Contents

Bail-in priced in?

European bank CDS put to the test

Mounting concerns over Deutsche Bank's financial health, along with bail-in speculation have coincided with significant widening in the bank's CDS - both at a senior and subordinated level. However, whether financial CDS prices are reflective of bail-in risk is debatable - as is investor confidence that CDS contracts will act 'as hoped', should a bail-in occur at a European bank.

Professor Edward Kane of Boston College highlights that CDS are conditioned on there being a declaration of an actual default and notes that this is something that global regulatory authorities are keen to prevent. "The culture of regulation and supervision is one of rescue - regulators think it's their job to rescue the economy from distress in the banking system by avoiding defaults as much as possible. The US is backing up the European banking system by swapping dollars with European banks and central banks. As long as the Fed's swap activity reliably targets banks whose survival is being tested, bail-in procedures will remain in doubt."

Kane suggests that bank CDS are not currently pricing in much of an expectation of actual default. "For example, at Credit Suisse and Lloyds, measures of their stand-alone default risk have been rising all year. But credit spreads on the bonds they have trading in the US appear largely unaffected. This suggests that bondholders are expecting to be bailed out."

During the financial crisis, a similar pattern was seen at the largest US banks. The default risk would rise, but their credit spreads would not. In Deutsche Bank's case, however, credit spreads are widening and there is concern over what the resolution will be.

"The market for bank CDS is thin, however, and it is possible for bank managers to arrange trades that keep their prices from reflecting the true default risk," says Kane.

CDS pricing is further complicated by the fact that, for payouts to be triggered, an event has to be declared by credit determination committees. "CDS are not as reliable an estimate of default probability and intensity as the prices of the bonds that trade regularly. Such prices can't be manipulated as easily as those for CDS," Kane continues.

Revised ISDA CDS documentation published in 2014 classifies bail-ins and governmental intervention as a credit event (SCI passim). In theory, this revision should mean that any loss that is imposed on credit investors due to the implication of bail-in rules is covered.

The documentation is yet to be tested fully, however. Furthermore, investors remain concerned that some jurisdictions may not adhere fully to Bank Recovery and Resolution Directive (BRRD) rules, which state that in the case of bank failure, losses must be borne by shareholders and creditors by means of a bail-in - not state aid.

Since the implementation of the BRRD in January 2016, there has not been a bank restructuring in Europe. The impending reform of the Italian banking system should act as a good test case for the European market, however, particularly in light of the provision of state aid and the country's potential exemption from certain BRRD requirements.

"If there is a nationalistic interest in doing something that is outside of the European framework, then it may trigger adverse effects for CDS protection buyers," says Jochen Felsenheimer, md at XAIA Investment. "If Italian banks ask for exceptions to BRRD - and these exceptions are granted - then investors will lose faith in European CDS contracts. The BRRD is clear on what the loss waterfall should be. Sub holders are hit first, then senior. If Italy gets exemption from this waterfall, then it impacts on the credibility of European regulators."

He adds: "If everybody sticks to the rules of BRRD, then the CDS should work perfectly. If the [Italian banks'] restructuring is fully compliant with BRRD, then I would expect that investors will be more comfortable with the European CDS format."

XAIA's Credit Basis Fund had a position in Portugal's Novo Banco, which was subject to losses when the Bank of Portugal moved a number of senior bonds to its associated 'bad bank' Banco Espirito Santo in December 2015 (SCI passim). In this case, the volume of bailed-in bonds was not large enough to trigger the CDS. A succession event was also deemed non-applicable.

"Novo Banco's senior bonds were removed at the very end of December 2015," says Felsenheimer. "On 1 January 2016, the BRRD was fully implemented in Europe. Therefore, this was probably the last chance Novo Banco had to take this action. Had the assets been moved after 1 January, the CDS would have covered potential losses in a bail-in situation."

The current focus on bank bail-ins and associated legislation highlights the desire to protect depositors, whereby senior bank debt is either pari-passu or subordinate to wholesale deposits. There is, however, a rich mix of different approaches in Europe to meet this aim and these may provide another explanation for country-specific bank CDS spreads.

For example, UK and Swiss banks are typically divided into a holding company and an operating company. The operating company is responsible for the deposits and the bank holding company issues senior debt - which is subordinate to deposits. However, in many cases the operating companies are currently creating the CDS in these jurisdictions (Credit Suisse Group is one exception) - meaning that, potentially, CDS are being created with the same seniority as deposits.

German and Italian banks have a different structure, employing legal subordination. German law requires, for example, that deposits are senior to any non-subordinated or senior debt.

In this case, senior CDS references senior debt that is subordinated to wholesale deposits. This is a different credit risk, however, and is something that is seemingly overlooked.

In France and Spain, contractual subordination - or reference to subordination - is used when entities issue Tier 3 debt (or non-preferred seniors in France). This situation could be applied to the CDS market, if the non-preferred seniors/Tier 3 debt were the reference obligation in senior CDS. However, this is not currently the case: French and Spanish bank CDS often reference debt from the operating company that is pari-passu to wholesale deposits.

In August, Markit hinted at amending the iTraxx CDS index rules to provide for bank constituents in the index to be included at holdco level for iTraxx Europe. The firm noted that due to regulatory changes, it is expected that Lower Tier 2 debt and senior debt issuance will increasingly be undertaken at holdco level for banks. Depending on the outcome of the review, implementation is likely to occur in the coming 12 months.

AC

Structured Finance

Safe haven?

Securitised sovereign bonds could bring economic stability

A European bond comprised of securitised sovereign bonds from multiple European countries could help bring funding and economic stability to the eurozone. This is according to a group of leading economists, who have drafted a proposal for so-called European Safe Bonds, or ESBies.

The proposal highlights that the euro area lacks a union-wide safe asset, the absence of which contributes to cross-border capital flights to safety during periods of financial stress. During sovereign debt crises, for example, a "diabolic loop" is initiated, whereby banks holding risky sovereign debt suffer losses to their net worth, causing them to cut back on their lending to the real economy and increasing governments' contingent liabilities.

Markus Brunnermeier, Edwards S. Sanford professor of economics and director, Bendheim Center for Finance, and others propose a union-wide safe asset dubbed ESBies. ESBies themselves would comprise the senior tranche of a diversified portfolio of euro area sovereign bonds, with sovereigns keeping responsibility for their own bonds, which would still be traded at a market price, exerting discipline on borrowing decisions.

Sovereigns could therefore default on their own obligations without others bearing any bail-out responsibility and without holders of ESBies bearing any losses. As part of the securitisation, there would also be a junior bond, dubbed EJBies.

To test the quality and safety of ESBies, the researchers ran tests to compare it with the German bund, simulating the default and loss-given-default rates for euro area sovereign bonds. In the benchmark scenario, it was found that ESBies with a 30% subordination level would be as safe as German bunds.

If the underlying portfolio had a face value of €6trn (equivalent to 60% of GDP), ESBies would amount to €4.8trn - approximately double the current size of euro-safe assets - and the remaining €1.8trn of the securitisation would comprise moderately risky EJBies. The junior bonds would be attractive to high-yield investors, due to their embedded leverage, and they could be securitised further to cater to various investor groups, the researchers' suggest.

The ESBies were further tested against an adverse scenario with higher default probabilities than in the benchmark scenario and greater correlations across countries. Even then, the researchers find that with 30% subordination, ESBies are as safe as German bunds - although they highlight that ESBies should be constructed out of all euro member states because "including even riskier nation-states enlarges the pool from which safe assets can be generated".

One of the benefits of ESBies - as touted by the research - is safeguarding the equilibrium of the economy with respect to sovereign debt, the likelihood of default and its correlations across countries. The intended effect of ESBies is to weaken the diabolic loop between sovereign risk and bank risk.

Sovereign debt crises can be triggered by "sunspots" that occur independently in each country, thus reducing the market value of domestic and sovereign bonds. Banks - which hold sovereign bonds - might need to be bailed out in order to continue lending to the real economy. But if tax revenues are lower than expected, the bail-out forces the government to default on its obligations - "ultimately bringing down the banks", the researchers claim.

Bank portfolios tend to comprise equity and sovereign bonds, with some domestic and some foreign bonds. With cross-border holdings, there then develops a diversification effect in that banks are less exposed to a domestic sunspot and a contagion effect in that banks are more exposed to a foreign sunspot.

Tranching can reduce both diversification and contagion risks, with diversification occurring at lower values of initial equity, and the contagion region shrinking as the "safe region" - in which there is no diabolic loop - expands. Tranching thus "shifts default risks to junior bondholders outside the banking sector", making tranching a "positive sum game".

With regard to putting ESBies into practice, the researchers suggest that policymakers need to take steps to make them a reality, such as deciding who should issue them, publishing an ESBies' handbook to define the standards ESBies should adhere to and finally to commence with issuance. Issuance might initially be limited, but could be aided by a centralised market or auction, whereby banks could swap their existing sovereign bond portfolios for a portfolio of ESBies and EJBies - although this process would be expedited by the ECB accepting ESBies into its monetary policy operations.

The research suggests that ESBies would enable the smooth functioning of the financial markets, increase the supply of safe assets and preclude distortionary flight-to-safety capital flows across countries. The availability of such a safe asset union-wide would also weaken the diabolic loop between sovereigns and banks, as banks will be encouraged to hold a safe asset instead of national sovereign bonds.

It concludes that ESBies would offer Europe the same benefits the US enjoys from federal Treasuries. These include symmetric and abundant supply, without the downside of mutualisation.

RB

Euro ABS/MBS quiet

This week has continued to be slow across the European ABS/MBS secondary market.

"There's nothing going on," says one trader. "UK half-term means a lot of people are out this week and anyone who is here will be looking at primary where there are few interesting deals marketing."

Secondary supply has been more limited than in recent weeks, the trader adds. "There have been a couple of BWICs here and there that have gone through OK, but secondary is really very quiet."

There are currently two BWICs on the European ABS/MBS BWIC schedule for today. The largest of which is due at 11:00 London time - a three line £77.5m original face RMBS auction comprising: DFUND 2016-1X A1B, FRIAR 3 A and LAN 2016-1 1A.

Only DFUND 2016-1X A1B has covered on PriceABS in the past three months - at 100.311 on 9 August.

Secondary markets

US CLOs partly pause

Aside from a busy equity space, the US CLO secondary market is taking something of a pause.

"Last week and this secondary overall has been bit quieter," says one trader. "People are generally happy to take a breather after the previous few weeks being so busy."

The trader adds: "CLO market focus continues to be on primary issuance on both sides of the Atlantic - for example, everyone is watching the Blackrock European deal closely to see if it prices inside 100."

However, there is a pick-up in BWICs today and as with recent sessions equity pieces make up a large proportion of the bonds in for the bid. "The rise in equity activity makes sense because a combination of external factors is directly impacting equity holders right now," the trader explains.

"Underlying loans are at high levels, which is pushing up NAV, but distributions are being hampered by rising Libor and there is pressure on weighted average spreads. As a result, the inherent value of equity is going up but equity payments are lower, so it's worth it to some investors to look to move out with a view to moving back when the situation changes."

There are nine BWICs on the US CLO calendar for today so far, with nearly half of the line items being equity pieces. The largest is a six line equity list due at 11:00 New York time.

The $156.7m auction consists of: ARES 2012-3A SUB, ARES 2013-1A SUB, ARES 2013-1X SUB, CGMS 2012-3A SUB, CIFC 2014-3X INC and KVK 2013-1A SUB. None of the bonds has covered with a price on PriceABS in the past three months.

Secondary markets

Euro secondary starts slow

It was a slow start to the week in the European securitisation secondary market, but a large CDO liquidation should generate some interest today.

Yesterday was quiet across the board thanks to an element of supply fatigue as the well-established pattern of primary focus linked to flurries of BWICs continued into the end of last week and was met with UK school holidays at the start of this. Nevertheless, sentiment is still positive and secondary spreads remain firm in all sectors.

Among the five European BWICs scheduled for today so far, the highlight is a CDO liquidation due at 13:00 London time. The 46 line AON list involves CLOs, CMBS and RMBS totalling 363+m original face.

The auction comprises: BERCR 6 C, CADOG 4X C, DECO 2007-E5X C, DECO 2007-E5X D, DUKEF 2006-11X A3E, EGRET I-X C, E-MAC DE05-I B, E-MAC DE06-I C, E-MAC DE07-1 A1, EMACP 2008-1 A2, EMACP 2008-2 A2, EMACP 2008-NL4 A, ESAIL 2006-1X C1A, ESAIL 2007-NL1X D, FAB 2005-1 A2, GARDC 2006-1X C, GARDC 2006-1X D, HIPO HIPO-6 B, HLCN 2005-2X A, HMSF XI B, IXION 2007-20X D, MESDG CHAR B, MESDG CHAR C, MINO 2004-1 A, MPS 2X M1B, MPS 3X M1B, MPS 3X M2B, NGATE 2006-3X CB, PBDOM 2006-1 D, PELIC 1 B, PRS 2005-2X A2A, PRS 2005-2X B1A, PRS 2006-1X C1A, QNST 2006-1X C1, RMAC 2005-NS2X M1C, RMS 21X M1C, SELMS 2006-1X D2, SPS 2005-3X B1A, TAURS 2007-1 A1, TDAP 1 B, TITN 2006-1X C, TITN 2007-2X C, UCI 7 B, UCI 8 B, ZOO II-X B and ZOO II-X C.

Only CADOG 4X C has covered with a price on PriceABS in the past three months - at 97.813 on 11 October.

Secondary markets

US CLOs tick over

US CLO secondary market continues to tick over despite continued distraction from primary.

After a busy end to last week, secondary activity and the BWIC calendar is light so far this week as focus remains on primary. Secondary spreads continue to hold firm across the bulk of the capital structure as a buying bias prevails and supply continues to be easily absorbed.

The exception has been some softening of tone around 2.0 double-Bs. However, that has not been reflected in price movement in anything but the weakest names.

There are four BWICs on the US CLO calendar for today so far. The most sizeable is a two line double-A list due at 13:00 New York time.

It comprises: $40m HLA 2014-2A A2 and $29.312m OFSBS 2014-7A B. Neither bond has ever covered with a price on PriceABS.

ABS

Utilisation drop hits container deals

Two container ABS deals - BEACN 2012-1A and GCA 2013-1A - have been called so far this month, removing about US$300m of bonds from the market. Both of the transactions had experienced declines in average utilisation rate and average portfolio lease rate, which likely contributed to the issuers' decision to call them.

KBRA recently noted that average utilisation in BEACN had fallen by over 11% since issuance, while the average lease rate declined by nearly 33%. The decline in utilisation was spread relatively evenly across the portfolio in terms of container types, while the drop in lease rates primarily came from the dry containers (accounting for a decline of 29% to 44%).

Wells Fargo structured product analysts point out that while BEACN had a smaller exposure to dry containers compared to the GCA 2013 deal - two-thirds of the portfolio net book value were dry containers, versus about 91% for GCA at issuance - the transaction still underperformed, relative to other post-crisis container deals.

The issuer added about US$30m of containers to the transaction in July to provide additional support. But with slightly over 10% exposure to Hanjin Shipping, almost US$26m worth of containers were removed from the asset base calculation, according to KBRA.

While interest was paid on the deal in September, the issuer failed to pay the full minimum principal amount. Even though KBRA notes the LTV of the transaction had declined nearly 12.5 percentage points since issuance to 63.5%, BEACN was called.

Similar to the BEACN deal, GCA 2013 was launched during a period of high box prices and lease rates. Given that the majority of the portfolio was made up of dry containers, the average utilisation rate and portfolio lease rate likely saw a similar decline, due to continued pricing pressure.

Following the calls, the Wells Fargo analysts calculate that the total outstanding balance in their container ABS universe now stands at approximately US$4.8bn. They note that except for GCA 2014, which S&P recently downgraded (SCI 3 October), no other deals appear to have triggered an early amortisation event or made any principal payments that were at or below the minimal principal threshold.

The container ABS market has contracted by nearly US$2.5bn since end-2013, according to Wells Fargo figures, due to a mix of muted primary issuance, a pick-up in deals being called and amortisation.

CS

ABS

Timeshare default repurchases climb

Timeshare ABS default rates are rising and there is a growing trend of default repurchases and substitutions, although Wells Fargo analysts believe investors should be well protected. Borrowers are increasingly being advised not to make payments on their timeshare loans, which chimes with observations of weaker trends in consumer credit performance in other consumer ABS sectors.

Default repurchases and substitutions have risen to the higher end of long-observed, historical levels. However, the Wells Fargo analysts believe timeshare ABS investors remain well protected from losses due to high levels of credit enhancement, excess spread and performance-based triggers.

There is also a strong alignment of incentives between the corporate sponsor and investors to repurchase and remarket defaulted timeshares to maximise cash flow and profitability. That does not mean that the changing performance trends can be ignored, however.

The ability of most timeshare ABS sponsors to repurchase or substitute up to 20% of loans if there are defaults provides an alignment of incentives between sponsors and investors. Timeshare sponsors can protect the value of their timeshares by remarketing the defaulted timeshares to new customers, while investors have additional protection from losses by receiving cash or a substitute loan.

Wyndham 2015 and 2016 deals have experienced a noticeable increase in defaulted loan repurchases and substitutions compared to deals in 2013 and 2014. During earnings calls this year, management has attributed an increase in loss provisions to third-party induced defaults, where consultants have advised borrowers to stop making payments.

"In Wyndham's Q3 earnings call on 26 October, management stated it has seen a slight improvement in third-party induced defaults in the quarter and in some cases, it is taking legal action against third-party advisors. However, they also noted it is too early to tell where defaults will go over the short- and medium term," the analysts add.

Diamond Resorts reported a similar situation before being purchased by Apollo. Diamond has seen more pronounced default repurchases and substitutions for its 2014 and 2015 ABS trusts than for earlier deals.

The trend towards higher defaults driven by third-party guidance may be temporary, rather than a longer-term issue. Marriott's earnings call two weeks ago reported no similar third-party induced defaults, although one significant difference between Marriott timeshare loans and those of Wyndham and Diamond Resorts is in the use of deeded versus right-to-use arrangements.

"Deeded timeshares are ownership in real property, which can be owned in perpetuity, transferred, or sold. Since the borrower owns an interest in the property, for legal purposes, any default would likely go through a standard real estate foreclosure process. Marriott mainly utilises deeded timeshares, and MVWOT 2016-1 consisted of 96% deeded mortgage loans and only 4% right-to-use loans," note the analysts.

Right-to-use timeshares grant the right to use a property at a certain time, often only for a set number of years, with no deeded interest in the property. This makes it more of a leasing arrangement than a property interest. Diamond Resorts mainly uses right-to-use timeshare, while Wyndham uses both right-to-use and deeded.

"There may be a school of thought that right-to-use timeshares may have less serious default repercussions, especially with new CFPB regulations potentially constraining third-party collectors from contacting borrowers and collecting on outstanding debt. Since the consumer does not own an interest in the property, the timeshare sponsor may not pursue the borrower as vigorously in order to remarket the defaulted timeshare," say the analysts.

They continue: "Although timeshare sponsors may have recourse to the borrower, the lenders have stated that it may not make economic sense for them to pursue defaulted amounts. Wyndham stated in its Q3 earnings call that it is trying to improve communication with borrowers to avoid third-party induced defaults."

JL

Structured Finance

SFR refi incentive boosted

Total home equity has increased by 27% since issuance across the 71,955 properties underlying the 18 single-family rental securitisations issued in 2013-2015, according to Deutsche Bank figures. The trend is expected to boost SFR issuers' refinance incentive.

Based on property-level data released by the SFR issuers, Deutsche Bank RMBS analysts estimate that the aggregate BPO value of these properties increased to US$18.1bn in July 2016, from US$14.3bn at issuance. At the same time, LTV declined to 58%, as of July 2016, from 73.7% at issuance.

Most of the SFR deals in the Deutsche Bank sample have floating rates, with a two-year initial term and three one-year extension options. With significant rising home equity in the underlying rental properties, borrowers of floating-rate SFR deals have equity-incentive not to extend.
Two SFR issuers - PROG 2014-SFR1 and ARP 2014-SFR 1 - recently chose not to extend (SCI passim). Progress Residential Trust prepaid a US$473.2m loan that serves as collateral for PROG 2014-SFR1 in July, with 88% (by loan count) of the underlying properties refinancing into a subsequent transaction, PROG 2016-SFR1. American Homes 4 Rent subsequently paid off the US$342.1m loan that serves as collateral for ARP 2014-SFR 1, prior to its initial maturity date of 9 September 2016.

The analysts estimate that the home equity appreciation in PROG 2014-SFR1 and ARP 2014-SFR1 were US$146m and US$128m respectively, as of July 2016. They note, however, that Progress paid off its deal prior to the maturity of the initial two-year term and had to pay a spread maintenance premium. In addition, there was a negative rate incentive to refinance the bulk of PROG 2014-SFR1 into PROG 2016-SFR1.

A further twelve of the SFR transactions in the sample are collateralised by two-year loans approaching their initial maturity dates. "We expect that more floating-rate SFR deals may not extend, given the large home equities that have accumulated," the analysts conclude. "Bonds with larger rising home equity are better protected against rental income shortfalls, as measured by the current certificate balance as a percentage of current BPO. Also, higher home equity reduces extension optionality. Consequently, we expect that bonds with larger home equities should be traded tighter."

CS

Structured Finance

SCI Start the Week - 24 October

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

Pipeline
The balance appeared to shift last week, as fewer deals joined the pipeline and far more departed. The week's additions were four ABS, two RMBS, two CMBS and four CLOs.

US$640m Apollo Aviation Securitization Equity Trust 2016-2, US$840.78m Chrysler Capital Auto Receivables Trust 2016-B, US$175m EARN 2016-D and CNY3bn Toyota Glory 2016-1 accounted for the ABS, while the RMBS were Fortified Trust 2016-2 and SapphireOne Mortgages FCT 2016-2.

US$953.2m MSBAM 2016-C31 and US$858m WFCM 2016-C36 were the CMBS. The CLOs consisted of LMREC 2016-CRE2, US$400m Neuberger Berman CLO XXIII, NorthStar 2016-1 and US$370m OHA Loan Funding 2016-1.

Pricings
Issuers appeared to have the approaching end of the month in mind last week. There were 22 ABS prints, with eight RMBS, a CMBS and five CLOs rounding out the week's issuance.

The ABS were: €434m abc SME Lease Germany Compartment 3; US$271.46m Ascentium Equipment Receivables 2016-2 Trust; US$201.23m Axis Equipment Finance Receivables IV series 2016-1; US$1.3bn CarMax Auto Owner Trust 2016-4; US$350m Credit Acceptance Auto Loan Trust 2016-3; £740m Driver UK Four; US$340m Flagship Credit Auto Trust 2016-4; US$1.32bn Ford Credit Auto Owner Trust 2016-C; £542m Globaldrive Auto Receivables UK 2016-A; US$1.14bn Honda Auto Receivables 2016-4 Owner Trust; US$117.29m JG Wentworth XXXVII Series 2016-1; US$1.037bn Mercedes-Benz Auto Lease Trust 2016-B; US$147.1m Oportun Funding IV Series 2016-C; US$176.46m Orange Lake Timeshare Trust 2016-A; US$250m PFS Financing Corp Series 2016-B; US$343.6m Prestige Auto Receivables Trust 2016-2; €171m Qunito Sistema 2016; €606m SCF Rahoituspalvelut II (Kimi 5); US$500m Securitized Term Auto Receivables Trust 2016-1; US$3.5bn Sprint Spectrum Co Series 2016-1; US$452.25m State Board of Regents of the State of Utah Series 2016-1; and CNY3.46bn VINZ 2016-2.

The RMBS were: US$580.7m Colony Starwood Homes 2016-2; €272m DCDML 2016-1; A$495m Liberty Series 2016-2 Trust; £242m London Wall Mortgage Capital Fleet 2016-01; €420m RMBS Prado III; US$343.16m Sequoia Mortgage Trust 2016-3; US$478m STACR 2016-HQA4; and US$382.5m Tricon American Homes 2016-SFR1.

US$196m Vertical Bridge Series 2016-2 was the sole CMBS. The CLOs were €466m Avoca CLO XVII, €415m Carlyle Global Market Strategies Euro CLO 2016-2, US$505m Newstar Berkeley Fund CLO 2016-1, US$413m Shackleton IX and US$715m Sound Point CLO 2016-3.

Editor's picks
Liquidity review: The use of liquidity data in determining asset values is subject to increasing industry analysis and the US SEC's finalisation of its liquidity risk management rules will likely focus attention on this topic further. But uncertainties remain surrounding the intersection of valuation and liquidity, as well as questions over how best to collect liquidity data...
Structuring alpha: Robert Allard, founding partner and ceo at Firebreak Capital, answers SCI's questions...
Refinancing activity accelerates: US CLO refinancing volume has shot up this month, impacting 14 deals for a total value of US$6.2bn so far, versus US$3.7bn seen during the whole of September. The increase in activity has created a clear term structure at the triple-A level...
New standard to drive transparency?: A new Mortgage Industry Standards Maintenance Organization (MISMO) XML commercial rent roll standard is due to be released by the end of the month. As the CMBS industry grapples with the Dodd-Frank Act and transparency issues, some believe that including such files in investor disclosures pre- and post-securitisation is the most important remaining step issuers could take...
US CLO supply spike: There is a spike in supply in the US CLO secondary market today. "It's a busy day today, with a few more BWICs than we've seen in recent days," says one trader. "There's plenty of mezz and equity in for the bid and that'll provide a lot of data points on the follow..."

Deal news
• The US$4m Delavaco loan, securitised in FirstKey 2015-SFR1, has been transferred to special servicing due to imminent non-monetary default. The loan has appeared on the master servicer's monthly watchlist since December 2015, based on a decline in occupancy below 80% - decreasing to 51% by August 2016 - as well as its failure to meet a debt service coverage trigger.
• A class B noteholder meeting has been convened in connection with Stanton MBS I, following one for the controlling class of the ABS CDO (SCI 11 October). The meeting - scheduled for 9 November - is to be held for the purposes of passing an extraordinary resolution that would allow NCB Stockbrokers to resign as Irish paying agent.
• Recent weeks have seen a flood of auto ABS deals announced (see SCI pipeline), but the trend is not constrained to the US and Europe, with Toyota now in the market with its first Chinese ABS of the year. CNY3bn Toyota Glory 2016-1 is the company's second Chinese deal overall and the first to be rated by Moody's.
• The unique structure of Amherst's inaugural single-family rental securitisation (SCI 6 October) - AMSR 2016-SFR1 Trust - presents specific risks regarding alignment of interest, says Moody's. The rating agency believes this may be partially mitigated by a strong property management agreement and the expertise of Amherst affiliate Main Street Renewal (MSR).
• Fitch has disclosed that interest payments to the class E and F notes of SCF Rahoituspalvelut I (Kimi 1) were incorrectly modelled in its initial rating analysis of the Finnish auto ABS as senior to clearing the implied principal deficiency ledger (PDL). Correct modelling would have resulted in different model-implied ratings for two classes: one notch higher for the class D notes and one notch lower for the class E notes.

Regulatory update
• SFIG has responded to the FHFA's request for information on Fannie Mae and Freddie Mac's credit risk transfer strategies. Along with its own letter, SFIG has also participated in the submission of a joint trade comment letter with organisations such as the American Bankers Association, Association of Mortgage Investors, Housing Policy Council of the Financial Services Roundtable, Mortgage Bankers Association and SIFMA.
• FINRA is set to implement changes to TRACE trade reporting and dissemination for CMO securities on 20 March 2017. The authority says it will issue details regarding testing of these changes in a future technical notice.

CMBS

CMBS market craving liquidity

Investors believe CMBS offers the best relative value compared to other asset classes, according to a recent Deutsche Bank survey. It also finds that CMBS investors' main concern is lack of secondary market liquidity, which could be having a knock-on effect on investment, particularly in long-duration CMBS paper.

In terms of whether investors would look to increase or decrease their CMBS index weighting versus the index in the next 12 months, 60% say they will maintain the same levels next year. Insurers were found to have the highest likelihood of increasing their CMBS index weighting, with 45% expected to increase and 0% expected to decrease.

When looking at investors' attitude towards relative value of CMBS and other asset classes, the survey finds that CMBS is seen as offering the most relative value - although CLOs were a close second. However, banks and insurers tended to rank CLOs higher than CMBS in terms of relative value.

Within CMBS, the single-asset/single-borrower (SASB) category is viewed as offering the best relative value, followed by new issue credit. New issue triple-As are overall ranked as having the least relative value among investors, followed by agency CMBS. Deutsche Bank CMBS analysts share the view that SASB is the most attractive area within CMBS, with triple-B minus new issue credit remaining unappealing.

Considering pricing expectations, investors anticipate that going forward new issue triple-A spreads will be tight, with an average expectation at 102bp. This is 14bp-18bp tighter than current deals and the Deutsche Bank analysts suggest that this is "likely reflecting expectations about better liquidity and credit quality."

Turning to issuance volumes, investors estimate that on average private label (conduit and SASB) expectations for 2017 will be around US$65bn for 2017. The analysts note that as a base case they project private label supply of US$60bn-US$70bn, "implying CMBS market share remains relatively low."

Gauging concerns for the CMBS market, investors state that lack of secondary market liquidity is the biggest concern. The analysts anticipate "dealer balance sheets for CMBS" to "shrink further", which will exacerbate the issue - with liquidity becoming very challenging, should credit outflows occur. They believe uncertainty over liquidity could explain money managers' waning optimism for long-duration CMBS.

In terms of how investors see liquidity in CMBS changing over the next 12 months relative to other sectors, only two of the 59 polled state that it will improve. The rest are fairly evenly split in stating it will remain the same or worsen, implying liquidity concerns will be an ongoing issue for CMBS investors going into 2017.

Of new issue CMBS, the respondents share two major concerns: low cap rates and soft underwriting. In terms of the property types within CMBS that investors are concerned about, respondents record overwhelmingly that retail is the biggest cause for worry.

Finally, the survey looks at the issue of risk-retention compliant deals and how these should be priced. It finds that overall investors do not think triple-As from a vertical risk-retention compliant deal should trade tighter than horizontal, although money managers were most evenly split, with around 50% saying verticals should trade 0bp-10bp inside horizontal deals.

RB

CMBS

Servicer performance scrutinised

A new Morningstar Credit Ratings study of aggregated consent-processing times of four large-volume US CMBS master servicers - Wells Fargo Commercial Mortgage Servicing, Midland Loan Services, KeyBank and Berkadia Commercial Mortgage - indicates that amid substantial request volume, their average completion times during the past few years have been fairly constant and even quicker in some periods. However, CMBS servicers remain under scrutiny, especially with regard to their performance.

Morningstar examined average consent processing times for 2013 through June 2016 for three common borrower requests that typically involve external-party approvals - loan assumptions, leasing consents and partial releases of property collateral. The agency found mostly narrow fluctuations for average completion times while the servicers confronted high processing volume in these periods.

Although consent volume decreased by 11% in 2015, it followed a 46.8% jump in 2014. For 2015, these servicers processed more than 8,800 requests involving loan assumptions, leasing consents, partial releases and defeasance. Loan assumptions show a positive trend regarding average internal-approval times, which declined in each subsequent period, while their total processing times dropped after 2013 and have remained fairly stable since.

Morningstar notes that many servicers have adjusted their operations and enhanced technology to strengthen consent processing and improve service levels, with both the CRE Finance Council and Freddie Mac working to standardise documents and requirements and streamline processes. In particular, many CMBS servicers have bolstered staffing with consent-management teams and subject-matter experts. In addition, they have enhanced their technology to facilitate transaction management and are working to improve borrower-communication channels.

The agency calculated that the average portfolio management staff experience of the four dominant CMBS master servicers increased to 18 years, as of June 2016, from 15 years as of December 2013. Their total portfolio management staff increased by 53% during that time, while their total combined volume of loan assumptions, leasing consents, property releases and defeasance requests increased by approximately 31% between 2013 and 2015.

To manage consent volume, some servicers may engage vendors to assist with compiling information, data input and cashflow modelling. For situations in which one entity is both the master servicer and special servicer, the servicer may consolidate the consent review to one team.

To facilitate borrower communication, many servicers have modified their operations from a strict siloed or functional approach to a relationship-manager structure, enabling borrowers to have a single point of contact. Some CMBS special servicers have established asset management teams for consent processing and, with non-performing loan volumes declining in recent years, have been able to reallocate staff to assist with consents.

Morningstar believes that some servicers' upgraded servicing systems, along with their proprietary applications, have stronger workflow management capabilities. Servicers also have been expanding the capabilities of their borrower web portals to be more interactive with secured email and chat capabilities, compliance alerts and document exchange features.

CMBS consents typically involve multiparty approvals, in which a servicer interacts with the borrower, obtains the required documents and information, underwrites the request, prepares the written case for internal review and procures any required external-party approvals. Additionally, the servicer normally must obtain consent from the transaction's special servicer for actions defined as major decisions, while the final approver for most consents is the controlling class representative (CCR). The servicer may also need rating agency consent in some situations.

In contrast to the traditional model, some CMBS servicing agreements permit special servicers to bypass the master servicer and unilaterally underwrite the consent request. However, critics cite concerns that this process potentially increases the opportunity for the special servicer to pursue terms and conditions that may unduly exceed a loan's original underwriting.

Morningstar analysed assumption and lease consent times of loans with this approval structure for two special servicers, Torchlight Loan Services and Rialto Capital Advisors. Total loan-assumption processing time averaged 35 days in 2015, based on 24 requests, and averaged 56 days in 1H16 based on 37 requests. For leasing consents, based on 37 requests in 2015 and 64 in 1H16 under this structure, the two special servicers averaged 21 days in both periods.

Nevertheless, a recent letter submitted to the CREFC by a group of issuers and investors highlighting concerns about servicing practices - and the subsequent creation of a task force - indicates that discontentment persists across the industry. Morningstar believes that servicers, motivated by competition and reputation, should remain critical of their own performance and continue to pursue process improvements to raise borrower satisfaction.

CS

Structured Finance

Ratings complaints prepped

The US Department of Justice (DOJ) is preparing a civil complaint against Moody's in the US District Court for the District of New Jersey, alleging certain violations of the Financial Institutions Reform, Recovery and Enforcement Act in connection with ratings assigned to RMBS and CDOs in the period leading up to the 2008 financial crisis. Moody's disclosed in its Q3 results that the DOJ also stated - in a letter received at end-September - that its investigation remains ongoing and may expand to include additional theories.

Additionally, a number of states attorneys general have indicated that they expect to pursue similar claims under state law, which may include additional periods, theories, asset classes or activities. Moody's says it is continuing to respond to the DOJ's and states' subpoenas and inquiries.

Structured Finance

Replacement chairman named

RAIT Financial Trust has separated its offices of chairman and ceo, which were previously both held by Scott Schaeffer. The REIT's board has elected Michael Malter to succeed Schaeffer as chairman.

Malter joined the board in November 2015 and currently serves on the risk management committee and the compensation committee. He also chairs the special committee that was responsible for negotiating Independence Realty Trust's management internalisation (SCI 27 September).

Malter retired as JPMorgan's co-head of the global financial institutions group in 2005. He currently serves as a director or member of the advisory committee of four investment vehicles that each use Varadero Capital as their investment manager.

Meanwhile, Schaeffer will remain a member of the board and continue as RAIT's ceo until the closing of IRT's management internalisation transaction, which is expected to occur in December. Scott Davidson, RAIT's current president, will become ceo and serve on the board effective upon this closing. He has been with RAIT since 2010, serving in various capacities, including md.

Structured Finance

Group sells debt division

3i Group has sold its debt management business, 3iDM, to Investcorp. The sale will generate £222m in cash for 3i and an exceptional profit on disposal of £36m, subject to closing adjustments that are dependent on the transaction's completion date.

The proceeds of the deal will be reinvested in 3i's private equity and infrastructure divisions. The transaction is set to close by 31 March 2017, subject to satisfaction of closing conditions, including the required regulatory approvals. As part of the deal, 3i will be selling its 3iDM fund management business and CLO equity investments required to meet risk retention requirements, valued at £182m, as of 30 September 2016.

Investcorp has agreed to take over 3i's debt warehouse commitments in the US and Europe, and 3i will continue to hold certain CLO investments valued at £56m (as of 30 September 2016), along with certain incentive fees. It will also maintain its commitments to the Global Income Fund and Senior Loan Fund.

3iDM's leadership is expected to remain intact, with Jeremy Ghose continuing as ceo of the overall division and John Fraser staying to oversee US operations. Other 3iDM employees are expected to remain as part of the transfer to Investcorp.

Structured Finance

Private debt team bolstered

Ardian has expanded its private debt offering with the appointment of Mark Brenke as co-head of Ardian Private Debt. He has over 20 years' private capital investment experience in European markets, encompassing both private debt and private equity.

Prior to joining Ardian, Brenke worked for Intermediate Capital Group, most recently with responsibility for establishing its European direct lending business. He has worked at Ardian for over two years, initially joining as an md.

CLOs

Credit manager adds partner

River Birch Capital has recruited a former Pine River Capital Management portfolio manager. Gaurav Tejwani joins the firm in New York as a partner.

Tejwani was co-head of structured credit at Pine River. He was previously part of the Y-Point Financials team which moved to Pine River, and before that he worked in credit derivatives and structured credit at Barclays Capital and in structured credit and CDO strategy at Lehman Brothers.

CLOs

Tikehau takes over senior debt funds

Tikehau Capital has reached an agreement with Lyxor UK to manage the investments of Lyxor's European senior debt funds. The deal will allow Tikehau to expand its leveraged loans and CLO business from €1.9bn AUM to €2.6bn.

Tikehau will replace Lyxor as investment manager of Lyxor's four European senior debt funds, while Lyxor's European senior debt operational team will join Tikehau IM in London. Lyxor will remain the management company of the funds involved and will continue to provide second-level supervision of risks and valuation.

Insurance-linked securities

ILS analytics firm acquired

Verisk Analytics has acquired Analyze Re. The software analytics provider will become part of AIR Worldwide, expanding AIR's analytical solutions beyond catastrophe modelling to advanced real-time decision making.

Analyze Re is a specialist provider of tools and services to the insurance, reinsurance and ILS industries. Its acquisition will enable AIR to provide clients with additional real-time pricing, exposure management and enterprise portfolio roll-up capabilities.

Insurance-linked securities

Strategic relationship formed

New Ocean Capital Management, together with its major shareholders XL Group and Stone Point Capital, has announced a newly formed strategic relationship with Mitsui. Mitsui has committed an initial US$100m of proprietary investment capital to New Ocean's private fund platform on a multi-year basis, and will endeavor to source additional capital by 2020.

As part of this strategic transaction, Mitsui also purchased a 15% stake in New Ocean from its existing shareholders. In addition, a Mitsui representative will join the New Ocean board, alongside existing representatives from XL, Stone Point Capital and management. XL remains the majority shareholder in New Ocean.

Mitsui has invested with New Ocean since 2014 and this transaction is expected to enable the firm to draw investor capital at key renewal dates in the reinsurance calendar, as opportunities present themselves. "We decided to grow our affiliation with New Ocean, due to the experience and expertise of its investment team led by Chris McKeown, and its differentiated access to risk - which combines market-facing capabilities with an affiliation with XL and its substantial distribution network," comments Takashi Nakai, general manager of Mitsui's insurance business department.

He adds: "At Mitsui, we are committed to building long-term businesses that will benefit Mitsui and other investors over time. For this reason, we are pleased to join New Ocean as a strategic investor, at a time when we believe ILS/reinsurance will become more appealing to institutional investors in Japan and across the globe."

Risk Management

Credit solutions service expands

NewOak Credit Services has expanded its capabilities to service the private credit market. The newly launched private credit solutions practice, led by md Yuri Yoshizawa, focuses on specialty finance and esoteric lending strategies.

NewOak plans to leverage its credit-focused technology platform to facilitate: outsourced middle-office and asset administration; valuation; analytics; reporting; and data and document management. Solutions will be designed for both managers deploying capital to these markets, as well as service providers in need of enhanced capabilities to keep pace with their clients.

The firm says it has hired several industry veterans to lead various sectors and has already on-boarded several clients within the private credit sector.

Risk Management

FICC beefs up

Jim Hraska has been named md and general manager of DTCC's Fixed Income Clearing Corporation (FICC). He will be responsible for activities including expanding buy-side participation in FICC clearing services and implementing the MBS novation initiative, a multi-year project to simplify the MBS netting and settlement process.

Hraska joins DTCC from Barclays, where he most recently served as global director of product management, specialising in financing and structural reform. He has 26 years of experience in the securities industry, with a background in fixed income and equity financing, including structured credit products.

He is also a member of SIFMA, where he served as the government operations chair and as a participant in numerous working groups, and the Treasury Market Practices Group (TMPG), supporting integrity and efficiency in the treasury, agency debt and agency MBS markets.

ABS

Gas-alternative recoveries analysed

Continued low gas prices have reduced Americans' appetite for hybrid-electric and all-electric vehicles. As a result, the share of gas-alternative vehicles in the collateral pools backing auto lease ABS has declined, according to Moody's.

The agency reports that these trends are pushing recovery values, as well as residual value down for gas-alternative vehicles. "We expect these trends to continue because although gas prices have risen somewhat recently, they likely will remain low at least through 2018, based on Moody's Analytics forecasts," it says.

Of the auto lease ABS transactions that Moody's rates with a meaningful portion of gas-alternative vehicles in the collateral pool, their share has declined. For example, in the most recent World Omni auto lease ABS (2016A), Prius leases made up less than 5% of the pool, down from 9.5% of the 2013-A pool. Similarly, in Ford Credit's most recent auto lease transaction (2016-A), battery electric or plug-in hybrid electric-powered vehicles represented about 5% of the pool.

The current low gas price environment has had the opposite effect on the sale and residual value of larger vehicles, however. Moody's analysis of recovery values for Toyota vehicles shows that historically the Prius has similar recovery values as the gas-powered Camry and Corolla, and has similar volatility as the RAV4 small sport utility vehicle (SUV).

For the past nine years, the Prius, RAV4 and Sequoia have fetched on average about 99%, 103% and 105% respectively of the residual value of the Camry and Corolla. Over the same period, the Prius' residual value shows similar volatility as that of the RAV4, with standard deviation of 8% (compared with 7% for the RAV4).

"Although the volatility is to a large extent a function of gas price changes, the residual value of the Prius and the RAV4 proves to be less volatile than that of the Sequoia, which has a standard deviation of 14% over the same period. This result is consistent with our belief that large vehicles have higher residual value volatility - which indicates that when gas prices increase, residual values of large vehicles, such as the Sequoia, tend to fall much more than the residual values of smaller vehicles, such as the RAV4," Moody's observes.

The decline in hybrid vehicle collateral in auto lease ABS comes as sales of hybrids declined in 2015 to about 2.2% of total US vehicle market share, or 380,000 units, from a high of 3.2% in 2013.

ABS

Debut aircraft ABS prepped

The first securitisation of aircraft managed by Air Lease Corporation (ALC) has been assigned preliminary ratings by Kroll Bond Rating Agency. The US$800m Blackbird Capital Aircraft Lease Securitization 2016-1 deal is Blackbird Capital I's first term securitisation.

The deal is split into three tranches, sized at US$200m, US$540m and US$60m. These have been preliminarily rated at double-A, single-A and triple-B.

The portfolio will consist of a fleet of 19 aircraft on lease to 16 airlines located in 13 countries. The aircraft will be purchased by Blackbird Capital I, which is a joint venture between Napier Park Global Capital and ALC.

Compared to other recent aircraft ABS transactions, the Blackbird deal's collateral has a relatively short average age of 3.3 years. All of the aircraft are in-production, making this a particularly liquid securitised aircraft fleet. The initial weighted average remaining lease term is 7.3 years, which is longer than most Kroll-rated aircraft ABS transactions and modestly reduces reliance on re-leasing activities to amortise the notes.

Structured Finance

Indian supply nears high

Indian securitisation volume has jumped to R45,000 crore in the first six months of the current fiscal year, rising from R17,000 crore in the first quarter. CRISIL Ratings consequently expects issuance to edge close to an all-time high of R1trn by year-end.

Krishnan Sitaraman, senior director at CRISIL, cites the sharper focus of both public and private sector banks on growing their retail books, the incremental priority-sector lending (PSL) targets set for foreign banks and a broadening of the investor base as drivers behind this growth. Of note, pass-through certificate (PTC) volume now stands at R²2,500 crore for the first-half, which is comparable to issuance seen in the entire fiscal 2016.

Vehicle loans accounted for around 52% of PTC demand, while microfinance and property loans accounted for 26% and 12% respectively. Construction equipment, micro SME and tractor loans made up the remainder.

The agency estimates that over R3,000 crore of PTCs backed by non-priority sector loans have been purchased so far by mutual funds and bank treasuries.

"We expect non-PSL securitisation to pick up in the coming quarters," says Ajit Velonie, director at CRISIL. "The trend should help boost securitisation volume and potentially support development of a secondary market for PTCs, which has witnessed negligible activity so far."

Structured Finance

APAC ratings affirmed

Fitch has affirmed the long-term ratings on 161 publicly-rated Asia-Pacific structured finance (SF) and structured credit (SC) tranches in 3Q16. The agency has also upgraded six bonds, placed one on rating watch negative and downgraded another.

Four of the upgrades were to Australian SF transactions, resulting from better-than-expected performance in terms of losses, credit enhancement (CE) build-up and the availability of excess spread. The remaining two upgrades were Japanese RMBS tranches, which benefitted from higher CE and an account bank that is considered eligible to support triple-A ratings under Fitch's revised counterparty criteria.

Under the same criteria, the class A notes from Nifty Warehouse Trust No 2 were placed on RWN, as the swap documents do not provide for any collateral-posting provisions in the event of counterparty downgrade. One junior note of an Australian prime RMBS was downgraded, as it did not have protection through subordination and excess spread was lower than projected.

Of the affirmed tranches, 72 were RMBS secured by Australian or New Zealand properties, 39 were Japanese CMBS and 38 were Australian or New Zealand ABS. In addition, Fitch affirmed four ABS ratings from India, four ABS ratings from South Korea and four SC ratings.

The agency's outlooks on most APAC public long-term ratings were stable at end-3Q16, except for one positive outlook on a SC rating.

Structured Finance

ABCP attracts new sellers

US ABCP outstandings remained stable during 1H16, at approximately US$209bn, according to Moody's. The agency reports that although there was no material increase in issuance, a wave of activity was apparent.

In the first half of the year, 22 new sellers were added to ABCP conduits on a prior review basis, with commitments of approximately US$7.3bn. Many of these commitments were for revolving facilities with outstandings lower than the commitment amount, which Moody's suggests may be one reason why there was no material growth in the market. The collateral for the new sellers consisted primarily of auto leases, fleet leases and trade receivables.

A new bank-sponsored multi-seller programme was added during 1H16, while one non-bank sponsored multi-seller programme was terminated.

The agency notes that activity continued during Q3, albeit at much lower levels than during the first half. Nine new sellers added to the conduits on a prior review basis, with commitments of approximately US$920m. Transactions were backed by swaps, repos, CLOs, equipment finance and auto leases.

The ABCP market continues to be dominated by bank-sponsored multi-seller conduits, whose primary activities are to fund assets of the banks' clients. The largest asset classes financed in the multi-seller conduits include trade receivables and auto loans and leases.

Nine of the largest 20 programmes are partially supported, four of which have liquidity structured to limit investor's risk to roughly 30 days. The remaining 11 programmes are fully supported through liquidity provided by Prime-1 rated entities. Fully supported programmes represent more than half of the outstandings and include three non-bank sponsored programmes.

Structured Finance

Landmark SME deals closed

The EIB has disclosed its recent participation in two European SME securitisations - ROOF Leasing Austria Compartment 2016 and Sinepia (see SCI's new issue database). The former deal is the first public Austrian ABS in which the EIB Group has participated, while the latter benefits from support from the EU budget guarantee under the European Fund for Strategic Investments (EFSI).

The EIB invested €150m and ING Germany invested €250m in the senior notes of the ROOF transaction, a Raiffeisen-Leasing securitisation sized at €440m. The senior tranche is covered by an EIF guarantee. Raiffeisen-Leasing subscribed to the mezzanine tranche of around €40m.

The transaction was structured, arranged and placed by Raiffeisen Bank International as the sole arranger. It is expected to further open up the securitisation market for financing SMEs in Austria.

The EIB says the securitisation complements its direct lending to the Austrian financial sector and enables higher financing volumes than would be possible with direct loans only. It describes its participation in Sinepia, meanwhile, as an "anchor investment".

In total, the bank has committed €250m under the transaction to help National Bank of Greece restore access to funding for SMEs and midcaps in Greece. The deal marks the first Greek SME securitisation transaction since 2007 and also involves cooperation with the EBRD, which invested €50m.

The new NBG financing scheme will be launched in November and is expected to benefit over 2,000 SMEs and midcaps, with at least 50% of the financing scheme targeting an increase in employment opportunities for young people.

Since 2008, the EIB has provided over €12bn in loans and guarantees in Greece. Outstanding EIB loans total around €18bn, approximately 10% of the country's GDP.

CLOs

CLO defaults slow down

US CLO loan defaults have slowed down in Q3, though the pull-back will be short-lived, according to Fitch's latest index for the sector. The agency attributes the slow-down to debt restructuring of several defaulted companies over the past quarter.

The CLO index though remained flat at 6.4% of the US$135.7bn portfolio, indicating the temporary nature of the slow-down. The energy sector continues to dominate the index at 1.3% of the portfolio.

Higher demand for institutional loans compared to the supply of new loans led to an increase in secondary loan prices and consequent haircuts on defaulted loans, especially for the 2012-2014 CLOs that are exposed to commodity sectors. The averages for 2012-2014 vintage CLO gain/loss remain in negative territory, while 2015 and 2016 vintages averaged 15bp of gains each and remain unchanged since 2Q16.

CLOs

Flurry of CLOs continues

US CLO issuance rose last quarter, along with refinancing activity on existing CLOs, according to Fitch's latest Global CLO Market Trends Quarterly. The agency reports that 36 US CLOs totalling over US$18bn came to market in 3Q16, higher than the US$16.5bn (39 CLOs) figure seen in 2Q16.

In fact, September claimed the highest volume of issuance, with 15 CLOs totalling nearly US$8bn coming to market (see SCI's new issue database). "The flurry of new CLOs coming to market will continue and may increase further as the deadline for risk retention nears," says Fitch md Derek Miller. "New CLO issuance through early 2017 will also be worth watching to see how the new deals are risk retention-compliant."

The number of US CLO refinancings and re-sets also continues to rise. Fitch states in its latest newsletter that three out of 14 CLO refinancings last quarter were re-sets. The rest were refinanced within their existing reinvestment period.

CMBS

CMBS conduit loan credit quality up

The credit quality of conduit loans backing US CMBS deals improved in 3Q16, notes Moody's. Conduit loan leverage dipped around 1%, while the share of collateral pools made up of loans credit assessed as investment grade doubled to 13%.

"Leverage for the conduit portion of loan pools dipped about 1% in the third quarter, while the share of investment-grade quality fusion loans doubled," says Moody's CRE research director Tad Philipp. "The improvement in the credit quality of both major components of conduit/fusion CMBS transactions led to a rare lowering of the credit enhancement levels we assessed for the 13 conduit/fusion transactions we rated last quarter."

Pari passu loans made up more than 40% of conduit/fusion collateral last quarter for the second consecutive quarter. While the collateral backing them was of higher quality than that backing other loans, more than 67% of the pari passu loans had an interest-only period, which Moody's notes is a credit negative.

The share of office collateral in which a single tenant occupied more than half the space was 38% year-to-date through Q3, some five percentage points above the average for CMBS 2.0 transactions. Moody's notes that in such cases, the loss of a single tenant could erode the entire debt service coverage cushion supporting a loan.

The portion of conduit loan pools backed by middle tier collateral has held steady about 80%. However, within the middle tier there was a pronounced shift from single-B plus and single-B quality to single-B and single-B minus quality.

CMBS

Borrower advocate role recognised

Morningstar Credit Ratings has awarded a MOR CV2 ranking to 1st Service Solutions for its extensive advocacy for CMBS borrowers. The firm, which pioneered the industry for borrower advocates in CMBS loan restructurings and assumptions, is the first to earn such a distinction.

Founder and ceo of 1st Service Solutions Ann Hambly responded to the news by stating that "we are honoured by Morningstar Credit Ratings' recognition of 1st Service Solutions and the important role of a borrower advocate."

CMBS

CMBS A/B mod considered

The US$47.5m Herndon Square Office Park loan securitised in CGCMT 2007-C6 appears set for a modification with an A/B split, based on October special servicer comments. An A/B modification has been offered by the borrower and is currently being negotiated.

Trepp notes that the value of the collateral behind the loan was sharply reduced last month. The loan was sent to special servicing in June for imminent monetary default (see SCI's loan events database).

The loan matures in June next year and makes up 1.35% of the remaining collateral in the CMBS. Herndon Square Office Park was written with an LTV of 80.51% and a property valuation of US$59m, but the valuation was slashed to US$35m last month.

"At the end of the 2015 fiscal year, DSCR (NCF) and occupancy for the loan were reported at 0.67x and 81%, respectively. Those levels are down from 1.44x and 94% in 2010, and 1.25x and 88% at securitisation. Numbers for the first six months of 2016 reflected a DSCR of 0.80x and an occupancy rate of 81%," says Trepp.

CMBS

Aussie CMBS has RMBS elements

Think Tank Group is in the market with a CMBS deal which includes features more typically found in RMBS. Think Tank Series 2016-1 Trust is a securitisation of loans to commercial borrowers secured by mortgages over commercial or residential properties originated by Think Tank Group.

S&P has provisionally rated the A$130m A1 notes and A$17m A2s at triple-A. The A$1.6m B notes are rated double-A and the A$14m C notes are rated single-A. The A$14m D notes are rated triple-B and the A$3.4m E notes are rated double-B, while the F, G and H notes are unrated.

S&P says there is "a need for a higher degree of subjective assessment than might be applied in other types of analysis", such as for RMBS, in rating this deal. This is because of limited historical data, the diversity of products and obligors, and the generally smaller loan pools that have been seen so far in the Australian small-ticket CMBS market.

The rating agency's credit model involves loan-by-loan and deal-wide analysis. Many assumptions are in line with those for commercial properties, but other factors used to adjust benchmarks, such as seasoning, repayment method and asset location, are generally in line with S&P's RMBS criteria.

CMBS

Large loss recorded

The One HSBC Center property - securitised in GSMS 2005-GC4 - has been sold for US$14.4m, equating to a loss of 109% on the US$73.3m loan balance, including fees, expenses and advances. The loan has been in special servicing since November 2013, after transferring for imminent default (see SCI's CMBS loan events database).

Fitch notes that the property's occupancy plummeted when the two largest tenants - HSBC Bank USA (representing 77% of total property square-footage) and Phillips Lytle (10%) - chose not to renew their leases, which expired in October and December 2013 respectively. The Canadian Consulate (3%) had previously vacated in 2012, while PricewaterhouseCoopers (1%) relocated to the nearby Larkin Exchange Building in 2014.

Property cashflow became negative in 2014 and the master servicer deemed advances to be non-recoverable in January 2015. A foreclosure sale of the office tower portion of the property was completed in October 2015 (with the deed recorded in November), while the foreclosure sale of the parking garage portion of the property was completed in March (with the deed recorded in April).

The borrower and the receiver - which was appointed in January 2014 - had been marketing the property for several years, but Fitch points out that prior efforts were unsuccessful, given the lack of leasing traction within the weak overall Buffalo submarket and the large blocks of vacant space at the property. The property was listed for sale with Cushman & Wakefield and finally sold last month. The buyer is reportedly planning to redevelop the property.

Insurance-linked securities

Calypso cat bonds upgraded

S&P has upgraded the Calypso Capital II class A and class B notes, following the advent of their final risk period and consequent lack of further resets. The ratings for the class A and B notes have been raised from double-B minus to double-B and from single-B plus to double-B minus respectively.

The AXA sponsored notes from October 2013 no longer had to be assessed with their maximum possible attachment probability. As S&P points out: "Because the class A notes are in their final risk period and the class B notes are entering their final risk period, the variable reset is no longer applicable and we base the nat-cat risk factor on the results from the most recent reset report."

They agency also states that based on the latest reset report, these notes have an updated one-year attachment probability of 2.21% (down from the current 2.61%), effective on 1 January 2017. As a result, the risk interest spread for the upcoming risk period will equal 3.66%, which is higher than the coupon the notes paid at the time of issuance.

S&P notes: "The latest reset report confirms that we do not need to use the maximum possible probability of attachment as the base case for our analysis. We are therefore able to raise the rating for the remaining risk period as well."

Risk Management

Margin functionality introduced

Smart Communications and IHS Markit have launched new functionality for the ISDA 2016 Credit Support Annex (CSA) for variation margin (VM). The firms say that the integration of SmartDX into IHS Markit's Counterparty Manager automates the production, exchange, negotiation and execution of the new ISDA 2016 Variation Margin CSAs, ISDA Master Agreements and Master Confirmation Agreements.

SmartDX maintains a machine-readable, controllable and audited copy of the document throughout the negotiation process. Documentation is stored alongside an accurate record of the data, which can then be consumed and actioned via an API to downstream systems.

RMBS

Russian RMBS risks recognised

High LTV Russian RMBS loans are twice as likely to default as lower LTV loans, says Moody's. There are also higher chances of default for loans taken out by borrowers who are self-employed, loans secured by houses rather than flats, and loans underwritten by small lenders.

In its first ever analysis of default drivers in the Russian RMBS market, the rating agency found loan performance history to be highly predictive of future default. Loans in arrears at closing subsequently show very high default rates. This is partly explained by the relatively early default definition of three months in arrears, which is standard in the Russian RMBS transactions.

While defaults are correlated to high LTVs, this relationship is actually more muted than in many other European markets. That said, loans with LTVs of at least 75% are almost twice as likely to default as those with LTVs under 75%.

Mortgages on houses are more than three times as likely to default as mortgages on flats. Loans from smaller banks with a higher risk appetite are over twice as likely to default.

Loans with high interest rates are twice as likely to default as those with low interest rates, although the effect is less pronounced for benchmark loans. Self-employed borrowers and borrowers whose income is not verified by tax form are more likely to default.

Loan size is not a default driver in and of itself, but it is predictive of higher defaults on the overall loan sample, mainly because larger loans tend to have other risky features, Moody's says. Borrower age is only predictive of defaults for risky loans.

Borrowers in wealthier regions default slightly less frequently than borrowers in less wealthy regions. Loan vintage is not a driver of defaults. Because originators can positively select the loans in the securitised pools from their books, there is no vintage effect in the securitisations.

Strong features of the Russian mortgage loans include moderate LTVs, a fixed interest rate and owner-occupied nature of the properties. These features have supported mortgage performance throughout the recession, with only a limited deterioration in performance to date.

Moody's expects mortgage performance to stabilise in 2017-18 as the economic recovery takes hold.

RMBS

UKAR sells as BAWAG preps

UKAR has launched the sales process for the Bradford & Bingley assets. Coinciding with the announcement was BAWAG's mandating of its debut UK prime RMBS - Feldspar 2016-1 - backed by Granite mortgages.

BAWAG - of which the majority shareholder is Cerberus - acquired the portfolio at end-2015. Barclays, Citi and Credit Suisse are joint-leads on the transaction, which is anticipated to launch next week. Only the triple-A rated tranche will be offered to investors.

Cerberus is also expected to bid on the B&B assets, with Blackstone believed to be among the other contenders. The sale was put on hold earlier this year (SCI 7 June), given the uncertainties surrounding Brexit.

UK Chancellor Philip Hammond confirmed yesterday (25 October) that the programme of sales is designed to raise sufficient proceeds for B&B to repay its £15.65bn loan from the Treasury. The sales process is expected to conclude before end-2017 to 2018 and a consortium of UK banks are said to be lined up to provide financing to support the sale.

RMBS

New CIRT structure trialled

Fannie Mae has secured commitments for a new front-end credit insurance risk transfer (CIRT) structure to be executed with affiliates of approved mortgage insurance companies. The FHFA sought feedback on front-end credit risk transfer transactions over the summer (SCI 30 June).

The pilot deal - CIRT FE 2016-1 - will be the first CIRT transaction done on a flow basis, where the risk transfer will be committed prior to Fannie Mae acquiring the covered loans, with the insurance coverage being effective as soon as the loans are acquired. The loan pool is expected to be filled over six months, beginning in 4Q16.

The transaction will shift a portion of the credit risk on pools of single-family loans with a combined unpaid principal balance of approximately US$3.7bn to a group of mortgage insurance affiliates. The covered loan pool will consist of 30-year fixed-rate loans with LTVs of 80%-97%.

Fannie Mae will retain risk for the first 35bp of loss. If that retention layer is exhausted, the participating mortgage insurance affiliates will cover the next 265bp.

"This innovative pilot transaction represents another milestone for Fannie Mae's risk transfer initiative. Front-end CIRT expands the options that Fannie Mae can use for transferring mortgage credit risk away from taxpayers, while tapping a diverse source of capital and risk-sharing partners," says Fannie Mae vp Rob Schaefer.

Fannie Mae plans to continue offering its traditional CIRT transactions that cover existing loans in its portfolio.

RMBS

Loan origination tool enhanced

Freddie Mac is set to add new capabilities to its Loan Advisor Suite in the spring. The GSE says that as the cost of originating a mortgage has more than doubled since before the financial crisis, it is collaborating with lenders to create innovative tools that reduce the costs of producing and selling high-quality loans.

These new capabilities include: a no-cost automated appraisal alternative; automated borrower income verification; automated borrower asset verification; and automated assessment of borrowers without credit scores. In addition, Loan Advisor Suite expects to broadly offer collateral representation and warranty relief in early 2017, which is intended to significantly relieve mortgage lenders from the risk of loan repurchase due to appraisal defects. Currently, Freddie Mac offers collateral representation and warranty relief in select circumstances.

By providing automation and transparency in the loan production process, Loan Advisor Suite assesses credit, capacity and collateral to help lenders validate the quality of the loans they originate. The tools cover the entire loan lifecycle from loan application to closing and beyond.

RMBS

Spanish special servicers 'key'

Loss severities on Spanish mortgage foreclosures have increased again this year, says Fitch, despite the continued price recovery in the broader residential property market. The rating agency believes the growing role of specialist mortgage loan servicers could be an important driver of future developments in the distressed market and may already be reflected in fewer foreclosures.

Sales price discounts on Spanish repossessed properties averaged 65% of initial appraisal values at origination in 1H16. Discounts were 61% last year and 53% in 2014, with the rise largely attributed to the best quality stock having been sold first and remaining stock being of lower quality.

The robustness of the overall recovery in house prices and how far the distressed market will be supported by the higher price expectations created by sales of better quality properties will be important in determining whether loss severities start to fall. The increasing role of specialist firms that manage NPLs may also influence the distressed market.

Fitch estimates that special servicers manage €20bn-€30bn of residential NPLs and expects their influence on mortgage enforcement techniques in Spain to grow as banks sell portfolios or attempt to replicate special servicers' resolution strategies. "Where some banks used aggressive foreclosure strategies to clean up their balance sheets, special servicers have taken a more consensual approach, reflecting the investment horizon and return expectations of institutional investors that have bought distressed portfolios," Fitch notes.

Such institutional investors typically favour private, consensual arrangements over longer and more expensive judicial proceedings. If debt restructuring is not an option, amicable repossession is often the next best workout strategy. This may include partial forgiveness of debt in excess of the repossessed property value.

"It is hard to isolate and quantify the impact of consensual resolutions from our loss severity data; however, anecdotal evidence suggests such resolutions deliver faster, higher recoveries. As such, we expect a shift away from aggressive foreclosure strategies which will be beneficial for creditors. The number of foreclosures in 1H16 was almost 40% lower than in 1H14, according to INE data, which may reflect this trend," Fitch says.

RMBS

Above par pricing anticipated

Achmea Bank is in the market with its second swapless RMBS. The €690.5m Dutch Residential Mortgage Portfolio II is also expected to be priced above par.

Rabobank credit analysts note that interest rate risk is mitigated by several features, including a Euribor cap agreement for the first ten years, subject to amortisation following a 5% CPR. Subordination to the senior tranche (13.5%) is also relatively high.

"Similar to other recent swapless Dutch RMBS transactions, the step-up margin after the FORD (December 2022) is subordinated. Nonetheless, the structure contains strong incentives for the seller to call the deal, as the senior notes have a preferred revenue claim over the B and C tranches after the FORD," they add.

The coupon for the senior tranche is indicatively set at three-month Euribor plus 40bp. However, in contrast to the recent Storm 2016-II RMBS - which also priced above par - the DRMP 2 pool will not revolve for the full period until the first optional redemption date.

The CPR assumption has been set at 7%, which is higher than the 5% modelled in most other Dutch RMBS, according to the Rabobank analysts. They point out that a 7% CPR is in line with the CPR seen in Achmea Bank's overall mortgage book.

The portfolio consists of residential mortgage loans extended to 3,866 Dutch borrowers. The weighted average LTMV of the pool is 86.7%, WA seasoning is 4.2 years and around 21.3% of the loans are concentrated in the Zuid Holland region. Over half (57.3%) of the assets are NHG guaranteed loans.

Fitch and Moody's have assigned provisional AAA/Aaa ratings to the class A notes. The class B and C notes are unrated.

RBS arranged the transaction and is also joint-lead manager, along with Rabobank, Deutsche Bank and SG. Launch and pricing are scheduled for next week.

RMBS

Deleveraging programme completed

Permanent TSB has finalised the sale of £2.29bn worth of loans by its UK subsidiary, Landsdowne 199, to Cerberus Capital Management. The gross proceeds from the sale of the assets - which represent RWAs of £855m - is approximately £1.95bn.

The loan assets constitute the total balance sheet of the residual book of the group's former UK subsidiary, Capital Home Loans. The residual book was transferred to Landsdowne in July 2015, following the sale of approximately 50% of the CHL portfolio and the associated legal entity - CHL - to an affiliate of Cerberus.

Consideration is in the form of a cash settlement and sales proceeds will be used to reduce the group's borrowings. Jeremy Masding, group ceo, states that the sale of these assets was a significant event for the firm.

"This transaction is a milestone event for the group. Its completion in the coming weeks will conclude the very ambitious deleveraging programme of some €8.4bn, which was set out for the group under the restructuring plan agreed with the European authorities," he says.

He continues: "Perhaps most importantly, it will complete our pivot to the Irish retail and SME marketplace and allow us to focus exclusively on growing our commercial position in key segments of the market here. That is now our overriding priority, as Ireland's only pure domestic retail and SME bank."

The sale is expected to close before 31 December.