Contents

Structured Finance

SFR strategy raises RMBS questions

American Homes for Rent (AH4R) announced this week an additional public equity offering, expecting to raise over US$250m, in the latest sign that single-family rental (SFR) companies are significantly changing their funding and operations. SFR securitisation performance has been strong, yet the market opportunity may be dwindling just as it proves its value.

"The SFR subsector remains small compared to other RMBS subsectors, but it is an interesting way to benefit from the thematic trend of home price appreciation. The danger, however, is that the opportunity in SFR may have already largely played out," says Sam Dunlap, senior portfolio manager at Angel Oak Capital.

AH4R is understood to be planning to use net proceeds from its public equity offering and a US$50m private placement to repay in full its first SFR securitisation, AH4R 2014-SFR1. The deal's current balance is US$456m and it is expected to be fully repaid by 7 April, ahead of its scheduled maturity in June.

Wells Fargo structured products analysts note that the funding cost of AH4R 2014-SFR1 is the lowest of all floating rate SFR deals, with a weighted average spread of 153bp. The deal has realised around 27% in home price appreciation, and recognising those gains could be part of the motivation for paying it off.

Meanwhile, Invitation Homes is using a US$1bn loan from Fannie Mae and Wells Fargo (SCI 31 January) to fully pay down Invitation Homes 2014-SFR1, as well as US$275m of Invitation Homes 2014-SFR². The loan will be funded through the issuance of securities, which will carry a Fannie Mae guarantee and be backed by a pool of rental properties owned by Invitation Homes.

Fannie Mae's move into the SFR market caught many participants off guard. However, as SFR companies realign their businesses, the GSE may be called upon increasingly more.

"The larger SFR players are more likely to look for more efficient forms of financing and are less likely to turn to securitisation, so this agency development is no big secret. It looks a lot like Invitation Homes might be ahead of the curve in getting this agency financing done, and that could actually be bad news for SFR RMBS issuance," says Dunlap.

Invitation Homes is also understood to be planning an IPO, the proceeds from which could be put towards restructuring or calling its other securitisations. As private companies such as Invitation Homes and AH4R pull away from securitisation, Fannie Mae's involvement has drawn criticism.

The Community Home Lenders Association (CHLA), for one, wrote to FHFA director Mel Watt two weeks ago expressing concerns about the US$1bn loan to Invitation Homes, asking questions "about this transaction with regard to its consistency with mission, its risk, its impact on communities and consumers, and its lack of transparency". The National Association of Realtors has also been a vocal critic.

The CHLA's criticisms primarily concern whether it is appropriate for Fannie Mae to move away from traditional financing of small investor-owned properties to a US$1bn refinancing of scattered site SFRs, adding risk to the taxpayer and impacting rental affordability. There are also specific RMBS concerns, however, such as whether this move will squeeze out bond-hungry investors. Fannie Mae's core mission to bolster home ownership is perhaps not best served by propping up the larger SFR firms, the critics suggest.

This has not prevented Freddie Mac from reportedly considering backing loans that finance SFR homes. Although the GSE has not commented officially, it was looking at SFR as long ago as 2012. Back then, it was blocked by the FHFA on the grounds that banks would be forced out of the market.

The arrival of the GSEs into the SFR sector comes at a time when outstanding SFR RMBS are either performing as expected or being upgraded. Kroll Bond Rating Agency upgraded its ratings on five classes of Invitation Homes 2014-SFR1 earlier this month and then placed three of those same classes - the D, E and F notes - on watch upgrade again less than two weeks later, as the transaction continues to pay down rapidly.

With SFR securitisation prepayments gathering pace, the opportunity in the sector appears to be dwindling. However, Dunlap notes that SFR is far from the only way to capitalise on the macro trends that have made this RMBS subsector so attractive.

"What SFR has done for bond investors is provide good credit exposure to an asset class with improving fundamentals," he concludes. "At Angel Oak, we still favour legacy RMBS, because you can get those same improving fundamentals and benefit from significant appreciation. It is a much larger market, with a lot of opportunity to benefit from home price appreciation and falling delinquencies. There is even a slow credit expansion."

JL

ABS

Canadian banks eye credit card appetite

Canadian banks are capitalising on strong demand for US dollar-denominated credit card ABS. The sector has seen a resurgence in recent months, with deals being upsized and performance remaining sound.

Last year was a record year for Canadian credit card ABS volumes and the pace seems set to continue in 2017, with two cross-border issuances so far this year, including the first US$1bn-plus Canadian credit card transaction (Golden Credit Card Trust Series 2017-1) (see SCI's new issue database). Indeed, credit card notes continue to dominate the overall Canadian securitisation market, accounting for 35.5% of the total outstanding at end-4Q16, according to DBRS figures.

One of the drivers behind the trend is Canadian banks realising better value by issuing in US dollars. Joseph Lau, md of Lord Capital, says that lack of a broad ABS investor base in Canada also plays a role, with only around 20 large domestic investors.

Lau adds that aside from the current economic benefit of issuing in US dollars, US investors are drawn by the quality of Canadian borrowers. "Canadian issuers looked at the US market and saw a strong investor appetite for Canadian credit card ABS. US investors are impressed by Canadian consumers and they have great credit profiles," he says.

DBRS notes that Canadian credit card receivables continue to perform well, with losses decreasing from 3Q16 to 4Q16 to an annualised loss rate of 3.16% - down 10bp from the previous quarter. The rating agency confirms that this is helping to whet investor appetite.

"The use of securitisation by the chartered banks to fund credit card receivables remains high, with the excellent credit quality in Canadian credit card portfolios driving foreign investors' demand," the agency says.

Additionally, lack of credit card ABS issuance elsewhere is driving interest in Canadian transactions, according to Lau. He says: "Investors now have a strong perception of the Canadian consumer. By contrast, cross-border ABS issuance globally has remained limited - particularly for credit cards in other jurisdictions."

He continues: "The UK had a vibrant credit card ABS market before the 2007 crisis. This was one of the major markets for cross-border issuance, where investors were seeking diversification, but that has really dropped off and very little ABS issuance comes from that market today. Many US investors still want diversification and Canadian credit card ABS can offer this."

The beneficial economics for Canadian issuers is set to continue, assuming there is no sudden drop in Canadian consumer credit quality. Lau notes, however, that a major concern for investors is around yield.

He says: "The main issue for investors is not enough spread. Credit card ABS has typically been viewed as a cash proxy. But even so, with spreads tight, there is a consistent complaint spreads are not wide enough."

The senior notes from the last three floating-rate US dollar-denominated credit card issuances have priced in the one-month Libor plus 40bp-45bp range. The fixed rate senior tranche of BA Credit Card Trust 2017-1 yesterday printed at swaps plus 18bp, compared to the plus 23bp achieved by American Express last month.

The sector has seen a resurgence in recent months, with 12 deals totalling over US$13bn pricing since the beginning of the year, according to S&P estimates. Also this week, COMET issued US$3bn of ABS across three series of notes - just under half of Amex's issuance last month across two series.

Moody's notes that overall US credit card ABS is performing well across several metrics, with charge-off rates remaining at historical lows and principal payment rates likely to increase marginally, bolstered by continued improvement in the US job market and GDP. The rating agency expects issuance to be further boosted by refinancing of maturing securitisations.

RB

CLOs

US CLOs solid

The US CLO secondary market remains solid as momentum rebuilds following last week's interrupted activity.

"It's still not incredibly busy, but it's an interesting market and bonds are trading," says one trader. "There are no truly big buyers right now, though there aren't any major concerns about fundamentals."

Mezz remains the most active part of the stack, but price moves have slowed to an extent, the trader suggests. "Mezz looks to be taking a little bit of a breather with fast money trying to capitalise on year to date returns, while buyers are focusing on opportunities around non-call or one year to call bonds."

At the bottom of the stack it is still relatively hard going. "Equity is still a difficult trade especially with the loss of excess spread," the trader says. "So you have guys sitting on positions to avoid realised losses for now. However, there is still some equity buying interest around 2013-14 paper, which is more appealing because you can refi those deals."

There are eight BWICs on today's US CLO calendar so far. The chunkiest of those remaining is a pair of double-As due at 14:00 New York time - $13m LCM 23A A2 and $15m OHALF 2012-1A B1R.

Neither bond has covered on PriceABS before.

Secondary markets

Euro CLOs mixed

Tone and spreads remain strong in the European CLO secondary market, but activity levels are still down.

"It's a weird market at the moment - it feels quiet, but we are still trading," says one trader. "Clip sizes have gone up so volumes are growing, but the number of trades has gone down. At the same time, a large chunk of trading seems to be with the Street and some investors from parts of continental Europe look to have been drawn away from CLOs by current sovereign spread levels."

The trader continues: "Overall, it remains difficult to source paper and BWIC volume is light. However, triple-A flows are strong, we are still trading quite a lot of 1.0s and 2.0s are at new tights."

Mezz remains a key area of interest, but there too activity is mixed. "A lot of triple-Bs are trading above par now, while single- and double-Bs are much harder to come by as people hang on to them," the trader says.

There are currently two BWICs on today's European CLO BWIC calendar. The chunkiest of which is a three line €10m list due at 13:30 London time.

It comprises: ARESE 8X F, BLACK 2015-1X E and DRYD 2016-46X SUB. None of the bonds has covered on PriceABS in the past three months.

Secondary markets

US ABS holds on

Despite a boom in supply US ABS secondary spreads are holding on.

After a quiet week last week, the pricing of the sizeable latest COMET deal and the ever-growing US ABS pipeline combined to give the secondary market a rocky start to the week. Hefty BWIC supply driven primarily by rotation activity added to the new issuance and pushed secondary spreads out across sectors by anything up to 5bp - the biggest moves in that direction since January.

However, those moves were short-lived as the deep liquidity seen across ABS since the start of the year reaffirmed itself in the subsequent session. Buyers returned in numbers to meet further strong secondary supply causing spreads to reverse and edge back towards Friday's closing levels.

Yesterday saw a similar story with flows once again robustly two-way and hefty BWIC supply also easily absorbed. Autos and cards remain at the centre of activity, but across the board ABS secondary spreads continue to hold firm.

The US ABS BWIC calendar is again building strongly for today. Among the early highlights is a chunky mixed list due at 11:00 New York time.

The four line $72m+ original face seniors auction comprises: AMCAR 2014-3 C, CHAIT 2014-A7 A7, CNH 2014-C A3 and FORDO 2015-B A3. None of the bonds has covered on PriceABS in the past three months.

Secondary markets

Euro secondary ticks over

The European securitisation secondary market continues to tick over.

Activity remains patchy across the board with sporadic BWICs and light bilateral volumes. Further distraction has emerged with a handful of new ABS, CLO and RMBS deals now actively marketing, but overall tone is still positive and secondary spreads continue to hold in or tighten.

The past couple of sessions remained centred round the most active sectors of late - CLOs and UK non-conforming. Today's BWIC calendar once again reflects this.

There are two lists on the schedule so far. First, is a single €135m original face single line of DUCHS VI-A A-1 due at 14:00 London time. The triple-A CLO has not covered on PriceABS before.

Then, at 15:00 there is a four line £54m+ RMBS auction comprising: ESAIL 2007-3X B1C, ESAIL 2007-4X B1A, ESAIL 2007-6NCX A3A and PRS 2005-2X C1C. None of the bonds has covered on PriceABS in the past three months.

ABS

Russian SME ABS sets the standard

The Russian SME loan market is anticipated to grow, with further SME ABS issuance following suit. As the Russian SME ABS sector develops, several innovations seen in last year's offering from Promsvyazbank are expected to be replicated.

Promsvyazbank's RUB10bn SPE PSB SME 2015, issued in September last year (see SCI's primary issuance database), was the first domestic issuance of SME ABS notes in Russia to be rated by Moody's. It is one of only a couple of transactions Moody's has seen to incorporate the concept of a special financial organisation (SFO) under the Russian securitisation law which took effect in July 2014.

The rating agency believes Promsvyazbank's deal highlights structural features which reduce risk and which will become common in future transactions. It says the deal "contains many structural mechanisms that are credit positive for Russia's ABS market" and "sets a positive tone for Russian originators, since it demonstrates availability of an alternative funding source through securitisation of non-mortgage assets".

SPE PSB SME 2015 is a revolving securitisation of SME loans. Among its many structural mechanisms which are still new to Russian domestic securitisations are: the presence of a noteholders' representative to provide a centralised decision-making function when noteholder decisions are required; replenishment criteria and early amortisation triggers limiting the potential deterioration of the portfolio credit quality during a revolving period; pledge accounts securing cash for the benefit of noteholders; strengthened limited recourse; and risk retention requirements which mitigate a potential misalignment of interests.

The appointed noteholder representative is an important development as it provides a more efficient decision making mechanism. These representatives have been a requirement since July 2016 so will necessarily be included in future deals and will act on behalf of noteholders to improve a transaction's adaptability to operational challenges. For Promsvyazbank's ABS, the appointed representative was Region Finance.

The replenishment criteria and early amortisation triggers should limit deterioration of the portfolio credit quality during a revolving period, where noteholders can be exposed to additional losses. PSB SME 2015 includes replenishment criteria at borrower, loan and portfolio levels, with performance-based early amortisation triggers also included.

As for the pledge accounts which protect bondholders, Moody's considers this "one of the most significant developments in the country's legal securitisation framework" in terms of benefits to noteholders as it will ensure that funds held in the account are only available to them. The rating agency notes that a pledge account is a relatively stronger arrangement for ABS noteholders than a traditional bank account, which does not allow for pledging the issuer's monetary claim in the noteholders' favour.

"On the other hand, the pledge account arrangement in ABS deals allows noteholders to enforce the pledge of the funds held in the pledge accounts, in case the issuer becomes insolvent or defaults. In the event of issuer insolvency, noteholders would have a priority claim on the funds held in the issuer's pledge accounts. For other accounts that are not in the issuer's name and are not pledged to the noteholders, noteholders' claims would rank pari passu with the other creditors," Moody's notes.

Russia's legal securitisation framework also paved the way for last year's deal to employ limited recourse and non-petition concepts, which should also be replicated in future ABS. Transaction counterparties other than noteholders or the note trustee legally cannot petition for insolvency if they undertake not to do so and a note trustee can only petition for the insolvency of an SFO upon a resolution passed at a general meeting of noteholders.

For contractual limited recourse, the transaction documents prescribe that even if, upon enforcement of the pledged collateral, the proceeds of the enforcement are insufficient to fully satisfy creditors' and noteholders' claims, the obligation of the SPV towards such creditors and noteholders will be deemed to be discharged in full.

There is also the absence of an independent control agent, but this is mitigated by checks performed by a calculation agent. This is to account for the lack of independent oversight.

The risk retention requirements also mitigate misalignment of interest. Russian legislation mandates that an originator must retain at least 20% of the notes issued from a special purpose entity, ensuring alignment of interest between the originator and other noteholders.

With all these innovations introduced to the Russian ABS market, Moody's believes the Promsvyazbank transaction to set the tone for additional SME financing. The rating agency says: "We expect further securitisations of this type in the Russian market as a number factors will support the growth of the SME sector and SME lending."

Russian SMEs represent around 20% of the GDP and 10% of the banks' loans, and the development of the SME sector is a strategic priority for the Russian government, with several measures in place to support SMEs. Additionally, Moody's notes that the Russian economy is recovering, with GDP expected to grow 1% this year and 1.5% next year, after two years of contraction and lower interest rates, which will encourage SME lending.

JL

Structured Finance

Counterparty revisions to hit EMEA ABS

Moody's is requesting comments on proposals to consolidate and revise its approaches to assessing a number of structured finance-related counterparty risks. If adopted, the changes are expected to have a ratings impact of one to two notches on approximately 210-220 structured finance transactions.

"The proposed changes are being driven by a variety of factors," says Moody's svp Michelangelo Margaria. "Among them are specific changes in market regulation, a review of new information made available to us, observations around the historical experience of the financial crisis of the last decade and our internal periodic reviews of our analytical approaches."

The approaches under review are currently detailed in five separate cross-sector methodologies: assessing swap counterparty-related exposures; the analysis of operational risk; the assessment of commingling risk; assessing risks relating to account banks and investments; and the analysis of set-off risks, namely deposit-related set-off. As part of its RFC, Moody's proposes to consolidate the five methodology reports into one methodology document, with a global scope applicable to structured finance transactions and covered bonds.

Specifically, the proposed changes to the agency's analysis of swap counterparty exposures include a new framework to incorporate global swap margin regulation. Other proposed changes include a clarification of its global commingling risk approach, several updates to the analysis of account banks and temporary investments, and a revision to its assessment of deposit set-off risk.

Additionally, Moody's proposes to restructure its operational risk analysis by breaking it into three schematic steps. Moody's svp Amelia Tobey adds: "At the same time, we offer a more generic description of mitigating factors and set forth clarified criteria used when analysing transactions with small and/or new sponsor-servicers."

The RFC has prompted Moody's to also seek feedback on a proposed update to its approach to rating credit card ABS. The proposed changes affect the way it incorporates commingling risk and local currency country (LCC) risk ceilings that are lower than Aaa. The agency notes that the expected commingling loss will be added to the Aaa level of credit enhancement given sponsor default, if necessary.

Meanwhile, when the LCC risk ceiling is lower than Aaa, Moody's clarifies that the rating output from its credit card approach will be adjusted downwards by the number of notches equal to the difference between Aaa and the relevant LCC. In instances where the LCC is at or lower than A3, the rating agency is proposing to take into account incremental quantitative and qualitative factors in assessing risks associated with credit card ABS.

EMEA transactions are likely to account for the majority of affected deals, including a limited number of European credit card ABS. Moody's does not anticipate the ratings of covered bonds to be impacted, however.

Market participants are invited to comment on both RFCs by 22 May.

CS

Structured Finance

SCI Start the Week - 20 March

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

Pipeline
Last week's additions to the pipeline took a slightly heavier skew towards ABS. There were nine ABS deals added, as well as five RMBS and three CMBS.

The ABS were: US$1bn Ally Auto Receivables Trust 2017-2; US$1bn Drive Auto Receivables Trust 2017-B; €448m Driver France 3; Sfr297m First Swiss Mobility 2017-1; US$1.282bn Honda Auto Receivables 2017-1 Owner Trust; US$257.44m Marlette Funding Trust 2017-1; US$1bn Nissan Auto Receivables Owner Trust 2017-A; US$461.5m SoFi Professional Loan Program 2017-B; and €783m Sunrise 2017-1.

The RMBS were A$1.7bn Firstmac Mortgage Funding Trust No.4 Series 1-2017, A$500m Liberty Series 2017-1, Light Trust 7, US$280.38m Shellpoint Co-Originator Trust 2017-1 and €400m SRF 2017-1. The CMBS consisted of US$900m CARS-DB4, DB5, DB6, DB7, DB8, DB11, CNI-2 Series 2017-1, US$758.8m LSTAR 2017-5 and US$637.5m WFCM 2017-RB1.

Pricings
The week's prints consisted of seven ABS, an ILS, three RMBS, four CMBS and 14 CLOs.

The ABS were: US$1.168bn BMW Vehicle Lease Trust 2017-1; US$869.86m CNH Equipment Trust 2017-A; US$131.78m JG Wentworth XXXVIII Series 2017-1; US$921.4m Navient Student Loan Trust 2017-2; US$312.9m OSCAR US 2017-1; PLN1.33bn SC Poland Consumer SP ZOO 1 (restructuring); and US$350m Sierra Timeshare 2017-1.

US$480m Aozora Re 2017 was the ILS and the RMBS were €2.72bn Caixabank RMBS 2, US$1.33bn CAS 2017-C02 and A$300m La Trobe Financial Capital Markets Trust 2017-1. The CMBS consisted of US$218.6m CSMC 2017-HD, US$1.02bn CST 2017-SKY, US$366.6m Greystone CRE 2017-FL1 and US$1bn JPMDB 2017-C5.

The CLOs were: US$484.3m A Voce CLO 2014-1R; €414.85m ALME Loan Funding III 2014-3R; US$439.5m Ares CLO 2013-3R; €1.185bn Asti Group PMI 2017; US$863.75m Atrium XI CLO 2014-11R; €419m Avoca CLO 2014-12R; €247.5m BNPP IP Euro CLO 2015-1R; US$345.8m Cutwater 2014-2R; US$330.25m CVP Cascade CLO 2013-1R; US$412.75m CVP Cascade CLO 2014-2R; US$322m ICG US CLO 2014-2R; €373.4m Jubilee CDO 2014-11R; US$493.8m Northwoods Capital XI CLO 2014-11R; and US$468.49m Palmer Square CLO 2013-2R.

Editor's picks
Landmark green SRT introduced: Mariner Investment Group and Crédit Agricole have collaborated to create the first green capital relief trade, the French lender's largest synthetic issuance to date. Dubbed Premium Green 2017-2, the innovative US$3bn risk transfer transaction combines capital management best practices with the objectives of socially responsible investing...
European AMC to create 'positive feedback loop': Further details have emerged about the EBA's proposed state-funded, pan-EU asset management company (AMC) (SCI 3 February). The initiative is expected to attract more investors to the European NPL market and by extension free up bank capital and spur more lending...
Greek servicing shift underway?: Piraeus Bank has hired Christos Megalou, a former Eurobank director, as its chief executive. The appointment signals a growing shift in Greek banks' NPL strategies towards the outsourcing of servicing needs to external servicers...
Innovative GARC transaction prints: Intesa Sanpaolo has printed an innovative risk transfer transaction - and the largest to date - from its GARC programme, with Banca IMI acting as arranger. The €2.5bn GARC SME-5 synthetic securitisation references a granular portfolio of Italian SME loans...
Loan tapes suggest auto trends are 'in line': Loan and pool level stratifications in US auto ABS show credit trends in line with economic expansion and the credit cycle. Rising rates and increasing lender competition could alter this dynamic, according to a new JPMorgan study, which analyses early stage delinquencies and loan modifications across 10 auto loan tapes from seven pools (averaging 60,000 loans per tape)...
Euro secondary strengthens: Tone and levels if not volumes continue to strengthen across the European securitisation secondary market. The large CDO liquidation BWIC last Friday bolstered the market's already strong tone, as expected...

Deal news
• The second US CMBS conduit transaction to use an eligible horizontal residual interest, and the first to have that horizontal interest held solely by a third-party purchaser, is currently marketing. JPMDB 2017-C5 is a US$1bn transaction rated by Fitch, Kroll Bond Rating Agency, Moody's and S&P (see SCI's pipeline).
• Multilease is prepping a debut Sfr297m auto lease ABS. Dubbed First Swiss Mobility 2017-1, it is a 32-month revolving cash securitisation of auto lease contracts extended to obligors in Switzerland.
• The roll of the IHS Markit CDS indices next week is expected to result in a number of lower quality constituents entering the reference portfolios. Ahead of the roll, Morgan Stanley credit derivatives analysts reiterate their long-term preference for Europe over the US via a long Crossover position versus CDX HY and buying upside options in the iTraxx Main versus CDX IG.

Regulatory update
• A number of positive developments have boosted the marketplace lending sector this week. Among them is the publication by the OCC of further guidelines for fintech firms applying for bank charter applications.

Capital Relief Trades

Risk transfer round-up - 24 March

Deutsche Bank is believed to have priced its CRAFT CLO 2017-1 capital relief trade this week (SCI 17 March), with market sources suggesting that the deal met with "good appetite from investors". The US$357m transaction printed at Libor plus 10.75%, having been upsized from US$200m on strong demand.

CLOs

Bespoke analysis needed for US retail

Although some US retailers continue to underperform, investors should be wary of taking a wholly negative view on the sector, according to Morgan Stanley CLO analysts. They point out that with broadly strong US retail sales and growing personal income, problems lie only in certain subsectors within the segment.

The Morgan Stanley analysts note that retail continues to play a bigger role in the number of distressed loans in CLO 2.0 collateral, with more than 30% of textile and apparel loans and 24% of retail loans (excluding food and drug) currently qualifying as distressed loans and/or loan prices. They add that of all the loans labelled distressed in the US CLO 2.0 universe, "retailing is now the largest contributor, surpassing oil and gas."

However, the analysts add that retail is not necessarily homogeneous and that investors should assess a range of factors that may distinguish one brand from another. These include a brand's e-commerce capability, as those with a stronger e-commerce strategy will outperform traditional companies that will likely continue to decline. Certain retail sectors - like food and drug retailers - are also typically less cyclical than consumer discretionary purchases, for example, which are more unstable in an economic downturn.

Additionally, whether brands have regional or national focus and loyal clientele are important considerations. Companies' debt coverage and leverage ratios too are "critical to watch" and the analysts stress that second lien loans from the same issuer are usually much riskier than the first lien loans. Of further importance for investors is the price the CLO manager acquired the loan at, as typically lower entry prices are better.

The analysts conclude that the risk in retail is not fully priced in in the US investment grade corporate credit market and that there could be further problems down the line, given "an elevated 'tail' and long-term secular challenges."

RB

CLOs

Term curve dislocations 'provide opportunities'

Carlyle recently priced what is believed to be the first post-crisis US CLO to feature a six-year reinvestment period - the US$612m Carlyle US CLO 2017-1. As the new issue CLO term curve evolves, JPMorgan CLO analysts suggest that investor market segmentation provides opportunities to add alpha when the term curve becomes mispriced.

"In theory, bonds with longer reinvestment periods should price at wider spreads, given longer spread duration and higher default risk," they note. "In addition, with longer reinvestment periods and non-call periods that have largely stayed at two years, the equity receives added call optionality - which should also, in theory, add extra compensation to CLO debt, which is short this option."

However, other factors also impact pricing, including manager tiering, portfolio ramp risk, debt assumptions, reinvestment language and credit profile.

The JPMorgan analysts suggest that, in practice, the CLO primary market doesn't seem to price maturities efficiently. One reason could be that variation in reinvestment periods is new, so it will take time for investor differentiation to evolve. In addition, heavy volume in shorter refinancings creates competing supply, keeping the short end wide.

The analysts compare the pricing of upper tier managers that issued in the same week as Carlyle (6-10 March), with reinvestment periods ranging from six years to a refi with 1.6 years until the end of the reinvestment period. At the top of the capital structure, triple-A tranches printed in a range of 115bp-130bp. There is a 5bp spread premium between the six-year and five-year reinvestment period deals, a 3bp spread premium between the five-year and four-year reinvestment periods, and a 7bp differential between the four-year and 1.6-year.

At the bottom of the capital structure, the term curve is relatively flat. For example, the differential between six-year and five-year double-B tranches is 5bp.

In the middle of the capital structure, the term curve inverts or flattens. For example, the six-year single-A tranche is 5bp tighter than the five-year single-A, while the four-year double-A tranche is 5bp tighter than the five-year double-A and there is no differential between the refi and four-year single-As.

These dislocations indicate an investor base in upper mezzanine that prefers longer duration, with demand driving spreads tighter for new issue. The analysts note that the single-A portion of the CLO capital structure appears the cheapest at the short end of the term curve.

Based on a further examination of new issues and refis that printed since July 2016 and are managed by a group of 14 US managers with price history that has consistently been at the tight end, they point out that when the term curve flattens, the short end seems cheap and/or the long end seems expensive. This dynamic inverts when the term curve is steep.

Since July 2016, the analysts estimate that the basis between top-tier new issue and refi triple-As ranges between 1bp-26bp. At the double-A level, the basis between new issue and refis has swung from an estimated 37bp to -10bp and averages 13bp.

When the term curve becomes negative - which occurred in December - the analysts believe it is mispriced. "The fact that the new issue term curve is negative at times in the double-A market indicates to us that double-A investors are less focused on the shorter end of the curve and that there could be opportunities for investors that are focused in this space," they observe.

Similarly, the single-A new issue to refi differential averaged -1bp from July to December 2016, but has increased to an average of 26bp this year. This suggests that refi single-As were cheap to new issues throughout 2H16.

CS

CMBS

JCPenney exposure gauged

JCPenney has disclosed the 138 stores that it plans to shutter in an effort to optimise retail operations (SCI 2 March). The impact of the closures on the CMBS market appears to be smaller than anticipated, with 14 liquidated stores encumbered by 17 loans totalling US$1bn, according to Morgan Stanley figures. The IHS Markit CMBX index has exposure to nine properties encumbered by loans totalling US$411m.

The liquidations are expected to commence on 17 April, with an estimated 5,000 employees being affected nationwide. The closures - which represent roughly 13%-14% of JCPenney's total store count - seem to be concentrated in lower quality properties located in smaller markets, although Morgan Stanley CMBS strategists note that there are a few surprises at better quality malls.

Of the 138 store closings, 73 are located at malls where sales per square-foot are below US$350. Eastland Mall, Lakeview Square Mall, The Boulevard Mall and Lycoming Mall are also on Macy's closure list, while Cortana Mall, Jasper Mall and Richmond Town Square are on Sears'.

With respect to CMBS loans, the Morgan Stanley strategists suggest that the exposures are split approximately 50/50 between legacy and 2.0 assets. Trepp highlights the US$388.5m Palisades Center loan - which accounts for 3.37% of JMDB 2016-C2 and 100% of PCT 2016-PLSD and is the largest exposure - as one of particular concern. JCPenney occupies around 8.30% of the 1.9 million square-foot mall in West Nyack, New York, with a lease that is scheduled to run through March 2018. The loan is current and is slated to mature in April 2021.

Additionally, the retailer is the fourth largest tenant at the Franklin Mills super-regional mall in Philadelphia, Pennsylvania, occupying 6.67% of the 1.6 million square-feet with a lease that expires in February 2022. The US$278.2m Franklin Mills loan was originally split into a US$174m piece in JPMCC 2007-LD11 and a US$116m piece in GSMS 2007-GG10 at securitisation, but was bifurcated into separate A/B notes in November 2012.

The modification also extended the loan's maturity date through June 2019 and introduced varying rate changes. Trepp notes that Franklin Mills is one of the few loans that remain outstanding in the high-profile Simon/Farallon retail portfolio.

Another loan of concern is the US$10.4m Hilltop Mall, which accounts for 1.10% of JPMCC 2012-CBX. With a lease that expires in October 2019, JCPenney is the top tenant and occupies 24% of the 172,933 square-foot shopping centre in Kearney, Nebraska. Set to mature in June 2022, the loan posted a DSCR and occupancy of 1.45x and 89% for the 2016 fiscal year.

In CMBX, most of the exposure to JCP is concentrated in CMBX.4, totalling US$284m. Half of this is attributable to Franklin Mills in JPMCC 2007-LD11.

Out of the CMBX series 6 to 10, only CMBX.10 has exposure - the US$12m Bosque River Shopping Center (securitised in CGCMT 2016-C1). "While the CMBX.10 exposure is limited, we nonetheless believe it is notable, as it underscores our view that the market may be complacent about the risk that the 34 mall-referenced loans pose to this index," the strategists observe.

CS

RMBS

Spanish RPL RMBS marketing

Blackstone affiliate Spain Residential Finance is in the market with its second Spanish re-performing RMBS. Dubbed SRF 2017-1, the €403.1m transaction is backed by 3,307 seasoned residential mortgage loans extended to borrowers in Spain.

Consisting of first lien mortgages on residential properties, the portfolio has a weighted average current loan to value ratio of 60.88%, which is lower than the average for Spanish transactions. The majority (79.16%) of the loans have previously been restructured and are now re-performing under modified terms, while the remainder have not been restructured. Over half (51.93%) are flexible mortgage products, meaning they are more likely to default, and payment holidays are also permitted on 31.56% of the loans on which principal and interest are not paid.

The loans being securitised form part of the €6bn portfolio transferred by Catalunya Bank to a Spanish securitisation fund (FTA 2015) set up for the benefit of an entity controlled by Spain Residential Finance (SCI 4 October 2016). The banking business of Caixa Catalunya, Tarragona i Manresa was spun off to Catalunya Banc on 27 September 2011. On 24 April 2015, BBVA acquired 98.4% of the share capital of Catalunya Banc and, as of 9 September 2016, Catalunya Banc was absorbed by and merged with BBVA.

Compared to other similar, recent Spanish RMBS, this transaction is unusual in being rated by three rating agencies, with Fitch, DBRS and Moody's assigning provisional ratings of AA+/AAA/Aa2 to the deal's €248m class A notes. DBRS and Moody's have assigned provisional ratings of A/A2 to the €40m class Bs, BBB/Baa3 to the €16m class Cs and BB/Ba2 to the €12m class Ds. There are also €84m unrated class Es, with all notes due in April 2063.

Spain Residential Finance is expected to subscribe to the class E note and the subordinated loans. The purchase price of the mortgage loans payable by the fund to the seller is expected to be below par value.

According to Moody's, credit strengths of the deal include availability of payment histories on the mortgage loans in the collateral pool, as well as average seasoning of 9.25 years. However, the agency notes that the transaction has several credit challenges, such as a lack of hedging arrangements to cover interest rate risk and the weaker historical performance of previous Catalunya Banc deals. A further credit challenge is the geographic concentration, with 75.59% of the loans concentrated in Catalonia.

The master servicer on the transaction is BBVA and the servicer is Anticipa Real Estate. The arranger is Credit Suisse, which is also lead manager with Deutsche Bank and Bank of America Merrill Lynch.

RB

RMBS

Irish RMBS recaptures attention

The recent resurgence in primary issuance is not the only way to tap Irish RMBS value, as further redemptions for a number of Celtic Residential Irish Mortgage Securitisation series transactions could also provide value in the secondary market. JPMorgan analysts believe indicative pricing levels for CRSM 9 A2 and CRSM 11 A3A could yield a sizable spread pickup relative to a no call scenario, should they be called between June this year and December 2018.

New issue activity has come back into focus recently as Lone Star is currently in the market with European Residential Loan Securitisation 2017-PL1 (see SCI's pipeline). That transaction is backed by performing and re-performing loans. Meanwhile there has also been an increase in the redemptions of legacy transactions over the last two quarters, as underlined by the recent redemption of the €665m Emerald Mortgage No.4 prime RMBS, which was originally issued in 2006.

The broader Irish economy is recovering, with GDP growing, unemployment falling and house prices up 36% from their trough. House building is recovering and the Central Bank of Ireland has launched a number of measures to tighten lending criteria.

Moody's Irish prime RMBS indices show that 90-plus day delinquencies have declined consistently since mid-2014, although they remain high at 14.63%. Cumulative losses have increased but remain low in the context of seriously delinquent loans, as just 28bp, which reflects the preference for mortgage restructuring over repossession.

There have only been three Irish RMBS, with a cumulative original balance of around €1.5bn, distributed to investors since 2008. These have been Fastnet Securities 9, Fastnet Securities 12 and Dilosk RMBS No.1.

A few private placements have also been completed, including a European Residential Loan Securitisation deal from Lone Star last November. Retained Irish RMBS issuance has averaged €1.6bn annually since 2010.

The public deals have brought consistent spread compression, which is particularly clear when compared to Spanish issuance. While the first two Irish prime RMBS seniors priced in line with, or at a premium to, newly-issued Spanish seniors, the most recent Fastnet A notes priced at 45bp over three-month Euribor, which was 20bp tighter than the Spanish Prado III transaction which priced a week later.

The JPMorgan analysts see scope for increased new supply of Irish RMBS, but expect overall volumes to remain fairly muted in comparison to other sectors. They also believe opportunities may be isolated, but see greater potential for additional issuance of non-performing and re-performing loan deals as mortgage restructurings continue.

"Increasing mortgage approval volume and the recovery in property prices in the jurisdiction to date is encouraging, though the implementation of tighter lending standards as well as the availability of cheaper funding may keep new supply from traditional bank issuers subdued. Alternately, consistent with our view of the Spanish RMBS market, we expect that the composition of any new Irish RMBS supply will shift more towards that from specialist lenders/opportunistic issuers (such as Lone Star)," the analysts say.

As for outstanding opportunities, there is around €4.6bn of distributed Irish RMBS still outstanding. Three CRSM deals account for €3.1bn of this, but bond tenders from the issuer are understood to have reduced the availability of outstanding bonds by as much as 60% for CRSM 9, CRSM 10 and CRSM 11.

Only €87.1m of Irish RMBS have been placed on BWICs since the start of 2016 across the prime and non-conforming segments of the market, so the JPMorgan analysts speculate that the primary market will provide the best route to adding exposure.

Performance has been significantly better for post-crisis deals than for legacy deals, despite considerable seasoning on the underlying collateral for the latter. The 90-plus day delinquency rates for Fastnet Securities 9 and Dilosk RMBS No.1 were 0.9% and 0% respectively at the start of the year, but stood at almost 17% for CRSM 9.

"At a high level, we remain neutral Irish prime RMBS senior bonds given the sizeable rally in indicative spreads seen since mid-2016 (at three-month Euribor plus 68bp, spreads are currently at post-crisis tights). For investors looking to add exposure, new issue opportunities will likely present the best opportunity to do so, though relative value may be transaction specific," say the analysts.

They continue: "We do note that one potential source of value to investors in the secondary market could be in further redemptions of the outstanding Celtic transactions CRSM 9, 10, and 11. Using current indicative pricing levels for CRSM 9 A2 and CRSM 11 A3A and generic prepayment and default assumptions (2 CPR, 0.5 CDR, 40% severity, 12 month lag), calling the transactions between June 2017 and December 2018 could result in sizeable spread pickup relative to a 'no call' scenario."

JL

Structured Finance

Job swaps round-up - 24 March

North America

Alcentra has hired Brandon Chao as svp in New York, joining from Omega Advisors, where he was a senior analyst for structured products and corporate credit. He will report to the firm's global head of structured credit, Hiram Hamilton, who is relocating to the New York office in April. Hamilton was previously executive director and head of the European CDO group at Morgan Stanley.

Acquisitions

Smith, Graham & Co has acquired the residential mortgage team from alternative investment manager Five Mile Capital Partners.

EMEA

Christophe Evain has decided to step down as ceo and cio of Intermediate Capital Group, and will be replaced by Benoit Durteste as of 25 July 2017, subject to Durteste's re-election as director at the annual general meeting.

Leadenhall Capital Partners has hired Adrian Mark as a non-life investments analyst. He joins from RMS, where he was a senior manager of model solutions.