Contents

ABS

Rehab boost

Rehabilitated loans, restructured ARS to drive SLABS prepays

Prepayments for student loan ABS remain historically low, although there are signs that they could be set for a modest pick-up. A greater role for restructured auction-rate securities (ARS) and rehabilitated student loans, as well as proposals in the Obama administration's initial 2012 budget could all lead to increased prepayments in the sector.

Katie Reeves, director at Deutsche Bank, says one of the reasons student loan ABS prepayments are so low is because a previous loophole has been closed. She explains: "Prior to 2007, there was a mismatch in how interest rates were calculated between the federal government's consolidation loan programme and regular FFELP loans."

With regular FFELP loans, a student could graduate with multiple loans outstanding - one for each year of their course. Until 2007 these loans were floating rate and consolidation loans were fixed rate.

"Borrowers could consolidate their various floating rate loans into a single fixed-rate consolidation loan, where the fixed rate was roughly the weighted average of the rates on the underlying loans being consolidated," notes Reeves.

The consolidation allowed a borrower to extend their term and lower their monthly payment. Consolidating underlying loans came through to any related ABS trusts as prepayments. However, Congress fixed that interest rate mismatch a couple of years ago so that now, while loans are still consolidated, it does not have the same effect for prepayments.

Furthermore, Reeves notes that the number of families with little or no equity in their homes to borrow against means another traditional source of prepayments has dried up. She also points out that while unemployment remains as high as it is, prepayments are unlikely to increase. An improvement in the unemployment rate is most likely to be the biggest driver for prepayments, she says.

In the meantime, a welcome boost to prepayments could be supplied by restructured ARS and rehab student loans, both of which could provide a greater source of FFELP student loan ABS going forward. Reeves is optimistic about the influence this supply could have on the market.

"Historically, new ABS issuance was backed by brand new originations, so I think the end of new FFELP originations did cause some concern. These alternative sources of new product give investors comfort that there will be ongoing liquidity," she says.

Reeves continues: "It makes for better secondary market conditions if you know there will be some new supply coming. One estimate of the impact that restructured ARS could make has been from Moody's, which thinks there could be about US$40bn-US$50bn of issuance over the next couple of years backed just by restructured ARS."

Brian Weber, vp at Houlihan Capital, is not so optimistic. He says: "I would not expect restructured ARS to become a very large source of supply for the student loan market. I would expect them to be a very minor portion of the market, because the amount that will be restructured will continue to be minimal relative to the overall size of the market."

Weber notes that the trend in the market lately has been a contraction in spreads. This has been positive for auction rates, which have continued to fail, and it has also been supportive of a general trend towards increased liquidity.

He continues: "Investors who were previously in auction rates are finding buyers so that they can exit their positions, which means they will have cash to reinvest. That will continue to support liquidity in other areas as well, eventually finding its way to the origination and securitisation markets for student loans. I think that will pick up a bit and continue to be supported by this trend."

As well as restructured ARS and rehab loans, Reeves reckons the 2012 budget request could have an effect on prepayments - albeit a limited one. Within the budget proposals are education provisions that would incentivise borrowers who hold both FFELP loans and Direct loans to convert those FFELP loans into Direct loans to help streamline payments.

Reeves says: "The effect on ABS is that any FFELP loans that were exchanged for a Direct loan would effectively be treated as a prepayment for the related trusts. The affected FFELP loans would come out of the securitised pools and cash would come into the trust as a prepayment."

The number of borrowers who hold both loans is limited and so the proposal in its current form would not on its own have a huge impact on prepayments. Furthermore, Reeves warns that the wrangling involved in negotiating the budget means that the proposal is open to change and might even be dropped.

She says: "The budget proposal is among the first steps in the process. A lot can happen between now and the finalising of the budget and it isn't clear that this particular proposal will survive all the redrafting likely to come. But it does appear that the current administration would like to continue to shrink the FFELP programme where possible."

JL

Regulation

Retention rules

Call for QRM impact analysis

The FDIC, Fed, OCC, SEC, FHFA and HUD yesterday issued their NPR requiring ABS sponsors to retain at least 5% of the credit risk of the assets underlying the securities. The proposed rule includes exemptions from these requirements, including for US government-guaranteed ABS and for RMBS that are collateralised by 'qualified residential mortgages' (QRMs). At first glance, however, the definition of a QRM appears to be stricter than expected

Under the NPR, qualified mortgages are limited to below 80% LTV for purchase loans, below 75% combined LTV for refinanced loans and below 70% combined LTV for cash-out refinance transactions. Front-end/back-end DTI is capped at 28% and 36% respectively, with these ratios calculated for ARMs at the maximum interest rate attainable in the first five years after origination of the loan.

There is also a restriction on the timing of prior delinquencies. In particular, mortgages made to borrowers that have been 60 days or more delinquent on a prior mortgage at any time in the preceding 24 months do not qualify.

According to ABS analysts at Barclays Capital, the definition of risk retention-exempt QRMs is slightly stricter than expected - hinting at tighter credit availability in the future, especially once the GSEs start pulling back from the market. SIFMA agrees that the QRM definition will have a significant impact on the availability and cost of mortgages for consumers.

The association says it is essential that regulators implement an effective standard, which strikes a balance between credit quality and availability, while not making mortgage credit unaffordable. It adds that a market impact analysis of the QRM proposal is imperative, including proposed servicing standards and how the QRM definition aligns over the long term with the conforming loan market that is eligible for the GSEs.

Nonetheless, SIFMA has welcomed the NPR. "We support the concept of risk retention as a mechanism that can serve to align the interests of securitisation participants, in addition to other measures that also promote this alignment," says SIFMA md and head of its securitisation group Richard Dorfman. But he warns that the calibration requires careful analysis of the impact of various constructions of retention regulations.

Under the NPR, the 5% risk retention can take the form of a vertical slice, horizontal first-loss piece, L-shaped slice, cash reserve account or representative sample. The sponsor can allocate risk to the originator, provided the originator has supplied at least 20% of the pool and will retain at least 20% of the risk.

The BarCap analysts suggest that the proposal benefits big balance sheet banks and REITs. A big balance sheet bank can originate loans through its retail channel and securitise them through its broker-dealer while retaining the risk on its balance sheet. Smaller originators and banks are at a disadvantage because of the 20% floor.

REITs - as sponsors - are ideal candidates to retain the risk on a transaction while funding the structure by selling the senior tranches. Given reduced competition from traditional aggregators and securitisers, the rules are a boon to the REIT model.

The other mechanism proposed for non-exempt mortgages is a premium capture account, which is designed to remove incentives for sponsors to profit upfront from securitisation. At first glance, the new proposal also seems to discourage the securitisation of premium loans.

However, the analysts indicate that the effects of a premium capture account can be mitigated. Since there is no cap on the coupon paid to the retained risk piece, the sponsor could structure and sell the top 95% of the capital structure as a par security with the retained 5% becoming a super premium security. The high coupon means that the sponsor effectively re-captures sales proceeds much sooner.

Overall, for non-QRM mortgages, traditional wholesale and conduit mortgage origination channels are likely to become non-viable, according to the analysts. "Risk retention, combined with FAS 166/167, is likely to result in consolidation onto balance sheets of bigger banks, nullifying any regulatory capital advantages of securitisation for non-QRM loans."

However, no immediate impact on the broader market is expected as over 90% of residential mortgage loans are originated by the GSEs and the FHA, which remain exempt from any risk retention requirements. But once the details are finalised and the economics improve, there could be an up-tick in non-agency QRM issuance.

Comments on the NPR must be received by 10 June. The notice will be published in the Federal Register after approval from all regulatory agencies.

CS & LB

CLOs

Warning for Euro CLOs

The European CLO market is awaiting a raft of upcoming loan prepayments, which traders fear will dry out supply. At the same time, two specific loans are at the forefront of investor attention.

First is Novacap's €209m all-senior leveraged loan, backing AXA Private Equity's buyout of a French chemicals group. The loan, which has been syndicated with existing lenders and new investors, is said to have been received well.

"We've had the allocations in on Novacap, which so far has seen a good response," one CLO trader says.

The second loan is the €480m senior loan supporting the buyout of Opodo and its subsequent merger with Go Voyages and eDreams. "Although the allocations on this one have not been received, the loan is also attracting investor support," the trader confirms.

However, despite the positive buzz surrounding this week's syndicated loan activity, the market is due to hit turbulent times with the arrival of numerous prepayments. "This week's activity can't compensate for the amount of prepayments ahead. One of our CLOs is having 10% of its assets prepaid next month, but I think that's fairly typical across the board right now," the trader says.

Although this prepayment news is not affecting the current deal flow, traders are concerned about the lack of supply ahead and the consequences this will bring. The trader adds: "Once all of the prepayments come in, we'll obviously need a lot more cash - and it doesn't look like there will be enough deals to fill that gap. That's the fear."

This fear is already beginning to creep in among investors as the absence of new issuance becomes apparent. "Participants are starting to show concern for the after effects of these prepayments. There is also no floor to how deals can be priced down now. I wouldn't be at all surprised if the first deal we see post-payments has an interest margin of below 4%," the trader remarks.

The ultimate effect of this issue will be a permanent shortage of assets for the next quarter - an issue that doesn't seem to be fading, the trader says. "At the moment, people seem to be focusing on re-pricing deals rather than actually going out and generating new ones. That's the problem we're faced with right now and, as far as we can see, it's only going to get worse," he warns.

LB

RMBS

Primary focus continues for Euro RMBS

The secondary European RMBS market remains quiet, as participants prepare for upcoming new issuance. RBS' Arran 2011-1 is the latest transaction to join the queue.

"The secondary market has been relatively quiet, especially when you look at the way it's been over the last few weeks - there hasn't been much turnover at all so far this week," one RMBS trader confirms. This slow-down is particularly apparent in triple-B rated paper, the trader adds, with pricing levels remaining unchanged from previous weeks.

Another factor to be considered in terms of the lack of secondary activity is the volume of new issuance, the trader says. "Everyone's focused on the new issue pipeline, which is taking the emphasis off secondary trading. We're also seeing some selling of the same names now in order to make room for more new issuance that's expected in the coming weeks."

Today's focus is on RBS' new Arran Residential Mortgages Funding 2011-1 transaction, which joins Northern Rock's Gosforth Funding 2011-1 (see SCI 23 March) and AEGON Levensverzekering's SAECURE 10 in the pipeline. The A1, A2 and A3 tranches of the Arran deal are expected to be publicly offered.

Nevertheless, bid-list activity appears to be resurfacing again. "A couple of lists have emerged; everything we've seen has traded and it's all coming in at the middle of the capital structure. It seems that people are selling what they're holding from year-end."

Elsewhere in the market, interest is mounting over certain Irish RMBS names, particularly Kildare and Celtic deals. However, the trader is puzzled by the interest in the Celtic paper.

He explains: "The fundamentals aren't looking too great on the Celtic transactions - they're being heavily impacted by negative equity and yet are still selling. I can't say why as the prices aren't cheap either. We're at a loss on this one."

LB

RMBS

Euro RMBS bouncing back

The European RMBS market appears to be recovering from last week's dip. In particular, market participants have welcomed Northern Rock's announcement of its first post-crisis deal, Gosforth Funding 2011-1.

"Dealers were not active in the market last week due to the news in Japan. We seemed to have bounced back this week, however," one RMBS trader says. As activity begins to flow, prices are firmer and performance has become stronger, he adds.

The primary market also received a boost with the announcement of Northern Rock's first post-crisis RMBS - the £1.5bn-equivalent Gosforth Funding 2011-1 - arranged by Deutsche Bank, JPMorgan and RBS. The as-yet unsized 1.99-year triple-A rated (Moody's and Fitch) A1a and A1b tranches, denominated in sterling and euro respectively, are set to be publicly offered. The sterling-denominated 4.98-year triple-A A2 tranche, double-A 5.07-year M tranche and unrated Z tranche will be retained.

The transaction, along with AEGON's €1.5bn SAECURE 10 Dutch RMBS, joins Lloyds TSB's standalone £1.2bn-equivalent Headingley RMBS 2011-1 in the pipeline. The latter is notable for including a tranche - the triple-A rated A1a class - denominated in Australian dollars.

"The market has been much livelier so far this week, so hopefully it's set to continue," the trader concludes.

LB

CMBS

'Innovative' Velvet loan restructuring proposed

The proposed restructuring of the Velvet loan, securitised in the Titan Europe 2006-2 CMBS, includes the deferral of interest - believed to be the first time this has featured in the European market. The restructuring, which also involves extending the loan maturity and investing in the underlying properties, is ultimately expected to increase the loan's recovery value.

"We believe that, given the limited flexibility to fund the necessary capital expenditure for underperforming properties, the interest deferral is a reasonable course of action in the event the borrower and/or sponsor lacks the financial means and when investment into the properties is highly likely to increase the recovery value," note CMBS analysts at Barclays Capital.

They add: "Notwithstanding further yield widening for German multifamily properties, investment in the Velvet loan property portfolio with the aim of reducing the maintenance backlog is likely to increase its value. In addition, we agree that the investments increase the chance of reducing the vacancy rate, which would be further value enhancing."

According to the special servicer on the transaction (Hatfield Philips), the multifamily properties securing the Velvet loan suffered from a substantial maintenance backlog. This affected the property value, which has declined by 51% since November 2005.

Over 2H10 the vacancy rate stabilised at a high level, which - in the opinion of the special servicer - can be attributed to the change of the asset manager. The new asset manager prepared a business plan indicating that, with proficient asset management, a value increase is possible over the years to come.

Based on a restructuring opinion, Hatfield Philips examined three work-out scenarios: an immediate sale of the properties; invest and hold until 2016; and invest and sell before 2012. Based on a NPV analysis, it chose the third option, which features a loan extension until December 2012 and a deferral of loan interest until then. The interest not paid will instead be invested in capital expenditure and property maintenance, which is expected to result in a lower vacancy rate over time and consequently a higher property value.

The restructuring plan foresees the disposals of some properties in Dueren, Herne and Gelsenkirchen in 2Q11 - generating proceeds of approximately €28m - and a sale of the remaining properties in 4Q12 for an estimated €125m. Not discounted and disregarding deferred interest, these anticipated sale proceeds would be sufficient to repay the current principal balance of the securitised loan.

On what basis interest will defer under the restructuring remains unclear, however. The loan is floating rate and the borrower level swap matured in January 2011. Consequently, the BarCap analysts assume that the basis for deferral will be the floating rate interest agreed on in the loan agreement - with or without default interest.

Nonetheless, they note that the Velvet restructuring is an "innovative and appropriate" way to work out the loan. "The fact that deferred interest on the loan is not due subordinates junior note interest to senior note principal recovery, which is in the spirit of securitisation, in our view. Other outstanding loans might be in a similar situation as the Velvet loan, so we can imagine that the Velvet loan restructuring will serve as a template for future workouts."

The analysts add that the special servicer's explanation of the rationale behind the restructuring and its analysis is very helpful, with the same openness in similar cases to be welcomed in the future.

CS

ABS

Valuations subsidiary established

Clayton Holdings has formed Asset Backed Solutions, an independent financial analysis and consulting group providing litigation support and valuation services of complex structured products and related assets. Based in New York, David Lehman will head the new group as president, reporting to Clayton ceo Paul Bossidy.

Lehman joins Clayton from Navigant Economics, where he provided valuation and advisory services for RMBS, CDOs and whole loans. Prior to this, he was a whole loan trader at WaMu Capital and Morgan Stanley, and a securitisation analyst at Credit Suisse and Deloitte & Touche.

Additionally, Tyler Simpson and Florin Nedelciuc have been named directors of the new venture. Nedelciuc also joins Clayton from Navigant Economics, where he advised clients on legal counsel and the valuation of structured products in bankruptcy and restructuring matters. His career includes RMBS trading and structuring roles at WaMu Capital Corp, Wachovia and Banc of America Securities.

Simpson was previously head of residential capital markets at Pentalpha Capital Group. He has also held trading and risk management positions at New York Mortgage Trust, JPMorgan Securities, Deutsche Bank and Nomura Securities.

ABS

Law firm adds two partners

K&L Gates has appointed Howard Goldwasser and Xavier Ruiz as partners in its New York finance and corporate practices respectively.

Goldwasser joins the firm from Curtis, Mallet-Prevost, Colt & Mosle, where he served as lead counsel in complex transactional and debt capital market matters, including securitisations. Prior to this, he was partner at Allen & Overy and managing partner at Orrick, Herrington & Sutcliffe.

Ruiz was previously with Garrigues, where he led the firm's US practice advising corporations on cross-border M&A, joint ventures and finance transactions with a focus on Latin America and Spain.

ABS

Bank names new structuring head

RBS Securities has appointed Shad Quraishi as head of its client structuring and solutions group for banks in North America. Based in Stamford, he will report to Miles Hunt and Joe Carney, co-heads of client structuring and solutions for the Americas.

Quraishi joins the bank from NewOak Capital, where he was vice-chairman and co-head of its capital markets team. Prior to this, he was with UBS, where he served as global head of the asset-backed finance business and subsequently joint-head of its real estate distressed workout group.

ABS

ASF names public policy md

The American Securitization Forum (ASF) is opening a Washington, DC office to further its advocacy efforts on behalf of the securitisation markets. Jim Johnson has been appointed md of public policy, reporting to ASF executive director Tom Deutsch.

Johnson previously served as senior counsel to the US Senate Committee on Banking, Housing and Urban Affairs for Ranking Member Richard Shelby. Here, he advised the committee on various matters, including the prudential supervision of bank and financial holding companies, asset securitisation and derivatives.

CDO

EMEA sales head appointed

BNY Mellon Corporate Trust has promoted Robert Wagstaff to md and head of sales for EMEA. He will report to Troy Kilpatrick, the firm's head of global sales. Wagstaff was previously vp of global corporate trust sales at BNY Mellon and prior to this was at JPMorgan, where he focused on SIVs and CDOs.

CDS

Management shuffle for TriOptima

TriOptima has made several changes within its management group as it implements two new business lines with independent management: triReduce, a multilateral compression service; and triResolve, a counterparty risk management service. The firm's evp and co-founder Per Sjoberg will assume the role of group ceo, while former group ceo Brian Meese will step down and continue in his role as non-executive director on TriOptima's board.

Peter Weibel will serve as ceo of triReduce, while Raf Pritchard will serve as ceo of triResolve. The pair will direct sales, service and business management activities for the service.

Finally, Mireille Dyrberg will assume the newly-created position of coo, responsible for infrastructure functions, including legal, marketing and industry relations. The firm's Asia Pacific presence will continue to be organised and run regionally, with Yutaka Imanishi as ceo.

CLOs

Portfolio management pair moves on

Elizabeth MacLean and Jason Duko are joining PIMCO next month. They will become members of the firm's bank loan portfolio management team and be based in Newport Beach, reporting to Marc Seidner, md and senior member of the portfolio management group.

MacLean joins PIMCO as evp and portfolio manager. She moves from Lord Abbett, where she oversaw bank loans and structured products. MacLean has previously served as md and portfolio manager for leveraged loan investments at Nomura and president and portfolio manager at Pilgrim Investments.

Duko joins PIMCO as svp and portfolio manager. He also moves from Lord Abbett, where he was an associate portfolio manager focusing on bank loan and structured product portfolio efforts. Previous roles include vp and assistant portfolio manager at Nomura and a post as research analyst at ING Pilgrim Research.

CLOs

India credit head appointed

ACPI Investments has appointed Karan Singh Chadha as head of specialist credit, responsible for expanding its hedge fund strategies and fund launches in arbitrage Indian fixed income securities. He will oversee investments in illiquid credits, reporting to ACPI co-ceo Alok Oberoi.

Chadha was previously a senior portfolio manager with Aladdin Capital Management, where he was responsible for credit products in high yield and emerging markets. He has also held senior positions at Washington Square Investment Management, Oaktree Capital and JPMorgan.

CLOs

Investment manager completes acquisition

Man Group has entered into a definitive agreement to take full ownership of Ore Hill Partners and Ore Hill Partners Capital Management for a predominantly share-based consideration. Completion of the acquisition is scheduled for the second quarter.

The strategic relationship with Ore Hill dates from 2008, when Man acquired a stake of approximately 50% (see SCI issue 89) - the remaining interest has been owned by Ore Hill's principals and employees. Man's acquisition of the remaining 50% of Ore Hill is in line with its strategic focus on internal investment management capabilities and continues the build-out of single strategies on the GLG platform.

Upon completion of the transaction, while Ore Hill will remain investment adviser, the operations will be integrated into and managed as part of GLG, Man's discretionary investment management platform. Ore hill co-founders Ben Nickoll and Fritz Wahl, as well as Alok Makhija will continue to manage the Ore Hill portfolios. The three principals have agreed to share the management and performance fees earned by the managed funds.

Ore Hill manages a series of hedge funds with funds under management of approximately US$800m, of which previously Man has consolidated 50%. Upon completion, these funds will be fully consolidated into Man's funds under management. In addition, Ore Hill manages a US$1.1bn structured product.

CMBS

Bank adds CMBS trader

Former Goldman Sachs CRE and derivatives trader Ben Solomon is joining Deutsche Bank as md and head of CMBS trading. He will report jointly to md and head of ABS trading Pius Sprenger and md and head of the MBS pass-through trading group Troy Dixon.

RMBS

REIT promotes four

Invesco Mortgage Capital has promoted its head of research, Robson Kuster, to the additional position of coo. The REIT's investment management arm Invesco Advisers has also promoted Jason Marshall to md and head of portfolio management, while both David Lyle and Kevin Collins have been named md and head of residential mortgage credit.

RMBS

Asset manager promotes chairman

Smith Breeden Associates has promoted its former chairman Michael Giarla to ceo. He will continue as chairman for both the firm and its executive committee.

As a widely-published authority on MBS investments, Giarla has 29 years of experience in developing and applying quantitative financial analysis to MBS valuation and trading. He has held a variety of roles during his time with Smith Breeden, including president and coo, as well as being a member of the CREF and TIAA-CREF mutual funds board of trustees.

Giarla will replace Eugene Flood, who is set to join TIAA-CREF in May.

RMBS

Broker recruits structured vets

KGS-Alpha Capital Markets has appointed Mark Noble as head of structured corporate and agency debt, while Jim Tymeck has been named head of its finance desk.

Noble joins the firm from MF Global, where he was head of agency debt. Prior to this, he was director of callable agencies and bullet debt at Barclays Capital, as well as svp of callable agencies and structured products at Lehman Brothers.

With over 22 years of funding and trading experience, Tymeck joins KGS-Alpha from Citi, where he was md and head of structured repo trading. Prior to this, he was md of macro proprietary trading at Bank of America.

ABS

SCI conference line-ups announced

Final panellist line-ups have been announced for both SCI's European CDS and OTC Derivatives Seminar in London and its Pricing, Trading & Risk Management Seminar in New York. The London event takes place on 28 March at Adelaide House, London Bridge, while the New York event is being held on 31 March at India House, One Hanover Square.

The London seminar brings together members of the market to discuss risk and collateral management, as well as the future of the OTC credit markets, particularly in light of ongoing regulatory developments. Experts speaking at the event include representatives from: B&B Structured Finance, BLP, BlueMountain Capital Partners, Citi, Financial Reform Consultants, Fitch Solutions, GFI, ISDA, LCH.Clearnet, ReMatch, Sapient Global Markets and Valere Capital.

The seminar in New York will focus on risk management issues for institutional funds, as well as on trading and secondary markets. The highly-focused event will also include case studies and presentations on methodologies for workouts and for pricing and valuation of ABS and CDOs. Speakers include representatives from: Advisors Asset Management, CapitalFusionPartners, Chasen Advisors, EIM USA, Federal Reserve Bank of New York, Grenadier Capital, Goldman Sachs, Gorelick Brothers Capital, Kingsland Capital, Nibco Consulting, Prudential Fixed Income Management, R² Financial, RBS, Reoch Credit Partners, Rochdale Securities, Schulte Roth & Zabel, SecondMarket, SORMS, S&P and Sterne Agee.

Sell-side and buy-side firms can attend the London seminar for free. Vendors and lawyers can register at 20% off, while CMA clients can also receive a discount. Buy-side and institutional investors are also invited to attend the New York event for free, while sell-side and vendors can register at 20% off for a limited time.

Please email SCI for discount codes or click here for further information.

ABS

Dealer networks boost floorplan ABS

Dealer floorplan ABS performance has been boosted by the economic recovery in the US as it has strengthened auto dealership networks, says Fitch. The agency expects dealer floorplan ABS to continue to benefit from improved credit and financial metrics throughout 2011.

Lower inventory aging, stronger monthly payment rates (MPR), improved dealer credit profiles and fewer dealer failures and bankruptcies are all positive signs for the market. Fitch also notes the slow but steady improvement in the wider economy and rebound in the US auto industry over the past 18 months as further factors underpinning consistent ABS performance.

Aging levels returned to pre-crisis 2005-2007 thresholds through February of this year, says Fitch. It adds that for MPR performance, dealer floorplan averaged 37.1% MPR in 2010, compared to 32.2% in 2009 and 29.8% in 2008.

Most industries in the diversified dealer floorplan ABS sector - including marine, recreational vehicles, consumer electronics and appliances, lawn and garden, industrial and power sports - have been slow to rebound relative to the auto sector. Despite this, Fitch expects diversified dealer floorplan ABS ratings to remain stable.

Last year was a particularly profitable one for US auto dealerships, with average revenues for 2010 17.2% higher than the year before, while costs only rose by 6.6%. Although the agency notes that a slow-down in the US economy could affect dealer floorplan ABS, it says a slow-down is unlikely to have too strong an impact on ratings in 2011 and points to structural features such as credit enhancement levels and early amortisation triggers, which provide protection from declining asset performance.

ABS

Portuguese ABS on review

Fitch has placed 41 tranches of 38 Portuguese structured finance transactions - 32 RMBS, one ABS and five structured credit deals - on rating watch negative (RWN). All other Portuguese RMBS tranches have a negative outlook.

The rating actions follow Fitch's downgrade of Portugal's long-term foreign and local currency issuer default ratings to single-A minus from single-A plus on 24 March. As a result of the sovereign downgrade, the agency has placed all triple-A rated Portuguese structured finance transactions on RWN with the exception of two SME transactions, where notes are guaranteed by the European Investment Fund. This reflects the heightened uncertainty of the direction of the Portuguese economy, increased risks to policy implementation and rising funding pressure on Portuguese banks that could undermine the performance of the securitisations.

To date, the majority of Portuguese transactions have performed well, with stable delinquencies and defaults. However, there are signs that delinquency levels are currently increasing. The future performance of the assets supporting these transactions may be further adversely affected by the changes occurring to the macro-economic environment in which they operate.

The outlooks on all other tranches are negative to highlight the negative trends that could result in downgrades over the medium term. Rating outlooks indicate the direction a rating is likely to move over a one- to two-year period.

ABS

Independent dealer floorplan ABS debuts

Dealer Services Corporation (DSC) has closed a US$252.2m ABS, which is believed to be the first independent dealer floorplan deal to come to market. The securities - issued via the DSC Floorplan Master Owner Trust shelf - comprise US$225m triple-A rated (DBRS) senior-secured notes and US$27.2m triple-B subordinate-secured notes. The Rule 144A series 2011-1 offering was led by Deutsche Bank Securities and placed with over 10 institutional investors.

In addition, DSC entered into a new US$290m revolving credit facility agented by Deutsch Bank. Together with the ABS, this facility provides DSC significant capital for continued growth.

"DSC is very pleased to be the first in our industry to successfully issue asset-backed securities to the capital markets," comments Marty McFarland, DSC president. "These transactions were highly rated and have brought DSC a new and broad funding source for our future growth... With these facilities available, DSC will continue to grow and provide our dealers the highest level of service and products available in the market."

ABS

Seasonal patterns supporting auto ABS

Seasonal trends resulted in another positive month for US auto loan ABS performance, with the trend likely to continue into the second quarter, according to Fitch.

"Late winter/early spring has shown to be a consistently strong period for auto loan ABS. Tax refunds, annual bonuses and salary increases will enable many consumers to make their auto loan payments, translating to lower loss and default rates for auto ABS," says Fitch director Brian Vorderbrueggen.

Prime annualised net losses (ANL) declined by 3.2% in February to 0.90% versus January and were 42% below 2010 levels. Prime cumulative net losses (CNL) (adjusted for seasonality) were 0.77% in February - 2.5% below January's level and 37% below 2010. However, prime 60+ days delinquencies increased by 5% in February month-over-month (MOM) to 0.61%, but remain well below February 2010's levels by 24%.

In the subprime sector, Fitch's 60+ days delinquency index declined by 7% to 3.24% in February - well below 2010 levels of 33%. ANLs were 5.94% in February, down by 13.7% from January and 35% below February 2010's figures.

Manheim Consulting's Used Vehicle Value Index declined for the first time in February since July 2010, but is still at a record levels. The index dropped 1% month-over-month to 123.6 from a record high of 124.9 in January and is up nearly 5% over February 2010. Despite the slight decline last month, used vehicle values remain strong and are supporting high recovery rates on defaulted and repossessed vehicles.

Meanwhile, fuel prices across the US remain elevated as a result of the turmoil in North Africa and the Middle East. The average price for a gallon of regular gasoline was US$3.56 as of 21 March, while the nationwide average for diesel was US$3.91 per gallon. Consequently, there has been marginal softness in the values of larger trucks and SUVs and a slight pick-up in demand for smaller fuel efficient cars, Fitch says.

"Due to improved industry fundamentals, the used vehicle market is better-positioned to manage the impact of higher gas prices than in 2008, when gas rose above US$4.00 a gallon. As a result, the rate of auto ABS loss severities will be lower than three years ago," adds Vorderbrueggen

Rating performance in 2011 continues to be positive, with an up-tick in rating upgrades issued this year relative to the same period in 2010. Fitch upgraded 26 classes of prime auto loan ABS outstanding notes through the first two months of the year, compared to 11 issued through February 2010. The positive rating actions are expected to continue in 2011, with limited negative actions and solid asset performance.

Stabilising macroeconomic conditions, positive momentum in the auto industry and the benefits of sound structural features present in transactions contribute to the stable outlook for asset performance for 2011, Fitch concludes.

ABS

Risk retention NPR awaited

The staffs of the Office of the Comptroller of the Currency, the Federal Reserve, the FDIC, the SEC, the Federal Housing Finance Agency and the Department of Housing and Urban Development have confirmed that they will this week consider for approval a notice of proposed rulemaking on risk retention (see SCI 24 March). The NPR addresses section 941 of the Dodd-Frank Act, which requires the agencies to prescribe rules to require that a securitiser retain an economic interest in a material portion of the credit risk for any asset that it transfers, sells or conveys to a third party.

A detailed announcement will be made when this process is complete. If approved, the agencies will publish in the Federal Register a notice of proposed rulemaking for public comment.

CDO

First Trups tender offer completed

While default and deferral rates for US bank Trups CDOs remain flat, the sector saw the first acceptance of a tender offer in January, according to Fitch's latest default and deferral index results. Four CDOs were tendered, each one receiving approximately 21% of par in exchange for termination of the Trups.

There have been several requests for noteholder consent from distressed banks to tender their securities over the last year. However, this was the first offer that was successfully completed within Trups CDOs to date, Fitch says.

"It's still too early to tell if additional tender offers in Trups CDOs will be accepted and completed in the near future, so Fitch is viewing the development as an unique occurrence for now. Whether a successful tender offer is a benefit or detriment to bank Trups CDO performance also remains to be seen," says Fitch director Johann Juan.

Bank Trups CDO defaults increased marginally by 0.03% to 15.15% last month, while deferrals remained at 17.97%. Subsequently, the combined default and deferral rate for banks within Trups CDOs increased slightly from 33.09% to 33.12%.

At the end of last month, 164 bank issuers were in default - representing approximately US$5.71bn held across 79 Trups CDOs - while 387 deferring bank issuers were impacting interest payments on US$6.77bn of collateral held by 84 Trups CDOs.

CDO

CDO liquidation scheduled

Stone Tower Debt Advisors has been retained to act as the liquidation agent for Forge ABS High Grade CDO I (see SCI 15 March). The sale will be conducted across three buckets - one containing RMBS, one with ABS CDOs and the other a mix of CDOs and RMBS - at 10am EST on 5 April.

The property will be sold to the best qualified bidder/s. The holders of the class A-1 and A-2 notes may provide credit bids on one or more items of the collateral in an amount not to exceed the outstanding principal amount of the notes that they own.

CDS

SEF rule scrutinised

ISDA outlines in a new paper that SEFs can play a positive role in the OTC derivatives market by strengthening its infrastructure, helping prevent insider trading and other market abuse, and increasing transparency and access for smaller participants. However, to achieve this and to become effective, SEFs need to offer derivative users broad choice in trade execution at very low cost.

ISDA believes that SEFs should be structured to provide maximum choice in trade execution to market participants, while providing pre- and post-trade transparency while maintaining liquidity. SEFs should also have reasonable, tailored and product-specific block trade exemptions that reflect the risk of a transaction instead of a 'one size fits all' approach.

In addition, the association notes that regulatory proposals mandating the use of SEFs for derivatives trading should be based on determining whether a product is available for trading by a SEF. The CFTC proposes to delegate this responsibility and further proposes that if one SEF has made such a determination, all SEFs will be required to treat the swap as made available for trading.

The proposed rule, however, does not set out any specific criteria to determine whether a derivative product has the liquidity to trade. In ISDA's view, the CFTC should state that a contract subject to mandatory clearing does not automatically make it available for trading and that the contract must also meet minimum liquidity and standardisation characteristics.

The rule is also believed to create a misalignment of interest, in that SEFs will have every incentive to declare a product available for trading in order to capture market share. Further, if a product trades very infrequently and every trade executed is known to the entire market as a result of SEF execution, participants will be very cautious in taking on positions.

To eliminate this conflict of interest and its negative implications, the CFTC should make the 'available to trade' determination subject to public notice and comment, ISDA says. The CFTC further states that a participant utilising a RFQ must send the request to at least five participants - another example of the CFTC being more precise and restrictive than it needs to be.

The DFA says that participants must only have the ability to accept multiple bids or offers, yet requiring bids or offers from five dealers may make dealers hesitant to price the transaction aggressively. The five dealer requirement limits how participants operate in markets when it does not serve clear purposes - another requirement that is bound to reduce liquidity, ISDA states.

CDS

Derivative trading revenues dip

In its quarterly report on bank trading and derivatives activities, the Office of the Comptroller of the Currency (OCC) indicates that commercial banks reported trading revenues of US$3.5bn in 4Q10. This is 80% higher than in 4Q09, yet still 17% lower than in 3Q10.

For the full year of 2010, trading revenues totalled US$22.5bn, nearly matching the record US$22.6bn in 2009. "We expected to see trading revenues fall in the fourth quarter, given the well-known seasonal pattern that exists in trading results. Although trading revenues fell in the fourth quarter, it's important to recognise that they were the second highest of any fourth quarter on record. Moreover, trading revenues for the year were very strong, only slightly below the record revenues in 2009," says Martin Pfinsgraff, deputy comptroller for credit and market risk.

The strong trading performance for the year occurred despite substantial reductions in risk, as measured by value-at-risk (VaR). Pfinsgraff notes that average VaR for the five largest banking companies fell by 24% during 2010.

"While some of the decline in trading VaR is due to lower volatility in financial markets, it's also very clear that banks have reduced risk in their trading operations," he adds.

The OCC reports that net current credit exposure (NCCE) - the primary metric it uses to measure credit risk in derivatives activities - declined by US$65bn, or 15%, to US$375bn this quarter. NCCE has fallen 53% from its peak of US$800bn at the height of the credit crisis.

"23 banks - the largest total ever - reported charge-offs in 3Q11 for a total of US$284m. In 4Q11, 15 banks reported charge-offs totalling US$111m. Past due derivatives contracts fell by 65% to US$54m. We were especially pleased to see that the number of banks reporting charged-off derivatives exposures fell sharply last quarter," Pfinsgraff continues.

Further, the notional amount of derivatives held by insured US commercial banks decreased by US$3.5trn in 4Q10 to US$231trn. Interest rate contracts declined by US$3trn to US$193.5trn, while FX contracts increased by 1% to US$21trn. Banks hold a high quality of collateral - 81% of cash - to cover 72% of their NCCE, according to the OCC.

It notes that derivatives contracts are concentrated in a small number of institutions. The largest five banks hold 96% of the total notional amount of derivatives, while the largest 25 banks hold nearly 100%.

CDS are the dominant product in the credit derivatives market, representing 97% of total credit derivatives. The number of commercial banks holding derivatives declined by 35 in the quarter to 1,070, the OCC concludes.

CLOs

CLO's key-man provisions updated

The trustee for Alpstar CLO 2 has approved a change in the transaction's key-man documentation. Nicolas Bravard, head of credit investments at Alpstar, is now designated as the sole key person on the deal.

CMBS

Delinquent unpaid balance rises again

The US CMBS delinquent unpaid balance last month increased slightly by US$330.4m, up to US$62.42bn from US$62.09bn a month prior, according to Realpoint's latest monthly delinquency report. This follows a slight decrease of US$229.8m in January, which marked only the second recorded decrease in the past 12 months.

A net decline in the 30-day and 60-day delinquency categories was noted in February, while ongoing loan modification, resolution and/or liquidation activity and increased new issuance have each contributed to a slower rate of new delinquency reporting for recent months. The delinquent unpaid balance in February increased, despite another US$859.3m in loan workouts and liquidations across 86 loans, at an average loss severity of 39.3%.

The 90+ day, foreclosure and REO delinquency categories each increased in February. With the ongoing rapid pace of loan liquidations, modifications and resolutions, the two most distressed categories of foreclosure and REO increased by US$1.89bn as a whole (8%) from the previous month and remains up by US$15.18bn (145%) in the past year.

However, Realpoint notes that when focusing on deals seasoned for at least one year, its investigation reveals more concerning results regarding legacy CMBS transactions. For example, all deals seasoned at least a year have a total unpaid balance of US$716.1bn, with US$62.42bn delinquent - reflecting an 8.72% delinquency rate (up from 8.65% a month prior and 8.14% six months ago).

When agency CMBS deals are removed from the equation, deals seasoned at least a year have a total unpaid balance of US$679.95bn, with US$62.37bn delinquent - reflecting a 9.17% rate (up from 9.06% a month prior and 8.48% six months ago). Finally, conduit and fusion deals seasoned at least a year have a total unpaid balance of US$617.56bn, with US$60.21bn delinquent - reflecting a 9.75% rate (up from 9.6% a month prior and 8.61% six months ago).

CMBS

US CRE prices slip again

US commercial real estate prices fell by 1.2% in January, the second consecutive monthly decline, according to Moody's/REAL National All Property Price Index (CPPI). Recent declines have been moderate, however, with prices currently 4.2% above the post-peak low reached in August 2010.

"Choppiness in the CPPI is starting to subside as the bottoming process that started in 4Q09 continues. However, some choppiness will remain as the share of distressed transactions continues to be elevated," says Moody's director of commercial real estate research Tad Philipp.

Performance of commercial real estate in the US is bifurcated, with larger properties in major markets recovering. Additionally, distressed properties remain well off the peak, the agency says.

While the CPPI shows prices down 42.8% from their October 2007 peak, prices on a six-city sub-set of non-distressed properties that have traded for more than US$10m are down 18.9% from October 2007. Prices on distressed properties, however, have tumbled 53.9% since October 2007.

During January 2011, there were 116 repeat sales worth US$1.45bn, which were down from December levels. Additionally, various sub-indices are recording ample gains in prices over the last year.

In the Eastern states, the apartment, office and retail property type indices realised gains of greater than 17% in the last year. Only the industrial property type posted a decline, dropping 5.7% versus one year earlier.

Two property types in the South saw significant increases over the past four quarters, with apartments increasing by 53.7% and industrial up by 39.4%. Southern office prices declined 10.9%, while retail was down by 16.5%.

New York and Washington office prices have rebounded sharply compared to a year ago, with gains of 32.9% in New York and 20.7% in Washington DC. San Francisco office prices are down by 9.9% as compared to a year ago, in part due to an elevated level of distressed trades in its suburban markets, Moody's says.

Apartment prices in Florida recorded their first increase since 2005, up by 33% from a year ago. Florida apartment prices peaked in 2005, two years earlier than prices in most other sectors - in large part because of a market appetite for condo conversion candidates.

CMBS

Euro CMBS repayments continue to decline

Only one out of the seven European CMBS loans scheduled to mature in February met its maturity obligation, according to S&P. Such performance coloured the month's loan level activity and contributed significantly to loan delinquencies and transfers to special servicing, the agency says.

February's results reinforces the trend set in 2010 when loans in European CMBS showed a greater propensity to fall into default, extend or enter into standstill than to meet their maturity payment obligations. Of the 80 loans that were scheduled to mature in 2010, only 30 repaid in full and of these 21 loans had reported LTV ratios of less than 70% and a further six had reported LTV ratios of less than 80%.

Additionally, there are more signs of borrowers struggling to meet maturity obligations, the agency says. The one loan scheduled to mature in March (the Agora Max loan in Indus (ECLIPSE 2007-1)) failed to meet its maturity obligation. At issuer level, Ares Finance also failed to meet the maturity obligation on the notes.

CMBS

Court direction sought for GSW funds

In light of certain submissions made to the trustee, direction from the High Court of England and Wales is being sought as to the proper interpretation and application of the definition of sequential payment trigger in relation to the distribution of the GSW funds in the Fleet Street Finance 3 CMBS.

The trustee understands that on 15 April 2010 the servicer - with the approval of the related subordinate lender - in accordance with the terms of the servicing agreement and the Saxony intercreditor agreement, consented to the amendment of the Saxony facility agreement to extend the final maturity date of the Saxony whole loan from 20 January 2011 to 13 July 2013. The servicer is further understood to have notified the cash manager that on 21 December 2010 a material senior default occurred in respect of the Orange senior loan and on 13 January 2011 a material senior default occurred in respect of the Blue Star senior loan.

Having taken further advice of leading counsel, the trustee has concluded that there is a reasonable degree of doubt as to whether the definition of sequential payment trigger requires the GSW funds to be applied in redemption of the notes in part on a sequential basis and in part on a pro rata and pari passu basis or only on a sequential basis.

Noteholders were notified on 28 February that the GSW funds would be applied on the next payment date as follows: the pro rata redemption amount towards redemption of the class A1, A2, B and C notes pro rata and pari passu; and the sequential redemption amount towards redemption of the notes pursuant to the issuer sequential pre-enforcement principal priority of payments. However, submissions have subsequently been made to the trustee suggesting that all pro rata redemption amounts and sequential redemption amounts received pursuant to the repayment of the GSW senior loan must be applied according to the sequential pre-enforcement priority of payments. If this were to happen, all the GSW funds would be paid to the class A1 noteholders.

CMBS

'Positive' first quarter for US CMBS

The first quarter was positive for the US CMBS market, according to research analysts at S&P. They point to an increase in new issuance on a year-over-year basis, the slowing delinquency rate, firming industry fundamentals and tightening spreads as evidence for this. Additionally, while rating actions remain primarily negative, most have been due to interest shortfalls and their impact has been relatively confined to the bottom or middle levels of deal capital structures.

"We expect the same trends to hold for the sector in the second quarter," notes S&P research analyst James Manzi. "We do, however, acknowledge the uncertainty with regard to the political situation in the Middle East/North Africa, the timing of Japan's resurgence following the recent tragedies and commodity pricing, which could hamper new issuance if spreads become too volatile."

CMBS issuance tallied US$8.7bn in the first quarter and current indications suggest that issuance could pass last year's total of roughly US$12bn before mid-year, with S&P expecting to see roughly the same amount of new issuance in the second quarter.

The CMBS delinquency rate has slowed markedly over the past two months, notching only 9bp gains each period. This puts the overall rate at 9.07%, compared with 8.89% at year-end 2010. The delinquency rate will continue to rise at a modest pace during the next few months, according to S&P.

After a lengthy tightening that took place since year-end 2010, the CMBS market has taken a breather over the past few weeks, however. Political uncertainty and the upcoming end to the US Fed's quantitative easing programme on 30 June may make trading more volatile in Q2 than it has been over the past few months.

Only multifamily and lodging assets showed positive rental growth on a national basis in 2010. The latest forecasts from CB Richard Ellis suggest that the office sector is poised to join in on the gains in 2011 and that retail and industrial properties are unlikely to see national rent growth until 2012.

CMBS

CMBS 2.0 standards unveiled

The CRE Finance Council (CREFC) has released its new market standards for CMBS 2.0. The aim of CREFC's new best practices is to create market standards that can be used in the CMBS market immediately and to provide support to US federal regulators as they work to implement the Dodd-Frank Act's goal of better aligning investor and originator interests.

First, CREFC's Principle-Based Underwriting Framework identifies underwriting principles needed to address credit risk in commercial mortgages, with the standardisation of Annex A building on the unparalleled disclosure in the CMBS market. Second, the Model Representations and Warranties and Model Repurchase Remediation Language initiatives provide consistent and enhanced assurance by originators and issuers for their underwriting standards and loan quality, as well as an efficient dispute resolution mechanism for representation and warranty breaches.

"The release of CREFC's best practices is an important and timely milestone in the commercial real estate finance market, a sector that has turned an important corner in 2011. CREFC's members have devoted an extraordinary amount of time over the past year to strengthen the market and provide important standards for commercial mortgages," says Lisa Pendergast, CREFC president.

The CREFC initiatives specifically address the Dodd-Frank mandate for commercial mortgages by creating standards for use in the market immediately, while retention rules would not go into effect for an additional two years after they are finalised. "We believe CREFC's standards are consistent with the risk-retention provisions in Dodd-Frank and go beyond the required government directives to improve transparency and promote a strengthened foundation. We have little doubt that our industry's initiatives will help commercial real estate in its recovery efforts," says Margie Custis, CREFC's md of capital markets.

RMBS

BlackRock analysis submitted in MBIA case

A detailed, independent analysis by BlackRock Solutions indicates that MBIA senior executives gave the New York State Insurance Department (NYID) financial statements that underestimated MBIA Insurance's future losses on structured finance guarantees by at least US$10bn, according to documents filed with the New York State Supreme Court yesterday. The MBIA loss estimates were provided to obtain NYID approval of parent company MBIA Inc's February 2009 restructuring (SCI passim).

"According to BlackRock's analysis, the expected insurance losses on less than one quarter of MBIA Insurance's portfolio rendered MBIA Insurance deeply insolvent as of 31 December 2008," the brief filed with the court by Sullivan & Cromwell explains. "Indeed, the BlackRock loss projections put to rest any notion that MBIA Insurance likely will meet the enormous pending liabilities on its structured finance insurance policies over the next 30 and more years."

BlackRock analysed more than 450 transactions involving RMBS and CDS that relate to various CDOs guaranteed by MBIA Insurance as of 31 December 2008. The NYID, on the other hand, looked at only three such transactions in any detail before allowing MBIA to split its main subsidiary into a new 'healthy' municipal bond insurer with US$5.2bn of MBIA Insurance's assets and an insolvent 'dying' insurer that MBIA itself has referred to as "leavebehindco". The NYID's decision to rely on MBIA's numbers rather than commission an independent analysis of the monoline's expected losses ignored NAIC guidelines for reviewing the restructuring of an insurer.

The development is the latest twist in the Article 78 action being pursued by a group of MBIA policyholders seeking to annul the monoline's restructuring. The group retained BlackRock to analyse expected losses based on information that was available up to the time of the NYID approval.

The BlackRock team analysed transactions with a face amount of US$50.1bn - equivalent to 22% of MBIA Insurance's exposure to US$233bn of structured finance and international products as of 31 December 2008 - to estimate the 'present value' of MBIA's expected losses as of that date.

Using the same discount rate that MBIA selected to discount its payment obligations, BlackRock estimated future losses ranging from US$13.8bn in a base case to US$20.8bn in a stress case on merely the portion of the MBIA Insurance portfolio that it analysed. By contrast, MBIA Insurance's loss reserves for its entire portfolio as of 31 December 2008 were only US$2.335bn (before reinsurance) and just US$116m as of 31 December 2010 (before reinsurance), according to the annual statements MBIA Insurance filed with the NYID.

"The NYID should have, but did not, obtain any independent expert assessment of projected MBIA Insurance losses to compare to...MBIA management's loss projections. Had the NYID done so, it would have recognised that MBIA Insurance's loss projections were unreasonably much more optimistic than those of a disinterested third party," FTI senior md Ronald Greenspan testified in a 169-page sworn affidavit.

RMBS

Op risk review hits Aussie RMBS

In light of its new operational risk criteria, Moody's has placed the ratings of 56 tranches in 25 Australian RMBS transactions on review for possible downgrade. This is due to the insufficient liquidity support and operational risk in the transactions, the agency says.

The effected ratings include 37 Aaa, seven Aa1 and 12 A1 rated tranches. Based on the rating guidance, the maximum rating migration of the notes on review is expected to be to in the single-A range.

According to the new criteria, transactions with a risk of servicing interruptions due to seller insolvency should have appropriately sized liquidity to mitigate payment disruptions to bondholders. For a transaction with a servicer that is an authorised deposit-taking institution (ADI) and rated below Prime-1, the liquidity guideline under the new criteria is for one to three months. For a transaction with a non-ADI servicer and a back-up servicing plan, the liquidity guideline is for two to six months.

The transactions placed on review relate to five servicers: FirstMac/First Mortgage Company (Firstmac programme), RESIMAC (Resimac programme), Members Equity Bank (SMHL and Maxis programmes), Receivables Servicing (RHG and RMS programmes) and Pioneer Mortgage/Collins Security (Trilogy programme). These servicers have low credit estimates and most of their reviewed transactions have less than one month of liquidity support.

Three of the eleven outstanding Members Equity transactions and one of three outstanding RESIMAC transactions were not placed on review due to adequate liquidity support, however.

Further, Moody's notes that some of the operational risk criteria may also affect some SF ratings already on review because of the review, in turn, of Genworth Financial Mortgage Insurance.

The ratings review is expected to be completed within three months, the agency says.

RMBS

Servicing settlement pros, cons examined

S&P has commented on proposals from 50 state attorneys-general (AGs) to five of the largest US banks on mortgage servicing standards (SCI passim). The proposals are part of ongoing negotiations with servicers over establishing unified servicing standards and some form of a monetary settlement fund for borrowers affected by servicer misconduct.

Research analysts at the agency believe the proposals are a mixed bag. They see several long-term benefits, such as increased transparency and efficiency of residential mortgage servicing. However, in the shorter term they say the proposals could negatively affect recovery prospects by lengthening foreclosure and resolution timelines, suggesting that the measures may drive up servicing costs and workloads.

Meanwhile, principal forgiveness has several benefits, the analysts note. They suggest that a wide-scale principal forgiveness initiative could reduce the number of non-performing mortgages and foreclosure liquidations, which should also have a positive knock-on effect for house prices. Using principal forgiveness to avoid foreclosures could also benefit RMBS investors by maximising ultimate principal value.

However, potential obstacles for principal forgiveness include the fact that many homes headed for foreclosure were investment properties and are not owner occupied, so may not qualify for principal forgiveness. Additionally, the amount of principal forgiveness required to re-equitise borrowers may be much more than the amounts currently being considered. There is also the moral hazard of borrowers being incentivised to strategically default in order to qualify.

"The proposed settlement appears to have a direct effect on a number of areas in the housing market and on its various participants. In general, the proposal would seem to benefit delinquent borrowers, but we think it's likely to increase cost to servicers," note the S&P analysts.

They add: "In our view, the final version of any servicing settlement will probably be quite different from this initial proposal, given the servicers' initial reactions to the proposal. Additionally, this new servicing proposal may add to the many headwinds already facing the housing market and continue to negatively affect investor confidence in the RMBS market."

RMBS

Valuation inputs survey results revealed

RMBS investors are still cautious about European residential mortgages, says Derek Caussin, associate director of S&P Valuation and Risk Strategies

The results of S&P Valuation and Risk Strategies' latest European RMBS input assumptions survey, conducted in November and December 2010, suggest that investors believe the negative consequences for RMBS mortgage collateral from the economic downturn are still not fully realised. While much of the survey reflects the same 'wait and see' attitude polled six months ago, certain expectations now run contrary to previous surveys. For instance, recovery lag and prepayment rate expectations have slightly deteriorated; however, on the plus side, loss severity and default rate expectations have improved.

The RMBS survey has been regularly tapping market opinion over the past two years. It monitors the valuation input assumptions used by risk managers, credit analysts, portfolio managers and front-office staff in their assessment of the collateral behind all classes of European RMBS. In the latest survey conducted in 4Q10, 26 institutions took part, split evenly between the buy-side and sell-side.

The survey polls the four key input assumptions required to evaluate RMBS transactions: default rates, prepayment rates, loss severity and recovery lag rates. Comparing market participants' expectations for the performance of these credit metrics with previous surveys shows how sentiment is changing and helps provide a consensus view against which institutions can benchmark their own assumptions. Applying these consensus assumptions to transactions within ABSXchange then allows us to see the implications for bond cashflows and, ultimately, net present valuations.

Prepayment rates
Much of the latest survey reflects the expectations polled in June 2010. However, expectations for prepayment rates have notably reduced since then.

For example, 12-month prepayment expectations for the mortgages behind Italian non-conforming loan (NCL) RMBS have dropped to 5.70%, down from the 6.78% forecast polled in June 2010 and 8% polled in December 2009. While RMBS investors welcome lower prepayment rates, these results may reveal survey participants' heightened concerns over Italian unemployment.

This outlook can also be extended to the UK. Expectations for NCL 2004 vintage 12-month prepayments are also at a new low, with participants in the most recent survey forecasting 7.4% compared with 7.64% in mid-2010 and 8.11% at the end of 2009 (see chart one). The survey of 4Q09 also predicted a rise in prepayment rates 18 months following the survey.

Expectations for a similar rise remain in the 2Q10 and 4Q10 surveys with the same 12-18 month delay. In the survey of 4Q10, however, the rise is also significantly tempered. Survey respondents pointed to a likely interest rate rise towards the end of this year as a reason for the change in outlook.

Default rates
Although default rate expectations have fallen in the latest survey from the previous surveys in most asset classes, they are expected to rise at a greater rate. Chart two shows that in the 4Q09 survey, defaults in UK NCL 2007 vintage securities were expected to rise from 5.14% to 5.52% over 18 months and then fall to 5.33% by December 2011. The most recent survey has them rising from 4.74% to 5.71% over an 18-month period, then falling to 5.56% by December 2012.

These assumptions reflect a general pattern in default rate predictions for all vintages and regions. According to the survey results from 4Q09, default rates were expected to have either plateaued or begun to fall by now. However, in the latest survey they are expected to continue rising for another year at least. These default rate forecasts may reveal expectations for a slower return to healthy activity in the mortgage market than previously anticipated.

Furthermore, the same 'rooftop' curve seen at the end of the three most recent surveys - where default rates are forecast to deteriorate before they improve in 12-18 months time - is suggestive of consistent investor sentiment for short-term concerns, followed by improvements in the medium term.

Loss severity rates
Loss severity assumptions in the UK NCL, buy-to-let (BTL) and prime mortgage markets have seen minor improvements since the survey of 2Q10. Though loss severity expectations in these markets have risen consistently through the two previous surveys, the latest survey conducted in 4Q10 shows that these expectations have dropped across the board.

For example, loss severity assumptions for 2005 vintage securities in the UK NCL market fell from 36.22% in 2Q10 to 32.69% in Q4. Similar changes were seen in the UK BTL market, where loss severity assumptions for 2004 vintage securities fell from 33.23% in 2Q10 to 29.66% in Q4. However, there are two vintages in the UK prime market where loss severity assumptions have slightly increased, as shown in chart three.

Recovery lag assumptions
Italian RMBS recovery lag assumptions rose from the 2Q to 4Q10 survey across all vintages and asset classes, but have not risen back to the level they were in 4Q09. All vintages were expected to recover 57 months after default in 4Q09.

In 2Q10 the recovery lag expected for 2006 and 2007 vintage securities fell dramatically to as low as 38.67 months. In the most recent survey, expectations have risen across all vintages to within a single month of each other, between 45.93 months for 2004 vintage securities and 46.73 months for 2006 and 2007 vintage securities. Chart four illustrates the uniform expectations for recovery lag on mortgages underpinning Italian RMBS.

Cashflow implications
By running these latest set of survey assumptions through ABSXchange, it is possible to model the cashflows of existing or pre-issued deals. Taking as an example a typical Spanish deal from 2007, the lowest risk junior bond would now be expected to experience total losses of 6.87% compared with total losses of 0.52% using the assumptions polled in 4Q409.

However, what has not changed between surveys is that investors who purchased coupons within all the other tranches in that transaction are expected to lose all of their investments. But because of the greater loss in the lowest risk category, expectations of total losses across all categories rose from €29.3m in 4Q09 to €35.8m in 4Q10 - clearly a significant rise.

According to the assumptions polled in 4Q09, cashflows from a typical UK transaction from 2007 were expected to pay back on all bond classes, but by 4Q10 those expectations had shifted sufficiently to result in losses on the three highest risk tranches. Tranches E and F are now forecast to suffer 100% losses, while tranche Db is expected to suffer a loss of 29.56%.

These anticipated losses, which were not present 12 months ago, result from changes in assumptions that may seem insignificant. However, through the lifetime of a security the slight changes we are seeing in the survey results are the difference between investors receiving their full interest and principal and incurring losses or, indeed, losing their investment in its entirety.

Benchmarking scenarios
In order to allow investors to test the survey assumptions against their own holdings, ABSXchange is in the process of incorporating corresponding 'scenarios' onto the platform. In effect, this will give investors a benchmark view on their holdings' cashflows.

Meanwhile, with more issuers now agreeing to release the loan level data within RMBS transactions, it is now possible for investors to take a view on the credit performance of individual loans within RMBS collateral pools. In some cases - for instance with the RMAC transactions, which are now accessible on ABSXchange - investors can go one step further and actually stress test and forecast the underlying collateral's individual cashflows.

With the recent credit crisis, market participants have also been calling for improved insight around counterparty risk within RMBS transactions. Indeed, whether swap counterparties, liquidity facility or bank account providers, RMBS and other ABS investors have been calling for improved insight and analytics around all their potential counterparty exposures. To tackle this, in addition to providing a full list of current and historical counterparty changes, ABSXchange now allows investors to forecast a counterparty default and see how it impacts their bonds' cashflows.

Conclusion
The intention of this series of RMBS valuation surveys and cashflow calculations is to improve investors' understanding of the underlying credit risk in RMBS transactions. This is a slow process that began two years ago when the first RMBS valuation survey was carried out. With a record number of respondents, the latest iteration has formed a clearer picture than ever.