News Analysis
Efficiency drive
Offshoring, automation shaping new IPV landscape
Pricing and valuation operations have become an increasingly essential component of investment banks since the financial crisis, particularly within structured credit. However, as banks strive to cut costs and streamline processes, IPV functions are no exception.
As part of recent efficiency drives, several large Tier 1 banks have wound up sections of their London or New York pricing teams in favour of setting up cheaper, offshore centres. As a result, there are now but a handful of banks that have kept a full IPV set-up in New York and London.
At present, the offshoring or outsourcing of a bank's IPV operations tends to depend on the size of the bank and the bank's holdings. Large Tier 1 banks with separate IPV teams for each asset class are tending to split their IPV team into two parts: price testing and model validation. Most of the price testing is carried out offshore, while a separate team dealing with model validation and methodologies remains in the main banking premises in London or New York.
Smaller banks tend to cluster IPV of different assets together into one role, so that credit, rates and equities can be covered within one team. In these instances, offshoring of operations is unlikely.
"As part of a cost-cutting and efficiency drive, we're finding that several Tier 1 banks are dividing the IPV function into two parts: price testing and model validation/methodology," confirms Felix Ko, managing consultant at Hudson. "As a part of these efficiency drives, we're seeing the offshoring of price testing teams to lower cost locations in Eastern Europe, Mumbai and Manila."
He adds: "Banks that are setting up pricing facilities offshore tend to encourage their own employees to set up these centres, often with a lucrative expat package."
Some banks are also known to be looking at low-cost locations in America as a suitable site for pricing hubs.
A UK-based bank IPV head agrees with the premise that some of the work could be done in other places; for example, where there are very uniform data sets such as large holdings of US treasuries or equities. "It's more about running through a set series of processes and controls and going to some established data sources, which would cover all of the items in your portfolio with the kind of thoroughness that you'd need for IPV control," he says.
However, he notes that the same cannot be said for the harder to mark and value illiquid portfolios that need expert judgement, particularly as there needs to be interaction with other areas in the bank to come up with a fair value for a given portfolio. "Offshoring IPV duties to other centres risks compromising your depth of experience," he adds. "When a regulator visits the bank, they are interested in the experience of the IPV team. It's much harder to demonstrate your expert judgement if you have outsourced it. You also need to be able to demonstrate a minimum number of staff to manage and control that team."
Indeed, regulatory scrutiny on asset valuation is upping the workload for IPV teams, particularly in Europe, where the PRA's Prudent Valuations initiative is taking effect. "It's not just the calculations, but also the massive disclosure requirements and reporting," says the IPV head. "Added to that is resourcing the staff for the increased workload. I'd say 90% of the work we now do tends to be regulatory-based issues. Pru Val is a huge commitment."
He explains, however, that a lot of IPV feeds directly into Pru Val. "With some small exceptions on the liability side, it tends to be the same portfolios of assets that you would use for both," he says. "The requirements for robust systems in Pru Val probably makes the IPV process a bit easier. However, the need for two data sets furthers our call for automation and process strengthening."
Advances in technology have enabled the automation of pricing functions that were once carried out with manual inputs - particularly on the vanilla credit side. But Brian Sciacca, a leading advisor in the valuation space, suggests that the use of technology and offshoring may create a false sense of security.
"You've rolled out new infrastructure, you've offshored what should be offshored and you've automated what should be automated," he explains. "However, you have to look at where your prices ultimately originate, i.e. the vendors. The vendors will always have a different level of precision from the in-house expert pricing a specific bond."
He continues: "In a benign market, that is less of a concern. But as markets become turbulent, that can grow into a real problem."
Ko adds that certain hiring managers share the concern that people in offshore pricing centres should be on the ground with the front office in London or New York. "Being so far removed, the managers have concerns over operational risk issues," he says.
As banks reorganise their IPV infrastructure and establish teams offshore, many employees that have previously worked within IPV have embarked on new opportunities. This includes jobs in market risk, consultancy or moving to banks that are at a different stage of their IPV strategy. Others are moving to different areas of investment banking completely, where their modeling skill-set can be transferred.
As a result, the IPV sector remains a candidate-led job market, where candidates with the right skills are scarce. "Sometimes you may find hiring managers looking to candidates with the IPV skill-set from another asset class, as there's a lack of experienced talents with structured credit experience," Ko adds. "It is also becoming increasingly difficult to find replacement candidates at the avp/vp level."
Looking ahead, the IPV sector does not currently appear to be an area of recruitment growth, reversing the trend seen earlier this decade. "I haven't noted any expansion of headcount within the IPV space," concludes Ko. "Most banks are rolling off legacy structured trades and, as a result, the majority of roles we're recruiting for are replacement roles."
AC
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News Analysis
Structured Finance
Accounting factor
Fair value, MOA lead retention options
Many US securitisation market participants are becoming bogged down in the numerous accounting considerations associated with the Dodd-Frank risk retention requirements. With less than eight months until the rules come into force, sponsors are weighing up the best options for consolidating the retained interest.
RMBS risk retention rules became effective in the US in December 2015, but the remaining asset classes face a 24 December deadline this year to be compliant. The rules require deal sponsors to retain a minimum 5% portion of each transaction. However, they have also been given guidelines presenting a number of options for holding and consolidating this retention interest.
One popular move among sponsors, particularly in the CLO market, has been to form capitalised manager vehicles (CMVs). These are newly formed, self-managed entities, designed specifically with the key purpose of holding the retained risk. However, the time and cost involved in the formation process of a CMV is driving a number of sponsors towards alternative methods.
"Consolidation of the assets is still the main area of interest right now on the accounting side and the key focus is actually how sponsors go about adopting and managing the majority owned affiliate (MOA) approach," says Bill Fellows, partner at Deloitte.
MOAs are defined as entities under majority control by a person or business. Through this approach, the rules permit a sponsor to transfer any of its risk retention to an MOA, which would subsequently receive any returns on that retained interest. Simultaneously, the sponsor would act as the collateral manager and receive the related management fees.
"According to its guidance, an MOA would usually be an equity stake of more than 50% for structures that are not variable interest entities (VIE)," says Fellows.
However, the rules suggest that not all consolidated entities will apply. As one example, funds managed by a common manager would not be sufficient in itself to constitute an MOA.
"The term 'majority' has to be as defined in the rules' criteria and there are two different clauses you can go down under the GAAP guidelines," says Fellows. "The first would be the voting interest model, where the sponsor holds more than 50% of the owning shares."
The other option would be a VIE, a concept which evolved in the early 2000s. In this scenario, a securitisation manager would have both control over the significant activities of the entity and significant exposure to the entity's economics.
"The sponsor would typically also have to hold around 10% to 20% of the MOA's economic equity," adds Fellows. "Most companies involved with a securitisation are considering the VIE option because it requires less capital and is therefore more cost-efficient."
The other area generating a lot of discussion has been the concept of fair value as defined under GAAP and how it aligns the relationship between the make-up of a transaction and the necessary compliance requirements.
Many managers are choosing to take a vertical approach in their risk retention, which sees them holding a slice of each tranche in a transaction. Its popularity partly derives from its exemption from having to determine fair value calculations, making a more straightforward option.
In contrast, other sponsors are adopting the horizontal retention approach - where a sponsor chooses to retain its 5% through the most junior tranche of a deal. In this case, fair value measures must be determined.
"The importance of fair value is that it considers the various aspects that shape the price of a tranche on today's market at closing," says Fellows. "The GAAP standard effectively requires the manager to consider the value of the tranche if it were to go through hypothetical sale."
The pre-sale disclosure requirements for this option comprise a number of details. The methodology for calculating the value of the horizontal interest includes key inputs after forecasting cashflows and seeing how this applies to the waterfall. A variety of aspects are therefore taken into account, including discount rate, default rates, prepayment speeds and forward interest rates.
Post-closing disclosures are also required and include the fair value based on the actual sale price and tranche sizes. Despite its thoroughness, the extensive nature of this process could also act as a deterrent for sponsors interested in adopting the approach.
"There have been some issues over hesitation," Fellows concludes. "Some clients I have talked to have been interested in adopting the horizontal approach and going through the motions for fair value disclosure. But when underwriters have seen the substantial disclosure requirements, they've backed off somewhat."
JA
SCIWire
Secondary markets
Euro secondary steady
The European securitisation secondary market continues to move steadily ahead.
Tone continued to be positive across the board at the end of last week and into the start of this. However, lack of supply is still an issue and is causing sessions to be steady rather than spectacular.
Nevertheless, many of the line items in for the bid are continuing to see strong prints. Overall though, secondary spreads remain flat to slightly tighter.
There are currently three BWICs on the European schedule for today. At 11:00 London time there is a £21m three line pub ABS and CMBS auction comprising: GNKLN 0 06/15/31, MARSLN 0 07/15/20 and MEADF 0 01/12/32. None of the bonds has covered on PriceABS in the past three months.
At 14:30 there is a £10.74m five line UK non-conforming list consisting of ESAIL 2007-2X 1A, ESAIL 2007-4X A3, GHM 2007-1 BA, MARS4 4X B1C and PRS 2006-1X C1A. None of the bonds has covered with a price on PriceABS in the past three months.
At 15:00 there is a mix of CLOs from across the capital stack. It involves five line items totalling €22.84m - ARESE 7X B, CELF 2006-1X A1, CORDA 2006-1X E, CORDA 3X E and DRYD 2013-27X C1AT. Again, none of the bonds has covered with a price on PriceABS in the past three months.
SCIWire
Secondary markets
US CLOs strengthen
Tone and activity in the US CLO secondary market continues to strengthen.
"The background remains positive with oil above 40, stocks hitting new highs and people happier with credit in general," says one trader. "For our part, we're seeing a bid for equity, mezz continues to rally and new issue activity is starting up again, so the CLO picture is a pretty good one too."
However, the trader adds: "There are some investors still scarred by what happened in January and February and so are showing a slight hint of caution. Overall though, the market appears to have healed."
As the market strengthens, it is starting to open up as well, the trader reports. "The BWIC market has become a lot more varied in the last week or so. There's now less of a focus on mezz with more equity in for the bid in response to the increased demand, along with more paper circulating from higher up the capital structure."
Nevertheless, mezz is still active, the trader says. "The leveraged loan price rally continues to help MVOC ratios and to get people increasingly comfortable with holding mezz."
Today's US CLO BWIC calendar reflects those increasingly wider interests. There are five lists scheduled so far, and while most line items are 2.0 mezz there are also some equity pieces as well as two sizeable triple-A slices.
The chunkiest equity piece is a single $9m line of OFSBS 2013-5A SUB due at 11:00 New York time. The triple-As come at 13:00 - $10m of PLMRS 2013-2A A1B and $20m of ZAIS2 2014-2A A1B. None of the bonds has covered on PriceABS in the past three months.
The largest mezz list is a 12 line $45.025m combination of triple- and double-Bs due at 14:00. It comprises: ALM 2012-5A DR, ALM 2015-12A C1, ANCHC 2014-3A D, ATCLO 2013-1A D, BALLY 2013-1A D, BSP 2013-IIA D, HLM 3A-2014 C, ICG 2014-1A D, LOOM 2015-2A D, NEUB 2013-15A D, NEUB 2014-16A D and RACEP 2015-9A C. Only ICG 2014-1A D has covered with a price on PriceABS in the past three months - at 64H on 17 March.
SCIWire
Secondary markets
Euro secondary picks up
The European securitisation secondary market saw an increase in activity yesterday to go with the improving tone of recent sessions.
"After being quiet for the past few days flows picked up across the board yesterday," says one trader. "Volumes are still not huge, but we're now seeing a lot of enquiries from investors looking for paper."
Notably, the trader adds: "That interest is for prime assets, which are tightening as a result. It's a pattern we've seen in Dutch RMBS for a while but it has now extended into UK prime and autos."
CLOs also continue to attract plenty of interest, the trader reports. "There was one BWIC yesterday and it saw very strong covers. Consequently, single-As are now around 320, which is quite punchy but in line with levels from the previous session."
Meanwhile, peripherals remain relatively quiet. "Italian and Spanish paper is seeing a little activity and is up a few bips since last week but Portugal is particularly slow. That appears to be linked to the ratings review due tomorrow - Portuguese govvies rallied a lot yesterday, but for once ABS/MBS didn't follow."
There are currently two BWICs on the European schedule for today. First, there is a small UK non-conforming auction due at 11:00 London time. It involves £300k NGATE 2007-1X A3 and £100k TRINI 2015-1A A. Only NGATE 2007-1X A3 has covered on PriceABS in the past three months - at LM80s on 8 April.
Then, at 15:00 there is a nine line 18.924m mixed RMBS list. It comprises: EMACP 2006-3 C, ESAIL 2007-1X B1A, IMT 2006-2GA A2, LMS 1 CA, LUSI 3 D, MPLC 7 D, TDA 22 B1, TDAC 4 B and TORR 2009-3 A. None of the bonds has covered on PriceABS in the past three months.
SCIWire
Secondary markets
US CMBS stays supply-driven
Activity and pricing patterns in the US non-agency CMBS secondary market continue to be driven by expectations over supply.
"Secondary is still fairly quiet as people are holding on to paper because of expectations of diminishing future supply," says one trader. "So spreads are continuing to tighten and we're also seeing a lot of people buying CMBX risk for the same reason."
At the same time, the primary market is moving in the same direction - again, for the same reason. "The last new deal to price was MSBAM 2016-C29 on 22 April where triple-A price talk was 129-132, but it printed at 125, because of the high demand," the trader says. "Now, there's only one more deal due before the end of the month."
The pattern will reverse next month, the trader adds. "There are seven new deals scheduled for May, which is obviously likely to push spreads out a bit."
However, the trader continues: "Those deals involve pretty much all of the loans the banks have and there's little new origination on the cards. So, supply will dwindle after that and spreads will move back in again."
News
Structured Finance
SCI Start the Week - 25 April
A look at the major activity in structured finance over the past seven days
Pipeline
Last week's pipeline additions were concentrated in ABS. There were six new ABS announced, as well as an ILS and a CMBS.
The ABS were: €800m Bavarian Sky Compartment German Auto Loans 4; €760.9m Cars Alliance Auto Loans Germany V 2016-1; US$350m Flagship Credit Auto Trust 2016-2; US$260m NP SPE II Series 2016-1; £300m RAC Bond Co; and US$2.1bn Taco Bell Funding Series 2016-1.
US$150m Residential Reinsurance Series 2016-1 was the ILS. The CMBS was US$358.6m Velocity Commercial Capital 2016-1.
Pricings
There was more variety in the week's prints. There were nine ABS, three RMBS, three CMBS and two CLOs.
The ABS were: US$184.22m Ascentium Equipment Receivables 2016-1; US$300.7m Avant Loans Funding Trust 2016-B; A$1.3bn Crusade ABS Series 2016-1 Trust; A$259m Flexi ABS Trust 2016-1; US$1.316bn Ford Credit Auto Owner Trust 2016-B; US$450m NextGear Floorplan Master Owner Trust Series 2016-1; US$1.5bn Nissan Auto Receivables 2016-B; A$901m SMART ABS Series 2016-1; and Sfr515.2m Swiss Car ABS 2016-1.
£367.23m Finsbury Square 2016-1, £1bn Gosforth 2016-2 and A$936m-equivalent RESIMAC Triomphe Trust - RESIMAC Premier Series 2016-1 were the RMBS, while the CMBS were US$160m CCRESG Commercial Mortgage Trust 2016-HEAT, US$809m MSBAM 2016-C29 and US$388.5m Palisades Center Trust 2016-PLSD. The CLOs were US$406.15m AMMC CLO 18 and US$502m OCP 2016-11.
Markets
It was the year's busiest week for non-US ABS, as European and Australian primary issuance surged, although secondary market activity was quieter. JPMorgan analysts comment: "Trading volumes remained moderate, although investors picked up peripheral opportunities resulting in ECB-eligible Italian and Spanish RMBS paper tightening 3bp each to close the week at 104bp and 105bp on average above three-month Euribor. Portugal, however, failed to benefit from investor engagement and ended the week unchanged at 227bp for ECB-eligible RMBS seniors."
The US CLO market continues to witness familiar trends, as SCI reported last week (SCI 21 April). Mezz paper continues to lead the way tighter, with one trader predicting that double-Bs could break the 700 threshold soon.
Editor's picks
Bidding goodbye?: BDCs and other listed vehicles are coming under increasing pressure - not least from their shareholders - to change the way they operate in the structured credit market. In some instances, they are being forced out of the sector altogether...
Green shoots: A combination of private placements and the banking market should be able to meet the European renewables sector's financing needs in the short term, according to a new SCI/Renovate America research report entitled 'Green securitisation: harnessing institutional investment to tackle climate change'. However, there is growing recognition that the ABS market could take a lead role in raising the €200bn a year that will be required over the next decade to meet the region's commitment under the terms of the Paris Agreement on climate change...
IMA-CVA abandoned: The Basel Committee's recent decision to drop the use of IMA-CVA from its proposed CVA risk framework has taken many in the industry by surprise. The move is also likely to disappoint institutions that were anticipating capital savings as a result of its use...
Chasing ubiquity: Representatives from Prosper Marketplace, MountainView Capital and Credit Suisse recently discussed the growth of marketplace lending during a live webinar hosted by SCI. This Q&A article highlights the main talking points from the session, including the impact of rising rates and the role of ABS in the sector...
Deal news
• Fannie Mae has completed its tenth Credit Insurance Risk Transfer transaction. CIRT 2016-3 shifts a portion of the credit risk on a pool of single-family loans with an unpaid principal balance of approximately US$5.7bn to a single insurer.
• Pursuant to a written resolution, the subordinated noteholders of Strawinsky I CLO have resolved to direct the trustee to appoint Dynamic Credit Partners Europe as successor investment manager, subject to controlling class (currently the class B noteholders) approval. IMC Asset Management tendered its resignation as investment manager for the second time on 15 April, having initially tendered its resignation on 31 December 2015.
• Navient has extended the maturity date on an additional US$1.2bn of bonds backed by FFELP student loans. The amendments include the A3 and B tranches of SLM Student Loan Trust 2013-6, which were respectively pushed back to 2055 and 2083.
• Moody's has downgraded an RMBS Mexican certificate after correcting an error in its cashflow modelling for the transaction. BRHSCCB 05U suffered the downgrade after the agency originally made an incorrect assumption that the deal was still protected through a partial credit guarantee (PCG).
• An auction to settle the credit derivative trades for Peabody Energy Corporation CDS is to be held on 4 May. ISDA's Americas Determinations Committee ruled that a bankruptcy credit event occurred with respect to the entity on 13 April.
Regulatory update
• The US SEC has adopted final rules implementing business conduct standards and chief compliance officer requirements for security-based swap dealers and major security-based swap participants. The final rules are adopted under the Dodd-Frank Act.
• The NCUA has had another of its recent successful RMBS settlements increased after UBS was ordered to pay the federal agency a post-interest total of US$69.8m. The decision was made by the US District Court for the Southern District of New York, after UBS recently agreed to dish out US$33m in compensation for its role in selling faulty deals to two failed corporate credit unions (SCI 1 March).
Deals added to the SCI New Issuance database last week:
American Credit Acceptance Receivables Trust 2016-2; BlueMountain CLO 2016-1; Cadogan Square CLO VII; Carlyle Global Market Strategies Euro 2016-1; CarMax Auto Owner Trust 2016-2; CAS 2016-C03; Chrysler Capital Auto Receivables Trust 2016-A; CPS Auto Receivables Trust 2016-B; Crusade ABS Series 2016-1 Trust; Discover Card Execution Note Trust 2016-2; Discover Card Execution Note Trust 2016-3; FREMF 2016-KP03; FRESB 2016-SB15; Hertz Fleet Lease Funding Series 2016-1; Master Credit Card Trust II series 2016-1; NCF Dealer Floorplan Master Trust series 2016-1; Penarth Master Issuer series 2016-1; Sonic Capital series 2016-1; ThunderRoad Motorcycle Trust 2016-1
Deals added to the SCI CMBS Loan Events database last week:
BACM 2005-3; BSCMS 2007-PW15; CD 2006-CD2; CD 2007-C4; CGCMT 2007-C6; COMM 2014-CR18; CSMC 2006-C4; DECO 2007-E5; DECO 6-UK2; ECLIP 2006-1; EURO 26; EURO 28; GECMC 2007-C1; GSMS 2007-GG10; GSMS 2013-GC10; GSMS 2014-GC22; INFIN SOPR; JPMCC 2005-LDP5; JPMCC 2006-CB15; JPMCC 2006-LDP7 & CD 2007-CD4; JPMCC 2006-LDP8; JPMCC 2007-C1; JPMCC 2011-C5; LBUBS 2006-C1; LBUBS 2006-C6; MLMT 2007-C1; MSC 2006-IQ12; MSC 2008-T29; MSC 2011-C2; TITN 2006-1; TMAN 5; WBCMT 2006-C23; WBCMT 2006-C26; WBCMT 2007-C32; WFRBS 2013-C16 & WFRBS 2013-C17; WFRBS 2013-C18 & WFRBS 2013-UBS1; WFRBS 2014-C21; WIND XIV
News
Structured Finance
Liquidity tops investor concerns
While investor fears over China-related uncertainty have subsided, concerns regarding liquidity and central bank policies have grown, according to Morgan Stanley's latest global securitised products investor quarterly survey. Liquidity is the top concern for 21% of respondents.
Central bank policies cause the most concern for 18% of investors while disappointing US economic growth is now the third greatest concern, at 16%. China-related uncertainty was selected by 15%, while only 4% chose depressed oil prices as their chief source of anxiety.
The latest survey is also the first for a year in which the share of respondents expecting to increase their securitised products allocation has grown. Only 8% expect their allocation to decrease, while 42% - up from 37% in 1Q16 - expect it to increase.
As for macro and market expectations, investors largely expect rates to be higher both six months and one year from now. The majority of respondents expect US house prices to increase in 2016 by up to 5%, but none expect prices to increase by more than that. Views on commercial real estate prices have turned slightly more negative, with 70% of respondents expecting prices to either remain flat or to fall.
Investors' six-month expectations for 10-year US Treasury rates have increased. 39% of respondents expect rates to move up to 25bp higher, while 20% expect rates to move 25bp-50bp higher. The one-year expectations are more dispersed, with 15% expecting it to be unchanged but the largest share of respondents, 31%, expecting rates to be 25bp-50bp higher.
Cash and consumer ABS have the highest concentration of overweights among investors, while CLO senior and mezz are trailing closely behind. Investors were most neutral on US agency RMBS.
Agency RMBS-focused investors continue to expect banks and money managers to be the largest buyers of the product over the next year, at 38% and 31% respectively. However, the number of investors expecting overseas investors or REITs to be the largest buyers has grown.
Exactly half of the agency-focused survey respondents were forecasting the basis between nominal current coupon spreads and the seven-year part of the Treasury curve to stay flat over the next six months. More investors expect the basis to widen (35%) than tighten (15%).
Among non-agency RMBS investors, the top concern is contagion from a sell-off in other risk assets, which weakness in the US housing market is also a worry. Non-agency investors believe spreads will tighten over the next six months.
CMBS-focused investors have shifted toward lower issuance expectations. The share of respondents expecting less than US$80bn this year climbed from 18% in 1Q16 to 65% for the 2Q16 survey.
CMBS 2.0 spreads are expected to tighten over the next six months by 40% of respondents and over the next year by 55%. This compares to 18% and 38% of respondents saying the same things in the previous survey.
CLO investors see higher relative value in mezz and subordinate mezz with less distressed portfolios. Around 70% of CLO-focused investors see generic CLO debt spreads unchanged or tighter in six months.
JL
News
CLOs
Middle ground
Issuance, investors challenging CLO mid-market
Issuance within the US CLO market has dampened so far in 2016 as the sector suffers from the reverberations of wider credit market volatility. The CLO mid-market has not been exempt, but many of its issues remain tied to its small investor base.
The sluggish start to the year has seen just US$9.9bn in US CLOs issued to date, according to JPMorgan's CLO analysts. Limited issuance and liquidity has affected the mid-market, which has subsequently witnessed unfavourable pricing trends.
"Spreads in the mid-market have definitely been wider in recent months," says Michael Mullins, partner at Winston & Strawn. "It is just not an efficient time for originators to tap the market, especially when warehouse financing is currently a competitive option."
Until spreads tighten, warehousing may continue to provide a more attractive alternative. However, spread recovery is not expected to come imminently, with liability pricing proving to be a major weight upon activity.
In addition, the mid-market is particularly suffering from a lack of triple-A buyers. Investors have come and gone in recent years, but many have not stayed active for prolonged periods. This lack of investor appetite is suppressing incentive to bring more deals to the market.
"It's a real problem, because a lot of investors are choosing to stick with broadly syndicated loans (BSL)," adds Mullins. "It is hard to argue against the good premiums that the BSL market provides. The spread difference has widened with the mid-market to at least 70bp for triple-A spreads, although there have not been many recent deals to validate that."
New issue BSL triple-A spreads have been hitting the 160bp range, according to Deutsche Bank's securitised products analysts. In comparison, Golub Capital's recent US$354m Golub Capital Partners CLO 31(M) deal recently priced in at 220bp.
Macro conditions are also playing a pivotal role in the issuance pullback. Unpredictable interest rate forecasts and numerous problems within the commodities and oil and gas sectors have proved detrimental. With the latter, default rates are expected to continue to rise in the sector, albeit this is not expected to be as profound for the mid-market sector.
"What is more interesting is the potential ripple effect that could come into play for the mid-market," says Mullins. "It is not a direct issue, but there could be a trickle-down effect."
Specifically, Mullins notes the role of mid-market companies as suppliers to those industries. As a result, loans tied into mid-market CLOs from these companies could still take a small hit if the companies start to struggle.
Nonetheless, this has not prompted knee-jerk, short-term structural innovations in the market. This could be in part due to the greater resilience and recovery abilities of mid-market CLO structures in downturns.
"The terms are still very tight for these structures," says Mullins. "The structural evolutions that have happened have been more a result of a couple of years' development. For example, some US private equity has edged down into the mid-market."
Other structural considerations have emanated from the talk of risk retention in the CLO market. The Dodd-Frank rules, which require CLO managers to purchase and retain 5% of their transactions, will come into effect on 24 December this year. As the regulation looms closer, managers are continuing to pursue the necessary compliance procedures in time.
"I think in the mid-market space the impact is not as profound," muses Mullins. "A lot of managers have already digested the rules and are already in economic compliance, so those that are more experienced should not really suffer."
Nonetheless, there is an expectation that the rules will also tie into reduced issuance in the mid-market space, and could be a particular deterrent for new CLO managers with little track record. "Although some deals are expected to hit the space in the near future, the market may have to rely on managers re-emerging in the space," adds Mullins.
One example of this is Antares Capital, which signalled its plans to re-enter into CLOs following its sale from GE Capital to the Canadian Pension Plan Investment Board in the middle of last year. The mid-market private equity firm recently showed its intent, hiring Vivek Matthew to push its CLO platform as head of its structured products group (SCI 25 February).
"They are going to be a larger issuer and I think they could be a wildcard in the market," says Mullins. "Investor interest should be strong, so the question is whether there is going to be sufficient investor demand for others."
JA
News
CLOs
CLO cashflow diversion eyed
Silver Spring CLO recently became the first post-crisis US CLO to experience full cashflow diversion from the equity. The 2014-vintage Silvermine Capital deal has a triple-C exposure of 15.6% and a 5% triple-C covenant, which is lower than the average 7.5% covenant in most post-crisis CLOs, according to JPMorgan CLO analysts.
Silver Spring CLO's exposure to energy and mining loans is 18.25%, including three defaulted names - Templar Energy, Peabody Energy and Southcross Energy. Both the single-B tranche and equity PIK'ed this month and diverted cashflows to pay down the triple-A notes.
"We see a handful of other CLOs at risk of cashflow diversion, with at least two more US CLOs failing an OC test and another six failing their reinvestment OC test," the JPMorgan analysts note.
Moody's estimates that 26 CLO 2.0s that it rates (representing 5% of all CLO 2.0s) are at greater risk of OC deterioration, as most of them are exceeding their Caa limit and have large exposures to the riskiest assets. Of the 26 CLOs, the agency rates only the senior notes in 20 - which it says are well-positioned to withstand collateral defaults and par losses, given their ample credit enhancement - and has downgraded junior or mezzanine notes in three of the others (Silvermore CLO, Silver Spring CLO and ECP CLO 2014-6) due to the transactions' large exposure to energy- and commodity-linked credits.
All but one of these deals are exceeding their Caa haircut limits and, as a result, are carrying excess Caa holdings at market value, putting them at greater risk of OC deterioration. Four deals' junior OC cushions have already eroded materially, to less than 1%, due to excess Caa haircuts, defaulted asset holdings and par losses from credit risk sales.
Furthermore, Moody's indicates that 15% of CLO 2.0s it rates would fail their junior OC tests - and some would also fail their mezzanine OC tests - if forced to carry some of the riskiest assets in their portfolios at market values. "However, our assumption of applying market value haircuts to all the riskiest assets in a CLO's portfolio is conservative because only defaulted assets and Caa-rated assets in excess of a limit (typically 7.5%) are subject to haircuts in OC calculations. Among the CLO 2.0s we rate, junior OC levels are on average four percentage points above their triggers," it adds.
Moody's considers the riskiest assets as those that it rates B3 or lower and trade below 80% of par because they are more likely to default, contribute to excess Caa haircuts or be sold at a par loss. Between January 2015 and March 2016, approximately 15% of the loan issuers whose senior loans traded below 80% have defaulted and nearly two-thirds of issuers whose loans are currently trading below 80% are rated Caa1 or below.
CS
Job Swaps
ABS
Start-up adds ABS pro
Financial technology start-up ZestFinance has appointed Steven Fernald as head of capital markets. He reports to ceo Douglas Merrill and will oversee new and existing capital markets relationships.
Fernald was previously part of the student loan ABS group at Morgan Stanley. He has also worked at UBS.
Job Swaps
CLOs
Expanding manager debuts Euro deal
BlueMountain Capital Management has closed its first European CLO with €410m in commitments, while it also continues to build out its European team. The firm closed four CLOs in the US last year.
BlueMountain appointed Nick Pappas as European ceo last year (SCI 16 April 2015) and says it has a strong commitment to building its European presence. It hired research analyst Tripp Lane in March last year and more recently has bolstered its leveraged finance business by hiring analysts Hugo Villarroya, formerly with ENA Investment Capital and Anchorage Capital, Vitaliy Ardislamov, who joined the firm from Strategic Value Partners, and Kristin Hall, previously with Warburg Pincus.
BlueMountain also recently brought Steve McMillan from Lloyds as a client advisor in its London office, where he is responsible for supporting client and business development services.
Job Swaps
CLOs
CLO services co-leads named
Hillel Caplan and Lynda Lazzari have been named co-leads for Deloitte & Touche's CLO services practice within the firm's securitisation practice.
A Deloitte Advisory partner, Caplan has more than 22 years of experience serving asset management and banking clients. Based in the firm's New York office, his new CLO services practice co-leadership role will focus on financial technology offerings to CLOs. He will continue to serve as co-lead of Deloitte & Touche's financial technology practice and leader of its Solvas software offerings.
A Deloitte Advisory director, Lazzari has more than 25 years of experience serving financial services industry clients. Based in the firm's Jersey City office, her co-leadership of the CLO services practice will focus on transactional services related to portfolio compliance and cashflow modelling for CLOs. Lazzari will continue to coordinate closely with the firm's broader advisory and tax practices, delivering valuation, financial accounting and reporting, and tax services.
Job Swaps
Risk Management
Analytics firm acquired
Bridgepoint and Summit Partners are set to acquire Calypso Technology. The firm says the acquisition will support its next phase of growth and continued innovation in capital markets technology.
The transaction is subject to standard competition authority clearances. Debt for the transaction was provided by Goldman Sachs, UniCredit, Crédit Agricole, Mizuho and Bank of Ireland. Calypso was advised by Wilson Sonsini Goodrich & Rosati, while Bridgepoint and Summit Partners were advised by Credit Suisse, Latham & Watkins, Kirkland & Ellis, Bain & Company and EY.
Calypso has over 700 employees and operates a network of 22 offices in 19 countries. Over 50% of the firm's employees are engaged in R&D across five global development centres.
News Round-up
ABS
Green Aussie ABS debuts
FlexiGroup has brought the first ABS to the Australian market to include a green bond tranche. The A$260m Flexi ABS Trust 2016-1 deal is backed by a pool of Australian unsecured retail payments plans - described as 'no interest ever'.
The transaction comprises eight tranches, with the senior class A1 notes taking up the largest chunk at A$91m. The green A2G tranche has been climate bond certified by the Climate Bonds Standard Board in London and is backed by A$50m worth of solar PV receivables.
The seven most senior classes of notes have been rated by Moody's and Fitch, and will be issued by Perpetual Corporate Trustee. FlexiGroup will retain A$13m of unrated class F notes.
The class A1 notes priced at 75bp over one-month BBSW, while the A2s came in at 155bp over. In addition, the A2Gs price at 150bp and the Bs at 225bp. Pricing for the other notes is undisclosed.
The transaction is FlexiGroup's ninth under its Flexi ABS programme, originated by Certegy Ezi-Pay. National Australia Bank arranged the deal and also acted as joint lead manager with Commonwealth Bank of Australia.
News Round-up
ABS
Yirendai completes ABS issuance
Chinese online consumer finance marketplace Yirendai has completed a CNY250m ABS issuance. Yirendai announced last month that it had facilitated a trust to securitise consumer loan products, with the first ABS expected to be listed for trading on the Shenzhen Stock Exchange within four weeks.
"We are pleased to see the substantial progress of the ABS products issuance," says Ning Tang, executive chairman, Yirendai. "This is an important beginning of our innovative efforts in diversifying our sources of funding. We will keep working with key value chain partners to better address the huge under-served demand in China's consumer lending industry."
News Round-up
ABS
Blade ABS hits rough patch
Moody's has downgraded Blade Engine Securitization Series 2006-1 due to revised future income expectations. The A1 and A2 notes have both been downgraded from Ba3 to B3, while the B notes have been downgraded from B2 to Caa3.
The rating agency has reduced its expectations for future income from the engine portfolio for several reasons, not least the fact that nine of the 37 engines in the portfolio are currently off-lease and not expected to be re-leased for the foreseeable future. Pursuant to recently-adopted IFRS guidelines, Blade also reported this month an impaired valuation of the class B notes on an accounting basis.
Meanwhile, although engine appraisal values are at good levels, recent sales have been below appraised values. The combined LTV of the class A and B notes is around 91% of the June 2015 appraisal values, but engine sale prices in 2H15 and 1Q16 have been "considerably lower than their most recent appraisal values".
Moody's notes that current cash collections have not been sufficient to pay the interest and principal on the Class B notes based on the priority of payments, and the class B notes have been receiving interest by withdrawing from the junior cash account. As a result, the junior cash account balance has declined from the minimum balance of US$4.05m to US$2.88m, as of April 2016.
News Round-up
ABS
Funding builds case for ABS
LendInvest has secured a £40m warehouse financing facility from Macquarie Bank. An ABS issuance is understood to be in the works.
This is the fourth bank funding line the real-estate marketplace lender has secured. LendInvest has now received a total of £230m in investments from UK and international institutions.
"We look forward to working with the Macquarie team as we expand our product range with longer term loans that are attractive to them and other capital markets investors," says Christian Faes, co-founder and ceo of LendInvest. "This warehousing line will assist us as we move towards being able to securitise our assets for institutional investors."
News Round-up
Structured Finance
Towd debuts WAC cap
Towd Point Mortgage Funding 2016-Granite 1 is the first European securitisation to place a cap on its net weighted average coupon (WAC) (see SCI 5 April). Moody's says that this could lead to less senior interest paid in the revenue waterfall than is suggested by the coupon on the notes.
"Senior interest payments are exposed to the servicer's ability to reset mortgage rates after a Libor increase," says Steven Becker, analyst, Moody's. "Interest paid to the senior notes will be highly correlated with the evolution of the pool's yield."
In its analysis, Moody's says that during a flat interest rate environment, net WAC additional amounts may occur after the original redemption date in the deal. However, excess revenue and principal proceeds could be used to make full payments of outstanding net WAC additional amounts.
"Various US transactions use net WAC caps, including the US Towd Point transactions," adds Olga Gekht, vp and senior credit officer, Moody's. "This concept is used in deals where the asset-liability basis risk is unhedged."
However, Moody's points out that while US deals have this mechanism, the net WAC cap applies to all rated tranches including the triple-A rated notes. In contrast, the cap in the Granite deal only applies to rated tranches other than the class A notes.
News Round-up
Structured Finance
European placements trending down
Only €14.3bn of securitised product was placed in Europe in 1Q16, according to AFME's latest data snapshot on the market, as €42.5bn was retained.
A total of €56.9bn was issued last quarter, a decrease of 20.3% from the €71.4bn issued in 4Q15. However, it was significantly up from the €35.3bn issued the same time last year - a 61.2% increase on 1Q15.
UK RMBS was the most popular asset class last quarter, with €5.8bn placed, but that was still a slight drop from the €6.1bn placed in 4Q15. Pan-European CLOs contributed to €2.6bn in placements for 1Q16, while Dutch RMBS was up to €1.8bn of the total figure.
News Round-up
Structured Finance
SFI website likely delayed
ESMA says it has encountered a number of issues in its preparations for developing a website on the disclosure of structured finance instruments (SFI). The absence of a legal basis for its funding is one key barrier, which has left the regulator admitting that the website will not be ready for entities to start reporting by the 1 January 2017 deadline.
The European Commission delegated ESMA in 2014 with forming a website that requires issuers, originators and sponsors of SFIs within the EU to disclose information and data on the transactions (SCI 30 September 2014). ESMA is required to issue the subsequent instructions by 1 July, given the reporting obligations will apply from the start of next year. However, it says that the instructions are also unlikely to be sent out in time.
The regulator expects that the new securitisation legislation proposed within the Capital Markets Union plan will provide more clarity on the future obligation regarding reporting on SFIs. The legislation is currently being looked at in the European Parliament.
News Round-up
Structured Finance
Argentine deals upgraded
Moody's recent decision to upgrade Argentina's sovereign rating has prompted it to consequently raise the ratings of a number of securitisations. Among those upgrades are several consumer loan, lease loan and vehicle loan deals, due in part to the reduced systemic risks for all local credits.
The affected deals are: Ames V, Pvcred Serie XXII, Lucaioli XIV, Lucaioli XV, Supervielle Créditos 81, Bancor Personales IV, ICBC Prendarios II, Supervielle Leasing 10 and Supervielle Renta Inmobiliaria I.
The ratings for the deals have been upgraded from B1 to Ba3, as their credit profiles were formerly constrained by the previous currency country ceiling for Argentina. The local currency country ceiling was recently upgraded to Ba3 from B1, together with Argentina's government bond rating moving up to B3 from Caa1.
News Round-up
Structured Finance
Record Philippines deal prepped
8990 Holdings has mandated China Bank Capital to arrange and underwrite a PHP5bn securitisation, which will make it the largest-ever deal from the Philippines. The deal will securitise receivables from 8990's property development subsidiaries.
The transaction will also be the first purely private sector securitisation in the country. Under the proposal, 8990 will sell up to PHP5bn in contract-to-sell receivables through an SPV set up by China Bank Capital. The vehicle will subsequently issue three tranches of notes with sequential payment.
8990 chairman Mariano Martinez signed off on the mandate last week. The deal is subject to the SEC giving it the go-ahead after the plan was sent to the regulator for approval.
President and ceo of 8990 Januario Jesus Atencio says that the deal signals a 'new horizon' for housing finance in the country.
News Round-up
Structured Finance
Warehouse financing weighed
Smaller lenders, non-bank entities and challenger entrants are increasingly opting for securitised ABS and RMBS warehouse financing facilities to access greater flexibility relative to traditional securitisations or unsecured funding sources, says Moody's. Although warehousing has been in use since the 1990s, the extent to which such facilities are being used is more varied by jurisdiction and investor appetite.
"In Europe, the use of warehouses looks set to become more common with small or new originators and mainly by way of VFNs," says Rodrigo Conde Puentes, a Moody's avp - analyst.
So far this year, the agency has rated three warehouse deals: Station Place Securitization Trust 2016-1, a revolving securitisation facility in the US backed by residential mortgages; Optimum One, a warehouse of second-lien mortgages backed by properties in the UK; and Startline Auto Receivables, backed by a revolving pool of UK auto leases from an originator with a limited trading history. Moody's says that warehouse funding offers more flexibility than some other types of funding.
"However, the borrower may be able to substitute or increase the underlying collateral; therefore, as the pool changes over time, warehouses face the risk of a potential decline in collateral quality, which is not present in traditional transactions. This risk is assessed when rating the transaction and factored into the achievable rating levels," says Conde Puentes.
"For the use of these structures to become more widespread, smaller players would need to have an initial pool of sufficient size that warehousing becomes an economically viable funding option and investor appetite for structured debt will need to recover more strongly," explains Greg Davies, an avp at Moody's.
The rating agency notes that these structures have unique risks. Alongside the substitution of loans, the originator does not benefit from the quality of the loan that it lends it, so it may be incentivised to originate higher volumes but with lower credit quality. Structural mitigants - such as eligibility criteria and portfolio limits - might not fully capture market movements, causing higher losses than those anticipated.
Finally, more than in static transactions, warehouses are exposed to originator and servicer performance. Consequently, smaller players might be more susceptible to additional operational risks, such as as key man risk.
News Round-up
Structured Finance
South Korean issuance up again
South Korean ABS issuance was up by 16.8% in 1Q16 from 1Q15, according to the country's Financial Supervisory Service. Issuance totalled Won13.4trn, which is a Won1.9trn increase from the Won11.5trn issuance figure a year earlier.
A majority of the growth came from Won8.7trn in MBS issued by the Korea Housing Finance Corporation (KHFC). The increase was mostly because newly-issued MBS backed by relief loans rose and rising interest rates in the US led to an increase in MBS issuance.
Meanwhile, ABS issued by financial and non-financial companies last quarter came to Won2.8trn and Won1.9trn respectively. These were respective drops of 3.9% and 9.6% from the same time last year.
In addition, underlying asset data shows that ABS issuance backed by instalment sales receivables totalled Won1.5trn - 129.7% more than a year earlier. ABS issuance backed by handset instalment sales receivables came to Won1.3trn, which is 23.8% less than a year earlier.
News Round-up
CDS
Norske credit event called
ISDA's EMEA Credit Derivatives Determinations Committee has resolved that a restructuring credit event occurred in respect of Norske Skogindustrier ASA. The move follows the execution of the firm's exchange offer for its outstanding €218.11m 7.00% senior notes due 2017 for an applicable consideration comprised of exchange notes due 2026, perpetual notes and the right to subscribe in cash for ordinary shares of the parent company. Any 2017 notes that weren't tendered (representing approximately 24%) in the exchange offer were redeemed.
The Committee also resolved that one or more auctions may be held in respect of outstanding CDS transactions of varying maturity buckets. The association will publish further information regarding any auctions in due course.
News Round-up
CDS
ISDA, Markit set CDS commitments
The European Commission is looking for feedback on commitments put forward by ISDA and Markit to address concerns surrounding their licensing of CDS data and indices. Both were alleged to have breached EU antitrust rules by blocking or delaying the emergence of an effective market for exchange traded CDS.
The allegations date back nearly three years when the Commission accused a group of investment banks of collusion to prevent exchanges from entering the credit derivatives business (SCI 1 July 2013). The purpose of such alleged collusion was to reduce competition at the benefit of the investment banks that already dominated the market.
The Commission decided to drop its case against the banks late last year, but to continue investigations into the involvement of ISDA and Markit. It says trading platforms must have access to the 'final price' - over which ISDA claims proprietary rights - and to CDS indices to attract liquidity.
In response, ISDA has offered to indiscriminately license all rights in the final price for exchange trading clearing and settling of credit derivatives. It has also offered to submit a third party arbitration procedure in the event of a disagreement to any terms on the final price licensing. ISDA's licensing decisions would be transferred from its board solely to the ceo, who must not seek the views of the banks.
Markit similarly proposes to license its rights in the iTraxx and CDX indices for the relevant exchange traded products. A third party arbitration would also be set up on any disagreements and would reduce the influence of investment banks on the issue through any advisory committees with the data provider.
The Commission says that both commitments would apply for 10 years and be monitored by an independent trustee. If they are found satisfactory, they may be adopted as legally binding. The breaking of any commitments could lead to a fine of up to 10% of Markit or ISDA's respective worldwide turnover.
News Round-up
CLOs
US mid-market mix emerging
Moody's expects the US mid-market loan sector to increase in variety if the upcoming 2016 to 2020 maturity wave coincides with an economic downturn. The agency expects CLOs, private equity firms, hedge funds and banks to play a larger role in the financing of mid-market companies.
Non-banks have driven the majority of mid-market lending growth since 2007. They accounted for almost all of the US$47bn growth between 2007 and 2Q15. In particular, BDCs have accounted for almost 70% of that figure.
However, roughly US$28bn of mid-market loan investments held by BDCs will mature and require refinancing. An additional US$20bn of the loans within CLO portfolios are also set to mature after their deals' reinvestment periods end.
Moody's says that a portion of the loans will be restructured or renegotiated prior to maturity, as happened in the past downturn. But the rating agency adds that the ability of BDCs and CLOs, especially those with limited performance history, will find refinancing challenging due to technical constraints.
This will provide space for other areas of the market to emerge, which may lead an even greater mix than was present prior to 2007. Private equity and hedge fund firms may refinance mid-market loan investments currently held by BDCs and CLOs - although BDCs will still have a significant influence.
The nature and timing of involvement should vary across different types of lenders, but Moody's believes funding shares will likely gradually revert to levels closer to 2007. In this period, BDCs financed roughly 20% of mid-market loan investments with CLOs, private equity firms, hedge funds and banks financing the remaining 80%.
News Round-up
CMBS
Hudson loss forecast increases
Rising store vacancies at the Hudson Valley Mall in Kingston, New York, has prompted Morningstar Credit Ratings to increase its loss forecast on the loan backed by the shopping centre. Sagging occupancy has now left the US$49.4m loan with expected losses of US$32.5m, a substantial rise from the previous US$24.7m projection.
This could have direct implications on CFCRE 2011-C1. The loan comprises 17.7% of the CMBS's pool. The mall lost Macy's in 1Q16 (SCI 19 January), which followed JCPenney's closure in April last year, after which the loan was transferred to special servicing (SCI 20 April 2015, see SCI's CMBS loan events database).
While the loan loss would be just the third material loss for the US CMBS 2.0 market, Morningstar says this would be by far the largest. Both post-2009 loans that have had material losses were backed by student housing properties, with respective losses at only US$7.1m and US$2.9m in comparison.
The Hudson Valley Mall had an occupancy rate of 95% five years ago. This has now dropped to the upper 60% range and could continue to slide by a further 24%. This 24% is made up of tenants with either less than 12 months left on their leases or who are operating with kick-out clauses in which they could vacate should their sales fail to improve within 12 months.
News Round-up
CMBS
Loss severities remain steady
Fitch reports that US CMBS loss severities remain steady year-over-year, rising only slightly to 45.7% in 2015 from 44.8% in 2014. The historical average now stands at 46.6%.
As the inventory in special servicing has fallen, special servicers accordingly resolved fewer loans in 2015 compared with 2014. However, the proportion of the loans resolved with a loss is lower.
"The proportion of loans resolved for a loss at 53% is at a six-year low and reflects 2015's robust commercial real estate markets from both a value perspective, as well as from a liquidity perspective," comments Fitch senior director Karen Trebach. "Average loss severity is expected to rise somewhat in 2016, as the increases in rents, occupancy and property prices seen over the last several years are likely to moderate and as the refinance wall of 2016 and 2017 faces a potentially lower CMBS issuance volume."
Overall loss severity for all loans resolved last year is 21.5%. However, when excluding the large Stuyvesant Town loan resolution that experienced no loss, the total loss severity is 26.4% - which is more in line with recent historical averages.
Legacy loans from peak vintages dominated resolutions in 2015. Four peak vintage transactions saw over US$250m in resolutions, which resulted in significant losses.
While making a dent in the peak vintage special servicing inventory, Fitch remains concerned about REO aging, currently in special servicing. The current REO aging suggests that servicers may be utilising a value-add strategy for underperforming properties, servicers may be waiting for market conditions to improve and the REO inventory may be adversely selected.
Of the major property types, retail once again saw the highest average loss severity at 54.4%, in line with 2014 when it was 52.1%. Office represented the largest amount of resolutions with losses: loans backed by office properties were US$2.6bn of the US$6.9bn resolved with losses and experienced an average loss severity of 43.9%.
News Round-up
CMBS
Sears exposure gauged
Nine loans with a balance of US$111.9m across nine CMBS have exposure to Sears Holdings Corp's latest round of store closures, according to Morningstar Credit Ratings. The retailer plans to shutter 68 Kmart and 10 Sears stores this summer.
Morningstar has identified five CMBS loans worth US$56.9m in five CMBS with significantly elevated risk of term or maturity default related to the Sears closings. The agency indicates that the US$32.2m Midland Mall loan (securitised in LBUBS 2006-C6) faces the greatest risk, as it was recently transferred to special servicing due to the borrower's desire to shed non-core assets (see SCI's CMBS loan events database).
It is concerned that the loss of Kmart at four properties could push the debt service coverage below 1x, as the retailer is a large tenant on leases that expire within the next 19 months. Sears has an October 2016 lease expiration and is the second-largest tenant, occupying 62,700 square-feet, or 17.7% of the total space.
Meanwhile, cashflow will likely absorb the loss of Kmart (occupying 35.7%) at Mariposa Shopping Center - which secures a US$21.2m loan in COMM 2015-PC1 - when its lease expires in April 2017. The 255,600 square-foot property generated a 2.10x DSCR for 2015. The loan pays interest-only for 36 months, so cashflow could fall below break-even once the loan begins amortising.
Morningstar notes that there is additional concern around the third-largest tenant, Ross Dress for Less, which has the right to terminate if Kmart is not open. Should Ross exercise its co-tenancy clause, the DSCR would fall below break-even. Also, the second-largest tenant JC Penney has an early-termination option with no penalty.
Additionally, the agency points to higher levels of risk with three smaller-balance loans - US$2.6m Cherokee Shopping Center (DLJCM 1998-CG1), US$532,938 Kmart - Paintsville (JPMCC 2007-LD12) and US$383,279 Kmart Montwood Point (DLJCM 1998-CF2) - as Kmart occupies a large percentage of the properties.
In contrast, the US$32.4m Champlain Centre loan (GSMS 2011-GC5) is expected to avoid significant default risk because of the property's strong net cashflow that should easily withstand the loss of Sears, which occupies less than 20% of the mall. The loan had a healthy DSCR of 2.05x, as of year-end 2015.
Similarly, Morningstar anticipates lower levels of risk at the US$12.4m Fort Roc Portfolio - Penn Plaza (MSC 2006-HQ10), US$5.6m Slate Portfolio - Springboro Plaza (JPMCC 2012-CBX) and US$4.6m Centro Portfolio - The Pines (JPMCC 2010-CNTR) properties. These assets are part of multi-property portfolios and cashflows will likely absorb the loss of the tenant.
News Round-up
CMBS
Euro CMBS to remain attractive
European CMBS investor demand will remain high over the next few years, says Moody's, as CRE returns are more attractive in the low interest rate environment than alternative investments. Investors will have to balance the defensive attributes of low yielding prime properties with looking further afield to find additional yield pick-up.
"CRE fundamentals are stable, but returns will not be uniform. Rebound markets like London, Ireland and Spain and retail logistics properties will achieve the highest rental growth. The property yield spread over government bonds is high, despite prime yields being at historic lows in core markets - even below levels seen in 2007. This gap will remain through to 2018," says Moody's avp Stephen Hughes.
A large segment of CRE investors - typically REITs, sovereign wealth funds and insurance companies - are expected to continue to focus on prime office and retail properties in the major European cities. Investors such as private equity companies are more likely to move up the risk curve to purchase good-quality secondary properties, which would typically require a more hands-on approach to property management.
Very low interest rates should constrain any further downward yield movements. Yields will remain divergent between prime, secondary and tertiary properties, even up until 2018.
Most CRE lending is heavily weighted towards the UK and Germany. Current lending terms appear relatively conservative, with all property LTVs at around 60%-65% and margins below 200bp in most core European cities.
News Round-up
Insurance-linked securities
London touted as cyber ILS hub
The London ILS market is "perfectly positioned to become the global centre for cyber risk insurance", says BNY Mellon in a new report. The report recommends new laws to allow the incorporation of SPVs onshore within the London market to offer ILS sponsors and investors more choice and potentially allow new and emerging risks to be transferred to the capital markets.
New data protection rules coming in across the EU are expected to drive up demand for cyber liability cover. While steps have been taken to standardise cyber risk data and to design products that cater for cyber terrorism, the insurance market for physical damage and bodily injury arising from a cyber-attack is nascent.
"There is huge potential for cyber risk to be transferred to the capital markets using ILS, in a similar way to how cat bonds underwrite hurricane and earthquake risks. However, before cyber risks can be successfully securitised, significant progress is needed in aggregating and modelling the risk. This requires more collaboration between major insurers and technology experts to better understand the interdependencies between systems and the frequency of attacks," says Paul Traynor, pensions and insurance segments leader, international, BNY Mellon.
As well as new laws to allow the incorporation of onshore SPVs, the report recommends tax incentives for SPVs to be located in London and a dedicated unit within the UK's Prudential Regulation Authority. It also recommends that London should leverage its expertise within specialist insurance markets and position itself within Europe to offer the ILS market something different.
News Round-up
NPLs
IMF warns China over NPLs
The IMF has praised Chinese attempts to tackle its debt problem through new schemes that introduce NPLs to the market, but warns that a lack of careful design could prompt the rise of 'zombie' firms. The organisation therefore lays out a number of recommendations, including the need for a diversified pool of NPLs within any proposed securitisations.
The response comes after recent moves by Chinese regulatory authorities to facilitate NPLs as a way for tackling the numerous sources of excessive corporate debt in the country. According to IMF figures, corporate debt represents roughly 160% of GDP in China.
The two key approaches being proposed are the conversion of NPLs into equity, and the securitisation and sale of NPLs. The securitisation programme is reportedly being piloted by a handful of large banks and capped at CNY50bn. NAFMII also released disclosure guidelines earlier this month regarding the granular makeup of NPLs (SCI 7 April).
However, the IMF says that NPL securitisation should, on top of presenting diverse pools of loans, allow banks to keep some skin in the game. Further, it believes the approach must encompass a legal and operational framework that will allow owners of distressed assets to force operational restructuring of firms and obtain the best value from those assets.
Moreover, the organisation says that for these techniques to help address the systemic problem of excessive corporate debt and impaired bank loans more generally, they need to be part of a comprehensive, system-wide plan. This plan would address the social consequences entailed in the NPL scheme.
In addition, it would assess the viability of distressed firms, while restructuring the viable ones and liquidating the non-viable ones. The zombie firms that the IMF warns about are applicable to the non-viable businesses in the country that are still operating. Other recommendations by the organisation include the requirement of banks to proactively recognise and workout NPLs, and set a shared burden among banks, corporates, institutional investors and the government.
News Round-up
Risk Management
Clearing rule completion requested
The FIA has sent a letter to the US SEC urging the agency to finalise rules setting enhanced standards for systemically important security-based swap clearing agencies. The organisation says that without such standards, clearing members that are located within the EU may no longer be able to access covered clearing agencies regulated by the SEC and may face punitive capital requirements.
The association says it is "concerned that further delays in the finalisation of these enhanced standards will prevent the SEC regime from being deemed equivalent under EMIR", which could prevent CCPs from providing clearing services to European members.
News Round-up
RMBS
Rate floor ruling assessed
A recent Madrid court ruling on interest rate floor clauses within retail mortgages should not pose a substantial threat to Spanish RMBS, according to Fitch. The court said that the clauses lacked transparency and were abusive, leaving the possibility that they could become obsolete.
However, the court did not state that the clauses were illegal, so the implications for affected mortgages may depend on a case-by-case assessment. Fitch's initial assessment on the fall-out is supported by discussions with trustees and a legal adviser. The full implications will depend on future legal decisions and their applicability to individual mortgage loans, but the agency does not expect to take rating actions as a result.
Where interest rate floor clauses are indeed nullified, Fitch says it is possible that this will apply retrospectively to May 2013. Banks would have to compensate borrowers for excess interest paid from this date, which could therefore spur them to appeal the ruling. In addition, the industry is awaiting a decision from the European Court of Justice on the matter.
According to Fitch's estimates, around 10% of existing securitised Spanish mortgage loans have floor clauses. This varies from lender to lender, but the low levels of excess spread in typical Spanish RMBS deals - close to 1% per annum - suggests that the proportion of securitised mortgages with floor clauses is low.
The biggest potential impact on RMBS could arise if final court decisions confirm that clauses were abusive because of insufficient transparency at origination, and borrowers have to be compensated as if the clauses had not been present since May 2013. In this case, Fitch expects that the originating banks would commit to either buy back affected loans or pay the required compensation to borrowers from their own funds.
However, if banks attempted to pass this risk onto issuing SPVs, it could generate administrative and legal costs. This could affect transaction cashflows if new senior costs arise, and potentially affect ratings, as SPVs do not reserve for this contingency. Nonetheless, Fitch says the risk is remote because SPVs purchase loans from originators with representations and warranties stating that all assets comply with local laws.
Further, some securitisations exposed to mortgages with rate floors would see further income margin reductions if the floors become ineffective. This would go even beyond the spread compression of past years. The magnitude would depend on the number of mortgages with interest rate floors in the underlying portfolio.
News Round-up
RMBS
FNMA to issue reperforming deals
Fannie Mae will later this year begin securitising reperforming loans held on its balance sheet. Reperforming loans are mortgages on which the borrower was previously delinquent but has subsequently become current - either with or without utilising a mortgage modification plan.
Potential sales of such securities are expected to begin in the second half of the year, but will be contingent on market conditions and investor interest. "With these securitisations we will have more flexibility to manage our risk and reduce the size of our portfolio," says Bob Ives, vp, retained portfolio asset management, Fannie Mae. "Over the long run, these securitisations can benefit investors, Fannie Mae and taxpayers."
News Round-up
RMBS
Irish RMBS delinquencies dropping
Severe delinquencies among S&P-rated Irish RMBS transactions have declined over the past four years as the Irish economy has recovered. However, they do remain stubbornly high and the rating agency expects it will take some time before housing market conditions and delinquencies normalise.
Total delinquencies among Irish RMBS rated by the agency were 15.7% as of 4Q15. They peaked at 23% in 3Q13.
Severe delinquencies are at a four-year low of 12.8%. However, they have also accounted for 80% of total arrears over the last three years, up from 60% in early 2010.
"Very long-term arrears of greater than 720 days are growing in both size and severity, as the direct result of elevated levels of long-term unemployment, long foreclosure processes, and the Central Bank of Ireland's forbearance measures," says Arnaud Checconi, credit analyst, S&P.
The degree of improvement in Irish RMBS collateral performance varies considerably by originator and transaction. The two main factors which explain Irish RMBS collateral performance are loan concentration by occupancy type and the amount of loan repurchases.
Transactions with a higher proportion of BTL loans have historically seen higher levels of arrears. Celtic 15 and 16 both have very high severe delinquencies and had 24% and 67% of BTL loans at closing.
"We believe that arrears should continue falling moderately on the back of the improving economic conditions in Ireland. However, we also believe that if the downward trend is to continue, Irish mortgage lenders will need to address the issue of very long-term arrears, and the Irish government that of long-term unemployment," adds Checconi.
News Round-up
RMBS
UK mortgage tool launches
Moody's Analytics has launched UK Mortgage Portfolio Analyser (UK-MPA), a tool to assess and manage credit risk for UK residential mortgages. UK-MPA enables users to project defaults, prepayments and loss severities to help them to determine loan level and portfolio level performance.
The tool incorporates a number of factors within its model, including loan and borrower characteristics, regional home prices and unemployment rates. The product is also used to price whole loan transactions and determine the value of each loan under mortgage portfolio acquisitions or sales.
UK-MPA supports mortgage portfolio analysis under a range of scenarios, including regulatory stress testing and macroeconomic circumstances. This is particularly relevant to the new IFSR 9 accounting rules coming into force in 2018, which require banks to conduct more rigorous estimates of expected credit losses.
structuredcreditinvestor.com
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