Contents

Regulation

Classification costs

European securitisation market adjusts to Article 122a

The full impact of Article 122a of the European Capital Requirements Directive (CRD) on the securitisation market remains unclear, given the dearth of CLO issuance. But the new rules certainly appear to have banks scrambling to classify their exposures correctly.

Sidley Austin partner Leonard Ng confirms that the rules have served to highlight whether certain types of transactions - for example, catastrophe or life insurance transactions - are really 'securitisations' at all under the CRD, given that the underlying is event risk and not credit risk (albeit the securities issued are tranched). "It's got the market thinking about what defines a securitisation," he observes.

He adds: "The correct classification of a bank's exposures is now more important than ever because if a transaction is a 'securitisation' under the CRD, it attracts not only a different risk weight profile, but also now attracts the additional requirements under Article 122a. This has brought increased scrutiny within the banks of all of their exposures. A bank cannot approach classification purely from a credit or economic perspective because the definition of 'securitisation' under the CRD is a legal one."

In addition, the requirement for all consolidated affiliates - including therefore US subsidiaries - of EU banks to also satisfy Article 122a of the CRD appears to be impacting the ABS market. Some US affiliates of EU banks feel they are at a competitive disadvantage as underwriters of US deals, since they have to comply with Article 122a, while their US competitors do not.

Ng says the inclusion of consolidated affiliates is driven by the idea that any credit risk exposure at an EU bank's affiliate (wherever located) can impact that EU bank. Yet there is also recognition that to impose Article 122a too strictly on non-EU affiliates would damage EU banks' competitiveness, so ultimately it depends on how the position is taken.

"For market-making and underwriting activities, banks take limited risks, so CEBS [now the European Banking Authority] has said that individual regulators can in effect permit non-material infringements of the retention rule where the activity doesn't constitute a large part of the bank's trading book and the bank has proper policies and procedures to assess the risks," Ng explains. "But, as a practical matter, this involves individual banks getting comfort from their regulators in order to conduct such market making activities. It is clear that banks are already in discussions with their regulators to get clearance for the activities of their non-EU subsidiaries."

Meanwhile, CEBS' guidance on Article 122a published at the end of last year clarified risk retention mechanics for CLOs (SCI passim). The guidance recognises that because a CLO manager will typically not be a credit institution, it cannot be a 'sponsor' within the meaning of the CRD, and thus another way for CLOs to fit into the risk retention requirements needed to be found.

"Clearly the authorities had RMBS and CMBS in mind when they first drafted the rules," Ng notes. "But from a public policy perspective, one can see why the regulators would want the retention requirement to be satisfied - regardless of the structure of the deal. So, in the case of CLOs, CEBS has agreed to an 'originator SPV' model, whereby an intermediate SPV would - by purchasing the loans and selling them to the issuer - be deemed to be the 'originator' for purposes of Article 122a."

However, he points out that the originator SPV will need to be funded in order to hold the 5% risk - and this cash will probably need to be provided by the CLO manager. This, in turn, begs the question of how the CLO manager will raise the cash.

Consolidation among managers to create economies of scale is one way, but Ng suggests that issuers of double-SPV structures might also have a banking group behind them that enables the retention requirements to be met on a consolidated basis. In contrast, small standalone managers may have difficulty finding the capital to take on the risk retention.

"But even if the manager is willing to stump up the cash, will they want to be in a situation where they have to agree to retain the 5% position for the life of the deal?" he asks. "Will they want to hold the position for 10 or 15 years and covenant that they won't sell or hedge the position, as required by Article 122a? It will be interesting to see what pricing can be achieved on such a deal."

While there continues to be a dearth of European CLO issuance, a couple of RMBS have launched since the beginning of the year and others are being prepared - indicating that the new rules have been absorbed relatively smoothly in this sector, albeit some master trusts are grandfathered until the end of 2014. "For new RMBS transactions which are subject to Article 122a right now, we've had fruitful discussions with the originators around disclosure and risk retention and the market appears to be agreeing on a common approach," confirms Ng.

He concludes: "The market has clearly thought about disclosure of the underlying loans and the templates based on Bank of England/ECB requirements are helpful. Ultimately, I don't expect there to be a significant impact in terms of RMBS."

CS

RMBS

Rethink required

Pressure mounts for RMBS remittance overhaul

Investors and analysts alike are struggling to make sense of increasingly indecipherable RMBS remittances. However, pressure is growing for reporting structures to be completely overhauled.

RMBS remittance reports should clarify a deal's cashflows and balances, but they have become far more complicated than they need to be. Sandipan Deb, residential credit strategist at Barclays Capital, argues that market developments have left remittance reporting stuck in the past.

Deb says: "These reporting structures were created at a time when the process was much simpler and there were not so many modifications or so much advancing. The reports were fine back then and served their purpose well, but a lot has changed in the market."

He continues: "There are many additional cashflows, non-cashflow adjustments, balance adjustments and so on, but as this evolution has occurred the reporting structure has not kept pace. Now you have many fields mentioned in reports that are totally unclear. Without asking the servicer, it is very difficult for investors to figure out what a remittance report is telling them."

One portfolio manager agrees that remittance reporting has not changed for a long time and that market developments have overtaken the reporting structure. He says that even more frustrating than this, however, is that reporting is not standardised.

The portfolio manager says: "The lack of a standardised format - either in how the report is laid out or more importantly what information is included - is a real problem. There are too many differences in how remittance reports are presented and that makes life harder."

Investors can have to spend hours working out where cashflows are - especially in cases such as subprime, where there are more modifications and more delinquent loans. Deb says: "For sectors such as subprime or option ARMs, it is getting to a point where it is very difficult to understand what is going on. This was especially true in January in the case of one deal - SABR 2006-WM3 - where no bond got any cashflow; there was no principal and no interest. We had difficulty in figuring out exactly why that was."

He continues: "To be fair to servicers, the amount of reporting has increased significantly. A typical remittance report these days could be as long as 60 pages, whereas even a year ago a remittance report would have been barely 10 or 15 pages. They have been providing more detail, but it is simply badly lagging the pace at which other changes have been made."

The portfolio manager is sceptical that much further progress will be made on this issue. He believes that updating remittance reporting is not in servicers' interests and that for the sake of a few basis points the issue is a low priority for them.

"I do not think there is a lot of incentive for the custodians to anything with the reports," the portfolio manager explains. "I am sure there are certain standards in the pooling and servicing agreements covering what sort of information they are required to provide, but I suspect those are not overly burdensome requirements."

Deb is more hopeful of change, but even he accepts that the one change that is really needed - a complete overhaul - is unlikely. He says: "Servicers are overwhelmed and trying to tweak the existing set-up is probably not the best approach. Ideally, you would come up with a new structure. Unfortunately, that is likely to take more time and more effort, so what would be best would just be for servicers to give out more detailed information."

He adds: "All we are asking is for a few more details to be given out. This is a call for more detail at the loan level, so that anyone looking at that data is able to figure out what is going on."

Deb believes that change will only come to the market if investors make it happen. He says investors are already expressing displeasure and asking questions about why remittance reports are so hard to understand. If that investor pressure grows on servicers and trustees, then action might be taken.

He concludes: "Given the number of questions the investors have, I am sure they are also reaching out to the trustee to ask these questions, which will increase pressure. At the same time, there are proposals from the US SEC, FDIC and Dodd-Frank, which have already incorporated some aspects of greater disclosure and more detailed reporting."

JL

CLOs

Equity appetite driving CLO bid-lists

Bid-list activity is once again dominating investor attention in the US CLO market. In particular, demand for equity continues to drive prices higher at the bottom of the capital structure.

"We've seen a very strong market in terms of bid-lists; in fact, it's all been driven by bid-lists over the last two weeks - the market's been on fire," one CLO trader says. The bid-lists have all been received extremely well, he adds, mainly due to the sudden influx of money that has come into the market.

He continues: "There's more new money coming in. We thought that the 'January effect' of people having more cash was a factor, but it's not just this - it's conservative, real money that we're seeing too. Additionally, people are viewing CLOs as cheap alternative to the loan market, so there's a significant lag-effect due to the demand."

In particular, European CLOs are still trading behind US CLOs, although interest in European paper is growing. "European supply has not been plentiful, however, so that has skewed the price moving up - but it's still lagging the US," the trader notes.

He says that one notable feature of demand is the wide diversity of offers on the table. "What we've seen lately is that the lists are more equity-orientated; we're not sure where the demand is coming from, but equity is trading very high, with prints in the 110-113 area."

He adds: "We expect that this will continue to be a very buoyant price point for equity for the period ahead as equity prices have really shot up dramatically. My sense is that this will not slow down; there's no visible supply other than the bid-list calendar."

The increased demand for equity paper is also driving more focus on risk. "While people are focusing on taking on risk, they're also focusing on the bottom of the capital structure, so returns are becoming more acceptable. But not all equity is alike: what hallmarks some pieces is if the deal is past its reinvestment period. In this case, it is important to be careful because if it's not, then you can't be sure about cash distributions," the trader warns.

LB

CLOs

Euro CLO sector takes a breather

A pause in the European CLO market today has brought to a halt a vibrant period of activity. However, the break in action raises questions of investor commitment, as traders foresee a volatile period ahead.

"It's been a strong market of late, with a fair volume of bid-list activity, especially in the latter part of last week," one CLO trader says. However, today has seen a slow-down in bid-list volumes, as line items underperform and sovereign issues loom large.

The trader continues: "Overall it looks like the CLO market is taking a breather - affected partly by the sovereign issues from the Middle East and Europe, which every market is taking notice of."

With the bid-list calendar expected to decrease dramatically, the trader predicts a volatile period ahead. "Previously, paper was being picked up at tighter levels, but that certainly hasn't been the case over the last few lists. Although we've seen a lot of spread tightening and a significant rally, things from here on will be a little choppier," he warns.

Given such uncertainty, the trader predicts an increase in product differentiation from portfolio managers and risk aversion among end-investors. "We'll probably see a lower uptake in any supply that is coming through from now on," he says.

This trend already appears to be in evidence, as last week's booming market prompted many early entrants to take advantage of the high prices and tighter spreads to take profit. "Now we're seeing other more aggressive buyers stepping back a little. Consequently, many of today's line items didn't trade, leading to the expectation of reduced volumes," the trader concludes.

LB

RMBS

Strong start for Euro RMBS

The European RMBS market has had an active start to the week, with a flow of bid-lists and non-conforming offers. Additionally, Granite paper has rallied due to a lack of new issue supply.

"So far, this week has been really busy for us. We've traded quite a lot of Granite, UK non-conforming, Dutch and UK prime paper," one RMBS trader confirms. One segment that has particularly benefitted from this activity is Granite triple-B bonds, which saw a one point rise to 65.25 today.

The trader continues: "It feels like spreads are becoming much firmer and this, I believe, is down to dealers not having a great deal on their books at the moment. Everyone's on the bids for the bonds and it's driving stuff much tighter."

Further, the trader says that tighter credit more broadly is also driving the market forward. "Dealers haven't got much of the flow paper on their books and this is affecting activity too."

He confirms that the current flow of bid-lists are all trading well, along with the non-conforming pieces, which continue to attract bids. "People are looking at the non-conforming offers more as they're searching for more yield; the sector is becoming more interesting to people. When prime is trading over par, it means that non-conforming offers come in at a higher DM and therefore at a higher yield."

Looking ahead, the market is awaiting the next instalment of new issuance after a particularly 'dry' February. "We're expecting a few deals to emerge soon - particularly a new Holmes deal; that's definitely on the cards. It's been a positive start to the week in the secondary market; we're just waiting on new supply now to see what happens," the trader concludes.

LB

CMBS

QMH exemplifies creditor activism

The Queens Moat House (QMH) loan - which backs the Fleet Street 1 transaction - repaid in full on the 23 February maturity date, following the collapse of loan extension negotiations. ABS analysts at RBS suggest that the eventual successful outcome for the bondholders, brought about by their consensual and co-ordinated response, could serve as a template for CMBS resolutions in the months to come. All associated costs and expenses were recovered from the borrower - thereby ensuring no dilution of the waterfall, which would have resulted in a loss to junior bondholders.

The level of effort that has gone into talks regarding an extension/enforcement for a loan of relatively modest size and low LTV - and therefore seemingly easily financeable - is notable, according to the RBS analysts. "At the outset of 2010, we argued that the year ahead is likely to see greater CMBS creditor activism - examples such as [QMH] lends to this argument and also to the increasing tendency generally for all deal parties to better seek how they can influence the outcome in distressed situations," they add.

The circa £100m outstanding loan was backed by a portfolio of 14 hotels. According to the January investor report, the loan had a reported LTV of 43% and a DSCR of 6x.

In August 2010 Cairn Capital was appointed financial advisor to the borrower in order to explore refinancing options, with statements to the effect that amendments to the transaction documents were being contemplated. This was widely interpreted as the first step towards a loan and possibly bond maturity extension, triggering a considerable - and, in the analysts' view, unprecedented - response from creditors. A group of investors then entered into non-public negotiations with the borrower and its advisors regarding a potential restructuring.

However, it was announced on 3 February that the talks had failed to reach an agreement and were therefore terminated. The consequent refinancing of the loan is understood to have been provided by Clydesdale Bank.

CS

ABS

ABS trading co-head named

RBS has promoted Adam Siegel to co-head of US ABS/MBS/CMBS trading for the Americas. He will report to Scott Eichel, global head of securitised products and head of US credit markets. Siegel was previously md and head of ABS credit trading at the bank.

ABS

Asset finance head appointed

Credit Suisse has appointed Jay Kim as head of its asset finance group. In this role, he will work on the relationship side of the business, focusing particularly on new issuance. Kim was previously co-head of securitised products origination for the Americas at Barclays Capital.

The bank is also said to be expanding the group further with the hire of a number of other securitisation officials from Barclays Capital.

ABS

KKR expands in distressed assets

Kohlberg Kravis Roberts & Co (KKR) has appointed Mubashir Mukadam as European head of the special situations platform within its asset management arm. Based in London, Mukadam will focus on secondary purchases of distressed assets, as well as rescue lending and structured investments in Europe.

He will report to Nat Zilkha and Jamie Weinstein, co-heads of the special situations platform at KKR. Mukadam was most recently md at York Capital Management and prior to this was director of Deutsche Bank's distressed products group.

Mukadam represents the second senior hire KKR has made recently in its special situations business. In September, Jessica Beattie joined the firm's New York office to focus on secondary distressed and structured investments. Before joining the firm, she worked as a senior analyst on the event-driven investment team at Eton Park Capital Management.

Additionally, Zilkha has relocated to London. He will continue to report to Bill Sonneborn, head of KKR Asset Management.

ABS

Consultancy adds business development md

Actualize Consulting has appointed Mark Kahn as md with responsibility for business development across its capital markets and mortgage and fixed income practices. He will focus on expanding the firm's capabilities and service offerings in risk management, valuation services, regulatory compliance and financial system implementations.

Before joining Actualize, Kahn served as head of sales for Principia Partners. Prior to this, he was vp at JPMorgan, Deutsche Bank and Bankers Trust, focusing on risk management, securities operations, structured finance and loan servicing.

ABS

Law firm boosts real estate practice

King & Spalding has appointed Scott Stengel as a partner in its capital transactions and real estate practice. Based in Washington DC, he will advise clients on a broad range of banking issues across the firm's capital transactions and real estate, corporate/mergers and acquisitions, and financial restructurings practices. A specialist in bank regulatory, capital markets and restructuring matters, Stengel joins King & Spalding from Orrick, Herrington & Sutcliffe, where he was partner.

CDO

CDO management rights acquired

Newcastle Investment Corp last month purchased the management rights of a number of C-BASS Investment Management CDOs, pursuant to a C-BASS bankruptcy proceeding. The acquisition cost approximately US$2m and entitles Newcastle to earn, on average, a 20bp annual senior management fee on a portion of the total collateral - which currently stands at US$1.3bn.

CDO

CDO counsel named

Dechert has appointed Lawrence Berkovich as counsel in its finance and real estate group. Based in the firm's Charlotte office, he will focus his practice on complex structured finance transactions, with an emphasis on CLOs and CDOs.

Berkovich was most recently special counsel at Cadwalader, Wickersham & Taft. He represents clients in the structuring and offering of interests in various opportunity funds, as well as in workouts and restructurings of distressed and defaulted structured products.

CDS

Bank beefs up in credit trading

Landesbank Baden-Württemberg has hired Paul Murphy and Andy Briggs as financial credit traders in London. The pair, who will cover cash and CDS trading, will report to the firm's global head of credit trading Stuart Lucas.

CDS

Heads hired to lead fixed income group

Ticonderoga Securities has appointed Martin Teevan and Alan Alsheimer to lead its new global fixed income group.

Teevan assumes the role of the group's global head of fixed income. He was most recently senior md with Cantor Fitzgerald and prior to this was the firm's global head of credit.

Alsheimer joins Ticonderoga as its head of US fixed income. He was previously at Goldman Sachs, where he built its loan credit derivatives platform after joining in 2006. He was previously at RBS Greenwich Capital, where he helped launch its North American credit trading business.

"We have successfully built out the Ticonderoga equity and equity research platform over the last two years and feel strongly that we can translate the client relationships and value-added approach of our equity business to the fixed income market place," says Shawn McLoughlin, ceo and co-founder of Ticonderoga.

CLOs

Fund manager adds client relationship md

Oak Hill Advisors has appointed Chris Cereghino as md in its client coverage team. He will be responsible for business development and relationship management, while helping to broaden the firm's existing relationships with investors globally. Based in New York, Cereghino will report to Oak Hill senior partner Bill Bohnsack.

Prior to joining Oak Hill, Cereghino was md at GoldenTree Asset Management. Prior to this, he was an executive director at JPMorgan, serving as a senior member of its global structured syndicate.

CLOs

TFG sued by former director

Six Tetragon Financial Group (TFG) directors have been served with proceedings in the Royal Court of Guernsey, instigated by former TFG director Alexander Jackson. Jackson was given notice to vacate office as a director on 24 January (see SCI 25 January).

Under the proceedings, Jackson is seeking to impugn TFG decision of 29 July to enter into a joint venture with GreenOak Real Estate. The proceedings are confined to claims for damages and other relief against TFG's directors, and do not seek to reverse or interfere with the GreenOak transaction, which was implemented in 3Q10.

TFG says that there is no merit whatsoever in the proceedings and it will take all necessary steps to ensure the proceedings are dismissed as quickly as possible.

Further, the firm has concluded that it is untenable for Jackson to continue in his current role as a consultant to TFG and is, therefore, taking steps to ensure that he will no longer continue in that capacity. He remains a shareholder of TFG's investment manager, however.

CMBS

Commercial loan business acquired

Capita has acquired the securitised commercial loan business of Barclays Capital Mortgage Servicing, which provides primary and special loan servicing for commercial real estate finance transactions. On completion, the business will be integrated into the existing Capita Asset Services business.

Robert Hughes, md of Capita Asset Services, comments: "The acquisition is a natural fit for Capita Asset Services, fully complementing the existing loan servicing business and providing us with added depth and breadth of expertise. The deal also further demonstrates Capita's commitment to, and investment in, the financial services industry. The increased capacity will help ensure our continued growth in this sector and we expect the acquisition to bring clear benefits to both new and existing customers."

CMBS

Advisory beefs up hedge fund team

The Collingwood Group has promoted Mary Lou Christy from svp to md of the organisation. Christy will launch a new investor relations practice, while providing support to its growing hedge fund/private equity advisory business. Prior to joining Collingwood in 2010 (see SCI 29 September), Christy held several executive-level positions at Fannie Mae, including svp of investor relations, vp of the MBS trading desk and vp of sales and marketing.

Collingwood has also appointed Mark DeGennaro as md to help build its hedge fund/private equity advisory and principal investment businesses. Prior to joining Collingwood, DeGennaro was md of a privately held boutique investment-banking firm in New York. He held a variety of roles in the firm, including managing partner, ceo and head of the restructuring advisory group.

CMBS

CRE joint venture formed

Jefferies Group, the Government of Singapore Investment Corporation (GIC) and LoanCore have formed Jefferies LoanCore, a new joint venture CRE finance company.

Jefferies LoanCore - led by Mark Finerman as ceo - has US$600m in initial equity commitments that will be leveraged appropriately. The new group will originate CRE debt through a team led by Finerman and with the support of Jefferies and GIC Real Estate, the real estate investment arm of GIC.

"Jefferies LoanCore expects to respond to the capital needs of CRE owners and investors across the US. As our industry recovers from the disruption of the recent financial crisis, we expect Jefferies LoanCore to be a leader in providing creative capital solutions," says Finerman.

RMBS

TBW treasurer charged with fraud

The US SEC has charged former Taylor, Bean & Whitaker (TBW) Mortgage treasurer Desiree Brown with aiding and abetting a US$1.5bn securities fraud scheme and an attempt to scam the US Treasury's TARP programme.

The SEC alleges that Brown helped enable the sale of more than US$1.5bn in fictitious and impaired mortgage loans and securities from TBW to Colonial Bank, causing them to be falsely reported to the investing public as high-quality, liquid assets. Brown also helped cause Colonial Bank to misrepresent that it had satisfied a prerequisite necessary to qualify for TARP funds.

The SEC previously charged former TBW chairman and majority owner Lee Farkas in June 2010 (see SCI 23 June). Farkas, who was also arrested in June by criminal authorities, pleaded guilty to criminal charges in a related action filed by the Department of Justice in the Eastern District of Virginia.

"Brown willingly participated with Farkas in a US$1.5bn fraud on Colonial Bank and its investors," says Lorin Reisner, deputy director of the SEC's Division of Enforcement. "Brown also aided efforts by Farkas to mislead Colonial Bank and its regulators regarding the bank's application for TARP funds."

According to the SEC's complaint filed in US District Court for the Eastern District of Virginia, Brown and Farkas perpetrated the fraudulent scheme from March 2002 to August 2009, when Colonial Bank was seized by regulators and Colonial BancGroup and TBW both filed for bankruptcy. Because TBW generally did not have sufficient capital to internally fund the mortgage loans it originated, it relied on financing arrangements primarily through Colonial Bank's mortgage warehouse lending division to fund them.

The SEC's complaint charges Brown with violations of the antifraud, reporting, books and records and internal controls provisions of the federal securities laws. Without admitting or denying the SEC's allegations, Brown consented to the entry of a judgment permanently enjoining her from violation of Rule 13b2-1 of the Securities Exchange Act of 1934. The proposed preliminary settlement is subject to court approval.

RMBS

Class action filed against BofA

Murray, Frank & Sailer has filed a class action complaint on behalf of individuals and institutions who purchased Bank of America Corporation publicly traded common stock and options between 9 May 2007 and 19 October 2010. The complaint, filed in the US District Court for the Southern District of New York, alleges that throughout the class period BofA engaged in dollar rolling - a practice whereby MBS were moved off its books to another entity and then repurchased after it reported its quarterly financial statement.

Accordingly, BofA classified these transactions as sales, when in fact the transactions were a form of secured borrowing. Dollar rolling enabled BofA to conceal from investors the true risks that it had incurred as a result of its investments in MBS, according to the complaint. On 9 July 2010, it was revealed that BofA dollar rolled US$4.5bn in 1Q07, US$1.8bn in 4Q07, US$10.7bn in 3Q08 and US$573m in 1Q09.

The complaint also alleges that during the period, BofA concealed from investors that due to its July 2008 acquisition of Countrywide Financial Corporation it failed to maintain adequate internal controls regarding the processing of foreclosures. On 19 October 2010 the bank issued a press release announcing its 3Q10 financial results, reporting a net loss of US$7.3bn. Between 8 October and 19 October BofA's stock dropped from US$13.31 to US$11.80 - a drop of 11.3%.

RMBS

Mortgage servicing subsidiary planned

Ocwen is forming a new subsidiary, Home Loan Servicing Solutions (HLSS), to be headed by Ocwen founder and chairman William Erbey. HLSS is seeking to raise US$316m via an IPO, using the proceeds to acquire mortgage servicing rights.

Initially, the company intends to purchase the HomEq mortgage servicing rights and the associated servicing advances from Ocwen. HLSS would then enter into a subservicing agreement with Ocwen to continue to service the loans on behalf of HLSS.

Ocwen would be paid a base servicing fee of 12% of the fee income and would have the potential to earn performance-based incentive fees. The move is expected to free up capital for Ocwen and allow it to focus on its core business - servicing loans.

ABS

Further improvement in credit card charge-offs

Moody's reports that charge-offs on US credit cards fell for a fifth consecutive month in January to 7.45%, down from 8.03% in December. The agency expects the charge-off rate to increase for the next month or two, before resuming a steady pace of decline that leads it to fall below 7% during the second quarter of the year (see also SCI 22 February).

"Every indication points to more room for further declines in the charge-off rate in 2011. For the second straight month, in January each of the largest credit card trusts posted monthly improvement," says Moody's avp Jeffrey Hibbs.

The charge-off rate index is now more than one-third lower than its August 2009 monthly peak of 11.50%. One important indication that charge-offs will fall below 7% is the recent decline in early-stage delinquencies, which fell again in January to a new record low of 1.01%. Overall, the delinquency rate fell to 4.10% for January - its lowest level since September 2007 and the 15th consecutive month of decline, Moody's says.

Also, the yield index dropped in December by 123bp to 20.52%, a decline the agency says is attributed in part to principal discounts expiring. The sharp decline in yield has helped to pull back the excess spread index off the all-time high set last month.

During January the excess spread index moved back 71bp to 10.11%. Still at historically high levels, the January figure marks the fifth month that excess spread has been higher than 10%, Moody's concludes.

ABS

Polarisation expected for Euro auto ABS

Robust performance among most European auto ABS has contributed to a return in investor confidence, favourable issuer economics and a consequent renaissance in new issuance, according S&P.

"According to our data, in the first four weeks of 2011, auto ABS accounted for almost half of all European investor-placed securitisation issuance, with more transactions in the pipeline," says S&P analyst Sabine Daehn.

However, the resurgence comes at a time when borrower performance is polarising along geographic lines, with more stable collateral performance and greater issuance in core European countries than in peripheral countries. Corresponding rating transition rates for auto ABS reflect these country differences, while collateral performance deterioration in Spain has led to some downgrades, S&P says.

For example, the agency lowered 40% of Spanish auto ABS ratings over the course of 2010. By contrast, there were no German auto ABS downgrades in 2010 and instead the agency raised 25% of ratings - mostly in highly-seasoned transactions that have benefited from significant deleveraging.

"We believe solid fundamental credit performance throughout the course of the recessions in many European economies has supported investor demand for the asset class, along with relatively low ratings volatility in the face of collateral deterioration," adds Daehn.

Looking ahead, S&P anticipates a slowing economic growth in the Eurozone and a continued divide in terms of economic strength. In this respect, Germany leads the pack; UK, France and Italy are in the middle ground; and Spain, Portugal and Ireland trail behind. This implies a continued greater rating pressure for auto ABS transactions originated in southern Europe.

In conclusion, the agency says that other rating drivers - including the implementation of its updated counterparty criteria and country risk - may also have an effect on the trend in auto ABS ratings for 2011.

ABS

Auto loan ABS losses spike

US prime auto loan ABS losses rose by 12% last month, although seasonal factors are likely to drive both delinquency and loss rates down during the next couple of months, according to Fitch.

"The arrival of tax refunds, annual bonuses and salary increases make the February-April period typically one of the strongest for auto ABS asset performance. Despite the rise in delinquencies and losses in the prime sector, auto ABS collateral performance continues to exhibit strong performance so far this year," says Fitch director Hylton Heard.

Delinquencies of 60+ days rose by 1.8% in January month-over-month to 0.58%, although they remain well below those of the same month in 2010 by 25%. Annualised net losses (ANLs) rose to 0.93% in January, though they're still 42% below January 2010 levels and 58% lower than the index's record high of 2.23% recorded in January 2009. Prime cumulative net losses (CNLs) were 0.79% in January - 2.5% below December's level and 34% below 2010.

In the subprime sector, Fitch's 60+ day delinquency index rose 5% to 3.49% but remained well below 2010 levels by 26%. ANLs were 6.88% in January, a 3.8% increase over December, yet still 22% below January 2010 levels.

The marked improvement in asset performance over prior years is attributed to the continued strength of wholesale vehicle values, tighter underwriting and strong credit quality of the 2009 and 2010 vintages, as well as stability and improvements in the US economy and the auto industry.

ABS

UK bond fund launched

PIMCO has launched its Select UK Income Bond Fund, available via its UCITS III platform. The fund will be managed by Mike Amey, md and portfolio manager for sterling portfolios, and aims to achieve enhanced income growth in a low yielding environment while assuming minimal risk.

"Growth in the UK is expected to remain subdued for a number of years, which is likely to encourage the Bank of England to keep interest rates low. Traditional sources of income derived from deposit rates, government bonds and equity income funds are unlikely to enhance income growth in the current economic landscape. In such an environment, there is a greater need to identify alternative sources of income through 'safe' higher yielding assets," says Amey.

Approximately 50% of the fund's assets are expected to be allocated to ABS and MBS, with the largest individual weighting to UK bonds, 10% in high yield and 10% in emerging market debt. The key features of the fund include: targeting an annual income distribution of 5%, distributed monthly; seeking to surpass other income-generating investments on a risk-adjusted basis; maintaining an average duration ranging from 1-8 years; and investing in high-quality instruments across a broad range of fixed income sectors.

ABS

Safe harbour comfort 'attainable'

Recent clarifications by the FDIC regarding treatment of securitisation-related asset transfers by banks and certain non-bank financial institutions have provided comfort that ABS ratings can continue to be de-linked from those of the sponsoring entity, according to Fitch.

Uncertainty over FDIC treatment of certain securitisation-related asset transfers arose late in 2010 following passage of the FDIC's final rule, which set forth new conditions to achieve safe harbour for insured depositary institutions or banks. More recently, passage of the Dodd-Frank Act and its establishment of an Orderly Liquidation Authority (OLA) raised questions regarding interpretation of the FDIC's avoidance and repudiation powers for certain systemically important 'non-bank' financial institutions (SCI passim).

"These uncertainties raised concern as structured finance ratings depend upon the predictability of treatment if the FDIC were to take over a bank or a non-bank financial institution that could be declared systemically important," says Fitch md Michael Dean.

In response to the uncertainty, the FDIC clarified its position on certain provisions in the final rule and its interpretation of OLA regarding its powers in the event it became receiver, conservator or liquidator of either type of institution. Dean suggests that by providing such clarity, the rights of investors can be determined at the outset of a securitisation and the ratings assigned to the transaction can be de-linked from those of the issuing entity.

Going forward, Fitch expects transaction counsels to provide a legal opinion that the FDIC - as conservator or receiver - would not reclaim or recover the assets. If such legal comfort is attainable, the agency would be able to rate the transaction above the sponsoring entity's IDR, it says.

ABS

APRA clarifies liquidity treatment

The Australian Prudential Regulation Authority (APRA) has clarified the treatment of high quality liquid assets it will apply when implementing Basel's new global liquidity standard, known as the liquidity coverage ratio (LCR) requirement. The LCR aims to ensure that banking institutions hold a stock of high quality liquid assets sufficient to survive an acute stress scenario lasting for one month.

Basel defines two categories of assets that can be included in this stock: Level 1 assets are limited to cash, central bank reserves and highest quality sovereign or quasi sovereign marketable instruments that are of undoubted liquidity; while Level 2 assets are limited to certain other sovereign or quasi sovereign marketable instruments, as well as certain types of corporate bonds.

In reviewing the range of marketable instruments denominated in Australian dollars against the Basel criteria, APRA has determined that at this point assets that qualify as Level 1 are cash, balances held with the Reserve Bank of Australia, and Commonwealth government and semi government securities. It has determined that currently no assets qualify for Level 2.

The LCR requirement comes into effect on 1 January 2015. During the preceding observation period, the Basel Committee will evaluate the liquidity characteristics of Level 2 assets. Depending on the outcome of this work and on market developments over this period, it is possible that some instruments may become eligible as Level 2 assets or that the range of qualifying Level 1 assets may expand.

ABS

Cajun Global WBS closes

Church's Chicken has closed the first whole business securitisation in the restaurant sector since 2007. The deal, dubbed Cajun Global 2011-1, was arranged by Barclays Capital and includes a US$220m 6.04-year A2 tranche rated Baa2/BBB (Moody's/S&P) that priced with a coupon of 6%. It also comprises US$25m in senior secured revolving notes.

The firm says the transaction attracted significant demand from institutional investors. Proceeds were used to repay the outstanding balance of existing credit facilities, to pay related fees and expenses, and to pay a dividend to shareholders.

"This new financing structure provides Church's Chicken with greater financial flexibility and a significantly lower cost of capital, which better positions us to execute on our strategy and achieve our growth objectives," says the firm's ceo Mel Deane.

ABS

Moody's operational risk guidelines explained

Moody's has published its comprehensive guidelines for analysing operational risk in structured finance transactions globally. The methodology applies immediately to new Moody's-rated deals, as well as to its outstanding ratings on ABS, RMBS, CMBS and certain other structured credit transactions.

In Europe, the changes will affect 131 tranches from 78 RMBS, 40 tranches from 26 ABS, 48 tranches from 29 CMBS and one tranche from one structured credit transaction. The ratings that will be placed on review for possible downgrade are mostly Aaa ratings, but will also include some Aa and A ratings. The agency says that only one US transaction will be placed on review for downgrade.

Moody's structured finance coo Nicolas Weill says: "The performance of a structured finance transaction depends not only on the creditworthiness of the underlying pool of obligors, but also on the effective performance of transaction parties such as the servicer, cash manager and trustee. If these participants are performing as intended, credit analysis of the transaction can be focused on the performance of the underlying collateral. However, a disruption in the performance of one of these parties can be disruptive to the transaction itself."

Going forward, rating committees for a particular transaction will employ the new methodology and review operational risk factors while determining whether the structural mitigants in place are sufficient for the desired rating. Moody's will also consider whether factors exist that support less stringent requirements; for example: the protections provided by the relevant regulatory regime; multiple servicers; back-up servicer facilitator; or significant liquidity and credit enhancement.

The final methodology will be published in April.

ABS

Visualisation tool launched

Codean has released Codean Visualizer, its new legal document visualisation software. Acting as a standalone desktop application, the software analyses documents for defined terms to produce a hyperlinked and navigable report. The report includes where and how the defined terms are used, while graphically showing how the defined terms fit together.

"Codean Visualizer's technology allows lawyers and financial investors, who work with complex legal documents such as offering circulars and commercial contracts, to read and analyse documents faster and more efficiently. Lawyers can also benefit from Codean Visualizer's automated proofreading tools, which improve productivity and reduce drafting errors," says Codean md Peter Jasko.

CDO

MBIA CDO commutations continue

MBIA Insurance Corp says it reached agreements with five counterparties for commutations of transactions including multi-sector CDOs, multi-sector CDO-squareds, structured CMBS pools, commercial real estate CDOs and high-yield corporate CDOs during 4Q10. The agreements eliminated US$15.7bn in gross insured exposure in exchange for one-time payments by MBIA Corp that were consistent with its aggregate statutory loss reserve for these transactions.

MBIA Inc president and cfo Chuck Chaplin comments: "The commutations and terminations of US$15.7bn of exposure in the fourth quarter improved the balance sheet position of MBIA Corp and eliminated the volatility associated with the commuted policies, while [National Public Finance Guarantee Corp] has been steadily improving its capital position."

CDS

Work underway on EU derivatives legislation

Werner Langen from the EU Economic Affairs Committee yesterday presented a draft report on EU legislation to regulate derivatives trading. The report states that the new rules should govern privately-traded derivatives only, in line with the original European Commission proposal (SCI passim).

Langen says: "My aim is to reach an agreement which regulates these trades as much as possible to reduce risk without setting costs which are too high for market participants."

The draft report rejects arguments that certain sectors, such as the energy sector or pension funds, should be exempted from the regulation and instead seeks to restrict exemption possibilities. Langen is also against a proposal to allow cooperation arrangements between clearing houses, known as 'interoperability', whereby traders would be allowed to choose where their trades are cleared. Such arrangements, he says, could cause a build-up of systemic risk.

MEPs from the economics committee will be able to submit amendments to the report until 16 March and a vote in the committee is expected on 20 April.

CMBS

Euro CMBS maturity repayments improve

Fitch reports that improving loan repayments and full and partial redemptions - totalling €232.5m - in February has increased its CMBS Maturity Repayment Index to 38.4% from 36.1%. These repayments also reduced the outstanding matured loan balance by 1.4%, with 53 of the 125 loans that matured since 2007 having been fully repaid.

The largest repayment recorded in February relates to the £100.2m Queens Moat House loan (securitised in Fleet Street Finance One), which had been extended for a year after it matured in February 2010 (see SCI 1 March). Other redemptions that occurred during the month were considerably smaller, however.

The €42.6m Anec Blau loan (Fornax (Eclipse 2006-2)) was fully redeemed at its maturity date on 10 February. This is likely to have been driven by the strength of its collateral, as well as the loan's low LTV of 61%, the agency says.

In addition to these full redemptions, the Castor & Pollux loan (White Tower 2007-1) recorded a partial redemption, with its securitised balance dropping by €33.2m to €13m. This resulted from property disposals during the last quarter - leaving three assets securing the remaining loan balance. Further, the partial pay-down of the sales resulted in an improvement in the reported LTV to 66% from 84% in the previous quarter.

CMBS

Opera Uni-Invest restructuring awaited

The sponsor of the Opera Finance (Uni-Invest) CMBS has defaulted on its standstill agreement, following the expiration of a 10-day cure period without the breach of the senior loan balance target being cured (see SCI 22 February). The special servicer on the deal, Eurohypo, has reserved the rights of the senior finance parties in respect of such a termination event, pending receipt of a business plan and a restructuring proposal from the borrower, which are expected to be received by 11 and 18 March respectively.

CMBS

Euro CMBS loan losses filtering through

Fitch reports that the increased number of loan workouts that commenced in 2010 is beginning to result in loss allocations to some European CMBS transactions. Four loans securitised in Fitch-rated transactions had a loss allocation during Q4, bringing the total for 2010 to six loans. No losses were realised in the previous year, the agency says.

Loan defaults and transfers to special servicing slowed down during 4Q10, but nonetheless registered a significant increase during 2010. The proportion of loans in outright default stood at 12.6% at the end of the year, compared to 5.4% a year earlier.

Gioia Dominedo, Fitch's European CMBS director, says: "A key driver of the increasing default rate is the volume of maturing loans. 134 loans are scheduled to mature in 2011 with a total balance of €12bn, double that of 2010, so Fitch expects this trend to continue."

The Fitch-rated European CMBS portfolio continues to shrink, with 668 loans at the end of 2010 compared to 778 a year earlier. This is being driven by loan redemptions and, in certain cases, repurchases, but Fitch expects losses to become a bigger driver over the next year.

Borrowers continue to struggle to repay loans at their scheduled maturity dates. Of the 115 loans that matured during 2010, 59 were repaid in full either at or after their scheduled dates or through a repurchase by the originator. The agency says it does not expect this level of repurchases to persist over the coming year.

CMBS

CMBS 2.0 leverage, DSCRs 'evolving'

Only 15 months since the first US CMBS new issuance after a lengthy dormancy, structural, leverage and issuance amount trends have quickly changed, according to S&P. The 'CMBS 2.0' market began with the pricing of three single-borrower transactions with relatively simple structures in late 2009, while more recent deals have been more complex, more highly leveraged and with much greater opening balances.

"Most recently, three US$1.2bn plus conduit/fusion deals were issued this month, each of which included an average of 10 principal and interest bonds and two interest-only classes. Compared with late-2009 issuances, the newer multi-borrower deals have higher leverage, less debt service coverage and somewhat looser underwriting," says S&P analyst James Manzi.

S&P analyst Brian Snow notes that the average size of the most recent 10 CMBS transactions has been well below the peaks reached within the 2007 vintage. However, the issuance amounts have easily surpassed the three single-borrower deals that priced in 2009 - which had an average balance of just over US$453m.

The evolution of the deals over the last 15 months has seen leverage steadily increasing and debt service coverage ratios declining. "Compared with the first two single-borrower deals in late 2009, issuer loan-to-value ratios are up about 10% and debt service coverage ratios are down quite a bit. Additionally, rating agency stressed loan-to-values have shifted upward - to the low 90s most recently - and stressed debt service coverage ratios have trended down to about 1.2x from 1.5x," says S&P analyst Kurt Pollem.

Manzi outlines several other deal 'quality' trends that his group is monitoring, such as spread tightening, higher concentrations of interest-only loans, improving property type diversification, structural loan features and a shift in the percentage of loans that already or will permit additional debt subject to certain thresholds.

CMBS

Special servicing fees impacting CMBS performance?

Some recent loan workouts highlight the implications that special servicing fees may have on concentrated US CMBS portfolios, resulting in rating downgrades to select tranches, according to Fitch.

Special servicing fees, which are often not a recoverable trust expense, are usually absorbed by non-rated or speculative grade classes. Fees are typically 25bp of the loan's balance at transfer per year while the loan is in special servicing and 1% of the outstanding loan amount due at liquidation.

"Servicing fees may place ratings pressure on concentrated pools, such as large loan floaters with little or no non-rated debt. However, special servicers have sometimes been successful in passing these costs on to the borrower during a loan workout," says Fitch director Britt Johnson.

In one instance, when one loan was paid off in full, fees resulted in realised losses to two classes, which Fitch subsequently downgraded to D. The agency says it is monitoring another loan that has recently transferred to special servicing - CarrAmerica National Portfolio - for the possibility of special servicing fees. BALL 2006-BIX1, CG 2006-FL2 and COMM 2006-FL12 have exposure to the CarrAmerica loan.

CMBS

Windermere X misallocation corrected

Investors in the Windermere X CMBS have been informed that available principal prepayments for the April and July 2010 payment dates were incorrectly applied on a pro-rata basis when they should have been applied on a fully sequential basis. The cash manager on the deal has begun discussions with Clearstream Luxembourg and Euroclear with the intention of correcting the misallocation by debiting the accounts of the noteholders that have been overpaid and crediting the accounts of the noteholders that have been underpaid. This correction will take into account the record date for each adjustment payment and any subsequent interest adjustments.

Both the cash manager and the master servicer maintain that it is not responsible for determining whether the full sequential pay test is met under the relevant transaction documents. However, in respect of future payment dates the cash manager has agreed to make the determination on the condition that the master servicer provides it with certain information, to which the servicer has agreed.

RMBS

Servicer enforcement actions due

S&P has stated that its residential servicer rankings on GMAC Mortgage, ChaseHome Finance, BAC Home Loans Servicing, Wells Fargo Home Mortgage, CitiMortgage and PNC Bank remain on credit watch negative in light of the ongoing review of US servicing practices by regulators. The servicing practices of 14 companies have been under review by US regulators since the middle of last year when concerns regarding certain affidavit and foreclosure procedures arose (SCI passim).

Last week, the Office of the Comptroller of the Currency testified during a Senate banking hearing that it and other regulatory agencies are finalising enforcement actions and possible fines against the firms. This comes after a probe found critical deficiencies and shortcomings in document procedures, oversight of outside law firms and other areas.

S&P says it continues to discuss foreclosure affidavit preparation procedures with management of the relevant servicing operations and will collect verification from all of the servicers it ranks to ensure that they are reviewing and following appropriate policies and procedures.

RMBS

Doubts raised on mortgage financing capacity

Fitch suggests in a new report that US banks may struggle to provide significant financing capacity in light of the recent housing reform proposals (see SCI 11 February). This is due to the likely persistence of 30-year fixed rate mortgages, which pose interest rate risk management challenges, and the leverage ratio - which limits balance sheet growth. Additionally, during times of stress, bank funding costs are likely to escalate, the agency says.

Other private sector alternatives for financing of mortgages include private label MBS, which has suffered a steep decline in origination activity since the credit crisis. It is uncertain how much of the funding capacity currently provided by Fannie Mae and Freddie Mac, with US$4.4trn in MBS, can be absorbed by a revitalised private label MBS market.

Fitch notes that these changes are likely to unfold gradually, given the current fragile state of US housing markets, the ongoing policy debate about key reform principles and objectives, and the implementation challenges of transitioning from current GSE dominance in mortgage originations. At the heart of US housing reform efforts sits a fundamental trade-off between increased privatisation - which would reduce mortgage availability and raise borrower costs - and continued government support, in which taxpayers subsidise mortgage lending and ultimately bear significant risks.

A shift towards greater privatisation, as proposed in the Obama Administration's plan, depends both on attracting sufficient private sector capital to offset a reduction in government support and achieving a sustainable equilibrium in the cost and availability of mortgage credit, particularly during periods of market distress.

RMBS

Irish RMBS restructured

Irish Life & Permanent has restructured Fastnet Securities 3, an Irish RMBS. Under the restructuring, the principal amount outstanding on the class A1 notes was increased to €2.3bn from €649m and reduced on the class A2s to €2.3bn from €5bn. Both classes of notes now pay a fixed rate of interest of 1.5% per year, while the reserve fund required amount has been reduced to €80m from €400m.

In addition, principal payments between the class A1 and A2 notes will remain sequential throughout the remaining life of the transaction. The swap has also been removed, resulting in interest rate risk between the fixed-rate liabilities and the predominately floating-rate assets.

Following the restructuring, S&P has lowered its credit rating to single-A plus from double-A on the class A2 notes and removed the rating from credit watch negative. It has also updated the credit watch status of the triple-A rating on the class A1 notes: the rating is no longer on watch negative for credit or counterparty reasons, but remains on watch negative because of its exposure to sovereign risk.

In addition to the restructuring, the downgrade of the class A2 notes is due to weak asset performance. In particular, severe delinquencies in Fastnet 3 have continued to rise in recent months: the level of loans more than 90+ days in arrears has risen to 7.33% in February 2011, up from 3.63% in February 2010.