News Analysis
Fair value?
Call for standardised approach to MPL valuations
In a sector where there is no standardised pricing methodology or standardised pricing reference data, a wide variety of approaches are currently being used to value marketplace loans (MPL) and peer-to-peer (P2P) loans. Not all of these approaches are deemed appropriate for the assets, however, and their continued use could have significant repercussions for the securitised MPL market.
The burgeoning MPL securitisation industry has had an eventful few weeks. Aside from the resignation of Lending Club's ceo, Renaud Laplanche, there was primary activity in the form of Funding Circle's debut European deal and an innovative transaction in the US from SoFi (SCI passim).
Against a backdrop of primary market activity, questions over how best to value the underlying loans persist. Most investors or managers of the loans have a fiduciary obligation and will apply - or seek to apply - a FAS 157 standard. However, there is currently no mandate relating to the interpretation of the valuation approach for these Level 3 assets.
Ram Ahluwalia, ceo at PeerIQ, says that market participants currently employ a number of different methodologies to price MPL loans, not all of which provide an accurate representation of fair value. The first methodology he has encountered is where the value is calculated using the outstanding balance plus accrued interest.
"That gives an overestimate of a portfolio value, as it doesn't include potential defaults and there's no haircut for loans that are not performing or that are associated with higher losses," he says.
The second is a haircut matrix approach, which is somewhat more sophisticated. In this approach, Ahluwalia explains that a matrix is used where one axis is the status of the loan (current, 30 days past due, etc) and the other axis is a risk score, grade or term.
"You map these loans to a matrix and measure historical losses and prepayments curve," he says. "You can make default and prepayment curves based on empirical data. A major weakness is that losses are not forward looking, there are no macro variables and loan-level granularity is lost. For example, if you look at never-late seasoned E or F loans, these loans should be valued above par, but the matrix will not value those loans correctly."
Another valuation technique involves looking at other loans with comparable obligors and tenors. Ahluwalia explains: "For example, in the treasury market, a 10-year bond five years from now will have the same price and yield as a new-issue five-year treasury bond. By definition, they have the same obligor and projected cashflows and tenor."
He adds: "But I also see people applying that technique in the P2P loan market. None of these projections work, as every loan in the P2P market is unique. The risk is highly idiosyncratic. They are not comparable or fungible."
A further methodology Ahluwalia has encountered is an amortised cost approach. "This is when you look at the outstanding balance of the loan. The flaw there is that it doesn't capture changes in discount rates. Also, as a portfolio seasons, you get more charge-offs in the final 6-9 months."
The use of these different valuation methodologies is likely to create significant problems for the industry, particularly if the MPL loans are securitised. In a securitisation of MPL assets, the loans are sold into the SPV at a price: this price is typically reached via the amortised cost methodology.
"If you are selling a seasoned portfolio of loans via this method, you're selling them at too-high a price into the SPV," says Ahluwalia. "The equity buyers are going to feel the pain."
He also suggests that if banks are holding off marketing MPL securitisations because of negative headlines, the loans will continue to age on-balance sheet and approach the point where charge-offs start happening. "The default curve takes a couple of months before defaults start increasing. You want as much excess spread early in the portfolio life before that happens," he says.
The correct methodology, says Ahluwalia, is a discounted cashflow approach, where cashflows are projected using low-level borrower attributes and macro conditions. "You are also projecting cashflows as the loan seasons and has updated borrower or payment information. The way to do that is to have a discount rate framework that discounts loans or bonds based on the risks of cashflows. It is worth looking at the ABS market to see what those risk premiums look like. This is the approach we take."
Meanwhile, initiatives are underway to improve pricing transparency in the MPL sector, such as the establishment of a secondary market for the loans. Ldger is one such firm looking to set up a secondary platform.
Having carried out its first auction of MPLs on 6 April (SCI passim), a second auction has been tentatively slated for 8 June. The firm has so far accumulated US$25m of stock to be sold on this date, with the final amount expected to be somewhat higher.
"The sole challenge around valuation in this asset class is that there is no liquid secondary market with volume," says Hyung Kim, co-founder and ceo at Ldger. "That's the only missing piece. You need a secondary market in order to have a fresh level for the loans."
He adds: "In an ideal world, you would have whatever assumptions you need for loss-adjusted cashflows. You would be able to present-value those loans using observable credit spreads. But there is no observable credit spread because there's no trading activity."
Having an active price for MPL assets is not necessarily what everyone wants, however. Some investors would rather there were no prices, so they do not need to mark the volatility into their books.
"There's not a perfect alignment of parties in ensuring price transparency," says James Wu, founder and ceo at MonJa. "Nobody wants to be the first to do better pricing of their funds. Although they [the managers] are not against better standards, they don't want to be the first that imposes a more stringent set of calculation of prices, as their investors will feel the repercussions first."
He adds: "A lot of people are still bragging about the Sharpe ratio in this asset class. There's very little volatility from one month to the next. This has nothing to do with the asset, but because there is no market, the price remains stable."
Wu suggests that some platforms do not have an interest in setting up a secondary market. "First, they don't want price discovery, but also a secondary market could offer another source of supply for anyone looking to buy loans," he says. "And for some platforms, that is competition."
Setting up a secondary market is not easy, he adds. "There are regulatory hurdles and technical challenges. There needs to be a way for the papers to settle, you need adequate and common disclosures and you also need capital to boost the whole thing. That being said, a secondary market would be a very useful input for pricing and valuation."
The MPL assets sold to date via the Ldger secondary platform have consisted solely of Prosper loans. The firm is not currently auctioning loans for other platforms, but it is apparently just a matter of time before this happens.
"We've started discussions with other platforms," explains Kim. "The only reason we haven't gone forward yet is because we want full partnership with the platform. Most platforms retain the servicing rights and effectively the settlements of the trades that take place via our auctions will be handled at the lending platform level. We want to make sure they are set up operationally to handle volume."
Other platforms may also enter the secondary market scene. Orchard, for example, recently disclosed that it has applied for a broker-dealer license and will be actively looking to create a secondary market for the loans (SCI 1 April).
"I'd love to see other participants in this space," says Kim. "In a market where you have just one trading platform, there's a concentration of liquidity. It's also a validation of our business model."
Without a voluminous secondary market, MPL loans will remain Level 3 assets. In terms of valuation, this means noteholders will have to do estimations, as opposed to using observed prices.
Beyond the advent of a secondary market, Wu suggests that having a consensus as to how to price a loan is important. "Reaching an agreement on a standard set of methodologies is needed: what are the standard comparables to look for? What are standard set-up curves and discounting methods?" he asks. "That would be hugely useful. We've seen those methods and standards emerge in other asset classes, but not yet in the MPL area."
Most industry participants agree that a standardised pricing methodology should - and will - emerge in this asset class. But before that happens, there needs to be an educative culture in the market, via conferences, white papers and, unfortunately, accidents from which others can learn.
"I honestly think that when investors apply more scrutiny to the quality of the loans and quality of the data, that is when you will see better disclosure and platforms with higher standards," concludes Wu.
For more on marketplace lending, sign up for complimentary access to SCI's sister website
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News Analysis
CLOs
Spring surge
US CLO rally riding into summer
The rally in the US CLO market is being reflected in new issuance, with investors witnessing some of the tightest spreads so far in 2016. Questions remain over the resilience of the sector, however.
A strong second half of April was followed by a more subdued start in May for new issue US CLOs, but a healthy pipeline began to bear fruit, with a flurry of issuance as the month progressed. This enabled the month to close out with the second highest monthly issuance total this year, at US$4.9bn.
A mid-month trio of deals worth over US$1.3bn underlined a shift towards spread tightening, particularly the York CLO-3 transaction, whose class A tranche priced at Libor plus 157bp. The senior notes of THL Credit Wind River CLO 2016-1 priced marginally wider at plus 165bp (see SCI's new issue database).
However, Deutsche Bank securitisation analysts suggest that the precedent was firmly set by Apollo Management International's deal at the beginning of the month, which priced at some of the tightest spreads across the US CLO capital stack to date this year. For example, ALM XIX's C tranche priced at a 300bp spread, the tightest single-A rated tranche since October 2015. Similarly, the deal's D tranche - rated Baa3 by Moody's - priced at 450bp, reportedly the tightest in this rating category since September of last year.
Last week's Octagon Investment Partners 27 print raised the benchmark even further at the top of the stack. The US$310m triple-A rated notes produced a 153bp coupon, while the B notes priced at a solid 225bp.
Mike Terwilliger, global portfolio manager and md at Resource America, says that a number of factors are continuing to play into this rally, including the broader supply and demand dynamic in the markets. "There's a lack of opportunity for yield in other global markets, so on a relative basis the US corporate market provides an attractive proposition right now," he explains. "I'd expect this yield-grab to continue, which should reel more investors into the market and further prop up demand."
The turning point for the market can be traced back to February after wider market volatility that spilt over from last year initially prompted spread widening in the early weeks of 2016 (SCI passim). However, a disappointing supply figure this year has since coincided with a growing appetite among investors.
"Eventually CLO investors believed prices dropped low enough that it made sense to buy, even if they were bearish on credit fundamentals," says Berkin Kologlu, senior portfolio manager at Angel Oak Capital Advisors. "This demand intensified, together with a broader rally across other markets, with spreads tightening up from improving macroeconomic conditions."
The April FOMC minutes signalled a shift to a more hawkish attitude from the US Fed and Fed Chair Janet Yellen last week expressed her support for another hike soon. But sentiment remains split, with the market currently projecting a 50% chance for a rate hike in June, according to JPMorgan CLO analysts.
In addition, the approaching start date of CLO risk retention is weighing on supply. The Loan Syndications & Trading Association recently estimated that 69% of US CLO managers that have issued deals in 2016 are compliant or have plans to deal with the upcoming retention requirements.
"It is making it more challenging to put deals together and certainly dampened supply," says Terwillinger. "It's difficult to predict a spread floor, but as long as supply continues to underwhelm, the potential is there for them to go lower."
However, Kologlu warns that the effect risk retention has on CLO spreads should not be overstated, with retention-compliant supply expected to pick up as the market moves into the summer. He states that the biggest impact from the rules will likely come through manager consolidation.
"The top issuers are already figuring out how to structure a deal to fit compliance measures," Kologlu explains. "If you compare two similar deals, one being compliant and the other non-compliant, there isn't much difference in the spreads at which they trade."
Nonetheless, recent trends spurred the JPMorgan analysts to lower the midpoint of their primary US CLO triple-A spread target for end-2016 by 10bp to 155bp. But Kologlu explains that despite the rally that started in March, spreads remain wide from both a relative and historical basis.
"In comparison to flow credit, for example, CLO spreads are still cheaper. One should expect structured credit to trade wider than flow credit as an asset class," he says. "However, this gap is at historically wide levels, given the huge rally in flow credit spreads including investment grade, high yield bonds and high yield loans. CLO spreads are still lagging behind when you compare them relatively."
He continues: "If economic conditions improve, it is possible that there could be a reduction of this gap between the spreads in the two markets."
Meanwhile, lower down the capital stack, mezzanine and subordinate spreads are still pricing in a wide range, leading to significant deal tiering. For example, triple-B spreads from the most sought-after issuers and cleanest deals are coming in at around 450bp, while weaker-branded issuers are pricing at around 600bp to 700bp. Some of the worst quality triple-B tranches are coming as wide as 900bp, adds Kologlu.
"It's reflective of the quality issue currently dominating investor demand," he says. "Investors have become very selective and are looking for cleaner portfolios. They've not forgotten that they were burned in the market just earlier this year."
Another issue also surrounds the fragility of the spread rally. The energy sector - in particular oil and gas credits - has proven to be unpredictable, while a slowing of the Chinese economy is adding to investor wariness. These concerns have left spreads vulnerable to a reversal if volatility re-emerges.
"Although [the energy sector] will have a more weighted impact on the high yield bond market than the loan market, it's still a big X-factor," Terwillinger concludes. "An up-tick in defaults could be a real issue, especially if it causes deterioration in the underlying fundamentals of the market."
JA
SCIWire
Secondary markets
Euro CLOs strong
Activity and sentiment in the European CLO secondary market is strong.
"Overall tone is very positive and the latest bout of price appreciation has been very, very fast," says one trader. "That speed could be a concern, but people have realised that even though we're now at recent tights we're still wider than a year ago, which has led to the belief that CLOs should be a lot tighter."
The trader continues: "2.0 single- and double-Bs have rallied the most in recent sessions, but triple-As have tightened too, though there's a lot less paper about, and demand continues for double-As to triple-Bs. At the same time, there's finally some demand for 1.0 deeper mezz with people more comfortable with the risk there and it's rallied at last - up ten points plus in a matter of weeks."
Nevertheless, the dealer suggests the rally is not yet universal. "The market feels a lot less client focused and more dealer led at the moment - for example, a big double-B list last week was bought by dealers and then sold on at a later date. Equally, even though single-Bs have rallied strongly the market there still feels a bit thin and as if the sector could go stagnant or even drop fairly quickly."
There are currently two BWICs on the European CLO schedule for today. Both are due at 14:00 London time.
One involves €6.812m of double-Bs across five line items - CGMSE 2015-1X D, CGMSE 2015-3X D, DRYD 2015-39X E, JUBIL 2015-16X E and TIKEH 2015-1X E. Two of the bonds have covered with a price on PriceABS in the past three months: CGMSE 2015-1X D at 86.31 on 7 April and DRYD 2015-39X E at 87.21 on 22 March.
The other list consists of five double-As totalling €39.35m - ALPST 1 B, CADOG 1 B, HARVT V B, JUBIL I-RX B and QNST 2007-1X B. Only JUBIL I-RX B has covered on PriceABS in the past three months - at 94.73 on 22 April.
SCIWire
Secondary markets
US CMBS secondary demand strong
The slow pace of primary market issuance is driving US non-agency CMBS trends.
"We see little bursts of activity and then everything slows back down. Over the last one or two weeks we have really seen the quiet primary market driving the secondary market," says one trader.
He adds: "Curiously, there was a decent amount of BWIC supply last week. That may have been people taking profits. The main observation from that secondary market activity is that low primary issuance is driving very strong demand across the stack in secondary. There is very high demand for triple-A to triple-B minus paper, while high yield has also tightened significantly."
The trader expects half a dozen conduit deals to price in June and July, with only one or two single-asset single-borrower deals due to join them. While new issue paper traditionally prices wider than secondary, recently that has not been the case and these coming deals are similarly expected to price tight.
SCIWire
Secondary markets
Euro secondary stays positive
The European securitisation secondary market is retaining its positive tone and momentum.
Despite the UK and US public holidays and month-end, activity has improved on the previous week throughout this. The last few days have seen trading across the board and spreads in the vast majority of sectors continue to grind tighter.
In ABS/MBS prime assets were the main focus yesterday with euro paper improving and UK assets holding up. CLOs still lead the way, however, with another busy session that saw 2.0 mezz paper nudge tighter once more.
Nevertheless, BWIC supply remains relatively thin. There are three BWICs on the European schedule for today, so far.
At 12:00 London time there is a three line 2.563m CMBS list consisting of: DBSSY 1X B, TAURS 2014-UK1 C and TAURS 2015-EU3 F. None of the bonds has covered on PriceABS in the past three months.
At 13:00 there is a 48 line €239m current face AON CDO liquidation comprising CDOs, CLOs, CMBS and RMBS. Only two of the bonds have covered on PriceABS in the past three months, last doing so as follows: AIREM 2005-1X 2A2 at 97.82 on 16 May and RMAC 2005-NS2X A2C at 89.76 on 1 March.
Then at 14:30 there is another AON BWIC, this time exclusively focused on CLOs. The six line €10.385m current face list comprises: GSCP I-RX E, LEOP IIX C, LEOP III-X E1, LFE III D, LFE III E and NWEST II-X D2. None of the bonds has covered with a price on PriceABS in the past three months.
SCIWire
Secondary markets
US CLOs firming up
The US CLO secondary market is heating up again after a subdued end to May.
"The market was exhibiting a bit of falseness over the last few weeks, but there's definitely a firmer tone this week," says one trader. "Triple-Bs in particular tightened up yesterday. This came following talk of new money arriving after 1 June."
The trader notes that prices had softened over recent weeks, particularly further down the stack. However, the tone is shifting. "Triple-Bs remain the best bid right now, but I'd expect some tightening to trickle down into double-Bs and single-Bs."
The trader continues: "The strong primary pipeline could also come into play as it competes for demand with BWICs. This could factor into slowing down some of the tightening."
There are nine BWICs on the US CLO calendar so far today. The chunkiest is a four line triple- and double-A list due at 14:30 New York time. The list comprises: BSP 2015-8A A1C, CLPK 2015-1A A2, APID 2015-23A A2B and MDPK 2015-18A B2. None of the bonds has covered on PriceABS in the past three months.
News
CDS
CDS liquidity moving to indices
The buy-side's ability to source single-name CDS liquidity and form prices remains centralised around banks' ability to warehouse risk on their balance sheets, but that service is being rapidly diminished by Basel 3 and FRTB proposals, says GreySpark Partners. The limited number of banks maintaining active single-name CDS underwriting businesses is "creating an oligopolistic environment, with built-in fundamental and regulatory barriers to entry for other banks".
The only way for the community of banks supporting single-name CDS demand to widen would be to loosen Basel 3 capital restraints, says the consultancy. The prospect of the creation by exchanges of a universe of new listed credit swap future contracts which counteract the risk of counterparty default while successfully replicating regulated markets trades seems remote.
Unlike the interest rate swap market, it seems unlikely that existing levels of OTC single-name CDS liquidity in either Europe or the US can be transferred into futures markets once central clearing mandates are implemented. GreySpark notes that no futures exchange has so far succeeded in developing a hybrid single-name/CDX credit swap future contract that accurately accounts for the probability that counterparties to a trade in the product might default.
GreySpark believes that changes in the structure of the single-name CDS market are therefore likely to be dictated by an expansion of CDX products. It says: "This means that the CDX market is ripe for continued optionisation as opposed to futurisation."
Illustrating this point, in 2011 Citi estimated that the market for CDX options was already worth more than US$5bn in trading volume per week on the Markit CDX index alone. When ICE launched the first tranche of Eris CDX high-yield and Eris CDX investment grade futures contacts in April last year, the contracts were designed to replicate the economic methodology underpinning the trading of single name CDS on the Eris Exchange. Meanwhile, the volume of outright contracts on benchmark CDX increased two-fold to an average of US$87bn in February.
"If innovations in the design of CDX swaptions are at least partially linked to the rapid increase in observable benchmark trades, the CDX market - backed by central clearing mandates in both the EU and US - could continue to support a dearth of single-name CDS liquidity depth and transparent pricing for the foreseeable future. Only a simultaneous and significant increase in EU and US government benchmark interest rates could force a derailment of the structure of the CDS and CDX marketplace by increasing variation margin rates, which would likely instigate numerous CCP margin calls," GreySpark concludes.
JL
News
CMBS
Gateway mod pulled
The February modification of the US$94.3m Gateway Salt Lake loan, securitised in JPMCC 2010-C1, has been rescinded. Trepp suggests that while the pulling of the modification may not be a first for the CMBS market, it is certainly the largest.
The 623,205 square-foot mall backing the loan was sold earlier this year to a group that included Vestar and Oaktree Capital Management (see SCI's CMBS loan events database). As part of the sale, the loan was assumed and restructured.
The terms per the February modification included a bifurcation that created a US$78.5m A-note. The new borrowers also received considerable rate relief and a maturity extension of almost four years.
However, special servicer notes were subsequently released indicating that the new borrowers were working on a "rescission" of the assumption and initial modification to mark-to-market the interest rate for the consolidated notes and to align the terms of the consolidated notes with the trust waterfall. A standstill agreement was signed and the balance was pushed back up to US$94.3m.
Trepp notes that the deal's remittance report was last week revised back to February. Under the revision, the loan balance was reduced to US$53m and the JPMCC deal was assessed US$41m in losses, which wiped out classes F, G, H and NR and almost half of the class E notes.
In addition, the new rate - which had been lowered to 1% as part of the original modification - has now been set to 4%. But the extended maturity (to early 2021) seems to have survived.
CS
News
CMBS
Building boom threatens hotel CMBS
Burgeoning hotel room supply could increase risk for the US$3.68bn of fixed-rate loans backed by Manhattan hotels and securitised in CMBS monitored by Morningstar Credit Ratings, says the agency. Delinquent and specially serviced loans account for just 2.8% of the Manhattan loans, but a further 14 loans - with a combined balance of US$730.9m - have DSCRs below 1.2x.
While Manhattan is one of the strongest markets for US hospitality properties, the rating agency believes that demand growth could fail to meet industry projections. Although there has been a historic under-supply of hotel rooms, Morningstar believes the boom in development may be going too far and says there are three factors spurring developers to keep building, despite falling expected returns: public policy, capital market trends and EB-5 funding.
A push by local government, businesses and labour unions to increase tourism led to a record 58.3 million tourists last year. Meanwhile, rising asset values have seen a cumulative 60.8% price increase for hotels between 2005 and 2015. As for the EB-5 funding, foreign investors are able to pump money into the US, with large hotel developers such as Lam Group and McSam Hotel Group making use of the programme.
However, demand growth for Manhattan hotel rooms, as measured in occupied room nights, dropped below 2% last year for the first time since 2009. Slowing demand could be exacerbated by the continued strength of the US dollar, which is impeding foreign visitors.
There is only one defaulted loan - the US$33.1m Shoreham Hotel loan securitised in CSMC 2007-C1 - among the US$3.68bn of CMBS backed by Manhattan hotels. Morningstar forecasts an US$11.7m loss on that loan if it is liquidated.
The reperforming US$70m Best Western President loan securitised in CSMC 2006-C5 is also in special servicing (see SCI's CMBS loan events database). The property generates negative operating cashflow and the borrower is seeking another modification, with Morningstar anticipating a US$10.2m loss if the loan is liquidated.
A further 14 loans totalling US$730.9m have DSCRs below 1.2x. Around half of these were securitised in 2006 or 2007, with the rest securitised in 2012 or later.
"Our concern is somewhat mitigated by the lower interest rates prevailing in the market. For instance, the Residence Inn Times Square loan [securitised in JPMCC 2006-CIBC17] has a coupon rate of 6.15%. If the borrower elected to refinance the loan today at an interest rate of 5%, the 2015 net cashflow DSCR would increase to 1.58x from 1.03x on an amortising basis," says Morningstar.
The loan enters its open period in June, with the borrower able to repay the loan without penalty. The Courtyard by Marriott - Times Square, securitised in COMM 2015-UBS3, would have a hypothetical amortising DSCR of 1.45x - assuming a 5% interest rate and a 30-year amortisation schedule.
The Flatiron Hotel loan securitised in WFM 215-C28 has a DSCR of only 0.36x. This is partly due to a water leak.
With 10,000 new hotel rooms likely to become available in the next two years, many in Midtown, Morningstar expects that demand won't keep pace with the burgeoning supply. "As a result, we believe that key hotel performance benchmarks - including occupancy, ADR and RevPAR - could dip this year and next. Consequently, we can expect the cashflow of many Manhattan hotels in CMBS to drop over the next two years. While hotels with net cashflow just above their debt service have elevated risk of default, we note that Manhattan hotel loans have historically not defaulted in large numbers," says the rating agency.
JL
Job Swaps
Structured Finance
Ex-SEC counsel joins law firm
BakerHostetler has added Walter Van Dorn to its New York office as a partner. He was most recently at Dentons and has also worked at Thacher Proffitt & Wood, Clifford Chance and the US SEC. Van Dorn has worked in London, Hong Kong and Washington and focuses his practice on corporate securities law, including ABS.
Job Swaps
Structured Finance
Real estate platform strengthened
C-III Capital Partners is set to acquire Resource America, following a comprehensive review of strategic and financial alternatives that the latter company announced in January. Under the terms of the agreement, Resource America stockholders will receive US$9.78 per share in cash, or a total of approximately US$207m. The price per share represents a premium of over 128% from Resource America's closing price on 28 January and a 51% premium over its closing price on 20 May.
The addition of Resource America's asset management business to C-III's diverse suite of commercial real estate services is expected to create a broad platform of products directed to retail and institutional investors. The combined company will manage over US$25bn of gross assets and own and/or manage over 70,000 apartment units across the US.
Andrew Farkas, chairman and ceo of C-III Capital Partners, comments: "The addition of Resource America's businesses further diversifies our platform and enables us to become an even broader and more robust full-service provider of commercial real estate debt and equity solutions, spanning loan servicing and origination, fund management, property management, brokerage and other services."
C-III intends to retain the leadership and staff of Resource America's asset management businesses. The transaction - which is expected to close late in Q3 or early in Q4 - is subject to approval by Resource America stockholders, regulatory approvals and other customary closing conditions. The acquisition is not subject to any financing conditions.
Evercore served as exclusive financial advisor to Resource America and Wachtell, Lipton, Rosen & Katz served as Resource America's legal advisors. Proskauer Rose served as C-III's legal advisors.
Job Swaps
Structured Finance
Tilton loses appeal
The US Court of Appeals for the Second Circuit has affirmed the district court's dismissal of Lynn Tilton and Patriarch Partners' suit against the US SEC for lack of subject matter jurisdiction. The appellants brought suit in the US District Court for the Southern District of New York to enjoin the Commission's proceeding before its completion, on the theory that the administrative law judge's appointment violated the Appointments Clause of Article II of the US Constitution. Tilton and four Patriarch entities are respondents in an ongoing administrative proceeding initiated by the SEC (SCI 31 March 2015).
The Court of Appeals agrees with the district court that Congress implicitly precluded federal jurisdiction over the appellants' appointments clause claim while the Commission's proceeding remains pending. The judge stated that, under the Dodd-Frank Act, SEC enforcement actions may take the form of a civil lawsuit in federal district court or an administrative proceeding conducted by the Commission or an administrative law judge (ALJ). Where both of those alternatives are available, the choice between them belongs to the SEC "without express statutory constraint".
In this case, the SEC's proceeding is subject to two layers of review: a party that loses before the ALJ may petition for de novo review by the Commission; and a party that loses before the Commission may petition for review by a federal court of appeals. Consequently, the appellants will be able to argue the issue in a federal court of appeals if they lose before the Commission.
The SEC reportedly has a higher success rate in pursuing fraud cases through in-house administrative proceedings rather than federal court.
Job Swaps
Structured Finance
Valuation firm hires secondary pro
Duff & Phelps has recruited Dexter Blake as md and part of its portfolio valuation practice. He has also been made leader of the firm's secondary market advisory group.
Blake joins from NYPPEX Private Markets, where he was md and co-head of sales and trading. He specialises in the transfer of illiquid limited partnership interests in the secondary market for private equity funds, hedge funds and real estate funds.
Job Swaps
Structured Finance
Public finance team poached
Norton Rose Fulbright has recruited Sidley Austin's entire public finance practice, expanding its own practice in this area. The 17 lawyers to move over include six partners, a number of which have experience in securitisation.
The recruited partners include Larry Bauer, whose experience ranges across derivatives and securities regulation. In total, eight lawyers will join Norton's New York office, with two joining in Washington, DC and seven lawyers helping to launch a presence for the firm in its new San Francisco office.
Norton's US head of finance, Bob Dransfield, says that the group will increase its public finance team by almost 50%. "In addition, their experience in securitisations, healthcare finance and municipal restructurings in particular will enhance our firm's public finance capabilities," he adds.
Job Swaps
CMBS
Goldman CRE head steps down
Ted Borter has taken over as sole head of Goldman Sachs' US CRE finance group after Jonathan Strain recently left his position as co-head. Strain departed from the bank to reportedly launch a CMBS B-piece fund. Prior to Goldman, he was head of CMBS capital markets at JPMorgan.
Job Swaps
RMBS
Eight institutions settle RMBS claims
The FDIC has achieved a US$190m settlement of certain RMBS claims with Barclays Capital, BNP Paribas, Credit Suisse, Deutsche Bank, Edward Jones & Co, Goldman Sachs, RBS and UBS. The settlement resolves federal and state securities law claims based on misrepresentations in the offering documents for 21 Countrywide RMBS purchased by five failed banks.
The settlement funds will be distributed among: Colonial Bank of Montgomery, Alabama; Franklin Bank of Houston, Texas; Guaranty Bank of Austin, Texas; Security Savings Bank of Henderson, Nevada; and Strategic Capital Bank of Champaign, Illinois.
The FDIC, as receiver for failed financial institutions, may sue professionals and entities whose conduct resulted in losses to those institutions in order to maximise recoveries. The FDIC has filed a total of 19 RMBS lawsuits on behalf of eight failed institutions seeking damages for violations of federal and state securities laws.
Job Swaps
RMBS
Ginnie fraud settled
California-based First Mortgage Corporation (FMC) and six of its senior executives have agreed to pay the US SEC US$12.7m to settle charges that they orchestrated a scheme to defraud investors in the sale of RMBS guaranteed by Ginnie Mae. The SEC alleges that from March 2011 to March 2015, FMC pulled current performing loans out of Ginnie Mae RMBS by falsely claiming they were delinquent in order to sell them at a profit into newly-issued RMBS. Further, FMC caused its Ginnie Mae RMBS prospectuses to be false and misleading by improperly and deceptively using a Ginnie Mae rule that gave issuers the option to repurchase loans that were delinquent by three or more months.
According to the SEC's complaint filed in US District Court for the Central District of California, FMC purposely delayed depositing cheques from borrowers who had been behind on their loans, falsely claiming to both investors and Ginnie Mae that such loans remained delinquent when in reality they were current. After repurchasing at prices applicable to delinquent loans, FMC was able to resell the loans into new Ginnie Mae RMBS pools at higher prices applicable to current loans for an immediate nearly risk-free profit.
FMC chairman and ceo Clement Ziroli Senior has agreed to a US$100,000 penalty, while company president Clement Ziroli Junior agreed to pay US$411,421.98, plus US$27,203.92 in interest and a US$200,000 penalty. FMC cfo Pac Dong agreed to pay a US$100,000 penalty, while svps Ronald Vargas and Scott Lehrer agreed to pay US$60,000 and US$50,000 respectively. Servicing md Joseph Sanders - who cooperated in the SEC's investigation - agreed to pay disgorgement of US$51,576.51, plus US$6,811.19 in interest.
In settling the charges without admitting or denying the allegations, each of the six executives agreed to be barred from serving as an officer or director of a public company for five years. The settlements are subject to court approval.
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ABS
PE investors provide CDQ ABS boost
Growth and consolidation in Italy's consumer loan Cessione del Quinto (CDQ) market is credit positive for CDQ ABS, says Moody's. The rating agency believes foreign private equity investment will strengthen the market.
"Foreign private equity firms' investment could accelerate lending growth in the CDQ market. The low level of net losses has attracted non-traditional participants, such as warehouse lenders and equity investors. Their additional capital investment injects liquidity into the sector," says Pier Paolo Vaschetti, Moody's vp and senior credit officer.
Consolidation should create larger, more financially stable institutions. Tighter rules for non-bank financial intermediaries will strengthen underwriting, while the arrival of non-traditional market participants and equity investors will increase liquidity.
CDQ loan origination reached €5.2bn in 2015, with the market achieving a compounded annual growth rate of 8% since the beginning of 2012. Last year alone, CDQ loan origination grew 12%.
However, Moody's notes that the number of insurers that operate in the CDQ market willing to provide coverage upon unemployment and death has not kept up with the sector's growth. As a result, the same insurance companies often provide protection across different loan portfolios, which leads to correlation risk.
Most rated CDQ deals continue to perform in line with or above original expectations and consistently show low net losses. Moody's does not currently expect growth in lending volumes to result in future deterioration in CDQ ABS.
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Structured Finance
Capital-arbitrage warning issued
The Basel Committee has warned banks against conducting capital relief trades. The regulator says such transactions will draw "careful supervisory scrutiny".
The Basel Committee notes that members have received many requests to review or approve transactions that seek to alter the form or substance of items subject to regulatory adjustments outlined in Basel 3. These include proposals for structured transactions that result in deferred tax assets being reclassified as a way of avoiding their deduction from regulatory capital calculations.
Transactions designed to offset regulatory adjustments include: the issuance of senior or subordinated securities with or without contingent write off mechanisms; sales contracts that transfer insufficient risk to be deemed sales for accounting purposes; fully-collateralised derivative contracts; and guarantees or insurance policies. These types of transactions pose a number of risks, says the Basel Committee.
Such transactions can be untested in their ability to fully address the underlying rationale for the regulatory adjustment and can overestimate eligible capital or reduce capital requirements, without commensurately reducing the risk in the financial system. This undermines the calibration of minimum regulatory capital requirements.
News Round-up
CDS
Bilateral CDS trading down
Bilateral CDS index trading metrics saw a decline to start the year, according to ISDA's latest quarterly index results for the sector. Although cleared CDS volumes continue to increase, the number of bilateral trades and notional volume both showed clear drops in 1Q16.
The average number of daily cleared trades increased by 34.6% between 1Q16 and 1Q15, with an increase of 42.5% versus 4Q15 too. Further, the average daily CDS index trade count is up on last year's numbers, with a 36.7% increase in 1Q16 compared with the same period in 2015. This also represented a 39.6% rise versus 4Q15 figures.
The average daily notional volume in CDS index trading was also up, to US$37.2bn in 1Q16 from US$25.8bn in 4Q15. However, bilateral volumes declined slightly by 1.2% to start the year, averaging US$8.2bn daily from US$8.3bn in 1Q15.
More notably, the average CDS index trade size fell by 7.1% in 1Q16 from the same time last year, from US$36.7m to US$32.2m. The average trade size had reached as high as US$38.2m in 2Q16, outlining a US$6m drop in size within nine months.
News Round-up
CLOs
Post-crisis single-A outperformed
The total amount of CLOs paid down in JPMorgan's CLO index (CLOIE) since the April rebalance through 31 May was US$3.83bn in par outstanding, split between US$3.65bn and US$180m of pre-crisis and post-crisis CLOs respectively. US$3.4bn across 53 tranches from 11 deals was added to the post-crisis CLOIE at the May rebalance.
The CLOIE total index saw total returns of +0.39% last month. Of the 11 tranches, 10 experienced positive total returns. Total returns of +0.60% in the pre-crisis CLOIE outperformed the +0.37% total returns in the post-crisis index.
The best performing post-crisis tranche last month was the single-A tranche, which tightened by -16bp and had +1.36% total returns, according to JPMorgan. Post-crisis single-Bs underperformed, experiencing total returns of -0.89%.
Over the last three months, the top performing tranches are the post-crisis double-B and single-B, which have returned +19.15% and +16.56% respectively. The top performing tranches year-to-date are post-crisis double-B, double-A and triple-B, which have returned +2.43%, +2.27% and +2.10% respectively.
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CMBS
CMBS metrics diverging
A number of metrics appear to be diverging within recent US CMBS 2.0 deals rated by Fitch. A recent comparative analysis of 2014 and 2015 deals undertaken by the agency reveals that originator leverage metrics improved, while the agency's own leverage metrics deteriorated.
In addition, cashflow haircuts and debt yield also worsened within Fitch's metric, an indicator of aggressive originator underwriting. "The rise in haircuts was due primarily to our difference in views on factors, such as revenue, expense and occupancy assumptions," says Fitch md Stephanie Petosa.
Fitch's net cashflow haircuts rose to 9.22% for the full year of 2015 from 8.18% in 2014. The average Fitch constant and cap rate, also used to calculate leverage, did not change over the period.
Further, nearly a quarter of the 2015 loans had a Fitch stressed DSCR below 1.00x, with the range between 0.53x and 0.99x. This resulted in an average loan level loss estimate of 8.7%.
Similarly, more than a quarter of the loans had a Fitch stressed LTV greater than or equal to 120% averaging a loan level loss estimate of 7.9%, compared to loans with a stressed LTV less than 120% averaging a loan level loss estimate of 3.8%.
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CMBS
CMBS delinquencies inch up again
The US CMBS delinquency rate inched up for the third straight month at the end of May, says Trepp. The rate for CRE loans in CMBS is now at 4.35%, an increase of 12bp from April.
The rate has crept up after two large decreases to start the year in January and February. However, on a relative basis, the rate is still 105bp lower than the year-ago level and 82bp lower since the beginning of the year. The all-time high was 10.34% in July 2012.
The percentage of loans seriously delinquent at the end of May was 4.24%, which is up 11bp for the month. Trepp adds that if defeased loans were taken out of the equation, the overall 30-day delinquency rate would be 4.58%, which would be up 13bp.
By property type, the delinquency rate for industrial actually fell by 23bp, but was still the highest at 5.72%. Meanwhile, office elevated to 5.51%, while retail was pushed up to 5.36%. Smaller increases happened in lodging, which is now at a 2.96%, and multifamily, which is at 2.36%. Trepp notes that apartment loans are currently the best performing major property type.
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Insurance-linked securities
Everglades Re upgraded
S&P has raised its issue credit rating on Everglades Re Series 2014-1 notes to single-B plus from single-B. The rating action follows the agency's review of the reset report for the final risk period that began on 1 June, the probability of attachment and the expiration of the variable reset feature.
The ILS transaction includes a variable reset feature that permits the probability of attachment to range between 2.74% and 3.04%. Based on the warm sea surface temperature analysis for the final risk period, the attachment probability is 3.14%. However, since the transaction is in its final risk period, S&P says the variable reset is no longer applicable and the rating will be based on the updated modelled results.
The agency notes that the attachment level has dropped significantly. The initial attachment and exhaustion levels were US$5.202bn and US$7.702bn respectively, while the updated levels are US$2.779bn and US$5.279bn.
The interest spread for the final risk period will equal 7.110%.
News Round-up
NPLs
Third community NPL pool sold
Fannie Mae has auctioned off its latest community impact pool of non-performing loans to New Jersey Community Capital (NJCC). The non-profit company purchased the latest pool of loans through its affiliate, the Community Loan Fund of New Jersey.
The purchase adds to NJCC's previous acquisitions of the first two community impact pools marketed by Fannie Mae. The latest pool includes 83 loans secured by properties in Miami, Florida and has an unpaid principal balance (UPB) of approximately US$19.7m.
The sale price for this pool was in the high 60s, while the average loan size equated to US$237,672. In addition, the average note rate was 5.07% and the loans hold an average delinquency of 51 months. The sale is expected to complete on 25 July.
Further, the GSE has sold another pool of NPLs to Goldman Sachs in a portfolio of 1,760 loans. The pool comprises an average UPB balance of approximately US$329,788 and was sold at a price in the low 70s.
The transaction is expected to close on 26 July. The announcement comes after the bank recently bid successfully for a US$1.48bn pool of NPLs from the GSE (SCI 16 May).
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NPLs
Freddie NPL auction results announced
Freddie Mac has sold a further US$130.2m of deeply delinquent NPLs via auction. The 487 loans are serviced by JPMorgan and the transaction is expected to settle in August, with servicing transferred post-settlement.
The loans were offered for auction last month (SCI 13 May) and have been delinquent for an average of around three and a half years. Due to their deep delinquency, borrowers are likely to have been evaluated for loss mitigation, including modification or other alternatives to foreclosure, or to be in foreclosure.
Freddie Mac notes that mortgages that were previously modified and subsequently became delinquent comprise approximately 27% of the aggregate pool balance. The aggregate pool is geographically diverse and has an LTV of approximately 91%.
The winning bidder on the pool was MTGLQ Investors. The cover bid price was in the low 70s.
News Round-up
RMBS
China RMBS steady so far
Chinese RMBS has been performing well in its early stages, according to Fitch. This has been attributed, in part, to the 'vanilla' mortgage features within the transactions issued to date, which reflects strong transparency standards.
There have been 12 transactions across eight different commercial banks so far in the market, amounting to CNY28.04bn. Of the 12 deals, 10 are too immature for Fitch to produce significant data, but the agency's initial observations have identified steady performance across the board so far.
The transactions include fully amortising and full-documentation loans, a lack of subprime features and uniform underwriting guidelines. The guidelines hold a number of strict measures, such as the nationwide Chinese LTV cap that currently limits lending to 80% of the value of a residential property.
Meanwhile, the agency notes on a broader scale that CNY95.7bn in structured finance deals priced in 1Q16, 53% of which was under the country's Credit Asset Securitisation (CAS) scheme. This was an 11% year-on-year drop for CAS issuance, resulting from the decline of CLO issuance due to lower growth and corporate funding needs across China.
However, RMBS and auto loan ABS grew steadily in the quarter, while there were also two consumer loan ABS deals. The highest default rate from all auto loan ABS issues has reached approximately 1.4%, compared to 1% for all RMBS issues.
News Round-up
RMBS
Alt-A recasts to test defaults
The looming recast to full payment of principal and interest for the remaining interest-only Alt-A loans in 2006-2007 vintage private-label RMBS is expected to drive default rates up again in 2016-2017. Moody's suggests that the spike in default rate will be less severe than that seen in 2015, but a larger portion of loans will be subject to recasts.
"Defaults on Alt-A IO loans with an IO period expiring in 2016-2017 will rise when they recast to full payment of principal and interest, owing to an expected future increase in monthly mortgage payments. However, default rates will likely stay below those of Alt-A IO loans which re-casted to full payment in 2015 because of a slightly smaller expected payment shock and slightly better borrower credit profiles," the agency observes.
Payment shock is anticipated to remain most significant for three-year, five-year and seven-year ARMs in 2016-2017, but the three cohorts will also likely register the most substantial declines from 2015 levels. Further, 2006-2007 vintage 10-year Alt-A IO loan borrowers who have remained always-current, on average, have higher original FICO scores (720 and 723) than their 2005 counterparts (700). Consequently, the remaining always-current loans for 2006 and 2007 - being of higher credit quality than those in 2005 and likely to experience lower payment shocks when they recast in 2016-2017 - are expected to default at slightly lower rates.
Roughly 47% of 2006 vintage Alt-A loans and about 57% of 2007 loans will have 10-year IO periods that expire in 2016-2017, with half of those borrowers subject to monthly payment hikes of 50%-70%. ARMs with 10-year IO periods account for roughly 24% of 2006 Alt-A loans and 26% of 2007 loans, compared with just 16% of 2005 loans.
The default rate on 2005 Alt-A 10-year IOs, on average, nearly tripled - rising to 10.1% in March 2016 from 3.4% in March 2015. The monthly principal and interest payment for 10-year Alt-A IOs, on average, increased by US$421 (or 37.2%) to roughly US$1,553 in March 2016 from US$1,132 in March 2015. By comparison, the average non-IO Alt-A loan's average payment was US$1,237 in March 2016.
Moody's believes that several macroeconomic factors will help temper the potential rise in default rates, including: low unemployment and growing wages; rising home prices; and broader use of loan modifications.
News Round-up
RMBS
UK mortgage servicing to change
The lack of growth in traditional third-party business for UK mortgage servicers will continue to drive diversification and M&A in the sector, says Fitch. The rating agency expects the majority of UK servicers to offer end-to-end mortgage processing from origination to repayment in the coming years.
End-to-end third-party mortgage processing, including origination, is well developed in the Netherlands and UK servicers appear to be following this trend. Adopting such an end-to-end business model should be positive if it generates a flow of new business and would support the viability of servicers which have previously had to rely on legacy business.
Paratus AMC and Pepper both set up their own lending brands last year, while Acenden has started servicing all Kensington Mortgage Company's newly originated loans after both companies were bought by funds managed by Blackstone and TPG. Capita acquired Crown Mortgage Management and Vertex Mortgage Services, stating its aim to become the leading end-to-end mortgage processing partner for clients.
Fitch has recognised the potential benefits of this trend in recent servicer rating affirmations. Last month it affirmed Paratus's servicer ratings, while Acenden's ratings were affirmed at the end of 2015. Acenden's ratings had been on rating watch evolving while Fitch assessed the level of support provided by its new owners.
Fitch does not think that third-party origination presents risks to underwriting standards in and of itself. Third-party origination has not had a detrimental impact on underwriting standards in the Netherlands, although the Dutch market is heavily regulated with little variation in mortgage product types.
"We think risks might be greater if third-party originators moved into non-conforming mortgage origination, where the greater range of products and credit criteria applied to individual borrowers can make control of originating and underwriting processes more challenging. We would assess these case by case via operational risk reviews, as described in our EMEA RMBS rating criteria," the rating agency says.
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