Contents

Capital Relief Trades

Leverage signals maturing CRT market

The increasing availability of leverage suggests that the risk transfer market is maturing. However, while financing can be applied in a number of ways, the extensive due diligence required means that participation in capital relief trades remains limited to sophisticated investors.

The availability of financing is a "sign that capital relief trades are developing into a more mature asset class," providing investors with an additional avenue to source liquidity from a portfolio of investments, confirms Arrowpoint Partners partner Kaelyn Abrell. "While we continue to see growth in secondary market activity, the ability to apply financing to investments is an alternative and - in many cases - a more attractive option to manage exposures and cash levels," she adds.

Dennis Heuer, partner at White and Case, says that investors are borrowing because they want to improve returns. "Sometimes investment banks come in to improve the investments by putting in an amount of money, which is charged at a (much) lower rate than the premiums that the investor receives for providing its credit protection."

If leverage is provided by third-party investment banks, it typically funds only a portion of the cash needed by investors to provide credit protection on regulatory capital trades, according to Heuer. Investment banks sometimes take a portion of the funding, he adds, contributing to the cash collateral.

The cash needed for these transactions has to be "funded from day one, otherwise it doesn't qualify from the regulator's point of view," he continues. Consequently, "it must be cash collateralised by raising money through the fund, plus - at times - additional bank leverage, with the cash going into a bank account," states White and Case partner Ingrid York.

Robert Bradbury, md at StormHarbour, agrees that such transactions are almost all funded. "They could be unfunded, but the bank's criteria in relation to the selection of the counterparty would be stricter," he says.

Bradbury points out though that this does not necessarily restrict the format. Even if investors trade without an SPV, they still generally have to provide cash collateral.

Nonetheless, SPV-based structures are a commonly used type. Bilateral CDS or similar structures are also used, but a smaller set of investors is willing or able to execute them, due to factors that include comfort with the format and ease of trading.

One risk is that the funding provided on day one is not fully paid back at maturity. Heuer notes that when funds invest larger amounts, they sometimes use multiple sub-funds.

"However, when banks lend to fund investors, the loans are typically not limited recourse. In other words, they do not share the same risk the fund investors face (i.e. not getting paid in full)," he says.

He continues: "Even if there is theoretical risk, most of the risk is not taken by banks. The investors though are typically quite sophisticated in terms of sizing the risk, since they have plenty of experience determining the quality of the loans."

Leverage, however, is rarely the driving factor in risk transfer transactions. "Many funds deploy their own capital and utilise limited or no additional leverage. Additionally, there is limited incentive for banks to provide significant leverage, since it is unlikely to be an efficient use of their balance sheet, given the probable treatment of the collateral," Bradbury observes.

Such trades make sense only when the lenders are burdened with high risk weightings, such as SMEs and corporates rated below the double-B to triple-B range, according to Chenavari Investment Managers partner and senior portfolio manager Hubert Tissier de Mallerais. "A lot depends also on how the bank is risk-weighting the assets," he says. "If a bank is, say, an IRB institution, it is in a better position than one using the standardised approach for most portfolios."

Investors interested in leveraged transactions tend to be sophisticated buy-and-hold players, such as hedge funds, pension funds and insurance firms. "The nature of the trades does not allow them to be actively traded," states York, emphasising the time needed to complete them - six months on average - and the extensive due diligence required.

But new investors are entering the space, including private equity funds. Heuer says: "It's a credit investment and non-banks lenders are getting more interested in all types of credit investments - including reg cap trades - due to diversification, while upcoming changes in regulation mean more deals this year." He points specifically to amendments to the CRR, which could increase risk weightings on retained senior tranches.

SP

CLOs

US CLO arbitrage favours refis

US CLO refinancings began in earnest late last year and have grown apace in 2017, dwarfing new issuance. Extremely tight arbitrage between leveraged loan spreads and CLO liability costs has further constrained primary volumes, suggesting refis will dominate issuance for the foreseeable future.

As of the end of last week, US CLO issuance for the year so far has consisted of 17 new deals totalling US$9.1bn and 55 refinanced deals totalling US$24.7bn, according to JPMorgan figures. Last week alone, there were six new issue CLOs and 10 refis.

Predominantly triple-A, double-A and single-A tranches are being refinanced. Tightening CLO spreads, coupled with the market's growing familiarity with and ability to execute refinancings quickly keeps that option in favour.

The US$24.7bn of refinancings and resets puts 2017 easily on course for a record. The previous annual record for US CLO refis, set only last year, is US$39.7bn. While the sheer weight of refis appears to be playing a role in squeezing out new issuance, new issues also have to grapple with very tight arbitrage, not helped by rapid spread tightening in the loan market.

Christopher Long, president and portfolio manager at Palmer Square Capital Management, notes that "the arb is incredibly challenged right now" and could well be at a post-crisis tight. "The bank loan market is on fire, with an awful lot of capital pouring in over the last 13 weeks, with the result that loan collateral is trading at par or above for the majority of the market," he says.

Long continues: "You could argue that the arb has become too tight. Really, that will depend on individual managers, how they manage their portfolios and how long they will have to manage their portfolios."

There are many different ways managers can manage the situation. Palmer Square, for instance, has taken the opportunity to issue static pool CLOs.

Palmer Square's third static CLO closed in December (see SCI's primary issuance database). Long notes that taking advantage of the firm's static shelf is one way it has been able to make the equity arb considerably easier, because the static CLO model allows for much tighter liability costs.

For the arbitrage to become easier for the broader market, both liability costs need to tighten and loan spreads need to widen. This latter factor is the one that is really holding CLO issuance back, argues Long.

"The single most important variable for the market right now is that loans need to widen. At the moment, there is no obvious driver to make that happen, but the nature of this market is that events can occur unexpectedly that put pressure on pricing and cause widening," he says. "We saw something similar in 2013."

Liability costs are also important, of course. Long believes the triple-A spread for CLO debt has to come in as it remains notably wide against other areas of comparably rated credit.

"Triple-A paper could get back to Libor plus 115bp again, which is how tight it got in early 2013. There are not many alternative options available with such low credit risk and volatility," says Long.

He adds: "There has been an influx of international investors into the US CLO market. Investors are hungry for yield and a lot of these investors - many of them new to US CLOs - are getting comfortable with the market by first dipping their toes in at the senior, triple-A level."

While Long does not rule out loan spreads widening any time soon and actively expects CLO liabilities to continue to tighten, that is not to say that the environment could not change at short notice. What does not appear set to change, however, is the continued slew of refinancings.

"There have been a lot of refis over the last few weeks and that is going to continue for the foreseeable future. Everybody is waiting to see loans widen, but if they are going to stay tight, then refinancings are at least one way of driving returns to CLO equity," Long concludes.

JL

RMBS

MSR transfers under scrutiny

The purchase by non-banks of MSR portfolios from large US banks has ramped up in recent months, as the associated capital charges bite. However, such activity has sparked concern about the ability of the buyers to adequately manage the MSRs and the potential impact on the RMBS market.

Two REITs that have purchased MSR portfolios and increased their involvement in the sector recently are Two Harbors Investment Corporation and New Residential Investment Corporation. The latter last month purchased US$97bn UPB of seasoned agency MSRs from Citi for approximately US$950m.

The former has wound down its mortgage loan conduit and reallocated capital to assets with higher anticipated returns, including MSRs and commercial real estate (SCI 29 July 2016). Bill Roth, Two Harbors' cio, comments: "Owning high quality MSRs was a key element in the stable performance of our portfolio [last] quarter, as it provided an effective hedge against the rise in interest rates and the widening of agency spreads."

The MSR side of the firm's business resulted in an additional US$32bn UPB of MSRs, with a total fair market value of US$693.8m, as at 31 December 2016. As a result, the firm saw net realised and unrealised gains of US$142.7m on MSRs, net of tax.

Ron D'Vari, ceo and founder of NewOak, says that banks are selling off their MSR portfolios because it has become too expensive for them, due to regulatory capital requirements after the implementation of Basel 3 and CCAR. As a result, other firms have moved to take advantage of this dynamic.

"Non-banks have, however, spotted an opportunity and have been quite aggressively buying up the MSR portfolios. Without the same capital requirements involved in holding MSRs as banks, they can service them more profitably," he adds.

Nevertheless, there is uncertainty over the ability of these non-banks to service these large portfolios, previously held by well-established banks with large administrative reach and with the knowledge and expertise behind them to service the portfolios adequately. D'Vari suggests that there could be questions around how well capitalised the non-banks are and also how well regulated. Answers will be provided in time, he says, when interest rates rise along with the cost of advances.

Moody's has also raised concerns about the effect of mass purchasing of MSR portfolios by non-banks. For instance, the rating agency states that New Residential Investment Corporation's purchase of MSRs is credit negative for the subservicer of these loans, Nationstar. It adds that the transaction with Citi - which increases the REIT's servicing portfolio by about a quarter - could stress its operations, due to such rapid growth, and could affect the company's credit quality.

The rating agency notes that RMBS rated by Moody's and serviced by Nationstar should be unaffected, due to only a modest impact on borrower interactions. It adds, however, that Nationstar will have to face the "typical myriad challenges in managing this servicing transfer to ensure that servicing quality does not deteriorate" and that the "size of the portfolio will...create operational complexities, such as capacity and staffing challenges". Larger volumes of customer calls and cash management is another identified risk.

Furthermore, Moody's says that prolonged exposure to the complexities associated with such a large increase in a firm's servicing portfolio could stress processes, controls, management, liquidity and systems' capacity. This could in time lead to operational errors and servicing deficiencies that result in elevated costs, greater regulatory scrutiny and the potential for fines and monitoring.

Ocwen Financial was barred from purchasing further MSRs by the New York Department of Financial Services and California Department of Business Oversight (DBO), although the DBO recently lifted this sanction on acquire mortgage servicing rights associated with California properties (SCI 24 February).

However, D'Vari doesn't believe that there is necessarily an issue of expertise at the non-banks, as they are "very sophisticated". He adds that non-banks are also "potentially better placed than the banks to service the debt, particularly given that for some of them it's their main focus. Banks obviously have much more reach in other sectors and less alignment of interest of management and more bureaucracy."

In terms of the wider impact on the RMBS market due to the MSR sell-off, D'Vari is optimistic, especially with regard to agency RMBS. "With agency RMBS, the risk is really taken on by Fannie and Freddie, which minimises the potential for disruption in the RMBS market. With agency RMBS, you're therefore not so bothered about the servicing aspect - you just know you're getting your coupon. The issue could be the refinancing aspect, but with rising interest rate expectations, that may not be a big factor at this time," he concludes.

RB

ABS

Rare consumer ABS readied

A rare UK consumer loan ABS has hit the market. Creation Consumer Finance's £535.69m LaSer ABS 2017 is backed by 470,321 unsecured personal and point of sale (POS) loans extended to individual borrowers in England and Wales.

The transaction is the first public securitisation from the originator, which is ultimately owned by BNP Paribas Personal Finance. JPMorgan international securitisation analysts note that the deal marks "the continued emergence of a more or less new asset class" in the UK. Prior to last year's MOCA 2016-1 deal from Zopa and Cerberus' TPMF 2016-Granite 3, only one other UK consumer loan ABS was previously distributed to investors (in 2007), according to JPMorgan data.

As of November 2016, the LaSer ABS 2017 portfolio consists of POS loans granted to finance purchases of mostly furniture and electrical goods (accounting for 70.1%) and personal loans granted to finance debt consolidation, car purchases and home improvements. The majority of the POS loans do not pay interest, while the personal loans have a weighted average interest rate of 14%. The average balance of the loans at closing is £1,139.

The portfolio has a weighted average seasoning of 13.3 months, a WA remaining term of 2.49 years and a WA interest rate of 5.30%. In terms of geographic concentration, the North East accounts for 17.81% of the pool, the Midlands 15.66% and the North West 13.63%.

The transaction will be revolving for the first 12 months after the closing date. During this period, the share of personal loans cannot exceed 30% and the minimum interest yield on the portfolio will be 4%.

Provisionally rated by Moody's, the capital structure comprises Aaa rated class A, A1 class B, Baa3 class C and Ba3 class D floating-rate notes. There is also an unrated fixed-rate class E tranche.

Only the senior tranche - which has a 1.8-year WAL, assuming a 2.5% CPR and exercise of the 10% clean-up call - is expected to be publicly placed. Pricing is anticipated next week.

Moody's notes that the transaction benefits from credit strengths, such as the granularity of the portfolio, stable historical performance of POS loans over the 2008-2011 downturn in the UK and the strong market position and experience of the originator. However, the agency also points to some credit weaknesses - including the fact that the level of excess spread may change substantially over the life of the deal, as around 64.5% of the portfolio consists of zero interest contracts.

Further, the portfolio expected mean default rate of 6% and portfolio credit enhancement (PCE) of 21.5% are "slightly worse" than EMEA consumer loan peers on average, according to Moody's. The PCE of 21.5% results in an implied coefficient of variation of 36.4%.

BNP Paribas, Santander, ING, Lloyds and RBS are lead underwriters on the deal.

CS

ABS

Court makes Madden usury ruling

Midland Funding violated New York usury laws by charging interest rates of over 25% to borrowers, the US District Court for the Southern District of New York ruled this week. The decision brings a measure of resolution to the long-running Madden vs Midland case (SCI passim).

The Second Circuit ruled in May 2015 that a non-bank assignee of loans originated by a national bank was not entitled to the federal pre-emption afforded to the bank with respect to claims of usury. That decision brought into question the enforceability of loans in accordance with their terms for non-bank marketplace lenders purchasing loans from an originating bank.

The Second Circuit left it up to the lower court to determine whether New York or Delaware law governed the contractual relationship of the parties. While the account agreement specified that Delaware law was the governing law, under which creditors may charge any interest rate agreed upon by a borrower in a written contract, the district court has now ruled that applying Delaware law would violate New York's criminal usury statute, which limits interest to 25% per year.

Law firm Chapman and Cutler notes that, broadly interpreted, the district court's decision could prevent the enforcement of choice of law provisions in credit agreements against New York consumers when interest rates exceed 25%. This is currently the case for many credit cards and other consumer loans.

"The lower court's holding compounds the uncertainty created by the Second Circuit's decision in Madden by further undermining common law principles that are routinely relied upon by creditors and their assignees. While the Second Circuit's decision undercuts the doctrine that loans are 'valid when made' and do not become invalid when they are assigned to a third party, the district court has now called into question the enforceability of a choice of law provision in a credit contract against New York consumers where the interest rate exceeds the state law usury limits," says Chapman and Cutler.

The firm adds: "However, the court did not directly address what happens when federal pre-emption and state public policy conflict. How similar cases in the Second Circuit (New York, Vermont and Connecticut) will be decided remains to be seen, as Madden has not been adopted specifically by any other court to date."

The district court has also ruled that although New York criminal usury law does not provide a private right of action, Midland Funding's violation of the usury limit could serve as a predicate for Madden's fair debt collection practices act (FDCPA) and state unfair and deceptive acts and practices (UDAP) claims. These have been permitted to proceed on a class basis.

JL

Structured Finance

Proposed retention metric assessed

Risk retention regulations in Europe and the US are severely flawed with respect to their key intention of imposing a strict loss retention requirement, argues a Sustainable Architecture for Finance in Europe (SAFE) white paper published last month. A new risk retention metric (RM) measuring an issuer's level of retention relative to the expected loss of a given securitisation is therefore proposed, but concerns about this metric have been raised.

SAFE Policy White Paper No.46 authors Jan Pieter Krahnen and Christian Wilde argue that the proposed RM metric could help to achieve better implementation of article 405 of the CRR in Europe and section D of the Dodd-Frank Act in the US by making disclosure of the RM-number compulsory for all ABS transactions. They also believe the RM metric "will be instrumental in achieving simplicity and transparency in securitisations".

The white paper presents a modelling technique to derive an estimate of the distribution of default loss expectations across the different tranches of an ABS transaction and uses it to compare the effects of the different retention rules for ABS. The paper concludes that 'true' risk retention varies significantly across the different retention rule specifications and claims "investors simply do not know the actual retention level of a given transaction and the implications for the originator's behaviour".

The lack of retention transparency will necessarily affect the functioning of the market for ABS securities, possibly leading to higher funding costs, lower liquidity and small issue volumes, says the white paper. This would decrease the attractiveness of ABS, making the legal requirement of 5% minimum retention "void as long as the effective level of default risk retention is undisclosed".

Because investors do not know the actual retention level of a transaction, the white paper proposes three policy options. One is to allow only horizontal retention so that issuers are required to have substantial skin-in-the-game and cannot simply select whichever option would provide least exposure, another is to require a given value of retention as defined by the RM retention metric provided an optimal retention level exists and is known, and the other is to impose an ongoing transparency by making RM disclosure compulsory for all ABS.

"The preferences of investors and issuers will decide [between the three options] - and the market can differentiate between retention levels, and will set prices accordingly. This will help to improve market quality, and may eventually increase the attractiveness of ABS as a funding instrument," says the white paper.

Having analysed the effects of different retention modalities on originator banks' capital post-securitisation, Bank of America Merrill Lynch analysts find that "there is no practical evidence that originators are using overwhelmingly the retention modality which affords them the lowest level of capital, nor is there evidence that investors are always demanding the retention modality which imposes on bank originators the highest level of post securitisation capital".

The analysts believe that to realign the interests in each individual transaction a separate transaction-specific retention level is needed under each retention modality. To determine the real realignment of interests in a given securitisation, both qualitative and quantitative aspects of the transaction should be considered.

"That raises the question about what optimal retention is and how to determine it for each securitisation transaction and for each modality. Overall, going down that path creates enormous complexity in the regulatory and implementation process," say the analysts.

The white paper authors propose that RM could be calculated by rating agencies as a model-based exercise during the securitisation issue rating process. While this seems very simple, the BAML analysts believe there are shortcomings and difficulties of implementation that should not be overlooked.

"Firstly, expected loss is a model-generated metric and [only] as good as the assumptions input into the model. Different users will derive different results even from the same model," the analysts note.

"It is ironical that after years of criticising the rating agencies' model shortcomings and attempting to steer regulations away from ratings, the regulators are now advised to adopt a rating agency based metric to determine the 'true' retention. This also goes against the flow of the current BIS efforts to reduce the reliance on internal models."

Secondly, the rating agencies' methodologies are different and could lead to rating shopping. Thirdly, the implementation of a retention metric of significant importance will likely require a regulatory technical standard (RTS) to streamline and standardise how expected loss is calculated for each asset class.

"Fourthly, a pure numerical value of 'true' retention will exclude numerous qualitative aspects associated with type of originator, business model, underwriting and servicing practices, etc. Those considerations do factor in the decision of the originators which retention modality to use and in the investor's assessment of the risks of a given securitisation transaction and its retention modality," say the analysts.

The analysts argue that what ultimately matters to investors is not the retention as a percentage of the model-generated expected loss of a pool but retention as a multiple of its actual loss. The proposed RM "is getting nowhere near" predicting that, with the burden remaining on the investor to determine the potential real-life outcome.

"We caution that calibrating retention on the basis of theoretical models and without reference to given market and deal characteristics, and established practices in loan management and loan securitisation, is likely to lead to distorted regulatory requirements in the same way as in our opinion good-in-theory models without reference to real market data and practices led to miscalibration of securitisation regulatory capital under BIS globally and under Solvency II in Europe," caution the analysts.

They continue: "The BIS 'harmonisation' of securitisation regulatory capital triggered a search for solutions in the form of STC/STS, which in turn sowed even more complications and complexity in the regulations and on the markets. The proposed retention metric, in particular, and the efforts of some to overhaul retention, in general, may be leading the markets down the same path."

JL

Structured Finance

Crossover opportunities touted

Although the investor community tends to remain 'monogamous' with regard to CLO and CMBS exposures, the asset classes can offer returns and opportunities for crossover investors. A new JPMorgan study suggests that while US CLOs are cheap at the top of the stack, CMBS offers value in comparably rated tranches at the triple-B level, but CLO double-Bs offer value for rating insensitive investors.

The US CLO market has seen a record start to the year, with US$30.7bn total gross volume, including refinancings and resets. However, with new issue US CLO volumes totalling only US$7.8bn, this is the second lowest new issue US CLO volume to start a year since 2013. With new paper lacking, CLO liability spreads have tightened by 17bp-123bp across the capital structure year to date.

US CMBS issuance has also been slow, with only US$4.9bn issued so far in 2017 - or 50% of last year's pace - largely due to a rush to issue new deals before the 24 December risk retention deadline. JPMorgan CLO and CMBS analysts note that low issuance and legacy pay-offs have resulted in negative net supply, with 2016's net supply of -US$68bn the largest negative figure they've seen.

Lack of supply and "supportive macro (risk-on) sentiment", the analysts suggest, has led to increased demand and so spread tightening across the capital stack. In CMBS, this has been most significant lower down the capital structure in the triple-B minus bonds, which had previously been wide to alternatives like high yield corporates and CLOs.

The JPMorgan analysts expect this supply/demand technical in both markets to persist through to 2H16 and support new issue spreads. Risk retention also appears to be slowing new issuance in both CLOs and CMBS, which will contribute to spread tightening across both asset classes.

In terms of the investor dynamic, the floating-rate nature of CLOs results in more involvement from bank treasuries than fixed-rate CMBS, while in CMBS pension funds and insurance funds have replaced banks at the top of the stack and replaced specialised real estate investors at the bottom. Investor overlap is seen in asset managers and high yield asset managers in the lower rated tranches of both asset classes.

The analysts note that "secondary market liquidity has been one of the primary challenges" in both markets for a number of years, but add that activity has picked up in the US CLO market since 2011, largely due to increased market size. Triple-A bonds seem to be more liquid due to fewer regulatory burdens, although liquidity in CMBS triple-B bonds continues to be poor, largely due to hedge funds pulling out of the space. In CLOs, BWIC volumes are dominated by triple-As, which have represented 38% of BWIC volumes in 2.0 CLOs since 2012 and 60% of the post-crisis US CLOs market.

The analysts suggest that CMBS triple-B minus bonds remain cheap, due to "a greater embedded liquidity premium", and that as "fast money demand has been diverted, subordinate CMBS clearing prices have naturally gravitated towards hurdles dictated by longer-term investors, such as B-piece buyers, asset managers and private equity funds".

CLO and CMBS also overlap in the area of retail exposure, the JPMorgan analysts note, with investor sentiment regarding retail affecting engagement in both CLOs and CMBS. Retail names comprise more than 25% of CMBS pools since 2011, while in CLOs it is lower, at 6.91% on average.

Notably, however, the exposure to malls in CMBS is typically absent from CLOs - something that possibly concentrates risk in the CMBS space, in the current environment. Furthermore, CMBS investors can "express views" on CMBS investments through the IHS Markit CMBX index, while in CLOs technicals are typically more stable without the volatility a liquid index brings.

Regarding the relative value of each asset class, the analysts suggest that while CMBS triple-A bonds have more duration certainty, the 45bp in spread pick-up for CLO triple-As gives the edge to senior CLO bonds. At the start of 2017, spread compression has continued through CLO triple-Bs/double-Bs and CMBS triple-B minus bonds, with CLO and CMBS triple-Bs moving 45bp tighter and, since the end of 2016, CLO double-Bs tightening by 93bp.

As well as a more "risk on" environment since the start of the year that has led to re-engagement with these products, the cleaner underwriting in 2016 CMBS vintages and the "anticipation of better underwriting under risk retention" has boosted investor demand for lower rated CMBS bonds, according to the JPMorgan analysts. Furthermore, they find that while CLO triple-Bs are at four-year tights, CMBS triple-B minus notes are relatively wide compared to 2013 tights and so they feel that CMBS triple-B minus offer more value than their CLO peers.

This may vary, however, for rating insensitive investors that may favour CLO double-Bs, which offer value relative to CLO triple-Bs and CMBS triple-B minus bonds. The JPMorgan study concludes that significant spread tightening in CMBS could be limited by fast-money investors taking a negative view on retail via CMBX, which could be a point of resistance against sufficient spread tightening.

RB

Structured Finance

Trading expansion underlines optimism

INTL FCStone's broker-dealer rates group has expanded its trading remit into US agency CMBS and a wider spectrum of ABS, following the formation of a new securitised products group. Alongside its existing involvement in other securitised mortgage products, the move signals the firm's optimism about the value structured products will bring in 2017 and beyond.

Rob Laforte, senior md, head of sales at INTL FCStone Financial, says that client demand drove the establishment of the new venture. "The structured products group was to an extent borne out of a growing need for greater specialisation in various fields. We felt like a more in-depth approach was something our clients wanted - so we wanted to narrow down on a smaller range of products and to focus on them more specifically," he comments.

He adds that this industry-wide move towards more in-depth expertise pushed the firm to gain more "colour, insight and depth in the market", which "our clients really appreciate".

Anthony Di Ciollo, senior md, head of securitised trading at INTL FCStone Financial's broker-dealer rates group, says that the firm originally found success in focusing on relative value and in the 10-, 15-, 20- and 30-year mortgage product range in 2012. Since then, it has rolled out the model across other products.

He concurs that client demand has pushed the firm to take a deep dive into certain assets, as opposed to being "generalists" in a range of areas.

Di Ciollo confirms that the group has found relative value in structuring and trading CMOs, MBS pass-throughs, agency ARMs and agency CMBS. The firm also started trading ABS in 2015 in the auto space and - while initially focused solely on triple-A rated paper - has since expanded the operation to all investment grades, including triple-B.

Di Ciollo believes that the firm is well positioned to take advantage of the swelling secondary market in ABS. He notes: "BWICS are plentiful in this space and our secondary trading mandate has made us an attractive counterparty to money managers looking for liquidity in this space."

More generally, Laforte and Di Ciollo feel there are a lot of opportunities to be found in structured products, particularly in the current uncertain economic environment. With rising interest rates, for example, the US Fed could begin reducing its MBS balance sheet and MBS reinvestments - which could leave investors uncertain where to place their money.

In terms of opportunities in other sectors, while the firm is interested in CLOs, it's not getting involved just yet - hoping to find value in a smaller range of assets they're more comfortable in. One area they expect to see more issuance in is agency CMBS.

Di Ciollo comments: "We think we'll see more agency CMBS - there's good net issuance there and think there are opportunities to be had. There has been more than expected, in fact. I think we'll see this uptick continue through this year and into the tail end of next."

Laforte adds that given the tightening in the upper capital stack in agency CMBS, they're likely to look further down the structure to achieve relative value.

Looking ahead, regulatory uncertainty - such as a potential repeal of the Dodd-Frank Act - is something the firm is focusing on, along with GSE reform and the development of a single security platform. Laforte comments that Fannie Mae and Freddie Mac have always hit milestones to date, however ,so proposals such as the single security platform by the end of 2018 is "likely to be hit too."

He adds that the effects of a possible roll-back of Dodd Frank, and risk retention, are hard to predict, but that so far it has had some positives. He says: "Risk retention has had some benefit to investors - it's been well received and, with CMBS, it seems to have got the engine up and running again."

Laforte notes that while volatility is absent from the market at the moment, the future may provide this, particularly around the issue of regulatory reform. He adds that when this happens is a crucial factor for the firm.

He concludes: "While volatility has been missing from the market so far, volatility will likely ensue. A Dodd-Frank roll-back is possible, but really it will be all about timing - that's what will have a major impact."

RB

Structured Finance

Blockchain applications explored

The Chamber of Digital Commerce and SFIG have formed a strategic partnership focused on advancing the use of blockchain technology in securitisation markets. The two associations will collaborate on research and educational efforts, beginning with a white paper that examines how blockchain can play a role at each stage of the securitisation lifecycle.

Prepared by Deloitte and entitled 'Applying blockchain in securitisation: opportunities for reinvention', the white paper outlines five distinct benefits associated with using blockchain in structured products. Not only can blockchain enable a single source of information for all participants in the network, it can also create a complete and immutable audit trail of all transactions, including changes in ownership in the secondary market.

Additionally, the transparency facilitated by blockchain technology could reduce information asymmetry and - through its simultaneous recording of information across the system - virtually eliminate time lags in information and payment flows throughout the securitisation process. Finally, blockchain's capacity to increase the security of transactions and data, as well as mitigate fraud could be appealing to the securitisation industry.

Regarding the securitisation lifecycle, the Deloitte white paper highlights how blockchain can be utilised at each stage of the process. Once the terms of a loan are agreed, a new electronic asset can be created on the blockchain, with ownership information and underwriting data attached. This smart contract governs the automated portions of servicing the loan, with payment history added to the loan-level data over time.

The sponsor/issuer then pools together loans and transfers them to an SPV, which records the transfer and the related loans on the blockchain. The automatable portion of the transaction's terms - including its cashflow model - can be written in a series of smart contracts, which the sponsor/issuer, underwriter, rating agencies and trustees agree to. This consensus creates a single governing model for the transaction, which investors can reference to perform their assessment of the securities.

In addition, portions of the offering and legal documents can also be automatically created with smart contracts. Regulatory compliance is therefore largely automated, as smart contracts are programmed to immediately note any potential irregularities.

A separate smart contract to service the securities is layered on top of the SPV and payments to noteholders made with only minimal delays for settlement. Ratings monitoring software is placed on the blockchain to match the security performance with expected cashflows and to trigger rating reviews when discrepancies arise.

The next step is to construct trading/market information platforms to interoperate with the blockchains used for the transactions and enable market-makers to create robust secondary markets in securitised assets. Large investors could potentially directly trade on these platforms without having to go through broker-dealers.

As the securities are created and traded, beneficiary information is stored and updated in a separate repository, which acts as a custodial entity. Less sensitive data could be made available to all secondary market participants.

With perfect data, lower costs, increased safety and quicker payment streams, Deloitte suggests that trading volume could rise, prices improve and the growth in safe and stable securitisation increase the supply and lower the cost of credit to the broader economy. The firm notes that one potential approach towards adopting blockchain technology is to start with a few institutions in a small slice of the securitisation lifecycle.

An early blockchain, for example, might connect a few originators and issuers that already have strong relationships. Once proven successful, this blockchain could open to other upstream participants and then eventually expand downstream too.

However, for such an approach to function, designers would have to create a blockchain ready for interoperability and scale. If cross-industry data standards are created, it would also be possible for different asset classes and industry segments to simultaneously develop their own blockchains, which are both tailored to their own needs and interoperable.

Another possible approach would be for one of the financial industry consortiums working on blockchain to offer a proof-of-concept blockchain for securitisation, which industry participants would be free to test. This approach could be relatively cost-efficient, according to Deloitte, since it would permit companies to perform a cost/benefit analysis and take a gradual approach towards one of the costliest elements of a transition to blockchain - the need to reorganise their own talent pools and IT landscapes.

Yet another possibility would be to leverage existing blockchain technology for limited use cases. For example, a blockchain with the capacity to create an immutable audit trail could be used for certain kinds of record-keeping.

An approach with greater potential might be to start by focusing only on non-sensitive data. The industry or a vendor could develop a blockchain custom-made for securitisation, which at a later stage could be expanded to cover first more sensitive data and then transactions.

CS

Structured Finance

SCI Start the Week - 27 February

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

Pipeline
Additions to the pipeline last week were fairly steady compared to the week before, as the industry now decamps to Las Vegas. There were five ABS, two ILS, three RMBS and three CMBS.

US$213.137m Arcadia Receivables Trust 2017-1, Driver UK Multi-Compartment Comp Driver UK Five, LaSer ABS 2017, CNY4bn Rongteng 2017-1 and US$704.21m World Omni Automobile Lease Securitization Trust 2017-A were the ABS. The ILS were US$125m Buffalo Re Series 2017-1 and US$125m Citrus Re Series 2017-1.

Bluestep 4, Galton Funding Mortgage Trust 2017-1 and La Trobe Financial Capital Markets Trust 2017-1 were the RMBS. The CMBS consisted of £215m Student Finance, US$348m VSD 2017-PLT1 and US$635m WFCMT 2017-RC1.

Pricings
Completed issuance was also strong. There were six ABS prints, six RMBS, two CMBS and nine CLOs.

The ABS were: US$209m American Credit Acceptance Receivables Trust 2017-1; US$1.35bn Ford Credit Auto Owner Trust 2017-REV1; US$350m Hilton Grand Vacations Trust 2017-A; US$758.64m John Deere Owner Trust 2017-A; US$1.023bn Santander Drive Auto Receivables Trust 2017-1; and US$375m TGIF 2017-1.

The RMBS were: A$1.25bn Apollo Series Trust 2017-1; £442m Finsbury Square 2017-1; €407.1m Grecale 2015 (re-offer); €4.115bn Lowland Mortgage Backed 4; US$1bn JPMMT 2017-1; and £229m Stanlington 1.

US$750m BBCMS Mortgage Trust 2017-C1 and US$1.4bn FREMF 2017-K62 were the CMBS. The CLOs were: US$611.37m Grippen Park CLO 2017-1; US$332.1m JMP Credit Advisors CLO 2014-1R; US$608.5m KKR Financial CLO 2017-17; US$334.4m KVK CLO 2013-2R; US$412m Mountain View CLO 2014-1R; US$541.8m Northwoods Capital 2014-12R; US$433.2m OHA Loan Funding 2013-1R; US$418.75m OZLM Funding 2013-5R; and US$510m Shackleton CLO 2017-X.

Editor's picks
UK government to securitise student loan book: The UK government is looking to raise £12bn through the structuring and sale of a series of ABS backed by student loans. Its first offering - Income Contingent Student Loans 1 (2002-2006) - securitises a £4.1bn portfolio, but it is not clear whether the paper will appeal to the traditional ABS investor base...
Slow start to year 'not concerning' for Euro ABS: The European securitisation market started the year with its traditional quiet January, but issuance has picked up through February and there are large, innovative deals on the horizon. However, the future of the ECB's ABSPP already appears to be weighing on the market...
Risk transfer benchmark introduced: PCS has launched the first risk transfer quality label for synthetic risk transfer deals. One of the aims of the label is to help incorporate synthetic securitisations into a future STS regulatory framework through criteria that identify key elements of a simple, transparent and standardised instrument...
Deploying capital: Chris Redmond, global head of credit at Willis Towers Watson, answers SCI's profile questions...
Warm investor response for debut turboprop ABS: Elix Capital has closed its debut securitisation of turpoprop aircraft at a time when investors are craving such assets to diversify their investment strategies. Dubbed Prop 2017-1, the US$411m deal is the first-ever aviation ABS backed entirely by turboprop airplanes...
Ratings expansion outlined: KBRA has named Jim Nadler ceo, with co-founder Jules Kroll stepping down from the position. The move coincides with the rating agency's plans to expand into rating European securitisations and CLOs...

Deal news
• GMRF Mortgage Acquisition Company is in the market with its first ever RMBS (see SCI's pipeline), funded by Mariner Investment Group. Galton Funding Mortgage Trust 2017-1 (GFMT 2017-1) is backed by 363 prime quality, mainly 30-year residential mortgages with total unpaid balance of US$254.5m, but Moody's warns that collateral is weak compared to recent prime deals.
• An innovative liquidation vehicle backed mainly by commercial real estate loans is marketing. Dubbed VSD 2017-PLT1, the securitisation has an aggregate unpaid principal balance of US$378.1m and monetises recoveries from performing, non-performing and REO assets to pay the notes.
• Of the 15 US CMBS loans exposed to MC Sports, there are six which stand to be particularly affected by the company's bankruptcy filing last week, says Morningstar Credit Ratings. The largest loan of concern is the US$17.2m Wilsontown Shopping Center loan securitised in JPMBB 2013-C17.
• Kabbage is marketing its first marketplace loan ABS of the year and its second since inception. Meanwhile, SoFi is in the market with its second consumer loan ABS - SoFi Consumer Loan Program 2017-2 - backed by US$343m of consumer loans and comprising several elements that differ from its previous securitisation.
• Brookfield Asset Management affiliate GL Europe RE Holdings is prepping a £215m single-tranche UK CMBS. Dubbed Student Finance, the transaction is backed by a single loan secured by 13 student accommodation buildings located in England and Wales.

Regulatory update
• Two European CLOs have priced since the US risk retention rules came into effect on 24 December (excluding refinancings) and both are structured to enable the manager to satisfy both European and US risk retention requirements. Several deals structured before the risk retention deadline and some refinanced deals priced recently have also been dual compliant.

Capital Relief Trades

Risk transfer round-up - 3 March

Intesa Sanpaolo Group has completed a €2.5bn synthetic SME securitisation through its GARC SPV, marking the programme's fifth issuance. The transaction was arranged by Banca IMI.

Sources expect more Italian issuers to tap the risk transfer market over the next nine months. They indicate that the market is likely to be dominated by "the usual suspects", including Intesa Sanpaolo and UniCredit.

Meanwhile, Deutsche Bank's new CRAFT CLO is said to have entered the investor due diligence phase and is expected to close in 2Q17.

CMBS

CMBX mall exposures stressed

A new Morgan Stanley study applies stress scenarios to mall exposures across the IHS Markit CMBX.6 to CMBX.10 indices in order to identify relative value. The results suggest that CMBX.8 is the best index to short, given a broader downturn in commercial real estate.

The Morgan Stanley study identifies 168 malls encumbered by a total of US$12.1bn of CMBS debt that are referenced across CMBX.6 to CMBX.10. Exposure ranges from a high of 46 mall loans in CMBX.6 to a low of 16 mall loans in CMBX.9. The stress scenarios involve defaulting every non-defeased mall with sales of less than US$400 per square-foot at losses ranging from 20% to 80%.

Base case losses for CMBX.10 are 2.80%, while the bear case is 5.61% and the bull case is 1.01%. By comparison, base case losses across the CMBX indices range from a minimum of 2.54% for CMBX.6 to a maximum of 4.93% for CMBX.8. Bear case losses range from a minimum of 5.47% for CMBX.6 to 9.64% for CMBX.8 and bull case losses range from 0.84% for CMBX.6 to 1.89% for CMBX.8.

Morgan Stanley CMBS strategists do not project any CMBX.6 tranche losses under their base case loss projections, but they increase substantially when mall loans are stressed. For instance, BBB-.6 takes a loss that is at least two times greater than any other triple-B minus tranche under the 80% mall loss scenario.

For investors that believe timing of default will be more back end-loaded, the strategists recommend moving higher in the CMBX.6 capital structure. "We don't see a scenario where BB.6 takes a significant loss without losses also rising as high as the AA.6 tranche in a 80% mall loss scenario, which we don't think is priced in. By comparison, we think a BB.6 short is predicated on losses occurring over the near term."

While base case cumulative losses result in a 13% write-down to BB.8 and an 18bp write-down to BBB-.8, losses rise to 92% and 32% respectively in the bear case. When mall loans are stressed, BB.8 base case write-downs rise to 47%, 15% for BBB-.8 and 67bp for A.8.

The strategists indicate that CMBX.8 is a better macro short for several reasons: the overall credit quality in CMBX.6 is superior to CMBX.8; CMBX.8 does not benefit from the same appreciation in CRE valuations since 2012 as CMBX.6 does; and the properties referenced in CMBX.8 are lower quality, but the idiosyncratic story is yet to play out in the same way as it has done in CMBX.6.

The study also shows that BB.10 loss projections accelerate as mall severity assumptions rise, with a projected write-down of 21%, assuming an 80% loss scenario - which is similar to the 22% projected for CMBX.7 under the same scenario. A 6% write-down is projected for BBB-.10, which is similar to the 7% write-down projected for BBB-.9.

BB.9 has the lowest projected losses across every mall default scenario, ranging from a minimum of 3.93% to a maximum of 13.36%, according to the study. This is because the index only has exposure to 16 mall loans, of which only three have sales of less than US$400 per square-foot.

CMBX.6 has hit the headlines in recent weeks because it references more mall loans (46) than the other indices - 27 of which produce sales of less than US$400 per square-foot. However, the strategists point out that CMBX.8 has the second-greatest number of loans that meet their default criteria, despite referencing only 24 malls loans overall. By comparison, CMBX.7 references the greatest number of mall loans overall at 48, but the study only stresses 12 of them.

BB.6 and BBB-.6 spreads have declined by 12 and nine points respectively since the end of January. Double-B and triple-B minus tranches across CMBX.7 to CMBX.10 have moved an average of six points lower over the same period.

CS

CMBS

Closures to increase CMBS strain

The effect of the expected closure of Macy's and Sears stores has already been anticipated by the CMBS market (SCI 6 January), but JC Penney's announcement that it too will close 130-140 stores has added considerably to concerns. A significant number of CMBS loans are exposed to all three retailers.

JC Penney returned to profitability last year for the first time in six years, but is cutting up to 13.7% of its store portfolio regardless as it streamlines operations. The full list of closures will be released this month, with operations at the individual locations set to cease by the end of June.

As well as the stores JC Penney is closing, Macy's has previously announced 100 store closures and Sears has declared that it will close 150, including 108 Kmart locations. In all, the three retailers will be closing as many as 390 stores, which Kroll Bond Rating Agency notes "could have debilitating consequences for retail landlords nationwide".

Regional malls with all three stores present are at the greatest risk of performance declines and market devaluation, reasons the rating agency. "The loss of just a single anchor can provide the stimulus needed for in-line tenants to demand lower rents or vacate through co-tenancy triggers, ultimately reducing operating cash flows. The loss of multiple anchors can be especially traumatic and influence a borrower to walk away from its asset entirely," Kroll says.

Kroll has identified 99 loans, across 128 CMBS deals, totalling US$14.53bn secured by collateral with exposure to all three department stores. The largest of these is the US$1.2bn Aventura Mall loan which is the only loan securitised in AVMT 2013-AVM.

The rating agency has also identified 110 loans, across 144 deals, totalling US$15bn with exposure to two anchors out of the trio of Sears Holdings, Macy's and JC Penney. The largest of these is the US$1.4bn Mall of America loan collateralising CSMC 2014-USA, which is exposed to Sears and Macy's, but not JC Penney.

Other significant loans from the first group, with exposure to all three stores, include the US$760m Starwood Mall Portfolio in SCGT 2013-SRP1 and the US$343.851m Alderwood Mall which backs MSCCG 2015-ALDR, MSC 2015-MS1, GSMS 2015-GC32 and also CGCMT 2015-P1.

Of the 20 largest CMBS loans with retail exposure to Sears, Macy's and JC Penney, only one is collateralised in a pre-crisis CMBS. That is the US$240m Westfield Centro Portfolio in JPMCC 2006-LDP7.

The other CMBS to be backed by one of these 20 largest loans exposed to all three retailers are: BBCMS 2015-VFM; BBUBS 2012-TFT; CGCMT 2014-GC21; COMM 2012-C4; COMM 2012-CR1; COMM 2012-CR3; COMM 2012-CR²; COMM 2012-CR5; COMM 2013-GAM; CSAIL 2015-C1 ;CSAIL 2015-C2; CSAIL 2015-C3; DBUBS 2011-LC2A; GSMC 2014-GC22; GSMS 2013-PEMB; JPMCC 2011-C3; JPMCC 2012-WLDN; MSC 2015-XLF2; UBSBB 2013-C5; UBSBM 2012-WRM; WFCM 2014-LC16; WFRBS 2012-C7; WFRBS 2012-C8; and WFRBS 2014-C20.

Other significant loans from the second group, with exposure to two anchors between the three retailers, include the US$885m DDR Southeast Pool securitised in CGCMT 2007-C6, COMM 2007-C9 and WBCMT 2007-C32 and the US$725m Starwood Mall Portfolio loan used for SRPT 2014-STAR.

The rest of the 20 largest CMBS loans with retail exposure to two anchors out of the three retailers are securitised in: BAMLL 2013-WBRK; CFCRE 2016-C6; JPMCC 2007-CB20; JPMCC 2014-DSTY; JPMDB 2016-C2; JPMDB 2016-C4; MSBAM 2016-C28; MSBAM 2016-C29; MSC 2016-PSQ; MSC 2012-STAR; PCT 2016-PLSD; QCMT 2013-QC; RBSCF 2013-GSP; UBSBB 2013-C5; UBSBB 2013-C6; WFCM 2016-C36; WFLD 2014-MONT; and WFRBS 2013-C18.

JL

CMBS

Horizontal retention CMBS debuts

JPMorgan is prepping an innovative US$1.1bn conduit CMBS collateralised by 43 commercial mortgage loans secured by 59 properties. Dubbed JPMCC 2017-JP5, the deal is the first conduit CMBS to utilise the horizontal structure to satisfy risk retention requirements.

The retaining sponsor will satisfy risk retention requirements by purchasing an eligible horizontal residual interest through its majority-owned affiliate. Starwood Mortgage Funding (SMF VI) has been designated to act as the risk retaining sponsor and its majority owned affiliate, LNR Securities Holdings, is expected to purchase the class DRR, ERR, FRR and NRRR certificates on the closing date, representing 5% of the fair value of the transaction based on GAAP.

Provisionally rated by KBRA and Moody's, the capital structure comprises 18 classes of certificates, with 14 entitled to principal and interest, three receiving interest only and one class residual interest. Both rating agencies note that the deal is supported by the trust component of the pool's largest loan to Hilton Hawaiian Village.

The asset accounts for 7.3% of the collateral and has credit characteristics consistent with a BBB+/Aa3 rating when analysed on a standalone basis. The loan is secured by a 2,860-key full-service hotel on Waikiki Beach in Honolulu, Hawaii.

The properties are located in 22 states, with the highest property type being office at 38.1%, followed by retail (9.3%) and lodging (17.5%). The five largest states account for 63.4% of the pool: California represents the largest state concentration at 20.3%, with Texas, Hawaii, Florida and Georgia accounting for 16.5%, 11%, 8.6% and 7% of the collateral pool respectively.

The loans have principal balances ranging from US$2.8m to US$80m for the largest loan in the pool (Hilton Hawaiian Village). The top five loans are secured by the Moffett Gateway, Dallas Design District, Fresno Fashion Fair Mall and Riverway properties, which comprise respectively 7.3%, 6.9%, 6.3% and 5.9% (or 33.7% in total) of the initial pool balance. The top ten loans represent 56.6% of the loan pool.

Most (21, or 39.2%) of the loan types are amortising balloon, while the rest are full term IO (7 loans, or 28.2%), partial term IO (15 loans, or 32.6%), existing additional debt (three loans, or 18.3%) and future additional debt provisions (eight loans, or 22.3%).

Other transactional strengths, according to Moody's, include general high real estate quality, low small market share, asset class composition, with over 30% of the loan pool collateralised by "less volatile" property types and cash management. Four of the loans, comprising 29% of the loan pool, have hard lockboxes in place at closing.

The agency identifies a number of credit weaknesses, including high Moody's LTV ratio of the pool, low diversity, lack of amortisation, supply/demand imbalance, single tenancy of four properties and cross-collateralisation. It also notes that there are several missing legal protections at loan level, which it considers to be worse than credit neutral.

Such missing legal protections include lack of warm-body guarantors on 10 loans, lack of non-consolidation opinions on 25 loans and 25 of the loans are structured by non-Delaware borrowing entities - which impacts heavily on the bankruptcy-remoteness of a borrower. Additionally, 21 loans have borrowing entities that are structured as a recycled SPE, exposing the assets to risks associated with the prior borrower's history and possible liabilities.

The main parties involved in the transaction are JPMorgan (which sold 84.6% of the loans) and Starwood Mortgage Funding (15.4%). The master servicer is Midland Loan Services and the special servicer is LNR Partners. The trustee is Wells Fargo.

RB

NPLs

German shipping loss provisions on the rise

Loss provisions against non-performing shipping loans by German banks are on the rise, due to the slowdown in the shipping industry. At the same time, a number of large German lenders are seeking to reduce their exposure to the sector.

Commerzbank and Deutsche Bank last month announced increased loan loss provisions for shipping to €900m and €346m respectively in 2016 from €696m and €124m the previous year. In December, HSH Portfolio Management disclosed that it had provisioned €341m for a €5bn portfolio acquired in June 2016 from HSH Nordbank for €2.4bn, translating into an overall pro forma coverage ratio of nearly 60%.

Several large German banks, including HSH and NordLB, aim to significantly reduce their exposures to shipping lending. However, given the difficulties facing the sector, Moody's suggests banks will have to raise loan loss provisions, which will in turn dampen their ability to reduce exposures.

German banks were among the biggest lenders to the shipping industry pre-financial crisis. But oversupply in the container market, depressed global shipping freight rates and industry concentration are challenging smaller shipping companies' operating cashflow and debt servicing capacity, reducing the value of the collateral pledged against shipping loans. According to Moody's, the combined shipping exposure for the German banking sector stood at €81bn at end-2015, representing nearly a quarter of global shipping debt.

The five largest ship-lenders - Bremer LB, DVB Bank, HSH Nordbank, KfW and NordLB - had a €64bn exposure at end-2015, a reduction of only 1% from their exposure in 2012. The shipping exposures of these five banks accounted for 350% of their Tier 1 capital at the end of 2015.

In a recent report, Moody's illustrates how shipping exposures and NPL coverage ratios as a multiple of Tier 1 capital differ from lender to lender. Commerzbank's 64% non-performing loan coverage ratio compares with 57% for HSH Nordbank and 44% for Nord LB. Commerzbank has the lowest Tier 1 capital multiples at 0.3x, compared with DVB Bank's 13.9x.

The largest German shipping NPL disposal to date was NordLB's sale of a €1.2bn loan book to KKR (SCI 10 November 2016). The deal was structured as a securitisation.

However, shipping loan disposals - especially in the form of securitisations - remain rare. According to Basil Karatzas, ceo at Karatzas Marine Advisors & Co: "Securitisation is not involved in the shipping NPL market, due to the lack of cashflows and all-time lows in the industry. The gap between the bid and ask is the biggest challenge, forcing lenders to accept sharp write-downs."

He continues: "Investors are typically opportunistic funds that want to invest in something where the price is such that you cannot go wrong and therefore have nothing to lose."

Adequate individual provisioning levels depend on several factors, including the type and purpose of ships. Moody's notes that offshore, container and bulker ships typically attract higher provisioning, while cruise ships do not. Also notable is that compared with the ship finance portfolios of Asian banks, German bank exposures appear to be more mature and thus on average appear to contain less efficient ships.

The agency has a negative outlook on the global shipping industry, as it expects vessel supply to exceed demand across all segments, particularly container shipping. "Low freight rates in the bulker segment and a subdued outlook for the tanker segment amid significant supply growth will challenge lenders focused on the sector," it concludes.

SP

NPLs

Carige NPL strategy unveiled

The Banca Carige board of directors yesterday unanimously approved an updated strategic plan, under which the bank is targeting an ROE of 7.4% and CET1 ratio of 14.1% by 2020. A critical part of the plan is to reduce the share of non-performing loans on its books to 13.1%, in line with the ECB's target, which the bank hopes to achieve through a €950m securitisation (SCI passim) and by spinning off its bad loan portfolio to a management vehicle.

Carige had €3.726bn bad loans on its books at end-2016, representing a gross NPL ratio of 34%. The strategic plan envisages that €2.4bn of these loans will be spun off this year, which - taking into account the securitisation - will leave €376m of NPLs remaining in the bank's portfolio by year-end (or an 18% NPL ratio).

Loans separately classed as 'unlikely to pay' and 'past due' totalled €3.487bn and €120m respectively at end-2016. The aim is to reduce the former to €2.511bn by year-end by segregating credit origination from NPL management.

The securitisation is anticipated imminently and will take advantage of the GACS guarantee. Meanwhile, the spin-off of the bad loan portfolio is designed to allow any upside from maximising recoveries on the bad loans to be retained by Carige shareholders. The management vehicle's debt may be placed in the market or the vehicle could potentially be opened to third-party investors.

A new independent unit dedicated to the management of the NPLs not transferred to the management vehicle will be established, with a view to minimising the impairment of performing loans and increasing the cure rate of non-performing loans. The unit, which is expected to comprise 70-90 employees, will report directly to the ceo and is tasked with developing new recovery strategies for the assets.

Additionally, the strategic plan includes a capital increase of up to €450m, possibly in combination with a liability management exercise. This is designed to support the spin-off project without incurring value dispersion.

CS

RMBS

First ratings for AOMT non-prime RMBS

Angel Oak is in the market with its first rated non-prime RMBS (see SCI's pipeline). As with the issuer's previous unrated deals, the collateral combines loans to borrowers with prior credit events and self-employed borrowers who use bank statements to verify their income.

The US$140m Angel Oak Mortgage Trust I 2017-1 RMBS has been rated by both Fitch and DBRS. The US$78.141m class A1 certificates have been rated triple-A by both rating agencies, while the A2 notes have been rated double-A by Fitch and double-A (low) by DBRS.

Fitch and DBRS provisionally rate the A3s at single-A and single-A (low), the M1s at triple-B and triple-B (low), the B1s at double-B and double-B (low), and the B2s at single-B and single-B (low), respectively. Neither rating agency has rated the B3 notes.

The transaction is collateralised with 79% non-qualified mortgages (non-QM) as defined by the ability-to-repay (ATR) rule, while 5% are higher-priced QMs and the rest is comprised of business purpose loans not subject to ATR, so none of the loan are designated as QM Safe Harbor. Roughly 29% of the pool's borrowers have prior credit events and around 22% are loans to self-employed borrowers underwritten to a 24-month bank statement programme.

Fitch notes that the Angel Oak deal is the fourth RMBS issued since the crisis that the rating agency has rated which consists primarily of newly-originated, non-prime mortgage loans. It says: "Fitch is taking a cautious approach towards this developing sector as many of the entrants have limited operating histories and performance track records."

This has made Fitch reluctant to give triple-A ratings to such transactions, so the triple-A rating assigned to the senior notes reflects a satisfactory operational review of the originators, 100% loan-level due diligence review with no material findings, a Tier 2 representation and warranty framework and also the transaction's structure. Angel Oak Real Estate Investment Trust I or a majority-owned affiliate will retain a vertical and horizontal interest in the transaction equal to at least 5% of the aggregate fair value market of all the certificates in the transaction.

JL

Structured Finance

Job swaps round-up - 3 March

Europe
DBRS has hired Keith Gorman to the newly created position of svp, global business development. Based in London, Gorman will focus on growing DBRS's RMBS business across Europe. He has been at DBRS for seven years and has 17 years of experience in global structured finance.

KBRA has appointed Stephen Kemmy as director of its European structured finance group, based in Dublin. He was previously a director at Fitch, London.

Winston & Strawn has hired Angus Duncan as a partner at its London office. Duncan, who was previously at Cadwalader, is the second partner to join Winston's expanding corporate department in London within the past month.

Acquisitions
Investcorp has finalised its acquisition of 3i's debt management business. The business will now be recognised as Investcorp Credit Management and adds US$11bn of AUM, bringing the total to approximately US$21.4bn. Jeremy Ghose will continue to head the Investcorp Credit Management business.

Technology
Novus and Cheyne Capital Management have entered into a partnership to build an innovative fixed income analytics platform for both allocators and managers within the investment community.

PeerIQ has partnered with Data1010, enabling whole loan and ABS buyers to access PeerIQ's MPL data through the Data1010 platform. It has also made several new hires, including Jason Sullivan. He joins as a software engineer and was previously a quantitative trader at FNY Capital and before that was at Rialto Capital, where he analysed and traded high-yield CMBS.

Moody's Analytics has integrated Solve Advisors' SolveQuotes technology into its structured finance portal. The integration of SolveQuotes enables users of the portal to monitor BWICS and provides market color on structured securities.