Contents

NPLs

ReoCos boost Italian NPL prospects

The Italian parliament recently approved new amendments to the Italian securitisation law, aimed at improving recoveries of non-performing loans and at facilitating disposals of NPLs by banks, including non-performing lease receivables. Along with a stronger macroeconomic environment, the measures are expected to help boost the liquidity of real estate asset disposals.

Under the amendments - which were introduced in June - SPVs are now allowed to purchase, manage and dispose of assets backed by secured NPLs, including assets subject to ongoing or terminated non-performing financial lease agreements, through specialised real estate-owned companies (ReoCos). All the proceeds realised by a ReoCo during this process must be paid to the SPV and segregated for the benefit of noteholders, as well as to pay transaction costs.

ReoCos are SPVs that can participate in auctions and acquire real estate assets, both on- or off-balance sheet. The former holds when a bank sets up and owns the vehicle, while the off-balance sheet option only applies if the servicer has been paid a fee to set it up and store the assets in a vehicle company in which the bank does not own the majority of the shares. Unlike standard SPVs, however, they are regulated, since they are consolidated on bank balance sheets and they are created for the sole purpose of serving a securitisation transaction (SCI 13 July).

Setting ReoCos up though presupposes local market knowledge and an understanding of technical issues. Massimo Famularo, head of Italian NPLs at Distressed Technologies, explains: "Acquiring an asset implies taking real estate risk - very different from the kind of lending that banks are accustomed to - and local market knowledge. Therefore, it is crucial to have the contribution and expertise of local market providers."

An additional challenge is consolidating ReoCos on bank balance sheets. Ugo De Vivo, legal director at DLA Piper, explains: "It would have been easier from an investor's perspective if ReoCos could have been controlled by the servicer, who is also a regulated entity, according to Italian securitisation law."

Another aspect to be considered is that ReoCos are set up for specific securitisation transactions, limiting the possibility to create a platform that can be used for multiple transactions. More importantly, however, the vehicles remain untested.

"Most likely depreciation of assets would be less significant with ReoCos, although we still need case studies and that is still pending," notes Alessio Pignataro, svp at DBRS.

Uncertainty is a theme that extends to the tax and legal aspects of the vehicles. "Given that ReoCos own property, this raises tax and legal issues," notes Gordon Kerr, head of structured finance research Europe at DBRS.

DBRS believes that it would be helpful if the Italian tax authorities could clarify whether and under what conditions the proceeds from the liquidation would be 'fiscally neutral' for the ReoCo, with the term referring to the taxation of capital gains. Pignataro elaborates: "Capital gains from the disposal of the asset should be fiscally neutral, otherwise they will be taxed, making the introduction of ReoCos in the context of a securitisation less palatable. This seems to be the intention of the law, although it still needs to be clarified by the Italian authorities."

Italian law stipulates that when an asset is bought at an auction, a 9% tax must be paid on the reserve price. There is a temporary special benefit that allows those who buy the asset to pay only €200 if they sell it within 24 months. Those who fail to sell the asset within the term will be subject to a 30% penalty.

"The benefit expired on December 2016, but it will likely be renewed this year," says Famularo.

According to Scope Ratings, the recent reforms will help improve the performance of securitisations in several ways. In the agency's view, their most meaningful impact will be to encourage SPV participation in foreclosure property auctions. This is likely to improve market liquidity and collateral valuation transparency, which in turn would have a positive effect on recovery timing expectations and the net present value of secured NPL portfolios.

The ability to establish ReoCos is also likely to support a higher volume of transactions. Indeed, Scope anticipates that private portfolio sales and public securitisations of NPL portfolios will continue to expand in 2018, as structural reforms start to bear fruit and the economic recovery gradually unfolds.

SP

Capital Relief Trades

Standardisation to bridge synthetic STS gap?

The EBA's recent discussion paper on significant risk transfer (SRT) outlines the common structural features of risk transfer transactions in an attempt to harmonise their regulation and supervision (SCI 20 September). The move ultimately may bring the CRR regulation closer to extending the STS label to synthetic securitisations.

The EBA's proposals are informed by the new European securitisation framework and the authority believes that SRT will be a crucial aspect of this reform. According to Christian Moor, policy advisor at the EBA, extending the STS label to synthetic securitisations would involve an assessment of how the concepts of simplicity, transparency and standardisation would apply to synthetic securitisations.

"However, there is no question that common structural features for risk transfer transactions are the first crucial step," he observes. Although incomplete, common structural features for risk transfer transactions would enhance structural consistency across EU jurisdictions, allowing issuers to argue their case in favour of synthetic securitisations much more forcefully when negotiating with national regulators.

The EBA identifies amortisation structure, excess spread, cost of credit protection and call options as examples where further specifications may be helpful. Notable for the amortisation structure is that the paper allows pro-rata amortisation if the transaction includes certain contractual triggers.

According to the document, pro-rata amortisation should only be used in conjunction with clearly specified contractual triggers determining the switch of the amortisation scheme to a sequential priority, safeguarding the transaction from the possibility that credit enhancement - and with it the extent of risk transfer - is too quickly wiped out during the life of the transaction. The EBA paper puts forward four triggers for an SRT transaction.

The first one concerns cumulative losses higher than a given percentage of the lifetime expected losses (EL) computed and disclosed by the originator, whereby lifetime EL equals the product of the regulatory one-year EL on the underlying exposures and the weighted average life (WAL) of the transaction. The second trigger is cumulative non-matured defaults higher than a given percentage of the sum of the outstanding nominal amount of the protected tranche and the tranches that are subordinated to it.

The third is where weighted average credit quality in the portfolio decreases below a given pre-specified level and/or the concentration of exposures in high credit risk (PD) buckets increases above a pre-specified level. Granularity of the portfolio falling below a given pre-specified level is the fourth trigger.

Regarding call options, the EBA notes that time calls can be included in synthetic securitisations if they can be exercised at a point in time where the time elapsed since the securitisation's closing date is equal to or higher than the WAL of the initial reference portfolio. If the transaction features a replenishment period, a time period equal to the WAL of the portfolio should elapse from the end of the replenishment period before the time call is exercised.

Finally, the paper offers a set of proposals aimed at tackling the limitations of the EU framework to measure SRT and, in particular, to provide a platform for a more harmonised assessment of the concept of commensurate risk transfer. Two options are suggested: enhance existing tests by introducing a new requirement on the minimum thickness of the first loss tranche and introducing a test of commensurate risk transfer, based on a comparison of the capital relief achieved by the originator with the portion of total portfolio losses that is transferred to investors; and introduce a new test that is able to measure both significant risk transfer and commensurate risk transfer.

However, a number of issues are expected to spark debate, most notably in relation to synthetic excess spread and early termination clauses. According to the document, excess spread in synthetic securitisations is permitted under certain conditions.

One is if originators do not commit amounts of excess spread that are excessive or cannot be generated by the portfolio. To deal with this, the paper proposes that the total amount committed every year may never be higher than the one-year regulatory EL on the underlying portfolio. Additionally, the originator may only use the committed nominal amount on a yearly basis in accordance with a trapping mechanism.

According to Moor, "the proposals essentially treat synthetic excess spread as a first loss position, which is why it will be controversial, since banks will have to hold more capital against losses."

A second issue concerns the early termination of the protection. The EBA document states that an originator's bankruptcy exposes investors to deterioration of the originator's servicing standards. This is why investors are keen to have an early termination clause as the originator's bankruptcy occurs.

However, this is where the issue becomes contentious. "In reality, the bankruptcy event is a very remote one that comes after all the measures contemplated in the BRRD for a financial institution going into trouble," says Pablo Sanchez Gonzalez, structured finance manager at the EIF.

The BRRD stipulates that as originators enter resolution, structured finance transactions are subject to specific provisions safeguarding the transaction's counterparties, through partial property transfers and other resolution measures. Gonzalez continues: "It is because of the BRRD that we think that the bankruptcy event is a much more unlikely event, compared with other resolutions or actions that typically come first and therefore should not be considered as something that potentially goes against SRT."

He suggests that the market has already taken into consideration many other kinds of call options, such as regulatory calls and clean-up calls, but the EBA paper doesn't seem to provide a solution to the most controversial - the bankruptcy event.

The EBA's consultation on SRT runs until 19 December. A public hearing will take place at the EBA premises a month earlier on 17 November.

SP

CMBS

Trustee role rewritten by court?

A ruling by the UK High Court could have significant implications for trustees, potentially redefining their role in securitisation. The court's ruling confirms that a trustee cannot outsource decision making and must take responsibility for exercising the discretion that deal documents allow them, although questions do remain.

GLAS Trust Corporation was brought into the Fairhold Securitisation (FHSL 2006-1) as a replacement trustee, at the behest of bondholders. Those bondholders removed Deutsche Trustee Company, apparently because GLAS was deemed to be more noteholder-friendly.

The Fairhold Securitisation is unusual and represents a hybrid between a CMBS and a whole-business ABS. It also has no servicer, making the trustee's role all the more significant.

An amenable trustee was desired because a group of bondholders would like to rescind the securitisation swaps, thus removing a significant senior ranking liability from the deal and therefore increasing recoveries for bondholders. Doing so economically would require the trustee's assistance.

In October 2015, UBS notified the issuer that it was exercising its optional early termination rights in respect of the swaps. GLAS was brought in to replace Deutsche.

In the same month, there was a potential event of default on the notes as the issuer failed to pay interest due, after which the cash manager informed UBS that the trustee had directed it not to make any payments under the swaps and to hold back amounts otherwise payable to the swap providers.

Last year, the issuer purported to rescind the swaps on the basis of alleged fraudulent misrepresentations made by the swap providers. Also in that year, the trustee was asked to pay expenses for an ad hoc group of bondholders for work which was said to be for the benefit of all noteholders.

That ad hoc group was therefore doing work for the benefit of all bondholders and charging the trustee for this service. The extent to which such an arrangement is permitted was central to the court case.

"Trustees have been a standard feature of bond issues since the first Eurobond deals in the 1960s, but traditionally their role has been quite passive with not much need for discretion. More complex deals, such as securitisations, with more complex assets, such as real estate, are a different matter," says Conor Downey, partner, Paul Hastings.

Such additional complexity increases the likelihood that there will be circumstances requiring decisions to be taken on behalf of investors. Where there is no servicer - such as in the Fairhold Securitisation case - this means trustees are relied upon to exercise discretion. However, with only 12 or so years of experience of distressed securitisations in Europe, and relatively few transactions that have come to court, Downey notes that trustees have been given little guidance as to how to act in such cases.

If trustees previously believed that they could outsource the exercise of discretion to a third party, that is no longer the case. "The significance of the court's decision is that this has been rejected," says Downey.

In fact, the decision appears to have created a significant duty of care for trustees. Trustees will currently typically review deal documentation to identify and limit circumstances in which they might be required to use discretion, arguing that they are not equipped to make commercial decisions. However, as Downey notes, the court "has been clear that trustees must act when required to do so, but that creates liability for trustees".

"This case is particularly helpful for the wider market because it establishes the principle that trustees can indeed incur some expenses on behalf of noteholders," says Jennie Dorsaint, partner, Paul Hastings. "It is important to keep in mind that trustees must also be able to justify those expenses."

These extra responsibilities and liabilities that trustees now appear to be saddled with would appear to require a higher level of compensation. Many of these issues were explored when the market debated the merits of so-called 'super trustees' as one reaction to the crisis (SCI 12 June 2012).

"Trustees may have to increase the fees they charge transactions, as the nature of their legal responsibilities seems to becoming wider than they had previously assumed to be the case and they may need to charge more for the risks they are taking," says Downey.

In the Fairhold case, bondholders had instructed GLAS to pay certain legal and advisory fees incurred and to be incurred. UBS appears to have come to the conclusion that some of these expenses would be for potential litigation against it.

While the court did not rule on that, it did note the difficulty in always drawing the line between expenses which the trustee could legitimately pay and those which would not be permissible. While the court has provided guidance as to how the trustee could make decisions, as this has not been definitively ruled on, the matter may yet have to be resolved in the courtroom.

Meanwhile, the Fairhold bondholders are left with a dilemma. While pursuing litigation may be prohibitively expensive, trying for an appeal would present difficulties of its own, considering the judgment was quite clear.

However, if the bondholders do nothing, they stand to lose hundreds of millions of pounds. The stakes are high in the Fairhold case, and the court's ruling suggests they are also higher than previously realised for trustees in the wider market.

JL

ABS

Caribbean consumer deal prepped

CFG Holdings is in the market with a consumer ABS backed by a pool of local currency fixed-rate personal loans originated by its subsidiaries in Panama, Aruba, Curaçao and Bonaire. Dubbed CFG Investments 2017-1, the US$222m securitisation features a Cayman Islands SPV as note issuer and a borrower SPE in each jurisdiction.

The pool comprises 75,805 loans totalling US$247.06m, with Panamanian receivables accounting for 52.30% of the outstanding balance, Aruba accounting for 23.55%, Curaçao accounting for 21.35% and Bonaire 2.80%. The average original balance was US$3,797, the weighted average seasoning is 10 months and the weighted average remaining term to maturity is 45 months. The WA coupon is 34.71%.

The underlying loans will be transferred at closing through a loan purchase agreement, representing a true sale. Each SPE will borrow funds from the issuer to finance the acquisition of the receivables, except for the Aruba borrower, in which case the cash will be extended via the Curaçao borrower in its capacity as intermediary. Simultaneously, each SPE will pledge the receivables to the issuer to secure its respective revolving loan.

The transaction has a three-year revolving period, during which the loan composition can change, subject to eligibility criteria. Each SPE will pay interest on its revolving loan at a rate equal to its allocable portion of the issuer's cost of funds, plus a spread. The issuer will subsequently transfer these interest amounts to noteholders.

The deal also features intercompany agreements, through which SPEs with insufficient funds can request a cash advance from those with excess flows to cover the amounts due under the revolving loan and purchase additional receivables. Payments on these promissory notes will be subordinate to the payments due on the revolving loans.

S&P has assigned preliminary ratings of triple-B to the US$173m senior notes and double-B to the US$37m subordinate notes. There is also an unrated US$12m risk retention class.

Among the factors considered by the rating agency in its credit quality analysis is the significant geographic concentration within CFG's existing pool of loans and within the allowed worst-case pool composition. Additionally, there is an increased risk of loss across the four jurisdictions from weaker economic conditions or event risk, such as natural disasters - albeit this is addressed to some extent by the company's ability to use resources from unaffected branches to service affected branch obligors.

The deal benefits from approximately 32.85% and 17.88% credit support to the senior and subordinate notes respectively, in the form of subordination, overcollateralisation, a reserve account and excess spread. The structure incorporates performance-based early amortisation triggers that are linked to a monthly cumulative net loss percentage, as well as early amortisation triggers that are linked to a servicer default.

CFG is a consumer finance company that offers unsecured personal loans and related credit insurance products in the Caribbean and Panama, with headquarters in San Juan, Puerto Rico. It began operations in 1979 and was previously a part of Wells Fargo's Latin American consumer division, which was sold in 2006 to Irving Place Capital.

The company operates through a branch network to individuals that have limited access to consumer credit from banks and other traditional lenders. Personal loans are unsecured and structured with a fixed interest rate, a fixed term, equal monthly installment payments and no early repayment penalties.

Servicing is centralised or branch-based and customer payments can be made via payroll deduction, standing order or counter payment. S&P notes that CFG attempts to balance payment by payroll deduction and standing orders (representing approximately 60% of active accounts), which provide for the highest likelihood of payment, and counter payments (40%) that help develop customer relationships and lead to repeat business.

In terms of operational risks, S&P suggests that there is a high risk of servicer disruption, given that a substantial percentage of obligors makes payments at their local branches and branch closures could delay payment collections. The rating agency also points to the low availability of potential servicer replacements, the limited history of portfolio transfers and the fact that CFG's servicers have idiosyncratic business practices that could challenge a replacement. Nevertheless, the deal provides for a back-up key transaction party: Grant Thornton's role of transition manager mitigates some of the servicing disruption risk.

CS

ABS

PCP agreements pressure UK ABS

The increased use of personal contract purchase (PCP) agreements is putting pressure on UK auto ABS, suggests DBRS. While the rating agency does not think deals will be negatively affected in the short term, the trend is worth monitoring.

DBRS has rated 15 UK auto ABS since 2010 and finds the correlation between new car registrations and prepayment rates, as well as the increasing weight of PCP agreements, reinforces the role of captive auto finance lenders in supporting new car sales growth. PCP agreements are gaining importance in auto ABS portfolios but more recently originated transactions are reporting higher voluntary termination rates.

A PCP agreement allows a borrower to pay a fraction of a car's purchase price as a deposit, followed by monthly instalments over the life of the agreement - which typically lasts three to four years - and then the borrower either makes a final balloon payment or returns the vehicle to the lender. Until that final decision is made, the finance company continues to own the vehicle.

Should the borrower return the vehicle to the lender at the end of the agreement, the lender relies on a healthy used car market to sell the car on. Borrowers also have the option of using equity in the vehicle as a deposit for a new vehicle, or to voluntarily terminate the agreement.

PCP agreements are increasingly being included in UK auto ABS. The balance of PCP loans accounted for 14% of the initial portfolio of Motor 2011, but 58% of the portfolios rated last year. While PCP agreements have been common in Volkswagen Financial Services deals for some time, more recent transactions have been 92%-94% PCP.

While vehicle return rates at maturity for PCP agreements continue to remain low, declining recoveries are being noted. DBRS also points out that PCP terms are lengthening, which is supporting increased new car sales volumes by making instalments more affordable.

Delinquencies and defaults have remained low for UK auto ABS despite the increased prevalence of PCP agreements and DBRS believes the deals it rates have sufficient credit enhancement levels to ensure these recent changes in the market do not negatively affect ratings. Excluding Startline, the 60-90 days delinquent bucket for deals rated by DBRS would average only 0.1%. Even with Startline, the average increases to just 0.2%.

UK law allows a consumer to terminate a car finance agreement prior to full repayment and return the vehicle to the lender, providing they have paid at least 50% of the total amount payable. An increase in such voluntary terminations is supporting an increase in CPRs.

"DBRS has observed higher voluntary terminations in more recently originated ABS transactions. This increase reflects a weakening in used car values and places further downward pressure on used vehicle prices," says the rating agency.

"Auto ABS UK and DUKM 3 have shown higher voluntary terminations 12 months after their closing dates at 1.2% and 0.6%, respectively. This is comparatively higher than the 0.1% for HCUK and E-CARAT 4 after the same amount of time from origination."

While CPRs are increasing, return rates on PCP agreements are low. DBRS believes borrowers are frequently using equity to purchase another vehicle before contract maturity.

While return rate data on PCP agreements is limited, PCP returns for Volkswagen deals have been minimal since 2011. For example, PCP returns for Private Driver UK 2016-1 (see SCI's deal database) have remained flat at 0.02% since May 2017.

"Overall, DBRS has observed decreasing recovery rates across DBRS-rated deals. The rapid turnover of new vehicles arising from PCP agreements has potentially led to an oversupply within the used car market because of an influx of clean, low-mileage vehicles typically fewer than four years old, placing downward pressure on used car prices," says DBRS.

"Focusing on Volkswagen transactions, recoveries on PCP agreements have been consistently declining year over year. From late 2013 to mid-2015, cumulative recovery rates frequently exceeded 100%. However, in late 2015, DBRS observed a fall in cumulative recoveries to 90%, which has continued to decline, dropping to 78% in July 2017."

This persistent fall in recoveries indicates that future vehicle values, projected at the start of PCP agreements and relied upon for future sales into the used car market, may be at increased risk of being higher than realised proceeds from vehicle sales at contract maturity. This increases the exposure of the lender and therefore of ABS transactions to residual value risk.

JL

ABS

Aviation ABS prepped for take-off

Global Jet Capital is marketing an inaugural US$1.48bn aircraft ABS. Dubbed Business Jet Securities Secured Note Series 2017-1, the transaction is supported by a portfolio of 181 business jet aircraft, representing 154 obligors, with a remaining term of approximately 62.1 months.

The securitisation is structured like a master trust with two note classes, each of which is time-tranched in two-, three- and five-year intervals. The notes must maintain predetermined advance rates, otherwise monthly parity payments will be required.

Global Jet Capital is a private investment fund formed in 2014 and owned by affiliates of the Carlyle Group and GSO Capital Partners, in partnership with FS Investments and AE Industrial Partners. Global Jet Capital entered into a sale and purchase agreement with GE Capital in October 2015 to obtain a number of business aircraft from GE Capital.

The company mainly focuses on aircraft within the mid-size or larger business jet market that are manufactured by Gulfstream, Bombardier, Dassault (Falcon), Embraer, Cessna (Textron), HondaJet or Pilatus. In a limited number of instances, it may also provide financing to Boeing BBJ series aircraft or Airbus ACJ series aircraft.

KBRA has assigned preliminary ratings of single-A to the class A1, A2 and A3 notes and triple-B to the class B1, B2 and B3 notes. The initial LTV on all of the single-A notes is 74%, while it is 83% on all of the single-B notes.

The A1, A2 and A3 notes have anticipated repayment dates of 25 September 2019, 2020 and 2022 respectively and legal final maturity dates of September 2049, 2050 and 2052. The repayment and final maturity dates are replicated on the single-B notes.

While a debut issuer of aviation ABS, Global Jet Capital has several staff members - employed previously by GECC - who have significant experience in the management, servicing and origination of leases and loans of business jet aircraft. The transaction is also supported by the quality and composition of the initial portfolio, which is strong relative to transactions backed by commercial airlines or large ticket equipment leasing transactions.

KBRA highlights that a majority of obligors are either high net-worth individuals or corporate entities that have investment grade quality characteristics. The portfolio is diverse with no single industry group representing more than 12.9% and a large portion of collateral is to corporate entities or HNW individuals in North America and across 40 industry groups.

The rating agency suggests that a potential weakness of the deal is the flexibility that Global Jet Capital has to purchase new assets and extend existing ones. The company can purchase new assets with the proceeds from prepayments, liquidation of aircraft and balloon payments in the remarketing account, and balloon payments can be extended for up to 24 months.

KBRA adds that business jets can suffer from price volatility, which could negatively affect the transaction. The deal is, however, supported by sufficient credit enhancement, along with a structure that accelerates principal payments on the notes if asset performance deteriorates.

Bank of America Merrill Lynch, Citi, Deutsche Bank and Morgan Stanley arranged the transaction.

RB

ABS

First solar ABS looks to pay dividends

Dividend Finance is in the market with its first term ABS securitisation collateralised by secured residential consumer solar loans. The transaction, Dividend Solar Loans 2017-1 (see SCI's deal pipeline), will issue three classes of notes in an aggregate principal amount of US$128.95m.

Kroll Bond Rating Agency has assigned a preliminary rating of single-A to the US$115.376m class A notes. The US$6.787m class B notes have been rated triple-B, and the US$6.787m class C notes have been rated double-B plus.

Dividend Finance is based in California and provides clean energy financing through residential solar loans as well as residential and commercial PACE assessments. Dividend Finance was formed through the merger of Dividend Solar and Figtree Finance Company.

The Dividend Solar Loans 2017-1 notes are backed by a pool of mostly prime quality residential consumer solar loans and underlying solar energy systems. Credit enhancement is provided through overcollateralisation, subordination, excess spread and amounts on deposit in the reserve account.

Dividend originates loans in 25 states. Loans typically have original balances of US$10,000-US$50,000 and original terms or 12 or 20 years, with fixed interest rates of 2.5%-9.99%. The loan collateral in the ABS will include a pool of US$135.7m of residential solar loans from seven different loan products containing a combination of interest-only periods, payment deferral periods and required or optional prepayment thresholds.

The weighted average original balance as of 31 July was US$23,195. Average loan term is 19.17 years, average seasoning is eight months and current interest rate is 6.6%.

Compared to Mosaic Solar Loans 2017-1, issued at the start of the year (see SCI's deal database), Dividend Solar Loans 2017-1 has higher borrower interest rate (6.6% compared to 4.34%), higher weighted average FICO score (753 compared to 746), longer original term (230 months and 205 months), lower California concentration (25.15% and 52.23%), and lower Kroll-expected loss (5.75% and 6.65%).

JL

ABS

BMO steps on the gas with debut ABS

Bank of Montreal is marketing an inaugural auto securitisation, called Canadian Pacer Auto Receivables Trust 2017-1 (see SCI's deal pipeline). The ABS is backed by 42,258 prime retail instalment auto loan contracts and is another first for the bank after debuting the first RMBS sponsored by a major Canadian bank earlier this year (SCI 18 April 2017).

The deal has US$500m of US dollar-denominated notes and C$29.1m of Canadian dollar-denominated notes. The US$110m A1 notes have been rated P1 and A1-plus by Moody's and S&P. The US$202m A2A and A2B, US$136m A3 and US$52m A4 notes have all been rated triple-A by both rating agencies. The C$15.9m class B notes and C$13.2m class C notes are unrated.

S&P notes that on the deal's closing date Bank of Montreal will purchase Canadian dollar-denominated auto receivables comprising primarily retail conditional or instalment sale contracts secured by new and used cars, light trucks, and utility vehicles. The trust will finance its ownership interest by issuing the series 2017-1 notes, which will be secured by, and with recourse limited to, the series 2017-1 ownership interest.

The transaction will hedge the currency and interest rate risk from fixed-rate Canadian dollar denominated receivables and fixed-rate US dollar denominated notes. In the case of the class A2B notes, with floating-rate interest, the issuing entity will enter a cross-currency and interest rate swap agreement with BMO as swap counterparty.

Moody's highlight many factors strengthening the transaction such as Bank of Montreal being highly rated by the agency, and the high quality receivables in the pool with an average FICO score of over 700. Furthermore, the transaction has a weighted average original term of 64 months which is much lower than other recent Canadian public transactions, and the receivables are highly seasoned at 22 months.

Furthermore, as a bank programme, the portfolio benefits from diversification across various original equipment manufacturers, as opposed to captive auto finance programmes. The deal also benefits from roughly 3.36% of excess spread enhancement to the transaction and credit enhancement will build as the pool amortises, because note principal payments will be made sequentially.

Moody's suggests that potential challenges to the transaction include the higher proportion of used vehicles which, at 66%, is much higher than other publically rated Canadian deals, which typically comprise 70% new vehicle loans. The agency also highlights the uncertain economic outlook for Canada added to by low oil prices, NAFTA renegotiations and uncertainties related to future US policy direction.

RB

Structured Finance

SCI Start the Week - 25 September

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

Pipeline
Additions to the pipeline last week were fairly broadly split. There were five ABS added, along with three RMBS, four CMBS and two CLOs.

US$750m Bank of the West Auto Trust 2017-1, Bavarian Sky German Loans 7, US$210m CFG Investments 2017-1; US$1bn Honda Auto Receivables 2017-3 Owner Trust and Securitized Term Auto Receivables Trust 2017-2 accounted for the ABS. The RMBS were Green Apple 2017-1, HBS Trust 2017 and Pepper Residential Securities Trust No.19.

US$283m COMM 2017-DLTA, US$1bn Great Wolf Trust 2017-WOLF, US$233m STACR 2017-DNA3 and US$818.3m UBS 2017-C4 constituted the CMBS. The CLOs were US$456.7m AMMC CLO 21 and US$817.5m Gilbert Park CLO.

Pricings
The week's prints were also relatively varied, although ABS and CLOs did once again account for the bulk of issuance. There were five of the former and seven of the latter, along with four RMBS and a CMBS.

The ABS were: €685m Globaldrive Auto Receivables 2017-A; US$1bn GM Financial Automobile Lease Trust 2017-3; £140m LaSer ABS 2017-1; Nkr2.2bn Scandinavian Consumer Loans VI; and £546m Silver Arrow UK 2017-1.

The RMBS were: A$1.5bn Apollo Trust 2017-2; A$500m Firstmac Mortgage Funding Trust No.4 Series 2017-2; US$1.5bn-equivalent Gosforth 2017-1; and £275m Together Asset Backed Securitisation 1. The CMBS was US$1.4bn FREMF Series 2017-K727.

The CLOs were: €386.6m Accunia European CLO II; US$712.9m Benefit Street Partners CLO 2017-12; US$516m Anchorage Capital CLO 2013-1R; €468m Dryden Leveraged Loan CDO 2015-39R; US$606m Gallatin Funding 2017-1; US$376m Neuberger Berman CLO 2013-15R; and €435.15m Tikehau CLO III.

Editor's picks
'Substantial' green ABS volumes eyed: Vehicle and housing loans have the potential to produce substantial flows of large-scale green ABS transactions over the next five years, according to a new SCI research report produced in conjunction with TMF Group and Ygrene Energy Fund. However, the report - entitled 'Impact investing and green ABS: creating a market of the future' - finds that would-be issuers face a significant challenge in the near term to assemble enough eligible collateral to support a deal of benchmark size...
Merger to impact SFR volumes: Starwood Waypoint Homes and Invitation Homes recently announced plans to merge, creating the largest single-family rental company in the US (SCI 11 August). The firms have also stated their intention to go public, a move that is likely to impact their securitisation strategy and potentially curtail issuance in the broader SFR RMBS market...
EBA releases SRT discussion paper: The EBA has released its significant risk transfer (SRT) discussion paper, the main elements of which were outlined last month (SCI 18 August), and has launched a public consultation on its contents. The banking watchdog wishes to further harmonise the regulation and supervision of risk transfer through securitisation...
Toys R Us CMBS exposure gauged: Toys R Us filed for Chapter 11 bankruptcy protection this week. Several US CMBS loans are exposed to the retailer, although no store closures have been announced...

Capital Relief Trades

Risk transfer round up - 29 September

The focus of this past week has been the EBA's SRT discussion paper. Regulators and market participants expect it and the resulting guidance to standardise structural features and boost deal flow in the market (SCI 28 September).

The paper comes at a time of a flurry of transactions in Q4. Among these, sources mention a Banca IMI-arranged transaction for UBI Banca.

Additionally, ABN Amro issued several mezzanine and junior tranches for its Dolphin Master Trust Issuer programme.

According to Rabobank analysts the tranches were retained, prompting speculation among market participants as to whether the Dutch issuer is prepping a capital relief trade.

RMBS

Legacy non-conforming collections fall

Average collection rates on loans in arrears backing some UK RMBS transactions are showing signs of weakening. At the same time, the average repossession rate for UK non-conforming RMBS has risen to 0.7%, although this is from post-crisis lows.

Bank of America Merrill Lynch European securitisation analysts highlight that the main transactions affected by deteriorating collection rates on loans in arrears are those from the RMAC, NGATE and Kensington programmes, with RMAC deals most notably affected. Among RMAC transactions, there was a "noticeable drop" in collection rates in 1Q17, with the 1H17 average of 88% around 4% lower than in 2016 - which also saw a 9% weaker average collection rate on delinquent loans than in 2015.

Furthermore, in the RMAC sample, this trend is seen across all arrears buckets - although it appears marginal in the 30- to 90-day category and most pronounced in the 180-plus bucket. As a result, the proportion of delinquent loans that paid their required mortgage amount, or more, fell to 44% in 1H17 - 8% lower than in 2016.

The Bank of America Merrill Lynch analysts note that this marks the first time since 1Q12 that less than 50% of borrowers paid their required mortgage amount or more. This is a trend shared by arrears buckets, although it is less pronounced in the 30- to 90-day category.

The NGATE transactions also saw a drop in collection rates, although of a smaller magnitude. The average collection rate fell by about 2% to 100.5% in 1H17 from 2016, driven by a 4% fall in the 120-plus day category, while the 120-day arrears bucket saw a 1% higher collection rate.

Conversely, the proportion of delinquent loans that paid the required mortgage amount or more deteriorated marginally for the 30- to 120-day bucket, but improved for the 120-day plus bucket, leaving the average 1.2% higher in 1H17 than 2016 (at 58%). For the sample of Kensington transactions, the number of loans shrank - due to many deals being redeemed - and the average collection rate on arrears dropped by 4% to 100.6% in 1H17 from 2016.

The analysts add that more severe arrears saw greater deterioration, such as by 9% in the 180-day plus bucket, by 3% in the 90- to 180-day plus bucket and by 1% in the 30- to 90-day bucket. The proportion of delinquent loans that paid the required mortgage amount, however, was up 1% in 1H17 from 2016.

Meanwhile, repossessions in the UK rose to 0.7% in 2Q17 - albeit up from 0.5% in 4Q16, which was the lowest level post-crisis. The increase is driven by 2005-2006 vintages and has been seen across most repeat-issuer programmes, barring ALBA, NGATE and RMAC.

The analysts suggest that increases in arrears and repossessions may continue, albeit marginally, due to a small predicted rise in unemployment of 0.3% in 2018, from 4.5% in 2017. Legacy deals with arrears triggers close to thresholds may see pro-rata trigger breaches benefitting senior classes.

The analysts add that UK interest rates look set to stay low for longer, with the rate of 0.25% expected to last until at least end-2018, supporting mortgage performance. Furthermore, they point out that rental alternatives continue to be more expensive than mortgages, with lower mortgage rates being beneficial for non-conforming borrowers.

Following a drop in mortgage rates, the average monthly mortgage payment fell from around £700 in 2007-2008 to £400-£425 in 2011-2017. This contrasts with rent rises in England and Wales from around £660 in 2009 to around £840 in 2Q17.

Finally, the analysts comment that while UK house prices have been decelerating since the Brexit vote, the impact this might have on negative equity will be small because the magnitude of negative equity in UK non-conforming RMBS is too low to warrant a link with default performance. They suggest that exposure to negative equity is estimated to be around 5.5% on average and, as such, UK non-conforming borrowers are less sensitive to house prices.

Moody's, for one, anticipates that UK buy-to-let mortgages backing RMBS transactions will deteriorate slightly over the next 12-18 months, due to a slowdown in the growth of rental income - with declines materialising in some regions. This is driven, the agency says, by rents increasing faster than wages over the last eight years, particularly in London.

The rating agency adds that pressure on the BTL market is increased by the erosion of landlords' rental income, due to a reduction in the interest deductibility and an increase in stamp duty. Furthermore, individual BTL landlord ability to deduct mortgage interest from their rental income before income tax is also limited, reducing income available for landlords to cover BTL mortgage payments.

Moody's concludes, however, that it expects the BTL RMBS market to remain stable, despite weaker collateral performance. This is buoyed by historically low levels of arrears and a build-up in credit enhancement.

RB

RMBS

Bear-flattener trades advocated

The Fed announced last week that it would unwind the System Open Market Account (SOMA) balance sheet, starting next month. This is part of a range of measures suggesting a tightening of monetary policy, in which case investors may wish to prepare for a flattening in the US yield curve, with several trade options available.

US$4bn of MBS will be allowed to roll off each month during the first three months of the new policy. The following three months - January to March - will ramp up to US$8bn per month, with a further US$4bn per month in each following three-month period, until October 2018, from which point US$20bn per month will be allowed to roll off.

FTN Financial calculates that, at current speeds, the SOMA portfolio unwind will take two decades or more. A scenario where the monthly runoff is not capped actually looks very similar.

FTN strategists believe that the "initial baby steps for the unwind will keep the market happy over the next few months but will likely have a very small effect on the policy decisions of future FOMCs". They believe that the market would be unable to handle a sudden SOMA unwind if there is a large burden of bonds 'behind' any initial sale, so say it is highly unlikely that the Fed will sell MBS "for well over a decade or more".

While the SOMA balance sheet taper does have steepening biases, other factors are expected to more than offset this and flatten the yield curve. Among those are deflation, a strong dollar, the economies of Europe and China and geo-political risk.

The Fed is the only major central bank tightening monetary policy. The base case for the US yield curve in the coming months is therefore that it will bear flatten.

FTN strategists identify seven guiding principles for targeting the bear flattener. These are higher yield, wider spread, higher coupon/dollar price, wider window and longer final, base case average life at the five-year or longer part of the curve, put on a more negatively convex bond/portfolio, and projected TRR profiles that outperform in the bear flattener and base case forward scenarios.

There are a few different trades which should perform well in a bear flattening of the yield curve. They all adhere to the seven principles outlined by FTN.

In the current coupon, new issue MBS market, FTN Financial strategists believe the 20-year 3.0 sector is "noticeably the cheapest". Looking at the spread curve on an OAS versus effective duration basis reveals the current coupon 15-year sector to be significantly overpriced.

"It is our general observation, supported in large degree by in-house portfolio accounting data, that many financial institutions and some money managers have a strong overweight to the current coupon 15-year pass-through sector. It is seen as 'safe' [and] some say it has just enough yield to compensate for the risk. We would argue differently, especially in the case of the bear flattener," say the FTN strategists.

The strategists identify a number of bonds and bond combinations which should outperform current coupon 15-year collateral in a bear flattening of the yield curve. The simplest of these is to sell 15-year 2.5s and buy 20-year 3.0s, which is almost duration-neutral.

"This trade ticks all of the boxes for the bear flattener," say the strategists. "The most important features are that it produces extra income (yield/coupon/spread) and outperforms in the base case forward (a mini bear flattener) and the explicit bear flattener. But this is hardly the only way to express this trade."

A barbell option would be to sell 15-year 2.5s in favour of a duration-neutral combination of a 10-year 2.5 and 30-year 3.0. Alternatively, 15-year 2.5s can be shorted in favour of current-pay PAC off US$200,000-max Fannie Mae 4.0s.

JL

Structured Finance

Job Swaps round up - 29 September

North America

HouseCanary has hired Josh Seiff to lead business development. He joins from Fannie Mae where he was vp, multifamily capital markets and trading.

GC Securities, a division of MMC Securities has announced the establishment of Cerulean Re SAC, a private syndicated collateralised reinsurance platform and Bermuda registered segregated account company (SAC) and licensed special purpose insurer. The joint venture between Marsh & McLennan Companies business units GC Securities (as arranger) and Marsh Captive Solutions (as insurance manager to Cerulean) provides an efficient and cost-effective placement process for collateralised reinsurance and private catastrophe bond deals.

Chapman and Cutler have hired Scott Pierpont as partner, New York, Mitchell Naumoff as partner, Washington and John Ketcham and senior counsel in Washington. All three join from Ashurst and will help support the firm's CLO practice and expands its asset securitisation and structured finance practice.

EMEA

Standard Chartered has hired Jonathon Noonan as an executive director in the ABS and CLO trading department. He comes from Imperial Capital where he was senior vp, trading CMBS & ABS.

Scope has launched Scope Risk Solutions (SRS), a new service to help its clients measure and manage credit risk, meet regulatory requirements and rely on an extended credit workbench.

Ratings

Fitch has placed 17 tranches of 12 National Collegiate Student Loan Trusts (NCSLTs) on rating watch negative. The rating actions follow an announcement by the Consumer Financial Protection Bureau (CFPB) of action taken against NCSLTs on 18 September 2017. The CFPB proposed consent judgment, if confirmed, requires NCSLTs to pay a settlement amount of at least US$19.1m depending on the results of an independent audit on NCSLTs' portfolios.

Moody's has taken action on 18 notes in 13 UK Housing Association CMBS transactions, affecting £2.577bn of CMBS. The agency has affirmed 10 tranches and downgraded 8 tranches of 13 CMBS transactions secured by loans made to multiple UK housing associations. The transactions affected are UK Rents No.1, Sanctuary Housing Association, Housing Association Funding, Haven Funding, Finance for Residential Social Housing Series 1-A3 and Series 1-B, 2-A and 2-B, The Guinness Trust (London Fund), Quadrant Housing Finance, Places for People Homes, Haven Funding (32), RSL Finance (No.1), Sunderland (SHG) Finance, Places for People Homes and Harbour Funding. The action follows the recent downgrade of the government of UK's rating to Aa2 with a stable outlook and the subsequent rating actions taken on the ratings of 40 housing associations.

Regulations

ESMA has issued its final draft regulatory technical standard (RTS) implements the trading obligation for derivatives under MIFIR. The draft RTS provides the implementing details for on-venue trading of both IRS and CDS. MIFIR's trading obligation will move certain OTC trading in derivatives onto organised venues, but those derivatives must be liquid and available on at least one trading venue. As well as a few types of IRS, ESMA has made iTraxx Europe Main and iTraxx Europe Crossover subject to on-venue trading. The trading obligation is closely linked to the clearing obligation under EMIR. Once a class of derivatives needs to be centrally cleared under EMIR, ESMA must determine whether these derivatives, or a subset of them, should be traded on-venue on a regulated market, multilateral trading facility, organised trading facility or an equivalent third-country trading venue. ESMA's RTS is now before the European Commission for endorsement and the Commission has already expressed its strong commitment to apply the trading obligation from the start of the MIFID 2 framework.

Subpoena

Tricon American Homes has disclosed that it received a subpoena from the US SEC requesting the production of certain documents and communications related to its securitisations, including materials related to BPOs provided on properties included in those transactions. The SEC's investigation is a fact-finding inquiry (SCI 21 September) and Tricon says it plans to cooperate fully. Separately, the firm calculates that fewer than 100 homes across its portfolio in Houston, Florida and Atlanta have experienced meaningful damage as a result of Hurricanes Harvey and Irma. Approximately 800 other homes experienced minor damage.