Contents

Secondary markets

Euro secondary ebbs and flows

Activity in the European securitisation secondary market continues to ebb and flow.

Trading patterns continue unchanged across ABS/MBS and CLO sectors - from time to time volumes begin to build before dissipating once again amid positive market sentiment. Last week reflected that as activity fizzled out towards the end of the week, while yesterday saw a flurry of auctions and there are more to come today, but it's likely that the Easter holidays will prevent any sustainable trading momentum in the near-term.

Demand for paper remains strong and bonds continue to trade at or above market expectations. As a result, secondary spreads are flat to slightly tighter week on week across the board and appear to remain insulated from macro issues.

There are currently five BWICs on the European schedule for today and the largest is a 41 line mix of ABS, CDOs, CLOs CMBS and RMBS. The 407.35m original face dollar-, euro- and sterling-denominated auction is due at 15:00 London time.

It comprises: BERCR 6 B, BPM 2 B, BPMO 2007-2 B, BTOA 2 B, BUMF 4 M, CAVSQ 1 A1N, CFAB 2002-2 2A1, CFAB 2002-3 2A1, CFAB 2003-2 2A2, CFAB 2003-3 2A2, CLAVS 2007-1 AZ, CLAVS 2007-1 M1A, CWL 2002-3 1A1, CWL 2003-3 2A2, DECO 2006-E4X B, DECO 8-C2X C, DOURM 1 A, FAXT 2005-1 A2E, FIPF 1 A2, ITALF 2007-1 B, LUSI 3 A, MSDWC 2002-NC3 A2, NCSLT 2007-2 A3, PARGN 10X A2B, RAMP 2002-RS3 AII1, RAMP 2003-RS4 AIIA, RASC 2002-KS4 AIIB, SAST 2004-1 A, SHIPO 2 A, TDA 25 B, TDAC 5 A, TITN 2006-1X C, TITN 2006-3X B, TITN 2007-CT1X B, UCI 11 A, UCI 12 A, VELAA 2006-1 B, VELAH 3 B, WINDM VII-X C, ZOO II-X A1 and ZOO IV-X A1B.

Two of the bonds have covered on PriceABS in the past three months - PARGN 10X A2B at 95.06 on 3 April and TDAC 5 A at 96.831 on 3 February.

Secondary markets

US CLOs slow

The US CLO secondary market is slowing down ahead of the Easter holidays.

"It was always going to be a pretty slow week given the early finish on Thursday and Friday's close," says one trader. "But there really is very little to report."

In addition, secondary is still hampered by so many bonds being above par, the trader notes. "Yields and DMs to first call are really getting squeezed, which reduces appetite for paper and makes trading difficult."

Meanwhile, primary appears to be suffering from pre-holiday challenges as well. "We're hearing about spotty prints in some of the refi deals," the trader says. "The only thing we can figure is that some parts of the market are a bit overcrowded and so issuers are having to widen some tranches out to get the whole deal done."

There are currently three BWICs on today's US CLO calendar. The chunkiest is a six line $9.829m list due at 11:00 New York time.

It comprises: CIFC 2015-1A E1, DRSLF 2015-41A E, KVK 2015-1A D, PLMRS 2015-1A D, REGT5 2014-1A D and TICP 2014-3A E1. Three of the bonds have covered with a price on PriceABS in the past three months - CIFC 2015-1A E1 at 96.4 on 21 March; DRSLF 2015-41A E at 97H on 20 January; and KVK 2015-1A D at VL99H on 16 February.

ABS

Debut consumer ABS prepped

Tidewater is marketing its first term consumer finance ABS. Dubbed Tidewater Sales Finance Master Trust Series 2017-A, the US$68.92m securitisation is backed by retail installment contracts.

While Tidewater has an established auto loan business, this transaction marks the first term ABS from Tidewater Credit Services, an originator of retail installment and revolving contracts to non-prime consumers for the purchase of home goods. The contracts are originated through regional and national retailers to consumers that are declined by the retailers' primary finance sources.

KBRA has assigned provisional ratings to the transaction of single-A on the US$51.32m class A notes, triple-B on the US$9.21m class Bs and double-B on the US$5.99m class Cs. It has not assigned ratings to the US$2.4m class Ds.

The expected principal payment date is 14 July 2019 for the class A notes, 15 September 2019 for the class Bs and 15 October 2019 for the class D notes. The series maturity date on the all of the notes is 15 April 2019.

KBRA notes that the transaction benefits from an experienced management team and a structure that provides sufficient credit enhancement, ranging from 29.8% on the class A notes to 5.72% on the class D notes. Additionally, the trust will include US$15.44m of delinquent receivables and 45,000 charged-off accounts that will provide additional cashflows for this series. The rating agency adds, however, that they are ineligible receivables for the transaction and are not included in the credit enhancement calculations.

The transaction features a transferor in the form of Tidewater Sales Finance Holding, which has designated 7% of principal collections as finance charge collections, with approximately 35.24% of the collateral subject to an active promotional plan. Ultimately, this could result in deferred interest payments and no interest income generation.

On one hand, this could prevent an early amortisation event, due to low excess spread. But on the other, it could raise the likelihood of it happening, if the transferor fails to add more receivables.

The transaction could also suffer from disputes over true lender status, with 63.46% of the collateral originated by a partner bank, Mid America Bank Trust Company (MABT). It is expected that nearly all future receivable interests sold to the issuer will be originated through MABT. With 2.12% of the receivables interests originated in New York, Connecticut and Vermont, there is the potential for disruption from subsequent decisions by courts in the second circuit regarding exportation of usury limits.

The collateral pool comprises 76,224 loans, with an average balance of US$1,052, a WAC of 27.12% and average FICO of 632 (4.02% of the borrowers have no FICO score). The top three states represented in the pool are California (accounting for 12.84%), Florida (12.80%) and Michigan (10.49%).

Tidewater and its subsidiaries represent the sponsor, servicer, administrator and transferor in the transaction.

RB

ABS

New ABCP conduit launches

A new European ABCP conduit has launched, securitising insured trade receivables that are fully guaranteed by Altradius Credito y Caucion (ACyC). Moody's has provisionally rated IM SUMMA 1's Euro-commercial paper (ECP) class at P2 and its European medium-term note (EMTN) class at A3.

IM SUMMA 1 is a fund with the ability to purchase further assets and issue further liabilities. The notes to be issued will be either short-term or long-term, depending on the maximum extended maturity date.

All trade receivables will be originated by ACyC's clients and insured by ACyC. The company will contact the debtor before any receivable is assigned to the fund, to avoid dilution and fraud risks. ACyC's guarantee will cover any payment due on defaulted assets 120 days after the corresponding default, while the transaction is structured such that if certain events occur it cannot continue to purchase assets or must liquidate the programme.

The ratings assigned to the ECP and EMTN notes are highly linked to the short-term and long-term ratings of ACyC, says Moody's. Ratings are also dependent on BBVA's deposit ratings in its capacity as issuer account bank.

A few features of the transaction present challenges, says Moody's. For example, there is a lack of performance history for the servicer, as it is a fairly new and small company.

Another challenge is that debtors of trade receivables assigned to the fund will also pay unassigned trade receivables from the same client into the fund collection account, which increases the complexity of the structure and the associated servicing process. Also, there is the lack of additional credit enhancement or liquidity besides what the structure will generate by itself to be considered.

IM SUMMA 1 is incorporated under the laws of Spain and subject to Spanish securitisation regulation. Credit enhancement comes from ACyC's guarantee and the fact that assets are purchased at a discount.

There is no liquidity facility available in the programme, although global eligibility criteria guarantees that the balance of all the receivables maturing before the next payment date, plus any cash not invested, is sufficient to reimburse the notes maturing on such payment date. Should a receivable default affect payment, the initial maturity date will be extended up to 125 days providing time for any recovery to be received and, if needed, for ACyC to cover the remaining unpaid amount.

JL

Structured Finance

SCI Start the Week - 10 April

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

Pipeline
ABS names once again made up the majority of last week's pipeline additions. There were also a couple of ILS and a handful of RMBS.

The ABS were: US$1bn CarMax Auto Owner Trust 2017-2; US$469.83m Conn's Receivables Funding 2017-A; US$224.94m CPS Auto Receivables Trust 2017-B; US$172.03m Foursight Capital Automobile Receivables Trust 2017-1; CNY2.884bn Fuyuan 2017-1 Retail Auto Mortgage Loan Securitization Trust; US$254.75m Helios Issuer Series 2017-1; US$1bn Navient Student Loan Trust 2017-3; CNY5.5bn Silver Arrow China 2017-1; and US$1bn World Omni Auto Receivables Trust 2017-A.

Everglades Re II Series 2017-1 and Residential Reinsurance 2017-1 were the two ILS. The RMBS were European Residential Loan Securitisation 2017-NPL1, Grand Canal 1, Harben Finance 2017-1 and Ripon Mortgages.

Pricings
The other side of the coin was also familiar, as CLOs once again dominated the week's pricings. There was some variety to the week's prints, with ABS, ILS, RMBS and CMBS each also making a showing.

The ABS were: US$125m BRE Grand Islander Timeshare Issuer 2017-A; US$1.9bn Citibank Credit Card Issuance Trust 2017-A3; US$500m Citibank Credit Card Issuance Trust 2017-A4; US$989m GM Financial Consumer Automobile Receivables Trust 2017-1; US$350m PFS Financing Corp 2017-A; and US$281m TAL Advantage VI Series 2017-1.

US$950m Kilimanjaro II Re 2017-1, US$300m Kilimanjaro II Re 2017-2, and US$100m Pelican IV Series 2017-1 were the three ILS, while the RMBS were US$221m Deephaven Residential Mortgage Trust 2017-1, A$500m Light Trust 2017-1, US$752m-equivalent Resimac Premier Series 2017-1 and US$1.32bn STACR 2017-DNA2. The two CMBS were US$1bn BANK 2017-BNK4 and US$758.8m LSTAR 2017-5.

Yet again, many of the CLOs were refinancings. The full list consisted of: US$1.177bn ALM Loan Funding 2014-14R; US$618.15m Apidos CLO 2014-18R; US$817.6m Ares CLO 2017-43; €316.5m Ares European CLO 2013-6R; US$359m Battalion CLO 2014-6R; €276m Cadogan Square CLO 2013-5R; US$409.44m Crestline Denali CLO XV 2017-1; US$408m Flatiron CLO 2017-1; US$463m KKR Financial CLO 2013-1R; US$495.5m KVK CLO 2014-2R; US$476.75m Magnetite CLO 2014-11R; US$415.5m Mountain Hawk CLO 2014-3R; €360.75m OCP Euro CLO 2017-1; US$507m Rockford Tower CLO 2017-1; US$391.3m Sound Harbor Loan Fund 2014-1R; US$492m Sound Point 2014-2R; and US$376.5m TICP CLO 2014-1R.

Editor's picks
B-piece buyer shift underway: The US CMBS B-piece investor base is shifting towards those with longer-term capital, following the implementation of risk retention rules. Greater clarity over the structural complexity associated with the rules, together with increasing credit quality is expected to facilitate growth across the sector...
Synthetics to receive an STS designation?: Momentum is growing for a simple, standardised and transparent (STS) designation for synthetic securitisations at the EU level, driven by the support of the European Commission and the EBA. Such a designation is expected to increase supply and enhance standardisation in the risk transfer market...
Leverage ratio driving off-balance sheet trend: A number of European banks are becoming more active in the true sale securitisation format for risk transfer transactions. The move is being driven by the focus on balance sheet reduction, following the introduction of leverage ratio requirements under Basel 3...
B&B portfolio sale to bring new RMBS: UK Asset Resolution has sold two asset portfolios comprising performing buy-to-let loans totalling £11.8bn to Blackstone and Prudential (SCI 31 March). The loans come from the old Bradford & Bingley portfolio and are set to be securitised in two deals, including potentially the largest post-crisis European RMBS to date...
Euro ABS/MBS active: The European ABS/MBS secondary market is once again active, without yet fully taking off. "There are selective opportunities, but there's no real stand-out activity," says one trader. "One possible exception to that is some of the racier positions from the big CDO liquidation are now emerging..."
China tipped as next NPL frontier: Distressed debt investors are becoming more active in the Chinese non-performing loan market. Recent government action - including the creation of a more transparent and effective legal system - is widening the scope of opportunities in the sector...

Deal news
• The first Chinese auto loan ABS to receive a triple-A rating from S&P is currently marketing, although Fitch has not rated it so highly. Fuyuan 2017-1 Retail Auto Mortgage Loan Securitization Trust is a CNY2.884bn secured by loans to prime quality borrowers.
• Sunnova Energy is marketing its inaugural US$254.75m securitisation. Dubbed Helios Issuer Series 2017-1, it is backed by a pool of 13,838 leases linked to residential solar photovoltaic (PV) installations.
• SBA Communications is marketing its first risk retention-compliant securitisation. The US$760m SBA Tower Trust Series 2017-1C is backed by a pool of wireless towers located across the US and their related tenant leases.
• Deephaven Mortgage is in the market with an RMBS backed primarily by non-QM loans extended to non-conforming borrowers. Dubbed Deephaven Residential Mortgage Trust 2017-1, the US$219.82m transaction features a double true sale structure and an atypical cashflow waterfall.
• Lone Star is back in the market with another Irish RMBS. It is currently marketing European Residential Loan Securitisation 2017-NPL1, which securitises non-performing loans.
• Freddie Mac has priced its largest STACR deal to date. The US$1.32bn STACR 2017-DNA2 is also Freddie Mac's second low-LTV deal of the year.

CLOs

Investors 'less bullish', despite record volumes

Global CLO supply last week hit a weekly record by count and volume for priced deals, with 29 printing at US$13.23bn-equivalent. Against this backdrop, however, JPMorgan's latest CLO survey suggests that investors are the least bullish on the sector for two years.

Last week's total of CLOs comprised five US new issue and 21 US refinancings/resets, while in Europe there was one new issue and two refis. This marks the second week in a row where global supply reached over US$11bn. The highest daily post-crisis volume was also seen on 4 April, when 11 CLOs were issued for US$5.11bn.

In terms of the evolving CLO term curve, investors generally believe there should be compensation for longer reinvestment periods, according to the JPMorgan survey. There appears to be willingness to concede some spread for longer non-call periods, even when reinvestment periods are extended out.

Respondents indicate that an appropriate spread for a two-year non-call/four-year reinvestment period is Libor plus 119bp, while for a two-year non-call/five-year reinvestment period it is Libor plus 126bp and for a two-year non-call/six-year reinvestment period it is Libor plus 133bp. JPMorgan CLO analysts note that their triple-A new issue spread forecast for the tightest/Tier 1 spread is Libor plus 110bp.

In the survey, 58% of responses indicated triple-A spreads in the 80bp-120bp range for a typical two-year non-call/four-year reinvestment period, which coincides with the analysts' view of spread tightening from the current range of 122bp-138bp. Equally, there is significant spread tiering in the responses, as the range of triple-A spread levels averaged 70bp across the different non-call/reinvestment structures. The two-year non-call/six-year reinvestment period had the largest range of 100bp to 190bp.

Meanwhile, Europe is yet to see reinvestment periods of more than four years in a new issue CLO. However, the analysts note that "as spreads have tightened in 14bp year-to-date, structures could take cues from US markets and extend reinvestment periods."

The survey also found less consistency among investors in Europe, where 5bp spread compensation for triple-As is considered reasonable with a two-year non-call period and the reinvestment period extending from four to five years. Extending by a further year, however, seems to require an additional 8bp spread pick-up on average.

When extending the non-call period to three years, investors are willing to concede 4bp and 7bp for reinvestment periods of five years and six years respectively, versus transactions with similar reinvestment periods and a non-call period that is one year shorter.

In terms of sector concerns, respondents were universal in their concern about retail in 2017, with worsening sentiment leading to year-to-date underperformance. Most respondents assume retail defaults within two years, with 40% stating they believe there will be retail defaults in one year.

In terms of relative value, US investors find most value in triple-A bonds, where primary and secondary spreads have tightened 20bp each year to date. According to JPMorgan, there is also demand for equity and double-B tranches in US primary and secondary markets, while across new issue Euro CLOs, triple-A, single-A and equity tranches received almost equal interest. Secondary European investors see value in triple-B bonds.

Generally, according to the survey, investing in new issue and secondary CLOs both received equal interest with 24 votes. Investing in refinancings is generally preferable, at 22 votes, to investing in resets - which only received 14 votes.

Finally, the survey gauged cash balances and CLO investment plans, finding that low cash levels have increased, while moderate, high and very high cash levels have decreased - "indicating that money has been put to work." Moderate cash levels remained about the same since last quarter (accounting for 32% of responses), while 59% of respondents are planning to add risk in the next six months, 32% plan to hold risk and 8% plan to reduce risk. The add/reduce ratio has fallen again to 7x and is now at the lowest level since 1Q15.

RB

CLOs

CLO refi value explored

US CLO triple-A investors should target longer refis from larger managers due to the relatively steep term premium, argue Wells Fargo analysts. Investors hoping to add yield should bear in mind that single-A and triple-B tranches have been most compensated for a move down in attachment point or market value overcollateralisation.

March refi and new issue pricing data shows CLO term curves are very flat, with triple-A investors seeing the largest spread increase when moving out from refis to new issue. Average triple-A refi tranches with one year or less remaining in reinvestment are pricing around 110bp, compared to new issue spreads of 124bp-130bp.

New issue investors therefore gain 14bp-20bp for an additional three, four or five years of reinvestment. The double-A curve is the flattest, while single-A and triple-B primary investors get 5bp-15bp additional spread versus refis.

Triple-A spreads have tightened more in longer refis in the period between January and March. Refis with 1.25 or 1.5 years of reinvestment remaining tightened 12bp from January to March, while refis with one year remaining tightened 8bp.

The double-A term curve steepened in that term as shorter double-A refis tightened more than longer ones. The March double-A term curve shows a 15bp premium for moving from 0.75 years to 1.75 years of reinvestment and 10bp for moving from one year to 1.75 years.

Trends further down the stack are less clear, but the steepening trend holds for single-As. Single-A refi tranches inside of a year of reinvestment tightened 20bp from January to March, while longer refis tightened by around half that.

Looking for value in WAL premium, the analysts note that triple-A and double-A tranches get the largest WAL premium moving from one year of reinvestment to 1.25 years. They get paid less to move from 1.25 to 1.5, but there is another spread increase moving from 1.5 years to 1.75.

Triple-A and double-A WAL premium is highest in the shorter end of the curve, with triple-A investors gaining 5bp-6bp from moving out half a year in WAL inside of 1.5 years of reinvestment, but only 3bp moving out half a year from 1.25 years to 1.75 years. The spread premium is 10bp for a half-year pickup in the shorter end for double-A investors but only 5bp moving from 1.25 to 1.75.

For single-A and triple-B investors, WAL premium is highest in the longer end of the curve. Those investors pick up 18bp and 40bp respectively for moving from 1.25 to 1.75 years, but only 13bp and 10bp for moving from 0.75 to 1.25.

The spread premium for a nine month increase of reinvestment is larger when moving closer to two years until end of reinvestment. Triple-A investors gain almost 10bp moving from one year to 1.75 years of remaining reinvestment, but only 5bp for moving from 0.75 to 1.5. Double-A premium is 10bp for both increments, while single-A premium goes from 5bp for 0.75-1.5 to 35bp for one year up to 1.75.

As for value between refi and new issue deals, the analyst find that triple-A investors can pick up the greatest premium by moving from shorter refis to new issue bonds, which brings an extra 11bp for an additional three years of reinvestment. Triple-A investors can get 19bp pickup for an extra five years in reinvestment.

"The double-A tranches give the least credit for moving out in WAL. For example, in March 2017 refis, there was no difference in the median pricing level for the double-A tranche for a refinanced deal with one year left in reinvestment and a new-issue deal with four years of reinvestment. Single-A investors also get paid less for moving from one- to four-year end of reinvestment, and from one to year end of reinvestment," say the analysts.

There also appears to be a degree of manager tiering, particularly in shorter refis, based on March activity. Triple-A and double-A investors get an extra 5bp-15bp moving from a larger manager (defined as one with 12 of more active US CLOs) to a smaller manger (fewer than 12 CLOs) in shorter refis. Triple-B and single-A refi coupons on shorter deals show 30bp of manager tiering.

"Tiering in triple-A and double-A tranches has decreased during 2017; for refis with 1.5 years of reinvestment, triple-A investors required a 10bp premium for smaller managers in January, but only required a 5bp premium for refis from smaller managers in March. Similarly, double-A investors required a nearly 25bp premium in January for smaller managers, while that premium decreased to about half of that in March," add the analysts.

The premium for smaller managers has actually increased for single-As and triple-Bs. Single-A investors required a 25bp smaller manager premium in January and nearly 35bp in March for refis with 1.5 years of reinvestment.

"Tiering has likely decreased in senior tranches due to the market rally - in general, as spreads tighten, tiering decreases. We also believe the tiering has decreased in the non-PIK-able tranches (triple-A and double-A) as buyers realised the value in refi tranches, while also recognising that the probability of principal loss on shorter bonds is lower - therefore, senior note investors may have paid up to get access to refis, with less concern for the manager size," say the analysts.

There also appears to be tiering based on tranche attachment level for all tranches from triple-A to triple-B, with higher attachment points equating to tighter coupons. However, this relationship is not strong and there are several outliers.

Tiering based on market value overcollateralisation is also observed, particularly down the stack. CLOs with higher market value overcollateralisation tend to price tighter in a refinancing.

A final comparison is to corporates. Assuming a three-year WAL for a refinanced CLO and seven-year WAL for a new issue CLO, the analysts estimate a premium of 12bp for moving from three years to seven years in triple CLOs. Meanwhile, investment grade investors demand 20bp-36bp for a move from three-year to seven-year maturity.

JL

CMBS

Payless closures to have limited impact

Only six CMBS loans with exposure to Payless ShoeSource - for a combined allocated property balance of US$34.8m - will likely be hurt by the retailer's planned closure of 379 stores, according to Morningstar Credit Ratings. The agency suggests that these loans may be at an elevated risk because either Payless occupies at least 20% of the gross leasable area or they have a debt service coverage ratio at or below 1.2x.

The retailer, which filed for Chapter 11 bankruptcy protection on 4 April, is a tenant in 91 properties securing US$572.8m in loans backed by CMBS. Of the locations listed for closure by Payless, 14 stores are among the five largest tenants at properties that serve as collateral in CMBS loans. The largest of these loans is the US$45m 215 West 34th Street & 218 West 35th Street, securitised in CGCMT 2016-GC36.

However, Morningstar notes that although the East County Square allocated property balance is just US$8.4m, it secures the largest high-risk loan with Payless exposure - the US$36.7m Chula Vista II Retail Portfolio (accounting for 3.1% of JPMCC 2007-LD12). The property makes up about 22.9% of the loan balance.

Payless is the second-largest collateral tenant at East County Square, accounting for 10.5% of the 28,500 square-foot shopping centre, on a lease that expired in October 2016. The loss of this store would push the DSCR further below break-even, as the latest reported DSCR was 0.80x on occupancy of 78% for the 12 months ended September 2016.

Morningstar believes that a full take-out of the debt prior to the loan's July maturity date would be challenging without additional equity from the borrower. The agency projects a 89.1% LTV ratio due to diminished net cashflow and the fact that the sister property, East County Village, is vacant.

Another affected asset - Pine Tree Plaza in LBUBS 2005-C5 - has been real estate owned since early 2016 and was just 32% occupied, as of June 2016. Payless occupies 4.1% of the strip centre and the store closure is likely to increase Morningstar's loss expectations for the asset. The property was last appraised in October at US$2.5m, down by 64.8% from issuance, and total exposure is now US$5.5m - implying a loss severity of about 68.1%.

Three other loans of note - all with allocated property balances of less than US$3.7m - are Peco Portfolio - Silver Hill, Kirkwood Retail and the Dumas property in the Texas Retail Portfolio. Morningstar is concerned that since the Kirkwood and Dumas properties are in tertiary locations, the spaces left vacant by Payless will be difficult to re-lease.

Meanwhile, the allocated property balance for the Lake Fredrica Shopping Center loan (1.9% of GSMS 2015-GC34) is US$15.89m. "While the loan reported a 1.2x DSCR for year-end 2016, we don't expect a material decline in net cashflow, should Payless reject its lease, because it occupies only 3.3% of the 89,285 square-foot shopping centre. The largest tenant, Publix Supermarkets, occupies 57.1% of the space on a lease that expires in 2036," Morningstar observes.

CS

NPLs

Chinese NPL ABS growing in size and diversity

The Chinese non-performing loan securitisation sector is set to grow, adding to the existing RMB16.33bn worth of transactions since the market opened in May 2016, according to Moody's. The agency notes that transactions with a mixture of unsecured and secured NPLs are emerging, with deals backed by unsecured loans having weaker credit quality and pricing at a bigger discount than those backed by secured loans.

Of the 16 Chinese NPL deals issued since the market opened, four are backed by unsecured NPLs, nine are backed by secured loans and three are backed by a mix of secured and unsecured loans. The deals backed by unsecured loans comprise non-performing credit card loans, while the deals backed by secured loans are often for non-performing corporate, SME and residential mortgage loans.

Typically, deals backed by unsecured loans have a higher proportion of loans categorised as 'loss grade' (the lowest CBRC grade), while loss grade loans make up only 7.4% of secured loans. Recovery rates are typically lower on unsecured loans, as there is no collateral to be repossessed and sold by the originator. As a result, it is more typical for unsecured loans to be categorised as loss grade.

Transactions backed by a mix of secured and unsecured assets typically feature loans secured by property, land or equipment, as well as unsecured credit card loans. A benefit of a mixed pool is that cash recovery from the unsecured assets is generally faster than those from secured assets, enabling the originator and issuer to meet ongoing fees and interest rate payments early on in the transaction, while the enforcement processes of the secured assets are still in progress.

Where deals have a mix of unsecured and secured loans, they mostly comprise 'doubtful' grade loans and have fewer loss grade loans than both unsecured and secured loan deals, according to Moody's. Often in mixed deals, the underlying collateral comprises both guaranteed and non-guaranteed unsecured loans and loans backed by property, land and equipment.

The agency notes that deals backed by unsecured consumer loans have more diversified and granular portfolios than those backed by secured loans. Unsecured deals typically have the largest number of obligors (at around 90,000), the smallest weighted average loan size at RMB57,290, a shorter expected term of senior notes at 9.53 months and the longest tail period of senior notes.

Unsecured NPLs also price at a bigger discount than secured NPLs. For the 16 Chinese NPL ABS issued so far, the amount issued relative to the total level of pool principal and interest of the NPLs is lower for deals backed by unsecured loans. Typically the ratio for unsecured loans is 12.24%, while it is 26.47% for a deal backed by secured corporate loans and 53.27% for deals backed by residential mortgage loans.

One possible reason for this lower ratio is that there is a larger haircut on the notional value of the unsecured NPLs when they are referred to a trust, according to Moody's. The rating agency says that this is because the expected recovery rate of unsecured loans is generally significantly lower and that the credit quality of unsecured NPLs is lower.

The proportion of NPLs to performing loans at Chinese commercial banks has risen to 1.74% at 31 December 2016, from 1.67% at 31 December 2015 and 1.25% at 31 December 2014. This suggests that growing NPLs is motivating banks to consider NPL ABS as a channel to diversify risk.

Moody's believes that support from China's State Council and regulators behind commercial banks using securitisation for NPLs means that there will likely be greater issuance over the course of 2017 and attract first-time issuers to the market. It adds that reporting guidelines published by the National Association of Financial Market Institutional Investors (NAFMI) in 2016 have helped the growth of NPL ABS in China.

Standardised documentation required by the guidelines promote transparency around Chinese banks' processes for reaching distressed asset valuations, which aids price discovery. Moody's concludes that there is a greater degree of cashflow uncertainty in NPL ABS and standardised information disclosure enables greater comparability, even across a wide range of asset classes.

RB

RMBS

Today's RMBS opportunity deconstructed

US RMBS continue to rally, supported by robust labour and housing markets, cheap credit and increasingly high-quality collateral. In this Q&A article, WyeTree ceo and cio Judith Sciamma explains that since RMBS also have several portfolio characteristics that institutional investors continue to search for in today's investment environment, the sector offers compelling value.

Q: Why are real money investors looking at US-based RMBS strategies?
A: RMBS portfolios can provide a number of attributes that institutional investors continue to seek, such as stable yield, diversification and inflation protection. Since returns are a function of the underlying performance of the mortgage collateral - i.e., borrowers repaying their mortgages - they provide diversification from and low correlation to traditional asset classes. RMBS-based portfolios can also protect from inflation and rising interest rates by investing predominantly in floating rate securities.

The asset class is also now accessible to a broader range of investors in more liquid, UCITS-compliant vehicles. Investors can achieve cost-effective and diversified exposure to the RMBS market in a portfolio backed by a highly analytical and thorough investment process.

Q: What are the drivers of RMBS performance?
A: Returns on RMBS are a function of both ability and incentive to pay by borrowers holding the underlying mortgages. The strength of the US economy, and its potential for further growth, continues to be highly supportive of both these factors and augments the investment case for RMBS.

The US labour market is increasingly robust, with close to full employment and continuing wage growth. Pro-growth government policies are expected to further bolster job creation and should be particularly beneficial to subprime borrowers.

Demand and supply dynamics in the housing market are also very positive. Healthy demand for homes is being driven by the formation of new households and, in particular, by millennials who are seeking houses to buy or rent. As the largest cohort in history, it's likely that their need for housing will continue to grow for some time.

Access to cheap credit for many borrowers supports this trend, and expected deregulation should further increase lending levels. Alongside this, the availability of spare homes is thin, with housing inventory at only 3.6 months - the lowest recorded since at least 1999 - and construction levels too low to fill the gap.

The combination of these factors has caused a 35% increase in US house prices since the end of 2012, according to CoreLogic. This is also a boon for RMBS, since higher house prices reduce loan-to-value rates (which, for US subprime borrowers, were at 74% in December 2016, compared to their peak of 117% during the financial crisis).

This makes it easier for borrowers to refinance and further incentivises them to repay their home loans. House price appreciation and low interest rates have also encouraged loan prepayments, further reducing the likelihood of borrower default.

These dynamics are borne out in the strength of key mortgage market indicators. Loan default rates are stable and delinquency rates have dropped by more than 25% since their peak during the crisis. When repossessions do occur, overall losses are now lower for two reasons: higher house prices have improved resale values, and liquidation is quicker because of excess demand.

Q: Many borrowers defaulted during the financial crisis, affecting the performance of RMBS investments. Is there still reason for concern?
A: These securities are considerably more robust now, for several reasons. When weaker borrowers defaulted during the crisis, the subordinated tranches - which are exposed to losses first - were written off, leaving only the senior tranches that hold mortgages from borrowers less likely to default. These borrowers had continued to repay their mortgages when interest rates were higher and during difficult economic conditions.

In addition, their houses are now worth more than before the crisis and their loans have fewer years remaining. Not only are the deals that survived the financial crisis therefore structurally more robust, but - given the time that has now passed - there is also substantially more information available on the cashflow of the underlying mortgages, allowing greater insight into the likelihood of default.

Deals issued since the crisis - although relatively limited in number - have benefited from the tougher underwriting criteria put in place after the crisis, meaning the collateral quality in these securities is also stronger.

Q: Investors can receive higher returns by investing in subprime mortgage pools, but this also means the potential for higher risk. How do you mitigate against this?
A: We believe that it's important to always take a bottom-up, analytical approach to looking at both bonds and transaction structures. This is particularly true in today's investment environment, where it's harder to identify strong top-down investment themes. By combining detailed quantitative analysis with extensive stress and scenario testing and independent qualitative research to construct a portfolio, it is better insulated from a less stable political and economic environment, and more able to provide stable returns from investment in high quality securities.

Q: What is the outlook for this asset class?
A: We expect positive sentiment for the asset class to continue, bolstered by further strengthening in the US economy, a healthy job market with room for more growth and supportive housing market dynamics. Stability in these factors gives borrowers confidence, better ensures they are willing and able to repay their mortgages and drives the performance of mortgage-backed bonds.