Contents

Derivatives

A perfect storm?

Expected volatility sees investors ramping up credit derivatives usage

The growing belief among institutional investors across the US and Europe is that volatility is set to become more of a concern in 2019 and potentially the years ahead. As a result, a number of investors are ramping up their use of credit derivatives in order to manage this expected volatility, particularly in terms of their exposure to corporate credit.

Larry Fondren, founder and ceo of DelphX, agrees that more volatility should be expected this year, “due to a number of factors such as the global tapering of quantitative easing and normalising of interest rate policies. Likewise, there are things happening in the credit cycle, like record numbers of new issues and the securitisation of a broader range of asset classes. All of these things are suggestive of more radical cycle behaviour.”

While single-name CDS was, historically, a useful credit hedging tool, its use has severely declined following the financial crisis, from notional volumes of around US$33trn in 2007 to less than US$3trn in 2017. Fondren says that many firms still need a tool like single-name CDS, however, particularly with greater volatility expected. 

As such, he has set about to create a product that hedges individual names, like single-name CDS, but which can be used by insurers and pension funds because it doesn’t fall under the same regulations introduced on single-name CDS. DelphX’s new instrument is a security-based alternative in the form of a covered put option (CPO) that pays holders full par value of underlying securities, upon an exercise resulting from a credit event involving the referenced CUSIP/ISIN.

To maximize the flexibility of CPO investment and trading, holders can exercise their option through either physical or cash settlements. Additionally, says Fondren, the collateral assets securing CPOs are sourced by DelphX through sales of new covered reference notes (CRNs).

These pay attractive yields to holders willing to assume the referenced default risk. To enhance their returns, CRN holders can also optionally pool that embedded risk with other holders, reducing both their exposure and required capital investment.

Fondren adds that the product will be, “available to qualified institutional buyers, as defined by SEC regulation, which includes broker-dealers, insurers, pension funds, hedge funds, fund managers and other institutions. All can purchase default protection or engage in speculation on more than six million outstanding securities, including corporate, municipal and sovereign debt issues, and asset-backed, mortgage-backed and other structured credit instruments.”

He is optimistic that the product will see good take-up among market participants that have yet to find as good a hedge as single-name CDS. Of the latter, he doesn’t think there will be a revival any time soon: “I don’t believe there will be a sustained revival of the single-name CDS market, largely due to the high capital cost of those instruments and the statutory limitations upon the use of derivatives among insurers and other investors”.

Ken Monahan, vp at Greenwich Associates, suggests that – regulation aside - the benign credit environment is a bigger cause for the decline of single-name CDS, added to by inconsistency from the main regulatory bodies. While the CFTC has finalised its rules on trading CDS indices, the SEC still - after ten years - has yet to publish a final set of rules on the trading of single-name CDS.

While there has been some more volatility in the last 12 months, investors have generally continued to act with confidence, particularly in the corporate bond space, says Monahan. He notes that many investors now use ETFs as a hedge, largely on their corporate bond portfolios – the product has its drawbacks, however.

For one, ETFs are capital intensive as they involve an exchange of principal and, like total return swaps (TRS), are a blunt hedging instrument, with no option to buy protection on a single credit. In a period of volatility, says Monahan, it will be hard for firms to hedge individual companies, with only single-name CDS offering this ability.

Despite this, Monahan doesn’t think a revival of single-name CDS is likely unless its myriad problems are resolved, with one of the biggest being manufactured defaults. He adds: “ISDA is meant to be the main regulatory body overseeing CDS in terms of payouts, but a separate body has been set up to oversee CDS rulings, which is a sign of a lack of trust in ISDA’s ability to oversee CDS.”

Vishwas Patkar, executive director, credit strategy at Morgan Stanley, suggests that a part of the decline single-name CDS volumes is that, pre-crisis, much of it was traded through structured credit investors and this has “has fallen steeply” today. CDS indices, however, are still more liquid than any other product available for credit investors, he says.

Despite this he notes that the size of the corporate bond market has paved the way for the development of more suitable hedging tools, like ETFs and TRS, which have outstripped CDS and CDS indices in terms of popularity. This has been fuelled by the fact that the CDX market hasn’t effectively tracked the cash market recently, exemplified by volatility in 2015 when CDX didn’t track cash as well as other products.

Patkar adds: “If you have a diversified portfolio and therefore don’t have concentration risk, you don’t want a product that trades risk on single names. Instead, you want a hedge that provides similarly broad risk management exposure - like ETFs or TRS.”

He reiterates some of Monahan’s point, however: “The main downside to ETFs”, he says, “is that they are still some way behind CDX in terms of liquidity.

Also, there is an additional cost in trading them, such as management fees and bid/offer. In comparison, TRS has no management fee, but there is a bid/offer spread associated with it. However, TRS liquidity is still well below ETFs and CDX. Also, TRS has to be traded as a swap and is not centrally cleared.”

Tricadia, a US-based multi-strategy credit asset manager, is also an active user of a range of credit derivatives, including single-name CDS and CDS indices, along with a number of other synthetic instruments. In particular, the firm is active in relative value and basis trades across synthetic indices, engaging in correlation trading on US high yield and investment grade indices.

Michael Barnes, md at Tricadia, comments: “We also trade tranches of these indices in order to create elegantly constructed tail hedges. So what we’ve been able to do is go long in the senior tranche, while going short on the lower, mezzanine tranches.

“We noticed” continues Barnes, “that when people are going long on the mezz tranche, this drives it tighter which causes widening in the senior tranches, opening a relative value opportunity. In line with this, we always watch the technicals; we look at single-name CDS, CDS indices and tranches of indices – looking for mispricing which allows room for a trade.”

One of the biggest areas of activity in terms of relative value trades, says Barnes, has been in CMBX. Barnes adds that his firm is “active in CMBX 6 and CMBX 7, in making relative value trades or finding arbitrage between the two.

“For example,” he continues, “we used CMBX 6 to take a position on retail, and have shorted CMBX 6 while going long CBMX 7. We also look at volatility in other areas correlated to commercial real estate, such as the oil and gas sector and look to profit through long or short positions in CMBS.” Barnes adds that another benefit of CMBX is is that it doesn’t require much capital, so the firm has been able to gain exposure on retail, while buying protection on certain names through single-name CDS, such as Sears.

Regarding single-name CDS, Barnes says that it is “far from extinct” and his firm is an active user, trading long and short positions in single name credits. He agrees, however, that it lacks liquidity in certain areas and that issues remain around credit events.

As a result he says: “While there is a lack of clarity on the rules around credit events, take up of the single-name CDS market will be dampened. Likewise, the rules around trading of single-name CDS still lacks clarity. This too needs to be cleared up by the SEC before single-name CDS can pick up again.”

Pierre Mortier, portfolio manager at La Française Investment Solutions (LFIS), agrees that the single-name CDS market is still a valuable tool and he says his firm is still an “active user” of the product. This is particularly so, as it is a “cheaper and more efficient tactical hedge for idiosyncratic risk than shorting cash.”

He adds that CDS has further benefits in offering “significant capacity and liquidity at the five-year point vs the bond market and allow[s] us to take finely tuned risk exposure with an immediate ROE gain versus cash, as leverage is embedded.” Additionally, he says that the firm uses CDS across the curve to implement relative value positions within the credit or a recovery term structure, with the most liquid being the front end – zero to five years.

Mortier belives that a revival of single-name CDS will require a change to regulations, as well as a lowering of central clearing costs. He adds that the termination of the European asset purchase programmes would also help, as would an increase in default rates.

Mortier also favours CDS indices, which he says LFIS uses to implement relative value positions across various asset classes and segments including equities, bonds, corporates, financials and CLOs. He adds that the firm’s “exposure to CDS indices is designed to benefit from under- or over-performance of structured credit or option strategies compared to their underlying instruments. We also use these instruments to express views on the steepness of credit curves in Europe or the US, on both the short and long ends of the curve.”

LFIS also uses additional strategies in its investment strategy including options premia, which provide a more cost effective way to position and hedge against gap risk or local volatility, says Mortier. The firm uses the instruments to build volatility strategies designed to benefit from trading in credit markets within a specific range and in a controlled manner, to take positions against tranched products and to arbitrage between leveraged products.

Additionally, Mortimer says that the firm uses, “Non-standard tranches of CDS indices…to leverage a view on a specific part of the capital structure against another or the relevant underlying, over a range of risk terms within 5 years.” Furthermore, LFIS is active in standard synthetic CDOs based on a Markit index, which present all of the characteristics of a benchmark instrument, says Mortimer, with embedded convexity.

In the next three to six months, Mortimer says that the firm sees opportunities in basis trade positions on leveraged loans versus high yield bonds, the impact of rate changes on bond markets and corporate debt refinancing.  He concludes that trades may open up around the potential convergence of monetary policies; mainly EUR and USD.

Richard Budden

This is the shortened version of an article that first appeared in SCI's quarterly magazine. The full version and the rest of the magazine can be accessed here.

NPLs

Servicing strength

Debut Spanish NPL securitisations anticipated

The Spanish non-performing loan market is reaching maturation, with the first securitisations from the sector expected this year. Developing an appropriate servicing capacity in the country has played a key role in facilitating this process.

“The fact that we envisage securitisation issuance going forward is a consequence of the maturity of the Spanish NPL market,” observes Antonio Casado, executive director at Scope. “Maturation is a result of the capacity of the market to dispose of the stock of repossessed assets and NPLs on bank balance sheets. This capacity has changed markedly over the last five years.”

The establishment of bad bank SAREB marked the beginning of the Spanish NPL market. The second stage of its development was private disposals to hedge funds and private equity funds, which were the first-mover investors in the market in 2013-2014. These first-movers are now seeking to exit their positions, which is expected to kick-start the growth of NPL securitisation in the jurisdiction.

“Hedge funds entered the market when NPL asset prices were very low. However, prices have increased substantially, due to the unlocking of servicing capacity in Spain. Now that the market has normalised, they can offload their NPL portfolios at an optimum price,” Casado says.

Indeed, since Spain didn’t have a servicing tradition – unlike in Italy, for example – the key to realising value in Spanish NPLs was for the first-mover investors to invest in both the assets and the servicing of the assets. “There is a strong correlation between hedge fund NPL activity and their shareholding in servicers,” confirms Casado.

He suggests that a number of other uncertainties – including the recovery of the real estate cycle (in other words, price risk), a paucity of data and systems to track information properly, and the quality of valuations - have also all been proven now. “Spanish NPL assets weren’t properly understood, while valuations were based on indexation or automated valuation methods. However, the Spanish real estate market has historically benefitted from readily available and transparent information regarding real estate prices.”

He continues: “The data indicates that the current valuation is a fairly good predictor of the sale price eventually achieved. This speaks to the improved capacity of servicers and a better understanding of risk drivers and quality issues; for example, differentiating by region, location and asset class.”

While operational and valuation concerns have decreased, market risk remains more nuanced, however. “The important question now is how sustainable the recovery is,” Casado notes. “With the prices of portfolios increasing, new investors in Spanish NPLs need to be comfortable that the market isn’t overheating in certain regions.”

He adds: “Demand is currently growing faster than supply. However, the recovery has been uneven across different regions - some areas of Spain remain depressed.”

Nonetheless, all elements are in place for NPL securitisation to take off in the country, according to Casado. He anticipates securitisation to account for around 10% of Spanish NPL volumes over the next year or so, with the first transactions potentially emerging in Q2 or Q3.

“In comparison to portfolio sales – which reached €43bn in 2018 – the proportion of the NPL market represented by securitisation is likely to remain fairly small. Banks have so far been unwilling to securitise and prefer direct private sales,” Casado says.

He continues: “Securitisation will broaden the investor base and open the market up to those that don’t have the ability to invest in private NPL portfolios. If the Spanish NPL securitisation market is capable of developing in the absence of external aid, such as a state guarantee, it speaks to its maturity.”

Looking ahead, Casado points to two uncertainties that may impact some of Scope’s assumptions when rating Spanish NPL securitisations. One is the efficiency of the legal system and enforcement process, with timing of recoveries potentially being affected by the transposition of EU directives regarding consumer protection standards into Spanish law. The other is political risk, given the forthcoming general elections in April and the fragmented nature of the Spanish parliament.

Corinne Smith

RMBS

Unencumbered value

Equity release RMBS on the cards?

The UK mortgage market is changing, with an ageing population driving increased issuance of equity release mortgages (SCI 5 June 2018). Speculation that a post-crisis iteration of equity release securitisations could soon appear in the UK has been fuelled by UKAR’s sale of an equity release portfolio last year.

Equity release mortgages allow borrowers to access the unencumbered value of their property, granting a sizeable cash boost to borrowers who are typically asset-rich but lacking in liquidity. Such loans provide an upfront advance to the borrower, with the loan then accruing interest and becoming due for repayment when the borrower vacates the property.

“The UK government has initiatives to recycle the housing stock and encourage older homeowners to downsize, but there is often strong resistance to the idea of selling the family home. One option for older people who want to stay where they are, and who may well be retired and therefore living on a low income, is to take out a non-traditional mortgage such as equity release, which provides them with liquidity in exchange for some of their property wealth,” says Rob Ford, partner and portfolio manager, TwentyFour Asset Management.

He continues: “An equity release mortgage is an obvious solution for retired borrowers because repayments can be made out of equity in the property. This kind of mortgage product will become more common, although it is a product which the banking sector has only limited experience with because it has typically been the domain of life insurance companies.”

Life insurer Norwich Union, now Aviva, brought five equity release securitisations before the crisis. Those RMBS were Equity Release Funding No. 1 through to Equity Release Funding No. 5, issued annually from 2001 until 2005.

The market for equity release mortgages remains small, with DBRS figures showing that the product accounts for less than half a percent of outstanding mortgage loans within the UK. However, lending volumes are on a strong upward trajectory, with quarterly lending volumes rising from £200m-£350m between 2007 and 2013 to more than £500m per quarter since 2Q16.

With a history of securitising these mortgages and supply now increasing, there is growing speculation that new equity release securitisations could soon appear in the UK. This speculation has been fuelled by UKAR’s sale of an equity release portfolio to Rothesay Life at the end of 3Q18 (SCI 5 October 2018).

That £860m portfolio comprises equity release mortgages from the legacy books of Northern Rock, Bradford & Bingley and Mortgage Express. There has been no public announcement that the portfolio will indeed be securitised, but other sales by UKAR have been, including the Durham A and Durham B RMBS.

“Our sense is that originators are thinking about securitisation. There are certain legacy portfolios which are trading and may be repackaged by life companies, so it would not be entirely surprising to see some of those assets work their way into securitisations,” says Edward DeVito, senior director, KBRA.

Nonetheless, equity release RMBS requires a different type of analysis by investors. Because the loans behave differently to typical mortgages, securitisations of the loans also behave differently.

Ford notes that the senior notes of the final Equity Release Funding RMBS, issued in 2005, have only recently  received their first principal payment, some 13 years later. The lack of regular interest payments from the loans means a securitisation would be required to be structured with a cash reserve in order to ensure that coupons can be paid, even when the loans are not throwing off interest.

Ford says: “For investors who are used to buying two- to three-year WALs with three- to five-year calls and regular principal paydowns, then equity release deals are clearly very different. As the product becomes more generic, however, there will be more seasoning and pools where the borrowers are older, so payments likely will flow through a bit faster in the future.”

DBRS has devised a model for approaching equity release mortgage securitisations. A proposed methodology was released for comment in August 2018.

“Equity release mortgage RMBS are not cashflowing in the way that traditional mortgage RMBS are, so the interest is more like a PIKable bond, in that it accrues in principal. The other key factor is that you are not dealing with a traditional event of default as the largest driving factor of determining the probability of repayment,” says Gordon Kerr, head of European structured finance research, DBRS.

One way or another, a borrower will eventually vacate the property. It is at that point that the loan will be repaid, so the challenge in analysing these deals would be calculating the timing of when that might be expected to happen.

“Rather than national life tables, we use regional ones for greater detail. We are able to look at life expectancy by region, gender, income or other factors to give ourselves a clearer picture of how loans will perform,” says Sebastian Hoepfner, svp, DBRS.

He continues: “Prepayments are treated as cash for the transaction. For an involuntary termination when the borrower vacates the property, we would then use a framework similar to our existing resi methodology. We look at house value declines and dilapidation, and assume that there will be some discount on the property value.”

However, securitisation is not always the optimal solution for the companies that buy equity release pools. “It is always important to remember that when life insurers purchase these portfolios it is not necessarily to securitise them. There are some seasoned portfolios now with relatively short maturities, high prepayments and high interest rates,” says Kerr.

Ford believes that Rothesay Life, in particular, is unlikely to securitise the loans it has acquired from UKAR. He says: “My feeling is that they probably bought it for book. Rothesay Life did an RT1 bond on 5 September and the UKAR portfolio purchase may well be connected to that.”

Ford concludes: “The company does have people with securitisation experience in-house, but I do not think that is the intended route. However, if the PRA changes the regulatory treatment that insurance companies get for these loans, then securitisation might make sense in the future, both for Rothesay Life and others.”

This is the shortened version of an article that first appeared in the spring issue of SCI's quarterly magazine. The full version and the rest of the magazine can be accessed here.

Structured Finance

Bright spot

European ABS market update

De Lage Landen’s newly mandated UK equipment lease ABS represents a bright spot in an otherwise “dull” European securitisation market. Both primary and secondary activity appear muted so far this week.

Investor meetings for the £410m DLL UK Equipment Finance 2019-1 were set for yesterday and today. “The DLL deal is a bit different and brings some much-needed diversity to the market, since the majority of the pool consists of hire-purchase agreements. Nevertheless, the timing of the deal is interesting, with Brexit around the corner,” says one portfolio manager.

He adds: “The market feels a bit fragile, with so many uncertainties remaining. The dealer community doesn’t seem to be stepping up either.”

While secondary trades are being executed at reasonable levels, volumes have dried up somewhat, after the market digested the £1bn original face of bonds auctioned on 28 February (SCI 21 February). “Paper is being traded, but there is no buzz,” the portfolio manager notes.

He continues: “Sellers are tidying their books and putting scraps out for the bid. With high yield spreads tightening, some are looking to exit short, stable ABS positions and rotate into other assets.”

Looking ahead, the ECB’s TLTRO III is expected to be supportive of ABS spreads, given that it should introduce positive technicals to supply/demand dynamics. The operations will be run on a quarterly basis from September 2019 to March 2021, with the loans having two-year maturities.

Corinne Smith

Structured Finance

SCI Start the Week - 11 March

A review of securitisation activity over the past seven days

Market commentary
A stronger tone emerged in the ABS market on both sides of the Atlantic last week.

Mezzanine CLO tranches, in particular, saw a tightening trend (SCI 5 March). "We were seeing a Norinchukin bid of around 130bp versus a non-Norinchukin bid of around 145bp, making it difficult for any spread tightening to occur. However, the market has returned from Vegas and we're now starting to witness some tightening across the mezzanine part of the capital stack, driven by the recognition that CLOs offer relative value," one trader observed.

For example, double-B rated tranches have tightened to around 650bp from the high-600s/low-700s in the US and to the high-500s/low-600s from 650bp-675bp in Europe, depending on spread duration and the manager. "CLOs have lagged the tightening seen in investment grade and high yield, with mezz paper offering around a 300bp pick-up on an OAS basis. Although dealers don't have a whole lot of inventory on their books at present, there has been good demand for shorter spread-duration discount securities," the trader explained.

Meanwhile, another trader suggested that a number of issuers in Europe are "ready to go", but are holding back as they await clarification around STS (SCI 8 March). He added: "Investors are not willing to sell paper, as they are waiting for new issuance to come alive." At the same time, "they don't want to buy paper that may or may not be verified as STS."

The trader noted, however, that the tone in UK securitisation has been very positive with strong trading of the Finsbury Square 2019-1 RMBS. In general, the deal has good quality collateral and the spreads are quite attractive, according to the trader.

There is, overall, strong demand for UK paper, which also suggests that "people aren't particularly bothered about the uncertainty regarding Brexit". 

Transaction of the week
Bancorp is in the market with an unusual static CRE CLO dubbed Bancorp 2019-CRE5. The US$518.3m transaction is structured as a REMIC trust, with no ramp-up or reinvestment provisions and a third-party investor acquiring the first-loss position (SCI 7 March).

The securitisation's cashflow waterfall is similar to those in CMBS pass-through deals and does not employ interest coverage or overcollateralisation cash diversion tests. The holder of the horizontal risk retention piece is BIG CRE5, an affiliate of BIG Real Estate Fund I.

The transaction is collateralised by seven floating rate whole loans (accounting for 13.6% of the pool) and 54 pari passu participations (86.4%), secured by the fee simple interest in 75 properties. Of the participations, 38 (80.7%) have a related companion pari passu participation that represents an unfunded future advance obligation. The aggregate unfunded amount of all future advance obligations is US$72.8m, which is held outside the trust by Bancorp.

Further, 17 assets (6%) have a pari passu companion participation that is collateral for Bancorp 2017-CRE2, Bancorp 2018-CRE3 and Bancorp 2018-CRE4. One loan (4.1%) has existing mezzanine debt, while another four (2.5%) have preferred equity interests with debt-like provisions.  

The collateral generally contains transitional and non-stabilised properties. The sponsors for each of the assets have plans to increase cashflow, which may include upgrading elements of the properties to attract tenants and/or re-lease space to attain higher rents.

The pool's property types include multifamily (82.4%), office (5.8%), lodging (5.4%), retail (5.2%) and mixed-use (1.2%). The multifamily exposure consists of 55 properties located in 16 states - representing a mix of primary (39.2%), secondary (25.1%) and tertiary (14.1%) markets - with a large concentration in the Houston MSA (11 properties, or 20.4%).

Other deal-related news

• Domivest is preparing the first securitisation backed entirely by Dutch residential buy-to-let mortgages. The transaction is likely to be sized at around €250m and is expected to close around April or May of this year, depending on market conditions (SCI 5 March).
• Scope has determined that the performance of Banca Popolare di Bari's last significant risk transfer transaction with the EIF (SCI 17 August 2018) has remained within its expectations. The sequential deleveraging of the transaction offsets the loss potential from a growing delinquency pipeline for the rated tranche, according to the agency (SCI 6 March).
• The NGP Rubicon GSA Pool loan - securitised in the WBCMT 2005-C20 and WBCMT 2005-C21 CMBS - is reported as 'performing matured', following the sale of the Lakewood property. Proceeds from the sale were used to repay advances and bring debt service current. For more CRE-related news, see SCI's CMBS loan events database.
• Judge Jennifer Frisch of the Minnesota District Court, Second Judicial District, has denied Goldman Sachs' motion to dismiss the claims asserted against it by Kasowitz Benson Torres, on behalf of its client, Astra Asset Management, seeking termination of the Abacus 2006-10 synthetic CDO. The case is proceeding with discovery, with trial scheduled for October 2019 (SCI 8 March).

Regulatory round-up

• The FHFA has issued a final rule requiring Fannie Mae and Freddie Mac to align programmes, policies and practices of TBA-eligible MBS, with the aim of improving the predictability of cashflows to MBS investors ahead of the introduction of the Uniform MBS. The final rule addresses feedback expressed by the market on the Notice of Proposed Rulemaking by refining alignment requirements to assure market participants that the enterprises will maintain consistent cashflows and makes explicit the potential consequences to the enterprises for misalignment (SCI 5 March).
• An ISDA working group has been discussing proposals to amend the 2014 ISDA Credit Derivatives Definitions to address issues relating to narrowly tailored credit events. The definition of the failure to pay credit event will be amended to add a requirement that the relevant payment failure result from or in a deterioration in creditworthiness or financial condition of the reference entity. This requirement would apply to corporate and financial reference entities but would not apply to sovereign reference entities. ISDA is asking for responses to the proposals by 27 March (SCI 7 March).

Data

Pricings
Auto ABS dominated last week's prints, as new issuance gathered pace post-SFIG Vegas. A number of CMBS and RMBS also priced.

The auto ABS prints comprised: US$254.52m American Credit Acceptance Receivables Trust 2019-1, US$1.19bn AmeriCredit Automobile Receivables Trust, US$437.35m NextGear Floorplan Master Owner Trust Series 2019-1, US$1bn Nissan Master Owner Trust Receivables Series 2019-A, Sfr250m Swiss Auto Lease 2019-1 and US$814m World Omni Automobile Lease Securitization Trust 2019-A. A handful of non-auto ABS were also issued: US$1.01bn John Deere Owner Trust 2019-A, US$453m SMB Private Education Loan Trust 2019-A, US$750m Synchrony Card Issuance Trust Series 2019-1 and US$1.2bn Verizon Owner Trust 2019-A.

The RMBS pricings were US$1bn CAS 2019-R02, £535m Finsbury Square 2019-1, €629m Jepson Residential 2019-1 and US$2.1bn Seasoned Credit Risk Transfer Trust Series 2019-1, while the CMBS were US$515m CALI 2019-101C, US$1.2bn FREMF 2019-K88, US$837m FREMF 2019-KF59 and US$934.9m MSC 2019-L2. Finally, last week's CLO prints included €409.79m Bilbao CLO II and US$501.85m Octagon Investment Partners 41.

BWIC volume

Conference
SCI's 3^rd Annual Risk Transfer & Synthetics Seminar is taking place tomorrow, 12 March. Hosted by Clifford Chance at 31 West 52 Street, New York, the event features for the first time two workshop sessions - one on creating structural common ground between capital relief trade investors and issuers; the other on how Basel 4 capital floors influence business models, pricing and profitability. Panels cover mortgage risk transfer, the regulatory and investment landscapes, emerging trends and the US perspective, with a cocktail reception rounding off the day. For more information on the seminar or to register, click here.

Structured Finance

'Steady stream' of STS deals needed

Market reacts positively to inaugural STS ABS

The market has generally reacted positively to the news that Volkswagen’s VCL 28 auto lease ABS transaction is the first ABS to receive the STS label. Some participants note, however, that more STS-verified transactions are needed to give the European sector the boost it needs after months of subdued activity.

Rabobank’s ABS analysts comment that VCL 28 is likely to be regarded as one of the most important deals of the year, but add that this isn’t just because of its STS designation. The analysts suggest that it is more interesting to “see how the STS factor will be translated into the spread margin on the deal.”

Additionally, Rabobank’s analysts state that all but one of the STS criteria are fully met, although one requirement, according to the verification report, is yet to be met. The analysts add that the deal should also be ABSPP eligible, which could provide the ECB an opportunity to reinvest.

Some market participants take a slightly different view and one trader says that the market has expressed a lot of “noise” about the transaction, but that one deal since the beginning of the year is “not meaningful.” The trader adds that given the deal “is coming out with strong technical factors” and that “given the high demand the deal is going to find” the STS label therefore “doesn’t change anything” in terms of investor appetite.

The trader continues that, in terms of pricing, there has yet to be any talk but given the “bulk of the VCL [deals] trade in the 15-20bp range, I do expect the deal to price in line with them”. The trader adds that this is particularly true as the “STS label doesn’t give a substantial benefit in the front-end,” in terms of a transaction’s risk/reward profile, aside  for some “embedded rarity value.”

Otherwise, the trader concludes that while the transaction is a positive in terms of buoying the European securitisation sector, it is “hard to see meaningful market impacts” as “we…need a stream of STS deals.”

As highlighted by Rabobank’s analysts, to STS Verification International’s (SVI) preliminary report notes that VCL 28 meets all of the criteria for the STS label apart from verification criterion article 22, regarding performance of an asset audit on the basis of a sample and defined audit steps by an external independent party. The report says that the originator has mandated a qualified and experienced audit firm to perform the asset audit followed by the audit firm.

The report notes that the final report to be prepared by the audit firm with regard to the eligibility criteria verification is expected to be available on or around 13 March 2019, but at the time of preparation of this preliminary verification report, this information has not yet been available. As such, this particular criterion is not yet fully met but, upon receipt of the final report, SVI will verify if the required compliance of the underlying exposures in the portfolio with the key eligibility criteria is fulfilled.

Structured Finance

Latest podcast now available

CRT themes and a Dutch RMBS first discussed

In this month's podcast, we explore some interesting themes within the CRT market: namely, eligibility criteria and replenishment conditions, as well as control rights within transactions. Additionally, we take a closer look at Domivest's debut securitisation of buy-to-let loans - a first for the Dutch market. 

Click here to listen to the whole thing on our site. Alternatively, you can listen on Spotify by searching for Structured Credit Investor and it is also available on iTunes. 

NPLs

GACS alternative?

Investor group completes NPL securitisation

A group of investors led by Värde, Guber and Barclays have acquired an approximately €734m GBV non-performing loan portfolio originated by 22 mutual, rural and cooperative Italian banks. The transaction is unusual for an Italian NPL securitisation, given that it has been achieved through mutualisation, as opposed to relying on a GACS guarantee.

Francesco Guarneri, ceo of Guber, notes: “We are very pleased to have successfully completed the second tranche of the deal with CCB (Cassa Centrale Banca), which has reached a total of €2.1bn (adding the first tranche to the second one), a market deal without any government guarantee.”

The senior notes (accounting for 70%) will be underwritten by the seller banks and the junior notes will be majority financed by Värde. Guber will hold a minority share of the notes and will also act as servicer of the portfolio. The transaction follows a nearly €1.4bn GBV NPL portfolio acquisition that was completed in July 2018 (SCI 12 July 2018).

According to Massimo Famularo, board member at Frontis NPL: “The significance of this NPL securitisation is that it has been achieved through mutualisation and not via GACS. Essentially, high risk bad loans are swapped with low risk senior notes. The senior notes are less risky because they benefit from the equity protection of the junior notes and the diversification of the bundled portfolio.”

The NPL securitisation route also allows for a higher transfer price than an outright sale. The transfer price can be higher due to the lower return required by the senior bond holders.

Nevertheless, it remains unclear why the transaction wasn’t completed as a GACS deal. “It could be because GACS was due to end on 6 March and it wasn’t clear if it was going to be renewed. Alternatively, the deal may have been designed as an alternative to GACS. If you can achieve deconsolidation through diversification, then there is no need for GACS,” says Famularo.

The portfolio comprises more than 1,300 positions, most of which are secured. The loans were originated mainly in the northeast and northwest of Italy.

Stelios Papadopoulos

NPLs

Formative stages

Greek NPL momentum continues

Of the investors surveyed in Ashurst’s latest global non-performing loan report, 39% state that they have already invested in Greece - a higher percentage than anticipated, given that the Greek market remains in its formative stages. This figure may be indicative of investors having acquired assets in Greece under single-name transactions or other smaller private transactions. Nonetheless, appetite remains high, with 46% of respondents indicating that they are at least moderately likely to invest in the market over the next two years.

“The 2003 securitisation law has been very important in this respect. The main benefit of the law is that it doesn’t require the seller to provide any advanced notice of a loan sale to the underlying borrower,” says Mark Edwards, partner at Ashurst.

Greece is viewed as the next major jurisdiction for European NPL investments. Since 2015 investors have been shifting their focus to the country and in 2018, the jurisdiction saw its first two major secured NPL transactions - Piraeus Bank’s Project Amoeba and Alpha Bank’s Project Jupiter. Unsecured and retail NPL momentum also continued last year, with the completion of eight deals, totalling €13.9bn GBV.

However, servicing remains an issue. The Ashurst report adds that despite the increasing number of servicers active in the market in the past year and a simplification of the licensing process, investors still suggest that they find the process for obtaining a licence onerous. Indeed, Ashurst notes that servicers and lawyers rank Greece as having the least efficient regulatory regime for obtaining and operating under a licence out of all the principal European markets.

Greece has also thrown up some unexpected results in the survey, reflecting uncertainty over the market and its medium- and long-term prospects. In particular, respondents are split almost equally as to whether they expect average IRRs to increase or decrease over the next two years in respect of transactions pursued in the country.

Nevertheless, growth continues amid further regulatory pressure to dispose of NPL portfolios. Greek banks have now been recapitalised three times since the 2010 debt crisis and are still weighed down by bad loans to a greater extent than their counterparts in any other EU country. Pursuant to targets agreed with the ECB, the aim of the banks is to reduce their aggregate NPL exposure to €65bn by the end of this year.

Looking ahead, Ashurst partner Olga Galazoula concludes: “Greece will keep growing as an NPL market and this year will prove crucial in terms of market prospects, due to this year’s general elections.”

Stelios Papadopoulos

NPLs

Mixed performance

Semi-annual NPL securitisation update debuts

Moody’s has published the first in a series of semi-annual updates on European non-performing loan securitisations, which shows that six out of eight Italian NPL securitisations it has rated that have performance history are exhibiting cumulative gross collections around or below those anticipated by their business plan, while two exceed it. Cumulative gross collections for the Evora Portuguese NPL securitisation have also exceeded servicer projections.

Overall, the report points to mixed performance for the rated NPL securitisations. However, the underperformance of the Italian transactions is attributed to an underestimation of the on-boarding process by the special servicers. Hence, the effect might be temporary, although this will depend on close monitoring of the evolution of the transactions.

Maria Turbica Manrique, senior analyst at Moody’s, notes: “The performance data are based on the servicer reports, which state collections that are then compared against the initial business plan. The on-boarding process refers to the time needed for property valuations and the lower recovery assumptions that follow from that.”

Moody’s has rated 19 transactions backed by NPLs only or NPLs combined with performing or re-performing loans. The report covers one Portuguese (Evora Finance), three Irish (European Residential Loan Securitisation 2017-NPL1, European Residential Loan Securitisation 2018-1 and Grand Canal Securities 2) and eight Italian transactions. The Italian transactions are Popolare Bari NPL 2016, Brisca, Elrond NPL 2017, Fino One, Popolare Bari NPL 2017, Siena NPL 2018, RED SEA SPV and BCC NPL 2018. Data for the other seven transactions are not available, given that they are recent deals.

Moody’s notes that actual gross collections have been above its expectations of gross collections, assuming a certain future property price scenario for all the deals, with the exception of Bari 2017. Some deals, like the Bari transaction, benchmark better with the business plan for net collections compared with gross collections. The opposite is observed for Fino One, with gross collections comparing better with the business plan than net collections. 

Italian servicing reports usually provide details on whether gross collections come from open or closed cases. Deals for which Moody’s has this information generally have a similar level of collections from fully resolved debtors in the 15%-25% range of cumulative gross collections.

The report adds that increasingly efficient foreclosure and bankruptcy court proceedings in Italy are credit positive for securitised deals with exposure to NPLs. The agency expects the speed of repayments to improve and legal costs to fall, mostly for deals with a large proportion of the portfolio at the initial stages of the legal process.

Stelios Papadopoulos

RMBS

Benchmark Sonia deal prepped

Unique UK RMBS transaction adds momentum to IBOR transition

The first third party hedged UK RMBS with Sonia-linked notes has been prepped by Principality Building Society. The £523.08m transaction, dubbed Friary 5, is a static cash securitisation of residential mortgage loans to 4,472 borrowers in the UK.

The transaction is unique in using Sonia as a reference rate for the note coupons, rather than sterling Libor. As a result, on each monthly interest payment date, the coupon on the notes is calculated by compounding the daily Sonia rate for the calculation period.

Friary 5 has been assigned provisional ratings by Moody’s and Fitch of Aaa/AAA on the £476.002m (Sonia plus 100bp) class A notes, which are retained by the seller, while neither agency has assigned ratings to the £47.079m class Bs. On the step-up date, January 2024, margin on the class A notes will increase to 2%.

Paula Couce Iglesias, associate lead at Moody's, comments that the benchmark transaction is credit positive because it reduces uncertainty over the transition away from Libor for newly issued instruments and helps pave the way for Sonia-linked swaps by helping build liquidity for Sonia-linked securities. Iglesias adds that the Sonia-linked notes are backed by a portfolio of mainly fixed-rate mortgages reverting to the seller’s standard variable rate (SVR).

To mitigate the fixed-floating mismatch, says Iglesias, the issuer entered a balance-guaranteed fixed-floating swap with Natwest Markets. The analyts adds that establishing sufficient market depth of alternative counterparties is particularly important to structured finance transactions given the swaps typically embedded.

The agency also notes that as a reference rate, Sonia is still in a developing phase, having made slow progress so far. Iglesias comments therefore that further development is needed before it can meet market needs as a fully functioning replacement reference rate for Libor.

Fitch’s structured finance analysts also comment on the related topic of the IBOR transition and state that - while substantial progress has been made in recent months - transition risks remain. In particular, securitisation sectors are “most exposed”, particularly with regard to legal and basis risk. Legal risks are much greater for transactions referencing retail borrowers, the analysts say, where amending legacy contracts will be more operationally burdensome and politically sensitive than for other asset classes.

In the leveraged loan market, however, institutional borrowers and lenders are more accustomed to contract renegotiation than retail mortgage borrowers. Fitch’s analysts add that risk exists too where assets and liabilities and derivative elements of a securitisation reset differently, which could increase basis risk and lower available interest or excess spread.

Furthermore, the analysts comment that securitisation ratings could be affected, but this would depend on the timing and nature of a benchmark rate replacement, how the technical and administrative challenges are addressed and the credit protection in place and remaining weighted average life after 2021. Fitch’s analysts conclude that the direct impact on its global portfolio of securitisation ratings will generally be limited in number and scale as most asset classes are resilient to basis risk stresses.

Richard Budden

Structured Finance

R-PACE rulemaking proposals outlined

Sector developments and company hires

Credit line secured

Foundation Home Loans has entered into a new £350m warehouse credit line with National Australia Bank to support the origination of new mortgages. The lender has also extended an existing warehouse, funded by Natixis and SMBC, by £100m.

ILS

Descartes Underwriting has hired Edern Le Roux as head of ILS and cat modelling. He was previously head of ILS risk at SCOR Investment Partners.

R-PACE scrutiny

The CFPB has issued an advance notice of proposed rulemaking on residential PACE financing, seeking information to support regulations for the sector that “carry out the purposes of” the Truth In Lending Act’s ability-to-repay requirements for mortgages and apply TILA’s civil liability provisions. In crafting the regulations, the CFPB is required to take into account “the unique nature of PACE financing”, according to a recent Morrison & Foerster client briefing. The ANPR requests information about residential PACE financing including: current PACE financing origination standards and practices; application of TILA’s civil liability provisions, the right of rescission and borrower delinquency and default to PACE financing; features unique to PACE financing and how the regulations should reflect those features; and the potential implications of “regulating PACE financing under TILA.” Comments are due by 7 May 2019.

US

Nick Robinson has joined Allen & Overy’s securitisation and structured finance practice as a partner, based in New York. Robinson comes from Milbank, where he practiced for almost 15 years, most recently serving as special counsel in the alternative investments practice. He has extensive experience representing underwriters, asset managers and investors in CLOs, with a focus on broadly syndicated and middle market CLOs. He also specializes in representing lenders and borrowers in structured loan facilities, CLO warehouse facilities and a variety of other ABS transactions.

GSO Capital Partners has expanded its North American origination effort to include two new office locations in San Francisco and Toronto, which are expected to open in 1H19. Ferdinand Niederhofer will lead coverage out of GSO’s San Francisco office, while Michael Carruthers will focus on Canada and the Midwest. Bill Hobbs will lead the firm’s efforts in the Southeast and will continue to be based out of the New York office.

Richard Budden

Structured Finance

UMBS trades to be accepted

Sector developments and company hires

UMBS trades to be accepted

In support of the Single Security Initiative, Fannie Mae will begin accepting forward Uniform Mortgage-Backed Security trades with a trade date on or after 12 March, 2019 and settlement dates on or after 3 June, 2019. The announcement follows confirmation on 7 March, 2019 from SIFMA that their To-Be-Announced (TBA) Guidelines Advisory Council approved revisions to good delivery guidelines for the UMBS (decision summary). The SIFMA guidelines allow for forward June UMBS trades to be filled with existing Fannie Mae TBA-eligible MBS, or UMBS issued in June. 

Freddie Mac has also announced that it is set to issue the first Freddie Mac 55-day TBA-eligible UMBS on 3 June, 2019. Freddie Mac will no longer issue new Gold PCs with a 45-day payment delay after 31 March, 2019. Beginning 7 May, it also plans to offer holders of 45-day, TBA eligible and non-TBA-eligible PCs and Giants the option to exchange their eligible 45-day securities for 55-day Freddie Mac mirror securities.

US

Athena Art Finance Corp has appointed Cynthia Sachs ceo, president and board member. She replaces Andrea Danese, who has served as ceo since Athena’s launch in 2015 and has decided to pursue other opportunities. Sachs has served as cio since Athena’s inception and has more than 25 years of banking experience - encompassing structured finance and data analytics - including at Morgan Stanley, Bloomberg, Natixis and Bank of America. She will continue to serve as cio in her expanded role, as well as managing Athena’s loan underwriting and risk management functions.

Structured Finance

Auto ABS looks set to receive first STS verification

Sector developments and company hires

Auto ABS looks set to receive first STS verification

The first European ABS that looks set to receive STS verification, by True Sale International’s STS Verification International, is being marketed by Volkswagen. The €719.9m auto lease ABS transaction is dubbed VCL Multi-Compartment, Compartment VCL 28 and is provisionally rated by Moody’s and Fitch as Aaa/AAA on the €705.7m class A notes and A1/A+ on the €14.2m on the class A1 notes. STS Verification International has released a preliminary verification report for the transaction and the firm notes the transaction is set to close on 25 April 2019.

US

Antares co-ceo John Martin is set to retire at the end of April, with fellow co-ceo David Brackett becoming sole ceo. The pair have served as co-ceos since 2015 and were founding partners of the firm in 1996. In recognition of Martin’s contribution to the firm, the Antares board is making a US$50,000 donation to Midtown Educational Foundation and a US$50,000 donation to Folds of Honor.

Jennison Associates has hired Dmitri Rabin as md and portfolio manager with the fixed income team. Rabin was previously portfolio manager and co-head of mortgage and structured finance at Loomis Sayles.

Structured Finance

Inaugural online auto ABS prepped

Sector developments and company hires

Online auto ABS debuts

Carvana, an online platform for buying used cars launched in 2012 by DriveTime Automotive Group, is marketing an inaugural securitisation. The US$338m transaction, dubbed Carvana Auto Receivables Trust 2019-1, comprises seven classes of notes provisionally rated by KBRA as triple-A on the class A1 and A2 notes, through to double-B on the class E notes.

According to KBRA the auto loans are fixed rate installment loans, made to prime and subprime borrowers with a weighted average non-zero FICO score of 635. In addition, the loans have an average current principal balance of US$17,998, weighted average interest rate of 13.47%, and weighted average original term and remaining term of 70 and 69 months, respectively. The collateral is 100% used vehicles. Carvana will use the net proceeds from the issuance of the notes to pay down existing debt and for general operating purposes.

Acquisitions

Brookfield Asset Management is set to acquire approximately 62% of the Oaktree Capital Group business. As part of the transaction, Brookfield will acquire all outstanding Oaktree class A units for, at the election of the unitholders, either US$49 in cash or 1.0770 class A shares of Brookfield per unit (subject to pro-ration). The Oaktree board, acting on the recommendation of a special committee, has unanimously recommended that Oaktree unitholders approve the transaction. Both Brookfield and Oaktree will continue to operate their respective businesses independently, partnering to leverage their strengths – with each remaining under its current brand and led by its existing management and investment teams. Co-chairman of Oaktree Howard Marks will join Brookfield’s board of directors. The transaction is subject to the approval of Oaktree unitholders, but is expected to close in 3Q19.