Contents

RMBS

CRT customisation gains traction

The GSE credit risk transfer (CRT) market has continued to evolve since it began in 2013, with Fannie Mae and Freddie Mac respectively issuing US$23.9bn and US$19.8bn in CAS and STACR securities to date. The sector has taken a further step forwards in recent weeks, following the execution of the first exchangeables trades.

GSE CRT deals are a compelling investment in post-crisis credit, according to Semper Capital Management portfolio manager and RMBS head Neil Aggarwal. "The CAS and STACR programmes offer different attachment points and coupons, whereby investors can express various views on collateral, structure and more fundamentally on home prices and interest rates."

The ability to customise these investments has gained traction over the last few weeks, with the execution of the first five modifiable and combinable (MAC) note exchanges, four of which Semper Capital Management was involved with. The MAC structure allows the holder of various bonds (such as a premium priced M2 class) to: strip off the interest-only portion and sell either the IO portion or a reduced coupon principal bond; or create additional credit tranching in the form of more senior and subordinate notes (for example, M2A and M2B classes).

"Structural optionality is a big step in furthering the CRT programmes: it allows investors to take explicit views on both the credit curve and the interest rate curve. The principal flowing in facilitates time tranching and also allows views on interest rates to be expressed. At the same time, protection from subordination provides the ability to express views on credit quality," Aggarwal explains.

According to TRACE reported data, the recent exchangeables trades involved: CAS 2016-C06 1M2, which was both credit and rate tranched into 1M2I (IO), 1M2T (senior) and 1M2B (sub); STACR 2015-DNA2 M3, which was rate tranched into M3F (reduced coupon) and M3I (IO); STACR 2015-DNA3 M3, which was rate tranched into M3F (reduced coupon) and M3I (IO); STACR 2017-DNA1 M2, which was rate tranched into M2R (reduced coupon) and M2I (IO); and STACR 2017-DNA2 M2, which was rate tranched into M2R (reduced coupon) and M2I (IO).

Aggarwal suggests that the exchanges were largely an interest rate play, while taking advantage of liquidity and tightening spreads. He expects more exchangeables trades to occur and investor focus on this area to increase going forward.

Indeed, Aggarwal indicates that increasing investor interest is spurring the GSEs on to continue innovating. "The GSEs have significant oversight on the underlying collateral and they are very involved in the process. As an investor, I feel that if I have a question, they're willing to discuss it. There are so many investors involved in the CRT programmes and their programme's survivorship means they have to be open; they are willing to hear different views and take action to improve the investor experience."

Mike Reynolds, vp at Freddie Mac, confirms that his organisation is continually seeking to refine the STACR programme to make it more accessible to investors. "Credit risk transfer is a huge component of our strategy: our mission is to increase market liquidity and the availability of affordable housing, and STACR is the full solution to that. We already have over 200 unique investors participating in the STACR programme, including from Europe and Asia. But we're mindful of the need to keep broadening our investor base, so the next step is to make the product more attractive to REITs."

He continues: "Our biggest challenge is that many investors in the non-agency RMBS market lost money during the financial crisis and so their credit committees no longer have the desire to invest in the housing market. Our message is that the products and mortgage loans of today are different to those seen pre-2008."

CRT is the most transparent securitisation product in the market, according to Reynolds. He cites Freddie's disclosure of documentation, pricing and origination criteria as examples. Most recently, the GSE began providing estimated current LTVs as part of the ongoing loan-level disclosure data set for each STACR transaction.

"Investors are hiring Freddie Mac to perform a range of duties, including managing counterparty risk, REO dispositions and loss mitigation. Consequently, they need to feel comfortable with the underlying loans and that there is no adverse selection," Reynolds observes.

Laurel Davis, vp at Fannie Mae, agrees that transparency is important and that much of the innovation introduced into the CAS programme is designed to facilitate investor understanding and access. "Investors need to be able to understand how loans have performed and who Fannie Mae is as a credit risk manager. Consequently, we published loan level and monthly performance data on 24 million loans going back to 2000, so that investors can analyse the cycle and build credit models specific to our loans."

She adds: "Some investors said that such a large amount of data was difficult to process, so we rolled out a free tool, Data Dynamics, that sits on top of the data to slice and dice it on a historical and loan-level basis. Whenever we bring a new deal, we load it into the system, so that investors can compare it pre-pricing. We've also recently enhanced the data with geographic characteristics at the MSA and zip code levels."

Part of Fannie Mae's aim with CAS was to build a programme that would be repeatable and scalable, in order to create liquidity, according to Davis. "We heard from investors that ratings are important and obtained retroactive ratings on some sub bonds, which facilitated liquidity even further. We've also seen 46 upgrades - reflecting strong performance in the underlying mortgages, HPA in the US and structural deleveraging - and upgrade pressure remains."

As the market increased in liquidity, larger asset managers have become involved. Davis says that each CAS issuance has attracted new investors, with the recent NAIC designations encouraging insurance companies to participate and the opportunity to access diversified geographic exposure to US consumers driving an up-tick in interest from international investors.

Reynolds concurs that the majority of outstanding STACR CUSIPs having a NAIC 1 designation is more attractive to insurance companies. "Equally, we've seen many bonds upgraded from non-investment grade to investment grade, which opens the door to more investors. There is a pick-up in price for the bonds when this occurs."

Both Fannie Mae and Freddie Mac issue CRT deals with high-LTV and regular-LTV reference collateral. CAS transactions initially featured a mixture of both types of collateral, but issuances now alternate between regular- and high-LTV pools. Freddie has always separated the pools, using the 'HQ' moniker for high-LTV assets and 'DN' for regular-LTV assets.

"We found that investors prefer to bid separately on high-LTV pools, so we split the offerings out. The majority of high-LTV loans have mortgage insurance, which Freddie backstops," Reynolds observes.

Davis says that while ratings have been added down the capital stack, Fannie Mae has otherwise tried to keep the CAS structure stable over time, so each deal has featured an investment grade tranche and an unrated sub-investment grade bond. The most significant structural change - for both the CAS and STACR programmes - was the introduction of a split B tranche (SCI passim).

"Beginning in 2017, we began splitting the subordinate-most tranche, the B tranche, into two slices. We typically retain the first loss position, the B2 tranche, and offer the next slice of risk, the B1 tranche, to investors. We found that the new structure appeals to a broader investor base: credit support for the B1 tranche can be 2-3 times expected loss or more, depending on the deal and risk model being used, so investors feel they have decent credit protection while picking up yield," she explains.

Reynolds adds: "As we collated more performance data and strong performance was observed across the STACR programme, the general comfort level among investors improved and they felt able to move down the capital structure. To aid this move, we split the first loss bond into B1 and B2 tranches, where the B1 slice represents 50bp-100bp of protection."

Fannie Mae issued US$7.4bn in CAS bonds across seven deals last year and expects a similar pace of issuance this year, while remaining mindful of balancing supply with demand. "We generally issue larger sized deals when the market is stronger," confirms Davis. "Credit markets continue to be strong and we project US$6bn-US$8bn of issuance in 2017, assuming current conditions continue."

Freddie Mac also expects to issue roughly similar STACR volumes this year to 2016. "We anticipate a drop-off in volume as rates rise and so originations may slow down in the second half by around 25%. Rates are the biggest driver of issuance expectations," Reynolds notes.

Looking ahead, both GSEs are planning to further enhance their CRT programmes by enabling them to issue notes via a REMIC arrangement, which would make them more attractive to REIT investors in particular. They would facilitate this change - potentially by early 2018 - by making a REMIC tax election on a majority of single-family loans that are acquired.

As part of the plans, CRT note proceeds would be put into a REMIC trust that would be used to pay principal and part of the interest on the notes, as well as compensating the GSEs for losses. Morgan Stanley RMBS strategists suggest that this could drastically reduce investor counterparty risk compared to the current model, where the securities are unsecured obligations of Fannie and Freddie. They believe that additional demand from REITs - an investor base with over US$300bn in assets that is a natural buyer of mortgage risk - will be a tailwind for spreads, especially for M2 and B tranches.

Meanwhile, Fannie Mae is exploring the creation of a new benchmark CRT index. Davis confirms that investors have indicated that such an index would be useful.

"The total return performance of CAS has been strong, so some asset managers would like to have a way of benchmarking and to demonstrate performance to their investors. We continue to explore ways of helping investors," she notes.

Aggarwal welcomes both the development of a benchmark CRT index and the potential introduction of REMIC structures. "They are interesting ideas when thinking about optionality: a CDS index will offer an additional way for investors to access mortgage credit, especially when it can be difficult to source the cash bonds; and the recent announcements regarding changes in REIT eligibility will increase the investor universe for the CAS and STACR product."

He concludes: "In the early stages of the programme, the GSEs likely forecasted what the future of their CRT programmes would look like and I think they got it right: we're seeing significant issuance and significant demand for the product."

CS

RMBS

Big appetite for BTL RMBS pair

The two UK buy-to-let RMBS issued by Blackstone and Prudential last month (SCI 4 April) provided a significant source of paper for the market. With UK Asset Resolution (UKAR) set to offload more loans later this year there could be future RMBS in the pipeline as well - although as with the latest two deals, absorbing that paper may test the market.

Last month both Ripon Mortgages and Harben Finance 2017-1 were met with high demand by a market hungry for paper. While Harben was predominantly pre-placed, Ripon, by far the larger of the two deals, was much more widely distributed. Even so, only around a third of the paper was sold to investors.

"When these RMBS were first announced there was an understanding that the whole £10bn might be placed, but that would have been very tough to do. It would have really driven the market and there might have been problems with the investor base, but as it is I think they managed to place a healthy amount of paper," says Holger Kapitza, director and structured credit analyst at UniCredit.

He adds: "Pricing for both deals tightened considerably. For Ripon, initial price talk on the senior tranche was around 85bp, which became 75bp-80bp during guidance and then settled at 75bp DM at final pricing. Harben's senior tranche priced at the same level over three-month Libor."

JPMorgan figures confirm DMs of plus 75 for Ripon's A1 and A2 tranches, as well as plus 140 for the B1 and B2s, plus 190 for the C1 and C2s, and plus 235 for the D1 and D2s. DMs for Harben were plus 75, plus 140, plus 190, plus 235, plus 264 and plus 344 for the A, B, C, D, E and F tranches respectively (see also SCI's primary issuance database).

Ripon alone was sized at £10bn. While only around a third was placed with investors, in the early days of the deal a minimum placed volume of just £683m had been on the cards. A large proportion of the deal was sold to a consortium of UK banks - consisting of Barclays, HSBC, Lloyds, Nationwide, RBS and Santander - which had pledged to take any paper the market would not.

"That consortium played an important role in getting the deals done. Their guarantee to buy unplaced paper was quite unusual for the market, as is a pledge they have made to hold onto that paper for a considerable amount of time," says Kapitza.

He continues: "For a year after closing, they will hold onto 100% of the paper they have taken, and then in the second year they can sell off 25% and the year after that they can sell another 25%, so they will remain significantly invested for a few years at least. That is an unusual way of getting deals placed, but otherwise the RMBS are both fairly standard; the deals contain the usual features that you might expect, such as their reserve funds or step-up margins if the deals are not called."

The role of this consortium of UK clearing banks was evidently significant in setting pricing and placing paper. TwentyFour Asset Management notes that there was also a "clever mechanism" through which the purchase amount paid to UKAR by the winning bidders "would be increased if a minimum amount of securitised bonds (approximately 7%) could be placed at tighter levels with ABS investors away from the clearing bank levels".

"If this was achieved those clearing banks would be obliged to take the balance of bonds at the same level. The net result being that the ABS investor appetite through tighter spread demand would translate into more proceeds for the tax payer, and it was clear to all that UKAR would shoot for the tightest pricing on the 7%," the firm adds in a memo.

This arrangement raised questions as to how much paper UKAR would actually allow ABS investors to get their hands on. As Kapitza notes, pricing ground tighter and tighter, eventually bettering committed levels.

"With the ball in its court, UKAR decided to take the unanticipated decision of giving ABS investors a full fill at the tightest end of ranges for each of the investment grade tranches. To put this into context, the Blackstone Ripon deal had a minimum size for the double-A rated class B of £48m and UKAR placed £409m, almost 10x what some may have assumed when placing orders," adds TwentyFour.

The strong demand that greeted the paper appears to have been fuelled by how quiet the market had been beforehand. The two deals have helped to propel UK ABS issuance, as a proportion of all non-North American issuance, up from 21% in 1Q17 to over 50%.

"Any paper can be placed right now, subject to certain risk levels. The market is incredibly hungry for yield and so is looking for every asset class available. The scarcity of assets - not just other BTL assets, but more generally as well - seems to have played into UKAR's hands," says Kapitza.

That scarcity may play into UKAR's hands once more. While the sale of the loans to Blackstone and Prudential lightened UKAR's load considerably, there are still more loans that can - and apparently will - be sold.

"At the end of last month, UKAR appointed Morgan Stanley for a £3bn Bradford & Bingley auction later this year. There are still assets to be sold and it looks as though UKAR intends to get rid of absolutely all of that legacy portfolio," says Kapitza.

The loans purchased by Blackstone and Prudential, and subsequently securitised in Ripon and Harben, had previously been securitised in Aire Valley. All of the loans are UK residential mortgage BTL loans.

For Ripon, the weighted average LTV of the loans is 64.4%, from a weighted average original LTV of 79.23%. The average loan size is £116,702 and weighted average seasoning is 134 months. There is considerable geographic concentration, with London and south east England accounting for 46.8% of the pool.

Ripon's A1 and A2 notes were rated triple-A by S&P, Moody's and Fitch. S&P and Moody's also rated the B1 and B2 notes at double-A and Aa1, the C1 and C2 notes at single-A plus and A1, the D1 and D2 notes at triple-B plus and Baa1, the Es at triple-B and Baa3, the Fs at double-B plus and Ba1 and the Gs at double-B and Caa1.

For Harben, the weighted average LTV of the loans is 64.14%, from a weighted average original LTV of 79.26%. The average loan size is £115,604 and weighted average seasoning is 133 months. There is considerable geographic concentration, with London and south east England accounting for 47.14% of the pool.

S&P, Moody's and Fitch rated Harben's A notes at triple-A. S&P and Moody's also rated the Bs double-A and Aa1, the Cs single-A plus and A1, the Ds triple-B plus and Baa1, the Es triple-B plus and Baa3, the Fs triple-B minus and Ba1, and the Gs double-B and Caa1.

JL

Structured Finance

STS discussions stumble on hierarchy

The Strasbourg Trilogue discussions on simple, transparent and standardised (STS) securitisation have been postponed until 30 May, due to disagreements between the European Parliament on the one hand and the European Commission and Council on the other over the hierarchy of CRR approaches. However, the European Parliament has made important concessions over risk retention, increasing the likelihood of a final deal before June.

Ian Bell, head of the PCS Secretariat, who has been closely following the Trilogue discussions, confirms: "A lot of deals were being struck, but a compromise stumbled on the hierarchy of approaches."

The European Parliament is proposing to swap the order of CRR approaches with the standardised approach (SA) coming second, the external ratings based approach (ERBA) third and the internal ratings based approach (IRBA) first. The European Council, however, prefers to retain the current hierarchy, with the SA third and the ERBA second. The institution seemingly objects on the grounds that the SA doesn't take into account the pools that are securitised.

"I suspect that the argument of some Council members is that it gives different pools with different risk characteristics the same risk weighting," observes Bell.

Pablo Sanchez Gonzalez, structured finance manager at the EIF, notes: "It's a discussion at the political level, which means that Parliament wants to reduce rating agency presence by moving the ERBA to number three in the hierarchy."

The opposite is true for the Commission and the Council, which are seeking to maintain the status quo. "Given the fact that the standardised approach may generate similar results for different asset classes, my understanding is that the Council would want to include the ERBA, since it may allow for some differentiation of asset classes by means of relying on the rating agencies," he adds.

Having the SA second in the hierarchy would be a boon for issuers, which would benefit from lower capital requirements, due to the supervisory formula. Sanchez points out though that this depends on the asset class.

"The SA can lower capital requirements for SMEs, but it is not equally benevolent for all asset classes," Gonzalez says. This is true, for example, for consumer loans that typically have short maturities and pay high coupons of 8%-9%.

Nevertheless, compromises appear to have been struck on almost all issues. The European Parliament, for its part, seems to have made a U-turn on risk retention and is said to be willing to retain the 5% risk retention rule within the context of a fully agreed deal.

As Bell notes: "There was a very positive bias, with agreements struck on very many fronts, but a cardinal rule of the EU is that nothing is agreed until everything is agreed."

This contrasts with Parliament's previous stance on risk retention. In a recent interview with SCI, MEP Paul Tang referred to a 20% risk retention requirement in the context of a prudential framework, the latter being "Parliament's biggest priority".

"We are essentially looking at five elements," he said. "First, you want to know where the risk ends up. Second, the STS market must be liquid; third, higher leverage must be associated with higher capital. Fourth, securitisation should not help accelerate the boom/bust cycle in the housing market and other markets. Finally, we want a clearer delineation of responsibility. There has to be a possibility for regulatory interference through volume limitation or rising retention."

Uncertainty remains over an STS designation for synthetics. "STS synthetics is not part of the framework for now," says Sanchez - although the Trilogue is currently "negotiating Article 270 of the CRR".

He refers specifically to the inclusion of private institutional investors on condition that the deals are cash collateralised. "From a market and a policy point of view, it makes perfect sense: eventually, you get the same zero risk weight and you open up the market to a broader spectrum of investors," he adds.

Indeed, Parliament seems to be developing a more open approach to an STS designation for synthetics. As Tang told SCI: "Initially, it was the Commission that didn't include synthetics in the STS label. Parliament sees synthetics as a separate complicated securitisation class that needs a separate legislative proposal from the Commission. However, we try to make a distinction between arbitrage and balance sheet synthetics, of which the second can be beneficial for the real economy. There is the question of how real the risk transfer is and there is no legislative proposal, but I can imagine an STS synthetic where the protection and risk retention is higher than in the current proposal."

He added that the label doesn't exclude private transactions, but "we can't allow private deals that circumvent transparency rules and shrink the public market."

In terms of legacy assets, he noted: "We could include previous securitisations, as long as they fulfil all STS criteria. We do not expect this to be applicable to many existing structures and therefore we are more focused on new securitisations and trying to create a new label. Including all past securitisations will dilute the value of this new label for high quality securitisations. It's not the major issue on the table."

The goal of the Trilogue is to finalise a deal before the end of the Maltese EU presidency on 30 June, with technical discussions slated to begin on 16 June. However, if a compromise is not found on 30 May, the political discussions may be moved to 16 June.

"There is a high probability that there will be a complete deal before June, given that there is political will on all sides," states Bell.

Gonzalez notes: "It would be good if they could be finalised before June, in order to get the market ready before January 2018, when the revisions to the CRR may kick in."

Tang also believes that a deal can be completed before the Maltese presidency ends, although he noted that the prudential framework is still a contested issue. In relation to this point, he said that a good trade off would be "less regulation for higher capital buffers, although I don't see momentum for the latter."

SP

ABS

Premium finance debut ABS lined up

Premium Credit is bringing to market is first term ABS, an unusual deal backed by premium finance contracts (see SCI's deal pipeline). While the size of the deal has yet to be confirmed, both Moody's and DBRS have assigned triple-A ratings to the senior notes.

PCL Funding II Series 2017-1 is a three-year revolving cash securitisation of non-life insurance premiums, sport and leisure membership fees, professional membership fees and private school tuition fee plans. All classes of notes will be denominated in sterling. The class A notes will account for 84.75% of the assets.

Moody's has rated the A, B and C classes at Aaa, A2 and Baa2 respectively. DBRS has rated the same classes triple-A, single-A high and triple-B high. Neither rating agency has rated the class D notes.

Moody's has rated a previous issuance from the same master trust. It notes that the historical performance of PCL Funding I compares positively to other EMEA consumer lending transactions, with delinquencies peaking below 2% and the average default ratio below 1%.

Moody's cumulative default expectation for the asset pool is 8.1%, recovery rate is 75% and portfolio credit enhancement is 14%. The rating agency notes that the class A notes would still have achieved a Aaa rating even if the cumulative mean default probability had been as high as 8.6% and the recovery rate as low as 65%.

The largest borrower accounts for only 0.2% of the pool and the 10 largest account for 1.3%. There is also significant geographic diversification, with the greatest exposure, to the south east of England, accounting for 24%.

Only 0.1% of the pool is more than 30 days in arrears. The balance of the portfolio in the total trust corresponds to around £1bn and the portfolio consists of 1,918,207 contracts. The weighted average portfolio interest rate is 10.9%.

Most of the receivables are linked to insurance or service contracts that allow the servicer to claim payments from insurance companies, brokers or the respective service provider in case of an obligor default. While PCL has extensive performance data, the master trust portfolio WAL is less than 0.5 years.

PCL has a market share over 50% in the UK market for insurance premium finance loans. It does not originate any loans other than what is included in the securitised pool.

Legal final maturity of the notes is June 2022.

JL

ABS

Subprime underwriting differences revealed

Regulation AB 2 loan-level disclosures have shed light on performance differences across transactions originated by the largest US subprime auto loan ABS issuers that would not have been apparent under previous disclosure requirements. A new Moody's analysis of Santander Consumer USA and AmeriCredit Financial Services data suggests that the differences reflect the sponsors' underwriting and pooling strategies.

For many years, net losses on the collateral backing Santander Drive Auto Receivables Trust (SDART) deals have consistently tracked higher than those of Americredit Automobile Receivables Trust (AMCAR) transactions. "Our initial analysis of the loan-by-loan data points to a number of potential contributors to the higher historical losses in loan pools backing SDART transactions relative to AMCAR deals that have been observed over time," says Moody's analyst Jody Shenn. "While the pools backing the first SDART and AMCAR deals of the year would have appeared to be generally similar based on previous disclosure practices, the new data show that the pool backing the SDART transaction includes a greater share of loans with certain layered risks."

The newly available data show that the pool backing the first SDART transaction after Reg AB 2 went into effect last November had a greater proportion of loans with combinations of specific risk factors that may make them more likely to default. In particular, a higher proportion of the SDART pool included loans with long maturities and high loan-to-value ratios that were extended to borrowers with relatively weak credit and without income verification. Additionally, SDART collateral includes more loans backed by used vehicles with long maturities and high LTVs, and more loans to borrowers without credit scores or with very low scores who did not use co-signers.

Relative to AMCAR 2017-1, SDART 2017-1 includes significantly more loans granted without income verification, a previously undisclosed loan characteristic. Income was verified for 64% of the total pool balance in the AMCAR deal, compared with 8% in the SDART deal.

Furthermore, although Santander increased its use of income verification as other loan risks increased, Moody's notes that the extra diligence was modest. In contrast, AmeriCredit frequently verified income for loans in high-risk categories.

"A lack of income verification weakens the usefulness of metrics that rely on borrower earnings to measure the affordability of loans and creates more uncertainty around whether borrowers will be able to afford their monthly payments, which becomes particularly important if they have poor credit records and risky loan terms. Such risk layering increases a pool's credit risk because it creates buckets of loans with especially high default probabilities," the agency observes.

The loan-level data also reveal that SDART 2017-1 included more loans with used vehicle collateral, high LTVs and long maturities. Under previous disclosure practices, only the overall higher proportion of loans extended to acquire used vehicles in SDART transactions would have been apparent.

Moody's analysis shows that loans with low or no credit scores, no co-signer and no income verification made up about 9% of the total pool balance of SDART 2017-1, compared with less than 1% for the AMCAR 2017-1 pool.

The agency notes that additional differences in SDART 2017-1 and AMCAR 2017-1 loan pools that are only apparent with the expanded disclosures appear modest, have uncertain credit implications or suggest lower risk for the SDART pool and hence would not explain the worse historical performance of SDART transactions. For instance, weighted average payment-to-income ratios - another attribute that issuers had not previously disclosed - appear similar in both new pools, at about 10%.

However, although the new disclosures may help explain the shelves' differing historical performance, Moody's notes that more information is needed to draw firm conclusions. For instance, loan-level performance data over time will be necessary to assess the degree to which individual risk factors and combinations of risk factors correlate with performance.

CS

Structured Finance

Regulatory proposal for SPVs 'credit negative'

Proposed European regulatory changes to classify SPVs as financial counterparties have created significant uncertainty and are credit negative, rating agencies warn. Should the European Commission's (EC) intended amendments to EMIR be carried out, transactions would be required to post two-way variation margin and clear derivatives centrally.

The EC's proposals remain subject to approval from the European Parliament and Council. Fitch says the proposed changes "create uncertainty over the use of derivatives" and Moody's notes they are "credit negative for existing deals with swaps".

"We think the imposition of a variation margin obligation on structured finance issuers could be incompatible with the relatively predictable cash flows received by the SPV and owed under its debt securities, unless mechanisms are developed and implemented to address this risk. SPVs have no operational mechanism to post variation margin that would be re-calculated regularly according to changing market prices, and our rating analysis would have to assess whether posting collateral would be likely to result in liquidity strains," comments Fitch.

The rating agency says that two-way variation margin posting could therefore limit the use of derivative contracts such as interest-rate and currency swaps because it is not clear how an SPV could comply with the collateral posting obligation. Particularly affected would be cross-border transactions that include exchange rate risk.

The axiom that swap counterparties for existing transactions can be replaced on similar terms if they become ineligible could also be jeopardised, so current deals would also be affected by this change, not just future ones, even without the proposal explicitly applying retroactively. It would not be possible to obtain a replacement if a transaction cannot comply with the two-way margin posting requirement for the new or novated derivative.

Outstanding ratings reliant on the performance of swaps could become constrained by the derivative counterparty's ratings. Transactions seeking replacement derivative counterparties would need to obtain investor consent to restructure or enter into derivatives on different terms, lengthening the time needed to replace a counterparty and exposing the transaction to increased risk in the intervening period.

Significantly, the proposal's negative credit effect is not limited to transactions with EU issuers, says Moody's, as margin rules would also apply to securitisation swaps between non-EU issuers and EU counterparties. The rating agency adds: "Non-EU issuers without sufficient local replacement counterparties typically seek global counterparties, but would likely only consider counterparties that are not subject to margining under the counterparties' own local rules. With prospective swap counterparties in the US already affected by margining requirements, the addition of equivalent rules for EU counterparties could materially reduce the likelihood of counterparty replacement for some issuers outside the EU and the US."

A proposal for all OTC securitisation derivatives exceeding a certain threshold to be centrally cleared is more likely to affect large issuers than smaller ones. Derivatives entered into by SPVs are generally too bespoke to be eligible for clearing in their current form, but if this changes then transactions using central clearing would become exposed to central counterparty clearinghouses.

"The full impact if the proposed amendment to EMIR came into force is highly uncertain," says Fitch. The STS initiative being reviewed by the European Parliament and Council could grant an exemption from central clearing and from two-way variation margin posting requirements.

Law firm Baker & McKenzie does not expect the legislation to be finalised until 2018. Even then, certain aspects will be phased-in, and of course not all aspects will survive the EU negotiation process.

"Following the example of the successful industry lobbying that saw covered bond issuers being exempted from the collateral posting obligation we can expect trade associations such as ISDA and AFME to lobby against the re-categorisation of SPEs as financial counterparties (having been involved in the original lobbying effort that saw SPEs avoid being classed as financial counterparties under the original EMIR). In any event, the securitisation industry has become accustomed to arguing for regulatory treatment which is proportionate to actual systemic importance while avoiding unintended consequences," says the firm.

JL

Structured Finance

SCI Start the Week - 15 May

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

Pipeline
There was a bit more variety to the pipeline's additions last week, although ABS once again led the charge. There were 10 ABS deals added to the list, along with a further four ILS, two RMBS and five CMBS.

The ABS were: US$1.05bn Ally Auto Receivables Trust 2017-3; US$575m ARI Fleet Lease Trust 2017-A; CNY3.111bn Autopia China 2017-1 Retail Auto Mortgage Loan Securitization; US$500m Barclays Dryrock Issuance Trust Series 2017-1; Bavarian Sky Compartment Germany 6; US$440m Five Guys Funding Series 2017-1; €1.1bn IM Grupo Banco Popular Leasing 3; PCL 2017-1; CNY4bn Rongteng 2017-2 Retail Auto Mortgage Loan Securitization; and CNY3bn Toyota Glory 2017-1.

US$250m Alamo Re 2017-1, US$100m Casablanca Re Series 2017-1, Riverfront Re 2017-1 and US$375m Sanders Re 2017-2 were the ILS, while the two RMBS were IDOL 2017-1 and A$342.6m Liberty Series 2017-2 Trust. The CMBS consisted of: US$500m 245 Park Avenue Trust 2017-245P; US$644.66m CFCRE 2017-C8; US$805m Hospitality 2017-HIT; US$143m NCMS 2017-75B; and US$480m Olympic Tower 2017-OT.

Pricings
The prints were once again divided between ABS and CLOs, with a couple of RMBS and CMBS thrown into the mix.

The ABS were: US$1.3bn AmeriCredit Automobile Receivables Trust 2017-2; A$495m Driver Australia Four; US$442.41m DT Auto Owner Trust 2017-2; US$515m Nissan Master Owner Trust Receivables Series 2017-A; US$760m Nissan Master Owner Trust Receivables Series 2017-B; US$530m SoFi Consumer Loan Program 2017-3; US$420m Textainer Marine Containers V 2017-1; US$1.75bn Toyota Auto Receivables 2017-B Owner Trust; and CNY3.4bn VINZ 2017-1.

RUB7.4bn Mortgage Agenct Vozrozhdenie 5 and US$2.28bn Towd Point Mortgage Trust 2017-2 were the RMBS. The CMBS were US$272m CSMC Trust 2017-LSTK and US$702.57m MSBAM 2017-C33.

The CLOs were: US$483.45m AIMCO 2014-AR; €411m Aqueduct European CLO 2; €353.7m Dryden Leveraged Loan CDO 2014-35R; US$493.8m KVK CLO 2015-1R; US$570.95m LCM Partnership 2014-15R; US$660.96m Octagon Investment Partners XIV 2012-1R; US$666.9m Palmer Square CLO 2015-1R; and €415.12m Weser Funding Compartment No.1.

Editor's picks
Landmark portfolio guarantee inked: The EIF has agreed to guarantee 50% of a €5.52bn Spanish SME credit portfolio originated by nine Spanish banking groups. Dubbed the SME Initiative Uncapped Guarantee Instruments (SIUGI) for Spain, the deal is a bespoke EU-sponsored risk transfer transaction (see SCI's capital relief trades database)...
Equity holds the cards amid heavy refinancings: While buoying European CLO deal volumes, refinancings and resets are not always favoured by senior investors that have little control over the resultant reduced margin and amended deal terms. However, if navigated adequately by the equity holders, European CLO investors across the capital stack can benefit from the refinancing/reset process and new investors continue to be drawn to the asset class...
Floaters beat ARMs in a bear flattener: Yield curve flattening and a rapid increase in prepayments on post-reset adjustable rate mortgages (ARMs) are expected as US interest rates rise. As such, certain floating-rate products - including SBA floaters, CMO floaters and agency CMBS - could become more attractive in the next 12-18 months...
Letter opposes Lehman proposal: Lawyers from Kasowitz Benson Torres, representing an investor group holding certificates issued by RMBS trusts with claims in the Lehman Brothers bankruptcy, have expressed concern over a proposed US$2.4bn settlement. The case is one of the few remaining put back disputes arising from pre-crisis RMBS and one of the last remaining Lehman bankruptcy cases...
Euro CLOs diverted: A busy primary market is diverting focus away from the European CLO secondary market this week. "It's much quieter this week as we're being dominated by primary," says one trader. "There, shorter dated triple- and double-As are drifting wider, but that's not yet feeding through into secondary spreads..."

Deal news
• Palomar Specialty Insurance Company has successfully closed its first cat bond obtaining protection against catastrophe perils. Torrey Pines Re Series 2017-1 is a US$166m ILS providing the insurer with US earthquake, named storm and thunderstorm reinsurance protection.
• Five Guys Enterprises has become the latest company to bring a whole business securitisation. The US$440m Five Guys Funding transaction is secured by most of its revenue-generating assets in the US and Canada.
• Groupe Eurotunnel is set to refinance its Channel Link Enterprises Finance (CLEF) whole business securitisation, as part of an ongoing strategy to optimise the structure of its debt and to reduce the cost of its debt service. The company proposes to issue up to €2bn-equivalent senior subordinated variable and fixed-rate notes, split across a number of tranches due in 2050.
• Textainer Equipment Management is in the market with the latest container ABS. The deal's arrival comes as part of a flurry of activity in the sector, which is riding high on a rebound in shipping container prices.

Capital Relief Trades

Risk transfer round-up - 19 May

Sources expect three true sale significant risk transfer trades to be issued by Italian banks this year, with NPLs as the underlying asset. Banca Popolare di Bari is rumoured to be one of them.

"Given that the senior tranche will be retained under GACS, I would expect a substantial portion of the mezzanine and the junior to be sold," says one market participant.

Banca Popolare di Bari was the first Italian bank to securitise NPLs under the GACS guarantee (SCI passim).

NPLs

Atlante momentum waning?

Italian bank rescue fund Atlante II has completed the purchase of its debut €2.2bn non-performing loan securitisation, clearing the way for UBI Banca's acquisition of three small rivals rescued in late 2015. The investment is believed to be one of four transactions that the fund will finalise this year.

The NPL sale was one of the conditions imposed by UBI to agree to the acquisition of Banca Marche, Banca Etruria and CariChieti (SCI 31 January). Atlante II is set to pay €713m initially for the portfolio, or 32% of its nominal value. According to Quaestio Capital Management, the price reflects the fact that 80% of loans in the portfolio are backed by collateral - with around half of them likely defaults and only approximately 12% new unsecured bad loans.

"It's not a market deal, but a bailout," says Francesco Franzese, md and founder of Aram Capital. "It would be difficult to find an investor to buy the mezzanine at 10%."

The €713m purchase price is set to be reduced to €513m, thanks to a €200m senior term financing, which is being arranged with a group of banks and which will be used to buy the mezzanine-junior tranches. The 10% coupon is based on a business plan that assumes cashflows able to repay interest in excess of 10% to the Fondo di Garanzia Banche, the national resolution fund.

"It's clear from this that the mezzanine is really the equity in terms of risk profile," observes Franzese.

The move comes at a time when momentum behind the Atlante initiative appears to be waning, with investors writing down their participations in the funds. In February, for example, Unicredit heavily wrote down the value of its €700m investment. Intesa San Paolo - which was the biggest investor in the fund, along with Unicredit - has written down the value of its stake by 33%.

This follows the announcement last August that three Italian first pillar pension funds - Enpav, Inarcassa and Eppi - would not invest in Atlante II. Developments such as these are reflective of investor pessimism regarding the future returns they can earn from Atlante, given that the funds are buying NPL portfolios above what many consider to be fair market value.

Nevertheless, Atlante II is rumoured to be working with three other banks - CR San Miniato, CR Cesena and CARIM - on a transaction "similar" to the one with Banca Marche, Banca Etruria and CariChieti.

Pessimism around the Atlante initiative is not expected to discourage investment activity in the Italian NPL market in the short to medium term, however. Italy was the most active market in Europe in 2016 and Deloitte expects the pace of deal making to continue this year. The firm cites more realistic pricing expectations, an improving transaction environment and a political commitment to NPL resolution as all pointing to a crowded deal pipeline.

According to the Bank of Italy, Italian banks held a total of €360bn of NPLs at the beginning of 2016, with an NPL ratio of 18% - the highest in Europe. But with completed and on-going deals totalling around €76bn, Italy's loan sale transaction rate was equivalent to that of UK, Ireland, Spain and the Netherlands combined last year. This rapid turnover has been facilitated by intensive government support of the loan sale market, which Deloitte expects to continue or even accelerate in 2017.

SP

RMBS

Optionality driving RMBS focus

The legacy US non-agency RMBS market is experiencing a 'perfect storm' of events, given the current low rate, low volatility environment. Strong performance and increasing optionality has prompted a renewed focus on the product.

The last 12 months have been stable - with a couple of short-lived bouts of volatility around the Brexit vote and in the run-up to the US election - for non-agency RMBS and the asset class continues to perform well. "While this partly explains the renewed focus on the product, it's largely because the fundamental value of the asset class remains strong. The remaining legacy loans continue to experience house price appreciation and the ability to refinance remains high with low mortgage rates, and therefore the overall performance in these sectors remains high," says Neil Aggarwal, portfolio manager and head of RMBS at Semper Capital Management.

He adds that the development of new product types - such as re-performing/non-performing loan, single-family rental and credit risk transfer deals - has reinvigorated demand by enabling investors to express new views on post-crisis residential mortgages. "Both the entrance of SFR sponsors and the GSEs' introduction of creative structures by transferring credit risk to the private market have been strong drivers of performance. The SFR markets have eliminated certain areas of excess housing supply and the GSEs have created a new way to express credit views in housing today."

Against this backdrop, another main driver of relative value is optionality, according to Aggarwal. "The market is pricing in quite a few interest rate hikes and there are opportunities in both the legacy RMBS universe and these new RMBS sectors to take differing views around these projections - will the projection of the forward curve be realised, or will it come in under or over the projection? It is possible to access different trades, depending on your view of the curve and on the timing of Fed hikes," he explains.

For legacy deals, assumptions around fundamental value, rate hikes and structural optionality were run conservatively immediately post-crisis. This meant that investors were able to make returns north of 20% because the scenario analysis was too harsh.

Whereas in 2010 estimated returns could be 50%-100% higher than base case estimates, within today's estimates there still is room for outperformance of 15%-25% over a period of time. Aggarwal suggests that base-case assumptions in today's estimates are a 4%-7% yield.

"The ability to add alpha requires in-depth analysis of the structure with expertise on the collateral, as well as a significant understanding of the technical nature of these products within overall markets," he concludes.

CS

RMBS

Structured sale to be resecuritised

Freddie Mac is auctioning an approximately US$292m pool of seasoned re-performing loans from its mortgage investments portfolio in its second such structured sale. The transaction will involve a two-step process and ultimately result in the issuance of the Freddie Mac SLST Guaranteed Securities Series 2017-1 resecuritisation.

The pool is comprised of loans with step-rate modifications (primarily HAMP) and loans modified under GSE proprietary modifications. Currently serviced by Select Portfolio Servicing, the loans are re-performing and moderately delinquent.

The initial step in the sale process involves a competitive bidding process, which will be executed on the basis of economics, subject to meeting Freddie Mac's internal reserve levels. The second step will require the winning purchaser to securitise the loans and retain the first-loss subordinate tranche. Freddie Mac will, in turn, guarantee and acquire the senior security issued from the securitisation and simultaneously resecuritise it via the Freddie Mac SLST Guaranteed Securities Series 2017-1 vehicle.

A key requirement of this transaction is that the buyer of the loans is an investor with substantial experience managing "high-risk" mortgage loans, as well as substantial experience in securitisations. The same requirement was stipulated in Freddie's US$199m pilot structured sale of seasoned loans (SCI 30 June 2016), which was expected to settle last October.

Chimera Investment was the winning bidder in that auction, but Freddie Mac didn't disclose whether it would resecuritise the resulting senior security in this case. The cover bid price on the pool was in the high US$70s.

Advisors to Freddie Mac on the current transaction are Wells Fargo, Credit Suisse and CastleOak Securities.

CS

Structured Finance

Job swaps round-up - 19 May

CDO manager transfers

Dock Street Capital Management has replaced Vertical Capital as portfolio advisor to Summer Street 2005-HG1 and Vertical CDO 2003-1. Moody's confirms that the move will not impact the ratings on the ABS CDOs.

EMEA

BlueMountain Capital Management has named Louisa Church ceo for Europe. She will also continue in her role as head of client advisory - Europe, Middle East and Australia, and as a member of the firm's management committee. Church had shared the role of co-ceo of Europe with Nicholas Pappas, who recently resigned from the firm.

Cairn Capital has appointed Brandon Kufrin as a co-portfolio manager for the Cairn Special Opportunities Credit Fund and for special opportunities within its multi-asset credit funds. He will work alongside Maria Rassam, focusing on CLOs, securitisation warehouses and bridges, corporate structured credit, specialty finance, asset-based private credit and risk transfer transactions with financial institutions. Kufrin was previously a senior investment analyst at Magnetar Capital in London, where he had co-risk management responsibilities for its US$1.2bn European credit portfolio.

Name change

The Arrowpoint CLO 2013-1, 2014-2, 2014-3, 2015-4 and 2016-5 transactions have respectively been rebranded Elevation CLO 2013-1, 2014-2, 2014-3, 2015-4 and 2016-5. The move follows the rebranding of the manager Arrowpoint Partners to ArrowMark Partners in March.

North America

BlueMountain Capital Management partner and portfolio manager Marina Lutova Meyers has been given expanded responsibilities for overseeing performing credit globally, while continuing to lead the firm's long/short credit portfolio in North America and its index arbitrage strategies. Additionally, fellow partner and portfolio manager Omar Vaishnavi has been made responsible for overseeing BlueMountain's distressed strategy globally, having previously been responsible for the distressed portfolio in North America. The pair are members of the firm's management committee, while Meyers is also a member of its investment committee.

Hercules Capital is expanding its ongoing review designed to determine the most appropriate investment advisory structure to enhance shareholder value (SCI 12 May). Accordingly, the special meeting of stockholders previously scheduled for 29 June has been postponed indefinitely and the proposal to seek stockholder approval to adopt an external investment management structure has been withdrawn. The independent directors intend to engage an independent financial adviser to consider all available options with regard to the company's investment management structure.

Redpoint Capital Group has hired Alex Dunev as a managing partner, responsible for driving the firm's strategic priorities, including sourcing new investment opportunities and raising capital to deploy into its investment strategies. He will also manage Redpoint's office in Westport, Connecticut. Dunev was previously an md in the investment banking division at UBS, leading the bank's specialty finance efforts in the Americas.

The US SEC has charged a pair of former head traders who ran Nomura's CMBS desk with deliberately lying to customers in order to inflate the profits of the CMBS desk and line their own pockets as a result. James Im and Kee Chan are alleged to have each misrepresented price information while acting as intermediaries on trades with Nomura's CMBS secondary market customers. Chan has agreed to settle the charges by paying US$51,965 in disgorgement, plus US$11,758 in interest and a US$150,000 penalty, and will be barred from the securities industry with the right to reapply after three years. The case continues against Im.