association, Managed Funds Association, the US National Association of Manufacturers, SIFMA's asset management group and Pensions Europe.

Risk Management

EMIR classifications updated

ISDA has published an updated classification letter to enable counterparties to notify each other of their status for clearing and other regulatory requirements under EMIR. The updated letter covers the clearing obligation for certain CDS index classes, as well as some interest rate derivatives.

The application of the clearing obligation under EMIR depends on the categorisation of each counterparty under a specified taxonomy. That categorisation determines whether a counterparty has to clear and, if so, when they must comply. ISDA's EMIR classification letter allows market participants to bilaterally communicate their status to counterparties.

The latest EMIR classification letter updates an earlier version published last summer (SCI 15 July 2015). It provides the ability for entities to make classifications in respect of the draft regulatory technical standards (RTS) for EEA rates and the RTS on CDS index classes.

Risk Management

EBA outlines compliance progress

The EBA has published a report identifying a number of recommended practices for market players to reach compliance within securitisation risk retention, due diligence and disclosure. The recommendations are based on the regulator's analysis of previous measures taken in 2014.

The report finds that institutions are generally undertaking appropriate actions to comply with regulatory requirements. In total, only 10 cases of non-compliance with risk retention and due diligence have been reported since the EU's rules came into effect in 2011. Sanctions made from the additional risk weights outlined in the Capital Requirements Regulation were applied in just one out of the 10 cases.

The EBA also suggests that the focus on compliance has taken a lower priority among supervisory authorities. However, this could be justified in light of the expectations on the development of a new securitisation framework at the EU level.

Nonetheless, the report outlines how the EBA fashioned a number of best practices for compliance per jurisdiction to contribute to the EU securitisation framework. Among the recommendations was the suggestion to place a complementary direct approach to risk retention. In this scenario, the current obligation of investors to check transactional compliance would shift the burden to originators, sponsors and original lenders.

Other recommendations include closing the originator definition loophole and additional convergence for risk retention rules in relation to international standards. The EBA says that all of its 10 proposals have been taken on board to some extent.

Risk Management

Liquidity tool reaches Europe, APAC

Interactive Data has launched its liquidity indicators services in Europe and Asia-Pacific, and has also branched out from sovereigns and corporates to include certain TBA-eligible RMBS pass-throughs. The tool is built to help firms assess their portfolios' liquidity profiles under a range of proposed market conditions.

Indicators include estimates of the projected trade volume capacity of a fixed income security. This can be used in conjunction with information on a firm's position to estimate the number of days to exit under various scenarios.

In addition to its geographical expansion, the service includes a new feature that calculates the expected market price impact based on a firm's target days to liquidate, as well as the projected days to liquidate when target price impact thresholds are set.

RMBS

SFR loan extensions expected

During 2016, the operators for eight single-family rental transactions are likely to exercise their loan term extensions for the first time, says Moody's in its latest ResiLandscape publication. This should not have a material credit impact on the securitisations, however.

Invitation Homes 2013-SFR1 was the first SFR deal to exercise its one-year optional term extension, which it did last December (SCI 9 November 2015). It will face its second extension option this year and Moody's expects it to extend again.

The underlying loans backing the SFR transactions have initial terms of 24-25 months, with three annual extension options. At the initial maturity of the loans, the SFR operators have a choice between extending the loan terms, refinancing the loans or defaulting.

Of those options, extension is most likely because the performance of the portfolios of rental properties is stable. There is no compelling financial reason to prefer to pay off the loans and the reputational damage of allowing the loans to default should rule out that option.

SFR operators can expect strong rental performance and property price appreciation. Vacancy rates for the rental properties backing SFR securitisations range from 3% to 5% and monthly rents on new leases are 3%-6% higher than previous leases.

Most SFR operators are required to deliver a written notice of their election to extend loan terms no later than 30 days prior to the maturity date. Colony American Homes 2014-2 and Silver Bay Realty 2014-1 must provide written notice not later than 20 days prior.

Unlike the other transactions, American Residential Properties 2014-SFR1 has a specific debt yield requirement to satisfy in order to extend the transaction's loan terms or the loan will need to be repaid. To extend the terms of the transaction, the debt yield as of June 2016 should be at least equal to or greater than the closing date debt yield.

ARP 2014-1 debt yield was 6.7% as of the closing date but 6.5% as of September 2015. The debt yield decreased because the net cashflow was slightly lower than it was at the time the loan was underwritten. The debt yield should, however, increase as a result of reduced expenses generated by last month's merger between American Residential Properties and American Homes 4 Rent.

RMBS

Aussie rent yields at record low

Rental yields for houses in Sydney and Melbourne have reached record lows, according to Moody's. This has reduced the affordability of servicing investment properties relative to household incomes, increasing the risks for residential property investors and RMBS.

The drop in rental yields has seen a rise in the level of cashflow losses suffered by residential property investors over the past three years. This has made investors dependent on greater levels of house price appreciation to cover their losses, thus increasing their exposure to risk.

Moody's says that these risks include loss of income, interest rate rises, vacancy or rent reductions and an increasing probability of default. Deteriorating affordability also reduces investors' flexibility around refinancing or restructuring their mortgage loan terms, providing fewer options, should they experience hardship.

The agency expects the performance of residential property investment loans to deteriorate through 2016 and 2017. Investment loans originated in 2014 and 2015 - at the peak of the recent house price cycle - will be behind this deterioration.

Moody's does not expect to see any major improvement in the cost of servicing residential property investment loans in the near term. The negative impact will be most evident in RMBS issued in 2016 and 2017.

Australian RMBS portfolios are typically made up of loans that have one to two years of seasoning and so the bulk of the 2014 and 2015 investor loans to be securitised will be found in 2016 and 2017 vintage RMBS.

RMBS

CRT TRID impact gauged

Credit risk transfer RMBS issued by Fannie Mae and Freddie Mac are likely to incur only small losses related to violations of the Consumer Financial Protection Bureau's TILA-RESPA Integrated Disclosure (TRID) rule, Moody's suggests. At least initially, however, the frequency of violations is expected to be high.

The FHFA has directed the two GSEs not to conduct routine post-purchase RMBS loan reviews for compliance with the TRID rule during an initial transition period. The rule applies to loans whose borrowers submitted applications on or after 3 October 2015.

"The lack of diligence related to TRID compliance will likely cause future credit risk transfer transactions to incur some incremental losses for lender compliance violations," says Moody's svp Yehudah Forster. "However, we expect overall losses owing to TRID violations to be fairly small, though the number of infractions is likely to be high at first."

While the CFPB says it will be lenient on lenders that make a good faith effort to comply with the TRID rule, this guidance doesn't protect against borrower claims, Forster adds. During the transition period - the length of which has not been specified - TRID-related checks will be limited only to whether a lender has used the correct forms, which won't identify incorrect information on the forms and could lead to violations of the TRID rule. Such infractions could cause losses on loans backing GSE credit risk transfer transactions if borrowers successfully claim TRID violations as a defence against future foreclosures or if attorneys bring class action lawsuits within the first year of the loans' closing.

Future private label RMBS will be less exposed to these risks because private label issuers are conducting thorough third-party due diligence for the loans they purchase, Moody's says. While this enables lenders who sell to private label issuers to cure TRID violations and fix flawed processes, lenders who sell only to the GSEs won't directly benefit from such feedback and may therefore be slower to improve their processes.

RMBS

Kroll quells TRID fears

Kroll Bond Rating Agency has published an opinion that tackles some of the key concerns that are surfacing following the TILA-RESPA Integrated Disclosure Rules (TRID) coming into effect late last year. The agency expects the rules to have a limited impact on US RMBS credit enhancement levels.

In a letter recently penned by the Association of Mortgage Investors, the body stressed that the rules had created a climate of legal uncertainty (SCI 1 April). Among the chief issues it outlined was the inability of many originators to reach TRID compliance early on, leaving them with the threat of departing from the market.

In discussions with RMBS market players, Kroll identifies that certain TRID provisions carry risks to both the originators and its assignees. In turn, this has prompted questions surrounding the agency's ability to rate deals backed by mortgage loans on or after TRID's effective date, as well as the impact that TRID violations will have on expected losses.

However, Kroll says that TRID violations are both quantifiable and limited. The agency would not decline to rate a transaction of TRID-eligible loans that failed to comply with the rules. Further, it says that a rating cap does not have to be assigned to such loans, thus leaving open the opportunity for deals to still obtain triple-A status.

The reasons behind Kroll's limited liability perspective spring from the belief that borrowers will not pursue affirmative claims for loans that have violated the rule. This is due to the meagre financial incentive from pursuing such a claim and the low likelihood of successfully certifying a class in pursuit of a class action suit.

Kroll will also consider an originator's ability to reach at least general compliance. This is due to the agency noting, in the absence of formal guidance from the CFPB, that many TRID-eligible loans originated in the near term will contain at least one technical error under TRID.

Such violations, even if corrected in good faith, may carry assignee liability. Kroll believes the risks associated with TRID-eligible loans become more significant where these violations go un-corrected by an originator. In this scenario, the agency may consider additional credit enhancement, applying a rating cap or declining to rate the transaction.

Finally, the agency notes that further changes and guidance are expected from the CFPB. This could change the dynamics regarding violations and potential solutions to correcting them. As a result, Kroll will likely address the evolving standards at a later date.

RMBS

GSEs offer new mod programme

Fannie Mae and Freddie Mac will offer principal reduction to certain seriously delinquent, underwater borrowers via its new Principal Reduction Modification programme. This will be a one-time offering for borrowers whose loans are owned or guaranteed by one of the two GSEs and who meet eligibility criteria.

The modification will be available to owner-occupant borrowers who are 90 days or more delinquent as of 1 March 2016, whose mortgages have an outstanding unpaid principal balance of US$250,000 or less and whose mark-to-market LTV ratios exceed 115%. Other eligibility criteria also apply.

The FHFA expects approximately 33,000 borrowers to be eligible for a modification. Servicers must solicit borrowers no later than 15 October.

The FHFA has also approved further enhancements to its requirements for Freddie Mac and Fannie Mae's sales of NPLs. NPL buyers must: evaluate borrowers whose MTMLTV ratio exceeds 115% for modifications that include principal reduction or forgiveness of arrears; forbid NPL buyers from unilaterally releasing liens and 'walking away' from vacant properties; and establish more specific proprietary loan modification standards for NPL borrowers.