Contents

Structured Finance

SCI Start the Week - 4 July

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

Pipeline
Additions to the pipeline were limited once again last week, although two large Chinese deals added variety. The week's three ABS were CNY3bn Driver China Four Trust, US$340.5m Engenium Capital Equipment Dollar Trust and US$1.169bn Verizon Owner Trust 2016-1, while the only RMBS was CNY3.8bn Jiamei 2016-1 and the sole CLO was €359m Accunia European CLO I.

Pricings
There were markedly fewer prints than there had been in the previous week. Last week there were three ABS, three RMBS, two CMBS and one CLO.

€1.1bn Silver Arrow 7, US$141.75m Tax Ease Funding 2016-1 and US$250m Top Commercial Auto I were the ABS. The RMBS were US$412.7m JPMMT 2016-1, RUB5.65bn JSC Mortgage Agent BFCO and US$209m Nationstar HECM Loan Trust 2016-2.

US$115m Cherrywood SB Commercial Mortgage Loan Trust 2016-1 and US$737m SGCMS 2016-C5 constituted the CMBS. The CLO was US$503.4m Mariner 2016-3.

Markets
US ABS activity picked up last week, having slumped on the prior Friday as the UK's EU referendum result came in. Citi analysts note that trading picked up from US$300m on that Friday to roughly US$550m-US$650m each day last week. They add: "Auto ABS dominated flows since last Friday, at 31% of dollar volume and 36% of trades. Several marketplace ABS traded this week on the heels of the Midland decision in line with pre-Midland spreads."

The US CLO market also began to rebound last week, as the dust from the Brexit vote settled, as SCI reported on Thursday (SCI 30 June). "Equity has been strong - prices haven't dropped much," says one trader. "It is a sign of the sector's robustness, which is particularly evident in the stronger names."

Editor's picks
Damage control: The UK's vote to leave the EU has caused untold damage to the recovery of the European securitisation market. Not only will issuance volumes suffer, but reform of the European capital markets via the CMU has also been set back significantly - both of which could limit the role that securitisation can play in economic regeneration and the reshaping of the financial system...
Recruitment rocked: The recruitment outlook for structured finance took a potentially big blow when the UK decided to leave the EU last week in its referendum vote. With hiring activity already at a moribund pace this year, concerns about immigration limits and capital outflows are weighing further on human resources both in Europe and the US...
Credible values: Alternative investment fund managers are facing a number of uncertainties following the UK's vote to leave the EU. Their immediate attention will be focused on how to reflect the Brexit result in their mid-year valuation reports. Longer term, UK-domiciled managers will be evaluating the prospects of relocating operations to a country within the EU...
False alarm?: The Basel Committee caused somewhat of a stir in June when it warned banks against increasing their use of capital relief trades. However, portfolio risk-sharing transactions are not expected to be affected...
Countrywide cash benefits 'broad': Holders of 512 legacy Countrywide deals receiving allocated shares of US$7.7bn in settlement proceeds are not the only beneficiaries of that settlement, say Morgan Stanley analysts. The massive paydown has also put many more bondholders into better positions in terms of credit enhancement and outstanding principal balance...
Reclassification challenges outlined: A number of financial institutions have reclassified their structured finance books in accordance with IFRS 9, in order to carry out parallel runs in 2017. Although the formal implementation of IFRS 9 is not due until 2018, firms hope that the early implementation of infrastructure and audit trails may eliminate capital management and volatility of provisioning risks, which are more likely given the unique structures and idiosyncratic risk profiles found in structured finance securities...

Deal news
• Engenium Capital is in the market with a cross-border Mexican equipment ABS. Dubbed Engenium Capital Equipment Dollar Trust, the US$340.5m single-tranche deal is backed by a revolving pool of equipment leases and loans originated in Mexico with the notes denominated in US dollars.
• Fitch has assigned preliminary ratings to the first securitisation to be backed by cell phone contracts in the US. At the top of the capital structure, the US$1bn of class A notes in Verizon Owner Trust 2016-1 have been assigned an expected triple-A rating.
• Hyundai Commercial has completed the first cross-border cash securitisation of auto loans to obligors in Korea. The US$250m Top Commercial Auto I ABS has two equally-sized tranches of floating rate notes, each rated Aaa by Moody's.
• Postal Savings Bank of China (PSB) is prepping a RMB3.82bn RMBS called Jiamei 2016-1. The transaction is backed by 9,441 first-ranking Chinese full-documentation mortgage loans with a weighted average loan-to-value ratio of 57.8%.
• Fitch has affirmed Acorn Re Series 2015-1's US$300m class A notes at double-B. The rating agency believes the notes and indirect counterparties are performing as required and adds that there have been no reported early redemption notices or events of default, nor have there been any reported covered events within the risk period.

Regulatory update
• The US Supreme Court has denied certiorari in the Madden vs Midland Funding case, electing not to review a Second Circuit decision that found state usury laws applied to debt that had been purchased from a national bank (SCI passim). The decision is expected to prolong the legal uncertainty related to the marketplace lending and securitisation industries.
• New York Governor Andrew Cuomo last week signed a series of laws that could have a sweeping impact on the foreclosure process in the state of New York, according to Morgan Stanley RMBS strategists. In particular, the legislation establishes a pre-foreclosure duty to maintain on mortgagees and creates an expedited foreclosure process for vacant and abandoned houses.
• ESMA has released a peer review which pinpoints areas for greater EU harmonisation among national securities regulators. The review notes that regulators are sufficiently resourced and have approved prospectuses within legal deadlines, but suggests further convergences would be beneficial.

Deals added to the SCI New Issuance database last week:
1828 CLO; Anchorage Capital CLO 8; Ares XXXIX CLO; Cabela's Credit Card Master Note Trust Series 2016-I; Caixabank Consumo 2; Elara HGV Timeshare Issuer 2016-A; Ford Credit Auto Owner Trust 2016-REV2; FREMF 2016-K722; GoldenTree Loan Opportunities XII; Green Storm 2016; Harbour Aircraft Investments Series 2016; Navient Student Loan Trust 2016-4; North Mill Equipment Funding 2016-A; NRZ Advance Receivables Trust Series 2016-T1; Oportun Funding III 2016-B; Private Driver UK 2016-1; SBA Tower Trust series 2016-1C; SCF Equipment Trust 2016-1; Seven Sticks CLO ; Sierra Auto Receivables Securitization Trust 2016-1; Silver Arrow Compartment 7; SoFi Consumer Loan Program 2016-1

Deals added to the SCI CMBS Loan Events database last week:
BAML 2015-UBS7, CSAIL 2015-C3 & MSC 2015-UBS8 ; COMM 2007-C9; COMM 2013-CR9; CSAIL 2015-C2; DECO 11-C3; DECO 2007-E5; DECO 2012-MHL; DECO 2014-GNDL; EURO 25; EURO 28; GSMS 2012-GCJ9; INFIN SOPR; MSC 2007-HQ11; MSC 2007-HQ12; TITN 2006-1, TITN 2006-2, TITN 2007-CT1 & TITN 2007-2; TITN 2006-5; WBCMT 2004-C11; WBCMT 2006-C26; WBCMT 2007-C32; WFRBS 2011-C3

CLOs

Manager options outlined

If Brexit concludes with the UK outside of the EU passporting regime, UK entities may be limited in acting as managers of and risk-retention holders for European CLOs (SCI 30 June). An informal survey of presale documents undertaken by Wells Fargo structured products analysts indicates that of the 84 outstanding 'sponsor retention' European CLOs, 51 have UK-based managers, 24 do not provide enough information and nine appear to have managers based in the EU.

UK-based CLO managers have typically favoured the 'sponsor' route for compliance with risk-retention requirements. In order to qualify as a sponsor under the EU Capital Requirements Regulation, managers need to obtain authorisation under MiFID from their national regulator (the FCA in the case of UK entities). However, proposed European Parliament amendments to the risk-retention regime would require all CLO originators to be EU-regulated entities (SCI 9 June).

A recent Ashurst briefing points out that during the withdrawal negotiations and while the UK remains part of the EU, FCA authorisation will continue to be valid for retention purposes, as sponsor and existing authorisations will not be affected. In the case of transactions that have closed prior to the effective withdrawal date, the firm believes it is unlikely that investors would be penalised for non-compliance where retention is held by a UK-based manager.

"This is because investors are only subject to capital penalties in the event of their own negligence or omission. If investors discharged their obligation to ensure that the sponsor did, at the time of investment, undertake to retain the required risk, it would be difficult for a regulator to establish the requisite negligence or omission," it explains.

Nevertheless, any investor that acquires a non-compliant securitisation position following the withdrawal date is likely to be penalised. Existing investors may therefore find that liquidity of their CLO positions in the secondary market is vastly reduced, the Ashurst briefing suggests.

In terms of structuring a transaction today that will remain compliant after the official withdrawal, the firm notes that one solution might be to establish a sponsor entity in another EU country, which would be the named collateral manager for new CLOs. In that case, managers will need to carefully consider the substance, tax and corporate governance implications of such an internal reorganisation.

Additionally, an Irish issuer might be preferable over a Dutch issuer for European CLOs managed by UK collateral managers. A recent Cadwalader memo notes that European CLO SPVs are generally established in Ireland or the Netherlands, but there is a difference between the jurisdictions, in relation to the need for non-EU collateral managers to be authorised.

In the case of the Netherlands, a collateral manager needs to be authorised in the Netherlands under MiFID. By contrast, if a collateral manager has no registered office or branch in Ireland, it would not generally need to be an authorised investment firm in order to provide CLO services in Ireland. In such circumstances, it is possible that a UK collateral manager could be used, according to Cadwalader.

The Wells Fargo survey shows that of the 84 'sponsor retention' European CLOs, 44 have Irish issuers and 35 have issuers based in the Netherlands. The jurisdictions for five others are not listed in the presale documents.

A further potential solution to the risk-retention issue is to include provisions in CLO documentation that allow the manager to move operations to another entity in order to ensure compliance. However, risk-retention rules have thus far not provided certainty that such a move would ensure that a transaction remains compliant, according to Ashurst.

Another option could involve the originator/manager structure, in which the manager originates a portion of the portfolio and holds credit and market risk of the assets for a seasoning period. "The use of an originator/manager does not depend on pan-EU licensing under MiFID and is currently favoured by the majority of US-based CLO managers that have sought to satisfy the EU risk-retention requirements. These transactions should not, on the basis of the current risk-retention requirements, become non-compliant upon the effective withdrawal date," the briefing explains.

Finally, it notes that following withdrawal, the UK could choose to amend - or even discard - the retention requirements in relation to a class of assets or a type of securitisation structure. But, even if that were to occur, the sale of CLO paper to investors within the rest of Europe would remain possible only if the EU retention requirements are also met.

CS

CMBS

Risk retention expectations surveyed

Just over half (51%) of the respondents polled in Morgan Stanley's latest US CRE survey believe the market will pay up for risk retention-compliant CMBS deals. Opinions varied about anticipated quality differences in transactions retained by banks versus B-piece buyers, but overall more participants (38%) expect banks retaining a horizontal strip to result in a higher quality deal. Just under a quarter (24%) said that banks retaining a vertical strip will be higher quality, while 11% expect no quality differences and 10% believe B-piece investor retention will be higher quality.

Of the respondents, 44% believe that a vertical strip retained by banks is a short-term fix, while 32% believe it's a long-term solution and the remaining 24% are not sure. Nevertheless, most of those polled (49%) expect a bank-retained vertical strip in loan form to have a higher return on capital. Only 12% think that CUSIP form would have a higher ROC, while 5% opted for 'no difference' and 34% were not sure.

With respect to CMBS 2.0 deals, most respondents project 2016 and 2017 private-label issuance of US$50bn-US$80bn, with the majority believing that credit quality has improved somewhat this year. Loss expectations have increased steadily from the 2011 to 2015 vintages, with 65% believing that 2015 losses will exceed 5%.

Morgan Stanley CMBS strategists note that most respondents see better value in secondary than in new issue, in 2016 versus other vintages, and the mezz part of the capital structure. They add that 74% of those polled think that CMBS is cheap to corporates, with most of that set believing that relative value matters.

Given recent concerns over multifamily REITs, most investors appear to be concerned about agency CMBS fundamentals. "A majority believe agency CMBS issuance will total US$40bn-US$60bn for 2016 and be US$40bn-US$60bn or over US$60bn in 2017. Respondents reported that they see better value in GNMA deals and less value in Freddie deals, with Fannie somewhere in between," the Morgan Stanley strategists observe.

Meanwhile, the majority of respondents expect legacy CMBS refinance volumes to decline from 2016 to 2017, with 65% anticipating them to be less than 70% next year. Most believe that 2007-vintage cumulative losses will exceed 9%.

"More respondents think lower-quality AMs and higher-quality AJs are attractive, given extension risk. More also think mezz bonds trading at prices below US$80 are not attractive," the strategists report.

Finally, most of those polled agree that CMBX liquidity will be impacted if the index is not on a clearinghouse by this autumn. The majority believe that concerns about mall exposure within CMBX.6 are warranted. However, more respondents think CMBX.8 is a better short than CMBX.6.

CS

Structured Finance

International expansion eyed

Tikehau Capital has completed two share capital increases of €510m and signed up two new institutional investors as shareholders of its holding company. These transactions will provide the group with additional resources to develop its global strategy and accelerate its international expansion.

Through a €94m capital increase, Tikehau Capital Advisors (TCA) has gained new shareholders Temasek and FFP (the listed Peugeot family office), along with long-standing partner MACSF. They join existing institutional shareholders Credit Mutuel Arkea and Amundi. These institutional shareholders now each hold over 5% of TCA.

A rights issue by TCA has also raised around €17m in subscriptions from founders, partners and senior management of Tikehau Capital in order to maintain their current ownership and remain the controlling shareholders of the group. In parallel, Tikehau Capital Partners (TCP) completed a €416m capital increase following an early conversion of the €176m of convertible bonds issued in 2015, as well as a rights issue raising an additional €240m in cash.

As of 1 July, the group had assets under management of over €8bn.

Structured Finance

Secondary markets advisors sought

ESMA has published a call for candidates to form a consultative working group (CWG) for its secondary markets standing committee (SMSC). The two-year term of the existing CWG will expire shortly.

The CWG mainly advises and assists the SMSC on technical standards to be submitted to the European Commission and on guidelines, Q&As and other guidance in relation to relevant legislative provisions. It also advises and assists the SMSC in assessing the potential impact of proposed technical standards and guidelines.

The SMSC undertakes ESMA's work relating to the structure, transparency and efficiency of secondary markets for financial instruments, including trading venues and OTC markets. Interested experts are asked to apply to ESMA by 15 August.

CMBS

Portfolio solutions head poached

Federico Montero has joined Evercore's investment banking business in London as an md, leading its European real estate portfolio solutions team. The team will focus on providing independent advice in relation to the sale of non-core loan portfolios secured by commercial real estate, along with related debt advisory opportunities.

In his new role, Montero will work closely with Evercore's financial institutions, restructuring and debt advisory practices in London, along with the firm's Frankfurt and Madrid teams in relation to European real estate opportunities. He was most recently a partner at Cushman & Wakefield in London, where he was head of loan sales within its EMEA corporate finance operation, having previously worked in the portfolio solutions group at KPMG.

CMBS

JQH loan transferred

The US$44.95m Chateau on the Lake loan securitised in Wells Fargo Commercial Mortgage Trust 2015-C26 has been transferred to special servicing. The loan is the largest underlying the CMBS.

Servicing of the loan has been transferred from Wells Fargo to Midland Loan Services, effective from 4 July, due to the bankruptcy of the borrower, John Q Hammons Hotels & Resorts. The borrower filed for Chapter 11 on June 28 (SCI 1 July).

CMBS

Multifamily lender acquired

Cornerstone Real Estate Advisers is set to buy Ares' agency lending subsidiary, ACRE Capital, for US$93m. The acquisition could close as early as this quarter, which would expand Cornerstone's commercial loan origination platform and double the size of its multifamily loan portfolio from US$5bn to US$10bn.

ACRE Capital originates and services multifamily residential mortgage loans, senior housing and healthcare facility loans by utilising programmes overseen by governmental agencies and GSEs. The company is one of 19 lenders that hold licenses with all three agencies - Fannie Mae, Freddie Mac and the FHA. ACRE Capital also currently manages a servicing portfolio of approximately US$4.4bn of unpaid principal balance of GSE and HUD loans.

Kimberlite Group provided financial advice and Goodwin Procter provided legal advice to Cornerstone. Proskauer Rose was the legal adviser for ACRE.

ABS

PREPA compromise confirmed

A number of parties within PREPA's restructuring support agreement (RSA) recently agreed to purchase new interest-bearing bonds from the utility, enabling it to fund outstanding principal and interest payments that were due to its bondholders on 1 July. The agreement also includes an extension to the RSA, which pushes it out to 15 December.

Among the buyers of the bonds was Assured Guaranty, which agreed to purchase US$25.8m worth at a 7.5% coupon. The bonds mature in 2020, between 1 January and 1 July.

In aggregate, the parties to the bond purchase agreement will purchase a total of US$263.8m in new bonds. PREPA's principal and interest payments that were due on the outstanding bonds for 1 July came to US$416.7m. Bondholders insured by Assured received their full US$41.4m share of payments at the start of this month.

"This interim solution facilitates the payment by PREPA of the principal and interest payments due 1 July, allowing the parties time to continue down the path of the permanent, consensual restructuring envisioned in the RSA," says Dominic Frederico, president and ceo of Assured.

ABS

Italy SME weakening noted

The Italian ABS SME securitisation market is being increasingly dominated by originators with both lower credit and asset quality, says Moody's. However, the outlook for the sector is stable.

Originator banks with an investment grade credit rating accounted for 13% by number of Italian SME transactions rated by Moody's in 2014 and 2015. They had accounted for 40% in 2011-2013. By volume, the trend is down from 81% to 23% over the same timeframe.

The decrease in investment grade rated originators is partly because large originators such as Unicredit and Unione Banche Italiane have not issued new SME loans transactions rated by Moody's. Additionally, repeat originators have been downgraded several notches.

From 2014 onwards, Moody's has raised its level of expected loss (EL) and portfolio credit enhancement (PCE) assumptions for Italian transactions. Mean EL has risen from 9% to over 10%, while PCE has moved from 27.3% to 33.3%.

The outlook for the Italian ABS SME securitisation sector is stable, due to several credit protections that mitigate the increased counterparties and asset credit risk. This includes the presence of a back-up servicer which can limit operational disruption caused by a non-functional servicer, while high subordination levels continue to protect senior noteholders and the senior and mezzanine tranches are protected by the fast amortisation of the portfolios.

Structured Finance

Leverage ratio response outlined

Five organisations have issued a joint response to proposed revisions to the Basel 3 leverage ratio framework, urging that the Basel Committee expand the scope of its review. The response includes the recommendation for a well calibrated leverage ratio that will recognise the benefits of securitisation for originating banks.

The five organisations to issue the response are the GFMA, IIF, ISDA, JFMC and The Clearing House. It arrives after the Bank of England just two days ago expressed concerns over the leverage ratio framework in its financial stability report. The central bank's concern focused primarily on the inclusion of central bank deposits, which would affect the ability of the banking system to cushion shocks.

In their own response, the joint organisations lay out their continued support for a simple, transparent and non-risk based backstop to the leveraged ratio framework. However, they warn that the Committee must carefully consider the way cash and unencumbered cash-equivalent assets are treated in the ratio.

"By excluding cash and cash equivalents from the exposure measure of the leverage ratio, regulators could alleviate the constraints on these important market activities, especially in distressed markets," says Kenneth Bentsen, ceo of GFMA.

The response outlines specific recommendations regarding the trade versus settlement date accounting proposals, cash pooling, calibration of credit conversion factors, and treatment of securitisations and derivatives. For the last point, the organisations say that a better calibrated leverage ratio could meet global and regional policy objectives of reviving the securitisation market, enabling support for growth and the real economy.

"Where a bank securitises assets in a traditional securitisation and sells tranches to third-party investors, without recourse to or repurchase obligation by the bank, the bank should be permitted to exclude those assets from its leverage ratio," say the organisations.

In addition, the response outlines support for the Committee's decision to recognise the exposure-reducing effect of initial margin in client clearing transactions. However, it expresses concern that the Committee chose not to consider the issue of whether to recognise collateral posted by counterparties on derivatives trades more broadly.

Structured Finance

RFC issued on IO clarification

Moody's is seeking comment on a proposed clarification to the methodology it uses to rate interest-only (IO) securities regarding when ratings will be withdrawn. If the content of this RFC is adopted as proposed, the agency would withdraw the ratings of approximately 35 US CMBS IO classes that have reference principal balances of zero, since the debt-like obligation associated with the IO security would have been discharged. Comments are to be submitted by 29 July.

Structured Finance

Florida NPLs sold

Freddie Mac is continuing its bulk offloading of NPLs, with its latest auction seeing it sell a combined US$43.7m across 189 deeply delinquent loans. The loans were spread across two separate pools, both of which had Community Loan Fund of New Jersey as the winning bidder.

The loans have been delinquent for almost five years, on average. Mortgages that were previously modified and subsequently became delinquent comprise approximately 33% of the aggregate pool balance.

The aggregate pool is geographically concentrated in Florida and has an LTV ratio of approximately 93%, based on broker price opinion. Both pools sold at a weighted average price in the mid-70s.

The transaction is expected to settle in September, with servicing rights to be transferred post-settlement. Bayview Loan Servicing has been the servicer for the loans while they remain part of Freddie's mortgage investment portfolio. Bank of America Merrill Lynch and The Williams Capital Group advised Freddie on the transaction.

Structured Finance

Further leverage ratio objections raised

The FIA has added its voice to the chorus urging the Basel Committee to rethink its proposed revisions to the Basel 3 leverage ratio framework. Five industry bodies issued a joint letter yesterday (SCI 7 July).

FIA says the lack of offset for initial margin in the current Basel 3 leverage ratio framework proposals would substantially increase clearing members' leverage exposure and therefore "would significantly reduce clearing services to clients, increase concentration of client clearing services and negatively affect the portability of client accounts, especially in times of systemic stress".

FIA president and ceo Walt Lukken comments: "[The proposal] also undercuts the G20's goal of increasing central clearing to mitigate systemic risk. Mandatory clearing in Europe is just beginning and regulators should work together to make sure this mandate is not thwarted by inappropriate capital requirements."

Using data collected from 14 clearing members, FIA notes that the aggregate leverage exposure of the 14 participating firms would be 80% higher under the standardised approach for counterparty credit risk (SA-CCR) without an offset for initial margin than it would be using SA-CCR with an offset. The clients that would be most adversely affected by the lack of an offset would be asset managers, insurers, and other end-users that use cleared derivatives to hedge risk.

Structured Finance

Global issuance trends diverging

S&P reports that that there is a clear divide in recent structured finance issuance trends, with the US, Europe and Australia all seeing recent declines and countries such as Brazil, Argentina, China and Canada witnessing increases. The agency attributes declines in the former group to both broader volatility and a host of recent regulations governing capital charges and liquidity ratios.

Amid strong underlying loan growth, US securitisation utilisation actually improved in 2Q16, but issuance was lower than expected for the first half of the year in general. US issuance to date this year totals US$166bn, 36% below the pace set last year.

The market saw US$28bn of deals printed in June, following US$39bn in May, which was the most active period so far in 2016. Uncertainty regarding the UK's EU referendum vote result led to a significant slowdown in activity late last month. The ongoing market challenges have led S&P to lower its full-year 2016 forecast from US$370bn to US$350bn for the US market.

Across the Atlantic, European issuance stood at €37.6bn, down 6% year-on-year. Overall RMBS issuance was up 27% to €18.6bn for 1H16, which included the jumbo Granite transaction. CLO issuance was steady at €7bn, while ABS was down 30% to €10.8bn. The most dramatic drop came for CMBS, with a 78% year-on-year decline to €500m.

With recent Brexit market volatility, S&P says that 2H16 issuance will be challenging. However, the agency is choosing to leave its full-year issuance forecast at the US$70bn-US$80bn equivalent level.

Meanwhile, Canadian structured finance issuance was C$1.8bn in June, bringing issuance by Canadian sellers to C$7.6bn this year - up from C$7.2bn in the same period of 2015. China is up even more at CNY270bn, a 60% year-on-year increase. Given ongoing 6.5% GDP growth and a typically more active second half, S&P is raising its 2016 expectation for the country to US$100bn (CNY650bn) from its previous US$90bn projection.

In Latin America, the domestic markets of Brazil and Argentina witnessed considerable growth in their respective local currencies. While in Argentina the issuance profile was dominated by ABS consumer assets, Brazil saw growth in repackaged securities with exposures to corporate debt and very limited use of traditional securitisation.

Structured Finance

Brexit ratings outlook 'unchanged'

Fitch has reassured the market that no more UK structured finance rating actions are expected in the near term following the country's vote to leave the EU. However, terms of the exit could present tail risks, including mortgages and leveraged loans experiencing longer-term underperformance.

Fitch says that the elevation in risk premiums following the UK vote to leave the EU will weaken private sector financial conditions in the UK, although the effect on structured finance ratings will depend on the nature of the political settlement brokered. However, the longer there is significant uncertainty, the greater the agency believes there is a likelihood of a hard landing for UK markets.

Within UK RMBS, buy-to-let (BTL) and legacy non-conforming deals are more at risk. For BTL, a reduction in immigration could temper upward pressure on rents, and in some markets lead to nominal declines as well as longer voids. For legacy non-conforming deals, higher delinquencies are also expected if economic growth falters.

Credit card performance would suffer in this scenario, although a substantial deterioration from today's levels is already built into Fitch's assumptions. Lenders also have a wide array of risk-mitigation techniques at their disposal, adds Fitch.

European high yield corporate credit quality is also expected to weaken, with single-B category credits in pro-cyclical discretionary consumer and fixed-asset related sectors in the UK most affected. However, European CLO exposure to UK high yield credits is limited.

More defaults of high yield UK retailers could exacerbate downward pressure facing UK retail property too. Nonetheless, CMBS exposure to this sector is dominated by prime super-regional shopping centres, and as current yields are well below Fitch's base case, values would have to fall significantly to trigger downgrades.

Another commercial property sector exposed to the referendum result is London office, which faces both reduced investment demand and concerns over the potential relocation of financial services. One CMBS - the Ulysses deal - has already downgraded (SCI 8 July), partly on fears the referendum result will tighten short term refinancing conditions for London offices.

Revisions to UK economic expectations, particularly those relating to unemployment and interest rates, may affect structured finance ratings given these factors are key drivers of credit performance. A negative agreement made with the EU could spike UK defaults and trigger house prices to fall from their current levels. Fitch estimates a 25% correction would restore longer term sustainability.

In such a scenario, Fitch says that UK RMBS, SME and consumer ABS transactions without sufficient build-up of additional credit enhancement would face negative rating action as household balance sheets became impaired, rebounding stress back to the UK financial sector and sovereign. Despite the prospect of falls in prime UK office and retail property prices of over 30% in such a scenario, CMBS would be relatively unaffected given the legacy UK book has largely been worked out.

CDS

Portugal Telecom bankruptcy called

ISDA's EMEA Credit Derivatives Determinations Committee has resolved that a bankruptcy credit event occurred in respect of Portugal Telecom International Finance. An auction will be held in due course in respect of outstanding CDS trades referencing the entity.

The move follows Portugal Telecom parent Oi's filing on 20 June of a request for judicial reorganisation with the Court of the State of Rio de Janeiro, pursuant to an urgent measure approved by its board of directors. The Oi companies had been seeking to optimise their liquidity and indebtedness profile, and had negotiated mutual agreement with creditors as to a consensual restructuring. However, given the maturity schedule of their financial debts and the threats to the assets of the Oi Companies in judicial lawsuits, the firm decided that filing for judicial reorganisation is the most appropriate course of action at this time.

The DC has resolved that a bankruptcy credit event had occurred with respect to the reference entity in relation to 2014 transactions and updated 2003 transactions. The intention is to combine the auction for 2014 transactions with an auction for updated 2003 transactions if the deliverable obligations for each set of transactions are identical.

The DC obtained Brazilian legal advice as to the nature of judicial reorganisation and the effect it has on the debtor requesting it and its creditors' rights. Judicial reorganisation is an in-court proceeding that allows a debtor to request an automatic stay and/or injunctions against its creditors for a 180-day period, in order for the debtor to submit a reorganisation plan. A debtor remains in judicial reorganisation for two years after the plan is ratified.

CLOs

CLO pay-downs drop

The number of CLOs paid down in JPMorgan's CLO index (CLOIE) since the May rebalance through 30 June was US$1.45bn in par outstanding, down from US$3.83bn the previous month. This was split between US$790m and US$650m of pre-crisis and post-crisis CLOs respectively.

The post-crisis CLOIE saw US$6.1bn added across 100 tranches from 18 deals at the June rebalance. However, CLOIE underperformed broader markets for the month. The index's total was about flat, with returns ranging from slightly negative to roughly +1% in pre-crisis double-Bs.

In contrast, high grade bonds are up +2.23% and high yield bonds are up +1.54%, with 10-year Treasurys also returning +3.31% in June. CLOIE subs performed in line with high yield bonds at -0.07%, with market volatility largely driven by Brexit-related macro stress.

CLOs

CLO equity distributions dropping

Equity distributions for US CLOs continued their decline in 1H16, a trend that started in 2013 for 1.0 vintages. S&P says that this is due to higher funding costs and a drop in the spread of the assets held in the transactions.

Loan prepayment levels were high in 2013, and 2014 saw a steady stream too. Because these deals are outside their reinvestment periods, cash from loan prepayments was used to repay the senior noteholders, increasing these CLOs' funding costs. The approximately 300 CLOs currently in their amortisation period paid down their liabilities by about US$23bn in 1H14.

Meanwhile, almost all CLOs - including the reinvesting CLOs - saw their weighted average spreads decline in 2014, as their portfolios are now left holding lower-yielding assets. The decline within CLO 2.0 deals is more gradual, as most deals are still reinvesting and did not experience a change in their funding costs.

Since the start of 2015, the subordinate overcollateralisation (OC) cushions of CLO 2.0s have declined by over 1% on average, due to corporate downgrades, defaults and shifts in market prices for loans with a defaulted or triple-C rating. To date, no CLO 2.0 rated by S&P has fully diverted excess spread because of an OC failure, though a few have reduced equity payments due to interest diversion test failures earlier in the year.

Despite the downward trend in distributions, S&P says that CLO 1.0 equity holders are nearing 200% in cumulative distributions. Equity holders are also equipped with tools to either exit or modify 2.0 transactions if returns are not meeting expectations. For example, during 1H14, CLO equity investors initiated 30 optional redemptions and eight refinancings.

Looking ahead, S&P expects downgrades to outpace upgrades among CLO assets. Currently, about 10% of the CLO assets that the agency rates have a negative outlook.

CLOs

CPT metric provides CLO insight

DFG Investment Advisers had the highest collateral portfolio turnover (CPT) among US CLO managers in 2015. According to the new portfolio turnover metric from Moody's, American Money Management Corp had the lowest rate.

Managers' CPT rates vary by month, but are largely consistent over longer periods. Moody's believes that CPT data can reveal important insights about CLO manager performance, particularly in terms of par building.

"Prepayments and trading activity are the two main drivers of CPT, and they affect par building differently," says Moody's analyst Nalin Aeron. "In a benign credit environment, a manager with a high prepayment rate but little trading activity is likely to either maintain par or build it slowly, while a manager with a high prepayment rate and a high trading volume will build par more quickly."

Following DFG in the top three for highest annualised average CPT rates in 2015 were Canyon Capital Advisors and then Black Diamond Capital Management. While American Money Management Corp had the lowest rate, Trimaran Advisors was not far behind, followed jointly by New York Life Investment Management and BlueMountain Capital Management.

CMBS

CMBS downgraded on London fears

Fitch has downgraded the class A notes of Ulysses (European Loan Conduit No. 27) and placed the class A to C notes on rating watch negative. These actions have been taken as a direct result of the UK's vote to leave the EU.

The £249m class A notes have been downgraded from triple-B to double-B and placed on watch. The £76m single-B rated and £48m single-B minus rated B and C classes, respectively, have been placed on watch, while the £45m and £11m D and E classes have been affirmed at double-C.

Ulysses is a standalone securitisation of one commercial mortgage loan that was originated by Morgan Stanley. At closing, the issuer used the proceeds of the note issuance to acquire the mortgage loan, which has a total outstanding balance of £429m and is secured by a single office tower located in the city of London. There has been no amortisation to date.

Fitch says that the negative rating actions "reflect the deterioration in market confidence for London City offices following the UK vote to leave the EU". The rating agency believes the referendum result has reduced the likelihood of the defaulted loan being resolved in time for legal final maturity in July 2017.

CMBS

Gating suspensions highlight risks

Fitch says that the UK's EU referendum result is posing immediate risks to commercial real estate through the suspension of trading, or gating, of several UK property funds. However, although market activity and valuations are at risk of decline, companies or structured finance transactions in commercial property have buffers to absorb these shocks.

The funds suspended trading this week following a wave of redemptions in the fallout of the result. This highlights liquidity challenges for open-ended funds invested in long-term property investments.

More open-ended property funds may impose some form of gating if redemption behaviour persists and cash cushions dwindle. Funds run by Standard Life, Henderson and M&G already reduced the value of their buildings by 5% last week, and share prices of UK REITs have fallen sharply.

The vulnerability of UK CRE to a vote to leave the EU was widely anticipated by the market. The sector had experienced particularly strong inflows of overseas capital since 2009 and there was already a sharp fall in activity this year ahead of the referendum. The Bank of England's financial stability report published this week identifies the sector as a potential risk to financial stability following the referendum.

In CMBS, the primary exposure is to long-leased collateral supporting significant amortisation, such as Broadgate and Canary Wharf. CMBS exposure to UK retail property is dominated by prime super-regional shopping centres, and values would have to fall significantly to trigger downgrades as yields are well below Fitch's base case.

UK banks' exposure to CRE is substantial, averaging about 55% of common equity tier 1 at end-2015, according to the BoE. However, risk appetite and the terms extended, such as LTV, vary significantly from bank to bank. Total lending to the sector is materially lower than in 2009 and capital set aside against this risk is generally higher.

CMBS

Private label CMBS volume drops

Private label US CMBS issuance has dropped to its lowest level since early 2012, according to Kroll Bond Rating Agency. Just US$968.3m priced in June, which represents a 48% decrease year-over-year through the first half.

However, the agency does note a robust pipeline slated through July, which could see up to five conduits hit the market. A number of single asset/single borrower (SASB) deals are also being prepped for a summer launch.

The US$736m SGCMS 2016-C5 became the first conduit to price post-Brexit, hitting the market on 1 July. The senior triple-A tranche priced at 138bp, with the triple-B minus notes posting a 760bp spread. Kroll says that this is noticeably wider than the four conduits that priced during the latter half of May, but  that pricing still fared well considering market volatility in the wake of the Brexit vote.

Kroll published presale reports for a combined US$1.2bn over three deals in June. This included two SASB transactions and the aforementioned SGCMS conduit. Secondary activity included 19 transaction reviews, which resulted in 205 affirmations and five upgrades.

CMBS

Commercial, multifamily expectations flat

Originations of commercial and multifamily mortgages will total US$500bn this year, expects the Mortgage Bankers Association. That would be roughly flat from the US$500bn originated in 2015 and slightly less than the US$508bn record set in 2007.

Mortgage banker originations of multifamily mortgages are forecast at US$210bn for this year. Total multifamily lending is forecast at US$273bn.

"The year has started off with more than its fair share of twists and turns," says Jamie Woodwell, CRE research vp, MBA. "Commercial and multifamily real estate finance markets are likely to end 2016 with another strong year of borrowing and lending. On the demand side, strong property fundamentals and prices should continue to support an active sales market, which will drive mortgage demand."

For the supply side, solid originations for life companies, Fannie Mae, Freddie Mac and bank portfolios should make up for some of the slowdown in the CMBS market. Commercial and multifamily mortgage debt outstanding is expected to end the year at US$2.9trn, more than 3% higher than it was at end-2015.

CMBS

CBD prices bounce back

The Moody's/RCA Commercial Property Price Indices (CPPI) national all-property composite index increased by 1.7% in May. Despite falling 2% over the last 12 months, including price decreases in each of the five months before May, CBD office prices finally arrested their slide and rose about 2% in May.

CBD office is the only CPPI segment to show a 12-month price decline. Core commercial prices increased by 1.8% in May and apartment prices were up by 1.3%. CPPI prices are up only 1% from six months ago.

CMBS

BBC-linked CMBS downgraded

Fitch has downgraded the class A notes of Juturna (European Loan Conduit No. 16) and Pacific Quay Finance to single-A plus from double-A minus, with a negative outlook. The action follows a change in the agency's view of the credit quality of the BBC, which is the sole tenant of the underlying properties.

The affected CMBS are fully amortising sale and lease-back transactions, securitising income under leases of the BBC's London Broadcasting House and Glasgow Pacific Quay headquarters respectively. As a government-linked entity, the BBC's credit strength is driven by the credit strength of the UK, which Fitch downgraded to double-A (negative outlook) on 27 June.

The transactions are structured so that the underlying loan will be fully amortised through payment of contracted rental income up to loan maturity. Lease payments as well as loan balance are indexed to a retail price index (RPI), subject to a floor of zero and a cap of 5%. For each transaction, an issuer-level swap converts payments under the loan into fixed-rate payments due under the notes.

Fitch applied a single-tenant CMBS rating approach, whereby the rating is floored by the BBC's credit profile. Any factors that could affect the Corporation's credit profile would therefore likely have a corresponding impact on the notes' rating.

CMBS

CMBS delinquencies ratchet up

Trepp's US CMBS delinquency rate took a significant jump up in June, as a number of loans reached their maturity date but were paid off. After the first two months of 2016 saw a drop in delinquencies, the rate has now crept up four months in a row.

The delinquency rate for US CMBS loans now stands at 4.6%, but remains 85bp lower than its level at the same time a year ago and 57bp lower since the beginning of the year. However, it represents a 25bp jump from April and is 45bp above its multi-year low of 4.15%, which was reached in February this year.

CMBS loans that were previously delinquent but paid off with a loss or at par totalled almost US$900m for June. But over US$500m in loans were cured last month, which helped push delinquencies lower by 10bp. This was offset by over US$2bn in loans which became newly delinquent, putting 42bp of upward pressure on the delinquency rate.

Of note is the percentage of loans that were classified as non-performing past their balloon date, which jumped 14bp in June. These would be loans that reached their maturity date and did not pay off or make an interest payment to satisfy the debt service. Separately, the volume of loans that were past their maturity date but did make an interest payment jumped 22bp.

The figures suggest that borrowers are struggling to refinance their loans. Trepp says that this is particularly true of loans issued before the financial crisis.

Insurance-linked securities

Cat bond activity dips

Insurers and reinsurers' overall cat bond sponsorship approached US$3bn for the first half of this year, according to a report by Property Claims Service (PCS). This represents the second annual first-half issuance decline in a row.

By capital raised, new issuance activity fell 26% year-over-year, with the number of transactions completed down by 12.5%. Average transaction size fell 21.5% to just above US$200m.

PCS says that a number of factors have played in this shift downward, including the absence of any large Everglades Re-type transaction, which contributed significantly to the difference in issuance activity between 2014 and 2016. In addition, it notes that the drop from 2014 to 2015 was somewhat expected, given the sponsor's usual issuance cycle. This cycle saw US$1.5bn issued in 2014 and US$300m in 2015 - following US$750m in 2012 and US$250m in 2013.

If a transaction comparable to 2014's Everglades deal had been completed this year, the year-to-date issuance total would have been US$4.3bn, a modest year-over-year increase from 1H15. PCS says this should warn against snap judgements on the cat bond market's healthiness.

Meanwhile, the report also notes that the drop off in cat bond-lite activity has been largely due to the result of market pricing and the abundance of capacity available. But after a silent first quarter, six transactions were completed in the second quarter, representing approximately US$300m in fresh capital.

Insurance-linked securities

Discount note cat bond emerges

Swiss Re Capital Markets has placed a US$100m transaction in the ILS market, the first catastrophe bond sold at a discount pursuant to Rule 144A since 2009. Laetere Re was issued on behalf of United Property & Casualty Insurance Company (UPC), Family Security Insurance and Interboro Insurance, providing reinsurance cover on named storms and earthquakes affecting certain US coastal states.

The deal, a debut transaction for UPC, comprises three tranches. Each of the US$30m class A notes, the US$40m class Bs and the US$30m class Cs has a one-year risk period starting 1 June. Swiss Re was the sole underwriter, structuring agent and bookrunner for the deal.

NPLs

GSE NPL programmes 'favourable'

The US FHFA has released its first report covering the progress and results from Fannie Mae and Freddie Mac's NPL sales programmes. As of the end of May, the GSEs have sold over a combined 41,600 NPLs with a total unpaid principal balance of US$8.5bn.

The NPLs had an average delinquency of 3.4 years and an average current LTV ratio of 98%. New Jersey, Florida and New York accounted for nearly half of the NPLs sold, while Community Loan Fund of New Jersey was the winning bidder on five of the six pools on offer in May.

The report also includes preliminary outcomes through 31 December 2015 for borrowers across 8,849 NPLs that were sold by 30 June of the same year. The information reveals that NPLs tied to borrower-occupied homes had a higher rate of foreclosure avoidance at 13% than vacant properties at 6.2%.

Simultaneously, NPLS on which the property was vacant had a 21.3% foreclosure rate, significantly higher than the 7.5% figure for properties that were borrower occupied. The FHFA views this as favourable due its belief that 'foreclosure of vacant homes can improve neighbourhood stability and reduce blight as the homes are sold or rented to new occupants.'

To date, only 24% of the 8,849 NPLs have been resolved, split evenly between 12% without foreclosure and 12% through foreclosure. Compared to a benchmark of similarly delinquent GSE NPLs that were not sold, foreclosures for NPLs sold trended lower than the benchmark loans that the GSEs did not sell.

The FHFA says that it will now publish updated reports on the programmes twice a year, with the next one due at the end of 2016.

Risk Management

Derivatives notionals up

Trading revenue of US commercial banks and savings associations rose to US$5.8bn in 1Q16, from US$4.3bn in the previous quarter, according to the OCC. The notional amount of derivatives held by insured US commercial banks increased by US$12trn during the quarter to US$192.9trn, primarily due to growth in interest rate notionals.

The OCC's latest 'Quarterly Report on Bank Trading and Derivatives Activities' shows that trading revenue increased by 35.3% from 4Q15, but decreased by 24.9% from a year ago. The increase in the first quarter reflects an increase in both combined interest rate and FX revenue, as well as credit revenue. Receivables from interest rate contracts increased by US$701bn to US$3.7trn.

The percentage of centrally cleared derivatives transactions decreased slightly to 36.5% in 1Q16, from 36.9% in the previous quarter. Clearing was most prominent in interest rate derivatives, with 45.4% cleared.

While four banks held 91% of the notional amount of derivatives, 1,421 US commercial banks and savings associations held derivatives in Q1, representing 11 more banks and savings associations than in the previous quarter.

Risk Management

SFIG warns against tax rules

The Structured Finance Industry Group (SFIG) has sent a letter to the US Treasury Department outlining its concerns that new income tax regulations could disrupt the securitisation market. The group's Tax Policy Committee describes the regulation as "overly broad" and says it could lead to potentially "adverse, market-chilling effects".

The regulations are proposed under Section 385 of the 1986 Internal Revenue Code, as amended on 4 April. SFIG says that the unintended consequences from these amendments could lead to the curbing of transactions that do not present the potential for certain debt planning tool abuses and lead to structural tax consequences on these transactions.

As a result, the committee is asking for the Treasury and IRS to either create a standalone exception from the proposed regulations for securitisations or to provide more clarity on the proposals. These clarifications include bond houses, brokers or similar organisations acting in the capacity as underwriters, placement agents or wholesalers not being identified as 'funding members' under the stock recharacterisation rules.

In addition, the committee is seeking rules with respect for dividend withholding and that securitisations are not deemed to be stock under the recharacterisation rules. The letter also calls for secondary purchases of securitisation notes to not be subject to the funding rule.

RMBS

Single security, CSP update provided

The FHFA has released an update on the implementation of the single security and common securitisation platform. The update includes expected milestones that Fannie Mae, Freddie Mac and Common Securitization Solutions (CSS) expect to meet to achieve the stated goals of the projects.

The 2016 conservatorship scorecard for Fannie, Freddie and CSS calls for the three to implement the first use of the Common Securitisation Platform (CSP) software this year. They are to begin using the CSP to issue single securities in 2018.

The FHFA's update describes the various phases of testing required for each goal, announces the planned issuance of final single security features and disclosures to the market, and provides information on the ongoing alignment of enterprise programmes, policies and practices and the processes that will be followed to further support the single security initiative.

"This update reflects our ongoing commitment to transparency. It also reflects the outstanding public and industry input and support we have already received and that we look forward to continuing to have as we move toward the goal of launching the CSP," says FHFA director Melvin Watt. "The CSP and the single security are ambitious projects that we are confident should improve the overall efficiency and liquidity of the mortgage market."

The FHFA has also developed a timeline of key achievements to date as well as upcoming milestones with targeted completion dates. Later this year, the FHFA expects to announce the intended launch date for the single security in order to provide stakeholders at least 12 months' advance notice.

RMBS

RMBS deal agent costs considered

The rating implications of including a deal agent in a US RMBS transaction would likely be modest, says Fitch. Deal agents have not yet been included in any RMBS of newly originated loans, but the proposed responsibilities would include investor reporting reconciliation, servicer oversight, and representation and warranty enforcement.

Fitch expects the cost of a deal agent to have a modest effect on credit enhancement levels. For prime jumbo deals, the rating agency anticipates the rating cost will be within a rounding margin and is unlikely to affect credit enhancement.

The anticipated cost would be higher for non-prime pools but still modest relative to absolute credit enhancement levels. Using conservative assumptions, Fitch believes the rating cost could be less than 50bp at the triple-A level for a non-prime transaction.

The cost could be offset by a benefit to projected mortgage losses for some transactions. The rating benefit for an acceptable deal agent will be realised in the transaction's representation and warranties framework assessment, says Fitch.

The rating agency adds: "The expected loss benefit at the triple-A level will likely be modest or immaterial for most transactions. However, the benefit may be as large as 25bp for a prime jumbo RMBS and 100bp for a non-prime RMBS."

RMBS

RMBS upgraded on CIFG merger

Moody's has upgraded 11 classes of structured finance securities as a result of Assured Guaranty Corporation's (AGC) acquisition of CIFG. The securities impacted by the move include Alt-A, option ARM, subprime, second lien and resecuritised RMBS.

Moody's notes that the action is solely driven by AGC's assumption of securities formerly wrapped by CIFG. The former insurer's insurance financial strength (IFS) rating is A3, with a negative outlook, while CIFG is not rated by Moody's.

The acquisition has added US$5.5bn to Assured Guaranty's insured portfolio. As of 31 March 2016, CIFG had approximately US$644m of statutory capital. AGC paid US$450.6m in cash to acquire the insurer.