Contents

RMBS

GSE footprint

FHFA changes to bring housing market reform?

President Trump’s nomination of Mark Calabria, currently chief economist for Vice President Mike Pence, to replace Mel Watt as FHFA director when his term ends in January could have a significant impact on the US mortgage market. Although Calabria appears to be a proponent of reducing the GSE footprint and has spoken publicly about the current administration’s commitment to ending the conservatorship of Fannie Mae and Freddie Mac, substantive changes are unlikely to occur unless Trump wins a second term.

Policy papers published by Calabria in the past suggest that he doesn’t care for securitisation in general in relation to the mortgage market and that, from a philosophical standpoint, he believes the GSEs’ role should be curtailed. As the director of the FHFA, he would be able to pull a number of levers - such as shrinking the credit box, increasing guarantee fees and abolishing high-LTV products – to reduce the GSE footprint.

However, putting the GSEs into receivership would need Treasury authorisation and at present Treasury officials are likely to block such a move. “Treasury Secretary Mnuchin is supportive of the single security initiative and would favour gradual changes of the GSEs’ mandates with the help of Congress. I would personally be more attentive to large changes regarding the GSE structure if Mnuchin is replaced,” observes Walter Schmidt, svp at FTN Financial.

He points out that first, Calabria still needs to be confirmed and the housing lobby does not want him in the role. Second, the administration is likely to be wary of up-ending housing finance - and the consequent possibility that house prices underperform - ahead of the 2020 elections. Third, putting the GSEs into receivership would have legal ramifications around grandfathering of their debt.

“For example, credit risk transfer deals have a 10-year term – meaning that every time one is issued, it puts the GSE on one side of a legally binding securitisation for 10 years into the future. The only way to reduce the GSE footprint without damaging the housing market is to de-lever them slowly, which is already occurring,” Schmidt notes.

Increasing g-fees has already made private label RMBS execution more competitive. The JPMorgan Mortgage Trust shelf, for example, has issued approximately 40 high-quality RMBS deals since the financial crisis and loans that would otherwise qualify for conforming jumbo status often account for a high percentage of the collateral in those deals – indicating that the pricing is at least good enough away from the GSEs.

“Logically, if g-fees are increased further, an even better bid (for non-agency RMBS) should emerge from trading desks,” Schmidt suggests.

Meanwhile, the GSEs are set to further strengthen their position in the housing market when the uniform security goes live on 3 June 2019 (SCI 2 January). The IRS has confirmed that the exchange of former Freddie Gold securities to the new Uniform MBS is not a taxable event and it provided guidance on rule 817(h) that assets backing endowment, annuity and life insurance contracts are allowed to presume that a 60%/40% division is assumed between Fannie and Freddie in the UMBS.

Only logistical issues remain, such as whether the exchange occurs smoothly and whether the new securities trade poorly, according to Schmidt. “Gold certificates will continue to trade until enough participants have exchanged 45-day delay securities for 55-day delay securities. Starting on 3 June 2019, both Fannie and Freddie will issue only UMBS for fixed-rate pools.”

Nevertheless, questions remain about the need for the single security initiative. “The TBA market is arguably already the most liquid market in the world. I can buy a bond for January, February and March settlement today. Where else can you buy a three-month forward security for a one tick bid/ask?” Schmidt asks.

He suggests that Freddie Mac has a strong incentive to combine with Fannie Mae because its securities trade at a discount to Fannie’s. On the other hand, Fannie’s systems were inadequate and it received a large technology spend to coordinate its issuance information as a result of the initiative.

Looking ahead, the housing market may be too powerful and have too much inertia that the Trump administration may not disrupt it too much. “My feeling is that Calabria will make small changes to test what political cover there is, including how much support he has from the Treasury department. However, if the administration wins in 2020 with enough rational support, we could see real change occur then. A two-term president is the most powerful in the first two years after their re-election,” Schmidt concludes.

Corinne Smith

CLOs

Middle march

Boost for middle market and hybrid CLOs

The US SEC’s no-action letter in connection with a recent Golub Capital CLO paves the way for middle market CLO managers to comply with risk retention requirements by holding through a BDC (SCI 21 September). The move effectively allows managers to transition loans between their BDCs and a CLO, and has the potential to significantly boost US middle market CLO issuance.

BDCs typically lend to privately owned US mid-sized companies and exist as a cheaper financing mechanism than raising a loan. Risk retention rules had previously prohibited advisors from selling securities to the BDC.

“The no-action letter focused on a particular part of the risk retention rules,” says Sean Solis, partner at Milbank. “There is a provision which allows sponsors to allocate risk retention to an originator if they sell at least 20% (up to 100%) in connection with the closing date.”

The conflict solved by the letter arose because of the Investment Company Act, which stipulates that the external advisor of a BDC cannot engage in certain prohibited principal transactions with the BDC. “As in this case,” continues Solis, “the external advisor to the BDC is usually also the collateral manager with respect to the related CLO issuer. There was therefore a contradiction that needed clarifying.”

BDCs are now able to hold a portion of a CLO without violating rules governing closed-end funds. Solis continues: “It clarifies for people who have BDCs how they can go about using them as an option to retain risk with a particular CLO. BDC CLOs are fairly common across the market.”

Thus far in 2018, US$12.8bn of US middle market CLOs have been issued by 13 managers. Solis believes the letter will lead to more such issuance in 2019.

“There are a lot of middle market loans, so there is enough collateral to do it. It would not surprise me to see more managers enter the market,” he says.

He continues: “It has to do with the financial costs. If spreads tighten so that it makes more sense from a financial point of view, then it will result in increased issuance. A lot will depend on investor demand, but people are feeling cautiously optimistic about 2019.”

Solis notes that there is differentiation between middle market and broadly syndicated CLOs. “Middle market CLOs tend to price wider, as they tend not to be as liquid - though there is not a huge difference in terms of performance.”

He anticipates more CLOs comprising mixed portfolios of middle market and broadly syndicated loans to emerge. “I think you could see more hybrid CLOs enter the market definitely. They are not as common, as they take some time to explain to investors. But the more issuance we see, the more people will become familiar with them.”

Tom Brown

ABS

Deal delay?

European ABS market update

A trader reports that nothing has been heard of the Alhambra SME Funding 2018-1 deal, which “should have been done and dusted by now” as the only European ABS left in the pipeline. The trader suggests that the transaction may have been postponed until 1Q19, despite it being announced in June (SCI 21 November).

He says: “It will be interesting to see how the deal performs with the new securitisation regulation taking effect.”

Away from primary, the European secondary market is seeing little to no activity. The trader continues: “There are a few single names trading on secondary, but that is about it.”

Spreads seem to have stabilised as a result of the lack of new issue paper. “I think people are ready to close the books after the last few weeks and now with Brexit,” concludes the trader. “A break is welcome after a very hectic year.”

Tom Brown

Structured Finance

Japanese dependence

European ABS market update

European ABS markets have effectively closed for the year. Deals in the pipeline are now expected to price in early 2019.

Looking ahead to 1Q19, one trader comments: “For UK buy-to-let and non-conforming RMBS, activity will depend 100% on what happens with Brexit. Unless we have more clarity about how Brexit will play out, investors are going to be very hesitant to invest in long-term paper. That is my gut feeling.”

For CLOs, prospects will depend on the appetite of Japanese investors. “The market will open with Japanese trade and triple-A bonds will likely be bought up. It is very important that demand from Asia continues next year, though we will not know for sure how the market will behave until the first or second week in January,” the trader concludes.

Tom Brown

CLOs

Cross-currency basis

US CLO market update

All but a few US CLO new issues have been postponed until 2019, although at least one deal is set to price imminently.

“Some third-tier CLO managers are still trying to get deals through,” says one trader. “This has been a tough time to get the best of deals done, so lower-tier managers are struggling.”

However, the trader feels “fairly positive” about 1Q19. In terms of cross-currency basis swaps, the trader points out that short-term hedging costs between the Japanese Yen and the US dollar have improved considerably.

“The increased hedging costs - which spiked around 29 September - have subsided and are now roughly back at levels we saw in the summer. This favours US dollar-Yen currency swaps,” the trader notes.

On the secondary market, the trader indicates that US spreads seem to have stabilised, but that US spreads are currently wider than their European counterparts. “The cross-currency basis does not warrant that type of relationship,” the trader concludes. “So, either US spreads will have to tighten or European spreads will widen.”

Tom Brown

Structured Finance

SCI Start the Week - 17 December

A review of securitisation activity over the past seven days

Market commentary
European CMBS BWIC activity swelled after the Taurus 2018-3 DEU deal priced last week (SCI 12 December). Unusually, noteholders were offered an early prepayment on 14 December as an incentive to price the transaction before the end of the year.

The market remains soft as conditions refuse to buck the widening spread trend. Several European dealers have decided to wait out the remaining few weeks until the end of the year.

Heavily discounted premium is being ignored as the year comes to its conclusion. "Even if we show bonds at very cheap levels, nobody is interested," commented one trader. "In the past, when spreads were similar, you still had buyers and sellers balancing each other. Now it is a one-way market."

In the European CLO secondary market, traders were also focusing on BWIC activity last week. "[We've seen] a bit of a turn-around in terms of BWIC activity, although the market is still a little weak and cautious," another trader noted (SCI 14 December).

CLO bonds were pricing significantly wider compared with other asset classes, as a result of recent uncertainty around STS and Brexit. The trader remained optimistic, however, and challenged comparisons with the market slowdown of a couple of years ago.

"Spreads are sliding wider each day," he observed. "We have not seen any panic selling just yet and there have not been any big waves like we saw in 2015/2016. In my opinion, it is not quite as bad as it was then."

Similarly, there was a spike in selling of investment grade paper on the US CLO secondary market, coming mostly from the insurance sector (SCI 11 December). "We are not sure if it is year-end cleansing or if this is more of a market call," one trader remarked. "It is good to be a buyer right now."

Meanwhile, regarding the primary market, the trader said: "It is easier to print the mezz tranches a bit wider, if you need to get deals done quickly. Sourcing loans is easier at the moment."

Transaction of the week
A Brookfield Asset Management entity, BSREP International II (A), is the sponsor of a new £367.5m UK single-asset single-borrower CMBS, dubbed Salus (European Loan Conduit No.33). The transaction comprises a first-lien interest-only mortgage loan originated by Morgan Stanley and backed by the landmark City of London property, Citypoint (SCI 11 December).

The mortgage loan comprises a senior loan which will be securitised in the transaction and makes up the class A, B, C and D notes, totalling £349.1m, while a VRR loan, retained by Morgan Stanley for risk retention purposes, equates to £18.4m, and makes up 5% of the whole loan balance. The floating rate loan has an initial three-year term with two, one-year extension options and requires quarterly interest-only payments based on three-month Libor plus a spread of 2.15%.

Proceeds from this £367.5m mortgage loan, along with £91.9m of mezzanine debt, were used to refinance £436m of existing mortgage debt. It also funded £16.9m of capital expenditures, leasing commissions, letting agent costs, tenant incentives and pay closing costs.

The total debt of £459.4m includes a £16.9m capex facility, which was funded into the capex reserve account at closing. The facility comprises a £13.5m portion that is pari-passu to the senior loan and a £3.4m portion that is pari-passu to the mezzanine loan.

The prior financing of £436m was originated by Morgan Stanley to facilitate the sponsor's acquisition of the property in 2016. Prior to that, the sponsor purchased a £106m junior loan associated with the property from Mount Kellett Capital Management in 2014.

The junior loan was associated with a £429m senior loan that was originated by Morgan Stanley in 2007 and securitised in the Ulysses (European Loan Conduit No. 27) transaction. The senior loan was transferred to special servicing in February 2012 due to a payment default but was paid off in full in January 2017, following the sale of the property to the sponsor, with no principal losses to the bondholders.

The transaction also marks the first European CMBS rated by KBRA, which has assigned provisional ratings, alongside DBRS, of triple-A/triple-A on the £211.3m class-A notes, double-A/double-A on the £66.29m class Bs, single-A minus/single-A (low) on the £52.4m class Cs and triple-B plus/triple-B on the £19.135m class D notes. There is also an unrated £100,000 class X note which collects excess interest from the transaction.

Other deal-related news

• ILS market participants are re-evaluating whether the pricing of wildfire risk in catastrophe bonds is adequate, after the 8 November US wildfires caused between US$9bn-US$13bn worth of damage (SCI 13 December). However, the picture is likely to only become clear over 2019 as the claims are counted and the full scale of loss across multiple perils is measured.
• Banco BPM announced last week a non-performing loan securitisation with Elliott International and Credito Fondiario for a nominal value of €7bn-€7.8bn, while Intesa Sanpaolo and Intrum completed a similar transaction the previous week (SCI 14 December). The agreements involve the sale and co-ownership of servicing platforms, which is part of a broader trend in Italian NPL disposals.
• Pillarstone has arranged a €174m restructuring in Greece for Famar, one of Europe's largest providers of contract manufacturing and development services to the pharmaceutical and health and beauty industries. The agreement is considered a landmark, given that restructurings are an exceptional occurrence in the Greek non-performing loan market (SCI 14 December).
• The facility agent for the THEAT 2007-1 and 2007-2 CMBS requested that the master servicer facilitate amendments to the propco facility and intercreditor agreements in connection with the restructuring of the lease. For more CMBS restructurings, see SCI's CMBS loan events database.

Regulatory round-up

• The EBA has published its final guidelines regarding a harmonised interpretation of the criteria for securitisations to be STS-eligible on a cross-sectoral basis throughout the EU (SCI 13 December). The guidelines – developed for both ABS and ABCP – will provide a single point of consistent interpretation of the STS criteria for all entities involved in STS securitisation, including originators, sponsors, investors, competent authorities and third-party STS verifiers.
• The Alternative Reference Rates Committee (ARRC) has issued a public consultation on US dollar Libor fallback contract language for securitisations, which outlines draft language for new contracts that reference Libor to ensure these contracts continue to be effective in the event that Libor is no longer usable (SCI 11 December). The consultation proposes one specific hardwired approach regarding triggering events and the waterfall for rate determination, and addresses the challenges presented by securitisation asset and liability components.
• Illinois Attorney General Lisa Madigan has announced a US$17.25m settlement with Wells Fargo as a result of the bank's misconduct in its marketing and sale of risky RMBS leading up to the 2008 economic collapse (SCI 11 December). The settlement with Wells Fargo resolves an investigation by Madigan's office over the bank's failure to disclose the true risk of RMBS investments. Under the settlement, Wells Fargo will pay $17.25m to the state that will be distributed among the teachers retirement system of the state of Illinois, the state universities retirement system of Illinois, and the Illinois state board of investment, which oversees the state employees' retirement system.
• The ECB has outlined the technical parameters for the reinvestment of the principal payments from maturing securities purchased under its asset purchase programmes after net asset purchases cease at end-December 2018 (SCI 14 December). It expects to reinvest ABSPP redemptions back into the ABS market and CBPP3 redemptions back into the covered bond market. The bank says it will aim to maintain the size of its cumulative net purchases under each constituent programme at their respective levels, as at end-December 2018, although limited temporary deviations in the overall size and composition of the APP may occur during the reinvestment for operational reasons. ABSPP redemptions stand at €7.4bn over the next 12 months, representing approximately 26.2% of the portfolio, according to Rabobank figures.
• The state of Colorado has filed a Second Amended Complaint relating to state court actions against Avant and Marlette, alleging that the platforms have violated its Uniform Consumer Credit Code (SCI 12 May 2017). According to a Chapman and Cutler client memo, in addition to making the same claims against the platforms, the state is suing trustees for the trusts into which Colorado loans made through the platforms had been securitised and the SPEs used to transfer the loans into the securitisation trusts (SCI 12 December).
• The FDIC last week announced multiple initiatives and resources related to the deposit insurance application process for organisers of new banks and to promote a more streamlined process for all applications submitted to the agency (SCI 12 December). One such initiative is the option to request feedback on a draft deposit insurance proposal before filing a formal application, thereby providing an early opportunity for both the FDIC and organisers to identify potential challenges with respect to statutory criteria and areas that may require further detail or support. The agency also wants to streamline its application process and is seeking comments on how that can be achieved. The move has been welcomed as the final step towards enabling fintechs to compete with traditional banks.

Data

Pricings
US new issuance volume appears to be drying up as year-end approaches. Last week's pricings were dominated by international RMBS and SME ABS deals.

The RMBS prints comprised A$1.6bn National RMBS Trust 2018-2, €255m Rural Hipotecario XVIII and €841m Strong 2018, while the SME ABS were €9.3bn Belgian Lion SME III, €5.28bn Brera Sec 2018 and €972.1m IM BCC Capital 1. The US$379.4m Kestrel Aircraft Funding 2018-1 and US$322m Sunrun Athena Issuer 2018-1 rounded out last week's ABS issuance.

A couple of CMBS also priced: US$1.049bn BMARK 2018-B8 and €476m Taurus 2018-3 DEU. Finally, the US$509m Benefit Street Partners CLO XVI transaction was among last week's CLO prints.

BWIC volume

Capital Relief Trades

Synthetic slew

CRT issuances hit before year-end

A slew of synthetic securitisations have hit the market before year-end. The risk transfer issuances include a trio of EIF financial guarantees, one of which is supported by blockchain technology, and a pair of Colonnade deals.

The blockchain transaction – which marks the first time a corporate loan securitisation has been executed via distributed ledger technology in the EU – involves the EIB Group granting BBVA a €60m mezzanine guarantee that will be used to provide up to €360m to finance new investment projects of Spanish SMEs and midcaps. The negotiations were recorded on the private blockchain Hyperledger, developed in-house by BBVA, while a unique identifier of the signed agreement was recorded on the public blockchain Ethereum (testnet). The agreement aims to provide SMEs across all sectors of the Spanish economy with loans that have favourable interest rates and longer repayment periods.

Another of the EIF guarantees represents the first synthetic SME securitisation in which the EIB and EIF are jointly participating in Poland. They have granted Alior Bank a PLN1.44bn guarantee on the senior and mezzanine tranches of a PLN1.5bn SME portfolio. The transaction aims to enable the Alior Bank Group to offer additional lending to Polish SMEs on improved terms, in the form of reduced interest rates.

The third EIF guarantee is split into five tranches, whereby the EIF guarantees to make payments to Banca di Credito Popolare (BCP) that cover 50% of the losses incurred from a €157m Italian SME loan portfolio. The remaining 50% is retained by BCP.

Scope has assigned a triple-B rating to the €52.3m senior tranche, which will incur a loss when portfolio losses exceed 18.9% of the portfolio (corresponding to the credit enhancement provided by the four subordinated tranches). The guarantee terminates on 30 September 2032.

Under the agreement, BCP receives cash payments from the EIF for 50% of the expected loss determined for defaulted assets, which the EIF allocates to the tranches in reverse order of seniority. Defaulted assets are defined as assets delinquent for more than 90 days or reported as subjective default, acceleration or restructuring of the credit right.

Scope notes that the guarantee agreement grants significant contractual rights to the EIF to assess and monitor credit policy applications and credit processing within BCP. An external verification agent will review the accuracy of the loss claims.

Meanwhile, Barclays has issued Colonnade Global Series 2018-4 and 2018-5. Rated by DBRS, both capital relief trades comprise 11 tranches each of unfunded financial guarantees referencing portfolios of corporate loans and credit facilities. Providing an eight-year credit protection period, the transactions have a three-year replenishment period and the credit facilities under the reference portfolios can be drawn in various currencies.

The 2018-4 portfolio is sized at US$2.33bn, with the CLN covering the first 8.6% of losses under the reference portfolio. The 2018-5 portfolio is sized at US$625m, with the CLN covering the first 8.8% of losses.

Borrower default events are limited to failure to pay, bankruptcy and restructuring.

Finally, Santander has listed a synthetic securitisation dubbed Santander Consumer Spain Synthetic Auto 2018-1 on BME’s fixed income market MARF. The €60.6m note issuance references a €1.01bn loan portfolio of new and used vehicles.

Corinne Smith

Capital Relief Trades

Wetherby 2 completed

SONIA-linked synthetic securitisation debuts

Lloyds has completed a £142.5m 7.25-year financial guarantee referencing a £1.5bn UK commercial real estate portfolio. Dubbed Wetherby 2 Securities 2018, the transaction is the first synthetic securitisation to reference the new SONIA interest rate benchmark and the third structured as a dual tranche trade (SCI 26 January).

The £82.5m first loss tranche (0%-5.5%) pays SONIA plus 10.75% and the £60m second loss tranche (5.5%-9.5%) pays SONIA plus 5%; these tranches were bought by five investors. The 25 senior tranches (90.5%) have been rated and retained on the bank’s balance sheet.   

The deal features a two-year replenishment period, which was not included in the first Wetherby deal last year. The latter deal, along with two others from Barclays and Santander last year initiated the first post-crisis wave of CRE CRT issuance (see SCI’s capital relief trades database).

Investors have been returning to the asset class, due to tighter underwriting standards that improve the ability for refinancing. Indeed, according to the Cass commercial real estate lending survey published in October 2018, high levels of income cover are now the standard thanks to a bias towards income-based lending criteria.

Meanwhile, the slicing of the junior risk into thinner tranches is a technique utilised by Credit Suisse (SCI 9 March) and Standard Chartered (SCI 14 November). The feature involves slicing the junior risk into thinner tranches that appeal to a broader investor base and address the thicker tranche requirements of the new Securitisation Regulation.

However, the regulatory challenges for UK banks do not end with the Securitisation Regulation. The PRA’s guidance issued last month assumes a 50% loss given default for slotted assets, such as commercial real estate portfolios (SCI 30 November). The latter effectively stipulates thicker first loss tranches and less RWA relief for CRE CRTs, raising the prospects of seeing the dual tranche option in future UK CRE deals.

As of 3Q18, Lloyd’s CET1 ratio equals 14.6%. Balance sheet strength has been maintained with a strong CET1 capital build-up of 41bp in Q3 and 162bp for all three quarters of the year. The bank is expecting a capital build-up of 200bp pre-dividend in 2018 and 170bp-200bp per year, according to its capital management plan.

Stelios Papadopoulos

Capital Relief Trades

Programmatic issuance

UBI Banca completes second CRT

UBI Banca has completed its second-ever capital relief trade, paving the way for more programmatic issuance in the future. Dubbed UBI RegCap2, the €100m financial guarantee references a €2.2bn portfolio of secured and unsecured Italian SME and corporate loans.

According to Simone Tufo, head of capital strategy at UBI Banca: “We intend to proceed with more programmatic issuance, but in the future we will also consider other structuring options to make the transactions more efficient, given the advent of the new Securitisation Regulation. These include the dual-tranche technique, excess spread and pro-rata amortisation.”

The dual-tranche technique involves slicing the junior risk into thinner tranches in order to address the thicker tranche requirements of the new regulation and appeal to a broader investor base (SCI 26 January). Credit Suisse, Standard Chartered and Lloyds have utilised the feature.

UBI RegCap2 features a three-year weighted average life, a time call with a three-year non-call period and tranches that amortise sequentially. Tufo notes that investors were drawn to the deal by low default rates, a granular portfolio and a relatively high IRR.

The Italian lender’s latest trade is broadly in line with its debut CRT last year, a €100m financial guarantee that referenced a €1.9bn Italian corporate portfolio (see SCI’s capital relief trades database).

As of 3Q18, UBI Banca’s fully loaded CET1 ratio stands at 11.42% and was unchanged quarter-on-quarter. Italian sovereign spread widening accounted for a minus 12bp reduction in the CET1 ratio. However, CreditSights notes that this has been offset by lower RWAs, due to a decline in loan volumes (most notably NPLs) and proactive collateral and guarantee management. 

Stelios Papadopoulos

CMBS

Investor indigestion

US CMBS widening on 2019 anxiety

A recent CRE CLO transaction brought to the market was sidelined until a later date after spread levels made the offering uneconomical. Widening US CMBS spread levels have exacerbated investor concerns that this trend will extend into 2019.

“Spreads have moved out across all the different asset categories in the final quarter,” says Rick Jones, finance and real estate partner at Dechert. “While we have been trying to get deals done, the investors have just gone home. They have met their goals and locked-in their yield targets for this year and seem to be sitting on their hands.”

He adds: “In the securitisation market, we are seeing lots of slow-walk deals, which could have been done in Q4 sensibly waiting for 2019 to get going.”

CRE CLO prints have moved back alongside CMBS. Senior CRE CLO tranches are generically pricing at Libor plus 150bp; in comparison, CMBS IPTs are in the low-90s up to between 105bp-110bp.

“Both sectors seem to have followed each other this year,” says Jones.

With regards to the capital structure, there has been some indication of triple-B tranches being hit particularly badly, although the impact has been felt across the board. “This quarter has been a mix of over-fed investors and anxiety about the next year,” Jones continues, “which has led to a lot of investors waiting until 1Q19.”

Market sentiment and the 10-year US Treasury nearing 2.90% has driven spreads wider on both agency and non-agency CMBS in order to fill order books. Jones concludes: “If next year pricing returns to the mean, then that will be a strong sign that the year will be a promising one. If they continue to grind out, it will mean we are moving into a very difficult environment. In terms of my business plan, we are predicting that 2019 will be a good year for capital formation.”

Tom Brown

Regulation

Disclosure draft not endorsed

EC refuses to endorse draft technical standards

The European Commission has stated that it only intends to endorse the draft technical standards on disclosure requirements, under the EU Securitisation Regulation prepared by ESMA, once certain amendments have been made. Market participants have suggested that this was not unexpected and could in fact buy more time for firms to install the necessary systems required to comply with reporting standards, when the Securitisation Regulation comes into effect.

The Securitisation Regulation, due to be applied to all securitisation as of 1 January 2019, says that the originator, sponsor, and securitisation special purpose entity (SSPE, or issuer) of a securitisation must make certain prescribed information available to investors – including potential ones – and regulators. The originator, sponsor and issuer have to then designate one of them to fulfil the disclosure requirements, which becomes the reporting entity.

Additionally, a requirement under article 7 of the Securitisation Regulation is the provision of quarterly underlying exposure and investor reporting to be made using standardised templates. Article 7 directed ESMA to develop draft technical standards specifying the form and content of these reporting templates.

The Commission states that while it agrees with ESMA’s approach in the draft disclosure technical standards, the standards could potentially place an excessive burden on the reporting entity, especially since they represent the first comprehensive EU-wide disclosure regime for securitisations. The Commission notes that there is a risk of “disproportionately strict disclosure requirements” disrupting securitisation issuance in the EU, particularly in light of the sanctions that can be imposed for non-compliance.

Cadwalader suggests that such an effect could be counter to the objectives of the Securitisation Regulation and notes that the Commission further stressed the need for proportionality in ensuring a balance between giving users the necessary available information on the one hand, and promoting a well-functioning securitisation market on the other.

The Commission goes on to stress the availability of a “no data” option in the draft templates and requests ESMA to examine whether this option could be available for additional fields, which, it says, is particularly important for ABCP securitisations.

Cadwalader suggests that it is difficult to see how ABCP sponsors could fully comply with completing draft disclosure templates in full and that this could deter ABCP conduits from making new issuances after 1 January 2019.

In terms of next steps, the legislative procedure provides six weeks in which ESMA may amend the draft disclosure technical standards on the basis of the Commission’s proposed amendments and resubmit them via a formal opinion to the Commission. However, if - after six weeks - ESMA hasn’t submitted amended technical standards, the Commission may adopt them with the amendments it considers relevant, or it may reject them.

The Commission states that it does intend to endorse the draft disclosure technical standards once the amendments have been made by ESMA. Cadwalader notes that this issue should be seen in conjunction with the joint statement on 30 November by the European Supervisory Authorities, which noted that the reporting templates being prepared by ESMA for the purposes of fulfilling the on-going disclosure requirements under the Securitisation Regulation, were unlikely to be adopted on 1 January 2019.

As a result, the Commission’s decision not to endorse the disclosure technical standards as they are was “widely expected”. Cadwalader adds that this shows the Commission has recognised the potential for substantial market disruption from the rushed adoption of complex and detailed reporting requirements.

Cadwalader concludes that this delay in the adoption of the disclosure technical standards may allow market participants more time to develop the necessary reporting systems to comply with the new requirements.

Meanwhile, the European Supervisory Authorities, have published two draft Regulatory Technical Standards (RTS) to amend the RTS on the clearing obligation and risk mitigation techniques for non-cleared OTC derivatives. In particular, the draft RTS on risk mitigation techniques amend the existing RTS by extending the special treatment currently associated with covered bonds to STS securitisations.

The treatment, which allows no exchange of initial margin and only collection of variation margin, is applicable only where a STS securitisation structure meets a specific set of conditions equivalent to the ones required for covered bonds issuers to be able to benefit from that same treatment.

Richard Budden

RMBS

Landmark transaction launched

UK RMBS is first securitisation tied to SONIA rate

The first securitisation with liabilities tied to the Sterling Overnight Index Average (SONIA) rate has been issued by Lloyd’s Bank, which is opting to retain the deal. The £7.6bn transaction, dubbed Elland RMBS 2018, is backed by owner-occupied residential mortgages in England and Wales, originated by Bank of Scotland under the Halifax brand.

While the assets in the transaction are not SONIA-linked, an interest rate swap exchanges the weighted average portfolio fixed rate to SONIA plus a margin, to hedge potential assets and liabilities mismatch. Although there have been four UK covered bond transactions that are SONIA-linked in 2018, this transaction is the first UK securitisation to be structured that references SONIA.

Moody's and Fitch have assigned final ratings on the deal of triple-A on the £1.634bn class A1 notes (SONIA plus 90bp), triple-A on the £1.634bn class A2s (plus 100bp), triple-A on the £1.634bn class A3s (plus 115bp) and triple-A on the £1.634bn class A4 notes (plus 120bp). There is also a £1.064bn class Z note (SONIA plus 50bp) that is not rated.

The transaction is a positive development for the sector, says Moody’s, as it reduces uncertainty around the phase-out of Libor and supports the growth of SONIA-linked interest rate swaps. The rating agency adds that Elland RMBS 2018 can serve as a model for future RMBS issuance in the UK.

Moody’s highlights however that only a small number of instruments using an alternative rate to Libor have so far been issued and this deal follows the current standard for SONIA-based securities and derivatives, with compounding of the daily SONIA rate over the interest rate period. The agency suggests that demand for longer-term rates may lead to a move away from the daily-compounding toward term rates more similar to Libor and the demand for term rates will also arise on the collateral side.

Referencing consumer debt directly to an overnight rate is problematic, Moody’s adds, because volatility and daily compounding are not suitable for retail consumers. As such banks’ reliance on their own standard variable rate (SVRs) will continue and the agency expects that SVRs will continue to provide the term rate required for retail customers and to provide a buffer against daily price moves.

However, Moody’s says that it considers the increase in SONIA-based debt to be a credit positive, but it may be hard to know if the transaction is a result of increased market depth in the SONIA-based interest swap market, or if it will support subsequent growth of the swap market.

Fitch notes of the transaction that, while BoS doesn’t capture the employment type in their systems, it assumes that 30% of the borrowers are self-employed, in line with the originator’s previous Permanent Master Trust transaction, raising default risk in the portfolio. The RMBS also features a three-year revolving period, which allows new assets to be added and that this can help mitigate concerns around migration of the portfolio’s credit profile.

Fitch says there is, however, the potential for deterioration due to the absence of limits on interest-only loans or self-employed borrowers. Furthermore, all the mortgages in the pool were originated between 2014 and July 2018, with 97.3% originated in 2018.

This contributes to a low weighted average (WA) seasoning of seven months, while the high proportion, at 39.4%, of mortgages to first-time buyers, increases the overall LTV of the pool, as first time buyers typically borrow at high LTVs.  

Richard Budden

Structured Finance

New frontiers

SF group uses innovative methods to provide private debt financing

REYL Group recently established a new structured finance department as part of the Corporate Advisory and Structuring (CAS) group. It has a heavy focus on private debt - mainly on a secured and securitised basis - to facilitate funding across a range of asset classes and jurisdictions, including initial transactions in commodities and project finance.

Ante Razmilovic, who joined as head of the new structured finance group earlier this year, says that the firm likes to run the complete deal chain structure from start to finish, including origination and structuring. Additionally, it constructs hedges and oversees placement and also acts in an advisory role for companies, throughout the process.

 “We are focused on the private debt space”, adds Razmilovic, “and utilise securitisation technology to facilitate the financing of secured deals. Our approach is to look for opportunities where investors are rewarded for the illiquidity premium and our willingness to deal with structural complexities. In doing so, this typically provides investors with additional security.”

The group is asset class and geographically agnostic, focusing on where the “economics” work and where an opportunity presents itself, in terms of capital shortages and market dislocation. Recent focal points have included energy, emerging market development projects and infrastructure.

Razmilovic elaborates: “We are currently working on two upstream oil and gas projects, one in West Africa and one in the US, both of which involve the securitisation of offtake proceeds. We are probably currently overweight in emerging markets, including Latin America, Africa and South East Asia.

“Cashflows will be generated from the sale of oil over ten years,” Razmilovic continues, “with the revenues protected by a hedging facility with a price guarantee, before flowing through a cash waterfall inside a bankruptcy remote vehicle. The securitisation vehicle then issues listed clearable notes which are fully transferable.”

James Spooner, who recently joined the new structured finance department as md, says that it is a “pretty standard structure” using familiar technology, but applied in a slightly different way. This is deliberate, he says, because both the firm’s clients and investors prefer well-structured robust transactions, as far as possible.

Spooner adds that the firm is also engaged in project finance “with a development angle”, meaning it has “significance to the infrastructure of a country, to jobs, the local economy or environmental benefits.” As part of this, his firm looks “to work with DFIs and tries to find projects at an early stage. We then look at how these may be of interest to private investors and how we can facilitate this investment.”

Looking to the future, Razmilovic says that his firm is challenged most, “not so much by the macroeconomic environment” but more, as a smaller team, in displaying the discipline to choose the right deals to work on. This is particularly so as the group wants to avoid becoming overweight in any individual area.

Spooner adds that the structured finance unit is fully operational to deliver on its current plan, leveraging off strategic partnerships with third party individuals, while benefiting from offices in strategic locations. He concludes: “We are based in London but benefit from REYL’s global presence, in particular with the offices in Singapore and Dubai as well as our head office in Geneva, which helps with our focus areas in commodities and project finance deals there.”

Richard Budden

Structured Finance

Cerberus explores RMBS options

Sector developments and company hires

Granite alternatives

Cerberus European Residential Holdings is exploring strategic alternatives with respect to the mortgage loans held in the Towd Point Mortgage Funding 2016-Granite1 and 2016-Granite2 RMBS, which will become eligible for optional redemption from April and May of 2019 respectively. The firm has engaged Morgan Stanley and Bank of America Merrill Lynch as its financial advisors to assist in evaluating its options.

Partnerships

RAC, a securitisation and asset management platform, has entered into a partnership with the MOAC Foundation, a not-for-profit organisation that supports the development of the MOAC blockchain. Together with MOAC, RAC hopes to expand the public’s access to securitised assets. Cherie Liu will be joining RAC as an advisor, from a previous role as chief marketing officer at MOAC. MOAC also invested an undisclosed amount into RAC’s seed round.

US

Hogan Lovells has hired Stuart Morrissy to the firm’s New York office as a finance partner in the international debt capital markets (IDCM) practice. His practice will focus on securities law with an emphasis on leveraged finance and high yield transactions. Morrissy joins from Milbank, Tweed, Hadley & McCloy where he was partner.

Two Harbors Investment has promoted Stephen Kasnet to chairman in addition to his role as lead independent director of the board of directors. Brian Taylor is stepping down from the role of chairman and member of the board to focus more on Pine River, where he is ceo.

Structured Finance

ILS ventures launched

Sector developments and company hires

ILS

Rewire Holdings and Vida Capital have announced the formation of Merion Square Capital, a joint venture which combines the two companies. The asset manager has established an open-ended fund structure which will primarily invest in ILS with an emphasis on property and casualty insurance, as well as annuities and mortality-related products. Merion Square will be led and managed by the Rewire managing principals: Stefano Sola, Richard Pennay and Markus Schmutz. Sola was previously a member of the board of directors and trustees at Pure Life Renal before joining Rewire, whereas Pennay was a director at Swiss Re Capital Markets and Schmutz was md at the same company.

RenaissanceRe and PGGM have announced the creation of Vermeer Reinsurance to provide capacity focused on risk remote layers in the US property catastrophe market. Vermeer will be initially capitalised with US$600m of equity from PGGM, with up to a further US$400m available to pursue growth opportunities in 2019, for a total of US$1bn of capital. The company has received a single-A financial strength rating from A.M. Best and has obtained approval in principle to be licensed and regulated by the Bermuda Monetary Authority as a class 3B reinsurer. Vermeer will be managed by Renaissance Underwriting Managers, and is expected to be consolidated into RenaissanceRe’s financial statements. PGGM is the sole investor in Vermeer.

Digital SME securitisation partnership

German digital SME lender creditshelf has partnered with CrossLend to offer the first digital securitisation of SME loans in Germany. CrossLend will act as an investor on the creditshelf platform and purchase loan receivables as part of its regular lending processes. CrossLend will then securitise the loan receivables and offer them in the form of a new product to a broad base of additional investors via its own channels. Initially, one institutional investor will invest a mid-single-digit million euro amount each month in creditshelf's new business via CrossLend. The transaction is processed via CrossLend's digital securitisation platform and there are other institutional investors in the pipeline that are set to invest in SME loans via the solution.

Multi-tranche CIRT debuts

Fannie Mae has completed its first multi-tranche Credit Insurance Risk Transfer (CIRT) transaction, covering a pool of approximately US$10.9bn of existing multifamily loans in the company's portfolio. The deal, CIRT 2018-M02, transferred US$273m of risk to nine reinsurers and insurers. The covered loan pool for the transaction consists of 1,085 loans, secured by 1,091 multifamily properties, acquired by Fannie Mae from February 2018 through June 2018. The GSE will retain risk on the first 150bp of losses, while the A tranche will transfer risk to reinsurers covering the next 150bp-300bp of losses and the B tranche will transfer risk to reinsurers covering the next 300bp-400bp of losses on the reference pool. Finally, once the pool has experienced 400bp of losses, the credit protection will be exhausted and Fannie Mae will be responsible for any further losses.

Stock purchase agreement

KCAP Financial has agreed a stock purchase and transaction with BC Partners Advisors whereby an affiliate of BC Partners will become the external manager of KCAP. Under the terms of the agreement stockholders will receive a direct cash payment from an affiliate of BC Partners of US$25m.

Structured Finance

Inaugural post-crisis CLO prepped

Sector developments and company hires

CLO manager comeback

AIG is marketing its first BSL CLO since the financial crisis, totalling US$503.15m. Dubbed AIG CLO 2018-1, the transaction is provisionally rated by Morningstar as triple-A on the US$296.5m class A notes. It does not have ratings on the rest of the notes.

Fairhold development

Fairhold Securitisation Limited has issued a notice that the new respondents, as set out in the announcement dated 2 November 2018, be joined as additional respondents and be subject to the provisions of the amended order. Furthermore, the return date hearing was heard on 18 December and the court made certain orders and amendments, including an extention of the injunction against Clifden and Rizwan Hussain, as set out in a prior order. It further emphasises that unless Clifden and Hussain pay the costs of the issuer’s application from 23 July 2018, they must be restrained from issuing or otherwise commencing any proceedings against the Issuer or the note trustee (in relation to the affairs of the issuer) and any such proceedings if commenced will be struck out. It adds that Clifden has to pay the costs of £150,000 to the issuer and £50,000 to the note trustee as of 2 January 2019 and that a copy of the amended order is brought to the attention of the insolvency service by the issuer. It further says that all of the issuer’s and note trustee’s rights as against Clifden, Hussain and the new respondents remain entirely unreserved.

UK

Kudu Investment Management has agreed to take a passive minority stake in London-based alternative credit manager Fair Oaks Capital and various affiliates. Kudu will have no role in ongoing operations of Fair Oaks but will offer strategic guidance and support as the firm expands its investment offerings and its network of investors. The transaction is expected to close in 1Q19, subject to receipt of regulatory approvals.

US

Regions Securities has hired Leo Loughead as md, reporting to Tom Dierdorff, svp and group head of financial services and md of Regions Securities. Loughead will be based in Atlanta and joins Regions from SunTrust Robinson Humphrey, where he led the firm’s asset securitisation group as md.