News Analysis
ABS
ESNs 'not needed yet'
European Structured Notes (ESNs) have been on the radar for some time and a recent Moody's analysis praises their potential to offer an additional funding tool to banks. However, it remains far from clear that the banks themselves are pushing for this new type of collateralised bond to be introduced.
In response to the European Commission's call to find new ways to build an effective EU-wide capital markets union, the European Covered Bond Council (ECBC) unveiled a plan two and half years ago to create ESNs as a blend of covered bond and securitisation techniques (see SCI 14 May 2015). There has been some refinement of the idea since then, and Europe's political forces are keen to see the instrument brought to the market.
"ESNs are something of a hybrid of covered bonds and balance sheet CLOs, but they are much more like the former than the latter because of features such as dual recourse. What these would do differently to covered bonds is expand the universe of assets that can be used, so whereas covered bonds are largely mortgage-backed, ESNs could cover SME loans, for example, which are currently seen as too risky for covered bonds," says Ruben van Leeuwen, senior ABS strategist, Rabobank.
However, while the politicians are in favour of the instrument, support on the ground is more muted. Another secured funding instrument is not necessarily what the market needs at this point in time, although van Leeuwen notes that there could well be greater need in the future, for example if central bank funding goes away.
"Where it might be useful in the short term is for weaker names, from places such as Spain, Italy, Greece or Portugal. For those weaker names, secured funding does become viable for central bank funding. In the longer term it might provide the stronger European names with a relatively cheap funding option," he says.
ESNs are being developed as part of the drive to establish a single pan-European legal framework for covered bonds. Only covered bonds backed by residential and commercial mortgages would technically be classified as covered bonds under the proposed framework, with bonds backed by other assets - such as SME loans or infrastructure loans - would be classed as ESNs.
Because the ESNs will most likely be on-balance sheet secured bonds, Moody's does not believe they will free up bank capital in the same way that securitisations do. There will therefore be no increase in bank lending capacity. There are also questions as to how the regulators will approach the instrument.
"The regulatory treatment of ESNs will be very significant. Covered bonds are treated very favourably and ABS is treated rather harshly; it would make sense for ESN treatment to be somewhere in the middle. I would expect higher haircuts than for covered bonds," says van Leeuwen.
Moody's also expects less favourable regulatory recognition than covered bonds currently receive. Favourable treatment could recognise the better credit quality of ESNs relative to secured debt, reckons the rating agency, reflecting the dual recourse and presumed high market liquidity of ESNs.
That does not, however, mean that banks will be rushing to issue ESNs. Most European banks already have strong liquidity and, with such a low interest rate environment, a new type of debt instrument is not going to be at the top of a European bank's wish-list. Banks are also building up loss-absorbing capital layers in order to meet TLAC and MREL requirements, which would argue against issuing ESNs and covered bonds in the near future.
"There is political commitment to this. The European Commission and European Parliament are both in favour, but I am not sure how banks feel about this. There is not real a big funding need at the moment, so while in the long term this could see the light of day, I do not see the banks pushing for it to be brought in quickly," says van Leeuwen.
Like van Leeuwen, Moody's believes banks are more likely to appreciate the opportunities presented by ESNs once market conditions change. "We believe that Italian and Spanish banks, and other smaller European banks, will have the highest incentives to issue ESNs. Retained ESN could also replace retained covered bonds, which can be sold more easily in the market."
Moody's adds: "Once the ECB tapers its quantitative easing measures and interest rates begin to increase, spreads will widen more significantly for lower-rated and smaller banks, which have more difficulty accessing the market. The issuance of ESNs, or a switch from retained covered bonds to ESNs, could provide some advantage for such banks. Entities could utilise their best collateral (traditional assets) to place covered bonds in the market, while keeping repo-eligible ESNs."
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News Analysis
Capital Relief Trades
Proportionality for capital floors?
The general secretary of the Basel Committee has confirmed that the "finish line is in sight" for the Basel 4 reforms, although his statement fell short of confirming any concrete compromise on capital floors. The statement could be taken as confirmation of a finalisation, given growing momentum at the EU level for more proportionality in regulation.
William Coen, general secretary of the Basel Committee, used the analogy of a marathon to argue that Basel 4 talks are approaching the "finish line". However, he did not directly confirm rumours of a 72.5% output floor compromise.
The floor has been the focus of a dispute, with Germany, France and the Netherlands at the forefront of European opposition to the proposal (SCI 25 April). However, Rabobank analysts note that the Germans and the Dutch are performing a turnabout, albeit French opposition remains.
Basel 4 proposals would limit a bank's ability to benefit from internal models by introducing input floors - constraining risk parameters for specific portfolios - and set minimum output floors on the basis of standardised models. Additionally, the proposals suggest that internal models may no longer be used for certain exposures, such as large corporates with assets over €50bn.
The question, therefore, of squaring the circle continues, which is where proportionality enters the picture. According to Martin Neisen, partner and Basel 4 leader at PwC, applying the principle to capital floors could mean making the standardised approach (SA) more risk-sensitive, but with more conservative risk weights.
He says: "You could do this through a more granular definition of exposure classes and the consideration of additional risk indicators. This would mean that the SA becomes slightly more complex but also more proportional."
Another possibility is to simply exclude certain exposure classes from the floor calculation. Neisen says: "This should be exposures that face huge differences between SA and IRBA risk weights but where rating models and risk parameter estimates are based on high quality loss data."
Proportionality has already gained traction at the EU level, particularly in relation to the fundamental review of the trading book (FRTB), the Basel Committee's regulatory framework for market risk capital requirements. The framework stipulates a more granular and risk sensitive capital charge calculation for market risk.
This was made clear in a November 2016 European Banking Authority (EBA) report, following a request for advice by the European Commission. In the report the EBA states that there is "room to increase proportionality of regulation in general", adding that the "consideration of proportionality is, of course, particularly relevant in the context of the implementation of the new Basel standards".
The report followed a growing consensus in 2016, at the Commission level, to exempt banks with small trading books of less than €50m from punitive FRTB market risk capital requirements. For instance, in May last year, former EU Commissioner Jonathan Hill said that he understood the concern of smaller banks that legislation is not doing enough to take their size properly into account and that this was being looked at as part of a review into the CRR and CRD IV.
As the previous statements suggest, however, discussion has been relatively skewed towards small standardised banks. In a recent ECB statement, ECB executive board member Sabine Lautenschlager notes that "the call for greater proportionality in banking regulation has been growing louder", but the statement makes it clear that "small banks face greater difficulties complying with complex regulation".
Yet given the never-ending deadlock in the negotiations and growing momentum, it is hard to see any other way to conclude them. Neisen observes: "Proportionality can allow Basel to save face and make everyone happy. I do not see any other way to finalise the floor proposal."
Another question is the impact of a floor proposal on the ECB's targeted review of internal models (TRIM). The ECB's TRIM programme is a response to Basel 4 which prioritises an assessment of the assumptions behind a bank's IRB models using historical data, rather than capital floors.
The impact of a floor proposal for the programme remains uncertain, but market participants agree that it would provide a more level playing field as opposed to Basel 4.
Dennis Heuer, partner at White and Case, says: "TRIM would not automatically lower RWAs for low-risk assets and raise them for riskier ones, such as shipping and aviation. It would simply streamline different internal models to reduce RWA variability amongst banks and establish a better, level playing field."
With higher RWAs coming whether or not Basel 4 is implemented, Heuer sees more opportunities for capital relief trade issuance. He says: "With TRIM resulting in less IRB model flexibility under certain circumstances and Basel 4 in higher risk sensitivity for riskier assets, risk sharing or risk transfer becomes an attractive option."
Rabobank analysts expect Basel 4 to be finalised by the end of the year. However, how the EU will translate a new Basel standard into final regulations remains an open question.
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News
ABS
Debut Veros deal markets
Veros Credit has prepped an inaugural rated US$165.28m subprime auto ABS. The transaction, Veros Auto Receivables Trust 2017-1 (see SCI's deal pipeline), is backed by a pool of 17,328 seasoned subprime auto loan contracts secured mostly by used vehicles.
Kroll Bond Rating Agency has assigned provisional ratings on the transaction of single-A on the US$128.74m class A notes, triple-B on the US$21.32m class Bs and double-B on the US$15.22m class Cs. The final maturity date on the A and B notes is 17 April 2023 and August 15 2024 for the class C notes. Initial credit enhancement is 28%, 15.75% and 7% for the A, B and C notes, respectively.
The transaction is the first rated term ABS for the company and Kroll notes that the firm intends to issue an ABS about once a year. Veros intends to use the net proceeds to pay certain debts, including a warehouse debt currently financing the automobile loan contracts that will be sold to Veros 2017-1.
There is high geographic concentration within the transaction, with 71.5% of loans made to borrowers in California. The next largest state concentrations are Texas (9.54%), Florida (6.70%) Arizona (4.36%) and Nevada (2.42%) and the concentration of receivables in the top five states is 94.58% of the total current balance.
The transaction will include US$9.88m of loans from Federal Emergency Management Agency (FEMA) declared disaster areas due to Hurricane Harvey and Irma. Veros has stated that on the first distribution date after the closing date, it will repurchase all loans in the FEMA declared disaster areas that do not make their first monthly payment. Kroll has also factored in a potential extra cumulative net loss of 0.7% based on the additional stress these borrowers may experience as they recover.
Veros also originates loans through an indirect channel where dealers submit loan applications on behalf of borrowers which can create additional risk. Kroll says the indirect market can be riskier than the direct market since third-party dealers are providing information on behalf of the borrower and have different incentives to the finance company.
The loan portfolio has an aggregate outstanding balance of US$268.1m and borrower average FICO in the deal is 557. Weighted average current loan balance is US$10,040 with average seasoning of 12 months.
Veros Credit rebranded from Capital One Corporation in 2010 and originates auto loan contracts to subprime borrowers for the purchase of used vehicles through applications submitted by independent dealers 98% of the time. Veros is privately owned by the Bozorgi family with total equity of US$24.2m and total capital, including long-term sub-debt held by the owners of the company, of US$55.4m. Kroll suggests that the ownership of the Bozorgi family is a positive for the deal as it creates a strong alignment of interests with respect to loan originations.
RB
News
ABS
Timeshare ABS uncapped
LV Tower 52 has launched a US$157m timeshare ABS, marking the firm's first transaction that Fitch has not capped at single-A. Elara HGV Timeshare Issuer 2017-A is backed by 5,309 timeshare loans tied to a single resort in Las Vegas.
Fitch and S&P have rated the US$105.48m class A notes at triple-A, US$31.48m class Bs at single-A and the US$20.03m class Cs at triple-B. In the two prior Elara transactions, Fitch capped the ratings at single-A due to limited managed portfolio and limited amortised ABS transactions, as well as the unique counterparty arrangements.
Fitch says that as the performance on the prior Elara transactions is generally within its expectations, and due to the stronger counterparty arrangements with the joint venture between Blackstone and Hilton Grand Vacations, it does not believe a rating cap is warranted this time. However, the rating agency does note that the collateral pool has an average FICO of 731, lower than its previous Hilton-backed deals, prompting the agency to keep the cumulative gross default proxy at 13.5%.
The transaction is backed entirely by loans linked to a single resort - the Elara, in Las Vegas. The agency says, however, that the risks of a single-site property are mitigated due to factors such as the owners having the same usage and exchange rights as other Hilton Resorts timeshare owners.
LV Tower 52, the originator, is a subsidiary of Resort Finance America. It has appointed Hilton Resorts Corporation (HRC) as sales agent and remarketing agent for the transaction.
HRC has been appointed for the purpose of marketing the timeshares, facilitating the closing of timeshare sales, and assisting with the origination of loans. HRC will also serve as remarketing agent for the purpose of remarketing the timeshare loans acquired by the issuer with respect to defaulted loans.
Strengthening the transaction is the presence of a prefunding account which will hold up to 20% of the initial note balance after the closing date to purchase eligible timeshare loans. The deal also allows for qualified substitutions of upgraded loans and is supported by credit enhancement of 35.5%, 16.25% and 4% on the A, B and C notes, respectively.
Trustee, custodian and backup servicer on the transaction is Wells Fargo. The structuring agent is Bank of America.
RB
News
ABS
Greek shipping ABS boosts liquidity
Alpha Bank has successfully completed a US$250m true sale securitisation via Citi, its second such transaction in three years. The non-recourse four-year term deal diversifies liquidity access for the lender, and is one of the very few shipping securitisations globally.
Greek banks have encountered challenges in accessing interbank market funding following the Greek crisis of 2010-2015. Through this transaction Alpha bank is granted access to the US dollar market.
Increased transactions in the interbank market and the rise in deposits in Greek accounts have considerably improved the liquidity conditions for local banks, as reflected by their reduced dependence on the emergency liquidity assistance (ELA) mechanism. The cap on ELA has been reduced this week by €4bn to €28.6bn. However, concerns remain over the large stock of NPLs and upcoming stress tests.
Sources close to the deal have confirmed a US$650m portfolio size, split between 50 performing shipping loans granted to international shipping firms. There is a sequential amortisation structure with monthly collections.
Pricing was below the margin lending levels achieved by the lender's main local competitors; the latter having recently placed covered bonds to investors. Eurobank, for instance, has placed a three-year €500m covered bond at a yield of just below 3%. Another covered bond by the National Bank of Greece was priced at similar levels.
Alpha has made some structural changes compared to its last shipping securitisation. According to one source close to the talks, the bank has established a framework of eligibility criteria for securitised shipping loans, which, along with an option to replenish the transaction with eligible portfolios, allows Alpha to redraw funding, monitor and enhance the efficiency of the deal.
Due to this, the 2014 structure has been slightly redesigned, in order to allow for the potential securitisation of more shipping loans in the future under the same vehicle. Shipping securitisations can be difficult to execute given the lack of granularity and investor fears concerning market volatility.
However, such issues were irrelevant for investors in the latest deal. "They were global investment banks with great experience in the shipping space and they paid more attention to the quality of the assets rather than the granularity of the portfolio," says the source close to the deal. "The shipping loans used in the transaction happen to be the best performing of the bank."
Alpha Bank will aim for more future shipping securitisations given the expertise it has developed. However, funding cost and efficient portfolio utilisation will remain drivers.
The bank's exposures from shipping securitisations amount to €168m as of end-June 2017. The Greek lender also had €319m of SME securitisation exposures as of end-June 2017.
Other securitisation exposures include consumer loans, corporates, credit cards and leasing, which are not included in 1H17 statements, since these securities - €4.5 billion in nominal value - have been issued by SPVs held by the bank.
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News
ABS
Jet ABS 'postponed'
Global Jet Capital's debut securitisation, Business Jet Securities 2017-1, has been postponed, according to a source close to the transaction. This follows a recent comment from Fitch (SCI 11 October) which questioned the integrity of the transaction and the ratings assigned by Kroll Bond Rating Agency (SCI 28 September).
A source close to the deal has refuted claims that the deal has been cancelled, saying instead that it has merely been postponed. "The company decided, with the full support of the sponsors, to postpone the offering," he says. "The deal will be brought back to the market very soon and the firm intends to become a serial issuer."
The ABS was initially marketed at US$1.48bn and is supported by a portfolio of 181 business jet aircraft. It was assigned preliminary ratings by Kroll of single-A on the A notes and triple-B on the B notes. Fitch strongly criticised the deal, however, stating that it did not meet its standards for an investment grade rating.
It is understood that Kroll stands by its ratings and the source close to the deal challenges the quality of Fitch's assessment. "In terms of the comments from Fitch, their report contained a number of statements that are materially incorrect," the source says.
Reportedly, Morgan Stanley, the bank driving the deal, had lined up buyers for approximately US$700m of the bonds. While short of the marketed total, it is understood that Morgan Stanley was confident of getting the transaction over the line, only to have its efforts to secure the final investors hindered by Fitch's comment.
Regardless of this, the source close to the transaction says that as far as Global Jet Capital is concerned, "this is just a road bump" and the developments have provided an opportunity to take stock of the interest the deal garnered. "The transaction generated a significant amount of market interest and it seemed like the right time to take a breath and reflect on the transaction before going to market," the source says.
With the transaction failing to close, questions could be asked about the financial security of Global Jet Capital. The source close to the deal says, however, that the firm is in a solid position.
They note: "The postponement of the deal will have no material impact on the company in the short or long term and the line of financing from GE Capital is secure for a number of years." The source concludes that Global Jet Capital intends to be a serial issuer of ABS going forward and that future transactions will likely have similar collateral.
RB
News
Structured Finance
SCI Start the Week - 23 October
A look at the major activity in structured finance over the past seven days.
Pipeline
Additions to the pipeline last week were once again heavily skewed towards ABS. There were 11 ABS names added, along with two ILS, three RMBS and four CMBS.
The ABS were: US$232.648m Avant Loans Funding Trust 2017-B; Bavarian Sky UK 1; US$539.81m Capital Auto Receivables Asset Trust 2017-1; US$500m Chesapeake Funding II Series 2017-4; Delamare 2017-1; Evergreen Credit Card Trust Series 2017-1; Ford Credit Auto Lease 2017-B; €142.5m Hefesto STC; €770m SME Grecale 2017; US$165.28m Veros Auto Receivables Trust 2017-1; and Wizink Master Credit Cards 2017-02.
US$368.11m Bellemeade Re 2017-1 and US$150m Galileo Re Series 2017-1 were the ILS, while the RMBS were US$638.1m CSMC 2017-HL2, US$911m JPMMT 2017-4 and Triton Trust No.7 2017-2. The CMBS consisted of US$977.1m CGCMT 2017-C4, US$310m COMM 2017-PANW, US$1.3bn FREMF 2017-K68 and C$407m REAL-T 2017.
Pricings
While many ABS names joined the pipeline, many also departed. There were 19 ABS prints, along with five RMBS, three CMBS and 11 CLOs.
The ABS were: US$235m Ascentium Equipment Receivables 2017-2 Trust; US$1bn BMW Vehicle Lease Trust 2017-2; US$1.28bn CarMax Auto Owner Trust 2017-4; US$250m CommonBond Student Loan Trust 2017-B-GS; US$350m Credit Acceptance Auto Loan Trust 2017-3; US$999.62m Dell Equipment Finance Trust 2017-2; US$956.92m Drive Auto Receivables Trust 2017-3; US$157m Elara HGV Timeshare Issuer 2017-A; US$850.1m Enterprise Fleet Financing 2017-3; C$396m GMF Canada Leasing Trust Series 2017-1; US$186.2m Marlette Funding Trust 2017-3; US$260.75m Mosaic Solar Loans 2017-2; US$546.69m NextGear Floorplan Master Owner Trust Series 2017-2; US$215m PFS Financing Corp Series 2017-C; US$285m PFS Financing Corp Series 2017-D; US$476m Prosper Marketplace Issuance Trust Series 2017-3; US$174m Renew 2017-2; €670m SCF Rahoituspalvelut Kimi VI; and €1.582bn VCL 25.
The RMBS were: £2.638bn Brass No.6; €525m Fastnet 13; A$750m Resimac Bastille Trust 2017; US$570m VOLT 2017-NPL10; and £1.75bn Warwick Finance Residential Mortgages Number Three.
The CMBS were: US$725m GS Mortgage Securities Trust 2017-SLP; US$1.1bn JPMDB 2017-C7; and US$705.4m WFCM 2017-C40.
The CLOs were: €465.7m Avoca CLO 2015-14R; Barings Euro CLO 2017-2; US$627.5m Catamaran CLO 2014-1R; US$714m CIFC Funding 2017-V; US$734.37m GoldenTree Loan Management US CLO 2; US$795.71m Golub Capital Partners CLO 2015-24R; US$438.75m Oak Hill Credit Partners 2017-14; US$655.5m OCP CLO 2015-8R; US$510m Octagon 33; US$512.3m TCI-Flatiron CLO 2017-1; and €412.38m Willow Park CLO.
Editor's picks
CRT outlook bullish: Optimism prevailed at SCI's recent Capital Relief Trades Seminar, where panellists were bullish on the future of the risk transfer market. While capital relief trade activity has slowed this year compared to last, speakers concurred that issuance will grow in 2018, with a greater number of issuers and asset classes emerging...
Swap downgrades 'justified, necessary': Fitch downgraded Deutsche Bank's ratings last month, stating that the bank is no longer a suitable counterparty for top rated securitisations. While the downgrade was prompted by issues relating to that bank specifically, other bank downgrades could - and, it is argued, should - follow...
MPS loan appraisal pending: Cerved Information Solutions, one of the largest Italian servicers, has been selected by Atlante II to manage nearly half of the non-performing loans backing Monte dei Paschi di Siena's (MPS) forthcoming €26bn securitisation (SCI 5 July). MPS can only receive the GACS guarantee for the senior tranche of the deal after a sound appraisal of the secured portion of the NPL portfolio...
Interest growing in infrastructure: Deutsche Asset Management subsidiary RREEF America has closed a US$431.3m managed project finance CDO, dubbed RIN. While the deal may signal growing investor interest in infrastructure and project finance debt, lack of homogeneity could hamper the growth of the asset class...
Deal news
• United Guaranty is in the market with Bellemeade Re 2017-1 (see SCI's deal pipeline). The mortgage insurance securitisation is the first of its type to be publicly rated, potentially opening the gates for an increase in similar issuance.
• A €142.5m Portuguese non-performing loan securitisation has hit the market. Dubbed Hefesto STC, the transaction is backed by a portfolio of secured and unsecured NPLs originated by Caixa Economica Montepio Geral.
• Freddie Mac is in the market with the first in a new series of risk transfer RMBS, backed by a US$1.252bn portfolio of 3,231 conforming and super-conforming fixed-rate mortgages. Dubbed STACR 2017-SPI1, the collateral is housed in a participating interest (PI) trust, which will issue certificates for every loan in the form of pass-through certificate (PC) participation interests and credit participation interests.
News
Structured Finance
ABS rating effect explored
Rating changes can have a significant impact on an ABS bond's price and value. While investors are less reliant on ratings than they were before the financial crisis, rating agencies continue to play a significant role in bond pricing.
An analysis by TwentyFour Asset Management of the 10-year Portugal sovereign bond reveals that larger rating changes correlate to larger spread changes. This is particularly true when the bond moves from investment grade to sub-investment grade. In July 2011, Moody's downgraded its Portugal rating from Baa1 to Ba2 and the bond sold off from 611bp to 1050bp in the space of a week.
"ABS bonds are affected by ratings as well, possibly more so than conventional bonds as different ratings are typically assigned to bonds at each level of the capital structure, and these may be subject to different drivers," notes Elena Rinaldi, portfolio assistant, TwentyFour Asset Management. ABS ratings are complicated because they take account of the structure of the deal, the parties involved, the nature and performance history of the collateral, the legal structure and domicile of the SPV used to issue the bonds, and the credit enhancement used to protect each of the tranche layers.
Rating agencies update their criteria and assumptions periodically, which can affect ratings. Ratings may also be affected by movements in a bond's respective sovereign credit rating.
Returning to Portugal, an RMBS from that jurisdiction - LUSI 5 - provides another useful example. The senior bonds were rated triple-A at launch in 2006 by each of the big three rating agencies, but by the end of 2014 they were downgraded to triple-B plus, double-B plus and Ba1 as a result of both performance due to the financial crisis and sovereign downgrades to Portugal.
TwentyFour Asset Management notes that there are examples of positive correlation between the sovereign and LUSI 5 A, but also examples of non-correlation, either because one agency has upgraded while another has downgraded, or because the sovereign has been upgraded but the ABS downgraded, or because the rating of the ABS bond has changed many times in a short period.
"At TwentyFour, we look at these cases closely as they could lead to unusual price action, up or down. Rating agencies in fact can and do make mistakes sometimes and their mistakes can turn out to be expensive for investors," says Rinaldi.
For example, in September 2015 the sovereign saw two upgrades, but LUSI 5 A was downgraded four notches by S&P, only to then be upgraded one notch 10 days later. The downgrade was driven by an update to the agency's criteria for Portuguese RMBS, despite the fact that the downgrade report highlighted an ongoing improvement in the transaction's performance since 2012.
"The bond was trading at around 86 and plummeted to 82.5 after the announcement. An investor holding €5m value would have made 3.5 points mark-to-market loss as a consequence, equalling €175,000. Furthermore, investors constrained by rating parameters in investment grade would potentially become forced sellers thereby crystallising the loss," says Rinaldi.
When S&P upgraded Portugal's rating last month from double-B plus to triple-B minus, LUSI 5 A traded up three points purely due to better sentiment. "Usually a one notch movement does not really move the market but three or more notches would cause a reaction. However in this case, the movement from non-investment grade to investment grade potentially reopens the investor base to a much broader universe, and this undoubtedly contributed to the price uplift," says Rinaldi.
S&P followed the Portugal upgrade with an upgrade of LUSI 5 A two weeks later. The senior RMBS tranche was upgraded from double-B plus to triple-B plus, leading the bonds to trade up a further three points.
Rinaldi observes: "The [LUSI 5 A] upgrade was not related to either the improved performance of the deal nor to the upgrade in the country rating. The rationale for the upgrade was given as 'an identified error' in how the rating agency treated borrowers in its prior review, and as a result, it imposed a higher default stress than required."
Considering the upgrade was a consequence of the correction of a previous wrong assumption, investors may well be led to question the rationale of the previous downgrade.
"The value of a rating is massive and it can also be quantified. In our €5m example, an investor who was a forced seller when the bond was downgraded and took a loss would now have missed out on a €300,000 recovery, all because of a potentially erroneous rating change," says Rinadli.
JL
News
Structured Finance
Libor replacement a "steep challenge"
A transition to a replacement reference rate away from Libor by 2021 will be a "steep challenge" within structured finance documentation, according to S&P. The rating agency says the ultimate impact will depend on a number of factors, including whether current IBORs will be maintained for existing transactions until final maturity or whether existing transactions need to shift benchmarks.
There could be disputes over which index should replace Libor and whether there are enough mitigating factors to address a potential basis mismatch between assets and liabilities, which may arise if and when replacement benchmarks are chosen. S&P says, however, that based on regulators' intent to maintain current benchmarks, it does not currently expect any rating impact on existing transactions.
The agency says that it has initially reviewed a range of contractual IBOR language in transaction documents and has found a "progression of fall-back reference options", with most resorting to the previous month's rate. The agency suggests however that none of the fall-back language would be easily implemented as there would likely be basis risk between existing references and a potential replacement, while borrowers, bondholders and issuers would likely have different interests.
Also of concern is that some products have "no existing language for an IBOR alternative". S&P suggests that having rate transitions subject to majority of bond class approval or having no language at all creates the potential for dispute risk because structured finance bonds usually have multiclass bond structures, so it could be difficult to achieve a consensus in selecting a new benchmark.
The rating agency suggests that the likelihood of disruption to structured finance transactions is low, however, because regulators appear to be supportive of transitioning to new rates if a viable alternative can be found.
Fitch's CLO analysts say that the Libor phase-out will lead a "clear market alternative to emerge and CLO liabilities" will adjust to the alternative accepted by the loan market. The rating agency adds that recently CLOs have begun incorporating language that provides greater flexibility to transaction parties, should Libor cease to exist or be replaced.
No single standard has yet emerged, but several variations of provisions for replacement have been used more widely than others. Fitch says that the three most common provisions it has seen include a reliance on the manager to make an appropriate replacement determination, provisions that rely on a combination of the CLO manager and certain investors or provisions that rely predominantly on certain CLO investors.
The agency suggests that some basis risk may occur on or around the point of transition from Libor to a replacement rate, from the market adaptation timing and whether that can be matched by the CLO liabilities, and whether Libor and the replacement rate converge as a transition nears. Fitch adds however that senior notes would likely be unaffected.
The rating agency comments further that CLO language regarding the actual replacement of the current base rate is varied, with CLO documents recently displaying a range of alternatives. These include using the last Libor determined, an agent requesting interbank lending quotes from banks, an agent requesting bank deposit quotes, relying on the alternative reference rate committee outcome, relying on the base rate used by greater than 50% of the portfolio or loan market, and finally referencing a new rate or a consensus rate as determined by the LSTA.
Rob Ford, partner and portfolio manager at TwentyFour Asset Management, comments that the recent replacement of SONIA (sterling overnight index average) may "set the tone" for a Libor replacement. He suggests that based on the changes to SONIA, Libor too may be replaced by a "trade-based" alternative, but that unlike the overnight market there are currently not enough trades happening in the term market to create a credible index every day.
Ford adds that a move to a Treasury-linked rate, such as that proposed in the US, or an extension of the SONIA rate along the term curve are both ideas that have been suggested. A problem here however, Ford says, is that there is not a liquid trading market in Treasury bills and the Bank of England does not currently issue bills with a three-month term, which would "rule the Treasury route out".
He adds that there is a question mark over what the new benchmarks might be relative to the existing ones. Looking to SONIA, there is a 1.3bp difference between the new and old SONIA rates - if the new term rates differ by a larger amount there could be issues.
Ford comments: "If overnight can differ by more than 1bp then there is no reason that the three-month rate might not differ by 10bp or more - and that is a significant difference. A generic three-month Treasury bill would currently trade around 10bp tighter than the current three-month Libor rate."
Furthermore, issuers and investors may react differently to a new rate that is potentially 10bp lower than Libor currently is. Issuers could be saved a "fortune", while investors will want to "avoid a cliff-effect at the changeover and ensure that they are rewarded for the credit risk they take on a commensurate basis," Ford says.
Finally, Ford highlights that the changes to SONIA have happened in full consultation with the market. He concludes that so far the same is being seen with Libor, whereby industry associations and participants are engaging with issuers, investors and policymakers to discuss how to engineer as smooth a changeover as possible.
RB
News
Capital Relief Trades
Risk transfer round-up - 27 October
Rabobank has sold a €600m portfolio of 3,600 loans that it originated. The loans all have the benefit of an NHG guarantee, backed by De Stichting Waarborgfonds Eigen Woningen (WEW).
WEW is a foundation that acts as a home ownership guarantee fund backing the NHG programme. The transaction is Rabobank's first Dutch mortgage portfolio distributed to non-Dutch investors.
Sources note that non-Dutch investors are increasingly more willing to gain exposure to Dutch mortgages. This includes risk transfer transactions referencing Dutch mortgage portfolios.
News
CLOs
Fresh yen repack prepped
Another CLO is being repackaged to issue the senior notes in Japanese yen rather than US dollars. There were three repacks in August arranged by Mitsubishi UFJ Morgan Stanley Securities (SCI 16 August 2017).
The repackaging effectively converts the repack portion of the Fortress class A notes into Japanese yen-denominated securities from US dollar-denominated securities. The expected closing date is in November.
The August repacks were Repackaged CLO Series KK-2, formed by repackaging notes from Marathon X CLO, Repackaged CLO Series KK-3, formed by repacking notes from Venture XIV CLO, and Repackaged CLO Series KK-4, formed by repacking notes from KKR CLO 10. The latest repack notes, to be issued by GC Repackaging 2017-1, constitute a repackaging of US$267m of the US$326.7m class A notes due 2029 to be issued by Fortress Credit BSL IV (see SCI's deal pipeline).
Mitsubishi UFJ Morgan Stanley Securities is once again involved as arranger and currency swap counterparty. The issuer will issue yen-denominated repackaged notes and purchase the US dollar-denominated CLO notes.
Moody's has rated the repack notes at Aaa and rated the underlying securities Aaa. S&P has also assigned triple-A ratings to both the repack and underlying notes.
JL
Job Swaps
Structured Finance
Job swaps round-up - 27 October
Australia
RMS has hired Pierre Wiart as md to its Sydney office, working on client relationships and market development. He was previously principal at Convergence Partners in Sydney.
EMEA
Goldman Sachs has hired Alex Snow as md to its structured finance division. He was also previously md at RBS in structured finance.
North America
Axis Capital has hired Brad Livingstone as vp to its New York office. He was previously vp in ILS at Willis Towers Watson in New York.
CVC Credit Partners has named Cary Ho as global head of CLO origination and md. Previously, Ho worked at Nomura Securities International where he was md and head of credit structuring.
Greywolf Capital Management has announced the formation of Greywolf Loan Management (GLM). GLM will sponsor and manage future Greywolf CLO transactions while acting as the risk retention investor for those transactions. Greywolf has also completed a first close of its second dedicated CLO equity fund with more than US$100m in longer-term capital commitments to support GLM's risk retention investments.
ILS IPO
Insurance Income Strategies, an ILS vehicle registered in Bermuda, has filed for IPO of up to US$57.5m according to the SEC filing. It intends to list common shares on the NYSE under the symbol ILS and is seeking to offer collateralised reinsurance in the property catastrophe market. IIS Re is an operating subsidiary of the vehicle and will manage its underwriting decisions initially intends to deploy most of its capital to collateralise a quota share retrocessional agreement between IIS Re and Iris Reinsurance. 1347 Advisors, a subsidiary of Kingsway Financial Services will provide certain brokerage and structuring services for a fee.
MiFID 2
Following consultation with European authorities and in response to concerns that investors could lose access to valuable research, the US SEC has issued three related no-action letters. These letters are designed to provide market participants with greater certainty regarding their US regulated activities as they engage in efforts to comply with the EU's MiFID 2 directive in advance of the 3 January 2018, implementation date.
The no-action relief provides a path for market participants to comply with the research requirements of MiFID 2 in a manner that is consistent with the US federal securities laws. More specifically broker-dealers, on a temporary basis, may receive research payments from money managers in hard dollars or from advisory clients' research payment accounts; money managers may continue to aggregate orders for mutual funds and other clients; and money managers may continue to rely on an existing safe harbor when paying broker-dealers for research and brokerage.
The temporary no-action relief facilitates compliance with the new MiFID 2 research provisions while respecting the existing U.S. regulatory structure. It also is intended to provide the staff with sufficient time to better understand the evolution of business practices after implementation of the MiFID 2 research provisions.
Portfolio acquisition
Proteus Funding, an entity financed by Goldman Sachs, has entered into a binding contract to purchase a €1.8bn portfolio of performing Irish mortgage loans from Danske Bank Ireland. The sale price has not been disclosed, but it is understood that the book traded at around 95 cents on the dollar. Danske Bank says that customer agreements are unaffected by the transfer and that individual customers, as well as the Central Bank of Ireland, have been advised of the transaction.
Settlements
Deutsche Bank has agreed to pay a US$220m settlement for defrauding US government and non-profit entities through the manipulation of Libor and other benchmark rates. The investigation was led by the attorneys general of California and New York and conducted by a working group of 43 other attorneys general.
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