Contents

CLOs

Brexit may see CLO managers up sticks

Article 50 may have recently been triggered following the Brexit referendum, but uncertainty remains rife about what it means for CLO managers in the UK. In combination with the slow-moving STS securitisation framework negotiations, CLO managers are consequently weighing up other jurisdictions and the possibility of issuing elsewhere in Europe.

Jonathan Bowers, senior portfolio manager at CVC Capital Partners, comments that Brexit has ceased to be a theoretical issue. "The fact is...the situation has become very real and that with a two-year clock ticking, people are now actively making arrangements. The feasibility of remaining in the UK and costs are being looked at and also the type of manager it is has an impact on where they may choose to stay. Different rules apply, depending on whether they are a MiFID-compliant manager, for example."

He adds that firms are now questioning the viability of remaining in the UK and are looking at other locations. "It's definitely a spanner in the works. As a result, we're analysing options for issuers and managers in Europe and currently we're focused on Ireland and Luxembourg. Lloyds Insurance has already announced it is setting up an office in Brussels."

Bowers says that when choosing where to position or launch a CLO manager, a lot of factors come into play, although cost is a major one. He says: "There are big cost differences, depending on your location. A big office in Luxembourg is not only very expensive, but it's also a difficult place to find a lot of highly skilled staff. In Ireland, however, we're seeing lots of graduates coming through and for some fund structures, Jersey is also cost-effective. When setting up a new manager, it takes three to four years to get to scale. It can take time to get familiar with the regulation in the jurisdiction too."

David Quirolo, partner at Cadwalader, suggests that a major issue post-Brexit is that it could affect European CLO managers' ability to issue in the UK and remain risk retention-compliant. He says: "Brexit has raised the issue that UK-based managers may be unable to act as a 'sponsor' retention holder. However, I think most managers can switch to an originator model."

Quirolo concurs that UK CLO managers are looking at Ireland and Luxembourg, although he says that "there are domestic exemptions in jurisdictions, which would allow a UK-based manager to manage a European CLO."

Furthermore, Quirolo says that the crucial element with regard to where UK CLO managers remain comes down to the STS securitisation initiative. "The drafting of the STS is still changing and it is unclear so far, but the key is in the STS - which, if drafted in line with the Commission or Council proposals, it will be possible after Brexit for UK managers to manage a European CLO while remaining compliant with the European risk retention rules."

While Quirolo and others agree that CLOs don't benefit from risk retention, Sergio Grasso, senior portfolio manager at Accunia, notes that it could level the playing field between Europe and the US. "Prior to risk retention coming into place in the US, managers were inclined to issue there. Now risk retention is on both sides of the Atlantic, managers are thinking, 'why not issue in Europe?', as there is no clear disincentive now. In fact, now Europe is potentially less volatile and they might be able to also benefit from a different investor base," he says.

As well as jurisdiction, other factors play an important role in launching a CLO manager, including sourcing collateral and investors. Both Bowers and Grasso comment, however, that finding collateral was only a challenge in terms of identifying assets of adequate quality.

A larger hurdle is the initial cost involved and finding sufficient investors willing to back a new manager - particularly those willing to take the equity. Grasso comments: "Finding equity investors is the most difficult thing from our experience. Considering equity buyers make up 10%-11% of the capital - so the equivalent of around £40m - it is not easy to find."

Beyond that, a quality workforce is also crucial, according to Bowers. He concludes: "Costs are substantial...the rest of it comes down to having the right people and the right team."

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ABS

Credit card charge-offs ramp up

Several US credit card banks have reported higher-than-expected net charge-off rates on their card portfolios in their 1Q17 earnings reports. The move seemingly coincides with lenders taking on more risk based on perceived borrower quality and larger credit limits. At the same time, borrowers appear to be taking on too much debt relative to their income growth prospects.

Year-on-year, net charge-offs increased by 98bp for Capital One, 59bp for Synchrony Financial, 50bp for Discover Financial Services, 32bp for JPMorgan, 28bp for Citi, 20bp for American Express and 3bp for Bank of America last quarter. Structured products analysts at Wells Fargo suggest that charge-off rates tend to follow an expansion in credit availability, with loan growth having accelerated since mid-2015. In 4Q16, loan growth rose 6.3%, up from 4.7% in 4Q15, coinciding with an increase in the number of open credit card accounts (reaching 453 million in 4Q16).

The Wells Fargo analysts comment, however, that credit expansion is still in keeping with economic growth and that the ratio of credit card debt to nominal GDP - around 4% - remains well below the pre-recession range of 5.5%-6%. Furthermore, supply remains restrictive and demand among consumers overall to hold credit card debt is weaker. In line with this, credit card limits have increased but utilisation rates of credit lines have remained relatively flat post-crisis.

Overall, credit card ABS are generally performing better than balance-sheet managed assets - which, according to the analysts, is due to positive selection of the ABS pools and long seasoning of accounts in most ABS master trusts. While there have been modest increases in charge-off rates on the ABS, they remain consistent with the experience of the past three years.

Furthermore, the use of ABS to fund credit card portfolios has declined since 2009, with only 18% of credit card debt funded by ABS, down from 35%-40% prior to 2010. While 2017 may see greater issuance figures, more credit card lending and outstanding receivables for ABS will be required for it to regain its previous role funding a larger portion of credit card debt.

In terms of where credit card ABS is pricing, the segment is currently showing spreads in the tighter range since 2010 - which reflect high levels of excess spread and credit enhancement available to protect investors against a maturing consumer credit cycle, according to the analysts. They conclude that credit card ABS is "rich on a relative value basis, compared to similar prime auto ABS."

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ABS

Alitalia exposure examined

Italy's troubled flagship airline Alitalia has been placed under special administration. Should the company ultimately be liquidated, a number of aircraft ABS could face temporary cashflow disruptions as aircraft are repossessed, repaired and re-leased by the lessors.

The Italian government has provided Alitalia with a €600m bridge loan to keep it operational and three administrators have been named to direct the airline through a six-month reorganisation process. The company stated that flights will continue to operate as planned.

Italian shareholders and Etihad (which owns 49% of Alitalia) had previously committed to restructure and recapitalise the company, contingent on trade union agreement, but airline employees voted against the plan. Etihad has since stated that without the support of all stakeholders for the restructuring, it is not prepared to continue investing in the company.

Alitalia has reportedly received over €7bn from the Italian state over the last decade, having been close to bankruptcy in 2008 and 2014. However, Italy's industry minister currently opposes re-nationalising the airline or providing further funds to it.

Wells Fargo structured products analysts suggest that due to the lack of enthusiasm for future investment in the airline, increased competition from low-cost carriers and heightened operational expenses, a sale of Alitalia's assets may be a more probable scenario. Based on an analysis of the latest data available, they identify eight post-crisis aircraft ABS that have at least one aircraft on lease to Alitalia.

Around a quarter of the CLAST 2015-1 (26.3%) and 2016-1 (23.3%) pools by current market value have exposure to Alitalia across eight aircraft each. DCAL 2015-1, EGLE 2014-1, DHAL 2015-1, EAFL 2013-1, ATLSS 2014-1 and AASET 2016-2 are the other deals, with exposure ranging from 19.3% for DCAL to 3.6% for AASET across one to four aircraft each.

Three of the aircraft on lease to Alitalia within current ABS transactions are widebody models, five are regional jets and 30 are narrowbody models, according to Wells Fargo figures. "Aircraft with larger operator bases, lower storage rates, limited competition and economical operation are more likely to be re-leased sooner," the analysts conclude.

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ABS

ILS firm seeks P2P platform funding

Sequant Re is looking to raise capital through a peer-to-peer platform which connects investors directly with companies and funds seeking to raise funds or gain market exposure. The novel approach may seem more suited to a technology start-up, but should bring new investors into the ILS market.

Sequant Re has been listed on peer-to-peer platform The OCMX. As part of its listing, Sequant Re says the company is "now ready to take off" and seeking investors "to partner with us and grow our business".

The investment opportunity is for up to US$5m in common shares of Sequant Re Holdings. The proceeds will provide operating capital as the company launches its first ILS offering and builds its assets under management.

Investors are promised a return of three times initial investment, to be realised through a sale or refinancing of the company. Sequant Re notes that even during years of severe natural disasters, ILS has delivered positive returns since inception.

Sequant Re is currently 31.1% owned by its founder, former Ordinance Holdings and American Safety Re leader Guy Cloutier, management and directors. A premier equity group owns 60.2% and other shareholders account for the remaining 8.7%. The collateralised reinsurer was founded in 2014 (SCI 16 December 2014).

The OCMX provides an open venue for innovative The  growth companies and investment funds to generate market awareness, raise funds and connect with investors and advisors. It provides companies, funds, investors and advisors with instant access to its online portal so that they can actively source and connect with the next opportunity.

The OCMX says it has "spent considerable time" studying the Sequant Re proposition "and concluded that there is indeed a tremendous opportunity for investors". The OCMX notes that Sequant Re "exhibits the main components of any solid investment opportunity", with a highly-regarded management team and innovative and efficient ILS investment platform "that will be a game changer in the ILS market".

JL

Capital Relief Trades

Risk transfer round-up - 5 May

Capital relief trade activity has been relatively subdued this week. However, sources report that the EIF is planning to tap the market again in two months.

The fund completed its first EFSI risk transfer transaction last month (SCI 26 April), as part of a programme to stimulate SME lending in Europe. Not much is known about the forthcoming transaction, other than it will reference SME collateral and the jurisdiction is described by sources as "core Europe".

The EIF is expected to complete between four to six transactions under the Juncker plan this year in France, Germany, the Netherlands, the Czech Republic and Poland.

CMBS

Lipstick Building lease CMBS prepped

Credit Suisse is in the market with a single-asset/single-borrower CMBS secured by two of three land parcels beneath 885 Third Avenue in New York, known as the 'Lipstick Building'. Dubbed CSMC Trust 2017-LSTK, the US$272m transaction is sponsored by a joint venture between BVS Acquisition Co and Shanghai Municipal Investment (Group) USA.

The collateral comprises the fee simple interest in the 20,608 square-foot land parcel (Lot B) that accounts for approximately 78.9% of the land beneath the building improvements at the Lipstick Building and the leasehold interest in the 5,500 square-foot land parcel (Lot A) that accounts for approximately 21.1% of the remaining acreage. Lot A is a 'sandwich' ground lease, where the borrower is both the lessee of the owner of the land and the lessor of the owner of the improvements.

The borrower subleases its leasehold interest in Lot A and fee simple interest in Lot B to Metropolitan. If the ground lease and sub-ground leasehold rents aren't paid by the improvements' owner, the improvements will revert to the borrower.

The loan has a term of 47 months and pays interest-only at a fixed rate of 3.35%. It represents non-recourse, first mortgage financing to 885 3rd Avenue Realty Owner and 885 3rd Avenue Realty Owner A, each a 'recycled' special purpose bankruptcy remote entity.

The trust includes two pari passu promissory notes from the sellers: the US$190.4m Note A1, sponsored by Column Financial; and the US$81.6m Note A2, sponsored by Natixis Real Estate Capital. Provisionally rated by Moody's, the deal comprises US$145.6m Aaa rated class A notes, US$27.7m Aa3 class Bs, US$25.3m A3 class Cs, US$29.9m Baa3 class Ds and US$28.5m Ba2 class Es. There is also a US$15m B1 rated horizontal risk retention class.

Although the Lipstick Building does not serve as collateral for the loan, Moody's notes that it considered a 'look-through' to the value of the non-collateral improvements in which the lessee defaulted on their ground lease payment obligations and ownership of the improvements passed to the borrower. In this scenario, its stressed value for the resulting fee simple property is "well below" the current market value of the collateral ground leases that are performing.

The agency says that the first mortgage balance of US$272m represents a Moody's LTV of 99.4%. The Moody's First Mortgage Actual DSCR is 1.94X and Moody's First Mortgage Actual Stressed DSCR is 0.70X.

Moody's suggests that notable strengths of the transaction include: priority of ground lease payment; quality of non-collateral improvements; strong occupancy/tenancy; New York City office market; debt service coverage ratio; and quality of both the ground lessor and lessee sponsorship. The property is owned by a JV between IRSA and the Marciano Brothers, and was 96.6% leased as of 28 February. It counts Latham & Watkins as its largest tenant (accounting for 65.3% of NRA and 68.4% of base rent).

Notable credit challenges of the transaction include: lack of diversity; high expense of the ground lease payment (US$17.9m); single tenant risk and tenant rollover; anticipated new supply in the New York City Class A office market; no amortisation from the loan; encumbrance of US$135m debt-like preferred equity; and missing legal protections at the loan level, including a deficiency in the Lot A ground lease. Among the anticipated new office supply, for instance, is SL Green's development of 1.6 million square-feet at One Vanderbilt in midtown Manhattan.

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NPLs

Chinese NPL ABS to expand

The Chinese government is set to allow some mid-sized banks to issue non-performing loan ABS this year, providing them with a new channel to offload bad loans. The move is part of an attempt to establish a risk curve, which aims to increase the alternatives available in the credit market.

Efforts to use securitisation as one of the means to tackle the excess credit in the Chinese economy began on 15 May 2015, when the People's Bank of China (PBOC) stated that it would increase channels for accelerating NPL disposals. "They're doing this deliberately to understand the process before they do bigger transactions," says Andrew Brown, partner at ShoreVest.

ShoreVest currently puts the size of the potential distressed debt universe in China at US$3trn. China Banking Regulatory Commission data cited by KPMG at end-2015 suggests that the balance of commercial banks' NPLs was RMB1.27trn, an increase of 51.3% compared to 2011. On the securitisation front, there have been 14 NPL securitisations from May 2016 until now totalling US$2.4bn (SCI 13 April).

The mid-sized banks include China Minsheng Banking Corp, China Everbright Bank, China CITIC Bank Corp, Industrial Bank and Bank of Beijing. The government first launched a trial programme early last year, granting six large state-owned lenders quotas to issue a maximum of RMB50bn worth of NPL ABS. The size of the programme will remain the same after the inclusion of more lenders this year.
The first transactions under the programme were a US$301m corporate deal from Bank of China, along with a US$233m unsecured consumer trade from China Merchants Bank. "The current programme fits with this pattern and aims to expand the number of institutions that can issue based on their infrastructure and needs," observes Brown.

However, this is not only part of the process to address NPL resolution. As Brown explains, it is "part of the overall development of capital markets in China and the establishment of a risk curve, which will see increased elements of alternatives in the credit space." This has been clear over the last six years when investment activity in distressed debt followed activity in Chinese corporate and sovereign debt.

An establishment of a risk curve is especially important for pension funds and insurance firms that prefer long-dated liabilities with high yields. The latter are necessary for pension reform and portfolio construction, another component of the government's multipronged approach in tackling the NPL issue.

Investment activity though will likely be dominated, at least in the short to medium term, by domestic investors - namely fund managers, banks, insurers and pension funds that invest in the senior tranche and fund managers that invest in the equity piece. Issuers, for their part, are required by the authorities to have some 'skin in the game' by retaining 5% of each tranche.

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RMBS

'Major uncertainy' from swap mismanagement

Notices have been released highlighting swap book mismanagement by 11 issuers in the E-MAC RMBS series. CMIS, which serves as loan servicer and SPV issuer administrator, has stepped in to cover certain fees, but in claiming for reimbursement has created what Rabobank analysts refer to as "a major uncertainty".

The affected issuers are: E-MAC NL 2004-1; E-MAC NL 2004-II; E-MAC NL 2005-I; E-MAC NL 2005-III; E-MAC NL 2006-II; E-MAC Program Compartment NL 2006-III; E-MAC Program Compartment NL 2007-I; E-MAC Program Compartment NL 2007-III; E-MAC Program II Compartment NL 2007-IV; E-MAC Program III Compartment NL 2008-I; and E-MAC Program II Compartment NL 2008-IV.

The 11 issuers each say CMIS, in its role as issuer administrator, has been found incompliant with stipulations under the swap documentation. These stipulations relate to the periodic determination of the swap notional schedule and resetting swap rates in case the underlying loans reset their fixed rates and tenors.

The issuers have instructed CMIS to manage the swaps in compliance with documentation, which has led CMIS to modify the constant prepayment rate assumptions underlying the swaps' notional determination. These changes have resulted in larger adjustment fees due by the issuer to the relevant swap counterparty.

"Prior to issuer security enforcement, these fees are payable junior to the interest amounts due to the rated notes (excluding subordinated extension interest) and replenishment of the reserve fund," says Fitch. The rating agency notes that the total subordinated swap amount unpaid by the issuers it rates is €91m, but it stands at €135m across all Dutch E-MAC issuers.

For E-MAC 2006-II, 2007-IV and 2008-I, CMIS has made payments to the swap counterparty as the issuer did not have sufficient funds to meet the subordinated obligation. CMIS has also made a claim for these amounts against the respective issuers, totalling €6.7m.

"At this stage, it is unclear if these claims are valid and how they would rank in the respective issuer's priority of payments," says Fitch. The rating agency identifies two potential risks.

"Firstly, any successful claim made by CMIS against the issuers may be detrimental to the ratings if the claim would be due and payable senior to the amounts due to noteholders. Secondly, CMIS may face financial distress arising from its indemnity obligations to the swap counterparties in light of the large increase in adjustment fees. This may lead to a disruption of the management of the issuers' swaps and the special servicing functions carried out by CMIS," Fitch says.

Rabobank analysts also believe that the CMIS claims create a major uncertainty. While the swap adjustment payments rank quite junior in the waterfall, there is a risk, as Fitch says, that CMIS's claim payments could rank more senior, the analysts warn.

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CLOs

European CLO investor base expands

The European CLO investor base is broadening, thanks to less perceived volatility than in the US market. As well as the stability Europe offers, panellists at IMN's European CLOs and Leveraged Loans conference last month said that low defaults and strong collateral quality is driving renewed interest in European CLOs across the capital stack.

While European investors have dominated the European CLO market recently, Japanese and US investors are increasingly being drawn to the top of the capital stack, in particular - albeit the middle and lower parts remain harder to place. Several investors noted that Europe doesn't yet appear to be as far along the credit cycle as the US and, as a result, investors are viewing the US as more volatile, with Europe a more stable proposition.

One investor pointed out that the European market has been more stable in the past as well. The volatility seen in US CLOs - around the energy sector, for example - has not been present in European CLOs.

Adeel Shafiqullah, md at Och-Ziff Capital, noted that the European CLO market will be strengthened by a greater range of loans added to CLOs and further entice a greater number of investors. "Further broadening and diversification of the European loan pool is beneficial to new CLO issuance, as it improves diversity, mitigates idiosyncratic risk and reduces collateral overlap between portfolios," he said.

However, concerns were voiced that the new investors might be "tourists", drawn by lack of opportunities in other sectors and with less of a long-term view. Shafiqullah commented that the impact of shorter-term capital varies depending on where they invest.

He said: "Regardless of whether there is a growing number of so-called 'tourists', it is certainly important lower down the capital structure to have investors with longer-term, locked-up capital."

As well as renewed interest in the triple-A notes of European CLOs, panellists reported that European CLO equity is finding demand. One investor commented that equity buyers particularly have benefitted in the last three to four years from low defaults and prolonged distributions, as well as the optionality of being able to refinance or reset CLOs (SCI passim).

Indeed, Prytania suggests in a recent client memo that there is renewed value in European CLO equity, which it had previously avoided, given "the lack of clear risk-adjusted value". More recently, however, the firm finds that liability spreads have tightened dramatically due to low supply, with a recent deal printing at Libor plus 163bp, some 50bp tighter than levels in 2013.

Prytania adds that that the leveraged loan market has seen 200bp spread movement in the last 10 years and, as a result, it concludes that European CLO equity could be a solid investment, as it may "benefit from asset spreads when they eventually gap out again over the next few years."

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Structured Finance

Job swaps round-up - 5 May

North America

Hunton & Williams has hired John Dedyo as corporate partner to its New York office. Dedyo represents issuers, underwriters, asset managers, credit enhancers, rating agencies and investors in all aspects of privately placed and publicly offered securitisation transactions. Dedyo was previously a partner at Weil, Gotshal & Manges.

Ares Management and Ares Commercial Real Estate (ACRE) has hired Jamie Henderson as partner in the Ares real estate group and will join John Jardine as co-head of real estate debt. In addition, Henderson has been appointed president and chief investment officer of ACRE. Most recently, he was head of structured real estate investments at Barings.

Pryor Cashman has hired Anthony Schouten to the firm's investment management group and will be based in New York. He joins the firm from Winston & Strawn where he was a partner.

Millennium Management has hired Mark Tsesarsky as co-head of fixed income and commodities and Stephen Haratunian as chief risk officer. Tsesarsky was previously head of securitised markets at Citigroup and Haratunian was chief credit officer at Credit Suisse.

EMEA

The board of Aberdeen Smaller Companies Income Trust has appointed Dagmar Kent Kershaw as an independent non-executive director with effect from 2 May 2017. Kershaw has over 20 years' investment experience specialising in credit and structured finance markets and was previously head of credit fund management for Europe and Asia-Pacific for Intermediate Capital Group.

CDO Manager transfer

Trapeza Capital Management has assigned its rights and obligations as collateral manager for Trapeza Edge CDO to Hildene Collateral Management Company. Additionally, Vertical Capital has transferred the collateral management agreement for the Vertical ABS CDO 2006-1 and 2006-2 transactions to Dock Street Capital Management.

Ramius Trading Strategies has been named successor collateral manager for the TABS 2004-1 ABS CDO.

Settlements

The National Credit Union Administration (NCUA), on behalf of the US Central Federal Credit Union and Western Corporate Federal Credit Union, has received US$445m from UBS and $400m from Credit Suisse for claims arising from losses related to purchases of RMBS by those corporate credit unions. In connection with the settlement, NCUA will dismiss its pending suits against UBS and Credit Suisse, neither of which admits fault as part of the agreement. NCUA still has pending litigation against various RMBS trustees and LIBOR banks related to corporate credit union losses.

Barclays is set to pay US$15.56m in remediation, plus a US$1m penalty to settle US SEC charges that it failed to supervise two non-agency RMBS traders - Yoon Seok Lee and David Wong - that charged excessive mark-ups on retail transactions between June 2009 through December 2012. The firm will be responsible for administering the payment of the remediation to affected customers.

Credentials

The exam for the Certified in Entity and Intangible Valuations (CEIV) (SCI 13 January) credential for fair value measurement is now available. It offers the opportunity for finance professionals to receive this credential from the American Institute of CPAs (AICPA), the American Society of Appraisers (ASA), or RICS (Royal Institution of Chartered Surveyors). To obtain the CEIV credential, finance professionals must have a minimum of 3,000 hours of experience in fair value measurement. They also must pass the credential exam to demonstrate a working knowledge of fair value measurement, business valuation, accounting and auditing standards, and the uniform guidance to be followed as a credential holder.