Contents

Secondary markets

Euro secondary patchy

Activity in the European securitisation secondary market continues to be patchy.

After a primarily quiet week last week, Friday saw a slight pick-up in volumes, which followed through into Monday in advance of month-end. However, activity across the board remains patchy and is further hampered by European public holidays this week and broader market volatility driven by negative headlines in the US.

Nevertheless, sentiment in European securitisation remains positive and secondary spreads in most sectors are holding firm. Senior mezz CLOs and Spanish ABS/MBS are looking strongest at present, while UK non-conforming is a little softer.

There is currently one BWIC on the European schedule for today - a €5m line of BLUME 2016-1A F. The single-B CLO has not traded on PriceABS before.

Secondary markets

US CLOs strong

Levels and activity are still strong in the US CLO secondary market, particularly lower in the stack.

"It's pretty busy in secondary even though the mad rush to print new issues is continuing," says one trader. "We're seeing a lot of mezz and equity going through at the moment - there are triple-A buyers out there, but not in force."

This week the main focus is mezz, the trader reports. "People are thinking that with the primary overdrag: 'is it right secondary mezz is trading where it is?'. Of course, that's only a theory at present as we've seen nothing going through indicating any kind of weakening yet."

At the same time, supply is being limited and therefore easily meeting demand. "A lot of investors currently seem to have large enough cash reserves to buy new issues and still keep their secondary positions," the trader says. "So it's mainly the smaller firms selling mezz right now, though some of the bigger guys who we haven't seen around for a while are doing the same, but they're not doing so in big blocks so it's likely to be profit-taking for clients rather than driven by a belief that we're about to move wider."

Nevertheless, even in mezz there is still some bifurcation between names and tenors. "Good shorter duration bonds are trading tight," the trader says. "For example some, MDPK 2012-8A E's traded at 100-09 yesterday, which is 523-524DM - very strong for double-Bs."

Meanwhile, the trader notes that equity still remains another key area. "We had $400+m equity on BWIC last week, which was the highest streak in years. We're not going to repeat that this week, but it's still a good trade  - because of the technical sellers continue to find they can get fair value for 2012 bonds, which enables them to transfer into longer dated new issue equity."

There are five BWICs on the US CLO calendar for today so far. Of those remaining the chunkiest is a four line $25.717m equity list due at 13:30 New York time.

The auction comprises: FINNS 2012-1A SUB, MAREA 2012-1A INC, MAREA 2012-1X INC and VIBR 2016-4X SUB. None of the bonds has covered on PriceABS in the past three months.

Structured Finance

SCI Start the Week - 31 October

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

Pipeline
As with the preceding week, last week's additions to the pipeline were relatively modest. The final count consisted of three ABS, an ILS, two RMBS and two CMBS.

US$800m Blackbird Capital Aircraft Lease Securitization 2016-1, US$115.3m Golden Bear Funding Notes Series 2016-2 and US$184.477m GoodGreen 2016-1 were the ABS, while Residential Reinsurance Series 2016-II was the ILS. The RMBS were €690.5m Dutch Residential Mortgage Portfolio II and Feldspar 2016-1, while the CMBS were US$787.5m CFCRE 2016-C6 and US$1.1bn JPMDB 2016-C4.

Pricings
Completed issuance was fairly varied. There were eight ABS, four RMBS, seven CMBS and 11 CLOs.

The ABS were: US$840.78m Chrysler Capital Auto Receivables Trust 2016-B; US$175m EARN 2016-D; US$162.59m ENGS Commercial Finance Trust 2016-1; US$188.75m Iowa Student Loan Liquidity Corp 2016A; US$250m Lendmark Funding Trust 2016-2A; US$896m Navient Student Loan Trust 2016-7; CNY3bn Toyota Glory 2016-1; and US$371.88m World Financial Network Credit Card Master Note Trust Series 2016-C.

The RMBS were: A$300m AFG Series Trust 2016-1; A$300m Conquest 2016-2 Trust; C$1.5bn Fortified Trust 2016-2; and €745m SapphireOne Mortgages FCT 2016-2.

The CMBS were: US$610m CGBAM 2016-IMC; US$710m COMM 2016-SAVA; US$1.3bn FREMF 2016-K58; US$557m JPMCC 2016-WPT; US$953.2m MSBAM 2016-C31; A$279m Think Tank Series 2016-1 Trust; and US$512m TRU Trust 2016-TOYS.

Lastly, the CLOs were: US$512m Barings 2016-III; US$404m Battalion CLO X; €372m BlackRock European CLO II; US$508.45m Carlyle US CLO 2016-4; US$348.7m Cerberus Loan Funding XVI 2016-2; US$330m LCM CLO 2012-17R; US$412m Neuberger Berman CLO XXIII; US$449m Salem Fields CLO 2016-2; US$290m Shackleton CLO 2012-1R; €1.739bn Siena PMI 2016; and US$411m TICP CLO 2016-6.

Editor's picks
Bail-in priced in?: 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...
Rights issues: The US tax lien ABS sector has grown steadily since 2014 in terms of both issuance and investor interest. While it provides several opportunities for investors, its growth could be hampered by unique challenges, in particular a lack of third-party servicers with sufficient operational capability...
Safe haven?: 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...
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...
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..."

Deal news
• 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.
• 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.
• 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.
• 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.
• 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).
• 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 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.
• 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.
• 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).
• 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.

Regulatory update
• 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.

CLOs

Combo repacks emerging

Several CLO combo notes on downgrade watch, following Moody's updated methodology for the instrument (SCI 10 October), have been resolved via dual-tranche repacks with the aim of keeping the rating stable. The rating agency is reviewing 38 securities backed by CLO debt and equity tranches after adding a refinancing scenario to its approach.

Moody's will no longer assign new ratings to CLO combo notes that are backed by both CLO secured debt and equity tranches, which have a rated balance that differs from the contractual promise of the combo notes. However, the methodology change is not expected to cause a significant reduction in demand for new issue CLOs.

While certain investors that purchased combo notes for yield pick-up may be disincentivised from participating in new transactions, Morgan Stanley CLO analysts estimate that the size of the existing CLO combo note market only represents less than 2% by balance of the outstanding CLO 2.0 universe. They add that Moody's could still rate non-standard combo notes where the rated balance equals the contractual promise.

The Morgan Stanley analysts confirm that several of the negative watch cases have been resolved recently by breaking the original combo note into a two-tranche repack, with the senior tranche of the structure rated by Moody's at the same level as the original security. They suggest that a similar alternative structure - a dual-tranche repack issued by a separate SPV from the CLO deal's SPV - could facilitate the rating of non-standard combo notes in the future.

"Such a repack structure would typically have a secured note component (class A) and a residual component (class B), and the structure is backed by a certain combination of the debt and equity tranches of a CLO deal," they explain. "The class A note will be rated, given that it will not have a mismatch problem between its rated balance and its contractual promise. The class B note will not be rated."

Other proposals include amending deal documents whereby if the original combo noteholder is also the majority equity owner, they can forfeit the right to refinance the debt tranches and therefore avoid a downgrade. "There will be many cases for which the potential downgrades cannot be resolved through deal amendments. In these cases, the original combo noteholder might face pressure if they continue to hold these combo securities and therefore look to sell their holdings on the secondary market," the analysts observe.

Combo notes have historically been rated investment grade to provide certain ratings-constrained investors with a convenient way to achieve simultaneous exposure to the debt and equity tranches of the same CLO deal.

CS

RMBS

Pooling requirements to boost confidence

Recent changes announced by Ginnie Mae to pooling requirements of streamline refinanced loans are logical, according to Deutsche Bank RMBS analysts. While they suggest that the changes can be seen as mildly more restrictive than current standards, they will overall provide a small but noticeable boost to the sector, particularly to investor confidence.

Ginnie Mae is requiring - as of 1 February 2017 - that in order to be pooled in GNMA I single-issuer or GNMA II multi-issuer pools, streamline refi loans must have had a pay history of at least six months at the time of streamlining. Prior to this, there was no pay requirement on the original loans for pooling streamlined loans, so the changes could disincentivise lenders that originate at above-market rates and then quickly refinance, by restricting them to custom pooling and delivery.

The Deutsche Bank analysts suggest that the changes are "slightly more restrictive" than at present, particularly impacting VA loans that have no seasoning requirement for streamline eligibility. Loans that were streamline refinanced with less than six months of pay history can still be pooled, but Ginnie Mae II custom pools are now the only pooling outlet and lenders will not now be able to deliver these loans into TBA, which could affect their pricing and execution.

Overall, the analysts believe that Ginnie Mae's "efforts will provide a subtle boost to investor confidence and should slow new productions G2 multis slightly" and that Ginnie Mae's response to investor concerns is a positive. However, they highlight that the changes do not outright prohibit the pooling of above-market rates into multis and they don't require a six-month seasoning requirement for a VA streamline refi, as that is under the VA's jurisdiction and lenders can in theory continue with current practices.

But for a new refinanced loan, lenders would be required to hold it on-balance sheet for six months or pool into a custom pool. The analysts note that if this restriction disincentivises these lenders, new production G2 multis should display less of a prepayment spike. They add that lenders aren't so far very concerned and some are even "willing to incorporate a six-month payment guideline for VA origination."

There may still be a pooling prepayment ramp, but the month-over-month increase should be more manageable, with speeds likely to increase from pooling because higher coupon multis tend to have a decent percentage of re-performing loans as collateral. Re-performers have historically re-defaulted and the analysts suggest that the market would only see more pooling ramps if Ginnie Mae excludes re-performing loans from multi-pools altogether, as some participants have requested.

Overall, the analysts believe that the change "does seem logical in that it helps unify multi pooling requirements with the qualified mortgage (QM) safe harbour requirements." They point out that a VA interest rate refinance loan qualifies as safe harbour QM once the borrower makes six consecutive monthly payments on the original loan and is not more than 30 days past due.

The analysts conclude that it follows that streamline refis of loans less than six months are not considered safe harbour, meaning they are therefore riskier to originate from a legal/compliance standpoint. As such, the new pooling requirements strengthen the case for lenders to wait before refinancing, especially when there is no real benefit to the borrower.

RB

RMBS

GSEs announce validation frameworks

Both Fannie Mae and Freddie Mac have announced new validation tools aimed at making the mortgage origination process smoother for lenders and borrowers, with greatly reduced rep and warranty risk uncertainty. Fannie Mae's programme, which will be fully ready by 10 December, is called Day 1 Certainty.

Freddie Mac's programme is expected to be ready next spring. Both programmes provide upfront income/asset/employment validation services as well as an automatic appraisal for eligible properties.

Morgan Stanley analysts report that "this latest development has the potential to be market moving once fully operational", as it will impact prepayment speeds, origination supply, closing timelines, and the credit box. The analysts expect prepays to pick up, but that the immediate impact will be faster closing timelines and shorter prepay lags.

Fannie's roll out includes updates to its credit risk assessment model, Desktop Underwriter, which provides validation services for, and rep and warranty relief from, income, assets, and employment, and a Collateral Underwriter (CU) system, which provides relief for appraised values that receive a qualifying score of 2.5 or lower. Furthermore, certain properties could be eligible for a property appraisal waiver.

"For now, Fannie has indicated that most refinances will still require a full appraisal and that to qualify for a waiver the loan must have an appraisal that was previously submitted through CU. Therefore, as the database grows, more properties could be eligible for the appraisal waiver," note the analysts.

Similarly, Freddie's updates to its Loan Advisor Suite are aimed at reducing origination costs. It will make available a no-cost automated appraisal alternative and automated income, asset and credit verifications.

Freddie Mac says its changes are intended to significantly relieve mortgage lenders from the risk of loan repurchase due to appraisal defects, although the agency does not explicitly state that rep and warranty relief will be granted on day one, as the Fannie programme does. As Fannie Mae has rolled out its programme before Freddie Mac, Fannie speeds are expected to come in a little faster in the near term.

The analysts expect the new initiative could potentially have a meaningful impact on supply and prepays, not least because lenders could grow more comfortable with opening the credit box if they are more confident about receiving rep and warranty risk upfront. That would result in increased purchase originations, especially for first-time homebuyers with lower credit scores.

"Additionally, closing costs have the potential to be lower, especially if borrowers are eligible for an appraisal review. However, we caveat this with the fact that neither borrower nor lender know if an appraisal may be waived before the underwriting process starts. According to Fannie, most refinances will still require a full appraisal, meaning that one of the most attractive elements of this new framework will only be available to a subset of borrowers," caution the analysts.

That said, it may be possible for lenders to use the possibility of a saving in closing costs as a way to get on-the-fence borrowers to refinance. The net effect is therefore expected to be a marginal pickup in refinance activity.

Automated validation for income, assets and employment will make the process easier for both lender and borrower, increasing efficiency and shortening timelines, thus reducing the lag for prepays. "This, of course, would cause a marginal pickup in prepayment activity as borrowers refinance to take advantage of these potential cost savings and efficiencies. That would be a negative for the basis and UIC, but a positive for spec pools, as call protection comes into play," say the analysts.

However, while this seems like a net positive for the credit box, the analysts note that the true impact remains to be seen. It could take lenders some time to get up to speed with the new framework, while the fact that lenders will not know whether an originated loan will receive rep and warranty relief until the application process has started means there is still uncertainty around Day 1 Certainty.

While loans which receive rep and warranty relief on day one through the GSE's initiative will receive relief on income, asset and employment verification, the loan is not exempt from going through a review as part of a QC review sample. Loans can technically still be found to have defects not related to the aforementioned verifications and have to go through the remedies framework, although the bulk of automated verifications should satisfy most of lenders' concerns.

JL

Capital Relief Trades

Converging approach?

Current status of capital relief trades discussed

Representatives from Chorus Capital, Citi and Clifford Chance recently discussed the current status of capital relief trades during a live webinar hosted by SCI (view the webinar here). This Q&A article highlights the main talking points from the session, including the impact of regulatory changes, the emergence of new assets and jurisdictions, and investor requirements. For a broader and more in-depth exploration of the RWA management space, attend SCI's Capital Relief Trades Seminar in London on 22 November (click here for details).

Q: Beginning with an overview of the regulatory framework for capital relief trades, what is the current status of the reform efforts in the European securitisation markets?
Tim Cleary, senior associate at Clifford Chance: The European securitisation markets have seen quite a lot of change over the last few years. There have been various proposals released by a number of bodies, including the Basel Committee and the European Commission. The reform efforts have been directed primarily at true sale securitisation and regulatory capital/balance sheet relief transactions have been left to one side, given they weren't viewed in a particularly favourable light by regulators.

The two key pieces of regulation currently going through the EU process are the Securitisation Regulation and the accompanying amendments to the CRR. What has attracted the most attention is the introduction of the STS framework and the proposed adjustments to risk weights for securitisation positions.

The latter is of more significance for capital relief trades, as synthetic securitisation is currently excluded from the STS proposals.

A key feature of risk transfer transactions is that the originating bank will almost always hold the senior tranche of the capital structure, while placing the mezzanine and possibly the junior tranches with investors. Consequently, the risk weights that apply to senior tranches are important in terms of the economics of the trade for the bank and therefore the viability and efficiency of the transactions overall.

The European Commission published its reform proposals last year and the European Council has since added its comments. The European Parliament is currently going through its process of reviewing the proposals and suggesting its own amendments. The special rapporteurs have published their recommendations and there's also an ongoing process where MEPs are adding their opinions.

The most interesting point to note so far from those amendments is that there may be an expansion of what people are starting to refer to as Article 270. In the Commission's draft, there was a special provision for banks holding the senior tranche of synthetic SME securitisations, where if the protection on the mezz or junior tranches was provided by government entities or multilateral development banks, the originating bank would be able to get a more favourable capital treatment on the senior tranche. This was seen as a provision to benefit certain types of transactions that the EIF, in particular, has been involved in to support the SME sector.

At the end of last year, the EBA published a report on synthetic securitisation that came out of a lengthy consultation process to consider whether the STS proposals should be extended to synthetic securitisation. The EBA ultimately did not recommend doing this. However, it did recommend that the senior retained tranches of some types of synthetic transaction, primarily relating to SMEs, should be accorded the same capital treatment as a corresponding position in a STS securitisation. Specifically, it was trying to build on the Article 270 provision and the key point there was that where private investors provide cash collateral for their obligations as protection sellers, that should enable the transaction to qualify for this treatment.

Some of the reforms before the Parliament do attempt to incorporate some of those ideas. For example, while the Commission's proposal was for SME exposures to account for 80% of a portfolio, some MEPs have suggested that this should only require 60% of the portfolio to be exposures to SMEs.

It's unclear whether these proposals will survive the negotiating process between the Parliament and the Commission, but there does seem to be some positive movement in the regulation of synthetics. If you look at where capital relief trades and synthetic securitisations are now, versus where they were a couple of years ago, it's quite similar to where traditional securitisation was a couple of years ago, after three or four years of rehabilitation of that as a product.

There are a number of other very technical amendments in the proposals, of which the most significant are the changes to the standardised approach, where SEC-SA is being put forward as a replacement for calculating the capital requirements for synthetic securitisations, as well as changes to the hierarchy for the application of the internal ratings-based approach versus the external ratings-based approach.

Another noteworthy aspect is the grandfathering arrangement in terms of when the new regulations will start to apply. At the moment, banks have the ability to continue to apply the existing capital requirements until the end of December 2019, but it's an 'all or nothing' election.

A bank wishing to grandfather its positions must therefore apply it to all outstanding securitisations at the time the new regulations come into force. Whether a bank chooses to do this would depend on whether it is beneficial to its overall portfolio.

Finally, there is another potential reform coming down the line. The Basel Committee is proposing to introduce specified capital floors for certain types of exposures, the effect of which undermines some of the benefits of the IRB approach.

Q: Is the 20% risk retention proposal by the MEP Paul Tang ever likely to be implemented? Could the current 5% be increased?
TC: It is impossible to say. Certainly the securitisation industry has reacted fairly strongly against this proposal.

Q: What are the implications of these reforms for capital relief trades from a commercial perspective?
Olivier Renault, EMEA head of financial institutions solutions at Citi: As a reminder of how capital relief is calculated, let's take an example where a bank has a €1bn portfolio and a 50% risk weight, so the risk-weighted assets tied up in the portfolio would be €500m. Assuming that the bank is operating with a core equity tier one ratio of 10%, the portfolio would tie up €50m of capital while it remains on balance sheet.

The bank decides to hedge the mezz and junior piece, say the 1%-6% tranche, via a capital relief transaction. The bank would keep the first €10m of risk and hedge the next €50m and retain the super-senior tranche (the remaining 94% of the capital structure).

The way a bank would typically calculate the capital benefit is by removing the €50m risk-weight from its balance sheet and then recognise on its regulatory balance sheet the three tranches created via the capital relief trade. The capital charge on the €10m first-loss piece is deducted on a one-to-one basis; if the mezzanine piece is collateralised by cash, it shouldn't carry any risk weight; and there is a small capital charge on the super-senior portion (of around €6.5m in this example). By hedging this mezzanine piece (which arguably contains most of the risk of the portfolio), the bank moves from €50m of capital tied up to €16.5m of capital.

In terms of what the regulations are changing, a big driver of the sector's growth over the past few years has been regulation related to the underlying assets themselves and to banks in general. The first big change is that under Basel 3, banks are required to hold more and more capital.

While a CET 1 ratio of 10% may have been comfortable for many banks a few years ago, they are now looking towards a 12% CET 1 ratio. What that means is that by executing the same transaction, a bank will free up more capital just because the portfolio itself is consuming more capital - €60m rather than the €50m in the example.

Another positive impact is the fact that risk weights associated with these portfolios are rising and we're seeing various initiatives from the regulators to push up risk weights, in particular for banks under the IRB approach. This increases the capital benefit of executing a capital relief trade.

However, the negative impact is the change to the securitisation risk weight, especially the formula for calculating how much capital should be retained for senior tranches. In theory, this will more than double from 1 January 2018: in the example, the capital charge against the super senior could jump to €20m. In addition, to achieve a relatively low risk weight on the super senior tranche, it will have to attach at a higher point, thereby requiring the bank to hedge a thicker mezz or first-loss piece - which implies more risk transfer and therefore more cost for the bank.

The forthcoming securitisation risk weights will claw back much of the capital savings from other regulations that were linked to the capital increase on the underlying portfolio.

Finally, the big uncertainty is regarding risk-weight floors and how they will be treated in the context of capital relief transactions. Depending on how the regulations are finalised, the calculations could remain as they are in my example and the risk-weight on the underlying portfolio is increased, which could have a positive impact on the growth of the sector.

Alternatively, if regulators require banks to calculate the risk weight of the retained pieces - in particular, the super senior - and floor that at 70%, say, of a standardised capital risk weight, it could have a very detrimental impact on the market and make many transactions uneconomical. But implementation could be a few years away yet and we won't have any clarity for a number of months.

Kaikobad Kakalia, cio at Chorus Capital: When a bank issues a thicker tranche and in turn transfers more risk, the cost should not proportionally increase. The incremental cost to hedge the additional amount to free up capital should be much lower than for a thinner tranche. The weighted average cost of the new tranche will be lower.

Q: With respect to recent transactions, is the mezz tranche placed with investors rated? How do investors normally price these tranches?
TC: There have been no rated transactions in this space since the financial crisis. Further, where the tranche is placed with investors (in other words, not retained by the bank), the bank does not need it to be rated under any of the CRR models. It does not appear that investors in this market are particularly interested in having the tranches rated.

OR: In terms of pricing, investors look at relative value in other structured credit asset classes (for, example CLOs or bespoke tranches), but the pricing of these transactions tends to be range-bound. Given that these transactions are illiquid and relatively complex and limited external leverage is available, they rarely are executed below 9% spread.

On the other hand, when spreads reach 12% and above, many opportunistic investors start to step in and take market share. So, in practice, most of the activity is in the 9%-12% spread region.

KK: Investors employ various techniques to price these tranches. Fully disclosed portfolios may be priced using tranche correlation pricing models. More granular and non-disclosed portfolios tend to be priced using the discounted cashflow methodology or by benchmarking to previous issuances.

Q: Differences in views on and the application of significant risk transfer remain among policymakers. How is the implementation of these rules diverging across various regulators from a practical perspective?
TC: Rather than a divergence in approach, it's more a lack of convergence of approach. Before the introduction of CRR, the capital requirements directive was implemented at the national level by each member state, so there was some variation between states as to exactly what rules applied in that jurisdiction. There was also the effect of national regulators each applying their own national rules, leading to further differences of approach on various issues.

When CRR was introduced in early 2014, in theory such divergence should have been swept aside because, as a piece of European regulation, CRR has direct effect in all member states in an identical manner. But at that time, as the various national regulators implemented the rules, some divergence was expected. Most recently, there's been a further level of convergence, due to the single supervisor (the ECB) effectively taking over the regulation of most of the banks in the eurozone - certainly the ones that tend to be involved in capital relief trades.

Nevertheless, there is still a dialogue between the ECB and each member state regulator, so banks are talking to both their national regulator and the ECB. So, the differing national views continue to be reflected in the transactions that banks are executing.

It appears that the regulators take a case-by-case approach to each transaction and each bank, and evaluate them on their merits and individual circumstances. Consequently, there is quite a bit of difference between deals - some will have certain features that appear unproblematic to one regulator but are problematic for another regulator.

The regulators also have an element of discretion as to whether to recognise significant risk transfer, which is what banks need to achieve to benefit from the capital reduction.

Areas that tend to see some divergence include credit events, where there are differing views as to whether restructuring needs to be included as a credit event, or whether defaulted obligations under Article 178 of CRR need to be classified as credit events.

Another area of divergence is time calls, which is important for maintaining the efficiency of the transaction. Most regulators seem to be accommodating towards some time calls, but certainly not all.

Amortisation mechanics go hand-in-hand with time calls. There has been a trend in recent years towards pro-rata amortisation, given that sequential amortisation can reduce the efficiency of a capital relief trade.

It appears that regulators are becoming more comfortable with pro-rata amortisation, although there is variation in its implementation. For example, there may be threshold levels where the pro-rata amortisation switches to sequential if losses rise above that threshold.

Another aspect that seems to be coming back into favour is the use of excess spread as a way of reducing losses for investors. This was quite common pre-financial crisis.

Finally, the use of external ratings - even when a bank is applying the supervisory formula - is another area of divergence, although it seems that only one regulator is an outlier here. It requires banks to obtain external ratings for the senior tranche and that obviously impacts the ability of a bank to execute a capital relief trade.

Q: How do you view the Australian regulator's punitive treatment of these transactions?
OR: I have a number of colleagues in Australia, who are very focused on this topic, and what I've heard from them is that historically a big focus for Australian banks was the establishment of master trusts and on cash securitisations because they're typically in good shape capital-wise. A number of Australian banks have commented in the past few months that they don't see much support for capital relief trades from their local regulator, but it's also a topic that they haven't brought up very recently.

Consequently, it may be worth the industry explaining how these transactions have moved on from a few years ago - the fact that they are now all cash-collateralised and are genuine risk transfer deals. Linked to this, I would like to highlight the European Banking Authority's great work over the past few years in trying to harmonise a set of quite diverse regulations across Europe and listening to originators and investors, as well as local regulators in trying to frame rules that are consistent. The Australian regulator could speak to the EBA and learn from the process.

Q: Capital relief trades have traditionally involved large corporate loans and SME exposures, but other types of portfolios are increasingly being securitised. Which new assets and jurisdictions are emerging?
TC: Traditionally, the capital relief trade space has been a market for European banks, primarily because the EU implemented Basel 2 through the Capital Requirements Directive and made it possible for banks to execute these deals. But we've also seen many transactions where European banks have securitised non-European portfolios - for example, North American or Asian loan portfolios - and may not be looking to obtain capital relief at the local or subsidiary level, but instead at the consolidated group level.

Historically, the largest jurisdictions have been the UK, Germany, Switzerland and, pre-crisis, the Netherlands. The regulators in these jurisdictions were relatively familiar with these trades and the big banks were fairly frequent users of the structures.

In the last couple of years, transactions have begun to emerge from a number of other jurisdictions, such as Italy, France and Spain, as well as Portugal, Austria and the Czech Republic. We've seen some interest from Ireland and Scandinavia too.

We're also beginning to see interest from non-European banks, although they are a bit behind the curve because their domestic regulators don't have the same history with these transactions as European regulators. But perhaps this will change in the future.

In terms of asset types, historically the market was dominated by large corporate and SME loan portfolios and trade finance portfolios. These assets tend to be difficult to securitise using true sale techniques.

In the last couple of years, we've seen an expansion into more esoteric assets, such as derivative portfolios, commercial leasing and agricultural portfolios. These assets aren't particularly suited to cash securitisation.

OR: We've gathered a database of capital relief trades executed since 2010 - which isn't an easy task, given that the market comprises mainly bilateral or small club deals. But we've been able to find information on over 125 transactions executed since 2010 and we estimate that this represents over 90% of the entire market.

Last year saw three times as many deals as in 2010-2011 on average, with around 30 executed in 2015. These deals were done by three times as many originators as in 2010-2011, suggesting that this market is expanding not only in terms of deal volume, but also in terms of participants.

Last year also marked a record in terms of the number of countries where originators are based. It's no longer just banks bringing repeat deals, as was the case a number of years ago.

A small half of the transactions across the 125 deals are large corporate portfolios (mainly disclosed or partially disclosed pools) and another small half are blind pools of highly granular portfolios, such as trade finance assets or emerging market and SME loans. The remaining 10% or so is made up of more esoteric assets, such as shipping loans or project finance loans and real estate.

Q: What should banks be aware of when investors analyse a new asset class or jurisdiction?
KK: First, banks shouldn't underestimate the learning curve. If it's a new asset class or jurisdiction, investors will have to get up to speed with that.

Corporate and SME loans in the main jurisdictions are fairly straightforward to analyse now, but new asset classes makes it more complex. Investors need a lot more information; they need substantial data on the bank's underwriting and credit modelling capability, as well as performance statistics on the portfolios. Having this to hand in order to get investors up to speed is crucial.

Assuming the new jurisdictions aren't part of the eurozone (because gradually more and more eurozone countries are issuing), one key challenge investors face includes currency. If the currency the bank wants to issue in is not a major currency, hedging the currency can be costly and operationally problematic. Most investors aren't able to take currency risk, especially given the volatility in currencies these days - a major swing in currency can wipe out a year's return - so having to hedge this becomes quite a costly and painful exercise.

Depending on which jurisdiction an investor is contemplating, there may be political risks to consider, in addition to the credit risks an investor is taking in the portfolio.
But the main point is how to price the risk. From a bank's perspective, it is seeking efficiency in terms of cost of capital and these aspects need to be considered.

Q: We're now seeing not only synthetic trades to free up RWAs, but also cash transactions, as issuers seek to improve their leverage ratios and balance sheets. What are the drivers behind this trend?
OR: Banks don't only care about risk-weighted assets, they also care about the leverage ratio and for some the binding constraint is not the CET 1 ratio but absolute balance sheet size versus capital. Synthetic risk transfer deals don't help in this respect because they free up RWA, but they don't shrink the size of the balance sheet.

To shrink the balance sheet, banks need to sell the loans or execute a full capital structure cash securitisation. But this isn't practical for many asset classes because many loans originated by banks aren't easily transferrable - there may be legal constraints or banking secrecy issues with the transfer. However, for asset classes such as mortgages or other consumer assets, it is often possible and we've seen a number of full capital structure deals executed in the past few years.

The other benefit of bringing a cash securitisation is that you'll receive funding from the deal. Not many banks need funding these days, but for some financing companies consolidated within a banking group, the funding element may also be a driver.

Q: What are the latest developments in terms of legal structures for these trades?
TC: The main area where we see development from a legal perspective is around collateral and that reflects the fact that historically cash collateral was held by the protection buyer. As ratings have become more of an issue for banks in recent years, a number of investors are seeking to avoid that bank risk and this often involves a form of non-bank collateral, such as government securities. This, in turn, results in complex structuring to avoid significant haircuts on the collateral or maturity mismatches between when payments fall due and the collateral would naturally pay.

The other area is whether people choose to do a traditional synthetic securitisation involving an SPV issuing notes and selling protection to the bank or to do a simpler structure. We're seeing an increasing number of purely bilateral transactions between the bank as protection buyer and the investor as protection seller, but they aren't necessarily structured in note format - they use a CDS or a financial guarantee, coupled with a collateral arrangement. Another structure gaining in popularity is the bank issuing a CLN itself: rather than having an SPV in the middle of the transaction, the CLN references the portfolio and effectively embeds the protection that way.

Q: Typically, what do investors require when investing in a capital relief trade?
KK: In my experience, different investors will have different approaches to transactions and partly that's due to the firm's background. For example, if they started by investing in corporate credit or ABS, that would generate a bias in their approach to analysis. An ABS investor would naturally prefer granular pools, whereas a corporate credit investor would prefer more disclosed portfolios with less granularity and the ability to do bottom-up credit work on those names.

At Chorus, we have a slight bias towards the latter. We like less granular corporate loan transactions because it allows us to do fundamental credit work in addition to understanding the bank and its processes. We can therefore help banks with portfolios that cannot be made granular.

Roughly 40% of our investments are in large corporate loan deals and over 50% are in the more granular SME portfolios, so we appreciate directional macro investments and portfolios where a statistical approach can be used to analyse the risk.

As an investor, we are meant to invest the majority (50%-60%) of our capital in European credit. We have about 20%-25% in North America and the balance across certain countries in the Asia Pacific and the Middle East regions.

However, more important than the geographic spread is the type of portfolios we're taking exposure to. This is probably common for many investors in this space, but we only invest in portfolios that are core to the bank we are partnering with and we call them risk-sharing transactions because we expect an alignment of interest with the originating bank. The portfolio also has to be performing (at the point of origination), where the bank values the relationships and wants to do more business with the borrowers.

Liquidity, on the other hand, is not a concern for us. We raise capital via closed-ended vehicles that typically have a life of seven-plus years, so we're able to invest in long-dated portfolios. At this point in time, we have investments from 3.5 years out to 6-7 years.

We like to have some influence on portfolio selection: this isn't so much about pricing but about shaping the portfolio - the ability to pick certain geographies and industries within the universe of transactions we look at is key. Transactions that diversify our risk effectively are attractive for us and are, in turn, more attractive to our counterparty banks because we price them more efficiently.

We value stable performance and so we target deals with low expected volatility rather than targeting the highest returning deals. We'd rather invest in a safer transaction at a lower price.

Finally, we like to hear that banks are building a platform because it suggests that they intend to become a regular issuer and remain in the market through cycles. We spend a fair amount of time getting to understand a bank and their motivation and objectives, how information is shared internally, as well as how they originate and risk manage their loans. It's a waste if we only ever do one transaction with that bank.

Q: A number of insurers are interested in participating in capital relief trades. Is this likely to be a continuing trend?
TC: We are starting to see insurers looking at capital relief trades not as an investment, but rather as a line of insurance business. There has been relatively little activity in this space for portfolio-based transactions at the moment, but we expect this interest to continue.

Q: The availability and quality of data is a major impediment to executing capital relief trades. How should issuers approach this issue?
OR: Data is definitely an issue. I know of several banks that had to shelve or delay transactions due to the lack of data or poor quality data.

Data requirements will be different depending on whether a deal concerns a pool of granular assets or a pool of large project finance loans, for example. In either case, it will take an originating bank a long time to gather the data.

For a blind pool, where investors undertake statistical due diligence rather than loan-by-loan analysis, they will typically require a whole credit cycle of historical data - ideally representing 10 years of performance. If possible, it needs to be stratified by rating bucket or industry and so on. This is often difficult to produce for banks with legacy IT systems or that are the result of mergers.

One piece of advice for banks considering a capital relief trade is don't wait until the last minute to gather this data because it could take weeks, if not months, to clean it and present it appropriately. If a bank doesn't intend to issue a transaction right now, but it might do in the future, they should already be collecting the data as it comes along and ensuring that their IT systems are set up correctly because it will ultimately save a lot of time.

Q: How do capital relief trades compare relative to simple AT1 issuance?
OR: They are quite different. AT1s would typically be executed at lower coupons than RWA management transactions, so that you could argue that RWA management transactions are more expensive, but by definition AT1 bonds do not contribute to the CET1 ratio. On the other hand, RWA management transactions reduce the denominator of the capital ratio and therefore increase all capital ratios from CET1 to total capital.

From an investor's standpoint, an AT1 investment requires taking a view on the overall solvability of the bank and its ability to maintain sufficient capital over time, so that it does not defer coupons or take write-downs. An investment in an RWA management transaction is much more focused on the performance of a specific portfolio of the bank, so the risks are very different.

KK: From the perspective of banks, these transactions generate capital capacity at the core capital (CET1) level, whereas AT1s by definition only add to total Tier 1 capital. From an investor perspective, risk-sharing transactions generate exposure to a pre-identified portfolio of credit exposures on a bank's balance sheet, whereas AT1s generate exposure to a bank's entire balance sheet, with some subordination provided by CET1.

An investor in CRT trades is exposed only to the credit risk of the portfolio, with minimal counterparty risk. However, an investor in AT1s is exposed to all the other risks (market, operational, regulatory, business etc) that accompany a lending and trading-oriented balance sheet. Coupons on AT1s may be withheld if the bank is sub-threshold on SREP requirements, whereas the coupon on CRT transactions must be paid and may only be adjusted for losses on the tranche that the investor is exposed to.

TC: Capital relief trades and AT1 issuance are in some ways flip-sides of the same coin. A bank that is facing capital constraints can either raise more capital or reduce its risk-weighted assets. In deciding which approach to take, the bank will need to consider the economic costs of each approach.

CS

Structured Finance

Deputy credit officer named

Pemberton has bolstered its London team with the appointment of Nichole Gates as deputy chief credit officer. She joins as a partner, following a thirty-year stint in the global credit markets, and will work alongside chief credit officer Conrad Teppema to enhance the firm's credit underwriting and risk management divisions.

Before Pemberton, Gates spent ten years at GE Capital International, where she was head of restructuring. Her previous positions also include md in Dresdner Bank's institutional restructuring unit in London and head of international intensive care unit at Kleinwort Benson.

Structured Finance

KBRA adds senior md

Kroll Bond Rating Agency has appointed Mark Miller as senior md of business development and sales. He was most recently at Blackrock, where he served as md in the iShares division, responsible for institutional distribution of fixed income ETFs.

Miller has also held business development roles at Citi and Bank of America. He spent 20 years at Salomon Brothers and Citigroup, where he was an md responsible for institutional distribution of fixed income products.

At Bank of America, Miller was md responsible for global distribution of all fixed income and equity market products. He was also managing partner at The Seaport Group, a fixed income investment banking boutique specialising in high yield, high grade and distressed debt products.

Structured Finance

Senior SF lawyer brought in

Law firm Sullivan & Worcester has added a new partner to its finance group in New York. Joel Telpner was previously at Jones Day and has strong experience in structured finance and derivatives.

Telpner spent seven years at Jones Day and before that was a partner at Mayer Brown. He also serves on the editorial board of the Journal of Structured Finance.

Structured Finance

Seed investment agreed

Canada's Public Sector Pension Investment Board (PSP Investments) has announced a €500m seed investment commitment in a new specialist European credit platform promoted by AlbaCore Capital. AlbaCore intends to focus on private and public credit markets where there are significant inefficiencies in pricing, including European high yield, leveraged loans and direct lending. PSP Investments may deploy further capital in partnership with AlbaCore in certain substantial investment opportunities in Europe.

"PSP Investments sees great opportunity in the European credit market and, as such, entered the market earlier this year with the hiring of Oliver Duff to lead our European private debt activities, which focus on sponsor-financed acquisitions, first liens, second liens and other debt instruments across the capital structure," comments David Scudellari, svp and head of principal debt and credit investments at PSP Investments. "With its expertise and extensive network of relationships, the portfolio team working for AlbaCore is well positioned to source bespoke, attractive transactions that will add to our existing activities."

Duff joined PSP Investments' London office in September, with the mandate to develop the organisation's presence in the European leveraged finance market, build relationships with local partners and contribute to achieving PSP Investments' deployment goal.

AlbaCore was founded in June by cio and managing partner David Allen. He had previously established a European credit investment team for CPP Investment Board. Before that, he worked at GoldenTree Asset Management and Morgan Stanley.

Structured Finance

Servicer continues Euro expansion

Situs has acquired Hatfield Philips International from Starwood Property Trust, with its combined assets under management globally now totalling US$160bn. As part of the transaction, Starwood Property Trust will retain a non-controlling minority interest in Situs.

"The European market is a dynamic and exciting place for debt servicers currently, as banks continue to deleverage their balance sheets amid regulatory pressure and new market entrants rush to deploy equity and debt products into Europe," comments Steve Powel, ceo of Situs. "The acquisition of HPI is another milestone in our ongoing European expansion and expands our professional capabilities in the performing and non-performing debt space now across 16 European jurisdictions."

Structured Finance

ABS team poached

KeyBanc, the corporate and investment arm of KeyCorp, has created a five-person ABS team to expand its fixed income sales and trading platform. Andy Yuder will head the team and is joined by Alan Staggers, Paul Richardson, Jon Markiewicz and Brian Switzer, all of whom join from BB&T Capital Markets.

Yuder has 25 years' experience in ABS and was previously at BB&T for 13 years, serving as md and group head. Staggers, Richardson, Markiewicz and Switzer all worked for BB&T for a number of years, in a range of senior roles.

Structured Finance

Information services chief appointed

Ranjit Tinaikar has been named president of Fitch Information Services, effective 1 December. Based in New York, he will join the Fitch Group management team and report to Fitch Group president and ceo Paul Taylor.

Prior to joining Fitch, Tinaikar worked for Thomson Reuters between 2012 and 2016 as md and global head of asset management, wealth management, investmentbanking and research. Additionally, he spent 14 years at McKinsey & Company and acted as a consultant for Deloitte.

CMBS

CMBS partner poached

Reed Smith has appointed Jodi Schwimmer as a partner in its global financial industry group in New York. She was most recently a partner at Dechert and brings with her two associates integrated into her practice - Samantha Chertoff and Carla Moore.

Schwimmer's practice focuses on CMBS, real estate finance and structured finance, representing issuers, underwriters, loan sellers and investors in both public and private securitisations. She has extensive experience in non-performing loan securitisations, CRE CLO execution and bespoke commercial lending platforms.

Insurance-linked securities

ILS firm nabs risk vet

RMS has hired Michael Steel as global head of solutions. He will also chair the company's Europe Leadership Council and provide overall regional leadership for the RMS London and Zurich offices.

Steel has over 25 years' experience in risk and capital management in the insurance industry and, prior to RMS, was group chief risk officer at AXIS Capital. He also previously worked at Aon Benfield for 12 years, where he held a number of senior roles, and is currently chairman of the Geneva Association's CRO Network.

Insurance-linked securities

Elliott to acquire Aeolus

Elliott Management Corp has agreed in principle to acquire a controlling stake in Aeolus Capital Management (ACM) and its affiliates. The deal is expected to be finalised before the end of the year.

ACM current shareholder and founder Peter Appel will retain substantial minority positions, along with his role as non-executive chairman of ACM. He comments: "This transaction has been months in the making and we have worked carefully to ensure that this new partnership will serve the best interests of our investors. Elliott...shares our analytical and disciplined approach to generating exceptional risk-adjusted returns for our investors and will provide us with access to additional resources, insights and relationships to help us broaden our product offerings and further establish Aeolus as an enduring and growing franchise."

Mark Cicirelli, a portfolio manager at Elliott, adds: "We have been investing in Aeolus since 2012 and are also very familiar with the company as a core reinsurance provider to Asta's Syndicate 4242 at Lloyd's, in which we are invested. Over the years we have developed a strong relationship with the Aeolus management team and have long recognised their ingenuity and skill in managing capital on behalf of their investors and structuring reinsurance and retro protection for their cedants."

RMBS

Nomura settles over RMBS

Nomura Asset Acceptance Corp and Nomura Home Equity Loan have agreed to pay the NCUA more than US$3m to settle claims related to the sale of RMBS that contributed to the failure of Western Corporate Federal Credit Union and US Central Federal Credit Union. The NCUA filed suit in federal district courts in California and Kansas against the Nomura entities. It will dismiss the suits as a result of the settlement, although neither Nomura entity admitted fault.

As of September, the NCUA had recovered US$4.3bn in its MBS suits. The agency announced in October that it will fully repay the US$1bn outstanding balance on its borrowing line with the Treasury Department, fully paying off the Temporary Corporate Credit Union Stabilization Fund. It is looking at a potential refund to credit unions in 2021.

ABS

MOHE discrepancy highlighted

Fitch has placed the Minnesota Office of Higher Education Supplemental Student Loan Program Revenue Bonds 2010 Series on rating watch negative, due to data inconsistencies in the servicer reports. The June 2015 servicer report showed a cumulative gross default value of US$1.96m and net defaults of US$1.37m, while the September 2015 report showed gross defaults of US$1.37m and net defaults of US$709,891.

Fitch says it is in the process of investigating the data discrepancy and the rating watch will be resolved when clarity has been received. The action affects 10 double-A rated bonds, with US$24.64m of notes outstanding.

ABS

CARAT juniors rated

Moody's has assigned ratings to the previously unrated class E notes of two Ally Financial auto loan ABS. The ratings are based on the quality of the underlying collateral, as well as expected performance, the strength of the capital structures and the experience and expertise of Ally as servicer.

The affected transactions are Capital Auto Receivables Asset Trust 2014-3 (US$28m class E notes assigned an Aa1 rating) and 2015-1 (US$66m class E notes assigned a Baa1 rating). Moody's median cumulative net loss expectation for the 2014-3 pool is 2% and the Aaa level is 14%. The CARAT 2014-3 class E notes benefit from 10.79% hard credit enhancement and excess spread.

Moody's median cumulative net loss expectation for the 2015-1 pool is 2.75% and the Aaa level is 15%. The CARAT 2015-1 class E notes benefit from 4.16% hard credit enhancement and excess spread.

ABS

VW settlement ABS 'credit positive'

Volkswagen has received final approval from a US federal court for a US$14.7bn settlement under which it will offer to buy back, terminate leases on, or repair around 475,000 vehicles affected by its diesel emissions scandal. Moody's believes this settlement is credit positive for the outstanding US auto lease ABS transaction issued by VW Credit as early lease terminations will increase prepayments to the securitisation trust.

The settlement will also increase prepayments in Volkswagen's US auto loan ABS transactions, where default risk will also reduce. Volkswagen's US dealer floorplan ABS transaction should benefit as well if car owners who sell affected vehicles then buy replacements from Volkswagen dealers.

"The settlement, approved by Judge Charles Breyer of the US District Court for the Northern District of California, resolves much of the uncertainty over whether Volkswagen will compensate customers in the US who bought or leased diesel-powered cars that the automaker had equipped with devices designed to evade emissions-testing standards," notes Moody's. The automaker will complete the buybacks within 90 days of eligible owners' acceptance of its offer, while lease terminations will be completed within 45 days.

The agreement covers Volkswagen and Audi vehicles with 2.0-litre diesel engines from model years 2009-2015. However, it excludes roughly 80,000 3.0-litre diesel models, which means that the Volkswagen ABS transactions will have continued credit risk related to compensation issues for owners of those vehicles.

Volkswagen reports that less than 1% of the settlement class has opted out of the agreement. So far, around 340,000 registrations have been created on the settlement website.

ABS

APAC auto ABS report launched

Moody's has launched the inaugural edition of its quarterly APAC auto ABS sector update. It is the second structured finance sector update published for the region by the rating agency, following the first China sector update published in September.

The APAC auto sector update provides updates on the macroeconomic factors and regulations that affect the sector, as well as new ratings and rating actions, new issuance and performance trends. Moody's latest research and upcoming industry events are listed, covering the Chinese, Australian, Japanese and Indian markets.

The first report states that auto loan performance in China, Australia, Japan and India is generally sound and stable, and should continue to be so, albeit to different degrees and with some markets outperforming others. Delinquency and default rates are low for China and Japan, but delinquencies have been increasing in Australia and are relatively high in India.

Auto sales in China are expected to increase 2.7% in 2017, supporting the growth in auto loan receivables. Australia should also see more ABS issuance as new entrants to the auto finance market turn to securitisation as a funding tool.

Japanese auto ABS issuance in the first three quarters of 2016 exceeded issuance from the same period in 2015. Commercial vehicle sales in India are expected to grow at a low double-digit pace in financial year 2017, supporting the growth in ABS backed by these loans.

ABS

SLABS worries prompt downgrades

A slew of Navient Solutions student loan ABS classes have been downgraded by Moody's as a result of concerns about tranches' ability to pay off by final maturity. The rating agency has downgraded 92 ratings, affirmed 34 and upgraded five across 49 FFELP student loan ABS sponsored or administered by Navient.

Moody's says its downgrades are the result of analysis indicating that the tranches will not pay off by their final maturity dates under some or all of 28 cash flow scenarios outlined in the agency's methodology. Losses are therefore expected to be higher than the benchmark levels set for the notes' previous ratings.

Low payment rates on the underlying securitised pools are driven largely by persistently high levels of loans to borrowers in non-standard payment plans, including deferment, forbearance and income-based repayment, as well as by the relatively low rates of voluntary prepayments. The downgrades of some lowest payment priority class A notes result in these notes being rated lower than the subordinated class B notes in the affected securitisations.

"Although transaction structures stipulate that class B interest is diverted to pay class A principal upon default on the class A notes, Moody's analysis indicates that the cash flow available to make payments on the class B notes will be sufficient to make all required payments to class B noteholders by the class B final maturity dates, which occur much later than the final maturity dates of the downgraded class A notes," explains the rating agency.

The upgrades and confirmations are mainly driven by expectations that the tranches concerned will pay off at maturity or have low expected losses. The SLM Student Loan Trust 2004-8 class A6 notes and SLM Student Loan Trust 2007-7 class Bs were upgraded as a result of a correction to an error in calculating investment earnings.

ABS

Bumper Chinese deal announced

A Chinese auto loan ABS thought to be the largest to date has joined the pipeline. Silver Arrow China 2016-2 is Mercedes-Benz's second Chinese auto loan ABS of the year and is almost CNY2bn larger than its last offering.

The new ABS has a €4.006bn A class provisionally rated Aa3 by Moody's, and CNY211m of subordinated notes which are unrated. The market's previous largest deals were Bavarian Sky China 2016-1 Trust and Rongteng 2016-2, which were each sized at CNY4bn and issued in June (see SCI deal database).

ABS

ACA achieves highest rating

S&P has removed its double-A plus ratings cap on American Credit Acceptance (ACA) subprime auto loan ABS. The move means that the lender's latest transaction - the US$211m American Credit Acceptance Receivables Trust 2016-4 - is its first to achieve a triple-A rating on the senior class.

S&P had previously assigned double-A ratings to ACA senior notes from July 2013 and before that single-A plus (see SCI's new issue database). However, the agency believes that ACA has sufficiently mitigated certain limitations that now allow the double-A plus cap to be removed.

First, S&P notes that the lender has been operating successfully for over nine years and has become a more stable and established finance company, with improved liquidity and enhanced operations. "We believe the company has better positioned itself for potential downturns - for example, with better liquidity, lower leverage and sponsors ready to provide funding - and has a strong compliance culture," it says.

Second, the agency notes that with a lower overall growth rate and additional years of data, ACA's performance is more stable and predictable. "The ACAR 2013-1, 2013-2, 2014-1 and 2014-2 pools did experience higher-than-initially-expected losses. The more recent transactions, though, have been performing in line with our expectations," it adds.

S&P also points to ACA's four paid-off securitisations. Series 2011-1 was called with a cumulative net loss (CNL) of 17.13% in January 2014 at an approximate 20% pool factor. This performance was better than its expectation for a 19%-19.50% lifetime CNL.

Series 2012-1 was called with a CNL of 24.81% in July 2014; series 2012-2 was called with a CNL of 23.82% in April 2015; and series 2012-3 was called with a CNL of 23.69% in September 2015. All three were called at an approximate 20% pool factor.

"While losses were higher than our original expectation - 21.50%-22.15% for the three series - the deleveraging of the transactions contributed to upgrades on classes A, B and C," the agency observes.

Both KBRA and S&P assigned provisional ratings to the deal, which comprises: US$96.88m AAA/AAA rated class A notes; US$26.88m AA/AA class Bs; US$43.13m A/A class Cs; US$37.5m BBB/BBB class Ds; and US$6.88m BB/BB class Es. Citi is underwriter on the transaction.

It features CNL triggers that will increase the overcollateralisation target to 25.75% of the outstanding pool balance, which are curable if CNLs remain below the thresholds for three consecutive months. The deal also has a three-month prefunding period that will end on 28 February. At closing, approximately US$46.5m of the note proceeds will be deposited in the prefunding account.

The number of receivables in the pool is 10,216 - split 61.01%/38.99% between Tier 1 and Tier 2 assets - with an average loan balance of US$15,214.

Structured Finance

European revival plan outlined

Issuance of securitised products has dropped in Europe from €75bn in 2Q16 to €40.2bn in 3Q16, AFME figures show, as macroeconomic volatility weighs on the market. Uncertainty and negative regulatory signals have also stalled investment, says the European Capital Markets Institute (ECMI), which believes more needs to be done to revive the European securitisation market.

After the well-documented perception challenge that securitisation continues to face, and with previous measures having proved insufficient to restart the market, the ECMI says there are three steps that must be taken. Europe must: issue securitisation products with transparent and easy-to-understand structures; streamline and consolidate EU financial services legislation; and devise smart ways of making cross-border investments easier.

To the end of issuing transparent and easy-to-understand structures, there have been initiatives such as the attempt to create a differentiation of 'high quality' securitisation products, which may receive preferential regulatory treatment (SCI passim). The ECMI says there also needs to be pooling and standardisation of loans, in order to ensure transparency and comparability.

The institute says: "This is likely to require the creation of an institutional framework, as well as greater willingness on the part of banks to develop the securitisation markets. Even though the [European Commission's] common securitisation initiative is still in its preliminary phase, closer collaboration with international organisations, such as the BCBS and IOSCO will be necessary to develop global standards for 'high-quality' structures."

To streamline and consolidate EU financial services legislation, the ECMI notes that the European Commission has already consulted on possible conflicts or barriers as a consequence of new legislation and established the European Post-Trade Forum (EPTF). It says that Europe has now reached a junction and must decide whether a sufficient level of regulation has been reached, in which case further rules such as the financial transaction tax (FTT) are not helpful.

As for finding smart ways of making cross-border investments easier, the ECMI argues that the markets needs legal certainty for all cross-border investment activities and so "any initiative to harmonise corporate laws in Europe is welcome". It describes the revision of the prospectus directive is a step in the right direction and urges the creation of one European form for tax reclaims, which would make things easier.

"A high-quality EU securitisation framework will promote further integration of EU financial markets, help diversify funding sources and unlock capital, thereby making it easier for lenders to lend. Moreover, harmonised criteria and reduced complexity are key for the development of high-quality securitisation, as well as for harmonised transparency in order to restore confidence in securitised products," the ECMI concludes.

Structured Finance

ABS impact investing highlighted

Community Capital Management (CCM) has disclosed a number of new innovative financing opportunities within the ABS sector, in which it has participated for its clients. The firm says these types of investments demonstrate the transformation occurring in impact investing, specifically within fixed income, for various types of bonds with a positive social and environmental impact.

Examples of the firm's recent ABS investments include the recent Oportun Funding securitisation. Oportun is a community development financial institution (CDFI), which aims to provide loans to communities with little or no credit history.

It has also invested in Renovate America's HERO programme, which recently issued green bonds secured by 24 PACE bonds. Proceeds are used to finance eligible energy efficiency, renewable energy and water efficiency home improvement projects in California.

Finally, CMM invested in Toyota Motor Credit Corporation's third ABS green bond, the proceeds of which will be used to finance new retail finance contracts and lease contracts for Toyota and Lexus vehicles that meet specific criteria, including powertrain, fuel efficiency and emissions. David Sand, cio and impact officer at CCM, states that "ABS, while common on Wall Street, has been relatively unavailable to the market-rate impact investing community.''

He adds that "since we began managing impact investments in 1999 and up until a few years ago, I could only point to a handful of ABS deals with positive impact outcomes. However, over the past couple of years, we have seen a substantial increase in deal flow for ABS with a focus on sustainability and community development. We anticipate and look forward to even more activity in impact-oriented structured finance."

Structured Finance

ECB makes ABS pronouncements

The ECB has reviewed its risk control framework for collateral assets, with implications for ABS. A range of guidelines have also been released, not only on valuation haircuts, but also on the implementation of the Eurosystem's monetary policy and additional temporary measures relating to Eurosystem refinancing operations.

As a result of its risk control review, the ECB will introduce graduated haircuts for eligible ABS based on their WAL as calculated from expected cash flows. It will also update the haircuts for marketable and non-marketable assets.

Also affecting ABS is a clarification under the monetary policy implementation framework of criteria for a loan-level data repository to become designated by the Eurosystem and the application process for designation. Only ABS for which loan-level data submissions have been made to designated repositories may be considered for compliance with ABS loan-level requirements.

Structured Finance

Brazilian CRA warning

One of Brazil's two main ABS vehicles may present greater risks than another for investors, Fitch says. The agency warns that securitisation companies that issue agribusiness receivable certificates - known as CRAs - are not required to define collateral-performing balances or loss provisions in measuring available credit enhancement to investors and may face regulations in the near term.

Brazilian ABS is typically issued via receivables investment funds (FIDCs), which are restricted to institutional investors. However, CRA usage has grown recently as these vehicles are open to retail investors that benefit from the income tax exemption.

CRAs backed by diversified portfolios may be riskier to bondholders as they have no specific regulations that require minimum collateral-performing balances or loss provisions, causing CE to be overestimated in some cases. This can also mean performance triggers will not properly alert investors to declines in the securitised receivables.

Although some securitisation companies have set up structural features to prevent these risks in their deals, the current regulations for CRAs do not require this. Nevertheless, these requirements may change as Brazil's Securities Exchange Commission (Comissao de Valores Mobiliarios) is preparing new regulations, which may partly address some of the structural differences between securitisation companies and FIDCs.

FIDC regulations evolved over years and may signal how regulations on CRAs will proceed. The regulator imposed standardisation of loan-loss provisions for collateral and conflicts of interest among transaction parties. The regulation also requires underlying obligors of securitised credits to pay directly into a collection account held by the FIDC or into a restricted escrow account in the name of the seller.

Structured Finance

Securitisation programme prepped

Callidus Capital Corp is expected to close its new securitisation programme by 15 November. The transaction - comprising four investment grade debt tranches rated from triple-A to triple-B - will be sized at C$165m.

The securitisation will allow the company to leverage its current loan portfolio by C$25m. Callidus will utilise the facility for growth purposes, given its commitment to doubling the loan portfolio over the next two to three years.

Additionally, Callidus has appointed Goldman Sachs to lead its privatisation process, which is to be completed before the end of 2Q17. The company also announced that it is increasing the number of shares eligible under its current issuer bid by 1.5 million shares, or approximately an additional 3% of the shares outstanding, as of 27 October 2016.

Structured Finance

Negative coupons 'widespread'

Negative calculated coupons are now widespread among European securitisation tranches, according to S&P figures. The agency notes that the market last month joined a host of other fixed income asset classes with its first new issuance of tranches at a negative yield.

"We estimate that calculated coupons are negative for 21% (or nearly €90bn) of the European ABS, CMBS and RMBS that we rate," comments Andrew South of S&P. "Issuers have so far simply paid no interest in these cases, but this raises the prospect of future disputes between noteholders."

The prevalence of negative calculated coupons differs widely by sector. Spanish RMBS has the largest volume of securities paying no interest (at €41bn), while the Portuguese RMBS sector has the highest proportion of balances affected (88%). The proportion of balances with negative calculated coupons is highest for transaction vintages from shortly before the financial crisis, when credit spreads were generally low.

"The very low-yield environment has also begun to change the norms surrounding new issuance," says S&P credit analyst Volker Laeger. In particular, the usual practice of pricing newly-issued floating-rate securitisation tranches at par may be shifting, given the increasing likelihood that the calculated coupon would be negative, flooring payments at zero and leading to potential issues (SCI 31 August).

"Since September 2016, some originators have come to the primary market with tranches priced at a premium, allowing them to maintain higher coupon margins," he adds. "This reduces the likelihood that further declines in the Euribo rate could lead to negative calculated coupons in the future."

CDO

Taberna CDO EOD waived

Barclays has settled with Taberna European Capital Management, the collateral manager for both Taberna Europe CDO I and Taberna Europe CDO II, agreeing to discontinue legal proceedings and release claims. Following the settlement agreement, the Taberna Europe CDO II event of default that arose on 28 June has been irrevocably waived.

Taberna Europe CDO II was served with a notice of default earlier in the year, with the issuer given 45 days to remedy breaches of the collateral management agreement and trust deed (SCI 18 May). Failing that, Barclays, as the class A1 noteholder, was able to direct that notes become immediately due and repayable.

CLOs

Limited upside for CLOs?

The total amount of CLOs paid down in JPMorgan's Collateralized Loan Obligation Index (CLOIE) since the September rebalance through 31 October was US$13.02bn in par outstanding, split between US$3.37bn and US$9.66bn of pre-crisis and post-crisis CLOs. US$8bn was added to the post-crisis CLOIE last month across 94 tranches from 22 deals.

All CLOIE sub-indices have now seen positive monthly total returns for the fourth straight month. However, every tranche (except pre-crisis triple-Bs) saw the lowest positive monthly total returns since June - indicating limited upside going forward. The CLOIE pre-crisis index returned 0.29%, while the CLOIE post-crisis index returned 0.26%.

The top performing tranches in October were post-crisis single-Bs, post-crisis double-Bs and pre-crisis triple-Bs, which returned +1.61%, +0.92% and +0.60% respectively. Year to date, post-crisis CLOIE triple-Bs, double-Bs and single-Bs have returned +10.26%, +17.14% and +12.69% - compared to high-grade bonds (+8.03%), high yield bonds (+16.54%) and loans (+8.13%).

CMBS

CMBS structured to meet risk rules

Morgan Stanley has once again teamed up with Wells Fargo and Bank of America to market a US CMBS structured to satisfy risk retention rules on both sides of the Atlantic. MSCI 2016-BNK2 is sized at a little over US$700m (see SCI pipeline) and is understood to be the third private bond designed to meet risk retention requirements as the market continues to prepare for upcoming regulatory changes.

The three banks previously worked together to issue WFCM 2016-BNK1, which was the first to feature a vertical interest strip (SCI 2 August). The latest deal will also rely on vertical retention.

Both Fitch and Moody's have assigned triple-A ratings for the A1 through A4 classes. US risk retention rules finally come into effect on Christmas Eve (SCI passim).

CMBS

Dispositions tick up

Trepp's October loss analysis shows a continued up-tick in US CMBS loan dispositions. The average loss severity for loans with losses greater than 2% is 63.12% for October, an increase of 3.79 percentage points from September's tally. Average loan size also climbed to its highest level since January at US$15.5m.

Several large office loans were liquidated last month, backed by properties located on the east and west coast. One headliner was the US$174m LNR Warner Center I, II, & III note, which was written off with a minor loss below 2% (see SCI's CMBS loan events database). The disposition helped drive the loss severity for all loans below the 40% mark for the first time since May.

Two noteworthy office loans that took considerable losses in October were the US$121.2m Two Gateway loan (36.99% loss severity) and the US$24.4m One Centennial Plaza (80.31%). Closing out with a whopping 108.66% loss, the US$73.3m One HSBC Center racked up the highest realised loss amount for the month.

When 'small loss' loans are excluded from the analysis, US$520.6m across 40 loans were liquidated in October. The average amount of loans liquidated over the last 82 months on this basis was US$868m, while the 12-month average is US$675.7m.

CMBS

Higher margins for Euro CMBS

European CMBS will remain a non-prime financing tool, according to Moody's. The agency believes that to guarantee excess spread in new deals, loans with higher margins will have to be originated, resulting from riskier features.

Such features could include weaker property quality, non-standard property type or non-core jurisdictions. Moody's suggests that direct lending and syndication are currently more attractive than CMBS for UK lenders, with prime commercial real estate in Germany also continuing to be held in funds. In other countries where bank funding and the syndication market is less active, CMBS issuance may be higher.

The agency adds that most core European cities have seen prime office yields trending down, below Moody's minimum yield of 5%, with prime retail yielding below 4% in all key markets. It states, however, that office and retail yields are stabilising in the UK, Germany and Italy after several quarters of yield compression.

In the UK, 70% of non-bank lenders recorded an increase in CRE loan book volumes in 2015, with insurance companies also ramping up secured lending to commercial property due to regulatory changes and the withdrawal of banks. This is reflected in increased market share of 15.1% by year-end 2015 and 99% of insurance firms recording an increase in CRE loan book volume.

Moody's concludes that commercial loans in special servicing have declined from a peak of 170 loans (totalling €17.8bn) in December 2013 to 99 loans (totalling €12.3bn) in September 2016. As of September 2016, it finds 44 loans - worth €6.4bn - undergoing liquidation, either through consensual property sales or forced sales, with another 18 loans (worth €2.8bn) moving towards a final workout, where the special servicers have already sold the underlying properties.

CMBS

Default rate dips

Fitch's cumulative loan default rate for fixed-rate US CMBS fell slightly to 12.7% as of 3Q16, slightly lower than the 12.9% rate at end-2Q16 and 13.2% one year ago. The decline is due to steady issuance levels, combined with overall low term default rates, according to the agency.

In 3Q16, 39 loans totalling US$387m newly defaulted during their loan term, compared to 3Q15 when 38 loans totalling US$779.1m defaulted. Additionally, 92 loans - with an original securitised loan balance of US$1.75bn - did not refinance at their 3Q16 maturity date, compared to 83 loans totalling US$943.8m in 3Q15.

Newly defaulted loans were smaller last quarter, with an average loan size of US$9.9m, compared to US$20.5m in 3Q15. Only one defaulted loan had an original balance in excess of US$25m.

Approximately 45% of the new defaults were in the 2006 vintage, 22% from the 2007 vintage and 27% from the 2011-2015 vintages. Retail properties were the largest contributor to new 3Q16 defaults by loan balance, with 20 loans comprising 38% of Q3 defaults.

Office properties were the second largest contributor, with five loans at 32%, but one large loan being the primary driver. Seven multifamily loans defaulted, comprising 15% of total Q3 defaults, while four industrial loans defaulted representing 10% of total defaults. Three hotel defaults make up the remaining 5%.

The five largest defaults in 3Q16 were: US$98.2m SBC Hoffman Estates (securitised in BSCMS 2006-PWR11 and MSCI 2006-T21), US$20.1m Market at Mill Run (WBCMT 2006-C28), US$19.7m Wausau Center (WFRBS 2011-C4), US$19.2m Granada Apartments (CGCMT 2007-C6) and US$16.6m Inland - Craig Crossing (JPMCC 2006-LDP7).

There were 14 loans from the 2010-2016 vintages that newly defaulted in 3Q16, with a total balance of US$102.9m. These defaults were largely driven by idiosyncratic events and by loans with exposure to areas where local employment is highly dependent on oil and gas exploration.

CMBS

Liquidity facility costs cause burden

Taurus (Pan-Europe) 2007-1 wishes to cancel its liquidity facility, after costs escalated sharply. The issuer has therefore contacted noteholders to seek permission.

The liquidity facility provider originally wrote to the issuer to outline the effect that a change to the rating on the notes has had on costs associated with maintaining the liquidity facility. The level of increased costs incurred has risen from 0.636% per annum to 11.25% per annum, while the commitment commission has also risen from 0.816% to 11.43% per annum.

The CMBS has been one of the casualties of the crisis (SCI passim). An event of default led to rating downgrades last year (SCI 8 July 2015), while safeguard proceedings have also complicated matters.

CMBS

Delinquencies rise as maturities bite

The Trepp US CMBS delinquency rate increased by 20bp in October to 4.98% and is now 19bp lower since the beginning of the year and only 25bp lower than the year-ago level. The rate began to rise in March as loans from the 2006 and 2007 vintages started reaching their maturity dates, causing the reading to move higher in seven of the last eight months.

In October, CMBS loans that were previously delinquent but paid off with a loss or at par totalled about US$820m, according to Trepp. Removing these previously distressed assets from the numerator of the delinquency calculation helped drive the rate down by 18bp. Almost US$500m in loans were cured last month, which helped push delinquencies lower by another 10bp.

However, over US$1.9bn in loans became newly delinquent in October, which put 42bb of upward pressure on the delinquency rate. A reduction in the denominator due to the maturation of performing loans accounted for the remainder of the difference.

Over US$2bn in loans were defeased last month. Excluding defeased loans, the overall 30-day delinquency rate is 5.20%, an increase of 21bp from September.

CMBS

CMBS losses analysed

Loss percentages for US CMBS loans reached a peak of 14.15% in 2011, but have since moved as low as 4% for loans liquidated in January 2015 or later, notes Trepp. For loans that resolved this year the average loss severity has declined consistently, from 6.41% in 4Q15 to 2.31% in 3Q16.

While total sector losses have declined along with the share of troubled loans, the average loss severity for loans that were written off with losses has remained relatively steady over the years. It has typically fluctuated around the low- to mid-40% range.

Trepp has conducted an analysis of losses reported on US CMBS loan liquidations between January 2010 and September 2016. It includes loans securitised between 1996 and 2015, with no loans from 2016 as none of these have yet taken a loss. They are split into liquidated loans, encompassing loans have been resolved via any method, and disposed loans, which have paid off with a loss.

The New York-Newark-Jersey City MSA is the largest in the US and has the largest volume of losses by MSA between 2010 and 2016 year-to-date, at US$2.2bn. Of the 3,379 CMBS loans backed by New York City area properties, just 3.74% was wiped out via loan losses, where average severity was 31.63%.

Close behind New York is the Las Vegas-Henderson-Paradise MSA, with around US$1.9bn in total realised losses. There were 679 Las Vegas property loans liquidated at an average loss severity of 22.88% and 292 loans from the Las Vegas metropolitan area disposed with losses at an average severity of 50.95%.

Among the 15 metropolitan regions with the highest cumulative dollar losses since 2010, the Cincinnati MSA finished at the top of several categories, including highest average loss severity among the top 15 MSAs when looking at all liquidated and disposed loans. Loans totalling US$2.44bn in CMBS were liquidated in any fashion, with US$628.5m of losses, amounting to an average loss severity of 25.7%. Average loss severity for the 64 notes disposed with losses was 66.5%.

In 2016 so far, New York has the highest losses as 465 loans have been liquidated with an average severity of 3.29%. Of that total, 40 notes were disposed with losses averaging 56.06% in severity.

The highest average loss severity for liquidations in the year so far is Akron, Ohio at 38.87%. For disposals, the St Louis MSA has the highest average loss severity with "a whopping" 102.53%.

For conduit loans with the heaviest losses in the first three quarters of the year, the US$363m Bank of America Plaza (see SCI loan events database) incurred the largest loss by dollar amount. The loan was disposed with a 55.66% loss severity.

By property type, lodging loans have suffered the most since 2010, reaching an all-time-high delinquency rate of 19.46% in September 2010. Over 2015 and 2016 so far, the average loss severity for liquidated lodging CMBS loans was just 3.89%. "However, loss severity remains elevated when looking at loan disposals, as the average loss severity for those notes has been above 50% over the last 21 months," notes Trepp.

Liquidated loans backed by multifamily properties have incurred the lowest average loss severity since 2013. Loss percentages rose to double digits between 2010 and 2011, but average severity dipped below 2% in 2015 and 2016.

US$160bn in CMBS debt is slated to mature by the end of 2018, with 11.5% of that balance currently serious delinquent and 14.4% in special servicing. Trepp notes that 40.1% of loans scheduled to mature in this quarter are 60-plus days past due on payment, while 43.27% have been transferred to special servicing. "However," Trepp notes, "the overall outlook on the ability of these loans to refinance at maturity (or to minimise losses at liquidation) appears favourable given the strong demand and property level fundamentals observed in the current CRE environment."

Risk Management

Bilateral efficiency enhanced

LCH is set to launch a new service for the non-cleared derivatives market. Dubbed LCH SwapAgent, the offering aims to provide market participants with a number of solutions designed to improve standardisation, efficiency and simplicity in the bilateral derivatives market.

It will act as an independent calculation agent, facilitating the exchange of bilateral margin and settlement payments, but will not become the central counterparty to the trade. Customers will be able to benefit from services, including CSA standardisation, end-to-end trade life cycle management, independent valuation and risk calculation, dispute elimination, payment netting and compression.

The service - which is expected to go live in 1H17 - will initially be available for all market participants trading non-cleared OTC interest rate derivatives. Eleven dealers have confirmed their support, including Bank of America Merrill Lynch, Barclays, BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley and RBS.

Nathan Ondyak, global head of LCH SwapAgent, comments: "We believe that an efficient bilateral market is critical to the functioning of the broader OTC market. SwapAgent increases the efficiency of non-cleared derivatives trading by extending the centralised clearing infrastructure - standardised document terms, trade processing, margining and payment processing - without requiring novation to a central counterparty or a change to the underlying trade terms."

Risk Management

Pricing solution enhanced

FINCAD's F3 solution now offers coverage for structured fixed income securities - including RMBS, ABS, CMBS and CLOs - via integration with data analytics providers AD&Co and Intex. Buy-side firms can use F3 to accurately hedge exposure and perform scenario analysis across their entire multi-asset portfolio.

Advantages of the service include precise hedging, accurate scenario analysis, consistent reporting and streamlined operations. Through Intex connectivity, F3 users can access cashflow waterfall information to price, analyse and manage any bonds covered by Intex. Meanwhile, AD&Co's behavioural models provide F3 users with a valuable tool for generating prepayment, default and loss forecasts for mortgage securities.

RMBS

UK ratings addendum released

DBRS has published a European RMBS Insight-UK Addendum methodology. The UK Addendum, together with the European RMBS Insight Methodology, supersede the Master European Residential Mortgage-Backed Securities Methodology and Jurisdictional Addenda published in August 2016 for DBRS ratings assigned to UK RMBS and UK covered bonds.

The methodology and the UK addendum is a significant change as the methodology introduces a new proprietary default model to forecast the expected defaults and losses of portfolios of European residential mortgages. The model combines a loan scoring approach and dynamic delinquency migration matrices to calculate loan-level defaults and losses.

Loan scoring models and dynamic delinquency migration matrices are developed using jurisdictional specific data on loans, borrowers and collateral types. In addition, the European RMBS Insight Model uses a home price model to generate market value declines (MVDs).

DBRS currently rates 38 classes of notes across 14 UK RMBS transactions. The expected impact of the adoption of the methodology on outstanding UK RMBS is expected to be neutral to positive.

Positive rating actions are expected to be concentrated in some but not all of the subordinate tranches of DBRS-rated transactions. The agency expects to publish the relevant rating actions in the near term.

RMBS

Error results in review

Fitch has placed the class A notes - currently rated single-A - of Atlantes Mortgages No 2 on rating watch negative. The action follows the discovery of errors in the manual processing of the loan-level data and manual entry of data into the agency's EMEA RMBS surveillance model for Portugal.

Fitch has found that the data relating to original loan to value (OLTV) ratios was incorrectly processed and entered into its EMEA RMBS surveillance model for Portugal. This resulted in an erroneous foreclosure frequency rate.

The agency says it will determine the effect of these inconsistencies by conducting a full analysis of the transaction. It warns that the resolution of the rating watch may result in a downgrade of Atlantes Mortgages No 2's class A notes by up to two rating notches.

RMBS

Roll-rate analysis updated

DBRS is requesting comments on its proposed update to the RMBS Insight 1.2: US Residential Mortgage-Backed Securities Model and Rating Methodology. The primary update to the methodology relates to the roll-rate analysis when loans migrate from 180-day delinquency to default.

DBRS has generally used a 100% roll-rate, except in certain post-crisis securitisations where the combined loan-to-value (LTV) ratios are low. In the update, the agency reviewed a sample of 5.8 million loans in the historical datasets from MBSData, Fannie Mae and Freddie Mac, consisting of mortgages that became 180-day delinquent from 1999 through 2014.

It then constructed a loan-level model that derives a roll-rate based on the loan's combined LTV, property type, occupancy, product type, loan balance, loan age, data source, year the loan becomes 180-days delinquent and, for modifications, month since modification. The agency intends to apply the roll-rate analysis to post-crisis RMBS where the transactions go through a rigorous data validation and due diligence review, both by third-party review firms. For pre-crisis securitisations or re-REMICs backed by pre-crisis legacy transactions, DBRS will continue to assume a 100% roll rate from 180-days delinquency to default.

Meanwhile, the second update refines the loss severity calculation for FHA-insured and Veterans Administration-guaranteed mortgages. In this update, DBRS details the derivation of losses as a shortfall of recovery from the US Department of Housing and Urban Development reimbursement and specifies the debenture rate and foreclosure timeline it uses in the calculation of interest reimbursement.

The third update relates to non-agency prime transactions issued in 2010 and later. According to Intex data, 114 such securitisations have been issued totalling approximately 52,152 loans and US$40.5bn, as of 31 September 2016. DBRS notes that the performance of these prime securitisations has been impeccable, with only 23 loans having a payment status of more than 60-plus days delinquent. Additionally, there has been a 0.04% loss to date on one transaction.

Positive loan attributes, along with conservative underwriting standards have contributed to excellent performance. Based on these factors, DBRS proposes to give the same credit (or penalty) to prime RMBS as it does to agency pools, with respect to certain characteristics, such as debt-to-income ratios, origination channel and the presence of a co-borrower.

As the fourth change, DBRS plans to update its loss severity calculation for post-crisis second lien mortgages as underwriting and performance improve. Rather than automatically writing the loan off at 100% loss severity plus six months of interest, if there are any funds remaining after the associated first lien is fully liquidated, they will be applied as a recovery to the second lien.

Finally, the agency is seeking to maintain minimum spacing among rating categories in certain securitisations containing large numbers of loans. In such transactions, the model-derived correlation is often very low, thus resulting in compressed expected losses among rating categories. DBRS proposes to maintain a floor of 30bp-40bp from lower to higher ratings between any two rating levels.

In conjunction with the updates, DBRS will review all affected securities from 2009 and take rating actions under the updated methodology if warranted. Comments on the proposal should be received by 23 November.

RMBS

Loan repurchase planned

Banca Popolare di Vicenza (BPVi) and Banca Nuova (BN) are set to repurchase on 1 November all the loans in Berica 6 Residential MBS that are classified as defaulted, as of 30 September 2016. The issuer will distribute the proceeds of the sale according to the transaction waterfall on the January 2017 IPD.

The amounts remaining after payment of the interest on the class E notes will be added to the cash reserve account as an additional cash reserve above the target cash reserve. On the January IPD following the repurchase of defaulted loans, the issuer will have an additional amount equal to approximately €62m available to cover any principal deficiency and to fill up the cash reserve above its target, which currently is approximately €12m.

RMBS

Leek redemption due

UK non-conforming RMBS Leek Finance Number 18 is set to be redeemed on 21 December, five years after the original step-up and call date. Currently £617m of bonds remain outstanding from the transaction, which JPMorgan European securitisation analysts estimate equates to nearly 2% of the distributed UK NCF opportunities held by investors.

The move follows the full redemption of Leek 17 on the optional redemption date of 21 June 2016 and represents another example of the shrinking legacy UK RMBS universe amid ongoing redemptions, including Aire Valley (SCI 22 August). Co-operative Bank announced in March 2011 its intention not to call the Leek 17 to 19 transactions on their corresponding scheduled step-up and call dates falling on 21 June 2011, 21 December 2011 and 21 June 2012 respectively (SCI 14 April 2011).

Instead, bondholders were given the option to put back the notes to the issuer on the extended maturity dates five years from the originally scheduled call dates, while the issuer maintained the ability to call the notes at any time. Taking into account Co-operative Bank's stance on the redemption of Leek 17 and 18, the JPMorgan analysts anticipate Leek 19 - with around £600m outstanding - to be fully redeemed on 21 June 2017.

RMBS

Jumbo RMBS 'could see growth'

Should lenders start offering jumbo mortgages to a greater number of creditworthy borrowers, the US jumbo mortgage securitisation market could grow, according to recent research from S&P. The research also looks at the variation in the jumbo-conforming spread over time and finds that it directly impacts the US RMBS market.

S&P analysts examine drivers of the variation between conforming and jumbo mortgage rates for the 30-year fixed-rate mortgage (FRM) in the US, assessing how capital market execution effects this and whether this leads to additional liquidity risk, looking at historical spreads between the two average notes over time and the impact of certain loan credit characteristics. The researchers conclude that the rate difference grows in periods for which the opportunity for securitisation declines as a viable exit strategy for lenders.

The report goes on to state that aside from mortgages made between 2008-2012, the jumbo-conforming spread has been relatively stable at around 25bp since 1998, due to the risk associated with higher loan balances and relatively lower liquidity, given the GSE restriction on loan size. The latter effect has then been exacerbated recently due to record low interest rates and spreads, meaning also that RMBS have often been uneconomical due to the difficulty associated with earning a return much greater than the fixed costs associated with issuing RMBS.

As such, lenders have chosen often to either sell whole loan pools or hold them on-balance sheet to collect interest, but there are relatively few entities that can afford to take on the credit and interest rate risk associated with a whole loan pool with a relatively long duration. Not being so able to securitise, this therefore leads to increases in the jumbo conforming spread.

S&P adds that the agency g-fee - which has been rising since 2010 - as well as improvement in collateral credit quality underlying jumbo originations, tend to lead to decreases in the spread. However, the agency highlights that the current spread is comparable to its pre-recession levels, suggesting jumbo lenders and GSEs are demanding greater insurance against defaults through their note rates.

The analysts point out that the jumbo-conforming spread did widen considerably from 2010-2012, when non-agency and jumbo issuance was at a low point, but suggest that this was due to excess liquidity risk taken on by lenders that likely have been forced to hold mortgages on their books due to limitations in the usual securitisation exit strategy.

The research adds that as the current jumbo-conforming spread is nearly as tight as pre-recession, this shows that a combination of g-fees and jumbo credit migration has served to offset the effects of reduced liquidity in the non-agency mortgage market. Currently, there are fewer lenders in the market and a limited appetite for non-agency/jumbo RMBS, which means many issuers can no longer use securitised markets in a competitive manner to achieve capital market-driven pricing, relying instead on portfolio whole loan financing, which loses the benefits of distributing credit or interest rate risk to investors.

The report concludes that while super-prime jumbo mortgages have dominated non-agency lending recently, the credit box may start to widen and, as such, an increase in interest rates and the yield curve slope could lead to more jumbo securitisation. If that does happen, jumbo paper could be more in demand and take back non-agency market share towards its historical norm of around 20%.