Contents

Varied approaches

Retained risk valuation practices gauged

The horizontal retention piece of a securitisation could be considered the very definition of a Level 3 asset: rarely traded - if ever - with very limited market information. Subject to fair value assessment before and after a deal closes, market participants are taking a number of different valuation approaches to such assets, with no single method yet considered to be best practice.

"I don't believe that we've reached a point where there's a single best practice for fair valuing the horizontal retention pieces," says Bill Fellows, partner in Deloitte's valuation & modelling practice. "That's because the guidance itself permits an issuer to use a number of different valuation approaches as defined under GAAP. Each of those approaches is going to be different in terms of how the issuer applies them and what disclosures are made."

Since the adoption of risk retention rules across all US securitisations on 24 December 2016, sponsors and managers of all transactions must choose to retain a vertical, horizontal or L-shaped retention piece (SCI passim). The horizontal and L-shaped pieces are subject to fair value, but not the vertical.

Several approaches to fair-valuing horizontal retention positions are currently under consideration. Some institutions employ third-party providers; others are developing internal solutions to come up with their estimate.

A number of those developing an internal solution have established an in-house model. Others are using an off-the-shelf solution, supplemented by their expectations for what the deal will ultimately look like in terms of tranche thickness, collateral and coupons.

"It is reasonable that there are different approaches out there: different collateral managers have different access to tools or to third parties, for example. It's a natural state of affairs at this stage," says Fellows.

He adds: "A potential valuation approach that may or may not be used is taking indicative pricing ranges from the underwriter for interest on the higher tranches. The sponsor then uses that indicative information for fair value calculations: an income-based approach is used to come up with the equity tranche valuation."

According to a recent survey of CLO managers carried out by Maples Fiduciary Services, 58% of respondents indicated they will take a horizontal retention piece when issuing new deals, 34% a vertical piece and 2% an L-shaped piece. Of those respondents with a horizontal retention plan, 22% indicated they have already appointed a third-party valuation firm. A further 50% said that they are currently engaged on such a project.

"A manager that takes significantly more than 5% of the CLO (horizontal retention strip) is likely more confident with the fair valuation calculation for that position because there is more of a cushion," says Mark Matthews, partner at Maples and Calder. "It is the managers that are closer to the 5% margin or that are taking a 5% in total that probably need to make sure that their fair value calculation is on the right side of the line."

The survey indicated that 28% of managers taking the horizontal approach plan to hold the requisite minimum of 5% of the deal, 44% said they will hold between 5% and 10% of the deal, while 28% of respondents said they plan to hold over 10%. "The closer you get to 5%, the closer the risk you run of your numbers being challenged," suggests Andrew Dean, svp at Maples Fiduciary. "And what better way to meet that than by having a third party come in and back up the numbers."

Matthews notes his surprise at so many managers taking more than 10% of the risk. "However, historically managers always typically took some of the equity in their deals," he says. "The equity usually performs pretty well, so not only do they get the manager fee, but also the upside on the equity itself."

Fair valuation of the horizontal retention piece takes place twice: prior to and post pricing. In both instances, the sponsor's valuation methodology and the resulting fair value determination is disclosed; any differences in inputs and assumptions upon final pricing must also be released.

"Horizontal risk retention pieces are, in many ways, the definition of a Level 3 asset," says Fellows. "They rarely trade - if ever - and market information is often unavailable. Often the only person buying the position is the risk retention holder, who is unlikely to have another trade they can compare it to."

He adds: "On the other hand, people have been valuing Level 3 positions for a long time. It is a matter of getting comfortable of valuing this retained strip in the absence of full information: in other words, you will have to make assumptions about the rest of the structure before it has priced."

Fellows notes that while assets such as CLOs are a fairly well-established asset class - and it is therefore not too difficult to make assumptions around the collateral - the challenges could be greater when fair-valuing the retention piece for more exotic deals. Challenges - or concerns - related to accounting for the horizontal retention strips may also be a decisive factor when it comes to a sponsor or manager's ultimate strategy.

Horizontal risk retention can bring economic efficiencies (SCI 16 September 2016). However, when retaining horizontal retention pieces, there's an expectation that the manager or related party will generally consolidate the CLO under accounting rules. Some companies - particularly public companies - are reluctant to do this, as it may be perceived as a distortion in their financial statements.

"Those institutions may therefore prefer to explore vertical risk retention structures, which would typically not result in consolidation," says Fellows. "Those with third-party investors in majority-owned affiliates may choose horizontal risk retention, as the yield can be more attractive to those investors."

Fair value OC disclosure has caused a certain amount of concern for sponsors too, according to Matthews. Maples' survey showed that, of the CLO managers intending to hold a horizontal retention strip, only 33% have a fair value disclosure ready to go, with 45% currently looking at this issue.

"A number of managers do not necessarily want to disclose how they have calculated their prices," says Matthews. "This may have been to do with disclosing discounts that were given to some investors and not others, for example. However, a standardised disclosure may go some way to sorting this problem."

AC

Capital Relief Trades

Cautious optimism

Secondary CRT market gaining momentum

The secondary market for capital relief trades has been growing alongside issuance of syndicated deals, which account for approximately 50% of CRT volume. In spite of a number of hurdles, market participants remain positive about the future of secondary trading in the sector.

Juan Grana, md of the structured solutions group at Nomura, notes that secondary capital relief trades tend to be non-bilateral/syndicated transactions. The inputs for pricing secondary trades are similar to those of primary trades.

These inputs include portfolio risk distribution, availability of subordination, tranche size, replenishment criteria and remaining duration, according to Kaikobad Kakalia, cio of Chorus Capital.

"Whatever minor differences there are they have to do with market conditions, which is not different from the primary market," adds Steve Gandy, md at Santander Global Banking and Markets. "The only difference is that in the primary market there is access to larger volumes of bonds, while secondary pricing will adjust better because of redemption and other issues."

Activity is driven by a number of factors, including strong performance and a track record of low volatility. Chief among these factors, states Francesco Dissera, md at StormHarbour Securities structuring and advisory division, is the fact that there is "no alternative instrument in the fixed income capital markets that can provide 9%-13% yield or IRR."

Additionally, "some investors who are not involved in the primary market because their requirements are too wide realise that there is an opportunity in this, with a lot of investment banks akin to finance hedge funds for this." He notes that "transactions tend to be sponsored by IRB banks, who can use the supervisory formula at the senior level and, as such, are solid banks."

Other factors, according to Gandy, include a desire for exposure in the home loan market and consumer loan leases. It is also easier to take exposure in this format than originate, given the lack of expertise, especially in relation to the selection of the portfolio and the recovery process.

The secondary market's development, however, is hindered by a number of internal factors. Such factors for Dissera include a different degree of due diligence (based on the type of assets) and the quick execution.

Disclosure, especially borrower disclosure, remains a hurdle. "The reduced documentation, combined often with a tight timetable means that you have to be a sophisticated investor with quick access to legal documents," Dissera says.

Additionally, most investors continue to pursue a buy-and-hold strategy. Market participants remain optimistic, however.

Indeed, there are technical solutions to deal with the issues of liquidity and transparency. For Gandy, having deals structured as CLNs is one such solution, since they are listed and tradable. Furthermore, growing issuance is encouraging more standardisation, which is supported by standardised supervision under the European single supervisory mechanism.

"Not everyone has the commitment to be involved in secondary trades of private/bilateral transactions," observes Dissera. "Some do not want to have inventory; others do not want to make valuations, while others don't have sufficient resources to be involved in relatively small transactions. Nevertheless, it is a market that does evolve."

He continues: "There is no jurisdiction that hasn't issued in the primary market (with therefore secondary trades being potentially available). Financial institutions in the UK, Switzerland, Poland, Austria, France and Italy have all executed transactions in the past few years."

Gandy expects new regulations to spur more origination, primarily from European banks. "Synthetic securitisation is more European and less American. American banks are subject to minimum leverage ratios, with US regulators less plugged in to the idea of RWAs. Americans therefore are focused more on the leverage ratio."

He adds that European banks finance a lot of government debt and fund the home loan market. "US banks, on the other hand, don't hold a lot of these assets. This is why SRTs have become more attractive for European banks. New regulations - such as TLAC, MREL and Basel 4 - will focus on the leverage ratio and thus encourage more origination from European banks."

SP

RMBS

Duration risk

Rate rises hurt Fed's MBS book

The December interest rate hike in the US reflected the increasing health of the economy, but it also created issues for the US Fed's large book of MBS, which make up US$1.7trn of its balance sheet. Indeed, rising rates bring the spectre of duration risk for certain fixed rate assets, such as Fannie Mae 30-year mortgage pools.

These assets account for 40.7% of the Fed's total agency MBS exposure. Jason Merrill, structured analyst at Penn Mutual, confirms that the impact of duration risk on the Fed's balance sheet is not small.

"It could be pretty significant. Our latest figures show the Fed has taken a US$50bn hit on their MBS book. As rate hikes continue, we're likely to see the Fed take a bigger hit," he says.

He suggests that the main holdings of the Fed that will be affected by interest rate rises are the Fannie Mae 30-year mortgage pools, although shorter-duration notes could also be affected. The Fed could dispose of these assets, but Merrill believes that it will avoid this strategy.

"I doubt the Fed will dispose of its assets at a loss - as a result, I expect the Fed to hold them to maturity. Disposing of its assets all at once might cause too much disruption to the market, which is something it wants to avoid. Disposing of the assets could cause a hiccup," he comments.

Merrill points out, however, that if the Fed does take such a route, it would do so in a "periodic and programmatic way, with a certain degree of transparency with Wall Street too about how it would be done."

He also suggests that in a rising rate environment, there could be a shift in focus towards other assets. "There might be a renewed focus on treasuries and non-agency RMBS/CMBS or more risky sectors. However, the general response from the banks is that it's been more economic for banks to sell pools of loans rather than securitise them."

Nevertheless, he notes that in the middle of 2H16 banks became "better able to handle risk retention and other regulatory issues", which sparked more non-agency RMBS issuance.

Despite the projected hit from duration risk, commentators point to the fact that the Fed is likely to already have made a significant profit from its MBS holdings. FTI Consulting structured finance md Vincent Varca says that he hopes the Fed takes a route that is not just looking at profit margins.

"I would like to think the Fed's first concern is the state of the economy and the wellbeing of America, rather than its profit/loss calculation, when looking at this issue," he states.

He adds that while rising interest rates may cause issues such a duration risk, which pushes down the value of the bonds the Fed holds, it should still be encouraged to raise interest rates. Varca concludes: "I think it's important for the Fed to raise interest rates, as it's an important tool. It has to rise now, when the economy is doing well, to allow [the Fed] to have it as a tool later when the economy is struggling."

RB

Secondary markets

Euro secondary slow

It's been slow start to the week so far for the European securitisation secondary markets.

Participants look to have taken the opportunity of the US public holiday yesterday to catch their breath and there was little movement in terms of trading or levels. However, tone remains very strong across the board and volumes are likely to pick up as the week wears on.

There is currently only one BWIC on the European calendar for today. Due at 14:00 London time it involves two €2m lines of double-B CLOs CLRPK 1X D and HLAE 2016-1X E Neither bond has covered on PriceABS before.

Secondary markets

Euro ABS/MBS accelerates

Activity has accelerated in the European ABS/MBS secondary market after a slow start to the week.

The continuing strong tone and investor cash reserves continue to fuel demand for paper, which has generated increased bilateral trading in most sectors over the past two sessions. At the same time, BWIC volumes remain low as sellers keep their powder dry, while the lack of primary supply gives no incentive to rotation activity. Consequently, secondary spreads are holding in across the board.

There are currently three BWICs on the European ABS/MBS schedule for today. The most sizeable is a £12.55m three line UK non-conforming list due at 15:00 London time.

The auction comprises: LMS 1 D, MARS4 4X E1C and RMS 28 F1. None of the bonds has appeared on PriceABS in the past three months.

Secondary markets

CLO test ahead

The second session in a row of high BWIC volumes looks set to test the depth of the US CLO mezz rally seen so far in 2017.

"It's another busy day in 2.0 mezz, which should truly test the market," says one trader. "We're sensing a little bit of exhaustion from buyers in 2.0 single- and double-Bs and saw a fair amount of DNTs yesterday."

However, the trader adds: "Mezz activity levels generally remain very good. Equally, there are a number of investors who are watching closely for any signs of softening as they wait for a slight pull-back to move back into the market. So, any kind of dip is likely to be short-lived."

There are currently 13 US CLO BWICs on today's calendar, which almost exclusively involve 2.0 mezz. However, the highlight is an equity auction due at 9:30 New York time.

"This is the first time this year we've seen a 2.0 equity list of this size and quality in terms of names and tenor," says the trader. "So, it'll be very interesting to see how and where it trades."

The $84.55m 16 line BWIC consists of: ACASC 2013-2A SUB, BOWPK 2014-1X SUB, BRCHW 2014-1A INC, CEDF 2014-3A SUB, CEDF 2014-4A SUB, CGMS 2013-3A SUB, CGMS 2014-1A INC, CGMS 2014-3A SUB, CGMS 2015-1A SUB, DRSLF 2015-38X SUB, DRSLF 2015-41X SUB, OCT14 2012-1A INC, PLMRS 2015-1A SUB, TRMPK 2015-1A SUB, VOYA 2014-3A SUB and WINDR 2013-2A INC.

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

Structured Finance

SCI Start the Week - 16 January

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

Pipeline
There were a few more additions to the pipeline last week. The final count consisted of two ABS, an ILS, two RMBS and three CMBS.

US$1.672bn Ford Credit Auto Owner Trust 2017-A and US$477.1m SoFi Consumer Loan Program 2017-1 accounted for the ABS, while the ILS was Vitality Re VIII. The RMBS were CAS 2017-C01 and €157.7m Delft 2017, while the CLOs were €320m Aqueduct European CLO 2, Aurium CLO III and Purple Finance CLO I.

Pricings
The first prints of the year have also started to come through. Last week there were four ABS, three RMBS, a CMBS and three CLOs.

US$206m CPS Auto Receivables Trust 2017-A, US$750m Discover Card Execution Note Trust 2017-A1, US$550m Discover Card Execution Note Trust 2017-A2 and US$1.106bn Hyundai Auto Lease Securitization Trust 2017-A were the ABS. The RMBS were €672m SapphireOne Mortgages 2016-3 (reoffer), US$340m Sequoia Mortgage Trust 2017-1 and €2.177bn STORM 2017-I.

US$1bn FREMF 2017-K724 was the CMBS. The CLOs were US$535m Limerock CLO 2014-2, US$644m Madison Park Funding CLO 2014-12 and US$490m Sound Point CLO 2014-1.

Editor's picks
Flawed logic: The regulatory drive to require multiple ratings for European structured finance products may not achieve its intended aims, despite necessarily adding costs. The findings of a recent Finance Research Letters study suggest that the regulatory initiative is based on an understanding of market practices that is not borne out by facts...
Green SRT emerging: The final panel at SCI's recent Capital Relief Trades Seminar struck an optimistic note regarding developments in new jurisdictions and asset classes. Indeed, 'green' lending is emerging as a consideration for some investors in the sector...
A nebulous concept: The challenges in defining the cost of capital were discussed extensively at SCI's recent Capital Relief Trades Seminar. Panellists agreed that it is a nebulous concept...
Euro CLOs start strongly: The European CLO secondary market has had a busy start to 2017, backed by strong price moves. "Since the start of the year, CLOs have shifted materially tighter across the board," says one trader. "That move is predominately a reflection of improving levels in other asset classes and most noticeable in triple- to single-Bs..."
Fair value credential introduced: A new credential intended to enhance the quality, consistency and transparency of fair value measurement results in financial reporting has been launched. The Certified in Entity and Intangible Valuations (CEIV) credential is a result of collaboration between the American Institute of CPAs (AICPA), the American Society of Appraisers (ASA) and the Royal Institution of Chartered Surveyors (RICS)...

Deal news
• Further details have emerged about Grafton CLO 2016-1, Santander's largest post-crisis corporate loan significant risk transfer deal and its second largest synthetic securitisation (SCI 3 January). The £1.25bn six-year CLN has a three-year replenishment period and provides protection for the first 8% of losses in the underlying portfolio.
• Morgan Stanley is in the market with the €157.7m Delft 2017, a Dutch non-conforming RMBS backed by loans originated by Lehman Brothers subsidiary ELQ Portefeuille I. The portfolio in its entirety is currently securitised in EMF-NL 2008-1.
• The US$8.7m Black Gold Suites Hotel Portfolio loan, securitised in COMM 2014-UBS6, has been modified. The loan was sent to special servicing early last year.
• Fitch has affirmed the Tradewynd Re Series 2014-1 class 3A and 3B notes, which are expected to mature on 8 January 2018, at double-B minus and single-B respectively. The agency confirms that no reported covered events exceeded the initial attachment levels of the notes within the annual risk period from 1 January 2016 through 31 December.
• All but six Freddie Mac STACR credit risk transfer bonds have received NAIC 1 designations for the 2016 filing year. The STACR 2015-HQA2, 2016-HQA1, 2016-DNA2 and 2016-DNA3 M3 tranches received NAIC 2 designations, while the STACR 2016-HQA2 and 2016-HQA3 M3s received NAIC 3 designations. All Fannie Mae CAS RMBS, except two, have also been assigned NAIC designations (SCI 6 January).

Regulatory update
• The FHA will reduce the annual mortgage insurance premium (MIP) most borrowers must pay for 30-year mortgages by 25bp for loans up to US$625,000 and by 45bp for larger loans. The new premium rates will affect most new mortgages with a closing/disbursement date on or after 27 January.
• The US SEC has partially overturned a decision penalising Wing Chau and his former firm Harding Advisory, which found Chau and Harding committed fraud in the selection of assets for two CDOs - Octans I CDO and Norma CDO I. Disgorgement and penalties previously imposed by a judge for Norma were upheld, but charges regarding Octans were dismissed.
• BNY Mellon has agreed to pay the US SEC a US$6.6m penalty to settle CLO-related charges. The SEC accused BNY Mellon of miscalculating its risk-based capital ratios and risk-weighted assets reported to investors.

Capital Relief Trades

Bilateral CLN closed

Further details have emerged of Deutsche Bank's recent capital relief trade, Gate 2016-1 (SCI 3 January). The €95m six-year bilateral CLN pays three-month Euribor plus 12.75% and references a €1bn portfolio of German SMEs.

The investor is believed to be a buy-and-hold investor that is experienced in the German SME CRT market and was attracted by the opportunity to gain exposure to a core granular SME portfolio of a leading German lender. One market source suggests that the investor likely has multiple funds investing in the sector, since the CLNs are issued as 122A-eligible and as Reg S.

"It's unlikely that the same fund would want both," he says.

Protection was bought for the bottom 10% of the capital stack.

SP

CMBS

Investment grade loss for CMBS 2.0

The US CMBS 2.0 market has seen its biggest loss to date, following the liquidation of the US$48.9m Hudson Valley Mall loan - securitised in CFCRE 2011-C1 - at an 80.4% severity on the US$52.4m original balance. The loss forced full write-downs on the NR, G and F classes, while the triple-B minus rated E tranche absorbed a US$7.2m hit.

According to January servicer data, the Hudson Valley Mall property was disposed of with a US$42.1m loss. Liquidation proceeds totalled US$9.4m, with US$2.6m of liquidation expenses.

The asset is a 765,465 square-foot super-regional shopping mall located in Kingston, New York. Anchor tenants include Macy's, Sears, JCPenney, Regal Cinemas and Dick's Sporting Goods. The loan was transferred to special servicing in April 2015, due to imminent non-monetary default (see SCI's CMBS loan events database). It was carrying an appraisal reduction of only US$12.2m before the liquidation, according to Trepp, and the only appraised value tied to the asset had been the US$86.9m one provided at securitisation.

Special servicer notes indicated that the mall was 33% vacant, with 24% of the tenants having either fewer than 12 months on their remaining lease or are operating with kick-out clauses. An additional 7.2% are operating under modified lease terms.

Financials have gradually declined each year since 2012, with a 0.93x NCF DSCR reported for full-year 2015.

S&P notes that the CREFC 2011-C1 pool originally comprised only 38 loans and says the transaction "demonstrates how a single loan can create investment grade losses" if loan diversity is lacking. The trust factor now stands at 36% (US$227.6m), with 21 loans remaining and no delinquencies, albeit two loans are on the watch list.

CS

Structured Finance

Ratings suits settled

The US Department of Justice, 21 states and the District of Columbia have reached a nearly US$864m settlement agreement with Moody's, Moody's Analytics and their parent Moody's Corporation. The settlement resolves allegations arising from Moody's role in providing credit ratings for legacy RMBS and CDOs, including pending state court lawsuits in Connecticut, Mississippi and South Carolina, as well as potential claims by the Justice Department.

The multi-faceted settlement includes a Statement of Facts, in which Moody's acknowledges key aspects of its conduct, and a compliance agreement to prevent future violations of law. The Statement of Facts addresses Moody's representations to investors and the public generally about: its objectivity and independence; its management of conflicts of interest; its compliance with its own stated RMBS and CDO rating methodologies and standards; and the analytic integrity of certain rating methodologies. It addresses whether Moody's credit ratings were compromised by what Moody's itself acknowledged were the conflicts of interest inherent in the 'issuer pay' model.

Among other things, Moody's acknowledges that starting in 2001, its RMBS group began using an internal tool in rating RMBS that did not calculate the loss given default or expected loss for RMBS below Aaa and did not incorporate Moody's own rating standards. Instead, the tool was designed to 'replicate' ratings that had been assigned based on a previous model that calculated expected loss for each tranche and incorporated Moody's rating level standards. In October 2007, a senior manager in Moody's asset finance group noted that RMBS ratings derived from the tool were four notches off.

Starting in 2004, the agency did not follow its published idealised expected loss standards in rating certain Aaa CDO securities. Instead, it allegedly began using a more lenient standard for rating these Aaa securities, but did not issue a publication about this practice to the general market.

In 2005, Moody's authorised the expanded use of this practice to all Aaa CDO securities and in 2006 formally authorised the use of this practice to all Aaa structured finance securities. Throughout this period, it did not issue publications about these decisions to the general market.

The Statement of Facts further addresses Moody's inconsistent use of present value discounts in assigning CDO ratings and its selection of assumptions about the correlation between assets in CDOs.

Under the terms of the compliance commitments, Moody's agrees to maintain a host of measures designed to ensure the integrity of its credit ratings, including the separation of its commercial and credit rating functions by excluding analytical personnel from any commercial-related discussions and excluding personnel responsible for commercial functions from determining credit ratings or developing rating methodologies. The rating agency will also enhance its oversight functions to monitor the content of press releases and the timeliness of methodology development.

The settlement includes a US$437.5m federal civil penalty, which is the second largest payment of this type ever made to the federal government by a rating agency. The remainder will be distributed among the settlement member states in alignment with terms of the agreement. The states involved include Arizona, California, Connecticut, Delaware, Idaho, Illinois, Indiana, Iowa, Kansas, Maine, Maryland, Massachusetts, Mississippi, Missouri, New Hampshire, New Jersey, North Carolina, Oregon, Pennsylvania, South Carolina and Washington, as well as the District of Columbia.

Structured Finance

Distressed debt vet hired

Drew Doscher has joined BTIG as md and head of fixed income credit. He has been tasked with launching the firm's distressed debt and trade claim business, as well as working to expand its high yield and convertible bond capabilities.

Based in New York, Doscher will report to Anton LeRoy, md and head of fixed income, currency and commodities at BTIG. Doscher was previously head of distressed debt trading at Jefferies. Before that, he traded distressed debt at Lehman Brothers and later managed the global distressed debt trading platforms at Barclays and UBS.

Structured Finance

Modelling head named

MSCI has recruited David Zhang as head of securitised products research. In this newly created role, he will oversee the firm's development of models that help traders, portfolio managers and other institutional investors analyse risk and return for securitised products.

Zhang previously headed modelling of securitised products at Credit Suisse. In 11 years at the firm, he designed models for measuring risk to mortgages and helped develop analytics used by financial institutions for assessing capital at risk, value at risk and other measures of risk.

At MSCI, Zhang joins a team of 40 researchers and specialists that has decades of experience in fixed income. Recent additions include Misha Shefter (who previously headed analytics modelling at Barclays Portfolio & Index Analysis Tools) and Nooshin Komaee (who previously headed analytics for JPMorgan's BondStudio).

Structured Finance

MS names structured credit chief

Morgan Stanley is moving one of its EMEA capital markets co-heads into Morgan Stanley Investment Management. Claus Skrumsager will take control of a structured credit team and fund that is yet to be finalised.

Skrumsager will join the firm's solutions and multi-asset platform as portfolio manager and head of private structured credit solutions. He has been with Morgan Stanley for 10 years and has 19 years of capital markets experience.

Skrumsager will be based in London and report to Rui de Figueiredo and Jacques Chappuis.

Structured Finance

Investment firm bulks out

Partners Group has hired Andrew Bellis as md. He joins from 3i Debt Management and is based at the firm's London office.

At 3iDM, Bellis was also md and helped managed its CLO strategy. Before that, he was a director at Credit Suisse and Merrill Lynch.

Structured Finance

CLO firm nabs SF vet

CIFC has hired Jason Ziegler as md and he will be based out of the firm's New York office. He joins from Orix Corporation, where he was portfolio manager for structured products, including CLOs, RMBS and ABS. Prior to Orix, he was a director in the structured products group for Highland Capital Management, focusing on CLOs.

Structured Finance

Trio appointed partners

Beechbrook Capital has promoted Sandeep Agarwal, Tim Johnston and Mensah Lambie to partner.

Agarwal and Lambie both joined Beechbrook in 2008 and are responsible for sourcing, executing and monitoring investments for the firm's private debt funds. Prior to joining Beechbrook, Agarwal worked at ICICI bank in corporate credit, where he was responsible for structuring and monitoring cross-border acquisition financings and other structured loans. Lambie previously spent three years with Goldman Sachs in the debt capital markets and leveraged finance teams in New York and London.

Johnston works on sourcing and managing investments for Beechbrook's UK SME Credit Fund. He joined the firm in 2009, having spent six years in audit and corporate finance at PwC, followed by three years in the mezzanine finance team at Intermediate Capital Group.

Structured Finance

CRE lawyer promoted

Sutherland has elected three new partners and nine new counsel to the firm. One of the new counsel - Brooke Parris - has securitisation expertise.

Based in Atlanta, Parris represents lenders, servicers, developers and pension fund advisers in various aspects of real estate finance and development. She devotes significant time advising clients on structured finance and real estate finance (including CMBS), as well as resolving non-performing or sub-performing real estate assets. Her general real estate experience includes joint venture formation, purchase and sales, and development and leasing for retail, multifamily and mixed-use projects.

Insurance-linked securities

ILS firm launched

A new alternative asset management firm focused on ILS investments has been founded in Tel Aviv. Dubbed IBI ILS Partners, it has been co-founded by Israel's IBI Investment House and Roman Muraviev.

Muraviev will act as managing partner of IBI ILS Partners. He was previously at Twelve Capital, where he managed the firm's cat bond strategy.

IBI Investment House is one of Israel's largest independent asset managers, with over US$11bn in AUM.

Insurance-linked securities

ILS firm placements head appointed

XL Catlin has appointed Anne Middleton as global head of placements, ceded reinsurance. Middleton will be based in London and be responsible for overseeing and negotiating the terms, structure and pricing of XL Catlin's reinsurance programmes.

Middleton will report to Mark van Zanden, chief executive of XL Catlin's P&C underwriting capital management team. She was previously head of finance for several XL Catlin insurance businesses, and before joining XL Catlin in 2012 she was at PwC for five years as a senior consultant.

XL Catlin closed the largest cat bond of the quarter in 4Q16, issuing the US$750m Galilei Re Series 2016-1. The US$525m Galilei Re Series 2017-1 cat bond has since followed.

ABS

Chrysler scandal 'ABS negative'

The US Environmental Protection Agency (EPA) has issued a notice of violation of the Clean Air Act to Fiat Chrysler because of the installation and use of engine management software to manipulate diesel emissions. Moody's notes that this is credit negative for some US auto ABS.

The EPA violation notice cites more than 100,000 model year 2014-2016 Jeep Grand Cherokees and Dodge Ram 1500 trucks with 3.0-litre diesel engines sold in the US. Moody's rates as many as 60 loan, lease and floorplan transactions with some exposure to Dodge and Jeep vehicles and expects any material exposure to the affected vehicles to be limited to the Chrysler Capital Auto Receivables transactions issued by Santander Consumer USA.

Moody's says the EPA notice of violation is credit negative for these securitisations in large part because of the potential for reduced consumer confidence in the performance and benefits of the affected diesel vehicles. A hit to consumer confidence would affect vehicle sales, increasing the risk of lower recoveries for the affected auto loan and lease ABS transactions when vehicles are resold.

The EPA's accusations are slightly different to the previous Volkswagen emissions scandal. VW was accused of using engine management software to defeat emissions tests and understate emissions (SCI 23 September 2015), while Fiat Chrysler is only accused of installing and failing to disclose the software.

Volkswagen has plead guilty to three US criminal felony counts and will pay US$4.3bn in criminal penalties and civil claims in the US. VW-sponsored auto lease ABS experienced higher residual value losses and its dealer floorplan deals incurred lower monthly payment rates.

Moody's expects Fiat Chrysler's ABS performance to be similar to Volkswagen's experience. "Primarily, there could be a negative effect on the performance of auto lease ABS if delays in the availability of a fix, combined with lower consumer confidence and demand, increases loss severities upon vehicle repossession or after lease turn-in," says the rating agency.

"In lease transactions, when the transaction servicers or sponsors are unable to re-sell the vehicle or must wait until fixes are made to remarket vehicles that have been repossessed or turned-in, the residual realisations used to pay the ABS noteholders are delayed or impaired."

Moody's adds: "For floorplan transactions, dealer monthly payment rates may decline if the affected vehicles cannot be sold until fixes or emissions issues are resolved. In loan transactions, we expect that the effect from any exposure would not be material, particularly because recalls historically have not been a defence against repayment of a loan and financial remedies could be provided to obligors."

ABS

Bar loan ruling 'ABS negative'

A 2016 ruling by the US Bankruptcy Court for the Eastern District of New York on the dischargeability of bar loans is credit negative for securitisations, says Moody's. The ruling found that a bar loan was not exempt from being discharged, which is credit negative because it could lead to future higher defaults and lower recoveries on similar loans.

The ruling splits from prior rulings that have determined that bar loans are akin to student loans, which are generally not dischargeable in bankruptcy. Instead, the judge ruled that the loan was similar to a consumer loan.

The loan in question was taken out by a law school graduate to prepare for the bar exam. However, the court found that this loan was not an 'educational benefit' within the meaning of the US bankruptcy code and furthermore was not encompassed in any of the three other exceptions for loan dischargeability under the undue hardship criteria, therefore the loan could be discharged.

Moody's believes that bar loan dischargeability could result in increased defaults and declines in recoveries for some private student loan ABS. There could also be negative credit implications for other types of loans, such as residency relocation loans that medical and dental borrowers use to cover expenses associated with travelling for residency interviews and relocating for their residency.

Defaults in securitisations backed by bar and residency relocation loans have the potential to rise if those loans were to become dischargeable in bankruptcy. Since there are no recoveries for securitisations on loans after they are successfully discharged, overall recoveries would necessarily decline.

Northstar Student Loan Trust III was issued after the ruling and has a high concentration of bar and residency relocation loans. Older securitisations with similar collateral will benefit from higher seasoning and low remaining balance, mitigating the uncertainty around potential loan dischargeability.

For Northstar Student Loan Trust III, which had a combined exposure to bar and residency relocation loans of around 22%, Moody's assigned a higher volatility factor when determining defaults in its stressed-case scenarios to account for potential spikes in defaults. The rating agency also assumed lower recoveries on bar and residency relocation loans by factoring in that a portion of borrowers who have defaulted will be able to successfully discharge those loans in bankruptcy court.

ABS

Card ABS volume to grow

Credit card debt in the US is growing while credit card utilisation rates are trending lower, suggesting that consumers are using credit cards as a "convenient payment option and less as a line of credit", according to Wells Fargo structured products analysts. They add that credit card debt levels are at a much lower percentage of nominal GDP than in the past.

ABS trust receivables hit a floor in 2016. However, market conditions improved later in the year and credit card balances from accounts pledged to ABS trusts are finally growing after years of contraction. Credit card debt has grown to US$747bn as of 3Q16, but is still short of the pre-crisis peak of US$866bn.

The Wells Fargo analysts note that credit card ABS performance remains strong, as charge-offs and delinquency rates remain historically low, while portfolio yield is rising gradually and excess spread is still elevated. They add that monthly payment rates are still not showing signs of plateauing and conclude that credit card ABS issuance is expected to pick up in 2017 as sponsors refund maturing deals.
 

ABS

Tobacco update affects ratings

Moody's has updated its methodology for rating tobacco settlement revenue securitisations. The methodology changes affect ratings on US$1.5bn of outstanding ABS.

The update reflects the incorporation of new formulas and procedures related to the October 2015 New York state settlement and an extension of recovery lag assumptions. Moody's has consequently upgraded the ratings of 12 tranches in 10 tobacco settlement revenue securitisations, downgraded the ratings of four tranches in three others and confirmed the rating of one tranche from another.

The upgraded bonds were issued by: Buckeye Tobacco Settlement Financing Authority, Tobacco Settlement Asset-Backed Bonds Series 2007 (State of Ohio); California County Tobacco Securitization Agency (Los Angeles County Securitization Corporation) Series 2006A Convertible Turbo Bonds; California County Tobacco Securitization Agency (Merced County Tobacco Funding Corporation) - Tobacco Settlement Asset-Backed Refunding Bonds; Golden State Tobacco Securitization Corporation (2007 Indenture); New York Counties Tobacco Trust II Series 2001; New York Counties Tobacco Trust III Series 2003; Tobacco Securitization Authority of Northern California (Sacramento County); Tobacco Securitization Authority of Southern California (San Diego); Tobacco Settlement Financing Corporation (New Jersey) Series 2007-1; and Ulster Tobacco Asset Securitization Corporation Series 2001.

The downgraded bonds were issued by: New York Counties Tobacco Trust I Series 2000; Northern Tobacco Securitization Corporation Series 2006; and Rockland Tobacco Asset Securitization Corporation Series 2001. The confirmed bond was part of Tobacco Settlement Authority (Iowa) Series 2005.

Structured Finance

Unconstrained fund launched

Dolfin has launched the Dolfin Unconstrained Credit Strategy, which targets consistently positive returns in all market contexts by capturing top-down market shifts and investing in attractive bottom-up opportunities across the global fixed income spectrum. Devised and managed by senior portfolio manager Alex Eventon, the strategy applies rare investment flexibility, institutional investment tools and dynamic risk management, with a performance target of Libor plus 4%.

"Most investors have to hold an allocation to fixed income securities, yet the outlook for generating returns in the current fixed income environment is challenging - especially when adhering to a rigid investment framework," he comments. "We manage a defensive core portfolio...enhanced with a mix of tactical and relative value opportunities. The strategy provides access to some less liquid opportunities and credit-linked structured products."

Demand for the strategy is currently led by institutional investors in the form of mandates. Dolfin is also considering launching a fund vehicle and UCITS-compliant strategy.

CLOs

Reviewed combo notes downgraded

CLO 2.0 combination notes have been downgraded by Moody's, following the rating agency's methodology change. Otherwise, CLO rating changes have generally been positive.

Moody's criteria for rating securities backed by both secured debt and equity tranches of CLOs was updated at the start of 4Q16 (SCI 10 October 2016). Moody's placed on review for downgrade the ratings of 38 combination securities in October. Last month, it concluded reviews on 26 of these.

Ratings on 12 combination notes in 12 deals with an original balance of US$333.1m were downgraded. Downgrades ranged from one to three notches, with an average of 1.8 notches.

Ratings on 14 combination notes with an original balance of US$850m were confirmed. Ratings on eight notes were withdrawn, as they were restructured into secured notes after being placed on review.

Also last month, Moody's upgraded the ratings on 20 tranches from 12 US CLO transactions, totalling US$482.5m in original principal balance. The upgrades ranged from one to three notches, with an average of 1.6 notches.

Credit quality as measured by WARF has actually deteriorated in five of the deals whose notes Moody's upgraded. This was driven primarily by an increase in the proportion of assets with a default probability rating of Caa1 or below.

Moody's also upgraded the ratings on seven tranches in five European broadly syndicated CLOs with an original balance of €473m. The upgrades ranged from two to four notches and averaged 2.43 notches.

Ratings on three tranches in two transactions with an original balance of €26.7m were downgraded. Two of the downgrades were by one notch and one was by three notches.

Ratings were withdrawn on 25 tranches in eight CLOs. The ratings on four tranches in four CLOs with an original balance of approximately €281.8m were withdrawn because the tranches were repaid in full and, in the case of one tranche, the committed amount had reduced to zero.

CMBS

RFC issued on IO approach

DBRS is requesting comment on its proposed stand-alone methodology for rating North American CMBS interest-only certificates issued via multi-borrower conduits, as well as agency, single-asset/single-borrower, CRE CLO and re-REMIC deals. It reflects a movement from rating these certificates using their position in the waterfall to rating the referenced notional amount to account for a decline in payments as the transaction seasons and prepayments or losses occur.

The DBRS IO rating is an opinion that addresses the likelihood that the notional amount of the IO will be adversely affected by collateral credit losses only. For single-tranche, multiple-tranche and weighted-average coupon/stack IOs, the rating will reference the most junior rated class of bonds, possibly adjusted upwards by one notch.

The rationale for adjusting upwards by one notch is driven by the default probability of the underlying collateral, which incorporates both term and refinance defaults. Because CMBS loans have both term and refinance default risks that are weighted one-third towards refinance risk, the DBRS IO rating recognises the muted impact on IOs by notching the IO rating up by one notch from the reference obligation rating.

All US and Canadian CMBS transactions will be affected by the introduction of the proposed methodology because the reference obligation varies with the IO's position within the waterfall. An impact analysis that considers this change in approach on a majority of such certificates rated by DBRS indicates that potential rating actions could be either downgrades or confirmations.

In conjunction with the finalisation of the methodology, DBRS will review all affected securities and take rating actions as warranted. Comments on the proposal should be received by 3 February.

CMBS

Multifamily drives delinquencies down

Fitch reports that US CMBS delinquencies closed out 2016 at US$12.1bn, down 21% by balance from year-end 2015. The overall delinquency rate finished last year at 3.34%, up 5bp from the previous month but down 68bp from 4.02% one year ago, according to the agency's latest index results for the sector.

The drop in delinquencies is primarily attributable to portfolio dynamics and the index composition, as multifamily was the only property type that showed a year-over-year improvement, with delinquencies falling 338bp over the year. Multifamily resolutions during the year totalled US$3.55bn, far surpassing new delinquencies of US$560m.

The majority of the resolutions was related to the payoff of the Peter Cooper/Stuyvesant Town loan, which was recorded in January 2016 (SCI passim). Since that loan's payoff, the multifamily delinquency rate has remained below 1%.

Meanwhile, the mixed-use delinquency rate saw the most substantial increase over the year, rising 129bp. This large increase was primarily due to the addition of two loans to the index: the US$150m City Place loan (CSMC 2007-C1) and the US$132.5m NGP Rubicon GSA Pool loan (WBCMT 2005-C20 and WBCMT 2005-C1) (see SCI's CMBS loan events database).

Resolutions nevertheless outpaced new delinquencies for the year, ending 2016 at US$11bn and US$7.8bn respectively, compared to US$8.5bn and US$5.6bn in 2015. Additionally, portfolio run-off of US$84bn exceeded Fitch's new issuance volume of US$64bn, resulting in a lower overall index denominator of US$362bn at YE 2016 compared to US$382bn at YE 2015.

Current and previous delinquency rates are: 5.25% for retail (from 5.17% in November and 5.20% at YE 2015); 4.88% for office (from 4.73% and 4.61% respectively); 3.83%for hotel (from 3.90% and 3.82%); 0.81% for multifamily (from 0.79% and 4.19%); 4.46% for industrial (from 4.29% and 3.88%); 4.02% for mixed use (from 3.96% and 2.73%); and 0.67% for other (from 0.61% and 0.89%).

For the month of December, the largest new delinquency was the US$90m Wells Fargo Place loan (securitised in CSMC 2007-C1). Foreclosure proceedings are expected to commence shortly for the asset, as a sale recently fell through and a forbearance agreement is no longer being negotiated.

Meanwhile, the largest December resolutions involved two REO retail properties: the Mall at Yuba City (CSFB 2005-C1) and North Grand Mall (BSCMS 2007-PWR16) assets were liquidated at a 64% and 70% loss respectively.

CMBS 1.0 delinquencies will face continued pressure from approximately US$47bn of loans within Fitch-rated transactions scheduled to mature in 2017. Assuming current market refinance rates for these maturing loans and factoring in similar new issuance volume for 2017, the agency projects that the overall delinquency rate will increase to between 5.25% and 5.75% by YE 2017.

Insurance-linked securities

Weather risk platform introduced

Speedwell Weather has launched its weatherXchange platform, which aims to help companies access index-based weather risk protection and which provides valuation and settlement services. As well as access to weather data, it also provides structuring tools to help new hedgers through the process of designing a hedge.

weatherXchange is designed to bring index-based weather hedging to new users in energy, renewables, agriculture, construction and tourism. "While we have seen dramatic growth in the last two years in the volume of weather hedging contracts traded, we believe that weatherXchange can help further grow this market," comments Stephen Doherty, chairman of Speedwell Weather. "weatherXchange reduces current barriers to accessing weather hedging services, while improving overall market efficiency."

The platform helps improve workflow for protection sellers by streamlining the process of handling pricing requests, including automated RFP processing in the Speedwell Weather System.

Risk Management

Pension clearing opinions published

ESMA has issued two opinions regarding the exemption of Swedish pension schemes from the obligation to centrally clear OTC derivative contracts under EMIR. Pension scheme arrangements meeting certain criteria were granted a transitional exemption from the clearing obligation, while some pension schemes are required to ask their national competent authority to be exempted.

Before deciding on an exemption, the relevant competent authority needs to obtain the opinion of ESMA, which also needs to consult EIOPA. ESMA has published two opinions on pension schemes where Finansinspektionen is the competent authority for securities markets. ESMA will publish the list of the types of entities and arrangements that have been exempted once these are granted by Finansinspektionen.

Last year, the European Commission extended transitional relief for pension scheme arrangements from central clearing of OTC derivatives transactions until 16 August 2018 (SCI 22 December 2016).

RMBS

FHFA seeks GSE mortgage feedback

The FHFA is requesting public input on chattel loan pilot initiatives for Fannie Mae and Freddie Mac and on proposed evaluation guidance on serving underserved markets. The FHFA issued a final rule on 13 December 2016 to implement duty to serve provisions.

The GSEs must serve three specified underserved markets by improving the distribution and availability of mortgage financing in a safe and sound manner for residential properties that serve very low-, low- and moderate-income families in these markets. The markets are manufactured housing, affordable housing preservation and rural housing.

After considering comments on the proposed rule, the final rule established as a 'regulatory activity enterprise' activities designed to facilitate a secondary market for loans on manufactured homes titled as personal property, also referred to as chattel, through pilot initiatives undertaken in a safe and sound manner. The FHFA's request for input concerns what an enterprise should include in a chattel pilot initiative.

The FHFA is also seeking input on its proposed evaluation guidance, which communicates FHFA's expectations regarding the process for developing the enterprises' underserved markets plans, as well as the process by which FHFA will evaluate the enterprises' achievements under their plans each year.

RMBS

Market risk highlighted

Fitch highlights Delft 2017 (SCI 12 January), which it hasn't rated, as an example of an RMBS that could expose investors to the strength and liquidity of housing and lending markets in a concentrated period near bond maturity. The agency says that such concentrated refinancing risk in portfolios of high LTV ratio interest-only mortgage loans can result in rating caps for RMBS.

Fitch believes that this market risk would result in a rating cap at single-A for the Delft deal. In contrast, DBRS, Moody's and S&P assigned triple-A ratings to the class A notes of the transaction.

Delft 2017 refinances EMF-NL 2008-1, which was rated triple-B plus (watch negative) by Fitch prior to the refinancing.

As of June 2016, 92% of the loans in the portfolio were due to mature between 2036 and 2038. Some 80% of them mature in 2037, just three years prior to the scheduled legal final maturity of Delft 2017.

Approximately 25% of the remaining borrowers in the portfolio self-certified their income when they took out their mortgage loans in 2007 and 2008. "If and when they decide to refinance their loans, it is likely that they will be subject to less favourable terms, as lenders may view the characteristics of their loans as being riskier than they did at origination. Refinancing options may also be limited, as non-prime lending in the Netherlands has reduced in recent years," Fitch observes.

The agency suggests that in a market downturn of the kind stressed in its higher rating scenarios, the servicer of the Delft 2017 mortgage loans could be forced to implement a high number of loan workouts or to swiftly liquidate the collateral to repay the notes at maturity. In practice, loan servicers will most likely try to reduce the interest-only exposure ahead of loan maturity, particularly for non-conforming borrowers. However, Fitch notes that its analysis is predicated on contracted terms and gives little benefit to work-out strategies that depend on borrower cooperation.