Contents

Secondary markets

Euro ABS/MBS starts slow

It was another slow start to the week for the European ABS/MBS secondary market.

Yesterday's session followed on from those of the previous week with another day of very light flows. Lack of significant primary activity continues to hold back any potential for secondary momentum, though spreads continue to be stable.

In the absence of any stronger focus Brexit continues occupy the thoughts of many. Consequently, what little trading there was yesterday centred on UK assets.

There are currently three BWICs on the European ABS/MBS schedule for today. Unsurprisingly, UK RMBS make up the vast majority of line items.

The largest list is a nine line 95.909m euro and sterling mix of UK non-conforming mezz due at 13:30 London time. It comprises: AUBN 9 B, MFD 2008-1 A2, NDPFT 2015-1 B, PARGN 13X B1B, ROFIN 1 B, SLT 1 B, TRINI 2015-1 B, TRINI 2016-1 B and WARW 1 B. Only WARW 1 B has covered with a price on PriceABS in the past three months - at 92.9 on 17 March.

Secondary markets

US CLOs ebb and flow

The mezz rally in the US CLO secondary market halted last week and that part of the capital structure looks set to drift this week as equity paper takes up the slack.

"It feels like we're in sideways mode today," says one trader. "Secondary volume is lighter across the board this week than it was last week when the mezz rally ran out of steam on the back of high yield widening 40 basis points and a lot of funds flowing out of the market."

The trader continues: "Our market is slightly weaker since last Friday and even though high yield is stronger today I don't expect any strong direction from it until we get the next earnings figures. So CLO mezz is likely to drift until then - we're not heading one way because there is still a depth of bid for clean names, it's just that there's no longer so much of a rush to buy generic bonds."

Meanwhile, lower down the stack interest is picking up. "There's a lot of equity paper out this week," the trader says. "It's still mainly small pieces floating around and not yet about controlling stakes, but the interest equity BWICs are now generating shows demand is growing. For example, the bids we've seen on this morning's 10 a.m. auction showed some pretty decent levels."

There are 10 BWICs on the US CLO calendar for today, so far. They almost exclusively involve 2.0 mezz and equity.

The chunkiest auction is a ten line $67.8745m collection of equity pieces due at 13:30 New York time. It comprises: ATRM 12A SUB, BANDM 2014-1A SUB, BSP 2014-VA PREF, CRMN 2015-1A SUB, HLA 2012-2A SUB, JTWN 2014-5A SUB, MAREA 2012-1A INC, SHACK 2013-3A SUB, SNDPT 2015-2A SUB and TICP 2015-1A SUB. None of the bonds has covered on PriceABS in the past three months.

Secondary markets

Euro secondary still sluggish

Activity continues to be sluggish in the European securitisation secondary market despite the tone remaining firm across the board.

In ABS/MBS, Tuesday saw a flurry of BWICs that traded well, but yesterday auction activity slowed once more. Flows continue to be generally light even though sentiment is positive with prime RMBS and autos, along with select peripheral names attracting the most attention.

Meanwhile, CLOs look to be going through a stabilisation phase with a number of DNTs on yesterday's BWICs though some other line items showed strong prints. Again, sentiment remains good though lower mezz spreads have edged out a little this week.

There is one BWIC on today's European schedule so far - a six line CLO and RMBS mix due at 15:00 London time. It comprises: €1.2m CFHL 2014-1 E, £1.75m EHMU 2007-1 B2, €2.5m JUBIL 2013-10A SUB, €4.25m MPS 2X B1, €1.5m TCLO 1X F and €5m TCLO 1X SUB. None of the bonds has covered with a price on PriceABS in the past three months.

In addition there is a seven line €12.5m CLO MWIC due by 14:00. It involves: AVOCA 13X SUB, CORDA 3X E, CORDA 5X SUB, DRYD 2014-32X E, HARVT 14X E, OHECP 2015-4X SUB and ORWPK 1X SUB. Two of the bonds have covered with a price on PriceABS in the past three months - CORDA 3X E at 87.96 on 27 April and DRYD 2014-32X E at L80S on 4 March.

Secondary markets

US CLOs pause

The US CLO secondary market looks to be taking time to reflect this week.

"It seems like the rally has taken a bit of a pause this week," says one trader. "People are looking at where things stand in respect to credit and deciding on what the path forward might be."

However, the trader adds: "This week has turned out to have been an active one for lists. It doesn't feel anything like a sell-off though as the lists have been varied - sellers are testing the market with paper across the stack and trying to establish how firm everything is beyond the mezz focus of the last month or so."

With no obvious external drivers, the trader suggests the market pause could last a few more sessions. "With the current stability in loans and oil we could be range-bound for a bit, but if nothing changes the grind tighter should eventually start again."

There are six BWICs on the US CLO calendar for today. The chunkiest is a six line $110+m 2.0 double-A auction due at 15:00 New York time.

The list comprises: ALM 2014-14A A2, AVOCE 2014-1A A2A, ACASC 2016-1A A2, INGIM 2013-3A A2, REGT3 2014-1A A2 and REGT4 2014-1A B. Two of the bonds have covered on PriceABS in the past three months - ALM 2014-14A A2 at 100A on 21 April and AVOCE 2014-1A A2A at M93H on 23 February.

IFRS 9 calculation warning

A recent study undertaken by Kamakura Corporation underlines the risks of using credit spreads to assess obligor creditworthiness in light of the upcoming IFRS 9 implementation and the FASB's current expected credit loss (CECL) model. The findings of the study, entitled 'Fair Value and Expected Credit Loss Estimation', highlight that the common usage of credit spreads - which are derived from observable bond prices but contain false assumptions - contributes large errors to valuation and credit assessment in the obligor creditworthiness analytical process.

Using Lehman data, Kamakura took a model validation approach and compared two methods of valuation and credit loss assessment from an accuracy point of view. The first approach used market-based credit spreads to establish obligor creditworthiness, estimate values and credit losses. The second approach used observable market prices of securities, rather than credit spreads derived from them, directly in the valuation and credit assessment process.

Creditworthiness assessment under both IFRS 9 and the CECL model allow for approaches including probabilities of default, internal or external credit ratings and credit spreads, the latter being the focus of Kamakura's study. The objective of IFRS 9 is to generate 12-month and expected lifetime loan losses based on changes to obligor creditworthiness from one observed point to the next.

The firm notes that there is a substantial imbalance in the transparency and price discovery available in two key markets that are potentially important for IFRS 9 and CECL: the corporate bond market in the US and the market for single name CDS.

"Widening credit spreads cannot be attributed purely to worsening customer creditworthiness. This is an area of focus that should be treated with caution," says Suresh Sankaran, chief risk officer at Kamakura.

He continues: "The IFRS standard does not mention a prescribed methodology in terms of which approach for creditworthiness assessment should be used. So what we are seeing is that every client or participant in the IFRS 9 structure is having to interpret it in their own way. A participant's course of action is, more often than not, driven by a consultant - whether that is one of the 'Big Three' or another smaller consultant. In our experience, most consultants advocate the use of credit spreads."

He adds: "Choose the method you want and choose spreads if you will. But choose carefully. Don't take spreads provided by raw data, as they are not always based on real trades."

According to Kamakura chairman and ceo Donald Van Deventer, there is a behavioural economics phenomenon at work. He explains: "In school you're taught to take the data that is most readily available and most useful - don't think too much about the quality of the data, but do lots of analysis based on the numbers. Show your results ASAP. When it comes to valuation, one of the first numbers that people turn to is CDS. Many people do not seem to realise that less than 3% of the spreads distributed by major CDS vendors are based on real trades."

He adds: "The vendor has chosen not to indicate which of the 2000 reference names has a number based on real trades. Essentially, you're relying on numbers made up by Wall Street, as opposed to actual traded spread levels. Errors from use of the spread calculation exist at all levels of default, except at zero."

The firm suggests that this incremental source of error can be avoided by fitting basic building block securities to observable bond prices in a no arbitrage framework. The result, it says, is a consistent and highly accurate valuation and credit estimation framework that meets best practice standards of financial theory, econometrics and trading precision.

The industry has until January 2018 to prepare for the implementation of IFRS 9. The FASB's CECL model is not expected to be effective until 2019.

In the meantime, Sankaran suggests a number of immediate challenges that institutions need to address with regards to the forthcoming standard implementation. "Does the firm have adequate structures to project macrofactors?" he says. "Does the organisation know how customer creditworthiness changes in line with changing macrofactors and what sort of confidence can they ascribe to it? Do they know how the evolution of interest rates take place, not just over one year, but over a lifetime? I think these are the immediate challenges that the IFRS need to put the spotlight on."

AC

ABS

Value to be had in card ABS

The first euro-denominated credit card ABS of the year priced this week, helping to chip away at the dearth of primary supply. European credit card ABS distributed issuance is just €550m year-to-date, the second-lowest tally since 2011, so investors are increasingly focusing on secondary market opportunities.

Just one UK credit card ABS - Penarth 2016-1 - had priced prior to this week's pricing of Carrefour Banque's Master Credit Cards Pass Compartment France Series 2016-1. The €550m issued so far this year is only 2% of the €27.7bn of international ABS sold in 2016 so far. Around the same time last year, distributed credit card ABS volume was €2.3bn.

"That being said, credit card ABS issuance in 2015 was very front-loaded, with €4.6bn placed in the first half of the year but a meagre €300m in the latter half. Anecdotally, this coincided with €1.8bn of scheduled redemptions of UK credit card ABS in 1H15 and a 2x step-up margin of the €400m MCCPF 2013-1 seniors in June, which were refinanced with the 2015-1 series," note JPMorgan ABS analysts.

The current redemption outlook for UK credit card ABS is limited until 4Q16. The senior bonds of the French Purple Master Credit Card Note Series 2015-1 are slated to double their margins in October if they are not called, suggesting there could be a refinancing transaction in the latter part of this year.

As primary supply remains scarce, potential investment opportunities are concentrated in the secondary market. As of the end of 1Q16, there was €9.4bn in bonds outstanding, which is larger than either Irish or Portuguese RMBS, for example.

Among the outstanding credit card volume, the UK constitutes 83% of supply (roughly two-thirds sterling- and one-third US dollar-denominated), followed by 11% France (all euro-denominated) and 6% Switzerland (all Sfr-denominated). The arrival of the latest French deal allows for euro-constrained accounts to diversify away from the UK, although only €1bn French credit card ABS is now outstanding.

Euro-denominated paper outstanding accounted for just under a third of the universe at the end of 3Q13, but had shrunk to just 11% by the end of 1Q16. The US dollar-denominated universe fell from 30% to 24% in the same period.

A benign macroeconomic environment in the UK has allowed for broadly stable credit card collateral performance. Penarth outperforms other outstanding UK shelves, with a total delinquency of only 0.6%. The leading French shelf is Master Credit Cards Pass Compartment France, where total delinquencies are 2.1%.

The JPMorgan analysts note that non-US dollar credit card ABS has performed well in the secondary market in the context of other securitised products. Indicative sterling-denominated tranche spreads have stabilised over the last three months and are around one-month Libor plus 58bp - 5bp wider than a year ago - while UK prime RMBS has widened 15bp year-to-date.

The lower beta nature of credit card ABS compared to RMBS should see it remain stickier in the face of Brexit uncertainty. JPMorgan remains neutral on the asset class, with select relative value opportunities.

"For US investors, US dollar-denominated UK credit card ABS presents an even more attractive relative value proposition than when it was discussed in our 2016 outlook at the end of last year. As comparable average life US credit card ABS spreads have rallied significantly throughout 2016, tightening 19bp to one-month Libor plus 23bp, US dollar-denominated UK credit card ABS now looks significantly wide to its US counterpart," the analysts say.

The liquidity premium and current Brexit premium embedded in US dollar-denominated UK credit card ABS should make them attractive to US investors seeking diversification in short-duration, high quality assets. For non-US dollar opportunities, the analysts like the look of NewDay's senior NDFT bonds.

"The senior classes of the two NDFT transactions issued, Series 2015-1 and 2015-2, priced at plus 100bp and plus 145bp respectively in June and November 2015; the £200m five-year A2 class from PENAR 2015-2 priced in June 2015 at plus 50bp," they note. However, the NDFT charge-off rate is markedly higher than other programmes and loss coverage is lower.

JL

Structured Finance

SCI Start the Week - 9 May

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

Pipeline
Last week's pipeline additions consisted of eight ABS, two RMBS and a single CMBS.

The ABS were: US$300m Exeter Automobile Receivables Trust 2016-2; US$1.105bn GM Financial Automobile Leasing Trust 2016-2; US$200m GLS Auto Receivables Trust 2016-1; €153m Master Credit Cards Pass Compartment France Series 2016-1; C$220m Master Credit Card Trust II 2016-2; US$190m New Jersey Higher Education Student Assistance Authority Series 2016-1; €600m SC Germany Auto 2016-1; and VCL Master Netherlands.

€1.34bn BBVA RMBS 16 and US$200m Station Place Securitization Trust 2016-3 were the RMBS. The CMBS was US$527.1m WFCMT 2016-C34.

Pricings
A similar number of deals left the pipeline last week. There were six ABS prints as well as an RMBS, two CMBS and three CLOs.

The ABS were: €760m Cars Alliance Auto Loans Germany V 2016-1; US$225m Earnest Student Loan Program 2016-B; US$787m MMAF Equipment Finance 2016-A; US$1.146bn Santander Drive Auto Receivables Trust 2016-2; US$2.3bn Taco Bell Funding Series 2016-1; and US$1.14bn Toyota Auto Receivables 2016-B Owner Trust.

€3.636bn Home Loan Invest 2016 was the RMBS, while the CMBS were US$840m CFCRE 2016-C4 and US$893m JPMDB 2016-C2. The CLOs were US$653m Brightwood Capital Fund 2016-3, US$397m Cedar Funding V CLO and US$407m Trinitas CLO IV.

Markets
Although US agency RMBS outperformed Treasuries two weeks ago, last week their performance weakened as the market rally continued, report Wells Fargo analysts. "Week over week through the May 5th close, FN 3.5s underperformed Treasuries by 2-plus ticks as the 10-year UST rallied 9bp to 1.75%," they note.

The holiday-shortened week in Europe kept European ABS activity light, say JPMorgan analysts. They add: "Investor engagement with the asset class remained somewhat subdued, although the equally subdued new issue market lent technical support to spreads. Consequently, generic trading levels ground tighter across most asset classes, with UK risk in particular attracting better investor participation."

Editor's picks
Compromised compliance: It is almost two years since the transitional period for AIFMD expired in Europe and the majority of AIF managers now consider themselves to have addressed the directive's requirements. However, as evidenced by regulator-imposed penalties in France, a number of managers have failed to implement adequate valuation controls...
Mobile phone EIP ABS mooted: As the business model of US wireless carriers moves to further embrace equipment instalment plans (EIPs), they become more likely to issue ABS, says Moody's. Verizon has publically stated its interest in securitisation and there is increased speculation that a deal could be on the cards...

Deal news
• Fannie Mae has made further enhancements to its loan level disclosure data for its Connecticut Avenue Securities (CAS) programme. From this month, Fannie Mae has expanded its relationship with Equifax to provide investors with monthly updated, anonymous, loan-level credit scores on all CAS deals since the programme's inception in 2013.

Regulatory update
• ESMA has proposed amendments to its draft regulatory technical standards (RTS) for MiFID 2. These include revising transparency requirements to non-equity products, including structured finance and derivatives products.
• The US CFTC has approved a final rule to amend a requirement that swap dealers (SDs) and major swap participants (MSPs) exchange the terms of swaps with their counterparties for portfolio reconciliation so that SDs and MSPs need only exchange the 'material terms' of swaps. This requirement is found in CFTC Regulation 23.500(i).
• Bank of America has agreed to pay a US$190m settlement to the Federal Home Loan Bank of Seattle regarding pre-crisis RMBS that it sold, according to its quarterly SEC 10-Q filing. The agreement resolves a six-year litigation battle between the two banks after it was finalised on 25 April.
• A US$272m settlement in one of the last remaining RMBS class action suits to come out of the financial crisis has been approved. Judge Loretta Preska of the US District Court for the Southern District of New York granted the settlement, which resolves a dispute over faulty pre-crisis RMBS pass-through certificates sold by Goldman Sachs.

Structured Finance

Insurers' structured holdings slip

Life insurers held more than US$380bn of structured products securities at the end of 2015, which Wells Fargo analysts note represents a decline of approximately US$20bn from year-end 2014. Insurers' balance sheets actually increased 2%, so the decreased allocation to structured products is even greater on a relative basis.

As a percentage of total cash and fixed income, structured products' exposure declined from 17.9% to 16.7% between 2014 and 2015. Commercial mortgage loans rose 0.8% and cash/short-term securities increased 0.2%.

The analysts attribute the reduced structured products exposure to a few factors, including the fact that structured products continue to pay down at a faster rate than insurers are able to reinvest. That is a challenge which could become more acute this year, as year-to-date issuance is trailing the same period in 2015.

"Second, the broader macro volatility in the second half of 2015 gave investors pause regarding structured products, as they waited for better entry points. In the second half of 2015, investors were increasingly concerned with lack of liquidity in the market. Structured products, with the exception of agency RMBS, were less liquid than corporate securities, when measured in turnover ratios," the analysts add.

So-called mega insurers, with cash and invested assets of over US$100bn, allocated an average of 19% of their balance sheet to structured products last year. Large insurers, with US$50bn-US$100bn, allocated 15%, while mid-size (US$35bn-US$50bn) allocated less than 10%.

The analysts note that purchases in structured products as a percentage of total investing declined in 2H15. However, the actual dollars invested in structured products increased across all insurer groups.

Mega Insurers' dollar allocation to structured products increased from US$11bn in 1Q15 to US$18.4bn in 4Q15. Overall, allocations to structured products increased more than 23% in 3Q15 and 4Q15, but the disproportional increase in allocations to corporate bonds and US Treasuries resulted in a lower percentage allocation to structured products in 4Q15.

Mega insurers are the only group to have reduced their bond holdings in 2015. Total bond holdings fell 1.6% while cash grew 12.4% during 2015.

However, all other life insurer groups increased their bond holdings. As of 4Q15, large, mid-size and small insurers each carried almost 80% of their portfolios in bonds.

Life insurers purchased around US$80bn of structured products in 2015. Insurers increased allocations to agency RMBS and agency CMBS in the second half of the year, while allocations to ABS and CLOs generally declined in 2H15.

By structured product asset type, agency RMBS makes up more than 25% of life insurers' total structured products exposure. This is most likely a reflection of the yield, duration and rating quality that the product offers.

Mega insurers hold relatively less non-agency CMBS than large and mid-size insurers, which could be a conscious decision by the insurers to allocate capital between CMBS and commercial mortgage loans and to cap total commercial real estate exposure.

Additionally, larger insurers tend to have larger CLO mandates. CLO allocations for mega insurers are two or three times those of the large insurers and mid-size insurers. CLOs were the only structured products sector where all insurance groups increased their allocation in 2015.

The analysts believe that insurance companies should favour structured products for several reasons. Not least among these reasons is the fact that structured products offer higher NAIC designations than corporate bonds, which translate to lower capital requirements.

They say: "Structured products also offer attractive book yield compared to other asset classes. The current overweight in corporate bonds could lead insurance asset managers to diversify further toward structured products as macro volatility declines and the demand for higher-yielding NAIC-1 assets re-emerges."

JL

Structured Finance

Treasury paper released

The US Treasury has released a white paper on marketplace lending, which continues the work initiated by last year's request for information (RFI). It reviews over 100 responses from a range of key industry figures and makes recommendations for the continued safe growth of the industry.

The report provides an overview of the evolving industry, reviews stakeholder opinions and provides policy recommendations. In assessing the risks and benefits of the industry, it also highlights best practices for established and newer market participants to consider addressing.

It also highlights several common themes arising from the responses, one of which is that the use of data and modelling techniques for underwriting is both an innovation and a risk. While it can help the consumer in terms of quicker credit assessment and reduced costs, it can also lead to a disparate impact on credit outcomes, fair lending violations and ultimately customers cannot correct data on them being used in credit decisions.

Another common theme is that marketplace lending could potentially expand access to credit for a greater number of borrowers, particularly in underserved markets. Of equal importance is the fact that these new credit and business models are still largely untested through a complete credit cycle.

Further, many respondents to the RFI said that SMEs should be afforded enhanced protections when borrowing from marketplace lenders.

Greater transparency was cited as another significant concern for the future of the industry, as it will likely benefit all market participants. Many RFI participants stated that greater regulatory clarity will benefit the industry in terms of the roles and requirements for various players.

Additionally, the paper mentions that a developed secondary market for marketplace loan ABS will only arise with greater transparency and greater repeat issuance.

The Treasury also makes several recommendations to the federal government and the private sector to encourage its safe growth and continued access to credit the industry currently provides. First, it recommends support for greater protections and oversight for SME borrowers, as well as ensuring a "sound borrower experience" and back-end operations.

Second, the paper encourages greater transparency for borrowers and investors, as well as expanding access to credit through partnerships to help provide safe and affordable credit. Third, it recommends that there should be access to government-held data to facilitate the provision of safe and affordable credit.

The final suggestion is for the development of a standing interagency working group for online marketplace lending. The Treasury recommends that the group is made up of a number of regulatory bodies and a representative from a state bank supervisor.

RB

CMBS

Oil boom remits 'muted'

April remittance reports showed muted activity for US CMBS 2.0 loans secured by properties located in oil boom regions compared to prior months, with only three such loans transferring to special servicing, according to Morgan Stanley CMBS strategists. Last month, 13 2.0 loans totalling US$137.7m became newly delinquent and 177 loans totalling US$2.6bn were watchlisted.

Overall, six loans totalling US$37m became specially serviced in April. A total of 72 loans with a balance of US$965m are now in special servicing, resulting in a specially serviced rate of 42bp.

The largest loan with exposure to oil boom regions to transfer to special servicing was the US$11.6m TownePlace Suites Odessa, securitised in COMM 2012-CR4. Meanwhile, the most notable delinquency was in relation to a DPO proposal put forward by the borrower on the US$6.7m Shuman Office Building loan, securitised in JPMBB 2014-C21. In total, 62 loans with a balance of US$630m were delinquent in April, resulting in a delinquency rate of 27bp.

The Morgan Stanley strategists suggest that the most notable loans added to the watchlist last month were the Lakeland Square Mall (COMM 2013-CR7) - where Sports Authority has announced a store closure - and Doubletree by Hilton JFK Airport (JPMCC 2012-CBX), given its forthcoming maturity. In total, 1,124 loans with a current balance of US$18.2bn are now on the watchlist, resulting in a watchlist rate of 7.8%.

US$712m across 33 loans was paid off in April, with a total of 358 loans with a balance of US$8.05bn having been paid off so far this year. "Of these loans, 76% by count and balance were securitised in 2011 vintage deals, reflecting original five-year maturity loans that are now starting to come due," the strategists observe.

Finally, 16 loans with a balance of US$174.7m were defeased. A total of 263 loans with a balance of US$5.3bn have now been defeased, of which 198 loans totalling US$3.2bn remain outstanding.

The largest loan to defease last month was the US$58m Hackman Industrial Portfolio (COMM 2013-CR9), which is scheduled to mature on 1 July 2023 (see SCI's CMBS loan events database).

CS

CMBS

Court rejects class X claims

A second judgment in less than a month has gone against CMBS class X noteholders. Last month, a judge ruled against the class X noteholders in Windermere VII, dismissing the plaintiffs' arguments (SCI 11 April), while the latest case concerned four transactions in the Titan series, including Titan Europe 2006-1.

The Titan case focused in particular on the interpretation of certain contractual provisions which impact the entitlement of class X noteholders (see SCI's CMBS loan events database), notes Reed Smith in a memo. The court was asked to consider four questions.

First, when calculating the class X interest rate, whether any additional interest due under the loans following a default should be taken into account. Second, what rate of interest should be paid on unpaid interest on the class X notes.

The third question was whether, during circumstances where notes remain outstanding following their maturity date or a note enforcement notice has been served, the class X notes should be immediately redeemed with the funds held in the class X accounts. The final question was how, in the event that the class X notes were not immediately redeemed following a maturity date or enforcement notice, the rate of interest should be calculated.

Reed Smith notes that the most significant is the first issue, where claimants contended that additional interest due under the loans should be taken into account when calculating the interest due on the class X notes. Class X interest was calculated as the difference between interest due on the loans over interest due on the notes, so if the court had accepted the plaintiffs' argument, then the class X notes would have been found to have been substantially underpaid on all four transactions.

"Issue two was therefore a consequential matter to be considered and issues three and four stemmed from the fact that two of the transactions had now reached maturity but the class X notes had not been redeemed. Needless to say, the claimants argued that class X notes should not have been redeemed and were entitled to additional interest going forward," notes the memo.

For the first - and most important - issue, the court judgment found that, as a matter of commercial common sense, no account should be taken of additional interest following a default under the loans. This conclusion was despite accepting that default interest does count as interest and that an interpretation of net mortgage rate which excludes default interest allows for the possibility of an excess going to the issuer's shareholders and so to charity.

"This was because there were a number of factors that 'lead the informed reader to understand that, giving the words their natural and ordinary meaning, per annum interest rate was not intended to include default interest'. These include the fact that the default interest rates were not set out in the offering circulars (and investors had no access to the loan documents) and that each of the other elements (such as the interest rate of the notes or the administrative expenses) used in the calculation of class X interest were uncomplicated calculations," notes the memo.

Having identified two competing interpretations, Justice Etherton based his conclusion on the fact that it was counterintuitive for class X notes to be entitled to benefit from a worsening performance of the loans and the fact the there was no indication in the offering circulars that the class X notes would perform in this way in case of loan default. It was also noted that the defaults on the loans were outside the range of expectations and such an extensive failure could not be remedied in full.

The second issue became irrelevant because the judgment found there was no unpaid class X interest. For the third issue, it was found that the class X notes should be redeemed upon their maturity date or following the service of a note enforcement notice, as "there is no discernible business justification at all" for not doing so.

If the claimants' arguments were accepted, the class X notes could have remained in existence indefinitely with first claim on payments of interest arrears at a higher proportional rate due to default interest and without bearing any of the additional cost consequences of recovering default payments and default interest. For the fourth issue regarding class X interest following maturity, the claimants' argument that interest should continue to be based on pre-acceleration rates rather than the judgment rate of 8% was rejected because of the noteholders' own arguments on issue one.

The memo notes that this judgment provides useful guidance not only for class X notes but also more broadly, albeit it is only directly applicable to transactions with the same class X provisions. This suggests that further disputes in this area are "more than possible".

"What is relatively clear is that the courts appear to be taking a dim view on complex technical arguments that run counterintuitively to the perceived commercial purposes of such securitisation transactions," Reed Smith concludes.

JL

NPLs

China NPL challenges considered

The Bank of China (BOC) has announced that it is proactively preparing for the pilot implementation of its NPL securitisation scheme. At the same time, Fitch has commented that NPL transactions in China will provide a challenge to investors due to the unpredictability of their cashflows and an uncertain judicial process.

As part of its preparation, the BOC is providing offering documents for investors that will outline key data and trends from Chinese NPLs in recent years. The NPL securitisation initiative was set up to clean up bank's balance sheets, given Chinese commercial banks reported CNY1.27trn in NPLs at end-2015. Regulators responded by setting CNY50bn for the six largest banks as an initial quota to securitise and offload the NPLs.

Fitch's primary concern with the scheme rests on cashflow uncertainty. The agency's rating process requires it to receive detailed loan-by-loan collateral information, servicer business plans, loan purchase price information and so on. This information allows the agency to form a view on base-case expectations and assess servicer effectiveness. However, the recent release of disclosure guidelines by NAFMII should improve data availability and transparency (SCI 7 April), Fitch adds.

In addition, the off-balance sheet treatment objective could be tough to achieve if lenders continue holding subordinated tranches, as they have historically, or if banks invest heavily in securitised NPLs from other banks. Banks currently hold most ABS in China due to the nascent nature of the Chinese investor base.

Fitch further explains that, if banks have not already taken significant loan write-downs, the NPL securitisation process is likely to crystalise losses and potentially require additional capital injections to maintain financial metrics. In past deals, subordinated tranches consisted of 20% to 50% of the capital structure.

Finally, the agency notes that the Chinese NPL securitisation sector has only seen four deals in its short lifetime, all issued between 2006 and 2008. The underlying collateral was largely a mix of secured and unsecured corporate loans, with the number of obligors ranging from 200 to over 1000 for each transaction. Actual performance varied among transactions, but for the four deals, all senior bonds were able to pay in full.

JA

RMBS

SFIG TRID framework 'adequate'

SFIG's draft proposal to standardise the framework for reviewing and grading loans for TILA-RESPA Integrated Disclosure (TRID) rule compliance is generally adequate to identify compliance risks that are likely to cause RMBS losses, says Moody's. However, the rating agency does disagree with one grading provision.

The framework has a grading scale designed to distinguish material TRID violations from immaterial ones. There is still some uncertainty as to what kind of errors could lead a trust to suffer damages, but SFIG assigns a grade of EV1-A where no TRID violation is deemed to carry assignee liability, EV2-B where an immaterial violation may carry liability but is unlikely to cause RMBS losses, and EV3-C where a material violation is likely to lead to statutory damages.

"SFIG's framework provides a thoughtful and standardised grading approach that will reconcile market disruptions. Initially, TPR firms tended to grade most errors as material because of a lack of legal certainty that such errors would not carry assignee liability. Furthermore, issuers complained because the different TPR firms all had different standards and TPR firms with the most lenient standards could cause the overall quality of the reviews to erode," says Moody's.

The framework also standardises the scope of the review, making reviews more streamlined. While TPR firms previously dedicated a lot of time to reviewing loan files for compliance with every provision of the TRID rule, the framework establishes that they need only review those parts of the TRID rule that are most significant to an RMBS trust.

Moody's believes it is reasonable that the framework proposes that TPR firms focus their review primarily on the closing disclosure. Under the framework, the TPR firms will review the loan estimate, limited only to the few circumstances where there is potential liability to the RMBS trust, such as when the TPR firm reviews for monetary tolerance limits.

The framework also identifies what actions TPR firms will deem acceptable to cure a material violation and Moody's believes that for the most part the framework adequately justifies the cures available for every provision that is significant to the RMBS trust. However, the rating agency disagrees with the framework in one instance where it allows two cures that Moody's says conflict with each other.

"One provision of the TRID rule imposes a disclosure obligation upon the creditor within a 60-day post-consummation period. The framework takes the overly broad view that the same provision could also be corrected by the legacy cure provisions within TILA, whereby a cure could be presumptively made by an assignee within 60 days from identification of the error, a cure period that could stretch beyond the 60-days post-consummation period," says Moody's.

The rating agency says there is a risk that a court may interpret the latter cure as inapplicable and subject the trust to statutory damages. The CFPB's section-by-section analysis of TRID notes that extending the cure period beyond the 60-day post-consummation would undermine the incentive for creditors to conduct quality control reviews as soon as reasonably practicable after consummation.

The CFPB is due to provide official guidance in July. Until then, SFIG notes that some of the framework's legal positions are subject to uncertainty as they rely on a non-binding interpretive letter from the CFPB director, issued last December. However, Moody's believes any risk to RMBS trusts from these positions are minimal over the long term.

JL

Structured Finance

Distressed portfolio acquired

TPG's special situations platform TSSP has acquired credit assets - including a part of Credit Suisse's distressed credit portfolio - for approximately US$1.27bn, utilising no portfolio leverage. The Credit Suisse portfolio comprises over 270 instruments across asset types and geographies relating to approximately 170 companies.

The transaction reduces Credit Suisse's overall distressed credit exposure by US$1.24bn. In addition to the US$99m of write-downs disclosed in respect of the overall distressed portfolio on 23 March, the transaction has resulted in a further charge of approximately US$100m.

Clint Kollar, a TSSP partner, comments: "This transaction leverages our global team's ability to provide speed, certainty and value to financial institutions and other sellers in complex situations. The portfolio we are acquiring has deep, long-term potential and fits well with our patient and flexible capital."

Contemporaneous with the transaction, Bob Franz and Ken Hoffman - respectively Credit Suisse's head of US credit trading and head of distressed research & trading - will lead the formation of a new asset management firm to assist in servicing these assets and other similar assets in the future.

Structured Finance

Renewables partner poached

David Burton has joined Mayer Brown's tax transactions & consulting practice as a partner in New York. He has decades of experience handling a range of US tax matters, particularly in the renewable energy, equipment leasing and asset-backed finance areas, and will lead the firm's renewable energy group in the New York office.

Burton joins Mayer Brown from Akin Gump Strauss Hauer & Feld. He was also formerly an md and senior tax counsel at GE Energy Financial Services, and before that was a tax lawyer at GE Capital.

Structured Finance

Credit solutions pro hired

SCIO Capital has recruited Sebastian Stoecker as director, reporting to business development and investor relations head Jörn Czech. Stoecker will be responsible for deepening dialogues with European institutional investors and delivering bespoke investment solutions. He previously worked in the banks and credit solutions group at Credit Suisse, with a focus on structured credit.

CDS

DC secretary sought

ISDA has issued an invitation to tender for the secretarial role on its credit derivatives determinations committees. A role currently held by the association, the DC secretary is responsible for administrative duties, such as distributing questions submitted by eligible market participants to the relevant DCs, coordinating the timings of DC meetings and publishing the results of DC votes. The DC secretary does not vote on whether credit events have occurred.

ISDA says its decision to issue an invitation to tender for the secretarial position is part of an ongoing initiative to strengthen the DC process and ensure it continues to align with evolving governance standards. The association will work with the new secretary during a transition phase to ensure minimum disruption to the credit derivatives market.

CDS

Citi taps traders

Faraz Naseer has been appointed as head of US high yield trading at Citi. He replaces James Nessell, who is understood to have left the bank earlier this year.

Kelly Maier has also been recruited as a credit trader, focusing on high yield and CDS. His experience includes high yield trading for Goldman Sachs and a previous credit trading role at Citi. Maier will report to Naseer.

CLOs

Manager replacement in the balance

The trustee for the Strawinsky I CLO has received notice from a class B noteholder disapproving the appointment of Dynamic Credit Partners Europe as successor investment manager (SCI 22 April). Pursuant to clause 10.5 of the master investment manager terms, the appointment of a replacement manager is subject to a simple majority of the controlling class (currently the class B noteholders) acting by ordinary resolution not disapproving the move within 21 days of notice of such a proposal.

The investor that has submitted the objection has a holding of class B notes insufficient on its own to pass an ordinary resolution. The trustee therefore requests other class B noteholders to contact it by 10 May, should they wish to disapprove the proposed appointment of Dynamic as successor investment manager.

CMBS

Production team bolstered

Greystone has recruited two new executives to its CMBS lending team. Harris Heller, an md based in Philadelphia, and Nicholas Diamond, a director based in New York, both report to the firm's CMBS production head Robert Russell.

Heller joins Greystone from RAIT Financial Trust, where he most recently served as an md. He has specialised in fixed and floating rate loan originations since 2013, sourcing more than US$400m in deal volume. At Greystone, he will focus on CMBS, bridge and agency lending for owners of all property types.

Diamond joins the firm from Pillar Multifamily, where he was a vp and underwriter for two years. He was also formerly a member of Credit Suisse's real estate structured finance group. At Greystone, Diamond will focus on CMBS, as well as agency lending platforms such as Fannie Mae and Freddie Mac.

CMBS

Executive director sought

The CRE Finance Council has selected Ferguson Partners to manage the search for a new executive director. The position - along with that of deputy executive director - is newly created as part of the association's organisational restructuring

Mike Flood has already been named as CREFC's new deputy executive director. He was formerly with CREFC and most recently was with the Structured Finance Industry Group.

Timothy Gallagher, md of Macquarie Group and chair of CREFC's transition committee, comments: "We are casting a wide, fine net to secure a strong staff leader for our organization. Ferguson Partners is well equipped to effect the search and help us evaluate candidates."

The New York office of the firm is handling the search.

Insurance-linked securities

Swiss Re promotes ILS leaders

Swiss Re has named Judy Klugman and Jean-Louis Monnier as co-heads of its global ILS business. Klugman will also remain as Swiss Re's global head of ILS distribution and lead the ILS team in New York. Monnier will take on responsibility for ILS structuring and lead the ILS team in London, while also remaining head of the property and casualty structured solutions regional teams in the UK and Africa.

Insurance-linked securities

ILS pro takes full reins

Rafal Walkiewicz has been appointed as the sole ceo of Willis Capital Markets & Advisory (WCMA). The move comes over a year after the ILS veteran was made co-ceo with Michael Guo, who has now stepped down from this role. As part of this reshuffle, WCMA's Vincent Lien in Hong Kong and John Philipsz in Australia will take on joint responsibility for leading the business' Asia strategy.

RMBS

Countrywide pay-out nears

The New York Supreme Court last week received a proposed severance order and partial final judgement from BNY Mellon as trustee for 512 of the 530 RMBS trusts subject to the US$8.5bn Countrywide Settlement. A group of investors, who have been actively involved in the determination of the proper procedures for handling the payout, have filed a motion consenting to BNY Mellon's proposal.

Of the 530 trusts subject to the settlement, Wells Fargo RMBS analysts note that 512 are deemed initial release trusts because their governing documents make clear the pay-out procedures for each trust's allocable share of the settlement proceeds. The remaining 18 trusts are expected to have their pay-out delayed as the court attempts to clarify the procedures for distribution of settlement proceeds.

The current proposal seeks to finalise the timing and the pay-out procedures for 512 of the affected trusts. A hearing is scheduled for 12 May to allow the court to review the proposal from the trustee and the consenting motion from the relevant investors.

"We expect that, given the agreement between the trustee and the investor respondents, the judge will sign off on the judgment for the pay-out proposal and thus initiate the timeline for payout to the 512 initial release trusts," the Wells Fargo analysts observe.

Should the court approve the proposal, this would lead to a June pay-out for the initial release trusts.

RMBS

UKAR transfer finalised

Computershare has been appointed to undertake mortgage servicing for UK Asset Resolution, following a competitive tender (SCI 2 February). Around 1700 UKAR staff based in Crossflatts and Doxford in the north of England will transfer to Computershare under the contract, which is expected to commence in mid-2016.

Following the transfer, Computershare will become the largest third-party mortgage servicer in the UK and Ireland. The firm was advised by Fenchurch Advisory Partners on the contract.

ABS

VW ABS ramping up

Volkswagen Financial Services' (VWFS) ramping up of its ABS programme in Europe has seen it issue €6bn in transactions since the emergence of the 'default device' scandal back in September 2015. Moody's says that the pace of the car manufacturer's ABS issuance is making it a more important tool within its overall funding mix.

VWFS' securitisation debt steadily grew to 16% of its capital and funding mix as of 2015, from 10% in 2012. The amount of ABS retained by VW Bank more than doubled to €9.2bn in 2015, from €4.5bn in 2014.

"Retaining a material proportion of ABS has increased VW Bank's on-balance sheet assets," says Bernhard Held, a vp and senior analyst in Moody's financial institutions group. "While the increased use of ABS enables maturity-matched funding, it also increases VW Bank's risk-weighted assets (RWA), against which more capital has to be held, and subordinate senior unsecured bondholders to a greater degree."

The firm recently announced that it plans to significantly expand the scope of its ABS issuance and introduce further countries and currencies into the overall programme. Specifically, it is working on new ABS programmes in Italy and Korea.

VWFS' decision to increasingly opt for ABS in raising funding prompts questions surrounding loss severity issues for unsecured obligations. As a secured funding source, Moody's explains that ABS cannot be included in a bail-in, while a shift towards greater ABS issuance gradually reduces the amount of unsecured debt available to share the burden if the issuing bank needs to recapitalise.

In addition, the marked increase in RWAs for VW Bank has led to a decline in its regulatory capital ratios. "VW's acceptance of these side effects on VW Bank capital ratios indicates that from an economic perspective funding is the main reason behind VW's ABS issuances through its Driver and VCL platforms, as opposed to capital relief or a transfer of risk," adds Held.

The fall-out from the emissions crisis has had little effect on the performance of VW European ABS deals, as they continue to exhibit low arrears. Moody's says performance should continue to be stable and losses minimal if the recall programme for affected vehicles is successful.

Structured Finance

NSR mapping approach updated

Moody's has published its updated methodology for mapping national scale ratings (NSRs) from global scale ratings (GSRs), following a market consultation initiated via an RFC published on 22 June 2015. NSRs are derived from GSRs using country-specific correspondences. The updated methodology introduces specific guidelines for the design of new NSR correspondences, or maps, and changes to existing maps, as well as the circumstances under which maps will be reviewed and amended.

Moody's associate md Aaron Freedman explains: "The changes to the methodology will provide greater consistency of our map designs and increased transparency regarding the timing of future mapping revisions, while ensuring the maps offer enhanced credit differentiation and clarifying the meaning of NSRs. Importantly, resulting rating actions simply reflect a recalibration, rather than a change in credit quality."

Moody's assigns NSRs to provide greater credit differentiation among a country's issuers when GSRs are concentrated in the lower portion of the scale. Although NSRs are represented with symbols similar to those used for GSRs, they generally reflect a higher degree of risk than analogous GSRs.

The agency says that one of the key considerations in designing an NSR map is determining the anchor point, or the lowest GSR that maps to Aaa.nn on the national scale, for a given map. In a second RFC published on 20 January, Moody's proposed that the anchor point be set at the sovereign rating for all maps in order to limit the impact that changes in the sovereign rating could have on NSRs.

While this remains the approach in the majority of cases, the agency has decided to de-link the anchor point from the sovereign in certain limited circumstances. This revision aims to ensure that affected maps will provide greater credit differentiation among issuers at the top of the national scale, while further enhancing the stability of NSRs following sovereign ratings changes in these countries.

At present, Moody's provides national scale ratings in 13 countries, with such ratings assigned to approximately 550 fundamental issuers and 330 structured finance tranches. Following publication of its methodology, the agency expects to develop maps for and assign NSRs in additional countries.

The implementation of this revised methodology will result in changes to all 12 of its NSR maps, excluding Mexico (where implementation is subject to receipt of local regulatory approval), and is expected to affect slightly more than half of fundamental issuers' primary NSRs and 35% of the NSRs assigned to structured finance tranches, with an average change of roughly two notches. Approximately 55% of changes to fundamental issuers' primary ratings and nearly three-quarters of changes to structured finance tranche ratings are expected to be upward movements. However, the impact will vary widely by country.

Structured Finance

CIR methodology finalised

S&P has published its methodology for assigning a rating type specific to the financial obligations that securitisation SPEs enter into with banks or other entities taking on the issuer's credit risk under a contract, such as a swap or liquidity facility. The agency's new counterparty instrument rating (CIR) aims to address an issuer's capacity to meet its financial obligations to a counterparty in a securitisation on an ultimate payment basis as funds become available, without regard to any specific repayment date that may be stated in the terms of the contract.

The CIR is a rating type with its own ratings definitions. S&P denotes it using the suffix 'cir' to distinguish it from standard issue credit ratings.

As these criteria are for a new rating product, there are no outstanding CIRs and no impact on issuer credit ratings.

Structured Finance

Mid-market fund closes

Czech Asset Management has closed its third direct lending fund complex, dubbed SJC III, with total commitments in excess of US$1.7bn. The fund's direct lending strategy will focus on providing privately negotiated, floating-rate senior secured loans to US middle market companies that generate revenue of US$75m-US$500m.

The fund has exceeded its US$1.5bn target, with all of the capital raised coming from existing investors or referrals from existing investors. It is the third billion dollar-plus direct lending fund raised by Czech within the past six years. SJC III has already invested around US$215m.

Structured Finance

PREPA bondholders set out offer

The PREPA Bondholder Group is offering to pre-fund the purchase price of the bonds they agreed to buy in 2016 from the commonwealth's utility under the bond purchase agreement (BPA). The group says that this will help facilitate the completion of the restructuring support agreement between the two, which has dragged on since last year (SCI passim).

Under the terms of the offer, the bondholder group is willing to deposit US$61m in an escrow account to fund the BPA. They are also offering to extend the termination deadline until 31 May or until the Puerto Rican legislature amends its Moratorium Act to exempt PREPA from the island's established standard to skip debt service payments.

Under the deposit arrangement, the funds would be transferred to the PREPA bond trustee following the passage of legislation. The bondholder group claims this would address issues created by the Moratorium Act preventing the consummation of the BPA.

"We continue to be supportive of PREPA and the Puerto Rico legislative process, which is why we are offering to remove a degree of risk and uncertainty by depositing this money up front," says Stephen Spencer, financial advisor to the PREPA Bondholder Group.

The news comes around a reported deadline of Thursday for PREPA to gain further financing from its creditors to extend the BPA.

Structured Finance

Excess rent impact analysed

Single-family rental (SFR) investor loans where the property income exceeds 1.2 times the debt service have generally experienced a better-than-average default rate, according to a new Morningstar Credit Ratings study. The agency expects these loans to be a driver of SFR market growth.

A new type of investor property loan has emerged from SFR originators - such as B2R Finance, First Key Lending and Colony American Finance - that are underwritten as residential rather than commercial loans (SCI 3 March). Borrowers provide the lender with the expected rental income with a portion of this rent added to the borrower's personal income. Lenders typically focus on the borrower's personal credit and income data and were less concerned with the ability of the property cashflow to cover the debt service.

To quantify the impact of debt service coverage on default, Morningstar analysed more than 900,000 non-agency investor property loans originated from 2002-2007. A challenge in performing this analysis is that rent is not typically provided for traditional investor property loans that are underwritten to a borrower's personal income and personal credit.

The rent can be included in the denominator of the borrower's debt-to-income ratio, but there is no way to segregate the property income from the borrower's personal income. Therefore, Morningstar attempted to match regional rent estimates from RentRange to individual investor properties in the CoreLogic non-agency loan-level data. The results showed significantly lower defaults for investor loans with rents exceeding debt service payments and higher defaults for similar loans with rents that do not cover debt obligations.

For example, examining loans with a borrower FICO score greater than 699 and a combined LTV less than or equal to 70, Morningstar found that, at 12%, the default rate for loans where rental income covers only half of the debt service amount was more than double the 5.6% default rate of loans where rental income covers twice the debt service amount. Consequently, when underwriting an investor property loan where rent is available and verified, default projections can be adjusted based on the amount of excess rent.

CLOs

Business services exposure gauged

The credit quality of many business services sector issuers has deteriorated over the past year, which Moody's cites as credit negative for CLO 2.0 deals. The sector is the second-most widely held among these transactions, with 200 issuers accounting for approximately 12.1% of total CLO 2.0 collateral.

Between January 2015 and April 2016, Moody's added seven more business services issuers to its B3 negative & lower ratings list, bringing the total sector exposure on the list to 27 issuers. Of these issuers, 22 are in 533 CLO 2.0s, with an average exposure of 1.5% and a maximum exposure of 5%.

Six of these 22 issuers - North American Lifting Holdings, Brock Holdings III, BakerCorp International, Sprint Industrial Holdings, Hoover Group and Boart Longyear - have suffered from their dependence on revenues from the energy and commodities sectors. Loan prices have declined along with the issuers' credit quality.

These six riskiest business services issuers are in 252 US CLO 2.0 portfolios, accounting for as much as 5%, according to Moody's.

Business services sector issuers are the second-most represented industry on the agency's B3 negative & lower ratings list at 9.3%, trailing only the oil & gas sector, which accounts for 31.6% at 92 issuers.

CLOs

Low-rated CLO risks downplayed

Compared to the overall European high yield universe, a relatively small number of low rated CLOs exhibit early warning signs of potential defaults, says Moody's. In total, 23 (58%) of the 40 European CLO-held assets that Moody's has rated B3 or lower show early warning signs of potential default, while 76 (67%) of the 113 such issuers in the overall European high yield universe show these signs.

In part, these results can be attributed to which industries CLO portfolios are largely based in. Of the obligors in European CLO 2.0 pools Moody's rated B3 or below, 90% operate in 11 industries. All have stable outlooks except for the capital equipment and the chemicals, plastics and rubber industries.

In addition, Moody's notes that CLO 2.0s have low exposures to obligors with the weakest credit quality. Issuers rated B3 negative and below represent only 6.6% of European CLO 2.0 collateral, compared with 12.9% of all European speculative grade issuers.

Issuers rated B3 negative and below are not widely held. Just six obligors rated B3 negative and below are in more than 25% of the CLOs that Moody's rates, and only two are in more than 50%.

CMBS

CMBS overvaluation case dropped

CMBS SPV White Tower 2006-3 has dropped a case against Colliers concerning losses it made on five London-based commercial properties. The real estate agency was accused of overvaluing the properties in a £1.8bn UK office portfolio, which allegedly led to a £39m loss.

White Tower decided to discontinue its attempts to sue Colliers following the case being at trial in the UK High Court for 16 days. The decision was made prior to judgement on the day after the start of Colliers' closing submissions.

White Tower claimed that overvaluations were as much as 25% over actual values. These valuations were made by Societe Generale in September 2006. The properties included Millennium Bridge House and 60 Victoria Embankment.

Societe Generale subsequently provided a £1.45bn loan to borrowers, with the £1.15bn senior part being securitised. White Tower claimed that the valuations were used by Colliers without a thorough process before determining its own valuation. The deal later went into receivership in September 2009, with special servicer CBRE selling the majority of the portfolio the Carlyle Group. 

Colliers says that there were doubts about White Tower's ability to meet an adverse costs order from the case. In these circumstances, Colliers agreed not to pursue an order in respect of its costs.

"The valuation of £1.8 billion, which we undertook in 2006 was well supported by evidence at the time, not only of comparable transactions, but also offers made for the portfolio from highly respected active investors in the market," says Russell Francis, head of Colliers' international valuation and advisory services department.

Francis adds that Colliers was also pursuing the argument that White Tower was never its client and therefore had no case against the agency. He says that Colliers is unwilling to pay any amount of money to the client, based on the conviction of their argument.

The announcement follows a Court of Appeal decision last year in Colliers' favour in the Titan case (SCI 17 November 2015).

CMBS

Canada CMBS under fire

The Fort McMurrary wildfire is adding stress to six Canadian CMBS, in particular, according to Fitch. This comes after the evacuation of the city's residents last week as the fire continues to spread.

The six deals that Fitch rates with exposure to properties located in Fort McMurray are: CMLS 2014-1, IMSCI 2012-2, IMSC 2013-3, IMSCI 2013-4, IMSCI 2014-5 and REAL-T 2014-1.

Of the nine loans in the area (totalling C$97.2m), six are secured by multifamily properties, two by hotels and one by an industrial property. Some of the properties were already under financial pressure before the wildfires, due to the economic turmoil in the oil and gas sector. All six of the multifamily properties were in special servicing before the fire began.

However, the wildfire could also add long-term uncertainty to the performance of the properties, as the number of residents likely to return remains uncertain. Fort McMurray's population leapt by 28.7% between 2006 and 2011, according to Statistics Canada. Fitch explains that many of those people were likely attracted to the city by jobs related to the oil and gas industry, which remains the largest employer in the city, despite the slide in oil prices last year.

This risk could be mitigated if properties that are not damaged benefit from housing displaced residents. However, Fitch says that gauging the damage to those properties and the impact on the transactions is too difficult as of now.

The agency does expect that properties affected by the fire would be able to recoup some of their potential losses through their insurance coverage. It adds that it has requested updates from the loan servicers regarding coverage, including any business interruption insurance. Residents may also be entitled to some disaster relief funding.

CMBS

Specially serviced loans continue to decline

The overall share of specially serviced US CMBS conduit loans decreased by 73bp to 6.04% in 1Q16, from 6.77% in 4Q15, according to Moody's latest surveillance review of the sector. The share of specially serviced loans remains 668bp below the April 2011 peak of 12.72%.

In the first quarter of this year, 14 loans totalling US$1.15bn were modified, up from just five loans totalling US$342.7m the prior quarter. The share of delinquent loans fell to 4.5% from 5.4% the prior quarter.

The agency's base expected loss for conduit/fusion transactions currently stands at 7.36%, down slightly from 7.42% in 4Q15, while its commercial mortgage metrics weighted average base expected loss fell to 4.3% in Q1 from 4.7% in 4Q15, reflecting improvements in delinquency and special servicing rates.

CMBS

Refi wave loans 'well positioned'

At its peak, the upcoming US CMBS refinancing wave will see loan maturities exceed US$12bn per month, according to Moody's. Nevertheless, barring significant market disruption, the agency suggests that most of these loans are well positioned to pay off.

"The US CMBS refinancing wave is now within a few quarters of cresting, when for several months loan maturities will surpass US$12bn," says Moody's director of commercial real estate research Tad Philipp. "CMBS loan originators should be able to accommodate the bulk of maturing loans, but a significant portion is likely to be refinanced by portfolio lenders or be extended."

More than two-thirds of the collateral backing pre-crisis peak vintage loans has a debt yield in excess of 8%, a level consistent with recent origination, Philipp says. In addition, more than 80% of maturing loans have a debt service coverage ratio above 1.40x based on current market rates, a level that is typically sufficient to refinance.

Coupons for 2006-2007 vintage loans average around 6%, about 1% higher than current market levels, Moody's notes. As a result, upon refinancing, most loans will likely achieve a loan coupon that is lower than the one currently in place - thereby boosting the likelihood of successful refinancing.

Meanwhile, the collateral composition of maturing loans is similar to that of 10 years ago, when they were originated. Retail is the only sector in which the share of collateral balance has increased by 3% or more, and retail properties with key tenant departures are likely to experience refinancing challenges. The only sector to see its share shrink by 3% or more is multifamily, which has seen strong rent growth in recent years.

CMBS

US CMBS values change course

Property values for specially serviced US CMBS fell in 2015, says Fitch. Appraised values for the 495 loans in the Fitch-rated universe fell 0.5%, with retail leading the decline.

The reduction in appraised values compares to a 1.5% increase in the year before. Retail valuations accounted for 10 of the 15 largest declines.

Just over half of the loans - 255 of the 495 - experienced a decrease in appraised value from the previous year's appraisal. Of the loans which experienced a decrease, the average reduction in value was 15.7%.

Appraised values increased for another 225 loans, with an average increase of 16.7%. There were 15 loans with no change in appraised value.

Fitch notes that the average loan balance is smaller for properties with increases in appraised value. Appraisals for the 380 REO loans saw increased valuations of approximately 0.4% over the past year. This is a slowdown from the trend in the rating agency's previous study when REO valuations increased approximately 3.1%

There were 19 assets with value declines of more than 40%. These have either been anticipated by the rating agency or offset by above-expectations improvements for other loans in the pool.

Retail saw a 3.6% decline. Retail loans with a securitised loan balance of more than US$40m experienced an average decline of 13.3% and the three largest declines in appraised value for loans greater than US$20m are all retail loans - St Louis Mills, Hanover Mall and Athens Promenade.

The appraised value for St Louis Mills fell 64% to US$12.5m in the year to June 2015. The US$90m loan securitised in MSCI 2007-IQ13 was transferred to special servicing in October 2011 and liquidated with an 86% loss severity this February (see SCI's CMBS loan events database).

The US$87.5m Hanover Mall loan is securitised in JPMCC 2005-LDP5. Its appraised value fell 56% to US$28m between February 2015 and January 2016, with a loss of tenants affecting the property's performance. The mall is currently 85% occupied, with US$12.5m in outstanding servicer advances and US$7.8m in ASERs.

The appraised value for the US$24m Athens Promenade loan securitised in BSCMS 206-PWR11 fell 56% from October 2014 to December 2015 and is 82% below the value at securitisation in 2006. Fitch notes that occupancy has plummeted to 43%.

However, multifamily valuations are rising, with a 4.4% increase in appraised values. Hotel values rose 1%, office values were up 0.9%, and industrial valuations increased 7.8%.

Fitch believes that the hotel sector may be nearing its peak, with the same possibly true for the multifamily sector, especially in certain markets. Oil and energy dependent economies and submarkets reliant on tech industry employment remain of concern.

Appraised values for specially serviced loans from vintages prior to 2005 declined on average by 4.4% and Fitch says it remains especially concerned with properties in non-core markets and expects that loans not resolved in the near term will continue to experience declining values.

Assets held for more than four years in special servicing saw an increase in value of 0.9%. The rating agency cautions, however, that servicer advances and expenses may outweigh any increases in value.

Of the 495 loans observed, 427 are from the peak vintages of 2005-2008, which experienced an average increase of 0.2%. There were only 12 assets from post-crisis CMBS, but they experienced an average decline of 5.5%, largely driven by three 2014 assets each experiencing declines in excess of 30% from their appraised values at issuance.

CMBS

Euro defaults, delinquencies drop

The 12-month rolling loan maturity default rate for the European CMBS in S&P's rated universe decreased to 8.1% from 10.3% at end-April. Overall, the senior loan delinquency rate decreased to 43.7% from 45.3% last month.

The delinquency rate for continental European senior loans decreased to 56.9% from 58.4%. The rate for UK loans decreased to 19.0% from 20.3%.

Insurance-linked securities

ILS affirmed on resets

Fitch has affirmed its ratings on five tranches from four catastrophe bonds - Long Point Re III series 2015-1, Alamo Re 2014-1 and 2015-1, and Cranberry Re. The move follows the agency's annual surveillance review of the notes that includes a scheduled evaluation of the natural catastrophe risk, counterparty exposure, collateral assets and structural performance.

Fitch believes the notes and indirect counterparties thereof are performing as required. There have been no reported early redemption notices or EODs and all agents remain in place.

With respect to the Long Point Re III class A notes, reset agent AIR Worldwide last week completed the reset report that indicated an attachment probability of 1.278% for the deal's risk period beginning 16 May 2016 through 15 May 2017. This corresponds to an implied rating of double-B minus under Fitch's ILS methodology.

The updated attachment probability includes updated property exposures within the subject business, resulting in a minor increase from the prior attachment probability of 1.276%. The updated trigger amount and exhaustion amount were lowered to US$1.968bn and US$2.468bn respectively from the initial levels of US$2bn and US$2.5bn. The updated risk interest spread was reset at 3.748%, compared to the initial risk interest spread of 3.75%, reflecting a decrease in the updated modelled expected loss to 1.105% from the initial 1.106%.

For the Alamo Re 2014-1 class A and 2015-1 class A and B notes, AIR completed reset reports for the annual risk period beginning 1 July 2016. At each reset date, the sponsor TWIA may exercise an option to decrease or increase the attachment levels on each of the classes within an exceedance probability range of 4.40% to 1%.

The updated attachment/exhaustion levels for the respective tranches are: US$3.245bn (from US$3.2bn)/US$3.972bn (from US$4bn); US$2.7bn (from US$2.6bn)/US$3.245bn (from US$3.2bn); and US$3.972bn (from US$4bn)/US$4.7bn (from US$4.8bn). The updated probability of attachment for the respective tranches has decreased to: 2.05% from 2.09% (corresponding to an implied rating of single-B plus); 2.58% from 2.74% (single-B plus); and 1.60% from 1.61% (double-B minus). The updated risk interest spreads are 5.20%, 5.78% and 4.62%.

Finally, AIR completed the reset report for Cranberry Re that indicated an annual attachment probability of 3.152% (versus 3.081%) for the second annual risk period beginning on 1 July 2016, corresponding to an implied rating of single-B. The updated attachment probability reflects updated property exposures within the subject business.

The attachment and exhaustion levels remain unchanged from the prior levels at US$300m and US$1.4bn respectively. The updated risk interest spread will be reset to 3.86% (versus 3.80%), reflecting the increase in the updated modelled expected loss of 1.407% (versus 1.377%).

Hannover Rueck SE, a reinsurance company that acts as a transformer, sits between the sponsor MPIUA and Cranberry Re. Fitch's issuer default rating for Hannover was downgraded to single-A plus from double-A minus on 21 July 2015. However, the downgrade did not affect the rating of the Cranberry Re note as the agency rates to the weakest link, which is currently the implied rating of the catastrophe event.

Insurance-linked securities

Legacy loan ILS hits market

United Guaranty Corporation (UGC) has obtained US$298.6m in reinsurance coverage for its legacy portfolio book in its latest ILS deal, Bellemeade Re II. The transaction is believed to be the first in the asset class to include a pre-2009 portfolio of mortgage insurance policies.

UGC, a subsidiary of AIG, is funding its reinsurance obligations through the issuance of three classes of notes with 10-year legal maturities. The reinsurance is on a portion of UGC's legacy first-lien US mortgage insurance portfolio. As of 31 March, less than 20% of UGC's gross risk in force was written in 2008 and prior years.

"The transaction not only helps United Guaranty manage risk, but also demonstrates that investors are willing to assign value to this type of portfolio from the 2008 and earlier period," says UGC president and ceo Donna DeMaio.

The transaction follows a similar announcement in August 2015 where AIG and UGC agreed to obtain approximately US$300m of indemnity reinsurance from Bellemeade Re (SCI 7 August 2015). That was for a portfolio of mortgage insurance policies from 2009 through to the first quarter of 2013.

NPLs

Italian insolvency laws praised

Fitch says that changes made to Italy's insolvency laws since mid-2015 are positive, as they should shorten the time that creditors must wait before settling claims. However, it warns that due to the early stages of the process, the laws must be put into practicality before a full judgement can be made.

The agency suggests that the most significant change to date was included in Decree Law 59 on 3 May. This provided the ability to insert a clause into lending arrangements, which allowed the automatic transfer of ownership of real estate assets held as collateral to a creditor once a corporate or SME borrower defaults.

Fitch says that this will end the need to exhaust the legal process. In turn, this should free up the judicial system and enable the courts to focus on addressing the backlog of NPLs currently weighing heavily on the banking sector. Government representatives have reportedly stated that this should significantly shorten asset recovery times to around seven to eight months.

If the reforms do achieve their key goals, namely to shorten court proceedings for the forced sale of collateral, they could improve the performance of new NPL securitisations. Fitch suggests that this could stimulate investor interest and support the government-sponsored securitisation scheme launched in February and the subsequent Atlante fund established in April (SCI passim). At least one NPL securitisation using the government guarantee is said to be in the pipeline and more are expected over the next year or two.

The fund aims to help shift NPLs off Italian bank balance sheets, but can also invest in NPL securitisations. However, given the size of the fund, its capacity for investment is limited relative to the volume of NPLs in the Italian banking system.

The bulk of new NPL transactions are expected to be backed by corporate and SME exposures and could benefit the most from quicker and cheaper creditor workouts under the new reforms. In the past, out-of-court resolutions proved difficult and protracted in Italy, due to the large number of creditors typically involved and the absence of mechanisms that could be used to force minority credit dissenters to agree to terms of majority proposed restructuring agreements with debtors.  

NPLs

Freddie offers new NPL batch

Freddie Mac has put up for auction a further US$135m of NPLs. The loans are serviced by JPMorgan and are the second batch offered by the GSE this year.

Bids are invited on the loans by 25 May, with any sales expected to settle in 3Q16. The NPLs are offered as one pool of whole loans. Credit Suisse and First Financial Network joined JPMorgan in advising Freddie on the sale.

The auction follows the announcement last month that the FHFA has approved enhancements to Freddie's NPL sale requirements (SCI 15 April).

Risk Management

EU CCPs 'resilient'

ESMA has published the results of its first EU-wide stress test exercise regarding central counterparties (CCPs). The exercise aims to assess the resilience and safety of the European CCP sector, as well as to identify possible vulnerabilities. The results show that the system of EU CCPs can overall be assessed as resilient to the stress scenarios used to model extreme but plausible market developments.

ESMA's stress test focused on the counterparty credit risk that CCPs would face as a result of multiple clearing member (CM) defaults and simultaneous market price shocks. The resilience of 17 European CCPs holding over €150bn worth of default resources with more than 900 CMs EU-wide was tested. The results show that CCPs' resources were sufficient to cover losses resulting from the default of the top-two EU-wide CM groups combined with historical and hypothetical market stress scenarios.

However, under more severe stress scenarios, CCPs faced small amounts of total residual uncovered losses varying from €100m up to €4bn, especially in scenarios assuming the default of the top-two CMs per CCP due to assumed CM defaults across CCPs. That is a scenario where a CM defaulting in one CCP would also be considered to be in default across all CCPs in which it is a member, leading to more than 25 CMs defaulting EU-wide.

Following the stress test, ESMA has issued recommendations addressed to the National Competent Authorities (NCAs) of CCPs that aim to ensure ongoing resilience, which will require follow-up within CCP colleges. One recommendation is that CCPs incorporate in their creditworthiness assessment of CMs the potential exposures these may face due to their membership in other CCPs.

ESMA has also identified that in a number of cases the stress price shocks applied by CCPs for some of their cleared products as part of their own stress-testing framework are not as conservative as the minimum shocks defined for this latest exercise or do not replicate the most extreme historic price changes observed. To achieve ongoing resilience of CCPs, the authority recommends NCAs ensure that CCPs revise their price shocks used in their stress-test methodologies where gaps have been identified.

RMBS

Mixed energy effects for Euro RMBS

While both Aberdeen and Groningen are affected by stress from the energy sector, mortgage arrears have surged in the former but stayed stable in the latter, notes Moody's. Aberdeen is affected by contagion from rising unemployment as oil prices plummet, while Groningen is affected by the prospect of earthquakes due to gas field operations.

Aberdeen is the city in the UK most affected by the nation's oil industry difficulties. Mortgage arrears have more than tripled in securitised pools from 1.5% in 2012 to 5.5% now. The city's mortgage arrears are double the level of the rest of the UK's securitised pools and Moody's warns they could rise further.

"Aberdeenshire's situation is symptomatic of a two-speed economy: the region's dependency on the oil industry has led to accelerated unemployment since mid-2015, while the rate has fallen in the rest of the UK overall. The housing market has suffered, with higher arrears," says Christophe Larpin, vp and senior analyst, Moody's.

Despite 180,000 houses in Groningen losing a combined €1bn in value due to earthquake risks, mortgage arrears in the Dutch city have been stable. They are also at par with the Netherlands' national level.

Earthquake risks due to gas field operations have forced down house prices and hampered recovery prospects for defaulted mortgages. Groningen's mortgage arrears level remains around 1.3%.

Moody's says diversification in RMBS will protect mortgage pools from pressure on loans in the affected areas, with average exposures in UK RMBS being below 2% and below 5% in Dutch RMBS.

RMBS

Deal agent rankings assigned

Morningstar Credit Ratings has assigned two new vendor rankings for the recently created roles of RMBS deal agent and representation and warranty reviewer, becoming the first in the industry to do so. The agency assigned its MOR RV2 residential vendor rankings to Clayton Holdings, a wholly owned subsidiary of Radian Group.

Morningstar says it is the only rating agency offering vendor rankings for these types of firms that provide governance and oversight for RMBS. "We believe these new vendor ranking functions are significant to the financial services industry and will play an important role in the revitalisation of the private-label RMBS market, which has slowed since the financial crisis of 2008," says Michael Gutierrez, md, operational risk assessments for Morningstar. "Having an independent assessment of a company's capability to perform these functions can serve to reassure investors who are reluctant to re-enter the marketplace."

The US Treasury Department and SFIG has supported and promoted the development of the deal agent role to add transparency to the mortgage securitisation industry and protect investors' interests.

RMBS

Loss criteria updated

Fitch has updated its criteria for estimating losses on US RMBS mortgage pools, following the release of an exposure draft in February (SCI 9 February). The update reflects the changes proposed in the exposure draft, as well as additional changes resulting from market feedback and additional research by the agency.

The core principle of the framework remains the interaction between borrower equity and market value declines in determining expected loss for each loan. In addition, the methodology accounts for both loan-level attributes and macroeconomic factors in deriving loss expectations.

The key criteria enhancements that were included in the exposure draft and remain in the criteria released today include: a revision to the distressed sale adjustment (DSA) to reflect new GSE historical data; a cure-rate adjustment (CRA) for borrowers that default but have enough equity to resolve the default without a loss; simplification of the liquidation timeline projections and stresses; and a reduction in the geographic concentration penalty.

The key criteria enhancements resulting from market feedback during the exposure period and additional research by Fitch include: a modest CRA for loans with a sustainable loan-to-value ratio (sLTV) between 100 and 120; increased credit for loan amortisation prior to default in the loss severity calculation; a reduced haircut on mortgage insurance credit in GSE credit risk transfer transactions; and an increased DSA for loans with an original property value over US$600,000.

The cumulative impact of the enhancements is expected to result in modestly lower average projected losses at all rating categories for both newly-issued and seasoned legacy RMBS pools. Fitch expects no rating implications for recently-issued RMBS pools. For legacy RMBS, it expects generally positive rating pressure on average, although a small percentage of bonds may have modest negative rating pressure based on concentrations of pool attributes and pool performance since the prior rating review.

The agency expects to review all outstanding rated RMBS with the updated criteria within the next six months.