Contents

Insurance-linked securities

Cat bond blip

ILS new issuance remains on track

The Tohoku earthquake, combined with the latest update to RMS's US hurricane model has led to a slightly slower second quarter than anticipated in the ILS market. However, the sector remains on track to see healthy issuance overall in 2011.

Pricing discovery in the secondary ILS market occurred soon after the Japanese earthquake, according to Jean-Louis Monnier, head of ILS Europe at Swiss Re. "Once the physical parameters became public, it was clear that some bonds would be affected; for example, the market expected a full write-down on Muteki and this was later confirmed by Munich Re and AIR. While there was some initial uncertainty due to the non-availability of data from some of the reporting stations, the market quickly reached a consensus about the impact," he explains.

Moody's downgraded the US$300m Muteki 2008-1 class A notes from Ba2 to C on 31 March. At that time, the agency said it expected losses in the transaction to breach the attachment level and reach the exhaustion level, likely resulting in complete loss of principal to noteholders.

Since then, S&P downgraded the €75m Atlas VI Capital series 2009-1 class A notes from double-B minus to single-B on 23 May, as a result of aftershocks following the Tohoku earthquake. The issuer submitted to RMS two event notices concerning earthquakes on 7 April and 11 April 2011, which it determined to be covered events, with the index values amounting to 57.05 and 46.53 respectively.

S&P warns that noteholders will consequently now be at a higher risk for losses of principal and interest for subsequent covered events that occur before 31 March 2012. If the covered events that take place between now and 31 March 2012 do not trigger a reduction of interest or principal to investors, the agency says it expects to upgrade the bonds to double-B minus at the next reset in April 2012.

Overall, only about 10% of cat bonds outstanding are exposed to Japanese earthquakes but only a subset were directly impacted by the Tohoku earthquake because of the location of the earthquake away from Tokyo. Between direct and mark-to-market losses, per occurrence, aggregate and second event bonds led the Swiss Re Cat Bond index down by only 3%-4%. However, further losses may have been experienced by sidecars and collateralised reinsurance transactions undertaken on a private basis.

"Certainly the impact on the ILS market was relatively minor, compared with the magnitude of the earthquake. It demonstrates that cat bond structures work: given the location of the epicentre, there were no surprises for sponsors. Interestingly, despite the losses, investors appear even more attracted by cat bonds because of the higher yields on offer," Monnier notes.

ILS spreads widened by about 10% following the Japanese earthquake. It - along with the New Zealand earthquake from January - has also served to harden the market in terms of renewals. "We are clearly coming out of a tightening market and expect spreads to stabilise at a wider level, especially with respect to US wind and earthquake perils," Monnier confirms.

He says that the release of RMS' new US hurricane model, which has higher expected losses than in previous versions, has also contributed to the spread widening. Nonetheless, the market appears to be integrating the new model alongside other models and a consensus is emerging about where pricing should be.

Peter Nakada, head of the RiskMarkets group at RMS, indicates that expected loss will increase by 90% on average for outstanding ILS impacted by US hurricanes due to the introduction of its latest US hurricane model - RiskLink version 11. Industry loss bonds are likely to be affected the most - with expected loss increasing by 150%, compared to 50% for indemnity bonds.

The jump in expected loss is driven by changes in several components of RMS's model: activity rates for landfalling hurricanes; industry exposure; hazard; vulnerability; and storm surge. Its new approach to estimating activity rates is based on six models of activity rates applied to six defined regions - Texas, the Gulf, West Florida, East Florida, the Southeast and the Northeast.

West Florida was identified as experiencing the most significant increase in activity rates under the new model, driven by an increased probability of hurricanes falling in the region. By comparison, Texas and the Southeast showed a moderate increase, while East Florida and the Northeast showed a decrease.

With respect to hazard, RMS has incorporated 10 times more on- and off-shore wind observations since its last hazard update in 2003. The data suggest that hurricanes are decaying more slowly as they move inland and so are causing higher losses inland. Equally, a decrease in wind speeds along the coast has been observed, caused by increased surface roughness over water.

Vulnerability has also been updated based on new claims data, comprising US$19bn claims from 16 storms, including data from Katrina, Rita and Wilma that emerged too late to be incorporated in RMS's 2006 model release. Based in part on data from Hurricane Ike, RMS has increased the damage ratios for lower wind speeds, predominantly impacting the Texas and Gulf regions.

"The data indicates that large areas are impacted by moderate wind speeds and performed worse than we originally assumed in our vulnerability curves," explains Nakada.

Finally, for surge, RMS now simulates explicitly for wave formation and water flows in bays and inlets. "Depending on the shape of the bay or inlet, the force of the storm can be amplified significantly. The additional variability of results consequently equals additional risk," Nakada continues.

S&P placed 16 natural peril catastrophe bonds on credit watch with negative implications on 18 April, due to the release of RiskLink 11, noting that the remodelling of existing transactions could end up in materially different results. The agency expects any subsequent rating actions to be between one and three notches and believes the process will be finished by the end of May.

The bonds placed on watch are: Ibis Re series 2009-1 class A and class B notes; Ibis Re 2010-1 class A and class B; Lodestone Re 2010-1 class and class B; Lodestone 2010-2 class A1 and class A2; Montana Re 2009-1 class A and class B; Montana Re 2010-1 class C; Foundation Re III 2010-1 class A; Longpoint Re II 2009-1 class A and class B; and the Calabash Re III 2009-1 class and class B notes.

Monnier reckons the fact that the market is discussing modelling in the US is healthy. "It is a reminder that there is always modelling uncertainty," he says. "The key is that investors need to be paid appropriately for it. The multiples in the market suggest that they are, indicating that it is probably a good time to enter the sector."

Looking ahead, Monnier believes that 2011 will be an active year in terms of ILS issuance. "It is possible that the RMS model change, as well as the Japanese earthquake led to a slightly slower second quarter than anticipated. But I still expect issuance to pick up before the wind season begins and again before year-end. Overall, I think this year will see some healthy issuance."

Last year saw a resurgence in non-peak and non-US perils - for example, a European windstorm bond based on industry loss triggers - and Monnier predicts that this will continue. In the medium term, new perils are likely to be introduced; in particular, flood - for which the modelling capability has improved significantly.

CS

ABS

Euro ABS 'ignited'

The European secondary ABS market has seen its strongest and busiest week for some time, suggesting a turning point in activity. The primary market is following suit, with a variety of new issues marketing.

"There's been a real turn in the market this week; activity has picked up considerably and become very strong," one ABS trader confirms. Contributing to this turn is the positive response garnered from Santander's Fosse RMBS (see also SCI 19 May).

"The actual pricing levels on the Fosse deal looked very generous and it was exceptionally strong post pricing," the trader adds. "We haven't seen a huge amount of paper being traded, so it's been pretty well placed. If we could buy the bonds now, we'd be buying them at least 5bp higher from where they were originally."

A variety of other transactions have also hit the market this week. One is NIBC's €750m Dutch MBS XVI, a prime RMBS offering two standard triple-A rated tranches with two- and five-year WALs.

Another is Volkswagen's Driver España One, its first public Spanish auto ABS. The transaction includes senior triple-A tranches with 1.5-year WALs.

Meanwhile, in the secondary market, the trader says that nearly all asset classes have benefitted from this week's strong technical performance. "It's been strong in pretty much every asset class - whether it's prime RMBS, non-conforming, buy-to-let, CMBS or CLO bid-lists, they have all traded pretty aggressively. Right now, the tone is very positive: dealer bids remain strong and investors are still managing to get involved."

However, the trader is unsure as to how sustainable this strong performance is, as secondary paper threatens to run low in volume. "There's a strong technical background to this, but there isn't a huge amount of secondary paper out there. There's not much issuance away from the UK prime and Dutch market, so that technical squeeze is really supporting the market at these high levels."

The trader continues: "There's bound to be a bit of a pause as people sit back and start digesting and realise they don't want to stay on board with this rally. We also need to see if it brings in any selling, which so far it hasn't. People are constantly selling paper, but it's more to do with selling down their legacy portfolios than taking a view on the market, so maybe that will cool down the dealer bid."

Nevertheless, he explains that Granite's strong performance is indicative of the current steady environment. "Granite has been trading up today: the triple-A level is strong around investor buying and it seems like the double-As are probably following suit. I'm sure the rest of the capital structure will catch up eventually too. It feels as though there's still appetite, even at the tighter levels."

Indeed, the trader says that the European ABS market appears to have "suddenly ignited", perhaps because of the knock-on effect of a particular investor buying paper. "It could also be that the summer's looming and there won't be a huge amount of issuance coming up. But there are a few things on the horizon - for example, questions around the Greek sovereign restructure - that could knock the market off track," he concludes.

LB

CLOs

Bid-list madness for Euro CLOs

The European CLO market has been inundated with bid-lists this week, with mostly mezzanine paper up for grabs. At the same time, CLO equity appears to have piqued investor interest.

"We've seen an unusual volume of bid-lists so far this week. It's gone mad," one CLO trader says. With seven lists launching yesterday alone, the volume can only indicate a growing market appetite, he believes.

However, yesterday's largest list - totalling approximately £150m - did not sell. The trader explains: "It was all mezzanine triple-B rated paper, but it didn't trade and the reserves were not met. The bids were pretty good, but I just think the seller wanted more for his money on this one. It shows that demand is out there though."

Despite this demand, current "jittery" conditions are creating an unstable and unpredictable marketplace. But the recently announced Celtic RMBS tender offer (see SCI 24 May) may have a positive effect on European CLOs, the trader says.

He continues: "Sentiment is shaky off the back of sovereign issues, although I do believe that news on the Celtic tender - which has lifted the RMBS market a bit - may do the same for European CLOs. The sovereign issues are being felt more in the US anyway and, all in all, our market continues to be well bid - at least for now."

Overall, the trader says it has been "business as usual". "Bad banks have been out selling and the paper has been taken down quite well. It's mainly senior paper being sold and senior spreads have tightened as a result - you could almost say that for a reasonable decent-size bond, they're selling at sub-200 now."

Meanwhile, investor interest in CLO equity is said to have been piqued by last week's CLO conference, which focused in particular on its performance. "There was a lot of bullishness around the subject of equity and a feeling that it is undervalued," the trader confirms.

"Since the conference, we have seen a rising interest in equity and people being prepared to pay more for it. It is certainly trading better as a result," he concludes.

LB

CMBS

US CMBS pipeline continues to build

Spread widening continued to plague the US CMBS market last week. However, the new issue CMBS - and CRE CDO - pipeline appears to be building ahead of the holidays.

"Activity was fairly muted last week. Some bid-lists were circulated, but not a lot of bonds traded from them, so overall it has been pretty slow," one CMBS trader says.

The slow-down has been driven by the spread widening seen over the last week, the trader says. Generic super-senior paper, for example, widened by 10bp, while the AM part of the structure widened by 25bp and AJs by 50bp.

"When spreads widen, people don't want to sell. So, unless this changes within the next few days, it will continue to be slow for a while," the trader adds.

In the primary market, meanwhile, Freddie Mac's FREMF 2011-K13 Mortgage Trust priced last week. The A1 tranche printed at 60bp over swaps, the A2 at 65bp over and the B tranche at 210bp over.

Joining JPMorgan in the market with its US$1.45bn JPMCC 2011-C4 deal (see SCI 17 May) are RBS and Wells Fargo, with another US$1.45bn CMBS - WFRBS Commercial Mortgage Trust 2011-C3. The transaction is backed by 73 loans secured by 144 properties. Both deals - which are due to price within the next week - are expected to be received well.

Looking ahead, the June pipeline includes CMBS from Deutsche Bank and UBS, as well as from Morgan Stanley and Bank of America Merrill Lynch.

Finally, the market is expecting a re-emergence of CRE CDOs in the coming months. "A couple of deals, including one reportedly from Deutsche Bank, are being talked about in the market. All we know is that there are people working on such transactions," the trader concludes.

LB

RMBS

Fosse leads Euro RMBS rally

The European secondary RMBS market has surged back to life this week, with UK prime paper leading the way. The primary market has also received a boost, with demand for Santander's Fosse 2011-1 proving to be extremely high.

Fosse hit the market with a splash, having been upsized to €4bn due to investor demand. The transaction includes a €3bn A2 tranche, as well as longer tranches with 2.7-year and 4-year WALs - both of which were also very well bid.

"The Fosse deal went massively well: it was upsized based on demand, especially from US real money accounts," one RMBS trader confirms. "Post going through to trade, bids went straight to par at 15; in the Street now bids are par 20/25. Not much paper has traded, so it looks like it's been taken down really well."

Another new issue, which was announced yesterday, is Yorkshire Building Society's Brass No. 1 RMBS. The trader reckons that the deal - which is expected to be particularly well-received - will roadshow and price next week.

Meanwhile, prices in the secondary market have risen on bonds offered from bid-lists. The trader notes: "Bid-list bonds have traded through offers on the Street, so people are paying very high prices to trade off lists versus where it's trading in the Street."

He adds: "UK prime paper has seen a huge rally based on the fact that no dealers have it on their inventory. Clients have been asking us too, but we're unable to source it anywhere."

The trader also observes increased activity in German SME assets. However, with many conflicting evaluations among investors, a great degree of uncertainly hangs in the mix.

"There is more of a market for this paper on the Street, although there is a lot of uncertainly about how to value these assets. So we're still seeing a lot of different valuations from various dealers and clients thinking different things," the trader explains.

He concludes: "It's a more interesting space to be in versus non-conforming, where the job has been done in the sense that a lot of the risk has been moved now. We're not seeing so much on the Street; it's just the stragglers left. Maybe some of the dealers have bought bonds too high and now they're offered on the Street all day; clients haven't really come in on that stuff."

LB

CMBS

Old and new in CMBS 2.0

New trends are emerging but old ones are also reappearing in US CMBS 2.0, according to research analysts at S&P. They point to higher deal sizes, loan counts and bond class counts, as well as higher concentration and the return of limited pro forma underwriting.

With the exception of Cantor Fitzgerald's recent US$634.5m CFCRE Commercial Mortgage Trust 2011-C1, transaction sizes so far in 2011 have ranged from US$1.3bn to US$2.2bn and new issues are expected to stay generally in this range to the end of the second quarter. Loan counts have also remained steady this year, ranging from 37 to 57 and averaging 46.

In terms of geographic concentration, meanwhile, the S&P analysts note that many recent top-10 loans are located in non-primary markets - likely because competition is higher for primary loans, especially from coastal areas. "Historically, loan credit performance has been more stable in primary markets, mainly because properties located in secondary and tertiary locations don't have the same barriers to entry or supply constraints that their primary market counterparts do," they explain. "Additionally, they may not attract the same quality of tenants. As such, if a property in a secondary or tertiary market loses a significant tenant and suffers from a significant decline in performance, it may take longer to find replacement tenants and begin increasing rents in these markets."

Perhaps even more worrying are instances where valuations are believed by the analysts to be questionable, especially within larger loans for certain property types - particularly office and hotel - in primary markets. Again, this is probably attributable to the fact that lending is competitive in these types of markets, where insurance companies, pension funds, foreign investors and REITs could be bidding alongside CMBS issuers.

"The part that we believe should be most alarming to investors is that the appraisals appear to be building in upside in rents and occupancy to arrive at a value for the properties in question, instead of using in-place rents and tenancy at the time of closing," the analysts note.

Further, a noteworthy structural twist appeared in the Marriott Crystal Gateway loan - securitised in DBUBS 2011-LC1 - relating to an incentive management fee, which represents 50% of cashflow above certain profit levels. The analysts point out that it's highly unusual for the incentive management fee to be senior to debt service.

"Moreover, this fee will take a significant chunk from net cashflow when it happens. As such, one would need to assume a significant increase in RevPAR to offset it," they add.

The average daily rate would need to increase by an estimated 30% to maintain the most recent trailing 12-month NCF, assuming the fee increase happened today. While this may not fall under the usual definition of pro forma underwriting, there seems to be a similar concept at work here.

Meanwhile, weighted average LTVs - as measured by rating agency stressed figures - are up by about 9% in 2011 compared with 2010 and DSCRs have fallen by 0.14x. Loan constants, measured by the annual debt service payment divided by loan amount, have also fallen.

Over the same time period, weighted average triple-A credit enhancement levels are up slightly, at 19% this year compared with 17.5% in 2010. However, the MSC 2011-C1 and to some extent the JPMCC 2010-C1 deals exaggerate the increase somewhat.

Viewing the figures deal-by-deal, credit enhancement levels at the triple-A and triple-B minus rating categories appear steady in the 17%-18% and 5.5%-6% ranges respectively. In terms of 2011 transactions, LTV has settled around 90% and DSCR at 1.15x-1.25x. The JPMCC 2011-C3 deal is the outlier, with noticeably more positive metrics.

CS

ABS

ABS vp appointed

Barclays Capital has appointed Jonathan Wu as vp in its securitised products origination business (SPO). He will focus on consumer ABS and report to Cory Wishengrad and Diane Rinnovatore, the bank's co-heads of SPO. Wu was previously at JPMorgan, where he was vp in its securitised products group, focusing on auto and equipment ABS origination.

ABS

SIX adds four in evaluated pricing

SIX Telekurs has expanded its evaluated pricing team with four new hires in its Stamford, US office.

Chris Chun Ma and Ben Binxiang Qin have joined the valuations team as quantitative analysts. Chun Ma previously worked in portfolio analysis and asset allocation for AXA Advisors. Binxiang Qin has worked as a quantitative analyst at Great Plains Energy and Northern Stone Capital Management.

Jun Xu has joined SIX's US-based development team as a senior programmer analyst and will be dedicated to evaluated pricing projects. He most recently worked for Risk Resources as a quantitative risk programmer.

Dustin Cline joins the firm's US product development team as the evaluated pricing consultant for the Americas. He has worked as a valuation specialist for JPMorgan Chase and BNY Mellon.

ABS

Bank adds financial solutions md

The Bank of Tokyo-Mitsubishi UFJ (BTMU) has appointed Terry McKay as md and head of the global financial solutions group, within corporate and investment banking. McKay will manage a New York-based team working with relationship managers throughout the Americas to help BTMU customers solve complex financial issues. He will report to Randall Chafetz, the bank's head of corporate and investment banking for the Americas.

McKay was most recently evp of corporate finance at Rabobank International. Prior to this, he was md of structured finance at JPMorgan Chase.

ABS

Law firm adds Moscow partner

Jones Day has appointed Konstantin Kroll as capital markets partner. Based in Moscow, Kroll's practice focuses on debt and equity capital markets transactions, structured finance and derivatives. He also advises clients on a broad range of debt, equity, and synthetic instruments, repackagings and securitisations.

Kroll was previously with Allen & Overy, where he led that firm's debt capital markets and derivatives practice in Russia. He has acted for both issuers and managers on Russian and other international.

ABS

Broker on hiring spree

CRT Capital Group has formed a capital markets group, which will be led by Justin Vorwerk. The group will leverage the firm's distribution platform to provide clients with debt and equity origination services and liability management advice.

Vorwerk brings over 30 years of corporate finance and investment banking experience to CRT. He was most recently co-head of corporate finance at The PrinceRidge Group. Prior to this, he was the head of North American sponsor coverage at RBS and held senior banker positions at Goldman Sachs and Credit Suisse/DLJ.

Vorwerk will be joined by David Dickson, who was most recently senior md at FBR Capital Markets and, prior to this, held positions at UBS, Dillon Read and Merrill Lynch.

The firm's credit distribution team has also expanded with the addition of three senior credit sales professionals: Pat Downey, former head of distressed credit sales at Bank of America; Sandy Volpert, formerly of Seaport Securities; and Ted Hines, from Chapdelaine Credit Partners and Merrill Lynch.

Finally, CRT has augmented its product offering with the formation of a loan trading business headed by Marc Nuccitelli. This will allow the firm to act as principal when settling loan trades, it says.

CDS

Palmer Square debuts credit fund

Palmer Square Capital Management has launched the Palmer Square Absolute Return Fund, its first open-ended mutual fund. Developed in partnership with Montage Investments, the objective of the fund is to seek capital appreciation, with an emphasis on absolute returns and low correlation to the broader equity and bond markets.

The fund utilises a concentrated group of seven institutional managers that operate a broad range of hedge fund-type strategies, including long/short and event-driven credit. It is managed by alternatives veterans Christopher Long, founder and president of Palmer Square, and cio Angie Long.

CMBS

CRE debt platform expands

CW Financial Services is enhancing its CRE debt platform by hiring four CRE finance veterans, who will lead an initiative to broaden the menu of financing services the firm provides to its clients. The new team, comprised of former Capmark and Ventras Holdings executives, will be based out of New York and develop additional forms of debt placement, including bridge, conduit, mezzanine and other permanent financing solutions. Greg McManus, a 21-year industry veteran (SCI passim), will lead the group.

McManus was previously ceo of Ventras and held various positions at Capmark, including cfo of Capmark Financial Group. He will serve as md and report to Michael Berman, president and ceo of CWCapital (CW's lending and loan servicing subsidiary), and Daniel McNulty, president of Rockwood Real Estate Advisors (CW's wholly owned brokerage subsidiary).

Joining McManus is Larry Kligman, svp, a 33-year industry veteran with broad expertise that includes loan originations, structuring, sales and syndication; Eric Baum, svp, a 17-year industry veteran with a diverse CRE background and a core expertise in loan underwriting; and Dennis Owen, vp, a 23-year industry veteran with a background that includes loan origination, real estate valuation and finance. All three will report to McManus.

CMBS

Deutsche scoops CRE vet

Deutsche Bank has appointed Don Belanger as md in its real estate finance division. He will be responsible for commercial real estate financing activities in Europe, reporting to the bank's head of commercial real estate business in Europe Cyril Courbage.

Belanger was previously head of real estate capital markets at UBS and prior to this was co-head of Credit Suisse's European CMBS programme, Titan.

RMBS

Bank beefs up agency MBS desk

RBS has appointed Perrin Arturi as md on its agency pass-through trading desk, where he will be responsible for trading 15-year MBS. Based in Stamford, Connecticut, Arturi will report to Brian Song, the bank's head of agency pass-through trading.

With over 20 years of experience, Arturi joins from UBS, where he was most recently head of agency pass-through mortgage trading. Prior to this, he specialised in trading agency pass-through securities and an array of mortgage products at Bear Stearns and Donaldson, Lufkin, Jenrette.

Other recent hires to RBS' agency pass-through team include Matt Shiel from Bank of America and Christopher Miller, who joins in a newly expanded role in trading specified pools.

RMBS

RMBS vet moves on

Two Harbors Investment has appointed Diane Wold as md in its senior management team. In this role, she will aid the integration of the firm's new loan securitisation programme into its business model.

Wold was previously svp and md at GMAC Residential Capital, where she led its US residential mortgage loan securitisation programme. During her time at GMAC, she oversaw the securitisation of approximately US$400bn of residential mortgage loans, with a majority of the issuance being backed by prime jumbo loans.

ABS

Rating transparency rules proposed

The US SEC has voted unanimously to propose new rules and amendments to increase transparency and improve the integrity of credit ratings. The proposed rules would implement certain provisions of the Dodd-Frank Act and enhance the SEC's existing rules governing credit ratings and Nationally Recognised Statistical Rating Organisations (NRSROs).

"In passing the Dodd-Frank Act, Congress noted that credit ratings applied to structured financial products proved inaccurate and contributed significantly to the mismanagement of risks by financial institutions and investors. Our proposed rules are intended to strengthen the integrity and improve the transparency of credit ratings," says SEC Chairman Mary Schapiro.

Under the SEC's proposal, NRSROs would be required to report on internal controls, protect against conflicts of interest and establish professional standards for credit analysts. They would also be required to publicly provide - along with the publication of the credit rating - disclosure about the credit rating and the methodology used to determine it, as well as enhance their public disclosures about the performance of their credit ratings.

The proposal also requires disclosure concerning third-party due diligence reports for ABS, the SEC says.

ABS

Mixed performance for Aussie ABS

The first quarter for the Australian ABS market showed mixed trends, according to Moody's.

During January to March, delinquencies deteriorated across most Australian ABS deals. Those displaying spikes in arrears mostly consisted of consumer loans and/or non-novated leases. However, delinquencies remained stable for Macquarie Leasing's SMART deals with 70% or more novated leases, the agency says.

High loan concentrations in Queensland and other effects from the Queensland floods represented the main driver for arrears for the Bank of Queensland's REDS EHP trusts.

At the same time, defaults and recoveries remained stable in 1Q11- in line with, or better than Moody's expectations.

Looking ahead, the default rates for most transactions are expected to be steady, underpinned by Australia's robust economic growth. Collateral performance will be typified by net loss and gross levels remaining within expectations. Indeed, the stable collateral performance of 2010 is expected to continue in 2011, the agency concludes.

ABS

Oil and gas VPP deal rated

Moody's has assigned ratings to US$879.6m Glenn Pool ABS notes, which are backed by oil and gas volumetric production payments (VPPs). The five-year Glenn Pool Oil & Gas Trust I note has been given a rating of Baa2, while the ten-year Glenn Pool Oil & Gas Trust II note is rated Baa3.

The notes are backed by VPPs carved out of a net working interest owned by a subsidiary of Chesapeake Energy Corporation in approximately 3,300 producing wells in an oil and gas field in northern Oklahoma. The production history of the field dates back to 1960s.

Originated by Chesapeake Exploration (CELLC), the first note is backed by hydrocarbon deliveries under a five-year VPP and the second is backed by hydrocarbon deliveries under a 10-year VPP. Each VPP is a non-operating, non-expense bearing limited term overriding royalty interest in the production from a set of designated wells located in the Sahara oil and gas field. With 95% of the wells by value operated by CELLC, both VPPs have a pro-rata share of the production from the same group of wells.

ABS

Concerns remain over premium capture

SIFMA has welcomed the Senate Banking Subcommittee on Securities, Insurance and Investment's hearing on the state of the securitisation markets. However, the association has expressed its concern that certain elements of the recently proposed rules on risk retention as prescribed by the Dodd-Frank Act could negatively impact the market going forward.

In particular, SIFMA believes that the premium capture provisions have the potential to eliminate securitisation as a source of funding in many markets by effectively regulating - and diminishing - the profitability of securitisation transactions, in a manner well beyond what is economical for securitisation sponsors. "Policymakers, regulators and industry must work together to ensure a securitisation system that serves the public by properly incentivising all parties to the transaction, from the originator to the investor," says Ken Bentsen, evp, public policy and advocacy at SIFMA.

ABS

No springtime blues for timeshare ABS

Springtime improvements appear to be taking hold again for US timeshare ABS, according to Fitch's latest index results for the sector.

Timeshare delinquencies fell at the end of 1Q11 and were noticeably lower than levels seen in 1Q10. Defaults also increased modestly, though the agency expects the trend to be short-lived.

"Timeshare default trends typically lag those of delinquencies, so the recent improvement in late-pays is likely to extend to defaults over the next few months. However, with timeshare delinquency levels now approaching historical norms, incremental improvements outside of seasonal patterns should begin to level off," says Fitch director Brad Sohl.

The agency's rating outlook for timeshare ABS remains stable, given the expected stable collateral performance and ample credit enhancement levels. Total delinquencies for 1Q11 were 3.38%, down from 3.76% at the end of 4Q10. Additionally, delinquencies decreased by 19.21% from 4.19% at the end of 1Q10.

Monthly defaults increased to 79% in March 2011, up from 65% at the end of 4Q10. On an annualised basis, defaults were at 8.19% for the index in March. While up from the 8.07% observed in 4Q10, this level remains well below its all-time peak of 9.36% seen in January of last year.

ABS

Credit card charge-offs continue to improve

Charge-offs on US credit cards continued to improve in April, falling to 7.16% from 7.35% the month before, according to Moody's. The charge-off rate is expected to move below 7% in the next two months, on the way to eventually falling below 4% by the end of 2012, the agency says.

"We expect the charge-off rate to continue declining throughout 2011 and into 2012, as weaker borrowers have charged off and originations have added fewer new accounts into the securitisations, resulting in pools with an increasing percentage of higher-quality borrowers," says Jeffrey Hibbs, Moody's avp.

Pointing to further declines in the charge-off rate was another fall in the delinquency rate in April. The delinquency rate index declined by another 26bp in April to 3.53%, marking the 18th consecutive month of improvement. The delinquency rate is just 28bp away from its lowest monthly reading ever posted in the 22-year history of the Moody's Credit Card Index.

In April, the early-stage delinquency rate index fell by another 10bp to 0.88%, breaking the all-time low it set in March. "The ongoing decline in early-stage delinquencies this year speaks to the steady improvement in the credit quality composition of obligors in the trusts today, an improving economic backdrop and an increasingly responsible use of credit," adds Hibbs.

One indication of the compositions of trusts moving towards higher credit quality obligors over the past several quarters has been the high payment rate - the payment rate index remained over 20% at 20.02% in April. Although a 1.75% decline from March, the payment rate continues to be at levels not seen since the peak of the housing re-financing boom in 2006-2007.

Also in April the yield slipped to 20.13%, its lowest level since July 2009, mainly as need for principal discounting expires. Further, the erosion of trust yields pulled back excess spread from its all-time high the month before, as excess spread declined 133bp during the month to 10.18%.

CDS

Call for third country CCP rethink

New barriers to international clearing could be erected by proposed new regulations for OTC derivatives in the European Union, according to the Alternative Investment Management Association (AIMA).

AIMA, which strongly supports mandatory central clearing of eligible OTC derivatives contracts, is calling on EU lawmakers to reconsider a key provision of the European Market Infrastructure Regulation (EMIR). This provision could in effect exclude EU-established financial services providers from using CCPs that are not located in the EU, according to AIMA.

AIMA's call to adjust the part of EMIR relating to third country CCPs comes as the European Parliament's Economic and Monetary Affairs (ECON) Committee is scheduled to vote on the issue today.

In the European Parliament's draft text, a third country CCP would only be permitted to provide clearing services to EU entities if those entities obtained an authorisation in each individual EU Member State. Furthermore, the third country CCP would only be allowed to obtain such an authorisation if the European Commission recognised that the legal and supervisory arrangements of its home jurisdiction were "equivalent" to those contained within EMIR.

The EP has also added various other conditions that third country jurisdictions must meet in order for their CCPs to be able to obtain an EU authorisation and that are not related to the prudential regulation of CCPs. Taken together, AIMA believes it could be difficult for many third countries and their CCPs to meet these criteria given the differences between the requirements on CCPs, clearing members and clients.

AIMA ceo Andrew Baker says: "We believe it is important that, in particular, counterparties in the European Union and the US can still trade freely and use each other's financial services. We believe that it is important that the international nature of the OTC derivatives market is maintained and that any unnecessary restrictions on international trading are avoided."

He continues: "What is particularly troubling about these proposals is that they go beyond OTC clearing and could potentially capture CCPs which clear shares or bonds. If that were the case, we would need hundreds of equivalence decisions or face the possibility that EU financial services providers would not be able to trade abroad. We would encourage representatives of the different European bodies to meet with non-EU regulators in order to find pragmatic solutions on recognising third country central counterparties in Europe, as well as to limit clearly the scope of this to the G20 agreement on OTC derivatives."

CDS

CDPC expands permitted investments

CDPC Athilon has amended its operating guidelines to expand its permitted eligible investments to include equity and fixed income instruments for which its capital exposure to loss is limited to the amount paid for the instrument plus accrued but unpaid interest, if any, and each party to or issuer of an instrument is a corporation or SPV that is not in default with respect to the instrument to be acquired nor is otherwise in bankruptcy or in other insolvency proceedings at the time of acquisition. Haircuts equal to 100% will be used in calculating the value of these instruments for capital sufficiency purposes.

The amount Athilon is allowed to invest in such instruments is subject to the maintenance of its current counterparty rating of Ba1 in Moody's CDOROM v2.8 following the acquisition. The amendment does not have a credit impact on Athilon's ratings because the haircuts, in conjunction with the counterparty rating maintenance requirement and investment amount limitations, constrain the risk posed by such investments, according to Moody's.

The agency has determined that the amendment will not cause the counterparty and debt ratings currently assigned to Athilon to be reduced or withdrawn.

CDS

Indian CDS get green light

The Reserve Bank of India has issued guidelines on the introduction of single name CDS for corporate bonds, effective from 24 October 2011. The guidelines cover: the definition of eligible participants, product design, documentation, credit events, settlement methodologies, pricing/valuation methodologies, risk management, collateralisation and margins, and trade reporting.

The guidelines take into account the feedback received from market participants and other stakeholders, following an RBI request for comment in February. The RBI recognises that the creation of market infrastructure, such as trade repositories, is essential for the development of a CDS market.

CDS

Dodd-Frank extension passes committee

Legislation that will extend the effective implementation date for the derivatives-related section of the Dodd-Frank Act by 15 months, H.R. 1573, has been passed by the House Financial Services Committee. The legislation will provide additional time for regulators to draft rules, conduct additional cost-benefit analysis and consider the cumulative impacts of these rules on the market and how they would affect businesses and consumers, according to SIFMA.

"Dodd-Frank created a whole new regulatory structure for derivatives markets and it is vitally important to our economy that regulators get this new structure and the underlying rules right," comments Ken Bentsen, evp, public policy and advocacy at the association. "While we remain committed to fully implementing the derivatives provisions in the Act, we believe that the current 21 July 2011 deadline does not provide adequate time for regulators to consider the critical issues related to this new regulatory system for over the counter derivatives markets."

CDS

Draft EU derivatives regs approved

The European Parliament's Economic Affairs Committee yesterday approved - with amendments - the European Commission's draft regulation on OTC derivatives, CCPs and trade repositories (SCI passim). The regulation will now go to the full Parliament for a vote in July.

During the vote, MEPs rejected suggestions by some EU Member States that all derivatives should be governed by this regulation. Instead, the rules will apply only to OTC derivatives, with reporting obligations to apply to all derivatives. In terms of exemptions to the clearing obligation, there will be a special regime for pension funds, provided that the national capital requirements offer a guarantee similar to cleared contracts.

Meanwhile, interoperability is limited to cash securities. A CCP will have to function in line with the standards for at least three years before it can apply for authorisation for interoperability.

Finally, the draft regulation envisages a central role for ESMA in terms of working closely with national supervisory authorities and having an important stake in authorising new CCPs to the market. The authority will be allowed to carry out on-site inspections as part of its remit.

CDS

Already-stressed Euro sovereign CDS widen

The highlight of a fairly uneventful week of CDS spread activity was some widening among already-stressed European sovereigns, according to Fitch Solutions.

Spreads on Greece widened by 5% on 23 May alone in light of the sovereign's rating downgrade late last week. "Already pricing at distressed levels, CDS on Greece are likely to remain sensitive to news surrounding a potential debt restructuring," says Fitch director Diana Allmendinger.

In light of the agency's revised rating outlook on Belgium, spreads on Belgium and Italy widened 5% after both sovereigns saw increased credit ratings pressure.

Elsewhere, CDS on Spain widened by 10%, while spreads for Italy came out by 9% over the course of last week. "Election and fiscal concerns are likely responsible for Spain's underperformance," adds Allmendinger.

The spread movements for Italy and Spain were most notable in a week where European CDS widened by just 1.1% overall.

CDS

CCP pros and cons examined

ISDA has released a paper on the function and issues associated with the central clearing of OTC derivatives. The paper argues that central clearing can provide significant benefits to the stability of the financial system. Current statistics indicate that approximately 50% of the interest rate swaps volume outstanding and over US$17trn of CDS have been cleared.

ISDA suggests that CCPs can successfully reduce and reallocate counterparty risk through rigorous preparation for and management of member defaults. But CCPs can also create systemic risk and so it is imperative that they have strong and conservative risk management and sufficient financial resources to withstand stressed markets, according to the paper.

Further, the paper highlights that the margin policies of CCPs can pose risks to the efficient functioning of the financial system. Mandatory clearing of OTC derivatives will lead to a large amount of liquidity being tied up as margin at CCPs and increases in margin requirements by CCPs during a crisis could be destabilising.

The paper concludes that CCPs should generally align control, governance and membership requirements with the interests of participants that absorb their risks and share their losses.

CMBS

CMBS loan defaults to exceed 12%

Increasingly successful loan modifications and growing new issue volumes will not be enough to stop rising US CMBS loan defaults, which are likely to exceed 12% by the end of this year, according to Fitch.

Loan defaults increased by 20% last year, with 1,477 loans totalling US$22.09bn defaulting for the first time in 2010. Cumulative loan defaults increased to 10.6% through the end of last year, compared to 6.59% through the end of 2009.

The pace of loan defaults declined to US$3.5bn during 4Q10, following a high watermark of US$8.41bn during 1Q10. "Although CMBS loan defaults declined over the course of 2010, it is still too early to predict a meaningful decline. Commercial real estate fundamentals are still lagging the overall economy," says Fitch md Mary MacNeill.

Not surprisingly, 2007 CMBS deals led all vintages, with nearly 50% of all new loan defaults coming from 2007 deals. The 2006 and 2005 vintages followed, with 19.2% and 16.1% respectively. Recent vintage large loans also continue to be a problem spot for CMBS, with 22 defaulted loans greater than US$100m emanating from the 2005-2008 vintages.

Multifamily led CMBS loan defaults last year, with 28.4% of the total. Office and retail followed with 24.2% and 23.7% respectively, with hotel rounding out the top four at 16.4%. Office properties are likely to experience the most stress in the coming months, with loan defaults increasing last year and likely to continue rising this year.

In 2010, US$5.36bn of loans backed by office properties defaulted compared to US$3.58bn in 2009. Office was second to multifamily in 2010 loan defaults.

"New CMBS loan defaults are likely to be from loans beginning to amortise. Future loan defaults are also likely to stem from properties in struggling or slow markets not likely to keep tenants at current rental rates," says Fitch director Britt Johnson.

CMBS

DB's CMBS shaping up

Further details have emerged about Deutsche Bank's much-anticipated new issue European CMBS (see SCI 17 February). The transaction - dubbed DECO 2011-E5 - is expected to be sized at £302m and comprise three tranches with the most senior tranche totalling £235m, according to ABS analysts at Chalkhill Partners.

The deal is backed by a five-year, 66% LTV loan to the Blackstone Group and secured by the Chiswick Park office complex. The complex consists of nine properties, with 36 tenants.

CMBS

US CMBS loss severities decrease

The current historical weighted average loss severity for loans backing US CMBS that are liquidated at a loss decreased in the first quarter of 2011 to 38%, down from 40% the previous quarter, says Moody's. Excluding loans with de minimis losses, the historical weighted average loss severity decreased to 52%, down from 53% a quarter ago.

The declines were the first reduction in the severity of losses since the fourth quarter of 2008. "As commercial real estate markets begin to bottom out and valuations firm up, loan defaults should taper off and smaller severities of loss can be anticipated," says Keith Banhazl, Moody's vp.

The agency expects to see stabilising property values, higher transaction volumes, a slowing in the pace of loan delinquencies and greater liquidity for commercial real estate in 2011. Weighted average severities remained up by 4% year-over-year in the first quarter.

From April 2010 through March 2011, a total of US$11.4bn of CMBS debt was in liquidation - a US$7.8bn increase over the same period a year earlier. During the first quarter, an additional 391 loans liquidated for a loss at a weighted average loss severity of 30.4%, compared to 425 loans of 45.9% a quarter earlier.

Loans backed by healthcare properties have the highest weighted average loss severity at 59%, while loans backed by office properties have the lowest weighted average loss severity at 34%, Moody's reports.

CMBS

CPPI hits post-2007 low

US CRE prices as measured by Moody's/REAL National - All Property Price Index (CPPI) fell 4.2% in March, bringing the index down to its lowest level since its peak in October 2007. The index is now 47% below its October 2007 level, but a high volume of distressed transactions are weighing on performance.

Moody's adds that a recent pick-up in the volume of transactions, is a positive sign for the overall CRE market and sets the stage for recovery. In March, there were 182 repeat-sales transactions totalling nearly US$2.5bn, a significant increase by both count and balance over February, says Moody's. It was second highest number of repeat-sale transactions since 2008, the total only exceeded by that of December 2010, which benefitted from being the end of the year.

"The CPPI continues to bounce along the bottom as a large share of distressed transactions preclude a meaningful recovery of overall market prices at this time," says Tad Philipp, Moody's director of CRE research. "Indeed, the post peak low in price has been reached in the same period as a post peak high in distressed transactions has been recorded."

In March nearly one third of all repeat-sales transactions qualified as distressed. "Given that it may take 12 to 24 months to foreclose on a property and execute an REO sale there is a lag effect that results in fewer distressed transactions coming to market in the early stages of a downturn and an increased level in later stages (i.e., now)," says Philipp.

In additional indices published this month, Moody"s quarterly national indices for the four property types all showed declines in first quarter 2011. Industrial recorded the largest decline, at -7.7%, followed by office -7.1%, apartment -4.7% and retail -4.5%.

CMBS

EMEA special servicer activity continues apace

April 2011 marked another month of high activity for specially serviced loans in EMEA CMBS transactions, says Moody's. During the past month, seven loans were newly transferred into special servicing, while the total number of specially serviced loans climbed up to 92 - 67% higher than one year ago.

60 loans passed their maturity dates since the beginning of the year until the end of April. Of these, 19 loans (32% by loan count) have been fully repaid or prepaid, 17 loans (28%) had term extensions, while 23 loans (38%) are in special servicing for a work-out. The remaining loan was transferred to special servicing in 2009 and was repaid with partial losses in April 2010.

A further 85 loans have scheduled maturity dates in the remainder of 2011. Of these, 11 have been prepaid and four have already been granted an extension. 12 loans are in special servicing due to various defaults, which leaves 58 loans with approximately €4.2bn balance that needs to be refinanced by year-end.

Overall, loans have been in special servicing for an average of 1.3 years, with the longest loan being in special servicing for 4.5 years. Although the UK is the largest contributor to loans in special servicing in terms of balance - at 36 loans and €6.8bn outstanding - Germany surpassed the UK in April this year, with 38 loans in special servicing, having more than doubled in size since one year ago.

Loan work-outs have so far been fully completed for nine loans, resulting in junior noteholders realising losses in seven different CMBS transactions. At the loan level, realised principal losses range from 1% to as high as 90%.

An additional 12 loans have been repaid, with no losses as the loan sponsors were able to secure refinancing while in special servicing. Out of the loans currently in special servicing, 12 loans are in their final stages of work-out, including the loan securitised in Epic (Industrious), for which the underlying properties have been sold.

While the last restructured loan to have been corrected was one year ago, 21 loans are under a standstill agreement or some form of restructuring. Overall, loan restructurings and modifications are expected to continue, which will primarily entail loan term extensions.

Given the number of loans that need to be refinanced by year-end and over the next two years, Moody's expects loan defaults to increase and special servicing activity to remain elevated.

RMBS

Legacy non-conforming RMBS prepped

Credit Suisse is in the market with an unusual standalone non-conforming RMBS dubbed Aggregator of Loans Backed by Assets (A.L.B.A) 2011-RP1. Preliminarily rated by S&P, the transaction comprises up to £278.6m floating-rate notes and up to £88m fixed-rate notes. A tranche of subordinated notes is also expected to be issued on the closing date.

The deal will be backed by a pool of re-performing non-conforming loans secured by first-ranking mortgages over properties in England, Wales, Scotland and Northern Ireland. The loans were aggregated and then sold to the issuer by Webb Resolutions.

The originators are Mortgages PLC, Edeus Mortgage Creators, Paratus AMC (formerly GMAC RFC), Platform Funding and Wave via intermediary channels. None of the originators are currently originating mortgage loans and Edeus Mortgage Creators is in liquidation. Accordingly, the portfolio consists of legacy assets.

On the cut-off date - 3 May 2011- 59.32% of the pool by principal balance was in arrears of at least one monthly instalment and 41.54% of the collateral was subject to a payment arrangement. Under the transaction documents, the issuer will exclude from the pool loans in arrears of more than two months, unless the borrower has paid an instalment at least equal to their monthly subscription in at least four of the last six months.

In addition to a general reserve fund, the transaction will feature a class A reserve fund, which will be topped up in the waterfall senior to all amounts other than senior fees, class A interest and amounts required to cure either of the class A note principal deficiency ledgers (PDLs). The rated notes will be overcollateralised by approximately 25% and will also benefit from a PDL mechanism, which traps excess spread if principal losses occur.

RMBS

Two Harbours preps debut RMBS

Two Harbors Investment Corp says it has taken the first step towards setting up a securitisation issuance programme by partnering with Barclays Bank to close on a US$100m mortgage loan warehouse facility, subject to future increase. The facility will be used to aggregate prime jumbo residential mortgage loans that the company will acquire from select mortgage loan originators with whom it has chosen to build strategic relationships, including those with a nationwide presence. Two Harbors is targeting a US$250m deal size for its initial RMBS, with Barclays Capital acting as underwriter.

"This programme is a natural expansion of our current business model and will serve to complement and enhance the Two Harbors' MBS brand," says Thomas Siering, Two Harbors' president and ceo. "We believe we can create mortgage credit investments at attractive yields resulting from high-quality loan origination and securitisation, while further extending the runway for the non-agency allocation in our portfolio. It is an exciting development in our ongoing mission to balance risk and reward in the mortgage sector for the benefit of our shareholders."

RMBS

Celtic tender offer launched

Ulster Bank Ireland has launched a tender offer for 15 classes of RMBS notes issued under the Celtic Residential Irish Mortgage Securitisation No 9, 10, 11 and 12 series. The bank says it is seeking to provide liquidity to noteholders by enabling them to exit the transactions, as well as to strengthen its financial position by purchasing some of the notes at below par.

Class A2 notes are being tendered with minimum purchase prices of between 77%-99.5%, class Bs between 48%-57% and class Cs 42%-50%. The aggregate principal amount outstanding of the notes accepted for purchase and the amount the bank will pay for them will be determined pursuant to a modified Dutch auction procedure.

The bank currently proposes to accept for purchase up to €1.7bn in aggregate principal amount outstanding. It will also pay an accrued interest payment in respect of notes accepted for purchase. In order to participate, noteholders must validly tender their notes by 7 June.

Ulster Bank notes that no decision has been made in relation to whether it will repurchase the underlying mortgage portfolios to enable any of the issuers to exercise their call options at the respective step-up dates of the relevant classes.

CLOs

New issue CLO equity returns: the impact of declining loan spreads

Andrew Jacobs, associate director at Moody's Analytics, finds that declining loan spreads can impact CLO equity returns in a variety of ways

Relative to historical levels, recent new issue CLO deals have featured high subordination, high tranche spreads and high underlying loan spreads to match - all positive signs for buyers of rated notes. Loan spreads have been declining, however, and already fast loan prepayments may accelerate further.

Should this environment continue, how will it affect equity returns? Among other results, we found that:

• For each 0.5% decline in loan spreads over three years, the equity IRR can drop by over 1%.
• The manager's choice in minimum weighted average spread covenant, all else being equal, can vary the equity IRR by over 2%.
• For each additional 5% of CPR, the equity IRR can decline by over 0.5%.
• The choice not to call the deal after three years greatly increases the volatility of the equity IRR.

Spanning 480 loan spread, prepayment, call date and manager behaviour scenarios, Moody's Analytics used a representative model in CDOnet of a new issue CLO to simulate equity IRR across 10,000 collateral default paths. The weighted average one-year annualised default probability of the underlying portfolio was about 5.4%.

For each of the 480 scenarios, we focus on three individual simulation paths out of the 10,000: the median, the 10th percentile and the 90th percentile. Table 1 highlights the best and worst of each result. For example, the highest median IRR out of all 480 scenarios is 8.88%.

The impact of declining loan spreads on equity IRR
The equity IRR is dependent on several factors, so let's examine the impact of each variable individually. For example, holding all else constant, how much does the equity IRR deteriorate as loan spreads tighten linearly across three years?

Assuming a three-year call, 35 CPR and declining loan spreads, every time we drop future loan spreads by 50 bp, the equity median IRR declines by about 60bp. With no call, the effect is more pronounced - each 50bp drop in future loan spreads causes, on average, about 100bp of equity IRR deterioration.

Table 2 shows that the decision whether or not to call the deal is critical. With a call, the equity tranche's median IRR varies by over 3%, depending on future loan spreads. Without a call, the equity is more volatile, with greater than 6% of variation.

 
Choosing the minimum weighted average spread: should the manager follow spreads down?
While managers have no control over loan spreads, they do control their deal's minimum weighted average spread covenant, typically by selecting it from a collateral quality matrix. In a declining spread environment, this minimum spread option is effectively a proxy for the choice between reinvesting in new loans versus winding down the deal. Thus, it can strongly affect equity returns.

For example, assuming no call and a 35 CPR, Table 3 shows that changes in minimum spread covenant can vary the equity median IRR by over 2%. In the scenario where future loan spreads tighten to 200bp, dropping the minimum spread covenant to compensate results in a 4.24% equity median IRR. Choosing, instead, to stop reinvesting and start paying down liabilities results in an IRR of 6.26%.

The effect of call options on equity returns and cashflow WAL
The call option adds another facet to the decision regarding minimum spread. To illustrate, we highlight one future loan spread scenario in Table 4.

 
With a call in three years, the equity median IRR is maximised by picking a low minimum spread covenant and continuing to reinvest. Reinvestment potentially builds par and the three-year call means the cashflow average life of the equity tranche would not be shortened much by accelerated paydowns - in this case, the equity's cashflow WAL is about 2.7 years, regardless of the minimum spread choice.

Turning off the call highlights a different dynamic - the decision between collecting excess spread for as long as possible versus winding down the deal quickly to capitalise on the equity's discounted purchase price (in this case, 92). For this scenario, travelling the middle of the road with a 350bp minimum spread results in the lowest IRR. In Table 5, we highlight the no-call scenario from Table 4 and show the impact on the equity's cashflow WAL.

Besides affecting IRR, the minimum spread covenant can affect the cashflow WAL of the equity tranche in Table 5. The range is more than two years.

Prepayments also have an obvious effect on average life, but they can affect equity returns as well. By how much?

If loan spreads tighten to 200bp, each additional 5% of CPR can reduce equity IRR by up to 50bp. With spreads staying at 410bp, on the other hand, each additional 5% of CPR reduces the equity median IRR only slightly and even improves it at the highest CPR levels (see Table 6). This is because, at 40 and 45 CPR, the speed at which the equity tranche is redeemed starts to outweigh the excess spread it misses when the deal winds down quickly.