Contents

ABS

Lights, camera, securitisation

Film rights ABS remains attractive to studios

The increasingly short length of time which films remain in movie theatres for these days may be frustrating for the average cinema-goer, but it is part of a trend which is optimising cashflows for film rights securitisations. This form of ABS allows the larger studios and their co-financiers to fund films, although smaller studios are expected to continue to struggle to get a piece of the action.

The average time a film has spent in theatres since 2002 has been one to four months, according to analysis by DBRS. The rise of digital distribution has dramatically decreased that theatrical window over the last decade and a half, with films in 2002 averaging 4.14 months in cinemas, but films released in 2017 averaging 2.36 months.

The shortening of this window is attributable to changing viewing habits – with customers increasingly watching films on computers, tablets and smartphones, using services such as Amazon Prime Video or Netflix – and also due to the industry’s realisation that consumers will pay a premium to view content that was recently on the big screen, which incentivises a speedy transition to home distribution.

Unlike a standard ABS transaction, film rights deals are future flow transactions. The bond is initially monetised based on the expected receivables from films.

“The cash flows are expected receivables not obligations like they would be in an auto loan ABS transaction. The receivables are the co-financiers’ expectations of revenue streams as well as the costs associated with distributing those films. When we rate a film deal we typically stress these revenue estimates and costs,” says Chris O’Connell, svp, DBRS.

DBRS has rated 10 film rights securitisations since 2010, with general rating levels of single-A and triple-B. O’Connell notes that performance of these deals has generally depended on how many films are in the securitisation and where the films are in their respective windows – whether that is in theatres, on TV or pay TV, or digital distribution.

Film rights deals are often unique and most often private. The split between library financing and slate financing, or between blockbusters and arthouse pictures, can vary.

“Some of the transactions we have rated are just libraries: where no additional films are added and the library might be in the films’ ‘second cycle’ of cash estimates. This means that the co-financier has an ability to forecast revenue from the different channels they sell the films through,” says O’Connell.

He continues: “We often will get a valuation of that estimate and discount that valuation. The declination rate as a film grows older is a natural part of the film business and, of course, part of our stresses in a library transaction.”

Library financing monetises the expected future cashflows that are realised form a portfolio of completed films. This includes both ‘first cycle’ films, which are those released in the last decade or so, and ‘second cycle’ films.

Slate financing occurs when a film is not yet released and the studio sells a portion of the film’s intellectual property or enters into a revenue participation agreement with a co-investor through a SPV.

With both library and slate financing, payments to co-investors come from the exploitation of the films through theatrical, video and TV distribution. DBRS notes that the number of films released each year since 2000 has ranged from 500 to 740, with 70%-80% of films shown at major cinema groups having gross revenue of US$12m or less.

Film rights ABS which have been issued so far have mainly been backed by major Hollywood studio-produced films, as the smaller ones generally lack either the necessary portfolio of films, financial strength to support film distribution, or the infrastructure to manage securitisation execution, notes DBRS. The rating agency expects this, and other trends in the space, to hold true going forward.

James Linacre

Capital Relief Trades

STS synthetics pending

EBA to publish report by year-end

The EBA is expected to publish a report on STS synthetic securitisations by year-end, which will then be reviewed by the European Commission. The main challenges that the supervisor will be dealing with are the lack of performance data on synthetic securitisations and the creation of STS criteria for the sector.

STS criteria for synthetic securitisations could further prevent banks from using certain structural features, such as excess spread and high credit protection premiums, given that the ECB and national supervisors have raised concerns as to whether significant risk transfer is achieved when these features are included in risk transfer transactions.      

The Securitisation Regulation gave the EBA a mandate to assess the feasibility of an STS designation for synthetic securitisations. The assessment has to be completed by July 2019 and, based on that report, the Commission will reach a decision by January 2020. However, EBA sources note that the deadlines will likely move because work has started this year, so an EBA report is more likely by the end of the year.

The biggest challenge for the supervisor is demonstrating the performance of synthetic securitisations, given the relative absence of performance data. Sound performance for the underlying assets will be crucial in the STS assessment for synthetic securitisations, but public ratings for these transactions are scarce and that has been particularly the case since 2007. Consequently, the supervisor is working with market participants, including the International Association of Credit Portfolio Managers (IACPM) to fill the gap.

Another issue is the creation of STS criteria. Traditional securitisations typically assess investor protection features, but in the case of synthetic securitisations, the banks retain some risk, so any framework will be structured from both an issuer and investor perspective. The EBA’s discussion paper on significant risk transfer and the PCS label will provide some guidance in this respect, as the debate over this topic continues over the next two months.

The STS criteria aim to further standardise the market and, hence, help prevent practices that supervisors have dubbed as regulatory arbitrage. The same EBA sources note that supervisors have raised concerns in relation to the achievement of significant risk transfer, when excess spread and high credit protection premiums are present in risk transfer deals.

Interest income from excess spread can be used to absorb losses in an adverse scenario. However, the ECB and European national supervisors have raised doubts as to whether SRT can be achieved when the excess spread that is generated and benefits investors is higher than expected losses.

Banks have responded to these concerns by emphasising the fact that excess spread is not a balance sheet item, given that it is future income and therefore there is no need to hold capital against it, as per CRR requirements. Consequently, if there is no impact on the capital position of the bank, then using it to absorb losses should not hinder SRT.

Steve Gandy, md and structurer at Santander, explains: “Excess spread shouldn’t hinder SRT, since it has no impact on the capital position of the bank. The CRR itself doesn’t make any distinction between the risk weighting of portfolios with differing levels of excess spread. So the position of the ECB and national supervisors to exclude excess spread from SRT deals makes it more difficult for banks to achieve SRT for higher expected loss portfolios. This seems to contradict policymaker intentions.”

However, most synthetic securitisations just don’t include it as a structural feature and if it is featured in a transaction - as is the case with most true sale ABS deals - it is simply passed through the waterfall with any remaining income going back to the originator (SCI 19 December 2018). Nevertheless, such diversion can significantly raise the cost of protection.

“It then creates a perverse incentive, where we are forced to buy protection for higher quality assets, as opposed to the most risky ones,” says Gandy.

Similarly, supervisors have long raised concerns as to whether SRT is achieved when credit protection premiums are higher relative to the portfolio’s expected losses.

Yet AFME and IACPM have stated that it would be “surprising” if the premiums did not exceed expected losses - assuming the protection completely covers the expected losses - since the investor providing protection expects to make a positive return on the transaction. The associations also add that high premiums need to exceed expected losses in order to cover both expected and unexpected losses.

The proposed Basel Committee guidelines on this issue stipulate that premiums above a certain threshold should lead to a deduction in the capital relief that a bank can achieve. Gandy concludes: “If this proposal is adopted, it could reduce issuance of SRT deals of long-dated portfolios, such as project finance and mortgages, unless investors lower their return requirements.”  

Stelios Papadopoulos

ABS

Different strokes

PACE prepayment volatility on the rise

A new Morningstar Credit Ratings study reveals increased volatility and a generally accelerating trend in residential PACE prepayments. Against this backdrop, different prepayment patterns are emerging across PACE ABS originators.

Monthly annualised CPR averages have been fluctuating between increases and declines for the last six months, according to the Morningstar study. For example, after a decline in the averages for a couple of months, prepayments shot back up, only to be followed by a declining trend in the past three months. However, CPR averages remain significantly higher than their single-digit start, with averages now in double-digits. 

The 26 months of data analysed in the study also suggests that different prepayment patterns are emerging across originators. For instance, prepayment rates tend to be higher for originators that did not impose prepayment penalties versus prepayments seen at originators with prepayment penalties. In some cases, originators may sometimes waive the penalties and put funds aside to cover them. 

“While there is some evidence that prepayment penalties serve as a deterrent, PACE is a very competitive market and one way for an originator to increase their competitiveness is to not charge penalties. So despite the fact that negative correlation between prepayment penalties and CPR may help the originators in managing the prepayment trends, it wouldn’t be surprising to see originators actually reducing these penalties, given increased borrower flexibility and greater wariness of consumer protection agencies,” observes Rohit Bharill, md and head of ABS at Morningstar Credit Ratings.

The data also shows two monthly prepayment spikes in 2017 after Ygrene repurchased select PACE assessments from its securitisation trusts, due to failed eligibility requirements specified in transaction documents. However, Stephanie Mah, vp at Morningstar Credit Ratings, notes that as the PACE ABS market matures and legal documentation across transactions become more standard, this trend is likely to decline.

“Failed customer eligibility is an operational issue. Standardised documentation could improve adherence to criteria and provide a clearer roadmap for originators to follow,” she says.

Tax reforms and government shutdowns are other potential variables influencing PACE borrower behaviour, according to Mah. She suggests that the acceleration in prepayments last year could have been related to tax reform measures, which now cap the amount of state and local property taxes a homeowner may deduct at US$10,000 and mortgage interest payments at US$750,000. Importantly, the interest payment on a PACE assessment may be eligible as a mortgage interest deduction.

Meanwhile, the recent prolonged 35-day government shutdown might have diminished the ability of some homeowners to prepay PACE assessments, due to potentially delayed income and tax refunds. A significant number of homeowners were out of work in California during the shutdown, according to the US Office of Personnel Management. For example, the Department of Homeland Security was closed during the shutdown, affecting 22,587 California workers, while the Department of Treasury saw 12,764 of its California workers sidelined.

In terms of the impact on PACE ABS notes, higher prepayments are positive for senior tranches, but negative for residual positions that rely on excess spread to pay down the principal balance.

Corinne Smith

ABS

Debuting duo

New ILS peril, domicile introduced

GC Securities has placed a pair of innovative catastrophe bonds. Insurance Australia Group’s A$75m Orchard ILS transaction marks the first ILS issuance from Singapore, while Pool Re’s £75m Baltic PCC deal is the first-ever cat bond to cover terrorism risk exclusively and only the second to be issued under the UK’s new regulatory framework for ILS.

Baltic PCC provides £75m of retrocession protection in excess of Pool Re – the UK’s state-backed terrorism reinsurer - members’ net loss of £500m. As such, it brings new sources of capital to the terrorism risk market, returns additional premium to the private sector and moves UK taxpayers even further from the risks Pool Re mutualises on their behalf.

Shiv Kumar, president, GC Securities, notes: “Executing this successful placement while the ILS market is processing losses from 2017 and 2018 demonstrates the strength and quality of Pool Re’s proposition and their market-leading risk analysis. This type of innovation is a great example of the major role the UK market can play in broadening the ILS asset class.”

The three-year bond provides cover on an annual aggregate basis and carries an initial interest spread of 5.9% per annum. It covers physical damage arising from terrorist attacks - including chemical, biological, radiological and nuclear attacks - on an indemnity basis, as well as losses emanating from cyber trigger. The risk was modelled using Pool Re’s own model, calibrated by Cranfield University using computational fluid dynamics.

Meanwhile, the Orchard ILS deal was issued under Singapore’s special purpose reinsurance vehicle (SPRV) regulations, which support the incorporation of purpose-built reinsurance entities to securitise risks and provides tax neutrality to the reinsurance entity and ILS investors. As part of its broader effort to develop the ILS market in Singapore, the Monetary Authority of Singapore also introduced the ILS grant scheme in February 2018.

Developed in consultation with the industry (including GC Securities and IAG), the grant scheme funds upfront ILS bond issuance costs. The move is aligned with the city-state’s efforts to establish itself as a global hub for Asian risk transfer.

David Priebe, vice-chairman at Guy Carpenter, comments: “Singapore’s ILS grant scheme is an excellent initiative that has played an important part in enabling this transaction to take place. We hope the pioneering work of IAG, MAS and GC Securities provides a springboard for greater use of insurance-linked securities to close the protection gap in Asia and promote sustainable economic development in one of the most dynamic regions of the world.”

Representing the first such transaction by IAG, Orchard ILS provides the company with A$75m of annual aggregate catastrophe protection for three years and is part of its aggregate sideways cover, which in total provides protection of A$475m excess of A$375m.

Corinne Smith

Structured Finance

Downward drift

Low default trend continues

Global corporate defaults fell in 2018 in advanced markets and were stable in emerging markets. The persistence of the low default trend - in particular, in advanced economies - is a positive sign for capital relief trades, given that the bulk of these transactions reference European corporate loans.

The default rate for non-financial corporates with rated debt in advanced economies fell to 1.6% in 2018 from 2.3% in 2017 and was largely in line with the 1.4% rate in emerging markets. In absolute terms, 2018 had the lowest number of defaults since 2015.

“In 2015 and 2016, we saw defaults in the commodities and energy sectors, due to lower commodity prices - although commodity prices have improved since then. The energy sector was the main driver for the decline in defaults in 2018, so global default rates have done better as a result,” says Richard Morawetz, vp and senior credit officer at Moody’s.

Energy led the list of 2018 defaults in the advanced economies, albeit the number of defaults fell from 31 in 2017 to 20 in 2018. Energy sector defaulters were largely small-scale companies with fairly concentrated asset bases and high leverage and capital spending requirements relative to earnings.

Overall, rating actions in the sector globally were more positive in 2018 - reflecting not only higher oil prices, but also companies’ initiatives to reduce debt, sell assets and reduce costs. The US saw the largest number of defaults, representing about two-thirds of the 66 defaults that occurred last year - reflecting not only the absolute number of ratings there, but also the high proportion of low speculative-grade ratings.

Moody’s expects the global speculative-grade default rate to remain fairly stable in 2019 versus 2.3% in 2018, based on its assumptions of healthy corporate financials, low refunding risk and positive economic growth. “We don’t expect much of a difference in speculative grade default rates this year, compared to the previous year. Default drivers in general could be due to a downturn in the economy or another fall in commodity prices. The prospect of rising rates doesn’t help, although we believe that the large majority of corporates can withstand rising rates,” notes Morawetz.

Indeed, rising interest rates will exert pressure on borrowing costs. Moody’s expects interest rates to rise in the US, with the Federal Reserve anticipated to raise the policy rate once or twice later this year. Yet the agency doesn’t expect the ECB to start raising rates until 2020.

In advanced markets, the effects will be felt by more highly leveraged or lower-rated companies in the US, where speculative grade ratings represent a higher share of non-financial corporate ratings. In emerging markets, higher interest rates can also add to currency volatility by inducing capital flows. This could exacerbate the effects of any currency mismatches, which tend to be a greater cause of defaults in emerging markets.

Sharon Ou, vp and senior credit officer at Moody’s, concludes: “Monetary policy and an escalation of US-China trade tensions is the main source of risk to the outlook. Nevertheless, we expect the global economy to continue to grow in 2019, which will support corporate financials and keep the default rate low this year.”  

Stelios Papadopoulos

Structured Finance

'Long term solution needed'

Day three from SFIG Vegas

The last full day at SFIG Vegas was again abuzz with strong attendance and widespread optimism.

One panel looked at UK firms looking to issue transactions into the US market. Brian Wiele, md at Barclays, commented that one of the steps needed at the moment to boost the sector is re-educating US investors on UK securitisations, as awareness of UK securitisations in the US has dissipated.

He went on to say that in terms of headwinds for the securitisation sector more broadly, Brexit has become more of a concern as no certainty as to an outcome has yet to be found. He added however it seems like the banks are well set up for a range of outcomes.

Francesco Paez, director and head of ABS and CMBS credit at MetLife commented that Brexit, along with the end of TFS could be drive the issuance of UK securitisations into the US market. He suggested that this is because both factors will prompt lenders to diversify their funding sources and he also added that as an investor, Brexit hasn’t yet deterred his appetite for UK securitisations.

UK banks also appear to have a strong appetite to issue transactions in the US according to Gavin Parker, head of securitisation and collateral at Lloyds. He said that his firm issues transactions in euro, dollar and sterling as well as other strategic currencies which helps the bank to maintain a diverse investor base.

In terms of general themes in the market Paez said that he agreed that a certain degree of re-education of US investors is important and that UK issuers should try to remain close to their investor base and to ensure they are kept informed. He said that what is also important for issuers is to stay in the market with repeat issuances in order to prevent liquidity drying up.

The panellists also discussed the issues associated with the Libor transition and Parker commented that, as a result of ongoing uncertainty, his firm is looking to issue deals with fixed rate notes. This was echoed by Wade who said that he has had several conversations recently with issuers about doing two to three year fixed rate deals.

Paez said that short dated fixed rate transactions might provide a viable solution if fixed rate transactions in UK securitisations become the new normal. He expressed concern, however, that if it’s just a short term solution, this could result in a small number of orphaned transactions which could then lose liquidity and he stressed the need for a long term solution.

Richard Budden

Structured Finance

Structured finance 'well positioned' for downturn

Second day at SFIG Vegas sees continued optimism

Day two at SFIG Vegas saw a bountiful turnout of attendees, all looking to hear the latest on structured finance and to meet the main movers and shakers in the industry. A standout panel looked at how structured finance is prepared for a turn in the turn in the credit cycle, while other notable discussions looked at the revival of private label RMBS.

When looking at the potential for a turn in the credit cycle, the consensus was that the US economy is broadly well positioned to survive a downturn. Structured finance in particular is thought to be in an especially strong position, having undergone a number of improvements following the crisis.

Mary Kane, head of securitised products research at Citi global markets, commented that her firm’s view is that the US economy is still strong and well placed to endure further rate hikes. She added that while retail shows some signs of weakness, the labour market remains very robust and housing doesn’t appear to be declining rapidly.

Nancy Mueller Handal, senior md, private fixed income and alternatives at MetLife Investment Management, said that they have been very focussed on US consumer ABS in terms of their investment strategy. She commented that the US consumer looks very healthy with improved housedebt levels, although there are concerns about the bottom quintile.

In line with this, she added that despite her optimism regarding US consumer ABS, her firm has been very cautious on transactions backed by subprime consumer debt. Either way, consumer ABS has been an outperformer for the firm and she thinks that it will be provide something of a safe haven should volatility pick up.

In terms the possibility of increasing delinquencies, particularly in auto ABS, Kane said that while the number of seriously delinquent auto loans has risen slightly, the securitisation market finances less than 20% of all auto lending in the US. She added that, on the whole, her firm is not overly concerned about the possibility of a deterioration in the performance of securitisations in prime or sub-prime asset classes.

Vandy Fartaj, senior md and cio, Penny Mac, generally echoed these sentiments and commented that he doesn’t see any imminent headwinds for the securitisation sector in the US. He added that while rate rises could stress consumer finances, the Fed has taken that off the table for the time being.

In terms of tipping points for the structured finance sector, panellists all seemed to be in agreement that rate rises are the main concern. There was also general agreement that the potential for rising defaults in corporate debt, along with the potential for downgrades in investment grade names, was a major concern for the wider economy and also structured finance.

In the event of a downturn, however, structured finance is expected to be resilient and Handal commented that the structured finance market is positioned “remarkably well” for a downturn. She put this down to the many improvements made to securitisation since the crisis, including stronger originations, better underwriting standards, risk retention, better disclosure standards and significantly increased credit enhancement.

In terms of moves to protect against the effects of a downturn, Handal said that her firm is “de risking out of IG/HY corporates into private corporates”.  She added that they are trying to de risk from companies that look most at risk of downgrades or leverage issues.

She also said that her firm has taken the decision in recent years to invest in residential whole loans and the firm has ramped this up from nothing in 2012 to US$15bn worth of residential whole loans to date. Handal concluded that whole loans now have sufficient breadth and depth and they are able to pick and choose across the risk spectrum giving the firm much more control over what they invest in.

Later on in the day, experts discussed the revival of the QM and non-QM private RMBS sector. John Hsu, head of capital markets at Angel Oak, said that one of the biggest challenges with regard to non-QM securitisations is a reputational problem whereby it is often linked to subprime mortgages. He added that he therefore has to do a great deal of education around why it differs to the pre-crisis product.

In terms of how the product has progressed since the crisis, Jeffrey Johnson, partner at Morgan Lewis, commented that lack of due diligence used to be a big concern, but said that this and disclosure issues have largely been resolved. He commented that this has been aided by greater guidance on underwriting and more standardised reps and warranties, along with greater understanding and standardisation of risk retention.

In terms of the use of technology in the private RMBS space, Quincy Tang, md at DBRS, commented that new technology has been useful in helping to improve the appraisal process. She commented that it has helped to verify borrower income, employment status, banking history and so on and she added that this has helped boost transparency of information, particularly that which is provided to rating agencies.

Tang went on to say that she thinks in non-QM underwriting has improved a great deal compared to pre-crisis non-QM transactions. In addition, she said that transactions often have a high level of due diligence and risk retention has boosted the quality of deals.

Richard Budden

Structured Finance

A strong start

Day one at SFIG Vegas

Moods appear to be running high at the start of SFIG Vegas 2019. Despite being only a half day, attendance already seems to be strong and the panels have so far been near to full.

A highlight of the afternoon was the the CRE CLO market update, where panellists spoke to a well attended room and generally voiced positive sentiments about the future of the asset class. The overarching view was that CRE CLO volumes will continue to grow this year and the asset class is expected to become more institutionalised as it matures.

Kunal Singh, md and head of CMBS, capital markets in North America for JPMorgan, commented that 2018 was a breakout year for the asset class and that it became far more institutionalised. He added that 2017 and 2018 saw CRE CLOs develop to be seen as legitimate source of financing by investors and issuers.

This sentiment was echoed by Gene Kilgour, evp structured securitisation at Arbor Realty, who said that 2018 saw increasing liquidity in CRE CLOs. He added that it saw greater acceptance by both investors and issuers, with the latter more closely investigating the possibilities of utilising the CRE CLO structure as a financing tool.

Missy Dolski, director at Varde Partners, agreed, stating that 2018 was the year the product found its footing. She added that issuers have now come to see it as a legitimate funding source and valuable way to achieve funding diversification.

She also said, however, that the market has become very competitive,with many new entrants having come in due to the availability of funding. She suggested that not all of these players will survive, with the number of players in the next 12-18 months set to shrink.

Another trend identified by the panellists is the growing number of managed CRE CLOs, with Singh predicting that 70-75% of deals issued this year will be managed. He commented, however, that there is generally more risk involved in a managed deal, all else being equal, versus a static transaction.

The panellists were also largely confident in the prospects for the asset class in 2019 and beyond, with Dan Chambers, md at Fitch, predicting robust issuance and continued high levels of liquidity. Dolski commented that while the product will remain strong, unpredictable macroeconomic factors are the main concern, such as those witnessed at the end of 2018.

In the last panel of the day on residential and commercial PACE, the mood on the panel was less sanguine with Brock Wolf, executive director on Natixis’ ABS banking team, saying that 2018 was broadly not a positive year for residential PACE. He added that volumes in residential PACE were far below 2017’s levels, with around half the number of transactions.

He noted however that commercial PACE fared better, with an uptick in originations and added that there were also several positive capital markets developments for commercial PACE.

Stephanie Mah, vp, ABS research at Morningstar echoed this sentiment on commercial PACE, noting that it is seeing continued momentum. She added that more states are passing the requisite legislation authorising the use of commercial PACE, with Montana doing so earlier this month.

The issue of consumer protections was also raised and Wolf noted that there are now many robust consumer protections in place, adding that originators might suggest they have gone too far. He added that residential PACE has now become very burdensome in terms of the application and verification process, to the point that contractors are steering consumers away from PACE - a big factor in the drop in volumes.

Looking forward, Greg Saunders, ceo of CleanFund, suggested that in commercial PACE, there will be a general move in 2019 towards much larger projects. He added that deals of US$350m will become more common as developers see the benefit of commercial PACE to lower their costs of capital.

Finally, there was general agreement that one of the most important things needed for commercial PACE to develop is greater standardisation. Mah said that it would certainly help from a rating agency perspective because, at the moment, the transactions are complex and more like one-offs than cookie-cutter deals, requiring an intensive amount of work on each one.

Richard Budden

Structured Finance

SCI Start the Week - 25 February

A review of securitisation activity over the past seven days

Market commentary
European secondary ABS activity was on hold last week ahead of a large BWIC auction due on 28 February (SCI 21 February).

"Secondary activity has dampened down in the run-up to the auction," confirmed one trader. "The BWIC has a good chance of trading well, despite the block sizes on offer. Although dealers don't appear to have much appetite for the paper, the lack of primary issuance is playing into the seller's hands in terms of investor demand."

The 24-item bid-list comprises around £750m of UK risk, across mainly senior RMBS 2.0 bonds, with a handful of legacy names and three 2018-vintage CMBS bonds.

Meanwhile, a flurry of Trups CDO activity was keeping traders engaged in the US (SCI 20 February). One trader highlighted a portfolio of PRETSL B tranches - totalling US$87m - out for the bid. Investor appetite is, however, uncertain as "the market has been pickier recently in its choices".

Elsewhere, activity has been somewhat muted. "The CLO market has been quiet recently and we haven't seen great volumes traded," the trader said.  "We're in something of an in-between phase this week, after a long weekend and the conference at the end of the week."

The trader suggested that there is a "slight preference for shorter deals" in secondary and a general move towards trading conservatively and for relative value.

Deal-related news

• The US bankruptcy court in Dallas has confirmed Acis Capital Management's Chapter 11 restructuring plan, following its conversion from an involuntary bankruptcy case initiated by former head of Highland Capital Management's structured products team and founder/former partner in Acis Joshua Terry (SCI 9 November 2018). Upon emergence from bankruptcy, Acis will be owned and operated by Terry, and the plan of reorganisation proposes to pay creditors in full (SCI 19 February).
• Weinberg Capital is set to issue and settle ABCP notes via a distributed ledger technology-based online electronic platform during a pilot phase. The platform will also record the ownership of the DLT ABCP notes, which will rank pari passu and benefit from the same security as other ABCP notes issued by Weinberg Capital, including full liquidity support and indemnity provided by the programme administrator LBBW (SCI 19 February).
• The first US CLO applicable margin reset (AMR) auction on the KopenTech platform is likely to occur in February 2020, at the end of the respective deal's non-call period and two years after the auction service provider's launch (SCI 30 January). However, while many CLO managers recognise the value of including a low-cost, streamlined refinancing option in their deals, they remain cautious about concerns from anchor investors and arrangers (SCI 19 February).
• The Finsbury Square 2016-1 RMBS issuer has disclosed discussions with the Northview Group in relation to the purchase of the loans in the underlying mortgage pool. Such discussions may lead to the redemption of the notes, although it states they are ongoing and preliminary in nature (SCI 21 February). 
• An SPA has been signed for the 10 remaining properties securing the Target Portfolio loan securitised in the TITN 2006-3 CMBS for €100m. Completion is expected at end-March, after which the proceeds will be applied on the April IPD. For more CRE-related news, see SCI's CMBS loan events database.

Regulatory round-up

• With only two years to go until Libor is officially phased out in 2021, a number of questions still remain about the ramifications for structured finance transactions. Aside from the lack of concrete replacement, there are also questions about legacy deals, assets and liabilities and swaps complications as well as the possibility for bondholder disputes (SCI 19 February).
• On 31 January, ESMA published a document that amends its draft regulatory technical standards (RTS) on securitisation disclosures by expanding the scope of no data options. The market has welcomed the move, given the compliance challenges in completing templates where the relevant information isn't available (SCI 22 February).
• The Greek government is working on a plan that aims to meet ECB non-performing loan reduction targets and help improve the attractiveness of non-performing portfolios, in particular, distressed mortgages. The plan includes subsidising monthly payments and protects borrowers from foreclosures under certain conditions, although this could render it antithetical to EU state aid rules (SCI 22 February).
• Law firm Pomerantz is investigating claims on behalf of investors in Domino's Pizza, concerning whether Domino's and certain of its officers and/or directors have engaged in securities fraud or other unlawful business practices. The move follows a recent report on the franchisee community website Blue MauMau that a whistleblower report filed with the US SEC details how Domino's allegedly forced and orchestrated an unapproved advertising and promotion increase to franchisees in order to pay a US$1.85bn securitisation transaction with a new partially funded US$1.67bn securitisation debt owed to securitisation entities (SCI 21 February).

Data

Pricings
US ABS once again accounted for the majority of pricings last week. An Australian RMBS print was the highlight for international securitisation investors.

Last week's auto ABS issues comprised: US$174.51m ACC Trust 2019-1, US$161.93m CIG Auto Receivables 2019-1, US$1.06bn Ford Credit Auto Lease Trust 2019-A, US$1.25bn Honda Auto Receivables 2019-1 Owner Trust and US$500m Securitized Term Auto Receivables Trust 2019-1. The non-auto ABS prints consisted of US$1.5bn Capital One Multi-Asset Execution Trust Series 2019-1, US$429.06m MAPS 2019-1, US$496.8m Nelnet Student Loan Trust 2019-1 and US$221.47m Upstart Securitization Trust 2019-1.

Among the CLO prints were US$451.52m Kayne CLO III and US$301.75m Palmer Square Credit Funding 2019-1. Finally, the US$533.42m-equivalent Pepper Residential Securities Trust No. 23 rounded out the issuance.

BWIC volume

CLOs

Wave of opportunity

Investors capitalised on 4Q18 volatility in US CLO market

Volatility seen in the CLO market at the end of last year provided managers and investors with a wealth of opportunities, according to panellists at SFIG Vegas this week. Unfortunately, this volatility has contributed to a more muted and challenging issuance environment so far this year.

Angie Long, cio and portfolio manager at Palmer Square, commented that 4Q18 provided a “huge opportunity” for her firm, which turned over almost 15% of its portfolio. She added that it was a “distinctly unique” environment where CLO double-B notes were pricing at an average of 95bp.

Long commented that “it was amazing how orderly the sell-off was” and that, even with US$25bn loans for sale, “everything traded surprisingly well - everything cleared.” Long went on to say that the volatile period was viewed as a “fork in the road”, whereby her firm needed to decide if the volatility was “real” or just part of a technical sell off and, as a result, they decided it was the right time to move into higher quality names.

In terms of how the volatility has affected the new issue market, Fitch md Kevin Kendra said there was a pause in new issuance, which he was “pleased to see after a frenzied year.” New deals coming to market now will generally have to have an anchor investor, he said, with some issuance going out with shorter terms to try to make the economics work and a handful of print and sprint deals.

Long echoed this, saying that her firm and others had lined up print and sprint transactions that have since been abandoned, as loans are not cheap enough for the transactions to make economic sense. She added that her firm is now “moving slowly as warehouses clear out and price deals.”

In terms of broader trends in the market or sectors of concern, Jonathan Insull, md and institutional portfolio manager at Crescent Capital said that “retail continues to be dislocated” although added that there are still opportunities within the sector but “that you need to be very careful.” He added that healthcare is a source of opportunity, along with technology, although suggested that the latter isn’t proven through a credit cycle.

Kevin McLeod, md at Cerberus Capital, said that retail is definitely of concern but areas of opportunity remain and he said auto has been a positive area for his firm. Generally, he feels that US CLOs are still a strong product offering a broad slice of the US economy and he is cautiously optimistic from a portfolio perspective.

Looking ahead, Kendra commented that 2019 to 2020 are expected to provide a benign default environment, with the US economy still likely to see GDP growth. He added that, generally, he thinks leveraged loan defaults will remain low but he does expect to see individual businesses under stress scattered throughout different sectors.

Insull largely agreed and said that the CLO market has been misrepresented in the press which “makes out that buying leveraged loans to be very risky, which is not the case.” He suggested also that while changes to documentation in CLOs is a concern, “if you’re confident in the ability of a business, you will be less worried about what the documents say.”

In terms of how various investor concerns are affecting their behaviour, Long said she didn't think investors are repositioning much at the moment. She did suggest, however, that investors are looking more closely at shorter dated, static deals and Kendra added to this that he has seen a general shift away from floating rate assets.

There was also widespread agreement that the middle market CLO sector is strengthening with growing investor interest and a growing desire for education. Kendra agreed on this and said that he is “seeing an evolution of the investor base” in middle market CLOs and expects that it will only continue to grow.

The investor base is now becoming more institutionalised, said Insull, with firms that have very long horizons, like pension funds and endowments, growing in number. He said that this is a positive development, comparing it to as recently as 2013 when middle market CLO investment was dominated by shorter term investors, like hedge funds.

The panellists were asked to provide their final thoughts on the stability of the asset class and Insull said that many lessons have been learned over the last ten to twenty years. As such, he commented that his firm designs transactions to withstand deterioration in credit, such as by employing less leverage and using more credit enhancement.

McLeod added that it is critical to have covenants in the loans backing the CLO and that his firm also carefully monitors the borrowers on a regular basis. He said that his firm will try to work with struggling companies before any issues become more of a problem adding that “if you get the loans right, the CLO should take care of itself.”

Kendra added that a lot of mainstream media coverage provides an unfair portrayal of the CLO sector, and that “the asset class and lending to corporations on a levered basis has been going on for a long time”. He concluded: “What we’re seeing now isn’t that different to anything we’ve seen before.”

Richard Budden

NPLs

Turkish NPL boost

Distressed debt surge anticipated

Turkish asset manager Hayat Varlik Yonetim expects non-performing loan sales in the country to jump 33% this year, as banks try to cope with a surge in corporate debt restructurings. TRY10bn (US$1.9bn) of NPL sales are anticipated in 2019, following the devaluation of the Turkish lira last summer.

“The devaluation of the Turkish lira last summer and the high interest rate environment since then has led to the underperformance of many firms, which have borrowed in foreign currency and invested in long-term projects,” says Hilmi Guvenal, ceo at Hayat Varlik Yonetim.

Turkey’s NPL ratio rose to 3.2% in September 2018, following a rise in exchange rates, and the upward trend is expected to continue. S&P notes in a December 2018 report that it expects the country’s NPL ratio to rise to 6% over the next 12-18 months.

“The rise in the NPL ratio coincides with the advent of more international investors. We have seen more of them since September-October. The market is basically unsecured retail and SMEs, and investors expect to play a role in restructurings,” says Guvenal.

Investors interested in the Turskish NPL market have to get a licence and set up an asset management company. “Operationally, they need to be fast, given that tenders start and close within a month or so. If they get a tender, they need to have a platform in order to collect and secure some servicing capacity,” he continues.

Guvenal expects banks to continue selling mainly unsecured debt, with local asset managers purchasing the portfolios. “However, 2020 onwards might be a totally different era, especially if the restructuring of corporate loans proves unsuccessful.”

Hayat Varli Yonetim has a market share of approximately 28%, rendering it the biggest buyer in the Turkish NPL market.

Stelios Papadopoulos

RMBS

Exit complete

Irish RPL RMBS refinanced

Ellington Residential Holdings Ireland is in the market with a €620m Irish re-performing RMBS dubbed Jepson Residential 2019-1. The transaction is a refinancing of European Residential Loan Securitisation 2017-PL1, sponsored by Lone Star.

“The deal is expected to be called next month, although the rationale for the move isn’t clear,” says one portfolio manager. “A lot of the underlying assets were restructured and the portfolio went from having zero arrears to some delinquencies. The bonds were originally issued at a discount to par and recently they were trading at close to par, so I think this was some sort of exit for Lone Star.”

Indeed, restructured loans comprise 75.8% of the mortgage portfolio and the proportion of loans paying 100% or more of the scheduled payment has slightly improved to 86.7% from 85.5% in March 2017, indicating stable performance to date and sustainable terms for the majority of the restructured loans. However, as of 31 December 2018, 7.8% of the mortgage loans are three months plus in arrears.

Rated by DBRS and S&P, the transaction consists of as-yet unsized AAA/AAA rated class A notes, AA/AA rated class B notes, A/A+ rated class C notes, BBB/BBB+ rated class D notes, BB/BB rated class E notes, B/B rated class F notes and B/B- rated class G notes. The class Z1 and Z2 are not rated and will be retained by the seller.     

Proceeds from the issuance of the notes will be used to purchase the first charge performing and re-performing Irish residential mortgage loans that were previously securitised in European Residential Loan Securitisation 2017-PL1. The mortgages were originated by Bank of Scotland (Ireland) (accounting for 67.1% of the portfolio), Lone Star subsidiary Start Mortgages (29.2%) and NUA Mortgages (3.8%). Lone Star acquired the loans originated by BoSI and NUA in February 2015 and December 2014 respectively.

Servicing is conducted by Start, which is also expected to be appointed as administrator of the assets for the deal. The transaction is arranged by Morgan Stanley.

The transaction benefits from a non-amortising reserve fund, which is split into a non-liquidity reserve fund (NLRF) and a liquidity reserve fund (LRF). The NLRF will provide liquidity and credit support to the rated notes, while the LRF will provide liquidity support to the class A notes. The deal also features an interest rate cap that terminates on 24 March 2026 and is capped at one-month Euribor plus 2%.

The origination vintages of the portfolio range between 2006 and 2008 (70.6%), with 13% of the borrowers having negative equity. The pool is primarily concentrated outside Dublin (59.7%), with the remaining 40.3% located in the Irish capital. Irish house prices in Dublin and outside the city have rebounded 102% and 79% respectively, following the peak-to-trough drop of 59.7% and 55.7% respectively.

Looking ahead, the portfolio manager notes: “The rating for this deal could be upgraded once it amortises, although that will depend on the recovery strategy for the loans. Generally, the refinancing of further re-performing portfolios will depend on each deal and we should bear in mind that there aren’t many such re-performing transactions. However, most of them do have call features, so I wouldn’t be surprised if we saw another refinancing.”

Stelios Papadopoulos

Structured Finance

CLO manager shake-up

Company hires and sector developments

Derivatives continuity
The US CFTC and the Bank of England have issued a joint statement aimed at reassuring market participants of the continuity of derivatives trading and clearing activities between the UK and US, after the UK’s withdrawal from the EU. The measures that will be in place by end-March include: information-sharing and cooperation arrangements to support the effective cross-border oversight of derivatives markets and participants and to promote market orderliness, confidence and financial stability; and the extension of existing CFTC relief and comparability for the UK, as well as UK equivalence for the US.

EMEA hire
Intertrust has appointed Amit Taylor as head of corporate services in Guernsey and a member of the firm’s new Guernsey senior management team. Taylor has over 20 years’ experience as a finance industry professional in the UK and Guernsey. He was previously Guernsey md of Estera, following stints at Trust Corporation and HSBC’s fund administration and custody business on the island.

Manager ranking shake-up
Moody’s CLO manager league tables saw a significant shake-up among US managers in 2H18, in terms of both deal count and AUM. CIFC took over the top spot from GSO/Blackstone in terms of CLO AUM with US$15.6bn and was tied with MJX, GSO/Blackstone and Carlyle in terms of highest deal count at 25. The biggest mover among the top 10 US CLO managers was MJX, which moved to third place from seventh in AUM at US$14.2bn, behind CIFC and GSO/Blackstone (US$15.4m). Finally, PGIM and THL joined the top 10 with 20 and 19 deals respectively. The other managers in the top 10 by deal count are Octagon (22), Ares (21), Och-Ziff (20) and Sound Point (19), and by AUM are Carlyle (US$13.4m), Octagon (US$12.8m), Ares (US$12.6m), CSAM (US$12.4m), Sound Point (US$11.7m), PGIM (US$10.9m) and Och-Ziff (US$10.5m). Meanwhile, GSO/Blackstone, Carlyle and PGIM remained the top three managers by AUM (€7.3bn, €6.5bn and €6.1bn respectively) and deal count (17, 15 and 14 respectively) in Moody’s European rankings, albeit with PGIM taking over the second spot in both rankings from Carlyle.

North America hire
Global Debt Registry has promoted its product director Patrick Dietz to head of product strategy, responsible for leading the development of new products and features across the firm to create new market efficiencies. The new products will complement ePledge, the GDR’s management tool for collateral pledge risk. Christine Stern has been hired to manage and develop the ePledge offering, bringing experience in delivering innovative new products dealing with loan-level data from her previous positions at Orchard Platform and Caliber Home Loans. GDR launched its distributed ledger platform based on the IBM Blockchain last year (SCI 29 June 2018) and now has over one million registered assets across its platform, including consumer, small business and student loans.

Whole business ratings cut
S&P has lowered its ratings on TGIF Funding series 2017-1 notes to double-B plus from triple-B minus and removed them from credit watch with negative implications. Since the close of the transaction in March 2017, the number of stores within the securitisation has decreased by 28 units and TGI Fridays has demonstrated nine consecutive quarters of negative same-store sales (SSS). While some of the other casual dining and quick service restaurant transactions rated triple-B minus by S&P have demonstrated intermittent negative SSS over the same period, most also had positive growth periods. TGIF Funding’s DSCR declined to 1.99x in December 2018 from 2.18x at close. The first cash-trapping trigger occurs at 1.75x, which causes a 50% cash trap before funds are released to the issuer.

Structured Finance

New fund for CDS recruit

Company hires and sector developments

ABL acquisition
Benefit Street Partners affiliate Business Development Corporation of America has acquired a controlling interest in asset-based lender Siena Capital Finance from Solaia Capital Advisors. Siena was founded in 2012 by an ABL team backed by Solaia consisting of professionals from Bank of Ireland subsidiary Burdale Capital Finance. Siena will operate independently as a portfolio company of BDCA, with affiliates of Solaia retaining a minority ownership interest in Siena. Solaia and BDCA intend to collaborate on future projects together.

CDO manager transfer
Dock Street Capital Management has assumed all the responsibilities, duties and obligations of collateral manager for the Jupiter High-Grade CDO, II and III ABS CDO deals from Maxim Advisory. Moody’s notes that the move will not impact its ratings on any of the notes issued by the transactions. For more CDO manager transfers, see SCI’s database.

CDS fund
Axiom Alternative Investments has launched Axiom Credit Opportunity, a market-neutral credit derivatives strategy fund that will be managed by Laurent Henrio - formerly global head of credit trading at Société Générale - who joined Axiom in September. The fund targets an annual net return of 12% and a Sharpe ratio greater than two, focusing on liquid investment grade and high yield credit in Europe and North America. The fund’s strategy aims to capture value arising from two principal sources: the structural price anomalies within the credit derivatives market and the opportunities created by the ongoing regulation that forces banks to reduce their risk and improve their return on equity. Henrio has over 16 years of experience in derivatives and will be supported by Adrian Paturle, portfolio manager at Axiom since its creation. 

Rating withdrawal
Moody's has withdrawn its B1 underlying rating on the class A7 whole business securitisation notes issued by Punch Taverns Finance B. Due to an internal administrative error, the underlying rating on these notes was not withdrawn on 9 October 2014, following the release of the financial guarantee on the class A7 notes due to restructuring.