Contents

Capital Relief Trades

Proportional protection reviewed

EU policymakers are currently negotiating an amendment to Article 234 of the CRR that would allow banks to treat first-loss protection as proportional protection. If successful, the move is expected to boost mortgage significant risk transfer issuance.

According to Article 234 of the CRR, loan-level insurance protection for synthetic securitisations that is tranched first-loss protection must apply Chapter Five of the securitisation framework, which is designed for portfolios rather than individual loans. This means that a portfolio of 5,000 loans would have to replicate the securitisation analysis and authorisation process for the regulatory SRT assessment 5,000 times. This approach is very complicated and to date there is no known case of capital relief being achieved through this route.

The amendment - dubbed 596 and drafted by MEP Caroline Nagtegaal - allows banks to treat first-loss protection as proportional protection (or partial protection) for the purpose of calculating capital relief and thus avoid having to go through the securitisation framework. This is accomplished by integrating the new Basel 3 rules into the CRR, which is expected to be introduced in 2022. However, the amendment itself will become immediately effective if it is eventually legitimised by the European Parliament.

Sources suggest that this is an idea that both regulators and the banking industry are comfortable with. In particular, by treating first-loss protection as proportional protection, banks will see the size of their protected loan reduced - even if the risk weight does not change.

The benefit here is that RWAs remain the same on a smaller loan, thereby raising the value of the protection. The amendment would lead to a reduction of capital that is proportional to the depth of the mortgage insurance cover.

Consequently, there would be no need to analyse and apply for thousands of single-loan SRT regulatory approvals. This introduces simplicity in the approval process that is expected to boost mortgage SRT issuance.

This explains why Dutch banks - who are burdened with a high a supply of mortgages - have been especially supportive of this amendment. European residential mortgages currently represent around €6trn, or approximately 40% of the overall balance sheet of European banks.

While the risk weight for mortgages is low, their sheer volume makes the total capital locked within them quite significant. Further complicating the issue is the ECB’s Targeted Review of Internal Models (TRIM) and capital floors, which are expected to raise the amount of capital absorbed by mortgages (SCI 14 December 2017).

However, policymakers and bankers supportive of the amendment will have to overcome certain challenges. Sources in Brussels observe support among for the move, given that it would benefit the European mortgage market by making mortgages less expensive throughout the region. The issues here though are more political rather than technical or economic.

According to the same sources, tradition stipulates an integration of the whole Basel package into the CRR. Consequently, the introduction of an amendment to the CRR without an integration of the whole framework may create an unwanted precedent.

This is why parliamentary rapporteurs and bankers, at present, formally support the creation of two separate dossiers: one focused on risk reduction, which doesn’t try to integrate international agreements and has to be completed first; and another one on the new Basel rules. However, counterarguments point to a piecemeal approach in terms of incorporating the Basel framework into the CRR.

Ultimately, the success of the amendment will depend on the rapporteur’s ability to convince negotiators that it provides a secure and reliable tool for the European mortgage market. The Parliamentary vote on the amendment is scheduled for next month.

SP

Structured Finance

SCI Start the Week - 16 April

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

Pipeline
The newly-announced transactions remaining in the pipeline at the end of last week comprised ABS and RMBS. The ABS deals were backed by auto, equipment and whole business collateral.

The auto ABS were: US$611m Canadian Pacer Auto Receivables Trust 2018-1, US$1.1bn CarMax Auto Owner Trust 2018-2, €488m Driver Italia One, Exeter Automobile Receivables Trust 2018-2, US$1.06bn Ford Credit Auto Lease Trust 2018-A and MBARC Credit Canada 2018-A. The equipment ABS included US$333.1m Ascentium Equipment Receivables 2018-1 Trust and C$390m CNH Capital Canada Receivables Trust Series 2018-1, while US$825m Domino's Pizza Master Issuer series 2018-1 and US$250m Driven Brands Funding Series 2018-1 accounted for the whole business securitisations.

Finally, the newly-announced RMBS consisted of: US$342.8m Citigroup Mortgage Loan Trust 2018-RP2, Flexi ABS Trust 2018-1, US$381.65m Mill City Mortgage Loan Trust 2018-1, £761m Paragon Mortgages No. 25, US$338.67m Sequoia Mortgage Trust 2018-4, US$140.13m SG Residential Mortgage Trust 2018-1 and £308.7m Tower Bridge Funding No. 2.

Pricings
ABS also dominated last week’s pricings. A couple of RMBS and a CMBS rounded out the issuance.

The US$1bn Chesapeake Funding II Series 2018-1, US$201.82m CPS Auto Receivables Trust 2018-B, €761m FCT Cars Alliance Auto Loans 2018-1 (re-offer), US$1.22bn GM Financial Consumer Automotive Receivables Trust 2018-2, US$873.2m Hyundai Auto Receivables Trust 2018-A and US$1.01bn Santander Drive Auto Receivables Trust 2018-2 made up last week’s auto ABS issuance. The US$104.66m Dividend Solar Loans 2018-1, US$200m ELFI Graduate Loan Program 2018-A, US$235.25m Mosaic Solar Loan Trust 2018-1, US$213m OnDeck Asset Securitization Trust II Series 2018-1, US$200m PFS Financing Corp Series 2018-C and US$300m Series 2018-D, and US$680.6m SoFi Consumer Loan Program 2018-2 also priced. Meanwhile, the RMBS were A$501m Light Trust 2018-1 and US$339.97m Tricon American Homes 2018-SFR1, and the CMBS was €531m FROSN 2018.

Editor’s picks
Mortgage 'institutionalisation' gains traction: The Dutch mortgage market continues to receive high levels of interest from investors, but RMBS faces stiff competition from other funding options like covered bonds and whole loan strategies. However, securitisation remains well-suited to funding the development of the fast-growing buy-to-let sector in the Netherlands, due to its lack of homogeneity and current light-touch regulatory regime…
Microfinance ABS regroups after defaults: A number of Indian microfinance loan securitisations recently defaulted, halting a trend of strong performance and steady growth in the asset class. While demonetisation is partly to blame, lender overexpansion and the introduction of a competing credit instrument also took their toll…
Provisioning impact muted: The ECB and European Commission have both put forward new rules for minimum loss coverage, which are a step towards improving provisioning practices across Europe and avoiding future unreserved non-performing loan build up. Although having two different sets of rules may create regulatory uncertainty across the banking sector, the impact for NPL securitisation seems muted…

Deal news

• Loosening documentation and a greater proportion of income being distributed to subordinate noteholders have sparked concern that US CLOs are becoming too equity-friendly. Nevertheless, headwinds may be approaching for equity investors as a result of a Libor mismatch.
• Build America Mutual Assurance Company (BAM) is in the market with what is believed to be the first ILS to transfer the risk of loss on a portfolio of financial guarantees. The Fidus Re Series 2018-1 transaction features US$100m twelve-year class A notes, with a five-year par call.
• Non-performing loan securitisation volume has outpaced outright sales in Italy, as banks seek to benefit from the GACS guarantee scheme. The trend is expected to continue this year, thanks to a strong track record over the last 12 months and an investment shift towards Southern Europe.

Structured Finance

Libor transition frailties exposed

The New York Fed has begun publishing the Secured Overnight Financing Rate (SOFR), a much-touted Libor replacement, despite industry participants suggesting that a thorough plan has yet to be made for the transition away from the benchmark. At the same time, there is concern over whether enough consideration has been given to the financial products tied to Libor - including securitisations - which will not mature by the Libor 2022 cut-off.

BlackRock analysts note that the market is yet to come up with a comprehensive transition plan for the trillions of dollars of products tied to Libor that will not mature before 2022. The New York Federal Reserve Bureau estimates that there is over US$900bn in outstanding securitisations and over US$1trn in consumer and business loans that reference Libor and will not mature before 2022.

SOFR began publishing at the start of April and has settled to around 1.80%, according to the LSTA, which is higher than overnight Libor. The association suggests this is surprising because SOFR is a risk-free rate, while Libor has an embedded bank credit risk element.

Additionally, SOFR is only an overnight rate, whereas Libor is a term rate with options ranging from overnight to one year. In line with this, the LSTA suggests that a term reference rate and a bank credit risk spread are key pre-conditions to SOFR becoming a functional bank loan rate.

The BlackRock analysts comment that while alternative reference rates (ARRs) have been identified, they are not direct substitutes for Libor and the differences need to be considered. They stress too that the relationships between assets in a portfolio should be handled with care to avoid disruption.

Furthermore, an effective migration from Libor depends on whether ARRs are seen by the market as viable substitutes for Libor and whether sufficient liquidity develops in the market.

The analysts add that too much focus has been made so far on the interest rate derivatives market because it makes up the largest notional outstanding exposures that reference Libor and will not mature by 2022. They indicate that too little focus has been placed on the needs of other asset classes, including securitisations, and they suggest intensified efforts should be made with regard to this from policymakers and market participants.

The analysts suggest too that the timeline for developing term rates should be accelerated, given the scale of the shift from Libor by 2022. They suggest the availability of term rates could reduce frictions and lead to a smoother transition.

In the absence of a functioning basis market, certain products, such as securitisations, are expected to continue relying on Libor for the foreseeable future. A further challenge is whether new issuance will easily transition to SOFR, as there may be prolonged discomfort with the absence of a bank credit risk component.

PGIM analysts also suggest that while SOFR has been identified as the best suitable replacement, several frailties need to be reconciled. They emphasise the issue of inadequate fall-back provisions and highlight that legacy bonds - including floating rate notes, structured products, mortgages and loans - are more problematic than derivatives, because of a lack of standard language that governs the process of determining a reference rate without Libor. In the absence of the benchmark, many legacy bonds are expected to transition to a fixed rate and others to the prime rate.

Flexible fall-back triggers could also be expanded to include a change in the calculation of Libor or the creation of an alternative benchmark, enabling a transaction that incorporates these triggers to switch to a more robust interest rate as soon as it becomes available, even though Libor might continue to be published. Additionally, the PGIM analysts note that even if fall-back language is enhanced to ensure structured product bondholders receive fair compensation in the absence of Libor, the issue of mismatch with a transaction may arise if the interest rate on the underlying assets doesn’t adjust similarly.

As such, the industry should ensure fall-back provisions for floating rate assets and floating rate liabilities are identical, according to PGIM. However, this goal could be challenging as borrowers on the underlying assets have different incentives than bondholders and so may not agree to similar provisions.

RB

Capital Relief Trades

Risk transfer round-up - 20 April

The capital relief trades market is undergoing a quiet period, following some unusual activity for Q1. Sources point to three transactions during this period from Deutsche Bank, Credit Suisse and a “UK bank with a non-standard portfolio”. Meanwhile, a Spanish bank is rumoured to be prepping another deal.

Drivers behind the Q1 activity include pent-up supply from last year and a reluctance to complete the bulk of the trades by year-end, given expectations of heightened volumes at that time. Additionally, banks can benefit from a two-year grandfathering period instead of one, if they complete some trades in Q1.

Further risk transfer trades are expected by June or July.

NPLs

NPL partnership inked

Intesa Sanpaolo and Intrum have agreed to form a strategic partnership in respect of non-performing loans. The agreement involves two transactions, including what is expected to be a landmark securitisation for the Italian market.

Under the partnership, the Italian NPL platforms of Intesa Sanpaolo and Intrum will be integrated to create a servicer with around €40bn of assets serviced and a 10-year contract to service Intesa Sanpaolo’s sofferenze portfolios. Intrum will hold 51% of the new entity and Intesa Sanpaolo will hold the rest. The two firms say they have major commercial development plans for the new platform in the domestic market, involving around 1,000 employees, including around 600 staff from the Intesa Sanpaolo Group.

The second transaction envisaged under the partnership is the disposal and securitisation of an Intesa Sanpaolo Group bad-loan portfolio, representing €10.8bn of gross book value, at a price in line with the carrying value already reckoned for the portion of the Group’s bad loans that have disposability features. The deal is expected to close in November and comprise a senior tranche equivalent to 60% of the portfolio price, as well as mezzanine and junior tranches equivalent to 40%.

In order to obtain full accounting and regulatory derecognition of the portfolio, the senior tranche will be underwritten by a number of leading banks, while the mezz and junior tranches will be underwritten by a vehicle (accounting for 51% of the notes) and Intesa Sanpaolo (49%). Intrum and one or more co-investors will participate in the vehicle, which will however act as a single investor for governance purposes.

The transactions - which remain subject to authorisations being received from the competent authorities - envisage a valuation of around €500m for Intesa Sanpaolo’s servicing platform and around €3.1bn for the bad-loan portfolio to be securitised. The agreement underpins the de-risking strategy envisaged by the bank in its 2018-2021 business plan and will result in a reduction in its gross NPL ratio to 9.6% (from 11.9%, as of end-2017) at no extraordinary cost to shareholders, thereby meeting supervisors’ expectations in respect of Italian bank NPL reductions. Further, a net capital gain of around €400m is expected in its consolidated income statement.

Intesa Sanpaolo also points to potential further improvement in the recovery on its retained bad-loan portfolio, as a result of benefitting from combined skills and resources with Intrum, and potential future value creation through the development of a best-in-class NPL servicing platform in Italy.

CS

Structured Finance

Market moves - 20 April

Acquisitions

BlackRock has acquired Tennenbaum Capital Partners (TCP), complementing its global credit business at a time when clients are increasingly turning to private credit as a higher-yielding alternative to traditional fixed income allocations. A key element of the transaction – which is expected to close in Q3 - is the continuity of TCP's senior management team, including all five partners (Lee Landrum, Michael Leitner, Howard Levkowitz, Philip Tseng and Rajneesh Vig). Together, BlackRock and TCP - as a wholly-owned subsidiary of BlackRock - expect to offer clients a premium and expanded set of private credit investment opportunities. TCP is based in Los Angeles and has approximately US$9bn of committed client capital, as of 31 December 2017, and a staff of over 80 people. Pending the approval of shareholders, TCP will remain the investment adviser of TCP Capital Corp, its BDC.

IHS Markit has acquired DeriveXperts, a provider of valuation services for OTC derivatives and other complex financial securities. The acquisition complements and enhances IHS Markit’s existing derivatives data and valuations businesses, and strengthens it client base in France and French-speaking Europe.

Pimco has acquired a 30% stake in NPL asset manager and special servicer Phoenix Asset Management (PAM). PAM founder and cio Steve Lennon, together with the firm’s other founding partners now hold 40% of the corporate capital, while AnaCap Financial Europe continue to hold a 30% stake. Following the transaction, PAM will remain operating as an independent platform, with the current management team confirmed.

B-piece sale

KKR Real Estate Finance Trust (KREF) has sold its CMBS B-piece portfolio for net proceeds of US$112.7m, representing the exit from four of its five direct B-piece investments and accounting for 87% of the market value of its total direct B-piece portfolio, as of year-end 2017. The investments were made between 2Q15 and 1Q16, and the weighted average realised IRR and multiple of invested capital for the investments exited to date were 18% and 1.3x respectively. Including the company’s estimated fair value for its remaining CMBS B-piece investments, the estimated net gain for its total direct CMBS B-piece portfolio for the six months ended 30 June 2018 is expected to be US$10.6m-US$11.9m or 20-22 cents per share. The company plans to redeploy the proceeds from the sale into its target assets, primarily floating-rate senior loans. After the sale, KREF continues to hold approximately US$14m of direct investments in CMBS B-pieces with a cost basis of US$10m and has a US$40m commitment to invest in an aggregator vehicle alongside KKR Real Estate Credit Opportunity Partners.

Fails charge floor

The Treasury Market Practices Group (TMPG) has updated the existing fails charge trading practices for US Treasury, agency debt and agency MBS by including a floor of 1% per annum to ensure that a minimal charge remains in place, thereby maintaining operational continuity of the practices. In February, the TMPG published the proposed updates to the fails charge practice recommendation for public comment and is says that feedback from market participants was, on balance, supportive of the proposed modification. The group recommends that the change is implemented for transactions entered into on or after 1 July 2018, as well as for transactions entered into prior to but which remain unsettled as of that date.

IM solution launched

Allen & Overy, IHS Markit and SmartDXfrom have launched Margin Xchange, an online platform that covers all stages of the mass repapering of derivatives contracts required to comply with initial margin regulations. It provides information reconciliation, document generation, negotiation and execution, case management and a full data export. Users will be able to record every variable as a data point, rather than text, enabling them to maintain a clear view of progress at every stage during the repapering task, provide higher quality progress reports to regulators and represent the documents as data that can be stored and interrogated in the future with ease. 

North America

Amherst Pierpoint Securities has hired Steven Abrahams as senior md and head of strategy. He will lead the firm’s structured products, credit and US rates businesses. Most recently, he co-founded Milepost Capital Management, where he led strategy, research, asset sourcing and selection and reporting for an SEC-registered manager of securities and loans for private funds and institutions. Abrahams will be based in New York and report to executive md, Ryan Mullaney, who among other responsibilities oversees all of APSEC’s sales and trading efforts.

Antares Capital has appointed founding partner Timothy Lyne as senior md and co-head of sponsor coverage and Vivek Mathew as head of asset management and funding. Based in Chicago, Lyne will be responsible for leading the company’s sponsor coverage activities on the East Coast, having previously served as head of the firm’s asset management group. Based in New York, Mathew has led the firm’s funding efforts since he joined in 2016, but in his new role will also lead asset management. He was previously md, head of global primary CLO business at JPMorgan and vp, structured finance at Deutsche Bank.

CAN Capital has hired Tom Davidson as cfo. He joins from Sierra Auto Finance, where he was cfo and chief capital officer. He previously worked at GE Capital for 16 years, most recently as senior md and chairman and ceo of GE Capital Markets, responsible for global securitisation. Ray De Palma, who has served as cfo at CAN Capital since May 2017, will take on the role of chief accounting officer, reporting to Davidson. De Palma will remain part of CAN Capital's executive committee.

The Carlyle Group has hired Taylor Boswell as md on the credit opportunities team and is based in New York. Before joining Carlyle, Boswell worked at Apollo Global Management, serving as an md and investment committee member in the illiquid opportunistic credit business.

Paul Vanderslice has joined CCRE as ceo, starting in 3Q18. Vanderslice previously ran the CMBS Group at Citi, heading up commercial mortgage distribution.

Cerberus Capital Management has named former JPMorgan coo Matt Zames as president, responsible for a number of strategic investing and operating initiatives. Concurrent with this appointment, Frank Bruno has been promoted from president of Cerberus to co-ceo, serving alongside founder and cio Steve Feinberg. Additionally, Lee Millstein has been promoted to president of Cerberus Global Investments, where he will assume responsibility for managing the firm's international business, in addition to his role as global head of real estate.

Dentons has hired Alice Yurke as a partner in its capital markets practice in New York. She provides strategic counsel to clients offering or seeking structured and derivative products, as well advice on risk-based capital and workout-related issues in derivatives and loan transactions. She was previously a partner at Alston & Bird.

Hunter Street Partners has announced the appointment of three members to its inaugural advisory board. They will provide guidance to the firm on its investment strategy, internal operations and management, and transactions. The advisory board members include Steve Adams, a former partner and general counsel at Wayzata Investment Partners, Van Zandt Hawn, md, Goldner Hawn Johnson & Morrison and Jeff Stolt, former partner and cfo at Pine River Capital Management. Stolt joined Pine River in 2002 at its founding and managed the accounting and operations functions until 2016, as the firm grew from US$5m to US$16.8bn in AUM.

PACE lawsuits filed

A pair of lawsuits seeking class action status have been filed in Los Angeles County Superior Court against Los Angeles County, Renew Financial and Renovate America, alleging that the county’s PACE programme has burdened many borrowers with loans that they can’t afford. In particular, the complaints allege that the PACE platform lacks adequate consumer protections. Both Renew Financial and Renovate America have since released statements stressing the high level of consumer protections embedded in their loans, which go beyond those found with other forms of home-improvement financing. For example, HERO PACE financing safeguards include calls to confirm financing terms with homeowners, written disclosures modeled on the federal ‘know-before-you-owe’ forms for mortgage lending and a guarantee that contractors aren’t paid until homeowners certify that a project is completed to their satisfaction.

Rating agency expansion

S&P has established a sustainable finance team and will be led by Mike Wilkins, md. The team will also be part of the innovation group within the global corporate and infrastructure ratings practice, which focuses on the analytical development of offerings in emerging areas of significant investor interest. The group is led by Hans Wright, head of innovation at S&P, and reports to Susan Gray, global head of corporate and infrastructure ratings.

Rating error

Moody's has corrected the rating on the class K notes issued by GMACCM 1999-C2 to B3 from B1. The agency has disclosed that due to an internal administrative error, the notes were inadvertently upgraded to B1 from Caa2 on 22 March 2018.

Tesla recall

Tesla has initiated a voluntary recall of 123,000 Model S vehicles built before April 2016, prompted by concerns regarding excessive corrosion to bolts in the power steering mechanism in cold winter climates. Moody’s indicates that the recall is marginally credit negative for the Tesla Auto Lease Trust 2018-A securitisation, as vehicles equipped with these bolts may have to be fitted with replacement parts before resale after lease maturity and delays in the repairs will temporarily disrupt and reduce residual value cashflows to the ABS. As of end-February, the affected leases make up 28% of the securitisation value, but lease maturities are fairly well distributed over the next year, mitigating the risk that the vehicles will not be repaired in a timely manner. Although there is a large spike in scheduled residual maturities for affected vehicles in March 2019, Moody’s expects that the supplier (Bosch Auto Parts) will have produced enough replacement bolts by then to avoid any potential delays in vehicle repair and remarketing, albeit early turn-ins and lease extensions could affect this maturity schedule. The agency notes that between the November 2017 pool cut-off and the February 2018 reporting period, TESLA 2018-A has experienced residual value gains of around 22% on 57 turned-in vehicles, representing about 0.11% of the transaction's initial securitisation value.