Contents

Reputation management

Side pocket pros and cons debated

Side pockets are a portfolio management tool that can benefit both investors and managers alike. But having fallen from grace in the wake of the financial crisis, it is debatable whether they can regain their reputation as a viable liquidity management resource.

A number of high-profile UK CRE funds were revalued and suspended trading last week as a result of the UK's vote to leave the EU. Should the current market unease persist in the UK, it is likely that more funds - particularly open-ended funds with illiquid investments - will bring liquidity management measures into play. The use of side pockets is one such measure that has been touted as a potential - albeit extreme - option for managers (SCI 29 June).

"There are positive and negative implications of using side pockets," says Oliver Fochler, managing partner and ceo at Stone Mountain Capital. "They are a legitimate tool and if a manager has been clear with investors from the start and it is in the fund's prospectus that this tool may be used, there shouldn't be a problem."

Simon Thomas, partner at Macfarlanes, notes that he has, relatively recently, seen some of the larger, new-entry funds seek side-pocket capabilities. "Their use is entirely strategy-specific, but I'm not aware of any fund having used them except in the most distressed circumstances," he says.

Side pockets are segregated accounts used by some hedge funds to separate illiquid or hard-to-value assets from the main fund. Investors that are active in the fund at the date of segregation are entitled to a pro-rata share of the investment.

The use of a side-pocket provision is usually strategy-specific. For example, a manager using a liquid strategy could use a side pocket to make a play on an illiquid asset. In this case, the illiquid asset would be put in the side pocket and not commingled with the main fund, with a view to returning the asset to the main fund once liquid or upon exit.

The financial crisis saw many side pockets being used defensively, however, and in some cases, illegally. Faced with highly illiquid markets, many fund managers used side pockets for assets that had turned sour, essentially allowing them to move those assets to a compartment of the fund and restrict investor access.

"Clearly there's a potential conflict with the use of them," says Kevin Scanlan, partner at Kramer Levin in New York. "A manager can put underperforming assets in side pockets and hold them there at cost, thereby avoiding the need to include any losses on these assets when determining the fund's NAV and any performance-based compensation."

As a consequence of their misuse during the financial crisis, it is now less common for managers to include side pockets in their documentation, unless there is a specific strategy in place and investors are fully supportive of the arrangement. The use of side pockets is also highly scrutinised by regulators, with the US SEC having successfully prosecuted a number of managers over the misuse of side pockets post-2008.

Fochler says that he is not aware of any enforcement on European managers under the AIFMD yet in connection with the use of side pockets, but suggests that a renewed financial crisis with increased investor redemption requests or maybe the revision of AIFMD could be trigger events that could result in enforcement action in Europe.

The valuation process for a side-pocketed asset depends on a fund's investment prospectus. Some managers may mark the asset to cost; some may write the investment down to zero.

If the fund's governing document states that assets are held in the side pocket at cost for purposes of calculating management fees and performance fees, then it generally doesn't matter if there's been a write-down or loss on that asset from a GAAP audit perspective, according to Scanlan. "It's irrelevant because investors have contractually agreed that the manager can hold it at cost for purposes of the calculation of these fees in the absence of a realisation event of that investment," he says.

Not all investors are able to participate in side pockets. For example, should an investor buy a share of the main fund, they would not share in the performance of the assets that were moved into the side pocket before their investment.

"As an investor, there is a degree of [opacity], as you don't know how the side-pocketed assets are performing...they might be performing quite well," says Fochler. "Some investors are not happy about this and rightfully, as the AIFMD requires a consistent valuation policy within the fund made transparent in its prospectus."

Unless the governing documents of the fund otherwise specify, there is generally no contractual limit as to how long assets can remain in a side pocket. There is usually a fair amount of discretion given to the fund manager to determine when the assets are liquid enough to move back into the general account of the fund.

"In my view, as soon as something is taken out of a fund and side-pocketed, it is unlikely that it will be included again in the main liquid fund," says Fochler. "Taking an asset out of the main fund must imply some level of distress. There is usually no way of return."

Thomas adds: "There may well still be side pockets from 2008 consisting of securities that there will never be a market for. But that is an extreme scenario."

For funds that do not have side-pocket capabilities, there are other liquidity management options in times of volatility. Funds have the ability to suspend redemptions, raise redemption gates or create synthetic side pockets (also known as liquidating SPVs), which serve the same purpose as a side pocket.

Scanlan explains that a fund either has or does not have a side-pocket provision in their governing documents. "It is not easy to add this authority subsequently, as this could be seen as an adverse move from an investor's perspective," he says. "Illiquid assets can be transferred to the liquidating SPV, either as a direct transfer of these assets or indirectly through the use of an economic participation right. The interests in the SPV would be distributed to redeeming investors."

He continues: "Unless the investment strategy requires it, fund managers tend to focus less on having side-pocket authority nowadays. If you have the ability to distribute shares of a liquidating SPV, then you can get to the same place as a side pocket."

Scanlan suggests that should funds face renewed liquidity problems as a result of events such as Brexit, he could see the need for increased focus on liquidity management. However, he adds that funds should already have an appropriate liquidity management programme and a robust valuation policy programme in place.

Thomas does not think Brexit would necessarily lend itself to a renewed usage of side pockets. "The markets are still open and liquid," he says. "Added to that, since 2008 there has been a real focus on liquidity. Potential investors - and regulators - will want to make sure a fund has appropriate liquidity management in place. While a side pocket is a liquidity management tool, it should not be used as a mere afterthought by the manager."

AC

Marketplace Lending

Next steps

Madden ruling creates landscape of uncertainty

On 27 June the US Supreme Court decided not to hear the Madden vs Midland case, resulting in a continued lack of clarity surrounding national and state usury rates. The move has led to marketplace lending platforms taking steps to adapt to the ruling, as well as other participants questioning the reasoning behind the case and the effect it will have on the industry.

In terms of why the case wasn't heard by the Supreme Court, there are various theories that tend to point towards a similar conclusion. Vincent Basulto, attorney at Richards Kibbe and Orbe, states: "It's a lot to do with deference to the Solicitor General. He also pointed out that the Madden case just simply wasn't a good case to hear because the argument hadn't been made well enough by either side from the outset."

Joseph Cioffi, attorney at Davis and Gilbert, seconds this. "The Solicitor General's point was that it wasn't a good test case for preemption - that neither party argued preemption well. In addition, other issues could determine the case on remand, so it wasn't worth hearing," he says.

Questions also abound about what the implications of the ruling will be - in both the short and the long term - and what impact it could have on further legislature. One possibility is that other courts will look to the Madden case and use it as precedent.

However, Basulto isn't so sure that this will be an issue. He states: "Given the response of the Solicitor General, it seems unlikely that other courts will adopt the Madden ruling. While it's possible other courts will point to the Madden ruling and seek to use it as a precedent, it would be hard for them to issue a decision in opposition to the strong view of the Solicitor General."

The obvious question next is what steps platforms will take to get around the Madden ruling or how they will work with it. Reducing business in the second circuit or perhaps taking steps to circumvent the ruling may be witnessed.

Basulto believes that both options are possible. "In the short term, we may see lenders pull back from lending within the second circuit. Some platforms may also try to adapt a model akin to Lending Club's recent changes, whereby the originating bank has greater ongoing participation in the loan," he comments.

The other way of increasing the participation of the originating bank is for platforms to seek licensing for the states they lend within. But Cioffi says that while attaining licensing in every state might be a viable option for the larger platforms, the smaller ones may simply not be able to afford the sizeable costs involved.

He adds that it might not be the panacea many platforms are searching for. "Lenders should be aware that getting state licensing does not necessarily mean that you are able to apply the state usury rates without question."

In the short term, the tactic of reducing or ceasing lending in the second circuit might be an easier option, but this could also present unique risks. Cioffi states: "The downside there though is that it narrows the borrower pool, which obviously results in lost business opportunities. With New York being one of the larger states in the country in terms of population, having to miss that state could have an immediate impact on business."

If platforms do go down the route of involving banks more heavily, potential hazards strew the path. One relates to increased true lender challenges, which might not be helped by partner banks becoming more involved in the life of the loan. Partner banks may also begin to question their position entirely.

Cioffi notes: "The other possibility is that if partner banks start to get more involved in the origination process so as to avoid the problems of Madden, these banks may start to question why they need the platforms at all and there is the potential that they may simply take over the process entirely."

While the sector was rocked to an extent by the ruling standing, some commentators believe the implications won't necessarily be long-lasting. Basulto says: "It's unlikely we will see clarity on this issue in the near future, but over time I'd expect that people will eventually become more comfortable with the situation."

Indeed, along with turmoil at Lending Club, it has actually led to a flurry of interest from some investors, according to Basulto. "The board of Lending Club acted very decisively, which was strongly suggestive of impropriety. From public information, the actions of Laplanche are certainly hard to justify, particularly in relation to the suggested hiding of the facts," he says.

He adds: "While it has rocked confidence in the sector to a degree, some investors have seen it as a buying opportunity. Their interest in marketplace lending dropped off for a short space of time, but there now seems to be a renewed interest."

Indeed, there is some optimism that the issues at Lending Club could have a long-term benefit. Basulto concludes: "Overall, it could well be a good thing for the industry. It will hopefully lead to better standards within platforms and a renewed focus on best practices, which should be better for the industry overall."

RB

Secondary markets

Euro secondary strengthens

Supported by the wider market rally the European securitisation secondary market is strengthening and spreads are edging in.

This week has again started with light flows, but many sectors are now back to around pre-Brexit levels as sentiment continues to improve in line with seeming greater political/central bank certainty. Once more, CLOs are leading the way in terms of both activity and tightening across the capital structure.

ABS/MBS is however a little more patchy. Prime autos and RMBS are faring best while UK CMBS and non-conforming RMBS are still lagging a little though improving on the levels seen mid last week.

There are currently four BWICs on the European schedule for today. All are single line item auctions.

At 14:00 London time there is £13m of ECLIP 2006-4 A. Also at 14:00 is $315+k of CRGT 2007-1 A1. At 15:00 is $10m of HMI 2011-3A A6. Also at 15:00 is €3m DUCHS VI-X B.

None of the bonds has covered on PriceABS in the past three months.

Secondary markets

US CLOs confident

The US CLO secondary market is exhibiting a more confident tone almost three weeks on from the destabilising effect of the Brexit vote.

"High yield has been climbing every day lately and is now approaching 105 after being at 104 yesterday," says one trader. "That's reflective of the risk-on sentiment we're seeing right now."

The trader adds that a number of weaker CLO names are also beginning to appear on BWIC. "These are names that were being held back earlier in the year, for example in weaker mezz territory, and the hope is that this practice will flow down the structure."

Meanwhile, equity has been stable, partly due to strong underlying fundamentals, the trader suggests. "That's leading to some interesting demand here too, particularly for some of the longer dated pieces."

There are five BWICs on the US CLO calendar for today so far. The largest of which is a ten line $24.5m double- and single-B auction at 10:30 New York time.

The list comprises: FRASR 2012-7X ER, HLA 2014-2X E, LROCK 2014-2X F, MVW 2014-1X E, OCP 2014-6X E, OFSBS 2013-5A B3L, TGCLO 2014-1X E, TRNTS 2014-2X E, TRNTS 2014-2X F and WITEH 2014-1X F. None of the bonds has covered with a price on PriceABS in the past three months.

Secondary markets

Euro secondary stays light

Flows in the European securitisation secondary market continue to be light though sentiment remains positive.

"It's been pretty quiet in general with little end-user activity and BWICs few and far between," says one trader. "However, everyone for choice is still a better buyer and looking for assets."

The trader continues: "As with wider credit the tone across ABS/MBS is strong. Consequently, everything is rallying and all sectors, even UK prime, are at pre-Brexit levels."

Meanwhile, the trader adds: "In CLOs it's much the same though sub-investment grade and triple-B paper is still 10-20bp wider than it was before the referendum. CLOs have seen a few more BWICs in recent sessions than other sectors and yesterday's traded in line with expectations."

There is currently one BWIC on today's European schedule a dollar, euro and sterling mix of LEEK paper due at 14:00 London time. The six line 80.3m original face list comprises: LEEK 18X A2A, LEEK 19A A2B, LEEK 19X A2A, LEEK 19X A2B, LEEK 19X A2C and LEEK 19X MA.

None of the tranches has traded on PriceABS in the past three months.

Secondary markets

US CLOs rejuvenated

The US CLO secondary market is continuing to exhibit strong activity after a positive start to this week.

"The last few days have been the busiest that I've experienced since the UK's EU referendum vote," says one trader. "There have been strong bids across the entire capital structure and we are finally seeing activity return to pre-Brexit levels."

The market's upbeat nature is leading to firm sentiment and confirming talk earlier this week that certain names are re-entering the fold. "Broadly, the stock market is rallying, as are leveraged loan prices," the trader explains. "People are latching on to these moves and coming back to re-test the CLO market - particularly around single-Bs."

There are seven BWICs on the US CLO calendar today so far. The largest is a five line US$63.5m triple-A auction due at 11:00 New York time.

The list comprises: BNPIP 2014-1A A1, CFIP 2014-1A A2, NMRK 2013-1A A2, TELOS 2014-5A A and TICP 2014-1A A1. Three of the bonds have covered with a price on PriceABS in the past three months - BNPIP 2014-1A A1 and TELOS 2014-5A A both at VL99H on 4 May; and TICP 2014-1A A1 at L99H on 2 May.

Structured Finance

SCI Start the Week - 11 July

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

Pipeline
Pipeline activity picked up again last week, with ABS leading the charge. There were nine ABS added to the pipeline, as well as an RMBS and a CMBS.

The ABS were: Aurorus 2016; US$755m Capital Auto Receivables Asset Trust 2016-2; US$1bn CarMax Auto Owner Trust 2016-3; US$980m Dell Equipment Finance Trust 2016-1; US$750m Enterprise Fleet Financing Series 2016-2; US$750m Nissan Master Owner Trust Receivables Series 2016-A; US$430m OneMain Direct Auto Receivables Trust 2016-1; US$300m Sierra Timeshare 2016-2 Receivables Funding; and US$750m World Omni Automobile Lease Securitization Trust 2016-A.

SapphireOne Mortgages 2016-1 was the RMBS. The CMBS was US$430m Waldorf Astoria Boca Raton Trust 2016-BOCA.

Pricings
There were fewer prints last week. These consisted of three ABS, an RMBS, a CMBS and two CLOs.

CNY3bn Driver China Four Trust, US$500m Evergreen Credit Card Trust Series 2016-2 and C$1bn Master Credit Card Trust II 2016-3 accounted for the ABS. The RMBS was €1bn Purple Storm 2016.

US$939m JPMCC 2016-JP2 was the sole CMBS. The CLOs consisted of €421m Accunia European CLO I and €454m CVC Cordatus Loan Fund VII.

Editor's picks
Big appetite: While political developments on the other side of the Atlantic may have increased risk, US ABS still provides ample opportunities to invest. Gross ABS issuance is up to almost US$90bn for the year so far, as investor demand remains high...
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...
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...

Deal news
• 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.
• 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 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.
• 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.
• 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.

Regulatory update
• 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.
• 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 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".

Structured Finance

STC risk weights reduced

The Basel Committee has scaled down the risk weights for 'simple, transparent and comparable' (STC) securitisations and reduced the risk-weight floor for senior exposures from 15% to 10%. The move had largely been expected and, in general, is viewed as catching up with European proposals for the STS securitisation framework.

"For this topic, the European Commission decided not to wait for Basel, as there is a high priority to revive the European ABS market. Operating on two different tracks on a single topic can be dangerous, but [this latest] document from the Basel Committee shows that the EU is broadly in line with the global standards," Rabobank credit analysts suggest.

The new Basel framework amends the Committee's 2014 capital standards for securitisations and builds on the 2015 STC criteria (SCI 23 July 2015). It sets out additional criteria for differentiating the capital treatment of STC securitisations from that of other securitisation transactions; for example, by excluding deals in which the standardised risk weights for the underlying assets exceed certain levels.

The Rabobank analysts highlight a number of differences between the Basel and EU frameworks, including that under the former investors have to comply with STC, while under the latter the compliance burden shifts to the issuer/seller. The requirements for STC securitisations are also more general, compared to the stricter requirements for STS.

Further, STC caps single obligor exposures to a maximum of 1% and sets a threshold for the weighted-average risk weight of the underlying exposures, but does not contain a LTV restriction for the loans in an RMBS (which is 100% in the EU proposals). Another difference is that the minimum risk weight of 10% also applies to triple-A rated five-year tranches under the external rating based approach (ERBA), while it is 15% in the European approach.

Finally, the Basel Committee has not altered the hierarchy of approaches for STC securitisations (IRBA>ERBA>SA). In Europe, however, some argue that the standardised approach should be second for STS (IRBA>SA>ERBA).

The analysts point out that STC is optional, due to the high compliance burden for the concept. Consequently, it is unclear whether other jurisdictions outside of the EU will ultimately implement this new framework.

The 2018 implementation deadline for the revised Basel securitisation framework remains in place.

CS

CLOs

Step-up tranches refinanced

Four US CLOs - ACAS CLO 2013-2, Carlyle Global Market Strategies CLO 2014-3 and Neuberger Berman CLO XII and XVI - have been refinanced over the last two weeks. None of the refinancings were plain vanilla, with three having been driven by the desire to refinance step-up tranches.

The most plain vanilla of the refinancings was for Neuberger Berman CLO XVI, according to Deutsche Bank CLO analysts. It involved a floating-rate tranche and three fixed-rate tranches being refinanced into three floating-rate tranches and one fixed-rate tranche.

The biggest gain from the refinancing was due to the US$60m A2 tranche carrying a fixed-rate coupon of 3.51%: US$55m of the tranche was replaced by floating-rate notes at Libor plus 145bp and the remaining US$5m by notes with a 2.32% fixed-rate coupon. The US$18.75m B2 and US$1m C2 fixed-rate tranches - paying coupons of 4.31% and 5.36% respectively - were refinanced into floating-rate tranches paying plus 217bp and 275bp. The Deutsche Bank analysts note that the refinancing has resulted in an average coupon reduction of 23bp for the deal.

"We have highlighted before the value of the call option of fixed rate, since it is not just a call option on tighter spread as with the floating rate tranches, but also an option on rates - which has been more valuable lately," they observe.

The other three refinancings involved tranches that had already or were about to see their coupons rise due to step-ups. Notably, the refinanced tranche from Neuberger Berman CLO XII had previously been refinanced in 2014 (see SCI's new issue database). The US$183m A2R notes had a coupon of Libor plus 115bp that was set to rise to 190bp this month, but the refinancing at 130bp prevents the step-up.

Meanwhile, ACAS CLO 2013-2 refinanced its step-up tranche - the US$140m A1B notes - which had already stepped up from plus 110bp to 160bp in April 2015 and to 190bp in April 2016. That tranche now pays a coupon of 145bp, as does the US$10m fixed rate A1C tranche, which previously had a coupon of 3.559%. A further fixed rate tranche - the US$10m A2B - saw its coupon lowered from 4.55% to 220bp, resulting in an average coupon reduction of 25bp for the deal.

Finally, Carlyle replaced the US$155m A1B step-up notes of its CGMS 2014-3 transaction with a tranche paying 145bp. The tranche originally had a coupon of 133.5bp, but was set to rise to 175bp at the July payment date and to 200bp a year later.

Deutsche Bank estimates that 26 US CLOs have been issued with step-up tranches since 2013 and another three step-up tranches have been created through refinancings. Of those 29 tranches, 23 have been in broadly syndicated loan CLOs.

Most of the BSL CLO tranches were structured to see coupon step-ups 18-24 months after closing, often with a second step-up a year later. Of the 23 tranches, six have now been refinanced, on average 26 months after the initial deal closing.

The remaining tranches are at different stages in terms of the step-up coupon. There are nine tranches still outstanding with coupons of Libor plus 175bp or higher, which - given current levels - should be refinanceable at lower coupons.

"So, overall the step-up feature has served to shorten the life of some of the tranches, while others remain outstanding but paying a handsome coupon relative to similar tranches; i.e. triple-A rated tranches of broadly syndicated loan CLOs that are nearing the end of their reinvestment periods," the analysts conclude.

CS

Structured Finance

MUFG poaches ABS head

Mitsubishi UFJ Securities has brought in Haan Ti as head of ABS for Australia and New Zealand. He joins from Westpac Institutional Bank, where he was director in structured finance and syndicate.

Ti has also held senior roles at HSBC and Rinker Holdings. His past duties include origination of ABS and RMBS term transactions, as well as origination of structured finance warehouse facilities.

Structured Finance

Hatteras acquisition completed

Annaly Capital Management has completed its exchange offer for all of the outstanding shares of common stock of Hatteras Financial Corp (SCI passim). The former's acquisition of the latter is consequently expected to be consummated today (12 July).

A total of 70,066,823 shares of Hatteras common stock, representing approximately 74.12% of Hatteras' outstanding common stock, were validly tendered in the exchange offer. Of the shares tendered into the exchange offer, 19,132,243 elected to receive the mixed consideration, 3,000,559 elected to receive the all-cash consideration and 47,934,021 elected to receive the all-stock consideration.

All shares of Hatteras common stock not validly tendered into the exchange offer will be cancelled and converted into the right to receive merger consideration in the same amounts offered in the exchange offer. Holders of these shares will have the opportunity to elect the mixed consideration, the all-cash consideration and the all-stock consideration, subject to proration.

Structured Finance

ABL vet joins middle market firm

Monroe Capital has hired asset-based lending veteran Marc Adelson as originations md. He will join Ben Marzouk and Lee Stern in the firm's New York office.

Adelson has more than 30 years of experience providing financing to middle market companies. He was previously cco at Medallion Financial and president of its asset-based lending business. Before that, he was ceo and president of commercial and trade finance at Capital Business Credit and he has also worked in asset-based lending at the CIT Group and at Heller Financial.

Structured Finance

Citizens hires for SF push

Citizens Bank has recruited Brent Hazzard as head of structured finance for its commercial banking business. He joins from GE Capital, where he led both the firm's restructuring and distressed debt initiatives.

Citizens' structured finance group is focused on building relationships with large and mid-tier investment banks, distressed-focus private equity funds and other intermediaries to source senior secured financing opportunities greater than US$20m.

Structured Finance

Demica boosts origination team

Demica is continuing to build out its origination team with the addition of three new members. Angel Blanco and Marc Wolf join as origination directors, while Enrique Jiminez becomes senior supply chain finance origination director. All three will report to Demica head of origination Tim Davies.

Blanco is tasked with originating receivables finance, trade receivables securitisations and supply chain finance programmes - mainly for Spanish and Portuguese multinational corporates and financial institutions. He joins from Santander, where he was most recently executive director and head of receivables. Blanco will be co-located between Spain and London in his new role.

Wolf will originate receivables securitisation and supply chain finance programmes for German and multinational corporates, and financial institutions. He joins from Credit Agricole, where he was an executive director, focusing on securitisation. Wolf will be located in London, but with Northern Europe coverage responsibilities.

Finally, Jimenez will seek receivables securitisation opportunities for Demica, but also focus on originating and building supply chain finance programmes across Europe. He was previously at Santander, where he most recently held the position of head of supply chain finance and trade for the bank. Jimenez is based in London for Demica, with broad geographic coverage responsibilities.

Structured Finance

Corporate development team boosted

Z Capital Group has recruited David DeMilt as md in its corporate development team. He will be based in the firm's New York office and is responsible for covering investors in North America.

DeMilt was previously an svp in Oaktree Capital Management's marketing and client relations group, where he spent four years expanding limited partner relationships in both private equity and credit strategies. Before that, he was a vp at Goldman Sachs and a senior director at Fitch, specialising in ABCP.

Structured Finance

Debt, syndicate teams reshuffled

CaixaBank has appointed Ainhoa Landa to head its debt capital markets business as part of a broader reorganisation of its debt and syndicate operations. Landa was formerly head of structured bonds syndicate, which will now be taken on by Lorenz Altenburg.

Landa's appointment sees her replace Maria Castro, who has moved on to lead CaixaBank's funding team. In their new roles, Landa will report to head of capital markets & corporate finance Ignacio Moliner, while Altenburg will continue reporting to Eugenio Tubio, head of syndicate and distribution.

CDO

Manager replacement rejected

A second successor collateral manager has been rejected by Gramercy Real Estate CDO 2007-1 noteholders. The controlling class had directed the issuer to appoint C-III Investment Management as successor manager (SCI 23 June), but sufficient objections to the appointment were received and certain collateral management agreement conditions weren't satisfied. As a result, the appointment of C-III will not occur.

Risk Management

Markit merger completed

IHS and Markit have completed their merger to form IHS Markit (SCI passim). The firm begins trading today (13 July) on the Nasdaq Global Select Market under the trading symbol 'INFO'.

The new 11-member board of directors for IHS Markit consists of: Dinyar Devitre, Ruann Ernst, William Ford, Balakrishnan Iyer, Robert Kelly, Deborah McWhinney, Jean-Paul Montupet, Richard Roedel, James Rosenthal, Jerre Stead and Lance Uggla.

In accordance with the terms of the merger agreement, IHS stockholders will receive 3.5566 common shares of Markit in exchange for each share of IHS common stock. As of 11 July, tenders and consents from holders of approximately US$740.7m - or 98.8% of the aggregate principal amount of outstanding existing IHS notes - had been validly received. Accordingly, IHS has received consents sufficient to amend the indenture governing the existing IHS notes.

The date by which tenders must be received for holders to receive the total exchange consideration has been extended to 25 July.

Risk Management

Risk expert tapped

Andrew Davidson & Co has recruited Richard Cooperstein to lead its risk model management. The firm says it will look to utilise his background in developing and implementing investment strategies for structured credit risk, mortgage insurance, financial guarantees and servicing rights with credit risk content.

Cooperstein was previously treasurer and vp of pricing and asset acquisitions at Ocwen Mortgage Servicing. He has also held other senior roles, including vp of structured transactions at Freddie Mac and md, head of modelling and analytics at HSBC.

RMBS

Ginnie Mae RMBS chief named

Ginnie Mae has added Nancy Corsiglia as evp and coo, reporting to president Ted Tozer. She will administer Ginnie's RMBS and REMIC programmes and be responsible for managing daily operations, including all RMBS operations.

Corsiglia replaces Mary Kinney, who retired in February. She brings more than 25 years of financial services and mortgage industry experience, and was previously md at the Devonshire Advisory Group. Corsiglia has also worked at Federal Agricultural Mortgage Corporation (Farmer Mac).

ABS

Card ABS downgrades expected

As much as 25% of S&P-rated European credit card ABS ratings could be downgraded following the agency's methodology changes to rating the asset class. The rating approach, which became effective from yesterday, has been revised to incorporate S&P's same global methodology for assessing the credit quality of securitised consumer receivables.

S&P rates approximately 50 European credit card ABS transactions, but no upgrades are expected from the move. However, the agency anticipates that all of the downgrades would be within one rating category and about half of them would be by one notch.

ABS

Negative interest rates hit ETD deals

Legacy securitisations of Spanish electricity tariff deficit (ETD) debt are effectively charging interest to noteholders in a negative interest rate environment, Moody's reports. In ETD securitisations with floating interest rate notes, the issuer chooses to deduct the interest payment from the value of the outstanding amount of the notes, while maintaining the pass-through payments to noteholders. As a result, the outstanding notes amortise at a faster rate compared to the principal payments being made to noteholders.

"These transactions are significantly different from standard securitisations and an exception to the general rule observed in the market regarding the flooring of notes' coupon at zero when it reaches negative levels," says Antonio Tena, a vp at Moody's. "We do not believe the reduction of principal by the negative interest amount constitutes an impairment in these transactions while maintaining the pass-through payments to noteholders."

Charging of negative interest to noteholders is affecting the following ETD transactions: Rayo Finance Ireland (No.1) Series 3, 4 and 5, and Alectra Finance. Additionally, Bliksem Funding is expected to reach negative coupon on this month's IPD.

Fondo de Titulizacion del Deficit del Sistema Electrico (FADE) deals are not affected as they are fixed interest rate notes. The coupons of Rayo Finance Ireland (No.1) Series 2 and Delta Spark - which are paying one-month Euribor plus 50bp and 55bp respectively - are expected to remain at positive levels on forthcoming payment dates. The swap counterparty in Rayo Finance Ireland (No.1) Series 1 will bear the cost of the negative rates and a floor of zero is applied to noteholders.

Out of existing ETD deals linked to floating interest rates, Moody's notes that both Alectra Finance and Bliksem Funding have an interest rate swap in place to hedge the interest due to the notes. Under the current scenario of negative rates, the swap will also ensure that there is sufficient collateral to cover any potential mismatch between the principal outstanding on the ETD and the notes at the time the swap is terminated. As in the other deals, the negative interest rate also reduces the value of the outstanding notes' balance.

Moody's considers the reduction of principal by the negative interest amount to be credit neutral. There is no specific prohibition in the documentation for these transactions to offset the negative interest payments from the principal payments. In addition, there is no apparent triggering of an EOD under the notes.

The agency adds that the electricity system has generated successive surpluses since 2014, helping to achieve sustainability in the medium term, which is credit positive for these deals.

ABS

RFC issued on fleet approach

Moody's is requesting comments on proposed changes to its methodology for rating ABS backed by rental cars and trucks. The agency expects the proposal to result in rating downgrades of up to one notch for some senior tranches in trusts with lower minimum depreciation rates and weaker historical fleet compositions, and rating upgrades of up to three notches for junior tranches of outstanding rental car ABS. For rental car and rental truck transactions with a single tranche, it also expects rating upgrades of up to two notches.

The proposed changes update how Moody's estimates or addresses certain risk factors, such as the disposal value calculation, fleet composition, sponsor probability of default and correlation. The general framework used to evaluate rental fleet securitisations remains unchanged, however.

Comments on the proposal should be received by 12 August.

ABS

Ownership change lifts ABS ratings

Fitch has upgraded the Bosphorus Series 2015-A, 2015-B, 2015-C and 2015-D notes, as well as the Bosphorus Series 2012-B, 2012-C and 2012-D notes from triple-B plus to single-A minus. The upgrades are a result of originator Finansbank's ownership change.

The Bosphorus transactions securitise diversified payment rights. These are payment orders processed by banks which can arise for a variety of reasons, usually reflecting payments due on the export of goods and services, capital flows and personal remittances.

The Bosphorus upgrades follow an upgrade to Finansbank's local currency issuer default ratings from triple-B minus to triple-B. This was prompted by the acquisition of a 99.81% stake of the bank by Qatar National Bank.

ABS

MPL ABS ratings confirmed

Moody's has confirmed its rating of Ba3 on the class C notes issued by the Prosper-loan backed Citi Held for Asset Issuance (CHAI) 2015-PM1, 2015-PM2 and 2015-PM3 ABS deals. The rating agency had placed the notes on review for downgrade earlier this year due to concerns over an up-tick in delinquencies.

Moody's has based its rating confirmations on the view that the structural features of the transactions and the available credit enhancement offset the increased expected losses and the volatility of the losses under stress scenarios. Additionally, the rating agency finds that there has been an absence of substantial deterioration in the loans backing the deals as they continue to season, relative to Moody's 12% expected lifetime losses.

The rating agency also highlights stress tests performed as part of its analysis. It found that the total credit enhancements built into the deals is generally sufficient to prevent losses to the C notes in a variety of stress scenario, but notes that ratings could still be downgraded in some instances.

Structured Finance

SME joint initiative launches

The European Investment Fund has teamed up with several national promotional institutions to launch the EIF-NPI Securitisation Initiative (ENSI). The initiative is a risk-sharing platform aimed at providing more funding to European SMEs via the capital markets.

The ENSI partner institutions alongside the EIF are KfW, bpifrance, CDP, Malta Development Bank Working Group, IFD, ICO and BBB. The EIF says that there are already a number of transactions in the pipeline which will be finalised in due course.

The joint cooperation will seek to revitalise the SME securitisation market while sourcing in resources from the private sector. The working group defines standard procedures and minimum criteria under which the respective institutions are generally willing to participate in securitisation transactions. The group also liaises with the European Commission to discuss deployment options for funds out of the European Fund for Strategic Investments for the purpose of securitisations.

Structured Finance

Progress 2014-SFR1 to prepay

Progress Residential plans to prepay the US$465.9m loan that serves as collateral for the Progress 2014-SFR1 securitisation, with the deal becoming the first single-asset single-family rental transaction to pay off in full as a result. The prepayment will be funded by a portion of the proceeds from the US$462.7m Progress 2016-SFR1 transaction that is currently marketing.

Progress 2014-SFR1 is collateralised by an interest-only loan with an initial maturity date of 9 October 2016. The loan has three 12-month extension options available, none of which have been exercised.

In connection with the prepayment, Progress may be required to pay a spread maintenance premium. KBRA notes that since issuance the transaction has performed as expected from a credit perspective and experienced deleveraging, due to the price appreciation of the underlying properties.

At the time of securitisation, the Progress 2014-SFR1 portfolio comprised 3,140 properties. Of those homes, 2,762 (88% by count) - with an aggregate broker price opinion (BPO) value at issuance of US$549m - are expected to be contributed to the Progress 2016-SFR1 transaction and will represent 67.9% of that transaction's collateral properties.

In June, the issuer obtained updated BPOs performed by a third-party vendor, which in total had increased in value to US$607.5m. The price appreciation (US$58.5m) represents an increase of 10.6% since securitisation, according to KBRA.

The remaining 378 properties from the 2014 transaction are expected to be held by Progress and may be disposed of as part of its ongoing strategic market consolidation.

So far, four loans underlying SFR deals have approached their initial maturity date and in each case the related borrower chose to exercise its first extension option. KBRA notes that over the next 12 months, 13 loans have impending initial maturity dates and the related sponsor will have to decide whether to extend the loan or refinance.

Structured Finance

Energy efficiency sale agreed

Susi Partners, managing authority of the SUSI Energy Efficiency Fund, is set to acquire €1.2m of loans related to lighting energy efficiency assets installed by TerniEnergia. These private contracts will be sold to an SPV regulated under Italian law and back a new Susi Partners receivables securitisation.

TerniEnergia operates as an energy service company (ESCO) through the 'Hub' platform, a new strategic alliance between players in the Italian energy industry that aims to open up the sector to the capital markets. The transaction will allow TerniEnergia to support growth of its energy saving services.

The portfolio sale agreement is conditional on the satisfaction by 3 September of a number of conditions, including the finalisation of all documents relating to the transaction by bank lenders of the ESCO projects.

Structured Finance

Macro fund prepped

Algebris Investments (UK) is launching a macro credit fund, managed by partner and macro strategies head Alberto Gallo. The Algebris Macro Credit Fund is designed to help investors generate superior risk-adjusted returns in the current volatile environment and will start trading on 19 July.

To survive this volatility, the firm says diversification and flexibility are paramount. At the same time, investors have few options left to find positive returns in this "world of QE-infinity".

Consequently, the fund will adopt what is described as a unique approach to investing in bond and credit markets, combing top-down macro research, bottom-up balance sheet analysis and quantitative risk management. The investment team includes macro analysts Aditya Aney and Tao Pan.

The fund will invest in government, corporate and bank debt, capturing what the investment manager considers to be the best opportunities globally. It will employ a range of directional and relative-value strategies, targeting a volatility of 5% and returns of 6%-7%.

CDS

Portugal Telecom auction set

An auction date of 21 July has been scheduled to settle CDS trades referencing Portugal Telecom International Finance. The unanimous decision by the 15-member ISDA Determinations Committee comes after it was agreed earlier this month that a bankruptcy credit event occurred in connection with the company (SCI 4 July). ISDA has identified an initial list of seven euro-denominated bonds as deliverable obligations, with a final list set to be published by the trade association on 18 July.

CLOs

Conformance period extended

The US Fed has extended the conformance period for the Volcker Rule to 21 July 2017. While the extension was largely anticipated by market participants, the timing was later than most expected, coming only two weeks before the previous extension date expires on 21 July 2016.

The extension allows banking entities to continue divesting ownership in legacy covered funds - including CLOs - that were made prior to 31 December 2013 and terminate relationships with funds that are prohibited under the rule. This is the last of the three one-year extensions that the Fed is authorised to grant.

JPMorgan CLO strategists note that 1.0 transactions are generally at the highest risk of being non-Volker compliant. They estimate that the CLO 1.0 universe has declined by approximately US$60.6bn from US$92bn only a year ago. In addition, the CLO 1.0 triple-A universe has dropped by 54% year-over-year, with an estimated US$21bn currently outstanding.

Upon the application of a banking entity, the Fed is permitted under section 619 to provide up to an additional five years to conform investments in certain illiquid funds, where the banking entity had a contractual commitment to invest in the fund as of 1 May 2010. It expects to provide more information in the near term as to how it will address such applications.

CMBS

CMBS balloon pay-offs plummet

The percentage of US CMBS loans that paid off on their balloon date slid sharply in June, according to figures from Trepp. The rate slid more than seven points from its May level, to 60.7%, which is the lowest reading since December.

The 12-month moving average stands at 68.6%. The 12-month rolling average by loan count is now 69.1%, after 67.9% of loans by loan count paid off in June. This figure was closer to the May total, which had been 68.3%.

Trepp notes that the declining pay-off rate is largely due to the fact that many of the loans now maturing are 10-year loans from 2006 that have not been able to be prepaid during their open period. Maturing loans during the rest of this year and 2017 will likely have lower credit quality than at origination due to having been originated later in the 2006-2007 lending boom.

In addition, the loans that reach maturity are likely to be the weaker performing properties, as all higher quality properties would have prepaid or defeased prior to reaching their balloon date. On this basis, it would not be surprising to see the pay-off rate sag further in upcoming months, says Trepp.

CMBS

Large loans push delinquencies up

US CMBS delinquencies last month increased by 20bp to 3.18%, according to Fitch's latest index results for the sector, rising for a third straight month. The sharp increase was mainly due to the addition of three loans to the index, each greater than US$100m in size.

In total, new delinquencies of US$1.43bn more than doubled total resolutions of US$678m in June. Further, the portfolio run-off of US$5.7bn also exceeded Fitch-rated new issuance volume of US$5bn from seven transactions in May, causing a decrease in the index denominator.

The largest new delinquencies were the Skyline Portfolio (accounting for US$474.6m in Fitch-rated transactions BACM 2007-1 and JPMCC 2007-LDP10, and US$203.4m in a non-Fitch-rated transaction), the JQH Hotel Portfolio (US$127.9m A-note in JPMCC 2006-LDP7 and US$8.4m B-note in CD 2007-CD4) and the Southern Hills Mall (US$101.5m in BACM 2006-3).

Meanwhile, the largest loans to be resolved were substantially smaller in balance, at less than US$40m in size. The largest resolutions included the US$38.1m Severance Town Center (securitised in GCCFC 2004-GG1), the US$37.5m Capital Plaza (MSCI 2006-IQ11) and the US$35.8m Steeplegate Mall (BACM 2004-6) (see SCI's CMBS loan events database).

Current and previous delinquency rates by property type are: 4.64% for retail (from 4.56% in May); 4.59% for office (from 4.15%); 4.22% for hotel (from 3.47%); 0.83% for multifamily (from 0.87%); 4.13% for industrial (from 3.41%); 3.94% for mixed use (from 4.08%); and 0.79% for other (from 0.79%).

CMBS

CMBS defaults move up

S&P's 12-month European CMBS loan maturity default rate moved up to 7.3% from 7% at the end of June. This coincides with a drop in the delinquency rate for continental European senior loans to 58.4% from 58.7%, while the rate for UK loans remained at 19.6% to end last month. On an overall basis, the senior loan delinquency rate decreased to 44.6% from 45% in May.

Insurance-linked securities

Foreign aid ILS mooted

London Market Group (LMG) has launched a white paper on an ILS solution for catastrophes in under-insured markets. It says the creation of a Foreign Aid catastrophe Bond (FAB) could provide a more cost-effective approach to catastrophe relief.

"The idea behind the FAB is a joint initiative between the [UK] government and LMG to provide a cost-effective response to catastrophes currently supported by the UK foreign aid budget," says Malcolm Newman, ceo of SCOR's London and Paris hub, who is leading the LMG workstream.

He continues: "We are looking to emulate other government-led forms of insurance, which already exist in areas such as Mexico and the Caribbean, to cover damage from the major natural perils of windstorm and earthquake. The LMG envisages a similar form of insurance to improve resilience in developing countries or regions which are under-insured against similar catastrophes."

The Nepal earthquake is cited as one example where a FAB could have provided a more cost-effective approach to catastrophe relief. The FAB is also in line with recent market innovations, such as the Pandemic Emergency Financing Facility (PEF) sponsored by the World Bank.

The proposal suggests the UK government would sponsor the issue of an insurance policy to cover the risk of catastrophes in a specified country or region. The risk premium would be paid by the protected countries and the Department for International Development's overseas aid budget would underwrite the bond issue.

Countries protected by the bond would be selected from those currently receiving development aid from the Department for International Development. Capital raised from investors via the issue of a bond would be placed in a trust account to secure the maximum level of risk in the policy.

NPLs

FNMA completes NPL sale

Fannie Mae has completed its sixth NPL sale, this time consisting of around 9,300 loans totalling US$1.5bn in unpaid principal balance, divided among six pools. The winning bidders are LSF9 Mortgage Holdings and PRMF Acquisition, with each submitting winning bids for three pools.

The loan pools consist of Group 1 and Group 2 pools. The Group 1 pools have an aggregate unpaid principal balance of US$746.44m and the cover bid price was 78.2% of unpaid principal balance. The Group 2 pools have an aggregated unpaid principal balance of US$759.86m and the cover bid price was 71% of unpaid principal balance.

Fannie Mae began marketing the loans on 16 June and the transaction is expected to close on 24 August. Part of the offering includes Fannie's fourth community impact pool, where bids are due separately on 21 July.

In April, the FHFA announced additional enhancements to its requirements for sales of NPLs by both Fannie Mae and Freddie Mac (SCI 15 April). Those additional requirements apply to this NPL sale.

Risk Management

Bail-in protocol launched

ISDA has launched a new protocol to help market participants meet the EU Bank Recovery and Resolution Directive (BRRD) requirement. The ISDA 2016 Bail-in Article 55 BRRD Protocol will allow Dutch, French, German, Irish, Italian, Luxembourg, Spanish and UK entities to meet the requirements of Article 55 of BRRD.

Article 55 obliges in-scope entities to include a contractual term in agreements creating any relevant liability and governed by the law of a third country to ensure their creditors agree to recognise any bail-in of those liabilities. "Article 55 will require market participants to make important changes to their outstanding contracts and the ISDA Bail-in Protocol will enable those changes to be made quickly and efficiently to ISDA Master Agreements and certain other contracts," comments Katherine Darras, ISDA's general counsel.

Risk Management

Clearing phase-in eyed

ESMA has published a consultation paper proposing to change the phase-in period for central clearing of OTC derivatives applicable to financial counterparties with a limited volume of derivatives activity under EMIR. The authority proposes to amend EMIR's Delegated Regulations on the clearing obligation to prolong, by two years, the phase-in for Category 3 financial counterparties.

The move aims to help these firms mitigate the difficulties they are encountering in connecting to central counterparties (CCPs). Direct membership at a CCP requires firms to meet certain minimum criteria and it is usually not feasible for financial counterparties with a limited volume of activity to access CCPs directly by becoming a clearing member. In particular, infrastructure/resource needs, minimum capital requirements and risks - such as the mutualisation of default fund resources - are significant barriers to becoming a clearing member.

For these counterparties, it is therefore necessary to become the client of a clearing member or to establish indirect clearing arrangements. ESMA's consultation is seeking stakeholders' feedback in order to better identify and quantify the difficulties that these counterparties may be facing in their preparation for the central clearing obligation. This assessment will also help the authority in determining whether further action is needed to address this issue.

ESMA notes that there is "an important number" of counterparties with a limited volume of derivatives activity and their overall contribution to the OTC derivative markets in terms of volume remains limited. This may enable a delay of the clearing obligation for these counterparties while not compromising the EMIR objective of reducing systemic risk.

The consultation closes on 5 September and ESMA aims to publish a final report by end-2016.

Risk Management

SEC adopts swap reporting rules

The US SEC has adopted amendments and guidance related to rules regarding the regulatory reporting and public dissemination of security-based swap transactions. The new Regulation SBSR rules and guidance are designed to increase transparency.

The final rules assign the reporting duties for platform-executed security-based swaps that will be submitted to clearing and for security-based swaps resulting from the clearing process. They also establish regulatory reporting and public dissemination requirements for certain cross-border security-based swaps and prohibit registered swap data repositories from imposing fees or usage restrictions on the security-based swap transaction data that Regulation SBSR requires them to publicly disseminate.

"This action ensures the public's accessibility to transaction information, extends the scope of Regulation SBSR to additional entities and transactions and completes an important mandate under Title VII of the Dodd-Frank Act," says SEC chair Mary Jo White. "By providing for the regulatory reporting and public dissemination of security-based swap transactions, Regulation SBSR will bring much-needed transparency to the security-based swap market."

The SEC is also issuing guidance with respect to the application of Regulation SBSR to security-based swaps resulting from prime broker arrangements and from the allocation of cleared security-based swaps. The rules establish a new compliance schedule for the portions of Regulation SBSR, for which the SEC has not previously specified compliance dates, with compliance for these portions being phased in over a period of months.

RMBS

Freddie factor change announced

Freddie Mac is implementing a new factor methodology for its single-family and multifamily MBS. The GSE says it will now round, rather than truncate, the last digit of the factors for all such MBS issued on or after 25 July.

The change is being made primarily in preparation for the single security, where Freddie will match Fannie Mae's current factor calculation process. The change should also help ensure a consistent approach to factor calculation across Freddie's securities products.

The news comes after the FHFA announced last week that it expects to see single securities issued by 2018 on the common securitisation platform (SCI 8 July).

Freddie's gold participation certificate securities will not be impacted, but will be included in the methodology change. The changes will affect, but not be limited to, the GSE's STACR deals, whole loan securities, multifamily K-deals and small balance deals.