Contents

CLOs

Risky retail

US retail exposure driving CLO differentiation

US CLO exposure to retail names has come under closer scrutiny in the last couple of months as store closures and the shift to online shopping weigh on the industry. Against this backdrop, the success of specialty brands is driving differentiation across the sector.

The median retail exposure across the US CLO 2.0 space currently stands at 7.8%, according to Morgan Stanley figures. Yet, despite the seemingly consumer-friendly economic environment, many retail names have underperformed in recent months.

"There is quite a lot of exposure to the retail sector within the 2.0 CLO market. It's all about what you own," says Oliver Wriedt, co-president at CIFC Asset Management. "Risk runs the gamut from highly stable credits to boom-and-bust examples."

The frequency of negative headlines has increased over the last month due to sub-par earnings among a number of high-profile retailers. This stands in contrast to a falling unemployment rate and historically low interest rates. The disconnect is particularly evident among apparel-based retailers, where many investors are currently more bearish.

"J Crew is a good example of a fashion brand that experienced volatility," adds Wriedt. "In contrast, you have more stable retailers - like BJ's Wholesale Club - that show higher cashflow stability because of their membership-driven customer model."

This underlines the issue that is splitting the success of retailers - accommodating the changing demands and expectations of consumers. Troubled retailers with exposures in US CLOs are commonly chains that have struggled to adapt to the popularity of online shopping. For instance, Amazon is estimated to have contributed 42% of all US retail sales growth in 2015, according to Wells Fargo structured products analysts.

"It's been an ongoing phenomenon and is why we think a lot of investors are looking towards specialty retail," says Wriedt. "When Amazon can ship any product directly to your doorstep, you need to create a unique shopping experience. Bass Pro Shops is a good example of a retailer focused on creating a more unique customer experience."

Wells Fargo figures show that Bass Pro Shops is the second largest-held retail name among US CLOs, accounting for US$864.55m of collateral in S&P-rated deals and US$918.4m in Moody's-rated deals.

Department stores and supermarkets, although currently not the hottest pick for CLO managers, have also proven resilient to the success of online shopping. However, this could partly be down to the mentality of the customers rather than the innovation of supermarket brands, suggests Wriedt.

"Most people still choose to do their grocery shopping in person, leaving supermarkets less exposed to the online threat," he says. "Non-differentiated big retailers, such as Sports Authority, have been forced to shut their doors, however."

Roughly US$146m in retail loans tied to US Sports Authority are still held by US CLOs, but the sports chain's recent Chapter 11 bankruptcy filing has caused the price its loans to drop to an average of just US$17.

Nonetheless, CLO managers have been snapping up loans in the pet food and supplies and department store sectors since the start of the year. PetSmart is currently the largest held retail loan in the sector, accounting for US$1.22bn and US$1.42bn exposure across S&P-rated and Moody's-rated CLOs respectively. Along with BassPro, the name is trading on average above US$98.

The Wells Fargo analysts note that CLO retail exposure is concentrated among higher-priced loans, with 86% currently trading at above US$90. In contrast, just 8% of CLO retail exposure is priced below US$80, meaning that only 0.43% of CLO assets are retail loans trading below US$80.

"In the end, the most important factor will always be the actual performance of the retailer, not the headlines," Wriedt concludes.

JA

RMBS

BTL stampede

Loan issuance surges ahead of tax deadline

Buy-to-let (BTL) lending in the UK surged in the weeks leading up to the recent stamp duty changes, with implications for RMBS. Lending rose from £3.6bn in February to £7.4bn in March, although the loan approval figures actually fell slightly.

While the net lending figure for March is the highest since October 2007, lending is expected to dip now that the rush has passed. The pending EU referendum will likely only exacerbate this slow-down.

"The market knew that stamp duty would increase for the UK BTL sector, so the recent surge in purchases and loan issuance can be seen as a very deliberate move to get ahead of that April deadline. The case of an increase in stamp duty for non-UK corporates buying of property in the UK a few years ago saw similar dynamics then, as well," says Alexander Batchvarov, head of structured finance research at Bank of America Merrill Lynch.

As well as the increased stamp duty for BTL investors, the UK Prudential Regulation Authority (PRA) has outlined new rules setting a consistent minimum standard for mortgage underwriting across the market. However, Peter Shorthouse, director of treasury and structured finance at Paragon, notes that those standards might not apply to pound-for-pound remortgages.

Shorthouse says: "That is curious, because one would think that any minimum standard should apply to all mortgages. The fact that it is a remortgage does not seem like a very good reason to ignore what are being proposed as a prudent set of minimum requirements for assessing affordability."

The PRA's proposals include treating any landlord with four or more BTL mortgages as a more complex proposition, requiring more testing quasi-commercial underwriting. Paragon has been applying standards similar to the proposals for many years already.

The effect of the new rules on the BTL market will depend on their final form, but the stamp duty rise, at least, should only have a limited impact. An extra 3% in stamp duty can be offset with a modest increase in rental. However, the reduction in deductible expenses - which is being phased in from next year - could have a greater impact.

Batchvarov says: "There is also the prospect of a Bank of England interest rate hike, although I think that might be a little overweighted. All the research suggests that the real pain would not kick in until the base rate moves up more than 2%, which will take a while. In the meantime, a 25bp-50bp increase in rates will not break the camel's back."

Bank of America Merrill Lynch analyst Altynay Davletova notes that the market impact will vary depending on when loans were issued. "Earlier post-crisis originations have higher interest rates and would be more vulnerable to the reduction in mortgage interest deductibility or interest rate rises," she says.

Davletova continues: "If interest rates increased 1%, we estimate most BTL loans should still have positive net income (after tax, interest and other expenses). A 2% increase would be sustainable for loans with lower rates, such as those in legacy pools, while loans with higher rates would be more exposed. In any case, even with a negative net income, BTL borrowers may still be happy so long as their overall cashflow position is strong and they can benefit in the long term through capital appreciation."

The changes that have already been introduced will likely affect prepayment rates for UK mortgages, both BTL and non-BTL. One possible effect for UK RMBS could be increased prepayments in existing mortgages, as many of the newly-purchased BTL properties will have been financed, with many of those mortgages sitting in existing RMBS deals.

If the increase in prepayments leads to an increase in redemptions at par, then RMBS investors in deals currently trading at discounts - as many older deals currently do - would benefit. However, Shorthouse notes that any increase in prepayments would probably be short-lived.

He says: "There may be a very short-term increase in prepayments as a result of the recent BTL surge pre the stamp duty change, if the properties being purchased were already mortgaged. However, beyond that, very short term the trend will be for prepayments to decrease."

A tightening of lending criteria could make lenders unwilling to relax credit standards to accommodate even pound-for-pound remortgages where the lender's normal minimum affordability criteria cannot be satisfied. Although it is not the intention, Shorthouse believes this could result in borrowers becoming trapped in their existing mortgages.

"The implementation of the MMR had similar impacts, with customers with weaker affordability having less choice in the market. These changes are designed to reduce potential risk in the BTL sector and we may see lower levels of prepayments going forward," Shorthouse adds.

Davletova believes the RMBS impact of the stamp duty changes will be mixed, depending on the collateral pool mortgage rates and interest coverage. She expects prepayments could actually increase.

"Newer originations (e.g. earlier post-crisis mortgages) would be more susceptible to arrears than older legacy deals. But it is likely that we may see an increase in prepayments alongside a slight increase in arrears, as borrowers may choose to unwind underperforming BTL investments," says Davletova.

A future rush of BTL RMBS issuance is not expected, despite the surge in loan originations. This is because loan issuance appears to have been front-loaded specifically to beat the stamp duty deadline and is therefore likely to even out over the coming months.

That said, TwentyFour Asset Management has successfully placed £263.3m of triple-A rated bonds via Malt Hill No. 1. The RMBS is backed by BTL mortgages originated by Coventry Building Society. The triple-A notes were issued with a coupon of three-month Libor plus 135bp (see SCI's new issue database).

Further issuance in the near future, however, is thought to be unlikely. UKAR will begin the sale process to offload a £16bn portfolio later this year, but not until 2H16 at the earliest.

Shorthouse notes: "RMBS issuers have already been paying a premium of 20bp-30bp because of Brexit uncertainty. From now until 23 June, it is highly unlikely we will see much activity. If we do see any, then investors will expect to be compensated for the risk."

JL

Secondary markets

Euro ABS/MBS defies concerns

Steady primary supply and a firm European ABS/MBS secondary market are providing cause for optimism.

"Despite the perceived increase in likelihood of a vote for Brexit, the market feels pretty firm. Those referendum concerns were shrugged off pretty quickly yesterday and prices are continuing to go up with spreads grinding down," says one trader.

He adds: "There have been a couple of recent BWICs with good execution, and bids are strong even where bonds do not trade. A lot of the paper out for the bid is coming from further down the capital stack."

There are currently two BWICs on the European ABS/MBS schedule for today. Both are due at 14:00 London time.

The largest is a five-line 26.439m euro and sterling auction comprising: BRNL 2007-1X A4A, CHSNT 2014-1 A, MINTS 2015-1 EURA, PRS 2006-1X A2C and ROFIN 1 A1. Only CHSNT 2014-1 A has covered on PriceABS in the past three months - at 98.77 at 8 March.

The other consists of two line items - €1.4m BCJAF 10 D and £3m SPS 2005-3X C1C. Neither of the bonds has covered on PriceABS in the past three months.

Secondary markets

US CLOs take a breather

The US CLO secondary market is taking breather so far this week after last week's pick-up in activity.

"It was a nice end on the new issue side last week with over US$1.6bn in new deals, but both the primary and secondary markets seem for the most part to be waiting for the interest rate announcement now," says one trader. "Nevertheless, there is some activity in the equity space with a decent sized list due today and I've been seeing a bit going on around 1.0s on offer, along with shorter dated 2.0s."

Overall, the trader says the mezz rally has shown some signs of slowing down particularly for double-Bs. "They're trading in the mid- to low-70s right now after hitting the mid-80s in May. Unless there is some broader-based tightening, they won't move back to that anytime soon."

There are seven BWICs on the US CLO Calendar for today so far. The largest is the above-mentioned five line equity list due at 11:00 New York Time. The $25.004m auction comprises: DRSLF 2012-24A SUB, FINNS 2012-1A SUB, OAKC 2013-8A SUB, SYMP 2007-4X SUB and WSTC 2013-1A SUB. None of the bonds has covered with a price on PriceABS in the past three months.

Secondary markets

Euro secondary stable

The European securitisation secondary market continues to show stability.

Secondary spreads across the board are flat to slightly tighter this week as the vast majority of securitisation sectors remain insulated from headline volatility surrounding Brexit and US rates. CLOs continue to lead the way in terms of demand across the capital structure, while ABS/MBS is seeing more two-way flows.

However, overall liquidity is still thin and BWIC volumes continue to be low as new issuance has taken centre stage over the past few sessions. Yesterday's secondary market highlight was a 37 line mixed MBS, CDO and CLO list that saw a strong appetite for all line items though high reserves meant a number did not trade.

There are currently six BWICs on the European schedule for today. Five involve no more than three line items but the largest is a CLO and RMBS mix due at 15:30 London time.

The latter is a 16 line 52.2m auction comprising: ARBR 2014-2X E, AVOCA 13A F, BABSE 2015-1X E, CELES 2015-1 C, CORDR 2 C, CORDR 4 B, DRYD 2013-29X F, GLGE 1X D, JUBIL 2013-10X E, LEEK 19X CC, NGATE 2007-1X MB, PHNXP 1X E, RMACS 2006-NS3X B1C, RMACS 2006-NS4X B1C, TIKEH 2015-1X E and TYMPK 1X CE. Three of the bonds have covered with a price on PriceABS in the past three months - AVOCA 13A F at 83.03 on 19 May; LEEK 19X CC at 97.03 on 13 April; and TIKEH 2015-1X E at H80S on 1 June.

Secondary markets

US CLOs solid

Activity in the US CLO secondary market is maintaining a solid pace in the latter half of this week.

"Equity remains the hot choice for investors," says one trader. "It's still the area where you get the most bang for your buck."

Nevertheless, the trader notes a number of lists are offering bonds at the top of the stack today. "Tier 1 triple-As are coming in at around 140bp at the moment. There's a chunky list that holds both Volcker and non-Volcker compliant pieces, so it will be interesting to see the spread difference on the bids."

The trader also reports that tomorrow has a handful of 1.0 equity pieces on offer, but expects activity will remain steady overall as the week closes out. "There's not a tremendous volume scheduled but it's not muted either," the trader adds. "Equally, there is still some activity going on outside of BWICs too."

There are three BWICs on the US CLO calendar so far today. The largest is the above-mentioned triple-A auction, which involves seven line items due at 10:30 New York time.

It comprises: AELIS 2013-IRAR A1A, AVERY 2013-3A A, CGMS 2013-2A A1, CECLO 2013-19A A1A, CIFC 2014-2A A1L, SMLF 2012-1A A, CIFC 2013-3A A1A. Three of the bonds have covered with a price on PriceABS in the past three months, last doing so as follows: AVERY 2013-3A A at L99H on 18 April; CGMS 2013-2A A1 at 98.75 on 30 March; and CIFC 2014-2A A1L at 99.5 on 24 May.

Euro SF risk overestimated?

The amended external ratings based approach (EBRA) for calculating regulatory capital changes in European structured finance (SF) transactions has come under scrutiny in a recent report from Scope Ratings. Entitled 'External Rating Based Approach: One-size-fits-all limits banks' lending capacity', the study analyses the 11 European SF transactions rated by the agency and questions whether the EBRA amendments may result in the overestimation of the expected economic risk in certain tranches.

"In the context where the political objective is to support the real economy through credit, to have a regulatory formula that is handicapping securitisation as an instrument is perhaps self-contradictory," says Carlos Terré, executive director at Scope Ratings. "By limiting the benefit of structured finance as a source of refinancing, it also reduces the much-desired lending capacity of European banks."

The Basel Committee is proposing to adjust the calculation of risk weights for SF tranches by accounting for the legal maturity of the transaction, capped at five years, and the thickness of the tranche invested into, capped at 50%. Before the refinements to the regulatory framework, there was no formula for the ERBA risk-weight calculation.

Risk weights tended to be found in a reference table and were driven solely by external ratings. The table incorporated a differentiation for tranche seniority and underlying portfolio granularity.

The risk weight - now a function of the legal maturity - is subject to a floor at one year and a cap at five years. Scope explains that if the exposures' legal final maturity falls between one and five years, linear interpolation applies. In addition, the risk weight is adjusted for the thickness of the SF tranche, subject to a floor of 50%.

Scope considers that the amendments to the risk-weight formula amplify the delinking of the risk weights from the expected economic risk by its application of these new floors and caps, in addition to the existing ones of 15% and 1,250%.

In particular, the agency notes that senior tranches that account for more than 50% of the SF transaction's capital structure and have an expected WAL of below five years receive the highest penalties in terms of regulatory capital charges. "The distortion is most significant in the senior tranches," explains Terré. "In deals where you find a rapid amortisation of the asset portfolios, you also find that that the senior tranches amortise very quickly. That means that the WAL of those tranches is very short. If you take the now-standard approach - i.e. you take the legal life of the transaction and not the economic life of the tranche - that results in significant overestimation of the risk."

Sebastian Dietzsch, senior analyst at Scope Ratings, adds that senior European ABS tranches often have a tranche thickness that is higher than the 50% cap set by the regulators. "These tranches therefore get an additional penalty due to their sheer size," he says.

Scope's review of the expected WAL for its rated tranches shows that the regulatory cap on lifetime at five years is too much of a one-size-fits-all approach, given the wide difference in expected WAL in various SF instruments and tranches. "Senior and generally least-risky tranches from granular SME CLOs and auto ABS have expected WALs which are significantly lower than the regulatory cap," the agency explains. "This is a result of the strictly sequential structure amortisation schedules and the amortisation path of the underlying portfolio."

In contrast, the riskier mezzanine tranches receive a relative regulatory benefit from the maturity cap, says Scope. These are usually exposed to the long end of portfolio amortisations and therefore have much longer expected WALs and, by this risk exposure, are well above the five-year cap. The same is true for RMBS transactions, where the senior tranches can also have expected WALs above the cap, due to the generally slow amortisation of residential mortgage portfolios.

Based on Scope's calculations, the excess capital consumed for the 11 transactions it analysed represents the equivalent of €1bn worth of additional loans a bank could have lent to the real economy. This is assuming a 100% risk weight for the underlying debt instruments of such transactions. The overall effect in Europe would be even bigger, Scope suggests, as these 11 transactions represent only a small share of the European securitisation market.

"The regulatory framework does not apply an equal treatment to all instruments, which means it modifies the incentives of the arrangers and the dynamics of the market," concludes Terré.

AC

Structured Finance

SCI Start the Week - 6 June

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

Pipeline
The holiday-shortened week resulted in a slowing of the pace of pipeline additions. As well as eight new ABS there was an ILS, two RMBS and a CLO.

The ABS were: CNY3.68bn Bavarian Sky China 2016-1; US$180m CCG Receivables Trust 2016-1; US$300m Harley-Davidson Motorcycle Trust 2016-A; US$324m Oxford Finance Funding 2016-1; US$230m SCF Equipment Trust 2016-1; €1.242bn Sunrise 2016-1; Sfr366m Swiss Auto Lease 2016-1; and Towers CQ 2016.

US$150m Blue Halo Re Series 2016-1 was the ILS, while the RMBS were A$250m La Trobe Financial Capital Markets Trust 2016-1 and US$345m Sequoia Mortgage Trust 2016-1. The sole CLO was €416.8m Avoca CLO XVI.

Pricings
A similar number of deals departed the pipeline. As well as seven ABS prints there was also an RMBS and two CLOs.

The ABS were: US$500m BA Credit Card Trust 2016-1; US$145m Drug Royalty III LP 1 (Series 2016-1); US$400m Hertz Vehicle Financing II Series 2016-3; US$400m Hertz Vehicle Financing II Series 2016-4; US$190m New Jersey Higher Education Student Assistance Authority Series 2016-1; US$317m OneMain Financial Issuance Trust 2016-3; and €190m VCL Master Netherlands.

£262m Oncilla Mortgage Funding 2016-1 was the RMBS. The CLOs were US$508m KKR CLO 14 and US$409m TCI-Flatiron 2016-1.

Markets
The US ABS market "smoked" corporates last month, say Citi analysts. They add: "The ABS market continues to perform well against the corporate market and May was no exception where ABS returned 0.17% compared to negative returns for triple-A and single-A corporates in the Citi 1-5YR BIG index and 0.026% returns for the equivalent WAL triple-B corporate index. Auto ABS as a whole returned 0.23%, with subprime auto as the standout performer, returning 0.44%."

The tone may have picked up around the periphery in European RMBS, but the bulk of last week's secondary market activity took place in the UK BTL and non-conforming space. Bank of America Merrill Lynch analysts comment: "Mezz notes were traded tighter, especially for the higher quality deals, both pre-and post-crisis vintages. The flattening of the curve in these sectors may suggest investors taking a more positive view on the referendum risk ahead, given that it is the non-prime RMBS that would benefit the most from the 'stay' vote."

European ABS in general has been tightening. JPMorgan analysts say: "Away from the UK, generic auto ABS seniors (overwhelmingly Germanic names) tightened 2bp to close at one-month Euribor plus 34bp, and are now at similar levels to those just before the Volkswagen scandal broke out last September."

Editor's picks
Spring surge: 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...
Fair value?: 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 and peer-to-peer 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...
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...
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"...

Deal news
• 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.
• 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.

Regulatory update
• The amended external ratings based approach (EBRA) for calculating regulatory capital changes in European structured finance (SF) transactions has come under scrutiny in a recent report from Scope Ratings. Entitled 'External Rating Based Approach: One-size-fits-all limits banks' lending capacity', the study analyses the 11 European SF transactions rated by the agency and questions whether the EBRA amendments may result in the overestimation of the expected economic risk in certain tranches.
• The Basel Committee has warned banks against conducting capital relief trades. The regulator says such transactions will draw "careful supervisory scrutiny".
• 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.
• 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.
• 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.

Deals added to the SCI New Issuance database last week:
Ally Auto Trust 2016-3; Avis Budget Rental Car Funding Series 2016-2; Carismi Finance 2016; CNH Equipment Trust 2016-B; ConQuest 2016-1 Trust; Driver UK Master Compartment 3; Duncan Funding 2016-1; FCT Laffitte 2016; Firstmac Mortgage Funding Trust No. 4 Series 2-2016; FREMF 2016-KSW1; GMF Floorplan Owner Revolving Trust 2016-1; Greene King Finance (tap 3); HERO Funding Trust 2016-2; Holmes Master Issuer Series 2016-1; Honda Auto Receivables 2016-2 Owner Trust ; Malt Hill No. 1; Octagon Investment Partners 27; Oncilla Mortgage Funding 2016-1; Orange Lion XIII RMBS; Orange Lion XIV RMBS; Orange Lion XV RMBS; Orbita Funding 2016-1; Steele Creek CLO 2016-1; Swiss Credit Card Issuance 2016-1; Synchrony Credit Card Master Note Trust Series 2016-2

Deals added to the SCI CMBS Loan Events database last week:
CSMC 2007-C5; DECO 2007-E2; DECO 8-C2; ECLIP 2006-1 & ECLIP 2006-4; GCCFC 2004-GG1; GCCFC 2006-GG7; GSMS 2006-GG8; GSMS 2014-GC24; JPMCC 2010-C1; LBUBS 2007-C2; UBSBB 2013-C5; WBCMT 2007-C31; WBCMT 2007-C32; WBCMT 2007-C33

Structured Finance

Euro secondary liquidity 'healthy'

Around 80% of European ABS BWICs have successfully traded over the last year, a sign that liquidity in the market remains healthy, according to TwentyFour Asset Management. The asset manager notes that €9.9bn worth of bonds has hit the BWIC market since June 2015, with an additional €5bn when European CLO bonds are included.

TwentyFour says that misconceptions about the liquidity of the market may be driven by the tendency for many market players to buy and hold. However, recent performance figures accumulated by the asset manager suggest that strong BWIC success is a reflection of increasing interest levels from buyers and the realism of sellers' target pricing.

It says that the total ABS outstanding market equalled €1.245trn as at December 2015, breaking down into 48% triple-A rated notes, 47% other investment grade and 5% non-investment grade. RMBS dominates in terms of asset class, comprising over 50% of the outstanding market.

In addition, there has been €76bn of distributed new issuance since June 2015, with RMBS taking up 61% of the portion and auto paper following at 22%.

UK RMBS continues to be the most traded asset by a significant distance, at 45% of total volume, with TwentyFour suggesting that the dominant activity may be in response to the upcoming Brexit referendum vote. Dutch RMBS (9%) and UK CMBS (8%) lag far behind, while the remaining pieces on BWICs were mainly peripheral or German bonds.

Asset managers dominated BWIC activity by contributing 62% of the total volume put up for sale over the last year. Hedge funds were responsible for another 22%, with the remaining 16% consisting of other institutions, such as bank treasuries and brokers.

JA

Structured Finance

REMIC guidance provides clarity

REMICs have long operated with only limited tax guidance, but two significant pieces of guidance have come out this month. The first is a Second Circuit Court of Appeals ruling concerning certain RMBS and the second is an IRS private letter ruling.

The application of the REMIC rules to mortgages that have a high probability of default or credit-based restructuring has historically been one of the toughest areas for tax practitioners to plan for. The court ruling from 2 June confirms that when a loan is defective, it is still able to be a qualified mortgage capable of being held in a REMIC, while the IRS letter from 6 June addresses how a REMIC should treat expenses incurred in the foreclosure of a qualified mortgage.

For the court case, Mayer Brown notes in a memo that many tax practitioners had already worked to the assumption that a defective mortgage could still be a qualified mortgage, even if its defect existed when the loan was contributed to the REMIC. This has now been confirmed.

An entity can only qualify as a REMIC if substantially all of its assets consist of qualified mortgages and other permitted investments. For a mortgage to qualify as a qualified mortgage, it must be principally secured by an interest in real property - which, in this instance, means that the mortgage must be at least 80% of the adjusted issue price of the mortgage at the time it was originated or contributed to the REMIC, or, failing that test, if substantially all of the mortgage proceeds were used to acquire an interest in real property and that property is the only security for the mortgage.

A defective mortgage is either in default or expected to imminently default, or was fraudulently procured by the mortgagor, not in fact principally secured by an interest in real property or does not conform to a customary representation or warranty given by the sponsor or prior owner regarding the characteristics of the mortgage or pool of which it is a part. The court's decision addressed the interaction of the qualified mortgage rules with the defective mortgage rules.

In the case - Jacobson v. Wells Fargo - the bank was accused of fraudulently claiming REMIC status on behalf of a series of trusts, thereby saving around US$1.5bn in taxes in connection with US$12bn of RMBS. The plaintiff argued that the bank had fabricated borrowers' income and employment information, which led naturally to those borrowers being unable to pay, making default reasonably foreseeable and thus rendering the mortgages defective.

The plaintiff argued that such defective mortgages could not be qualified mortgages, but the court disagreed, holding to the definition of qualified mortgages outlined above. It found that holding defective mortgages was not sufficient to lose REMIC status.

The subject of the IRS letter is foreclosure property, which is defined as property acquired in connection with the default or imminent default of a qualified mortgage and which is a permitted asset of a REMIC. Property is not foreclosure property if the mortgage with respect to which the default occurs was acquired by a REIT with an intent to foreclose or if a REIT had reason to know that default would occur.

The IRS emphasised the distinction in the 1990s between the inadvertent acquisition of a mortgage which subsequently defaulted and the acquisition of a mortgage with knowledge that a default was imminent. Holding a mortgage in danger of imminent default could cause a REMIC to cease being treated as such and lead to the imposition of significant taxes.

The IRS' new private letter ruling - PLR 201623007 - involves a REMIC which held a portfolio of commercial mortgages. One loan was secured by a retail shopping mall and the debtor was current on all payments when the REMIC acquired it, with no reason to expect default, so the IRS was able to treat the property as foreclosure property.

Following the bankruptcy of several tenants, the debtor defaulted and the REMIC foreclosed on the loan before becoming the owner of the shopping centre. A long-running issue concerning wastewater system repairs threatened to invalidate the foreclosure property status because such status is only valid for three years and the repairs were scheduled to take longer. The scale of the repairs could also have been too great to allow the property to be classified as foreclosure property.

The IRS was able to waive the requirement that the property be disposed of within three years. It was not able to waive the requirement that no more than limited improvements be made, but could allow the taxpayer to count significant expenditures made by the prior owners as costs incurred prior to default, and measuring expenditures in this way allowed the REMIC to expend no more than the amount permitted for the property to remain a foreclosure property.

"The vicissitudes of the real estate market and their effects on the secondary mortgage market make it increasingly likely that REMICs will hold mortgages that default. The dual developments of the Wells Fargo case and PLR 201623007 offer favourable guidance on how REMICs can address these situations. The good news is that the courts and the IRS both appear intent upon finding solutions that will not disrupt the REMIC market," says Mayer Brown.

JL

Structured Finance

Rapporteurs push for tougher stance

The European Parliament's ECON Committee rapporteurs have published their first drafts for resolutions on the proposed new European securitisation regulations. The tone of the documents suggests a preference for a tougher regulatory stance on securitisation.

"We note these drafts are early versions of the regulations and mainly reflect the opinion of the rapporteurs themselves," Rabobank credit analysts observe. "In our understanding, the documents should be considered as input for further discussions in the ECON Committee."

They add: "As such, these proposals could easily change and it could be the case that some proposals have been made tougher for negotiation tactics. For the state of the European securitisation market in general, however, these proposals are not positive in our view, as unfortunately the stigma on securitisation is back in focus."

Rapporteur Paul Tang has drafted the European Parliament's response to the proposed Securitisation Regulation, which also includes the new framework for Simple, Transparent and Standardised (STS) securitisation. Rapporteur Pablo Zalba Bidegain has drafted a response to the Amendment to the Capital Requirements Regulation (CRR), in which a new framework for setting risk weights for bank securitisation exposures is proposed.

Tang's draft proposes to increase the risk retention rate for all securitisations to 20%. The Rabobank analysts believe that the higher the percentage is set at, the more unattractive securitisation becomes for sellers.

"Having said this, the risk retention requirements are mainly a burden for arbitrage-driven sellers in our view. In contrast, securitisations structured for funding purposes - or even capital relief - are less impacted by these rules, especially if they are sold by bigger banks. Nonetheless, we note that similar skin-in-the-game rules do not exist for other financial instruments and, if there are mandatory minimal levels of overcollateralisation in for example covered bond programmes, they typically do not exceed 5%," they note.

The analysts suggest that it would be easier to comply with these requirements in deals backed by riskier collateral, as the mezzanine and junior tranches are often much bigger than in Dutch RMBS, for example.

However, Tang inserted a hedge against this tough rule, proposing to mandate EBA, ESMA and the EIOPA to allow for a lower risk retention rate for the "market as a whole or for certain segments". Any lowering should be well justified by these agencies.

Additionally, Tang calls for more insight into the investor base. According to the proposal, a new data repository should be established, in which investors and their ultimate beneficial owners should be disclosed, all subject to privacy and market laws.

"We think this is quite a heavy proposal and do not think most investors will like this. As such requirements do not exist for other financial instruments, we fail to see the logic as to how this proposal should make investments in securitisations more attractive," the analysts observe.

Further, in order to promote green investments through STS securitisation, the draft suggests that information on the long-term sustainable nature of the securitisation should be published by originators, sponsors and investors - including how the securitisation contributed to real economy investments and how the original lender used the freed-up capital. For ABCP, it suggests that greater transparency and financial solidity of the sponsors should be required (including at the macro-prudential level), given their provision of full credit and liquidity cover.

An additional proposal would see securitisation investments available only to regulated institutional investors. The explanatory statement at the end of the draft mentions that the 'shadow banking sector' should be excluded from the securitisation market.

"We are not sure what this means, but it seems that private equity and hedge funds are not liked. We doubt whether this is a smart move, as especially for capital relief transactions, these parties are exactly the ones which are able to buy the junior tranches," the analysts add.

Meanwhile, a proposal to create a single source for interpretation of STS criteria is viewed as positive, given the currently proposed requirements for STS securitisations are subject to interpretation.

Zalba Bidegain's draft contains fewer amendments. The major amendment calls for changing the hierarchy of setting risk weights for STS securitisations. Similar to the revised Basel securitisation framework, the proposal to implement this framework in Europe contains three approaches to attach risk weights to securitisation positions: internal rating-based approach (SEC IRBA), external rating-based approach (SEC ERBA) and standardised approach (SEC SA).

In a recent opinion on the proposed regulation, the ECB advocated changing the hierarchy for STS regulation, as some deals - mainly those out of the eurozone periphery - could achieve lower risk weights under the SEC SA approach than following the SEC ERBA approach.

A committee vote on the proposals is expected in November and a plenary vote in the European Parliament in December. But even if the Parliament agrees on the resolutions in their current form, further negotiations with the European Commission and European Council will follow.

"In our view, the tougher the stance of the EP, the longer these further negotiations would take, which also would not be helpful for the market," the analysts conclude.

CS

CMBS

Gap exposure weighed up

Morningstar Credit Ratings has identified 231 CMBS loans totalling US$13.89bn with exposure to struggling US retailer Gap. With more than half the loans backed by collateral where leases are set to expire in the next two years, closing stores could impact CMBS deals sooner rather than later.

Gap - which also owns the Old Navy, Banana Republic, Athleta and Intermix brands - reported its comparable-store sales in May, showing a fall of 6%. The company reported a 1Q16 revenue of only US$3.44bn, while also announcing intended international store closings, most of them being Old Navy stores in Japan. However, Morningstar indicates that underperforming US stores may be shuttered too.

The agency says that although the majority of CMBS properties exposed to Gap's brands would be minimally affected by a potential departure, loans that list the company's stores as a large tenant and have low DSCRs are at a heightened risk. A total of 32 loans at a combined US$819.4m could see their property's occupancy fall below 80% if the retailer vacated. 

One notable loan of concern is the US$35.8m specially serviced Steeplegate Mall, which accounts for 97% of BACM 2004-6 and has a 0.54x DSCR. The already distressed loan was transferred to the special servicer in April 2014 because of its weak cashflow after the departures of multiple tenants. The loan defaulted in August 2014 and became real estate owned in March 2015 and Gap's departure would lead to a projected US$18.5m loss on the property.

In addition, Gap occupies 100% of the gross leasable area at the Alexandria, Virginia property that backs the US$2.9m King Street loan in MSC 2008-T29. Despite the loan's low LTV ratio of 34.4% and high DSCR of 2.13x at issuance, the retailer's departure would render these statistics meaningless. The loan, which is current, matures in January 2018 - one month before Gap's lease is up at the property.

Morningstar adds that Old Navy is currently the primary concern and could have a disproportionate impact on CMBS compared with the Gap or Banana Republic brands. Despite being the low-cost alternative to Gap's pricier brands, Old Navy occupies 69.6% of the company's square-footage in CMBS and saw May store sales down 7%.

JA

RMBS

UK BTL portfolio sale planned

UKAR plans to follow last year's £13bn Granite portfolio sale (SCI 15 November 2015) with the offloading of a further £16bn in mortgages, understood to be the pool backing Bradford & Bingley's outstanding Aire Valley master trust securitisation programme. The sale process is expected to start this year.

B&B launched Aire Valley in 2004 and issued around £8.7bn of securitised notes through mid-2008, around £4.9bn of which were distributed to investors. The mortgage book was brought into UKAR in 2010, before eventually breaching a non-asset trigger (NAT) in May 2012 (SCI 11 May 2012).

Since the breach, principal payments have been prioritised to the funding share, with the senior bonds paying according to legal final maturity. The subordinate classes will be paid sequentially once the senior bonds have been paid down, with each bond in a given class receiving pro rata principal.

As of the most recent reporting period, £3.1bn of distributed bonds and £2.5bn of retained bonds remain outstanding in the programme, while the seller share totals £2.8bn. This makes Aire Valley the second-largest BTL programme behind Paragon and means Aire Valley accounts for a fifth of the distributed UK BTL market outstanding.

Of the outstanding Aire Valley bonds, JPMorgan analysts believe 77% are seniors. By currency, 41% are sterling-denominated, 38% are euro-denominated and 20% are US dollar-denominated.

Whereas the NRAM pool had 13% BTL loans, AIREM contains 69% BTL loans. It also consists of 94% interest-only loans, compared to 40% for Granite when that pool was sold.

Leverage in the B&B book is more conservative than NRAM's, with a current weighted average LTV of 68.3% versus 73.2% for NRAM around the time of its sale. The percentage of 90-plus days delinquent loans is also lower.

The Granite sale to Cerberus took over a year. The UK government says it intends to compete the Aire Valley sale by the end of 2018, giving a 30-month window.

The JPMorgan analysts believe that other than issuers well established in the BTL market - notably Paragon - interest is most likely to come from more opportunistic buyers. Bank lenders may not see value in moving from prime lending so heavily into the BTL space.

Whoever buys the pool will have to address the securitisation positions. There are three main avenues they could go down.

First, a buyer could opt to effectively purchase the £2.8bn seller share and £2.5bn of retained portion of AIREM, and leave the funding share outstanding. The analysts believe a buyer could then potentially roll the funding or access the Bank of England's FLS or third-party repo, thereby achieving a lower capital outlay for the purchase. Bondholders would experience a rise in prepayments in this scenario.

Second, a buyer could issue additional bonds from the master trust, which would drive an increase in the blended funding cost of the structure but ultimately lever the overall position. Bondholders would expect to see slower principal repayments as cashflows would be distributed across larger notionals.

Finally, a buyer could call the bonds, as Cerberus did with Granite. The structure would have to be called in full and doing so would meaningfully shrink the UK BTL RMBS market. Full repayment would provide a need for investors to reinvest into other assets and may lead to new issuance backed by the prior Aire Valley pool.

Whichever route is taken, the analysts expect bondholders to be repaid in full. They also believe that the outstanding bonds could currently offer value.

"Prices on AIREM bonds across the capital structure have drifted substantially higher post-NAT breach on the growing assumption of full repayment, with indicative prices for AIREM seniors in the 97-98 range. In our base case scenario of 8% CPR, 0.5% CDR, 30% loss severity, and a six-month lag to recovery, the average DM on AIREM seniors at current prices is 110bp, inside indicative secondary levels for the broader BTL universe," say the analysts.

Increasing the prepayment speed to 10% CPR pushes the average DM to 125bp, and there could be better value in a call scenario. Maintaining the 8% CPR base case, an optional redemption in 18 months would result in a spread pickup of 100bp for the senior bonds, while a redemption in 12 months would result in a pickup of 160bp. These figures equate to DMs of 200bp and 270bp respectively at a much shorter average life.

Current indicative DMs suggest Aire Valley seniors trade 40bp-60bp inside pre-crisis Paragon seniors, although at a much shorter WAL, and 15bp-25bp inside newer vintage Paragon bonds. However, Paragon bonds do not have the call upside now embedded in the AIREM structure.

It will be up to investors to decide on the likelihood and timing of a call. The analysts believe current bondholders should see value in maintaining their positions considering the potential for significant pickup if the bonds are called. UK RMBS investors lacking current AIREM positions could benefit from adding exposure.

They conclude: "Taking into account the current situation, we recommend investors with capital to put to work consider adding AIREM exposure to supplement existing UK prime and/or BTL positions, but would refrain from actively swapping into AIREM by selling other assets at current levels, as we see continued appeal in wider BTL opportunities such as PARGN."

JL

RMBS

Non-prime RMBS debuts

Caliber Home Loans is in the market with the first post-crisis RMBS backed by newly originated non-prime mortgage loans. Dubbed COLT 2016-1 Mortgage Loan Trust, the US$161.71m transaction is backed by 368 loans with credit scores (701) similar to legacy Alt-A collateral.

The pool comprises fixed- and adjustable-rate, prime and non-prime first-lien residential mortgages originated under five programmes: Jumbo Alternative (accounting for 34.8% of the collateral); Homeowner's Access (50.1%); Fresh Start (10.5%); Investor (4.2%); and Foreign National (0.4%). DBRS notes that although the loans were originated to satisfy the CFPB ability-to-repay (ATR) rules, they were made to borrowers that generally do not qualify for agency, government or private label non-agency prime jumbo products.

In accordance with the CFPB qualified mortgage (QM) rules, 2.6% of the loans are designated as QM Safe Harbour, 41.4% as QM Rebuttable Presumption and 51.8% as non-QM. Approximately 4.2% of the loans are not subject to the QM rules.

Rated by DBRS and Fitch, the deal comprises US$89.42m A/A rated class A1 notes, US$48.35m BBB/BBB class A2s, US$9.06m BB/BB class M1s and US$14.88m unrated class M2s. There are also US$89.42m A/A rated class A1X and US$48.35m BBB/BBB class A2X IO tranches.

Compared to a post-crisis prime jumbo securitisation, COLT 2016-1's R&W framework is considerably weaker, according to DBRS. Instead of an automatic review when a loan becomes seriously delinquent, the transaction employs an optional review only when realised losses occur (unless the alleged breach relates to an ATR or TRID violation). In addition, rather than engaging a third-party due diligence firm to perform the R&W review, the controlling holder (initially the sponsor or a majority-owned affiliate of the sponsor) has the option to perform the review in-house or use a third-party reviewer.

Finally, the R&W provider - Caliber - has limited performance history of non-prime, non-QM securitisations and may potentially experience financial stress that could result in the inability to fulfil repurchase obligations. However, DBRS points to a number of mitigating factors.

Among these are that the sponsor (or an affiliate) will retain not only the residual interest, but also the M1 and M2 tranches initially. Noteholders representing a 25% interest in the deal may also direct the trustee to commence a separate review of a mortgage loan to the extent they disagree with the controlling holder's determination of a breach. Additionally, third-party due diligence was conducted on 100% of the loans included in the pool, thereby mitigating the risk of future R&W violations.

CS

Structured Finance

Natixis recruits for trading push

Natixis has recruited Reginald Fernandez as executive director and head of its newly formed global structured credit and solutions credit trading team in the Americas. The team will be active in ABS and CLO trading, as well as repos.

Fernandez joins the firm following his most recent role as co-head of CLO sales and trading at Brean Capital. He has also held roles at Mashreq Bank, Deutsche Bank, UBS and Kidder Peabody.

Fernandez will report to Brad Roberts, head of credit trading Americas at Natixis.

Structured Finance

REIT pro snapped up

Hunton & Williams has hired Robert Smith as a partner to its real estate capital markets practice. His practice focuses on REITs, with a focus on the mortgage REIT space, including publicly traded mortgage REITs on securities offerings and corporate and securities law reporting matters.

The law firm adds that Smith's experience will include significant contributions to securitisation. Prior to moving, he was a partner at K&L Gates.  

Structured Finance

Index research head named

Markit has appointed Aram Flores as md and head of index research and development, based in New York. Part of his remit is to explore new index opportunities within US fixed income and expand into cross-asset products.

Flores previously spent 13 years at Deutsche Bank, where he co-headed index and ETF research and development. He had overall responsibility for the bank's index platform and managed a global team focusing on index construction across a broad range of financial products and asset classes.

Prior to this, Flores led Lehman Brothers' index business in Europe and held various index and strategy roles in the industry for 15 years.

Structured Finance

Apollo reshuffles

Apollo Investment has appointed Howard Widra as president, following on from his most recent role as co-head of direct origination for Apollo Global Management. Widra replaces Edward Goldthorpe, who resigned the post along with his role as cio of Apollo Investment Management (AIM).

The company has also made further moves with AIM's deputy cio Tanner Powell named as the unit's cio. In addition, Patrick Ryan has been given the title of AIM's chief credit officer to formalise his existing role as md.

Structured Finance

Leadership appointments unveiled

IHS and Markit have announced senior executive leadership appointments for IHS Markit, following the consummation of their merger of equals (SCI 21 March). The appointments will be effective upon completion of the merger, which is expected to close in 2H16.

Jerre Stead, IHS chairman and ceo, will assume the same role for IHS Markit. Lance Uggla, chairman and ceo of Markit, will be president and a director of IHS Markit. He will assume the role of chairman and ceo of IHS Markit upon Stead's retirement on 31 December 2017, and will also serve as chief integration officer, leading the integration of the two firms.

The other senior executive leadership team members reporting to Stead are: Daniel Yergin, vice chairman (currently vice chairman of IHS); Todd Hyatt, evp and cfo (evp and cfo for IHS); Shane Akeroyd, evp-global head of account management and regional head of Asia Pacific, based in Hong Kong (head of sales for Markit); Jonathan Gear, evp-resources and transportation (holding the same position for IHS); Sari Granat, evp and general counsel (general counsel for Markit); Randy Harvey, evp and chief technology officer (svp and cto for IHS); Adam Kansler, evp-financial markets (co-head of information for Markit); Yaacov Mutnikas, evp-financial market technologies (co-head of solutions for Markit); Jane Okun Bomba, evp and chief administrative officer (svp-marketing, chief sustainability and communications officer for IHS); Jeff Sisson, evp and chief of staff (svp and chief human resources officer for IHS); and Michele Trogni, evp-consolidated markets and solutions (co-head of solutions for Markit). The IHS Markit board of directors and other leadership roles are expected to be announced around the time of the closing of the merger.

Structured Finance

AMG buys stake in five firms

Affiliated Managers Group (AMG) has agreed to purchase 100% of a minority stake in five firms owned by a Goldman Sachs-managed investment vehicle. Petershill Fund I will sell its combined US$800m in equity interests in Capula Investment Management, CapeView Capital, Winston Capital Group, Partner Fund Management and Mount Lucas Management.

Upon completion of the deal, AMG's AUM is expected to increase by US$55bn to nearly US$700bn, while its economic earnings per share would go up by 50 cents to 80 cents in 2017. Senior management at each of the firms will continue to hold a majority of the equity in each of the respective businesses and retain autonomy of their operations.

The transaction sees AMG gain an equity stake in two firms - Capula and CapeView - that focus on credit. Capula manages approximately US$12.7bn in AUM and follows absolute return, enhanced fixed income and tail risk strategies. CapeView, with roughly US$1.7bn in AUM, operates a European credit and distressed fund.

The closing of the deal is expected during 2H16. AMG's investment in interest, representing approximately half of the total transaction value, is expected to close by 3Q16. The balance of the investment is expected to close by year-end.

Structured Finance

Fund misuse settlement agreed

A UK-based investment adviser and its cio have agreed to settle US SEC charges that they breached their fiduciary duties by operating two private funds in a manner inconsistent with prior disclosures. James Caird Asset Management (JCAM) and Timothy Leslie will pay more than US$2.5m to settle the charges.

JCAM and Leslie told the board and investors of the JCAM Global Fund that there would be little expected trading overlap with the much smaller JCAM Credit Opportunities Fund. However, most of the latter's positions did indeed overlap with the Global fund.

Leslie owned a much larger percentage of the Opportunities fund than he did of the Global fund and also invested far more money in that fund. The SEC found that he routinely allocated as much as 100% of highly profitable short-term, liquid, underwritten offerings to the Opportunities fund.

The SEC says JCAM failed to completely and accurately disclose the nature and extent of the trading overlap and the allocation practices. JCAM and Leslie neither admit or deny the findings, but Leslie has agreed to pay disgorgement and prejudgment interest of approximately US$1.9m and a US$200,000 penalty, and JCAM has agreed to pay a US$400,000 penalty.

Structured Finance

Business development exec hired

Monica Blocker has joined Houlihan Capital as a vp of business development, joining Michael Norton. Blocker will be responsible for building and maintaining client relationships throughout the US. She joins Houlihan from Geneva Advisors, where she was part of the institutional sales team.

Risk Management

ISDA appoints general counsel

ISDA had appointed Katherine Darras as general counsel in an additional move to the expansion of its board of directors (SCI 9 June). In her role, Darras will lead ISDA's efforts to develop legal standards, documentation and opinions necessary to support global cleared and non-cleared derivatives businesses.

Darras' responsibilities will also include the development of documentation for facilitating compliance with new derivative regulations. These regulations will encompass margin rules for non-cleared derivatives, the expansion of the ISDA Resolution Stay Protocol and the ongoing publication of close-out netting, collateral and clearing opinions.

Darras has held previous roles for ISDA, including general counsel for the Americas and assistant general counsel prior to that. She has been acting general counsel for the organisation since January of this year.

Risk Management

ISDA expands board

ISDA has appointed two new members to its board of directors after it decided earlier this year to expand its size and scope. The new directors are Credit Suisse's global head of prime derivatives services, John Dabbs, and the president of global operations, technology and risk for CME Group, Kim Taylor.

Dabbs' role at Credit Suisse sees him focus on listed derivatives and cleared swaps. He has also held senior, derivative-linked positions for Lehman Brothers and Nomura.

Taylor oversees CME's operational functions on a global scale, including clearing, operations, technology and platform development. She will sit on the ISDA board for just a year, as part of a new revolving seat initiative to allow other CCP representatives to provide their input.

Simultaneously, ISDA has established a new CCP committee to complement the trade organisation's existing work in cleared derivatives. The new committee will provide a forum for ISDA's CCP members to discuss the regulatory, legal, policy, risk and infrastructure issues facing CCPs and cleared derivatives.

ABS

Navient extends three more deals

Navient has extended a further US$1.1bn in FFELP student loan ABS. The amendments include the extension of the legal final maturity dates for the A7 and B tranches of SLM Trust 2003-14 to 2065.

SLM Trust 2004-3's A6 and B tranches have also been extended to 2064, while the maturity date on the subordinate tranche of SLM Trust 2014-1 has been extended to 2068. Since December, Navient has now extended the legal final maturity dates on US$6bn of bonds from FFELP securitisations.

ABS

PACE deal sets landmark

Renovate America has priced the largest PACE ABS to date, a US$305.3m designated green bond. HERO Funding Trust 2016-2 is the seventh deal from Renovate, pushing the programme's total issuance to US$1.35bn.

The transaction comprises a single tranche of class A notes, rated double-A by Kroll Bond Rating Agency. The notes are secured by 13,432 PACE assessments levied on residential properties across California. The PACE loans have an average balance of US$24,433 and were originated between January and April of this year.

"This transaction is our most successful issuance so far in terms of the level of interest from investors, including, for the first time, international investment," says Renovate America's ceo JP McNeill. "This private capital is directly benefitting homeowners and communities by lowering utility bills, reducing carbon emissions and creating clean energy jobs."

The news follows a successful first-half for the HERO platform after it hit the US$1bn mark earlier this year (SCI 15 February).

ABS

Malaysian MTN programme readied

Amanah Saham Nasional Berhad (ASNB) is prepping the first issuance under its new RM10bn Perpetual Nominal Value MTN Amanah Saham Bumiputera (ASB) securitisation programme. Dubbed Westeros Capital, the deal is the first rated Malaysian ABS involving personal loans secured against ASB investments.

The Series 2016-1 transaction is expected to comprise RM970m class A and RM30m subordinate MTN notes, preliminarily rated AAA/stable and BBB2/stable by RAM Ratings. Under the terms of the programme, the issuer may issue discrete series of MTNs from time to time, each backed by its own portfolio of ASB loans. A default on any MTN series will not cause a cross-default on the other outstanding MTN series.

The ASB funds are open-ended, fixed-price unit trust funds that benefit from ASNB's repurchase obligation. Series 2016-1 is the first rated transaction involving financial assets that relies on refinancing or a sale of collateral to make full and ultimate principal redemption by the final legal maturity of the rated MTNs.

RAM believes that the profile of the ASB loans - including the broad homogeneity of ASB loan products and their semi-regulated nature - adds to the attractiveness of these loans as an asset class. In particular, the fixed-price repurchase obligation by ASNB reduces the credit risks of the portfolio and moderates concerns about price volatility.

Under the terms of the programme, the issuer may use excess principal collections to purchase new ASB loans until an early amortisation event is declared, upon which the transaction will start to deleverage. Principal redemption of the MTNs is expected to be primarily met through a refinancing exercise and, secondarily, through a sale of the underlying ASB loan portfolio.

ABS

Auto ABS ratings RFC issued

Scope Ratings has issued a request for comment on its proposed auto ABS rating methodology. The publication of the methodology will not impact any outstanding ratings.

The proposed auto ABS methodology applies to securitisations of auto loans or leases that finance new or used vehicles, including transactions exposed to residual value and voluntary termination risks. The methodology complements the rating agency's general structured finance rating methodology. Market responses are requested by 15 July.

ABS

Fitch finalising SLABS update

Fitch is in the final phase of updating its criteria for US FFELP student loan ABS. The rating agency expects to publish the new criteria within 60 days.

The final phase of the criteria review includes transaction testing and model validation. Revisions have been made to reflect changing payment behaviour and loan status trends in FFELP collateral, with slower payment rates placing some transactions at risk of missing stated maturity dates.

Key criteria changes are expected to include: using a constant default rate approach to replace the FFELP default model and default timing curves in the maturity scenarios; changes to deferment assumptions, floor and stresses in the maturity scenarios; changes to forbearance assumptions, floor and stresses in the maturity scenarios; revised assumptions to include loan forgiveness for outstanding loans in IBR, starting in 2036 and over a set window of time; and a revision from a single-A cap to a double-A cap for bonds that fail certain maturity stresses.

Fitch is also considering an approach to modelling cashflows post an EOD. Under the approach, the agency would assume that no collateral liquidation will occur upon an EOD and all cash collections post-EOD will be used to pay down senior note interest and principal pro rata before applying it to subordinated notes.

Fitch expects to complete rating changes within three months of finalising and publishing its new criteria.

Structured Finance

Placed issuance declining

€56.9bn of securitised product was issued in Europe in 1Q16, a decline of 20.4% from 4Q15 (€71.4bn) but an increase of 61.2% from 1Q15 (€35.3bn), according to AFME's latest securitisation data report. Of the total issued during the quarter, €14.3bn was placed (representing 25.2% of issuance), compared to €15.6bn placed in 4Q15 (21.8%) and €19.7bn placed in 1Q15 (55.9%).

For the first quarter, UK RMBS continued to lead placed totals (at €5.8bn), followed by European CLOs (€2.6bn) and Dutch RMBS (€1.8bn).

Net issuance remained negative, with €1.27trn outstanding at end-1Q16, down from €1.3trn at end-4Q15. Of this, €718.1bn - or 56.8% - was retained.

AFME notes that upgrades outpaced downgrades in Q1 across European securitised product, with upgrades concentrated in European CLOs and RMBS.

Meanwhile, European ABCP issuance stood at €95.8bn at end-1Q16, a decrease of 16.2% quarter-on-quarter and an increase of 16.5% year-on-year. Multiseller conduits continue to dominate as the largest category of issuer in the ABCP market, particularly from Ireland and France.

European ABCP outstandings decreased slightly from the previous quarter, ending Q1 at €17.9bn, down by 2.2% from €18.3bn in 4Q15.

Structured Finance

Vacancy decline supporting SFR deals

Nationwide rental vacancy in the US is presently 7%, down from 11% in 2009, according to the US Census Bureau. Moody's believes that this drop in vacancy bodes well for the single-family rental securitisations it rates, especially regarding anticipated future enhanced rental revenue, as Generation Y renters are a large component of SFR renters. It also portends higher liquidation proceeds on potential sales of SFR properties.

Home ownership rates in the US continue to decline from pre-crisis highs to very low levels for households headed by younger Generation Y individuals. For individuals aged 35 and younger, the home ownership rate declined from 40.4% in 4Q09 to 34.2% in 1Q16. For those in the Generation X cohort (aged 36 to 51), the decline over the same period is from 65.7% to 58.9%. For households headed by individuals aged 45-54, the rate of decline has fallen from 74% to 69.2%, although remaining well above the national average of 63.5%.

According to the National Association of Realtors (NAR), overall US home buyer affordability remains high, due mainly to low mortgage rates. The First Time Homebuyer Buyer Index, however, continues on a negative trend - falling to a value of 1133 in 1Q16 from a value of 116 in 2013.

This drop is the result of more expensive homes and lagging income growth. Low interest rates have not had the expected positive impact on the Gen Y cohort, which represented 67% of first-time home ownership in 2015.

On top of stagnant income, high non-mortgage debt also increases the burden of US households. Even though absolute household debt has declined marginally from 2008 highs, student loan and auto indebtedness has grown considerably to 10% and 9% respectively of total debt held by consumers at 3Q15.

In addition, a low inventory of homes for sale - especially of starter homes at low- to mid-tier home prices - can discourage potential first-time homebuyers. Moody's notes that the current monthly supply of homes remains well below the recent peak in availability of late 2008 and marginally below the six months' supply that economists generally consider a balanced supply.

Meanwhile, the Inflation-Adjusted US Rent of Primary Residence is up 15% since 2000, with year-over-year growth of around 3%. This upward trend is in line with home price appreciation and strong consumer demand for rentals as the rate of home ownership rate declines. Median asking rent for vacant rent units as reported in the US Census survey continues to rise, averaging US$850 nationally in 4Q15, up from approximately US$675 at commencement of the financial crisis.

"We believe the increasingly unattainable goal of home ownership for many, in tandem with the low national rental vacancy rate, will persist and continue to buoy rental demand and the ensuing higher rents - both of which bode well for SFR cashflows," Moody's observes. "The majority of SFR rental properties in transactions that we rate are located in or near urban centres, but these do not include the largest MSAs in the northeast and the west, where very high home prices and related rents are less economic for SFR securitisations."

As of March 2016, the vacancy rate of the rental properties backing SFR securitisations was 4.2%. Moreover, SFR operators have been able to secure monthly rents on new leases and lease renewals that are 3% to 6% higher than on previous leases. The transactions are all generating monthly rental revenues of 3.6x to 6.1x the monthly distributions necessary to service the debt obligations.

Structured Finance

Russian regs choking issuance

S&P expects Russian structured finance issuance to dampen for the rest of the year due to recent regulatory changes. Financial market turbulence, a decrease in origination of underlying loan assets, asset deterioration and diminishing state support for investor demand have already hit issuance in the country this year.

As of 1 January, the Central Bank of Russia increased the risk weight for junior tranches in structured finance transactions to 1,250% from 100%. Tighter capital requirements have particularly reduced banks' origination capacity in traditional ABS and RMBS, contributing to a further slow-down in market activity.

"Although this has pushed down many loan originators' regulatory capital adequacy ratios, it does not change the calculation of our risk-adjusted capital ratio and therefore has no effect on our ratings on structured issues and originators," says S&P analyst Anastasia Turdyeva.

Nonetheless, Turdyeva explains that it will discourage new deals that incorporate junior tranches, since it will increase the risk potential on subordinate losses. This adds to an already lowered investor demand and weakening growth of underlying assets in the market.

However, the agency suggests that originators could push out alternative structures and solutions to offset the negative effect from higher risk weights. Among the options being discussed by market players is the sale of existing junior tranches.

An additional option could be a significant reduction of the proportion of junior tranches, in favour of using subordinated loans, reserves or mezzanine tranches as a form of credit enhancement. The other approach could just be to issue transactions with no structurally subordinated components. The question that remains for such solutions though is whether they will accommodate investor needs.

"Russia's small investor base has been the main constraint to the securitisation market's evolution since its inception," says S&P analyst Irina Penkina. "Possible changes in regulatory requirements affecting the risk-weighting of structured notes on investors' balance sheets will be a crucial element influencing investor appetite for securitisation products in Russia."

Structured Finance

Brazilian trustees feeling squeeze

Smaller trustees will have to exit the Brazilian securitisation market or merge with larger competitors, says Fitch. This is because of markedly decreased issuance, high operating costs and low profitability.

Smaller, lower-capitalised companies which rely on non-recurring structuring fees to cover ongoing operating expenses are expected to feel the most pressure. The rating agency notes that companies which only act as third-party service providers usually generate sizeable structuring fees at issuance, but marginal recurring trustee service fees over the life of the deal.

The Brazilian securitisation market is already highly concentrated and smaller companies may find it difficult to merge with larger ones. Just three of the market's 30 or so companies account for nearly 60% of market share in mortgage-backed certificados de recebiveis issuances (CRIs), for example.

"We believe that inherent operating risk in some CRI issuances might increase if smaller firms cannot properly maintain personnel and systems to control and monitor existing issuances," says Fitch. CRI issuance has grown rapidly since 2010 and reached R$60bn, which is 1% of national GDP.

However, structured product issuance has fallen 47% since the start of this year. Some companies have diversified trustee services beyond mortgages into agribusiness loan-backed issuances, which has driven up competition there as well.

Structured Finance

Commingling risk concerns rating agency

EMEA ABS is showing increasing credit exposure to the seller/servicer through commingling risk and other risks contingent on the financial quality of the seller/servicer, says Fitch. The rating agency believes this is accounted for in Fitch-rated transactions, but is not being sufficiently addressed in the wider market.

Counterparty and seller/servicer ratings have drifted downwards over the past several years, with corresponding higher default probability increasing the likelihood of exposure to commingling or other seller/servicer-contingent losses. Fitch believes investors may not be aware of these risks or may be underestimating them in their analysis.

The agency notes that other rating agencies may allow for a greater level of commingling risk because it is deemed 'immaterial'. Prime auto transactions can have one-month commingling exposure of up to 4% of a transaction's asset balance, for example.

"As senior notes of these transactions typically benefit from credit enhancement between 7%-10% of the asset balance, commingling exposure could represent 20% to 50%-plus of total enhancement - which we deem a 'material' amount," says Fitch.

The agency believes that material exposures to the seller/servicer should be addressed via the same minimum rating expectations for the collection account bank holder as for issuer account banks, swap counterparties and liquidity facility providers in cases where no other structural mitigants are in place. If the risks are not adequately mitigated, the transaction cannot achieve or maintain a triple-A rating.

Structured Finance

Firm launches third credit fund

AnaCap Financial Partners has closed its third credit fund after initially upsizing it on investor oversubscription. The AnaCap Credit Opportunities III fund holds a €595m mandate to target performing, semi-performing or non-performing credit assets that primarily comprise consumer, SME and mortgage debt across Europe.

The fund is approximately 30% larger than its predecessor vehicles and was upsized from an original capacity of €550m. The debt instruments that the fund will target include loans, leases, securities or other obligations that require granular analysis for pricing and active asset management.

The fund used Gibson, Dunn & Crutcher as legal advisors. Combined with AnaCap's latest private equity fund, the firm has now closed funds totalling nearly €1.5bn in 2016.

CDO

Steady CDO growth projected

The global CDO market is expected to grow at an annual growth rate of 5% between 2016 and 2020, according to a new report by Technavio. However, the research firm says that this should be expedited by growth in the integration of global financial services within the same period.

The report outlines two other trends that will also contribute to CDO volume, which are a dynamic market structure and third-party due diligence services. It says that due diligence - a primary mandate under Dodd-Frank - continues to increase public reporting standards, which is an advantage for issuers and underwriters.

This, in turn, will allow transparency to yield greater insights into the securitisation process. As a result, Technavio believes this could modify investor contributions to portfolio diversification going forward.

The report also notes that enhanced strategic formulation and the adoption of structuring and pricing tools will be an ongoing beneficial trend in the CDO market. Strategies such as risk management analytics and versatile market standard models help in the shaping and pricing of the currency exchange execution, the report explains.

CDO

CFO deal prepped

Astrea Capital, a subsidiary of Azalea Asset Management, is in the market with a collateralised fund obligation. Astrea III consists of notes backed by the cashflows generated by a pool of 34 private equity funds.

Fitch has rated the S$234m class A1 notes single-A, the US$170m class A2 notes single-A and the US$100m class B notes triple-B. The notes are expected to be marketed to non-US institutional and high net-worth investors, and listed in Singapore.

The transaction consists of US$1.14bn NAV of funded commitments and US$201.4m of unfunded capital commitments across 34 private equity funds of various vintages, with 592 underlying investments across different sectors and regions, tempering market cyclicality. The sponsor holds the entire equity stake in Astrea III and will retain this for the duration of the transaction.

CLOs

Mezz CLO fund offered

AXA Investment Managers has launched the AXA IM Novalto - CLO Credit Fund, which will invest in mezzanine CLO tranches. The fund aims to offer investors 6% to 8% net performance with an expected annual volatility of 3% to 5%, while maintaining an investment grade average rating.

AXA IM says that the fund seeks to take advantage of the current attractive spreads in CLOs and offers an option for investors who want to access alternative credit strategies but also retain some liquidity. The firm notes that CLO debt tranches have demonstrated their ability to remain resilient through various market cycles and, as floating rate instruments exposed to senior secured loan markets, they can help investors limit their exposure to interest rate risk.

Christophe Fritsch, co-head of securitised and structured assets and head of structuring at AXA IM, comments: "We believe that CLO tranches represent a significant market opportunity currently relative to traditional credit instruments. This is due to the considerable widening in CLO spreads driven by the macroeconomic environment, especially the decline in oil price, as well as some recent forced selling by hedge funds. CLO mezzanine tranches can also offer high credit enhancement, which can provide investors support against potential future losses."

The firm says it has already seen significant client interest in the fund, including a US$50m-plus investment from its first investor. It expects to see further interest from pension funds and family offices primarily across Switzerland, Germany and the Nordics.

The fund - a FCP SIF domiciled in Luxembourg - invests in both dollar- and euro-denominated CLO debt tranches, and offers investors monthly liquidity. It will be available to investors in Belgium, Denmark, Finland, France, Germany, Italy, Luxembourg, Sweden, Switzerland, the Netherlands and the UK.

CLOs

Negative trade date usage surveyed

European CLO managers have increased their use of negative trade date principal cash balances to minimise the impact of negative interest rates, according to a recent Fitch survey. Managers mostly rely on announced repayments as the main source of prospective funding for committed trades in excess of the available trade date principal cash balance. Only a few managers occasionally rely on asset sales in addition to announced repayments.

The majority of managers polled are of the opinion that this strategy does not expose their CLOs to additional default or liquidity risk. A majority indicated to Fitch that the fund could be impacted by additional market value risk when the negative trade date principal cash balance is not covered by announced repayment. Most managers agreed that more disclosure on the use of this strategy would be beneficial for investors.

Fitch received responses to its survey from 13 different CLO managers active in the post-crisis European market. These managers represent 43 post-crisis European CLOs, accounting for approximatively 45% of the European post-crisis universe.

CMBS

CMBS loss severities recover

US CMBS loss severities dropped in 1Q16 to 49.3% across 143 loans after posting high weighted averages to close out last year, according to Moody's. The figures represent a decrease from the 58.2% weighted average loss severity posted across 240 liquidated loans in 4Q16, but are still higher than the 42.8% average since January 2000.

"Loan liquidations from the troubled 2006 to 2008 vintages were a major driver of the above-average loss severity in the first quarter of this year," says Moody's associate md Keith Banhazl. "Those vintages accounted for 88% of liquidated loans by balance during the quarter, the highest share since we began tracking CMBS loan loss severities in 2010."

Of the 1998 to 2016 vintages, the 2008 vintage had the highest loss severity in 1Q16, at 59.3%. The 2006 and 2007 vintages had the second and third highest loss severities, at 48.5% and 44.4% respectively.

Two loans liquidated with a loss amount of more than US$100m and loss severities at or above 50% in the past quarter. These were the Bank of America Plaza in Atlanta, which liquidated with a US$202m loss for a loss severity of 55.7%, and Riverton Apartments in New York, with a US$112.5m loss for a loss severity of 50%. The loss on the former was the fourth highest recorded since January 2000.

In addition, Campus Habitat 15 liquidated during 1Q16 with a loss of US$7.1m and a severity of 57.3%. This is the first substantial loss recorded for a CMBS 2.0 transaction.  

CMBS

A/B loan transfers eyed

Fitch reports an up-tick in US CMBS loss severities as more modified A/B loans transfer back to special servicing. The agency adds that many A/B loan modifications have still not stabilised and are unlikely to be able to refinance in the current market.

Loss severities are likely to continue increasing as modified A/B loans transfer back to special servicing, according to Fitch director Melissa Che. The primary reason for this is due to adverse selection. If the outstanding B-notes are considered write-downs, the loss severity for A/B loans would be approximately 23%, the agency says.

Fitch has identified 26 previously modified A/B loans (totalling US$2.14bn) as transferring back to the special servicer post-modification. Of that total, 16 transfers took place in the last two years. The agency has identified 186 loans (US$11.73bn) that were modified into A/B loans within the Fitch-rated CMBS conduit universe.

A/B loan modifications have become less common as a workout strategy among special servicers over the past two years, as many underperforming legacy loans have already been modified and liquidity has returned to the market. Approximately US$1.15bn of loans were modified into A/B notes in 2014 and 2015, which is one-third of the peak volume of US$3.58bn in 2011.

CMBS

Liquidation volume climbs

US CMBS liquidation volume climbed to US$854.5m in May, up from US$436m in March and US$501.5m in April, according to Trepp. Last month 72 loans that averaged US$11.9m in balance were paid off.

Including two B-notes totalling US$29.1m, eight loans comprising US$87.1m paid off with over 100% in losses. The top five loans disposed of with the highest losses last month were all anchored by retail properties.

Backed by a 746,410 square-foot mall in Reading, Pennsylvania, the US$33.3m million Fairgrounds Square Mall ranks as the loan with the highest loss severity in May, at 123.25% (see SCI's CMBS loan events database). In addition to low tenant sales and high maintenance fees from severe winter storms, the property suffered from the closure of its main tenant, an outlet spin-off of JCPenney.

Other noteworthy retail loans with heavy losses are the US$63.7m Coventry Mall and the US$30m Temple Mall, which were resolved with 81.2% and 91.54% in losses respectively.

May loss severity dropped for the second consecutive month, falling by 140bp to 33.27% from April. Excluding losses lower than 2%, volume was US$455.5m, with a 61.59% loss severity.

Risk Management

Derivative ties strengthened

The US CFTC's chairman Timothy Massad has signed a memorandum of understanding with ESMA that allows the regulators to share information on central counterparties (CCPs). This adds to the growing supervision shared between the two authorities over trade reporting within the global derivatives market and provides the official mandate for ESMA to recognise US CCPs.

Prior to this announcement, the most recent agreement involved the CFTC and the European Commission over a common approach to transatlantic CCPs (SCI 17 March). As part of that approach, both sides agreed to a dual compliance framework for registered CCPs to function in both jurisdictional regions.

Risk Management

Collateral cloud service debuts

CME Group and CloudMargin have teamed up to provide CME Clearing and CME Clearing Europe customers with the first cloud-based software service that integrates and automates the management of collateral in one place. The service will seek to provide market players with access to their complete collateral inventory to utilise for both cleared and non-cleared derivative transactions.

The tool handles complex collateral requirements with multiple counterparties. It also provides automated connectivity to global custodians, banks, clearing brokers and clearing houses in order to manage and concentrate collateral across all asset types and instruments.

Risk Management

SEC adopts more SBS rules

The US SEC has adopted trade acknowledgement and verification rules for security based swaps (SBS), requiring related entities to provide full terms of transactions. The move is designed to help promote the efficient and effective operation of the SBS market.

The specific requirements include entities providing prompt trade acknowledgement electronically to their transaction counterparties, with this being no later than the end of the first business day following the day of execution. Other guidelines outline the need for the entity to promptly verify or dispute with its counterparty the terms of the trade acknowledgement. This must also be followed up with 'reasonable' written policies and procedures in place.

The rules exempt certain transactions that are processed through a registered clearing agency, as well as those executed on an SBS execution facility or national securities exchange. Further, the rules provide an exemption from the requirements of Exchange Act Rule 10b-10 for broker-dealers that are SBS entities and which satisfy the requirements already.

The rules will become effective 60 days after publication in the US Federal Register.