Contents

ABS

Legal issues weigh on Earnest acquisition

Navient's recent acquisition of Earnest is seen as a bold move, given its ongoing legal challenges (SCI 13 October). While the takeover could lead to a surge in refi student loan ABS from the firm, investors in future transactions may need to consider whether they are buying into additional risks.

Joe Cioffi, partner at Davis & Gilbert, says: "I think it is a bold move from Navient that shows it is undaunted by the ongoing legal troubles hanging over it and is taking a big gamble on the disputes being resolved successfully."

The acquisition also represents a certain degree of risk-taking, particularly given the timing. "Navient might be betting on its success, but it is a strange time to take on stiff competition in the refi market when it is beleaguered by, and could eventually be consumed by, legal action," Cioffi adds.

The acquisition could have a significant impact on the ABS market, particularly as it provides Navient with the chance to originate loans, albeit only refi student loans until 2018, due to a non-compete clause following its split from Sallie Mae. Cioffi suggests that Navient could now be well positioned to harness expertise in the securitisation sector that Earnest lacked and so provide access to a new supply of refinanced student loans to investors through the ABS market.

Cioffi questions whether investors will necessarily find the acquisition cause for celebration, however. "Investors might ask whether they should celebrate the potential for more high-quality refi student loans to come to market or be concerned that Navient's deals come with additional risks, if the loans are subject to the same servicing practices that are at issue in all of the Navient legal actions."

Navient ceo Jack Remondi is believed to have expressed a desire to become the leader in the refi student loan space, currently dominated by SoFi. This may raise the question about whether the sector has the capacity for a firm of Navient's size.

Cioffi believes there is most likely room, however. "The refi student loan market is large and it stretches across all age groups, so there is most likely enough room for Navient to compete with SoFi and smaller lenders that dominate the market. Navient's experience and the halo currently surrounding the refi market will likely support Navient's ambitions, if Navient can put its legal issues to rest and convince investors and consumers it is worthy of their trust."

Separately, Nelnet recently entered into an agreement to acquire Great Lakes Educational Loan Services, making the combined firm the largest servicer of government-owned student loans. Moody's comments that the move is credit negative for Nelnet and for Nelnet and Great Lakes-serviced ABS.

One reason for this, according to Moody's, is that Nelnet intends to maintain distinct brands and separate servicing centres and operational teams. This may be challenging when both firms operate large, complex servicing platforms, which are under significant legislative and regulatory oversight.

Furthermore, "student lenders have had a number of regulatory issues over the years," with the acquisition bringing increased scrutiny to Nelnet, adds Moody's. The rating agency suggests that the acquisition will be subject also to integration risk and there is "uncertainty over Nelnet's ability to drive efficiencies and achieve costs savings," which was a primary driver of the deal.

Moody's suggests that the deal will be credit negative for ABS serviced by Nelnet and Great Lakes backed by FFELP student loans because of the regulatory scrutiny and integration risk. Equally, the rating agency concludes, should the integration be successful, a "steadier" firm may emerge, reducing the likelihood of future servicing disruption.

RB

NPLs

Secured exposures eyed

The ECB's recent proposal regarding higher non-performing loan provisioning is expected to have a modest impact, in particular for unsecured loans. However, the provisioning backstop for secured exposures poses a challenge.

According to DBRS, unsecured loans will be dealt a minimal blow by the ECB's proposal, since many jurisdictions already have standards in line with the central bank's approach. The picture differs for secured exposures, owing to differences in legal regimes.

"Banks in some jurisdictions run into problems with their secured portfolios, as they face lengthy legal problems associated with the sale of the collateral," says Elisabeth Rudman, md at DBRS.

However, the rating agency notes that the backstop will only apply to newly created NPLs. Moreover, secured NPLs need to be fully provisioned over a seven-year period, boosting the agency's assessment of a modest impact over the short term.

The addendum - announced on 4 October (SCI 4 October) - proposes a prudential provisioning backstop that will apply to new NPLs from January 2018. It requires banks to fully provision for unsecured NPLs over two years, with seven years allocated to secured NPLs.

Banks would need to report annually if they fully meet the guidelines. If deviations are not sufficiently explained, the ECB could consider any unexplained deviations as requiring higher capital requirements.

The ECB's actions are part of a broader action plan for NPLs. Recently, the European Commission announced that by spring 2018, it will present a comprehensive package of measures to help address legacy NPLs; currently standing at €900bn in Europe, as of end-June 2017.

The addendum follows qualitative guidance published in March 2017, with additional policies expected to address the NPL stock in 1Q18. This could include publishing additional quantitative guidance for banks that are lagging behind in relation to their plans to reduce NPLs, as recently mentioned by the chair of the ECB's Supervisory Board.

DBRS notes, however, that although the publication of NPL expectations would enhance transparency, it could create challenges for those banks with high NPLs. "What's important is the pace of NPL reductions," states Pablo Marzano, avp at DBRS. "A faster pace means banks would have to push for extra provisions, leading to additional capital requirements."

The last point is particularly relevant for the unsecured exposures of Italian banks. According to analysts at Fidentiis, the impact of a first-time adoption of the new regulation would prompt a 15bp CET1 hit for the sector - which appears manageable, given existing capital buffers, but which is skewed towards unsecured exposures.

This is due to the gap in the timeframe for unsecured exposure coverage, between the ECB guidance and the one used by Italian banks. Another gap in the coverage ratios of secured NPLs between the ECB guidance and the ones used by Italian banks could force the latter to keep provisioning over the medium term (5-6 years).

Fidentiis research points out that coverage for Italian secured loans reaches 65% over a five- to six-year period, while for unsecured ones it is 90% coverage over three to four years.

There are, however, some caveats in the methodology. Fidentiis explains that the aforementioned capital impact should be considered conservatively for a number of reasons: most importantly, the fact that there is no granularity or vintage for non-performing exposures. This renders any capital calculations a challenging proposition.

Despite reservations, some market participants anticipate that the proposals will spur more deal flow; for instance, in the Italian NPL market.

Massimo Famularo, head of Italian NPLs at Distressed Technologies, notes: "Higher provisioning may have some impact on unsecured loans because it will provide an incentive to increase provisions, even when additional collections are to be expected, although evidence for this is not persuasive."

He adds: "The increased provisions should help close the bid-ask gap in the NPL market and therefore stimulate more deal flow."

Implementation of the new measures though is expected to be a lengthy process, as it has to go through a number of legislative bodies, including the European Commission, Parliament and Council. Consequently, DBRS anticipates the supervisory powers of the ECB to have the most impact in the short term.

SP

Structured Finance

Secured warehouse use broadens

Be-Spoke Loan Funding (SCI 3 October), a direct lending warehouse facility set up as a cashflow securitisation, exemplifies one of the ways in which secured warehouse financing continues to evolve. While the sector has already demonstrated adaptability, rising interest rates could pose a significant challenge.

Warehouse funding is mainly used as either an acquisition bridge facility, a private facility for funding assets prior to a public securitisation or as a more permanent financing tool primarily used for business growth. Indeed, one of the trends in the market is the increasing reliance on warehouse funding as either a permanent or semi-permanent strategy.

Securitised warehouse funding is typically provided by a single or small number of lenders on a limited recourse basis to an SPV and secured on a portfolio of assets acquired by that SPV from the originator. Funding can either be a loan or a variable funding note, with little significant difference between these two approaches. Lenders will generally only fund a proportion of the portfolio assets, with the originator funding the rest through a subordinated loan or note.

Be-Spoke Loan Funding was set up to fund a portfolio of loans to Spanish SMEs. The initial transaction portfolio totalled €70.8m, with warehouse notional expected to reach €400m.

Be-Spoke serves as an example of direct lending, which is unusual for the sector, although it is certainly not the only example of new or different assets being used. This evolution in assets is also driving some change in secured warehouse structures, although these continue to look much as they did a year or more ago.

"What little variation there has been in the structures has been driven by the changing nature of the assets being funded. Asset classes have broadened out from a concentration on residential mortgage products to more unsecured consumer portfolios," says Kevin Ingram, partner, Clifford Chance.

Mortgage loans, auto leases and other consumer assets are increasingly funded through securitised warehouse financing facilities. Ingram continues: "Increasingly we are seeing unsecured and secured portfolios used alongside each other. Near-prime auto firms have been active in using this kind of funding, and they provide a good example of firms that are creating businesses which utilise securitisation funding through private warehouses, instead of simply using warehouses as an intermediate phase prior to developing public transactions."

Warehouse financing may typically be seen as an option for smaller originators, but larger institutions can also benefit from mixing warehouse financing and term ABS. As Ingram notes, it is a flexible form of financing which also helps to diversify funding.

"Larger institutions which do not wish to access the public market at any point in time can also benefit from warehouse financing, although it is most likely to be a stepping stone on the way to the public market rather than a final destination in and of itself," he says. "Where warehouse funding securitisation really makes sense is for new businesses, which can then ramp up to get enough mass to go to the public term market. The public term markets have been very strong and that has recently led to a number of warehouses being emptied."

Ingram adds: "The use of warehouses on a permanent or semi-permanent basis does, of course, raise the question of when this ceases to count as warehouse financing and simply becomes an asset-backed loan." A developing trend of more pre-placed transactions using a public ABS structure also blurs the lines between private warehousing and public transactions.

While secured warehouse financing continues to evolve and grow in popularity, it will be interesting to see how things change when the economic climate shifts. In the UK, the Bank of England is widely expected to begin raising interest rates when it meets tomorrow, and it is not alone.

"Money remains cheap at the moment, but interest rate risk has the potential to affect warehouse funding use, as do the risk of geopolitical events towards the end of this year," says Ingram. "An interest rate rise will dampen the need for new business and it will make portfolio acquisition more expensive."

JL

Capital Relief Trades

Balance sheet optimisation continues

Rabobank has transferred part of the risk on a €3bn commercial credit portfolio to pension fund Pensioenfonds Zorg en Welzijn (PFZW). The synthetic securitisation forms part of the lender's efforts to optimise its balance sheet and follows the disposal of a €600m mortgage portfolio to La Banque Postale (SCI 27 October).

Bas Brouwers, Rabobank cfo, confirms: "This transaction is part of Rabobank's strategy of further optimising its balance sheet. It means that Rabobank's risk-weighted assets are reduced by €1bn. We will use the capital released by this transaction to grant new loans to customers. The transaction with Pensioenfonds Zorg en Welzijn shows that there are increasing opportunities for Dutch pension funds to participate in the funding of business."

The transaction involves loans to business customers in Europe and North America. The Dutch lender's total private credit portfolio amounts to €418bn. Rabobank and PFZW closed the transaction in Q3, following a similar one in January 2014 that referenced a €3.2bn portfolio.

According to Serdar Ozdemir, portfolio manager at Rabobank, balance sheet optimisation occurs using "a number of tools from whole loan sales to true sale securitisations and to a lesser extent synthetics". He says the greatest challenge for both whole loan sales and true sale transactions is asset de-recognition. He notes, though, that assets used in securitisations that achieve significant risk transfer may be exempt from balance sheet consolidation for regulatory purposes, once CRD 5 kicks in.

Rabobank's foray into the true sale format began with its debut off-balance sheet RMBS from last July, Purple Storm 2016 (see SCI's primary issuance database).

According to the lender's current objectives, as stated in its Strategic Framework, it aims to maintain the common equity tier 1 (CET1) ratio at a minimum of 14% and to achieve a total capital ratio of at least 25% by the end of 2020. One factor that the bank takes into account when setting these targets is the expected impact of new regulations. For instance, when referring to the fully loaded CET1 ratio, it means the CET1 ratio that would apply if the CRR/CRD 4 were already fully phased in.

CRR/CRD 4 requires that various adjustments must be made to the CET1 capital calculation on 1 January of each year during the transition period. These regulations have applied to Rabobank since 1 January 2014 and will be phased in over a number of years.

According to 1H17 statements, the bank has already made improvements in this regard. In 1H17, the CET1 ratio increased by 1% to 15% and the fully loaded CET1 ratio increased by 1.2% to 14.7%.

At the same time, the total capital ratio improved by 0.5% to 25.5%. Additionally, the actual leverage ratio is well above the minimum leverage ratio of 3% required by the Basel 3 guidelines.

Although not as active as other issuers in the synthetic format, Ozdemir expects Rabobank to issue more synthetic securitisations, given the expected implementation of the Basel 4 capital floors. Higher capital requirements mooted under Basel 4 are likely to disproportionately affect Dutch banks, given their large mortgage exposures (SCI 25 April).

SP

ABS

Pre-emptive lawsuits envisaged

The threat of significant losses has sparked concern that the US subprime auto ABS sector could see pre-emptive legal actions emerging. With spreads continuing to tighten in the face of increasing delinquencies, investors may start to question whether they are being adequately compensated for the risks involved.

Joe Cioffi, partner at Davis and Gilbert, says that while losses in subprime auto ABS have yet to "flow through to investors", they may start to look more closely at these transactions and ask whether they are appropriately priced for the risks involved. As such, he suggests that investors are starting to develop a "growing feeling that something is not right."

Given this growing concern, the potential for legal action could arise in the event that auto deals start to see losses. Investors may also wish to avoid the delays associated with the subprime mortgage crisis, after which participants sometimes waited several years to launch legal action.

Cioffi says: "Trustees may be much more inclined to act, and investors may also encourage trustees to act faster than in the case of subprime RMBS. Trustees may consider taking legal action against sponsors and depositors to pre-empt suits against them by investors, because investors may try to claim they are being exposed to a material increased risk of loss as losses are incurred by the trust itself, even if credit enhancements are providing investors with a cushion."

Consequently, trustees may start changing their behaviour to highlight that they are performing their duties and also "taking discretionary action where warranted for the benefit of investors", as well as cooperating with them. They may want to show, Cioffi suggests, that they are not just relying on the cushion of credit enhancement.

In particular, comments Cioffi, trustees in subprime auto ABS transactions may be asking themselves if they want to be questioned in future about "why they took no action if they have reason to suspect any of the issues that have been reported in certain instances - issues such as dealer fraud, low incidence of income verification or dealer fraud, low incidence of income verification or missing documentation - are present in their deals. They could ask these questions now or they could be asked by investors in lawsuits."

Along with rising delinquencies, auto debt's status as consumers' priority payment may also be threatened, posing further risks to the sector. Cioffi comments that this could result from a range of factors, including the rise of alternatives to car ownership - such as car-sharing services - as well as generational shifts that now see "a quarter of high school students graduate without a license to drive."

As a result, he notes: "If subprime borrowers get behind in their car payments, it may be more convenient for them to let the car go and find another way to work."

Wells Fargo structured products analysts agree that caution is warranted until the market takes account of these risks and suggest that investors may want to move up in credit or temporarily slow purchases of new bonds. Furthermore, they indicate that a material risk of legal action could harm bondholders in the near term through increased headline risk and wider spreads.

Nevertheless, the analysts comment that lower FICO and higher WAC subprime auto ABS pools are exhibiting "relatively stable" cumulative net loss rates, suggesting credit trends are relatively stable and close to market expectations. They add that so far the subprime auto ABS sector is adequately enhanced to account for the current credit and market risks.

While uncertainty persists around the rise of delinquencies in the subprime auto ABS market, opportunists are making preparations to capitalise on potential disruption. Cioffi concludes: "There are some investors known to be considering funds to invest in distressed subprime auto ABS."

RB

Secondary markets

Euro secondary strengthens

Levels continue to strengthen across the European securitisation secondary market.

October has been another month of more of the same and November looks unlikely to differ in the short term as technicals still hold sway and volumes remain relatively light. Demand continues to outstrip supply with holders unwilling to release seemingly ever-improving paper and other participants, especially dealers, very keen to add.

Consequently ABS/MBS secondary spreads have ground tighter across all sectors over the past month. CLOs have exhibited the same pattern, but with a little more activity that has simply generated even stronger prints throughout the capital structure and across vintages.

There is currently one BWIC on the European schedule for today - two lines of Dutch prime RMBS. Due at 11:00 London time the list consists of €39.5m E-MAC NL04-I A and €29.6m E-MAC NL05-3 A.

Neither bond has covered on PriceABS in the past three months.

Secondary markets

US CLO stand-off

The US CLO secondary market is caught in a supply-demand stand-off.

"The secondary market has effectively reached stalemate," says one trader. "Levels are such that for many buyers prices are too high, but holders aren't seeing enough value or alternatives to warrant selling, so it has been very quiet over the past few weeks."

The trader continues: "That said, the bonds that do come out do trade very well and we continue to grind tighter. Though it looks like it's going to be a while before we see the higher coupon bonds of the last couple of years circulating, which will really get things going again."

Meanwhile, there does at least appear to be something of an uptick in BWIC activity this week, albeit from recently low volumes. "It's partly due to month-end, but there are some interesting lists later in the week too, notably a large equity one on Thursday, which will be closely watched," the trader notes.

For today, there are three BWICS on the US CLO calendar so far. The largest is a $20.5m eight line mix of 2.0s.

Due at 10:30 New York time the list comprises: BABSN 2015-2A AR, BLUEM 2017-1A C, CAVY 2014-5A D, EATON 2013-1A CR, GTLNF 2013-1A C, JTWN 2015-6A D, KKR 13 C and MIDO 2012-1A CR. None of the bonds has covered on PriceABS in the past three months.

ABS

Protection 'gap' targeted

Plans to establish Singapore as an Asian insurance-linked securities hub were unveiled today at the Singapore International Reinsurance Conference. Lim Hng Kiang, minister for trade and industry and deputy chairman of the Monetary Authority of Singapore (MAS), outlined a three-pronged strategy aimed at closing what he described as a "protection gap" in the region.

"As Asia continues to grow in economic importance - fueled by rapid urbanisation, infrastructure development and trade growth - insurance penetration continues to be low and the growing protection gap in the region remains a challenge. The low penetration arises from of a lack of risk awareness and data paucity, making it difficult for risks to be well-modelled and priced. As a result, less than 5% of disaster losses in Asia were insured over the past decades," the minister explained.

The strategy involves developing alternative risk transfer mechanisms and government insurance pools in order to provide financing quickly and effectively in the aftermath of loss events, as well as incubating insurance solutions for new and emerging risks, such as cyber, reputation and environmental liabilities. The Singapore government will also seek to transform the insurance market through technology and innovation.

Speaking at the conference, the minister pointed out that alternative capital has been growing more rapidly than traditional capacity, demonstrating greater acceptance of ILS instruments by both investors and issuers. Indeed, he noted that a growing number of institutional investors and fund managers - such as Quantedge - are exploring allocations to catastrophe bonds. On the supply side, there has also been healthy interest from Asia-Pacific issuers in the development of an APAC market for catastrophe bond issuances, due to "the proximity to and better understanding of the underlying risks".

MAS has consequently formed an alternative risk transfer work group, comprising industry experts in the ILS space. Chaired by Jon Paradine of Renaissance Re, the group will advise the Authority on specific initiatives that will support the development of Singapore as an ILS hub.

Another initiative unveiled today is an ILS grant scheme, whereby the MAS will fund 100% of the upfront costs incurred in issuing catastrophe bonds out of Singapore. The grant will run from 1 January 2018 and will be applicable to ILS bonds covering all forms of risks beyond just natural catastrophe risks.

MAS is already working with industry players, such as IAG Re Singapore, with a view to issuing a catastrophe bond in Singapore.

CS

ABS

Unique SLABS relaunched with revisions

The first securitisation of income-contingent repayment (ICR) student loans originated by the UK government (SCI 29 March) has been re-jigged after being postponed due to the UK general election in June. Dubbed Income Contingent Student Loans 1 (2002-2006), the £3.94bn ABS is the first of its type globally and has been relaunched with structural changes and revised provisional ratings.

Rabobank credit analysts comment that the transaction structure differs from the structure announced earlier this year, as the slow-paying senior tranche (class A3) has been dropped. Otherwise, the deal will be offered with two senior notes: the class A1 notes are pass-through, while the class A2s are subject to scheduled amortisation. The class B and X notes are also pass-through.

Fitch has lowered its provisional rating on the class A1 notes from double-A to single-A, while S&P has reassigned provisional ratings to the deal following an earlier withdrawal. S&P comments that the withdrawal came after a delay in the transaction's closing and changes to the sale pool and capital structure.

The provisional ratings from Fitch and S&P now stand at single-A on the £851.5m class A1 notes (which are anticipated to pay 12-month Libor plus 100bp), single-A on the £732.3m class A2s (2.5%) and triple-B on the £126.7m class Bs (index rate plus 145bp). The £2.016m class X notes are unrated, but have an interest rate of 0.5% and final maturity of July 2056.

S&P's preliminary ratings take into account the transaction's credit enhancement, provided through overcollateralisation of 57.5% on the class A notes and 54.1% on the class Bs. The rating agency adds that it has assigned its triple-B rating to the class Bs on the basis of deferrable interest.

S&P notes that the unique element of the type of student loan being securitised is that a borrower's annual repayment obligation depends on whether the individual's taxable income exceeds a pre-specified repayment threshold. The repayment threshold is adjusted annually to account for the change in the March retail price index (RPI). The loans will bear interest at the lower of the March RPI or the interest rate cap (base rate plus 1%).

The Rabobank analysts add that they expect the transaction to be the first of many and note that the payments are collected by the UK tax system and therefore have very low risk of arrears or defaults. There is, however, no government guarantee on the loans.

Additionally, there is no step-up or call present and the seller will comply with the risk retention requirement by retaining a random selection of 5% of the assets. The deal is expected to launch at the end of November or beginning of December.

RB

ABS

ISPV approach published

The UK PRA has published its final approach and expectations in relation to the authorisation and supervision of insurance SPVs (SCI passim). In light of public consultation, a new safeguard has been introduced that removes the need for multi-arrangement insurance SPVs (MISPVs) to notify supervisors of proposals to assume new risks before they take effect. The authority has also issued additional guidance on the fully funded requirement and the senior insurance managers regime (SIMR).

The updated rules now require MISPVs to provide post-transaction notification to the PRA of the assumption of new risks, provided this is within the vehicle's scope of permission (SOP). Where a protected cell company (PCC) assumes risk, it must notify the PRA within five working days beginning with the day it assumed the risk.

Respondents to the public consultation regarding a UK ILS regime expressed concerns over the commercial viability of the previous proposal to establish a new cell at least 10 working days before the assumption of a new risk. The SOP - which replaces the regulatory business plan that formed part of the draft Supervisory Statement on the authorisation of ISPVs - outlines the arrangements, structures and mechanisms to which an ISPV is limited.

During the consultation, respondents also suggested that limited recourse clauses be mandatory for ISPVs or that the existence of a limited recourse clause might be relied upon by ISPVs as sufficient to demonstrate that the fully funded requirement was met. In its update, the PRA points to the fully funded ISPV definition under Solvency 2: that an ISPV must have "assets the value of which is equal to or exceeds the ISPV's aggregate maximum risk exposure" and the ISPV "is able to pay the amounts it is liable for as they fall due".

Consequently, the authority notes that an ISPV cannot rely on a limited recourse clause as an alternative to holding assets the value of which is equal to or in excess of its aggregate maximum risk exposure (AMRE) or be relied on in a way that undermines the effectiveness of risk transfer. "The impact of a limited recourse clause on the effectiveness of risk transfer and how it contributes to the ISPV's ability to meet the fully funded requirement, in combination with its risk management and investment strategies, must therefore be assessed case by case," it observes.

Indeed, the PRA's view is that limited recourse clauses should not be used to justify 'underfunding' of an ISPV on the assumption that off-balance sheet support may be available or to deal with the risk of receipt of funds being delayed until after contractually agreed changes in the AMRE have become effective. In light of this, the authority would not expect any risk transfer to an ISPV to become effective until the corresponding funds have been received by the vehicle.

However, it clarified that renewal, rollover and top-up arrangements can be accommodated in connection with meeting the fully funded requirements. While contingent assets cannot be included as part of the requirement, they can be considered when assessing the effectiveness of risk transfer, in combination with a vehicle's risk management and investment strategies.

Regarding the SIMR, the PRA says it continues to believe that the requirement for three mandatory senior insurance manager function (SIMF) roles is appropriate and proportionate for an ISPV. However, it has clarified that an individual can perform more than one of these roles and that a SIMF role need not be held by an employee of the ISPV.

The PRA's changes will be formally adopted once the Risk Transformation Regulations 2017 (RTR) - the final version of which was laid before Parliament on 12 October - have been passed into law.

CS

ABS

First Aussie personal loan ABS prepped

The first Australian personal loan ABS is marketing. The A$542.5m Latitude Australia Personal Loans Series 2017-1 transaction (see SCI's deal pipeline) securitises a portfolio of Australian unsecured and partially secured personal loans originated by Latitude Personal Finance.

Moody's has assigned preliminary ratings of Aaa to the A$331.5m class A notes. It has rated the A$56m class B, A$40m C, A$27m D and A$45.5m E notes at Aa2, A2, Baa2 and Ba2, and has not rated the A$42.5m seller notes. Fitch has rated the class A notes triple-A and the class Bs double-A, but has not rated the other notes.

The A-E notes benefit from 38.9%, 28.6%, 21.2%, 16.2% and 7.8% of note subordination. Following the end of the substitution period, the notes will be repaid on a sequential basis until the credit enhancement of the class A notes is at least 57%.

The receivables are typically unsecured, although a portion are partially secured by motor vehicles. The transaction also has a substitution period of 12 months from the first payment date, subject to certain amortisation triggers.

The total securitised portfolio amount is A$534.775m and consists of 35,556 contracts with an average balance of A$15,036. The weighted average remaining term is 58.3 months and weighted average original term was 75.9 months.

All of the loans are fixed rate. Only 2.6% are in arrears greater than 30 days.

Moody's base case assumptions are a default rate of 9.7%, coefficient of variation of 42.4%, and a recovery rate of 15%. Initial seasoning of 19 months is unusually high, and contributes to the rating agency's mean default rate assumption being adjusted to 8.3%.

The notional amount in the interest-rate swap agreement is based on the repayment profile of the rated notes, assuming a prepayment rate of 20% on the underlying receivables. The notional amount under the swap agreement may exceed or fall below the outstanding balance of the rated notes if prepayments deviate from 20%, exposing the transaction to being under- or over-hedged, depending on interest rates. There is a derivative reserve of A$7.5m to address this risk.

JL

ABS

Loss coverage ratios scrutinised

Loss coverage ratios on a number of World Omni Auto Trust class A ABS bonds should have been adequate before the recent introduction of a cash-trapping mechanism, according to a new Wells Fargo study. However, the analysis suggests that loss coverage ratios on class B bonds have been lagging, particularly for 2016 vintage deals.

Fitch recently affirmed its ratings on the outstanding notes of WOART 2015-B, 2016-A and 2016-B, after World Omni Financial Corp amended the transactions to include supplemental reserve amounts of US$14.5m, US$20m and US$21m respectively. The amendments will result in a build-up of cash over the next 12 months by trapping excess spread that would have otherwise been released at the bottom of the waterfall. The trapping of excess spread in ABS deals increases credit enhancement in order to mitigate risk and maintain ratings.

In their study, Wells Fargo structured products analysts deployed an unrealised cumulative net loss (CNL) coverage model to gauge the credit risk in the deals reviewed by Fitch. CNL rates for WOART 2015-B and 2016-B have been running at elevated levels, causing the rating agency to increase its CNL expectations, given concerns that loss coverage multiples would fall short of the required 5x for triple-A and 4x for double-A bonds.

"The steeper trajectory of CNL rates is being influenced to a large degree by higher default rates early in the life of each of these transactions. Higher default rates early generate higher dollar losses based on a larger pool balance, which results in the steeper CNL curves," the Wells Fargo analysts observe.

Generally, auto ABS default rates follow a seasoning ramp and reach a peak after months 12-24, after which they stabilise or decrease. The analysts suggest that to the extent these WOART deals follow the historical pattern, the dollar amount of losses should slow going forward.

Loss severities on WOART bonds remain relatively benign at an average of 44% for the six deals - series 2014-B, 2015-A, 2015-B, 2016-A, 2016-B and 2017-A - examined in the analysis. However, using CNL rates by pool factor to adjust for relative amortisation, the loss trajectories of 2016-A, 2016-B and 2017-A appear to be rising faster from the outset.

The study highlights WOART 2015-B as the most seasoned deal from the shelf. The analysts' pool factor target CNL for the transaction of approximately 2.35% over the past 10 months is close to Fitch's revised target CNL of 2.45%, up from its initial baseline CNL assumption of 2.10%.

"We find that at the time the cash-trapping mechanism was executed in September 2017, the loss coverage multiples were already at or above the required levels, based on our model of prospective losses. In our view, the extra protection from trapping excess spread may not have been needed for 2015-B," they comment.

For the 2016-A deal, the Wells Fargo pool factor target CNL stabilised at roughly 3%, versus Fitch's revised expectation of 2.83% (up from an expected 2.25% when the deal was rated). "Our unrealised CNL loss coverage model indicates that the loss coverage ratio for the class A bonds was already headed back to the 5x level required by Fitch. However, the loss coverage ratio for the class B bonds continues to lag, running below 3x coverage - although it has begun to accelerate somewhat since the boost in credit enhancement began in September. In our opinion, the capture of excess interest in WOART 2016-A will provide a more significant benefit to the subordinated bonds compared to the senior bonds as the cash reserve builds," the analysts continue.

Meanwhile, for WOART 2016-B, they warn that their model can be somewhat volatile in the early stages of an auto ABS deal due to potential variability in loss rates and the degree of adjustment when pool factors remain high. Nevertheless, their pool factor target CNL currently stands at around 3%, while the October reading jumped to 3.26% based on a larger increase in CNL this month.

The class A loss coverage ratio is recovering toward the 5x level needed to maintain its triple-A rating, according to Fitch. "The bonds do not seem to be at risk for a write-down, in our opinion, but potential rating volatility would be possible if the loss coverage ratios do not recover to their required levels," the analysts conclude.

CS

Structured Finance

SCI Start the Week - 30 October

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

Pipeline

There were notably fewer pipeline additions last week. The final count consisted of an ABS, five RMBS, four CMBS and a CLO.

US$340m Tesla 2017-1 was the ABS. The RMBS were: US$170.2m Bayview Opportunity Master Fund IVb Trust 2017-RT6; US$207.2m CoreVest American Finance 2017-1; US$486m Flagstar Mortgage Trust 2017-2; C$520m Fortified Trust Series 2017-1; and US$343.51m MetLife Securitization Trust 2017-1.

US$1.1bn BANK 2017-BNK8, US$470m JPMCC 2017-FL11, US$743m UBS 2017-C5 and US$705m Worldwide Plaza Trust 2017-WWP were the CMBS. The sole CLO was US$510.5m THL Credit Wind River 2017-4.

Pricings

There were 14 ABS prints in the week, as well as an ILS, three RMBS and nine CLO/CDOs.

The ABS were: €958.4m Alba 9; US$1.825bn American Express Credit Account Master Trust Series 2017-6; US$782.14m American Express Credit Account Master Trust Series 2017-7; US$570.55m American Express Credit Account Master Trust Series 2017-8; US$160.58m Avant Loans Funding Trust 2017-B; £535m Bavarian Sky UK 1; US$565.31m Capital Auto Receivables Asset Trust 2017-1; US$1bn Chesapeake Funding II 2017-4; US$1bn Ford Credit Auto Lease Trust 2017-B; C$519.25m Ford Auto Securitization Trust Series 2017-R5; £223m Marketplace Originated Consumer Assets 2017-1;US$883.56m Synchrony Credit Card Master Note Trust Series 2017-2; US$128.74m Veros Auto Receivables Trust 2017-1; and Wizink Master Credit Cards 2017-02.

US$368.11m Bellemeade Re 2017-1 was the ILS. The RMBS were €415m FT RMBS Prado V, A$605m-equivalent Pepper Residential Securities Trust No.19 and STACR 2017-SPI1.

The CDO/CLOs were: US$535.31m Cerberus 2017-4; US$563m Fortress Credit BSL IV; US$338.52m ICG US CLO 2014-1R; US$375m Ivy Hill Middle Market Credit Fund 2013-7R; US$537m Jubilee CLO 2017-XIX; US$350m Monroe Capital MML CLO 2017-1; US$561.3m Neuberger Berman Loan Advisers CLO 26; €435m St Paul's CLO IV; and US$340.4m Trups Financials Note Securitization 2017-2.

Editor's picks

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...

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...

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...

Deal news

• Veros Credit has prepped an inaugural rated US$165.28m subprime auto ABS. The transaction, Veros Auto Receivables Trust 2017-1, is backed by a pool of 17,328 seasoned subprime auto loan contracts secured mostly by used vehicles.
• 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.
• 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.
• 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).
• Another CLO - Fortress Credit BSL IV - 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).

Capital Relief Trades

Risk transfer round-up - 3 November

Two US public pension funds in Arizona and Pennsylvania are rumoured to have completed a capital relief trade each, although the exact identity of the funds could not be confirmed. According to one industry insider: "The risk transfer market is private, so the details of the transactions are sketchy. However, if I am hearing of these deals, I suspect there are more."

CMBS

Online retail drives CRE growth

Industrial logistics space outperformed office, retail, apartment and light industrial space in terms of supply, demand, occupancy and rent growth in 1H17, notes Morningstar Credit Ratings. Online retailers such as Amazon have been central to the industrial sector emerging as the leader of growth in CRE.

Amazon's industrial space backs US$2.41bn in CMBS. The company's fulfilment network, comprised of fulfilment and sortation centres, is central to its operations and accounts for 87.2% of CMBS exposure by loan balance to Amazon logistics/industrial space where the online retailer is a tenant.

The largest CMBS loan backed by Amazon fulfilment or sortation centres is the US$964m loan secured by the 800 North 75th Avenue property in Phoenix, Arizona. That loan is securitised in CSMC 2015-GLPB, CSAIL 2016-C6, CSAIL 2016-C7 and MSC 2016-UBS9.

There is also a US$822m loan securitised in CORE 2015-WEST. Others include a US$164.547m loan in WFCM 2010-C1, a US$48.587m loan in JPMCC 2016-JP3, a US$40.8m loan in MSBAM 2013-C7, a US$38.5m loan in JPMCC 2012-LC9 and a US$20.912m loan in COMM 2015-LC21.

Amazon does not disclose the exact number of fulfilment and sortation centres it operates, but analysis by TaxJar suggests there are at least 171 operating and announced fulfilment and sortation centres in the US. Amazon itself says only that there are more than 70.

However, fulfilment and sortation centres are not the only type of industrial space serving as collateral in CMBS that Amazon occupies. There are four other property types securing eight other loans. Morningstar notes that all loans are current.

There is an Amazon Locker property backing three loans. An Amazon Fresh and Prime property also backs three loans. An Amazon Web Services property supports a single loan, as does an Amazon Flex Warehouse property.

Industrial warehouse has performed well compared to other commercial asset types. Logistics' year-over-year supply growth at the end of 2Q17 was 3.3%, demand growth was 3.7%, occupancy growth was 0.4% and rent growth was 6.9%, exceeding office, retail, apartments and light industrial. Morningstar notes that e-commerce has climbed every quarter since the end of 2008, reaching 10.5% of total retail sales (excluding automobiles and gas) as of 1Q17. "Additionally, annual growth for online sales was about 15% as of first-quarter 2017, so there is potentially significant demand going forward," Jennifer Jones, CMBS senior loan analyst at Morningstar Credit Ratings adds.

Amazon is currently looking to build a second US headquarters, with US$5bn pledged to construct and staff it. While this would be a boon for the US office sector, Morningstar notes that the CMBS office sector has been significantly affected by Amazon before.

"Amazon had occupied 1200 12th Avenue South in Seattle from 1998 to 2011. The office loan was in CSFB 2000-C1 at an original amount of US$23m [see SCI's CMBS loan events database]," says Jones.

Jones continues: "In 2011, Amazon vacated when its lease expired, and the loan defaulted on debt service two months later. The property was foreclosed upon and a subsequent liquidation in August 2012 resulted in a US$20.2m realised loss."

JL

Capital Relief Trades

Using insurance to lay off risk

Alan Ball and Fiona Walden, senior underwriters leading the structured risk solutions team at Liberty Specialty Markets, answer SCI's questions

Q: How did Liberty Specialty Markets become involved in providing capital relief-driven transactions?
A: We're one of the leading insurers operating in the London insurance market, providing both specialty insurance and reinsurance. Our structured risk solutions team was set up just over three years ago to provide insurance cover for transactional risks and structured financial risks.

Our involvement in capital relief-driven transactions grew out of our work on transactional risks. Traditionally, cover for these risks was provided not because the policyholder was concerned about the risk to be covered, but because it enabled them to achieve another strategic goal.

For example, by taking out insurance against breach of warranties in a share purchase agreement, a private equity fund can more quickly distribute the proceeds to its investors. This is because the insurance mitigates the need to reserve for contingent liabilities arising from the share purchase agreement.

Based on our growing experience with transactional risks, we began to explore other areas in which similar dynamics and motivations existed. Capital relief cover was one such area.

We originally insured legacy non-core credit assets held by banks, for which they struggled to find solutions via traditional routes. These assets represented good quality credit risks, but had become capital intensive as a result of the changing regulatory landscape.

Having analysed the legislation, we drafted our policies to meet the requirements for eligible credit risk mitigation set out in the Capital Requirement Regulation (CRR). This enables a banking client to realise the associated capital benefits as a result of the risk transfer.

Relevant regulators are aware that insurance is being used as eligible credit risk mitigation under CRR and Basel 3. Some clients have shown our policies to their regulator in advance of signing a deal; others have been audited by their regulator post-signing.

Since writing our first policy, we've worked with a number of major financial institutions and have deployed a significant amount of cover across of a variety of risks, jurisdictions and sectors.

We take a principles-based approach to our underwriting and risk selection. This is important to give us the flexibility to deliver effective solutions to our clients, as many risks we cover are bespoke or niche and require suitably tailored solutions.

One of our key underwriting principles is that while insurance is clearly the business of risk transfer, there needs to be a wider, credible strategic goal driving the purchase of insurance - not simply a desire to offload poor quality credit risk. We scrutinise the motivation for insurance cover closely in our underwriting and look for alignment of interest with our insureds to prevent any moral hazard.

Q: What are your key areas of focus today?
A: Initially, we focused on solutions for legacy non-core assets held by banks. An example would be providing default cover for legacy securitisation positions, such as SPV liquidity facilities.

Such facilities are unrated and therefore attract a high capital weighting relative to the risk they represent. This is because the risk weighting is driven by the rating of the most senior note tranche. Insuring the default of the facility reduces the capital requirements of the bank through PD substitution - the bank no longer has exposure to an unrated SPV, but to a single-A rated insurer.

Interest rate swaps for legacy RMBS are also of interest to us.

While we remain open to working on legacy non-core banking assets, they represent a finite pool of opportunity, so we've begun to focus on other risks, such as providing portfolio credit solutions. Portfolio credit solutions can be structured in a variety of ways, such as insurance of a junior tranche on a portfolio of loan assets, allowing the bank to achieve significant risk transfer using unfunded credit risk mitigation. Alternatively, where a bank has aggregation to a particular sector or territory, insurance can facilitate increased flow of business for the bank.

We've also provided cover in relation to securities lending indemnification exposures and are familiar with the counterparty credit risk issues in this area. Here, the driver can be capital: simply affording the lending agent's clients an extra layer of comfort or addressing some other issue that is unique to that particular lending agent.

Provided there is a strategic driver for cover and the risk insured is financially catastrophic for that asset class, rather than ordinary course losses, the scope of credit risks we can look at is very diverse.

Q: How do you differentiate yourself from your competitors?
A: We're the only team in London that focuses on structured credit risk transfer through insurance. In terms of our team's expertise, we have insurance, corporate, legal, private equity, structured finance and tax expertise, with 25 years' professional experience in leading and advising on unique, complex and often precedent-setting transactions.

This broad range of experience means we are comfortable approaching unique or niche risks. It also means that we have a first-hand, intimate understanding of deal dynamics and the challenges and constraints (both internal and external) that parties trying to execute such transactions can face. The key reason behind our success has been the backing of a stable, creditworthy insurer such as Liberty and the ability to effectively translate regulatory issues and financial risks into insurance grounding.

We typically form long-term partnerships with all of our clients. Our hope is that after executing an initial transaction, we can replicate a transaction with the same client or tackle other areas of their business.

Q: Which challenges/opportunities does the current environment bring to your business?
A: Creating awareness of the possible usages of insurance for structured credit risk transfer is certainly a challenge. We have a genuinely differentiated offering, given how we approach transactions. It's our ability to bridge the disconnect between banking and insurance.

We strive to keep on top of the multitude of issues facing financial institutions at the moment. We are starting to see more actions focused on asset managers and private equity funds, rather than solely banks.

Q: What is your strategy?
A: To grow our profile and continue to execute on innovative transactions, as well as establishing long-term partnerships. The focus of our book is swinging to risks driven by strategic motivations, rather than solely capital relief.

The nature of the risks we target means that we have to be flexible and adaptable to the commercial and regulatory environment, but we also want to target areas where we think there is longevity. In this regard, the area of portfolio credit risk transfer is particularly interesting.

CS

Structured Finance

Job swaps round-up - 3 November

EMEA

The Carlyle Group is set to reorganise its executive leadership, effective from 1 January 2018. Deputy cio Kewsong Lee and president/coo Glenn Youngkin will replace David Rubenstein and William Conway as co-ceos of the firm, while deputy cio Peter Clare will become co-cio alongside current cio Conway, with the trio also joining the board of directors. Rubenstein and Conway will become co-executive chairmen and continue to serve in Carlyle's executive group. Meanwhile, Carlyle's current chairman Daniel D'Aniello will become chairman emeritus and continue to serve on the board and executive group. Lee will focus on Carlyle's corporate private equity and global credit businesses, while Youngkin will focus on its real estate, energy and infrastructure businesses.

FRP Debt Advisory has hired Andy Pickford as a director, based in the Manchester office. Pickford was previously director of origination in RBS's asset backed lending division. The hire coincides with the name change to FRP Debt Advisory after the integration of Litmus Advisory within the FRP Advisory partnership of business advisory services.

Liberbank is to establish a company with Bain Capital Credit and Oceanwood to manage, develop and dispose of a portfolio of real estate foreclosed assets of Liberbank and its group, in which Liberbank will hold, directly or indirectly, 9.99% of the capital. Bain Capital Credit will hold 80% of the capital and Oceanwood will hold the remaining 10.01%. Liberbank will transfer gross real estate assets amounting to €602m, of which €180m are land and work-in-progress, €80m tertiary and €342m residential. The management of the assets transferred to the company will be done by Bain Capital, upon the moment of completion of the transaction, which is expected to be before 31 December 2017, once all conditions precedent have been fulfilled. Liberbank has enough provisions as of 30 September 2017 to offset the negative impact of the execution of this portfolio sale.

North America

Hiscox Re has hired Aaron Garcia Ehrhardt as portfolio manager, ILS to its Bermuda office. He was previously a property underwriter at Novae.

KBRA has appointed Dana Bunting as md of issuer business development. Bunting joined the firm in April 2017 as md and head of public finance investor relations, joining from Goldman Sachs where she was working for 21 years in the public sector and infrastructure group.

Acquisitions

Artex Risk Solutions has acquired Chandler Insurance Management. Chandler brings to Artex more than 20 years of captive insurance management experience in the Cayman Islands.

Duff and Phelps is to be acquired by a company backed by the Permira Funds for US$1.75bn. Selling equity holders include The Carlyle Group, Neuberger Berman, the University of California's Office of the Chief Investment Officer of the Regents and Pictet & Cie. As part of the transaction, the Duff and Phelps management team will maintain a significant equity stake in the firm and will continue to lead the company in their current roles. The transaction is subject to customary conditions and is expected to close in the first quarter of 2018. Carlyle's equity for the investment came from Carlyle Global Financial Services Partners II, Carlyle's dedicated financial services investment fund.

Redpoint Capital Group has agreed to sell a stake in its affiliated general partner and management company to an affiliate of Dundon Capital Partners (DCP). DCP is led by Thomas Dundon, one of the founders and former ceo and chairman of Santander Consumer USA. As part of the transaction, both Dundon and DCP partner, John Zutter, will sit on Redpoint Capital's board of directors along with Redpoint Capital Managing partners Alex Dunev and Andy Thomas. Thomas and Dunev will continue to manage Redpoint Capital's operations in Dallas, Texas.

Name change

Mount Street's acquisition of EAA Portfolio Advisers (EPA) has received regulatory approval from BaFin and the Bundesbank and EPA will be renamed Mount Street Portfolio Advisers (MSPA). The agreement between Mount Street and EAA was signed in December 2016 subject to receipt of regulatory approval and Mount Street has acquired the whole of MSPA, including approximately 70 employees at offices in London, Düsseldorf, New York and Madrid.

Joint venture

Annaly Capital Management and Capital Impact Partners have launched a new US$25m joint venture dedicated to supporting community development in underserved cities across the US. The two firms have established an innovative mortgage REIT that will provide direct financing for socially responsible projects in low-income communities over a five-year period, with the option to increase their overall investment as the venture matures. Separately, Annaly has appointed Katie Beirne Fallon (global head of corporate affairs for Hilton) and Vicki Williams (svp, compensation, benefits and human resources information system at NBCUniversal) as board members, effective from 1 January 2018.

Fund partnership

Groupama Asset Management and Tikehau Investment Management have signed a cooperation partnership, whereby they have the option to delegate management, create co-branded products and enter into distribution agreements. The move is designed to enable the two firms to broaden their product offering in terms of asset classes and to offer their clients access to the expertise of both entities. The firms say they share the same fundamental approach to management.

Settlements

RBS Securities has agreed to pay a penalty of US$35m to the US Attorney's Office as part of a non-prosecution agreement in relation to securities fraud through its now-defunct US ABS, MBS and CMBS securities trading group. As well as the US$35m penalty, RBS will also pay over US$9m in restitution to victim customers which include firms affiliated with recipients of federal bailout funds through the Troubled Asset Relief Program. The government's investigation revealed that RBS, principally from its trading floor in Stamford, Connecticut, perpetrated a scheme from 2008 to 2013 to defraud its customers in trades of RMBS and CLOs The purpose and effect of RBS's fraud was to increase its profits on RMBS and CLO trades at the expense of victim customers. RBS conducted this scheme by, through and with its employees, who acted with the knowledge, encouragement and participation of RBS supervisors or its compliance-related personnel.