Contents

CMBS

Tip of the iceberg

Special servicers to benefit from increased CRE disposals

Following the successful sale in August of the Anglo Irish portfolio, several more non-core commercial real estate asset dispositions could be on the way. Special servicers will need a comprehensive skill-set to deal with the volume of troubled assets due to be sold, but could benefit significantly from them.

With a principal balance of approximately US$9.5bn and comprising loans on 250 properties, the Anglo Irish portfolio was very strongly bid by several institutional buyers. The pool is one of the largest to hit the market since the downturn began in 2007. Lone Star won the auction for the sub-performing assets, comprising about half of the portfolio, while Wells Fargo and JPMorgan bought the performing assets.

David Levin, vice chairman of LNR Property, says that non-core CRE disposals allow for the deployment of large amounts of institutional capital with risk-adjusted returns, which he notes can be particularly attractive. He believes that special servicers have a large role to play in these disposals.

"The special servicers basically design the business plan asset-by-asset and then execute on that business plan - whether it is a discounted payoff, a foreclosure, A/B structure or another approach. This is the same in the US and in Europe," Levin explains.

By getting involved in asset dispositions, special servicers can add significant size to their portfolios. However, as more portfolios come to market, the capacity to service them is somewhat lacking.

Levin notes that the required expertise is not easy to come by. "The first thing that is needed is the ability to underwrite asset-by-asset every piece of the portfolio and identify what the eventual outcomes might be. That requires significant infrastructure and expense, and expertise."

He adds: "You need professional asset managers and workout experts. It is really important to have people that have been trained in this art because it is not something that you just wake up one day and do. LNR has been doing it since 1992, so there is a lot of DNA and a lot of technical training that goes into it."

Although LNR is larger than its competitors, Levin notes it is not only size that is important. Between the US and Europe, LNR employs around 400 people in the workout side, which is a number Levin says rival firms do not come close to.

It is not just the number of people available to workout a loan, but also the experience of those people that counts. Over the 20 years that LNR has been involved in the market, for example, a lot has changed. Experiencing those changes all contributes to the 'DNA' required.

"A lot has changed with how pervasive CMBS has become in those workouts," Levin explains. "How you manage your workout process is now largely governed by the pooling and servicing agreements. Whereas before it was just you and the borrower, now there is a lot that is pursuant to documentation of the trust and the servicer is acting as a fiduciary to that trust."

Servicers such as LNR will want to draw on all the experience they can, because the market is set for more disposals in the coming months and years. Levin agrees that the sales seen so far could be just the beginning of much more activity to come.

"What we are starting to see is bank portfolios that are coming to market, where banks are testing market depth and pricing," he concludes. "We think there is a lot more to come: we have seen the successful marketing and sale of several portfolios, but we think this is the tip of the iceberg. There will be a lot more of this over the next two to three years, both domestically in the US and in Europe."

JL

Risk Management

Tall order

Banks ready CVA infrastructure, strategies ahead of Basel 3

The advent of Basel 3 significantly changes the way in which financial institutions address counterparty credit risk (CCR) and credit value adjustment (CVA). While a small number of banks are geared up for the regulatory changes and are actively managing CVA, the complexity and cost of implementing the necessary infrastructure remains a daunting task for the majority. (The full SCI CVA Special Report can be downloaded here.)

"Moving from Basel 2 to Basel 3 means quite a change in the level of counterparty risk analysis," confirms Rohan Douglas, ceo at Quantifi. "For most banks that may not have been doing anything particularly sophisticated in that space, it's a huge step up in terms of where they were to where they need to get to."

According to Dan Travers, product manager, risk solutions at SunGard, three big challenges are associated with CVA: the policy challenge, the data challenge and the calculation itself. "Banks need to decide whether CVA will be charged on some or all transactions," he says. "They then need to get the go-ahead and investment to implement a CVA function across the bank, which can take a considerable amount of time."

He adds: "Many of the Tier 1 US and European banks have started to insist that all deals are subject to a CVA charge, which comes out of the P&L of a deal, and will be actively managed by a centralised CVA desk. Getting an agreement from board level as to what the bank is going to do, however, is a big challenge."

CVA desks - of which there is a growing number - not only provide counterparty credit insurance to derivatives dealers, but also proactively monitor the state of the market and hedge positions to maintain the quote they give to dealers. Some desks have embarked upon CVA securitisations, whereby CVA exposures are pooled, tranched and then sold on to investors.

"People are at different stages in terms of completing these transactions," says one structured credit manager. "From a regulatory perspective, I think this market has the potential to grow. The capital charge arising from CVA under Basel 3, which is based on the stressed VaR adjustment, is much larger than the capital charges under Basel 2. Therefore banks have the incentive to carry out these transactions because capital charges in this space are increasing so much."

Not everyone agrees that this market has a future, however, with questions over the investor base and the complexity of such deals. "While it is good to push the boundaries of financial engineering with talk of securitising CVA, at the same time we also have to understand our own limitations," notes Dan Rosen, ceo of R² Financial Technologies.

It is questionable whether investors will be able to understand and model the underlying risks of a structure based on the CCR of complex underlying portfolios of derivatives, which are also changing continuously. "I think we will look for better solutions, but I don't think securitisation is the solution to managing counterparty credit risk. Just because we can do it, it does not mean we should do it," Rosen adds.

AC

ABS

SCI Start the Week - 10 October

A look at the major activity in structured finance over the past seven days

Pipeline
European transactions dominated the pipeline by the end of last week. It comprised two sizeable RMBS - £9bn Silverstone Master Issuer series 2011-1 and €3.5bn Home Loan Invest 2011 - and the Penarth Master Issuer 2011-2 credit card deal. A European windstorm cat bond, the €100m Calypso Capital, and the A$350m SMART Trust series 2011-3 rounded the pipeline out.

Pricings
Three credit card deals - the US$1bn Gracechurch Card Programme Funding series 2011-5, the US$545m-equivalent Turquoise Credit Card Backed Securities series 2011-1 and the US$1.1bn American Express Credit Account Secured Note Trust 2011-1 - printed last week, along with two auto ABS (US$1.1bn Ford Credit Floorplan Master Owner Trust A series 2011-2 and US$750m Santander Drive Auto Receivables Trust 2011-4). Additionally, two European RMBS priced: €792m Arena 2011-2 and €5.9bn Stichting Green Lion III.

Markets
The primary US consumer ABS market was active last week, with five transactions pricing. At the same time, the FFELP student loan ABS sector saw S&P downgrade 118 tranches that were unable to meet its triple-A stress scenario, with little market impact.
"Investors' focus was definitely more on the primary market this week," say securitised products analyst at Barclays Capital. "As a result, secondary market activity slowed. Sellers continued to outnumber buyers, with most sales occurring in the short end of plain vanilla products as investors looked to extend duration and pick up yield from primary issuance."
The selling pressure and lack of focus on the secondary market served to push spreads wider in many sectors. Fixed rate senior credit card spreads were the only segment to emerge unscathed, but senior floaters were 3bp-5bp wider and fixed and floating rate mezzanine/subordinate credit card paper finished the week 15bp-25bp wider. More off-the-run sectors were also weaker, although trading activity was limited.
At the same time, Bank of America Merrill Lynch ABS research analysts suggest that the rating actions taken by S&P remove some of the uncertainty that has been hanging over the FFELP ABS market. However, they add: "We would have thought S&P would have found mitigating factors for more deals."
Before the rating action, spreads on longer-dated FFELP ABS were 5bp-7bp wider week-on-week and were unchanged afterwards, partly because the announcement took place late Friday and before a holiday weekend. The BAML analysts expect the rating actions to have a minimal impact on FFELP ABS spreads, as the rating actions were largely already priced in.
Meanwhile, US CMBS underperformed the broader markets, according to Barclays Capital US CMBS strategists. "While equities quickly recovered after the mid-week decline, a similar move has not followed (at least yet) in CMBS," they say.
The strategists go on to suggest a number of potential explanations. "We believe that the most significant driver of the current dislocation is lower CMBS liquidity. The upcoming long weekend was likely one of the contributing factors to the lower trading volume at the end of the week, prompting us to believe that there might be some recovery in the 2006-20007 duper space after the holiday. However, since Tuesday will coincide with the upcoming new remittance period, all eyes will be on the new remittance tape, watching for new delinquencies, modifications and watchlist transfers."
On a low volume, 2006-2007 lower quality dupers were about 15-20bp wider week-on-week and more substantial widening occurred in the AM space. The Barcap strategists add: "AJs seems to be finally stabilising in the low dollar-price territory, making them less sensitive to the macro-driven volatility."
Meanwhile, CLO market participants were last week focused on their month-end valuations, with marks expected to be down by three to five points on average across the capital structure. The secondary market remains mixed, albeit with European CLO tranches seeing heightened demand. European CLOs continue to trade at a wide basis to US deals, with the basis becoming wider over the last few months, thereby providing opportunities to pick up cheap paper.

Deal news
• ABPP has confirmed that the total redemption amount (post-swap breakage costs) for EPIC Opera (Arlington) will be £132.3m, following the sale of Reading International Business Park. Due to the net proceeds being below the allocated debt amount for the property, they will be applied pro-rata with the distribution set to take place on the 28 October IPD.
• Nearly a year has passed since modifications to the US$2.7bn Beacon Seattle & DC Portfolio loan were set in motion. However, with concerns over equity shortfalls at maturity and the inability of some servicers to protect senior bondholders' rights, the jury is still out as to whether the restructuring has been - or will be - classified a success.
• An investor notice was released on 6 October advising of a manifest error in the documentation for the recently priced Mesena CLO 2011-1. The error is contained in the sections entitled 'Article 122a of the Capital Requirements Directive' and 'Description of the Portfolio Servicing Agreement' of the prospectus
• Nomura Corporate Research and Asset Management has filed a fifth amended and restated notices of proposed assignment of the investment management agreement for Clydesdale Strategic CLO I and Clydesdale CLO 2005. It has also requested consent from subordinated notes and rated notes, as well as a waiver from the rated notes.
• Dynex Capital says it expects to exercise its option to refinance this month approximately US$74.2m in collateralised financings with repurchase agreement financing in order to take advantage of the lower interest rate environment and reduce its overall borrowing costs. Approximately US$23.7m of the collateralised financings is a CMBS issued by the company in 1998.

Regulatory update
• The European Banking Authority (EBA) has published a set of answers to questions received about Article 122a of the EU's capital requirements directive. In "a huge step forward for the market", the answers build on the CEBS guidelines from December 2010 and clear up many previous uncertainties.
• The US SEC has issued a report on its observations and concerns following an examination of ten credit rating agencies registered as NRSROs. Although improvements were noted, concerns about each of the NRSROs remain.
• Many market participants appear to underestimate the potential impact of Solvency II on European ABS. This has led to a call for the securitisation industry to intensify its lobbying efforts in the region.
• The FDIC is to hold a public meeting on 11 October to discuss the implementation of the Volcker Rule under the Dodd-Frank Act. The rule restricts the proprietary trading and private investment fund activities of US banks and bank affiliates, as well as foreign banks with banking operations in the US.

Deals added to the SCI database last week:
Apidos CLO VIII
CNH Capital Australia Receivables Trust series 2011-1
Credit Acceptance Auto Loan Trust 2011-1
GE Equipment Midticket series 2011-1
Hyundai Auto Receivables Trust 2011-C
Lannraig Master Issuer series 2011-1
National RMBS Trust 2011-2
Panhandle-Plains Higher Education Authority series 2011-2
Series 2011-3 WST Trust

Top stories to come in SCI:
Prospects for Trups CDOs
ABS recruitment trends
CVA special report
BlueMountain Capital Management profile

ABS

Law firm boosts SF team

DLA Piper has appointed a new structured finance partner in London. Mark McGiddy joins the finance and projects group, reporting to Alex Dell.

McGiddy moves over from Deutsche Bank, where he was a director within global markets structuring. He has previously served as a senior associate in Freshfields' structured finance team and has experience in cross-border transactions, with an emphasis on tax-efficient financings and derivatives transactions.

CLOs

CLO manager acquired

GSO Capital Partners has acquired Harbourmaster Capital, which manages and advises on approximately €8bn of assets, including a number of CLOs. The Harbourmaster Capital Dublin-based team will continue to support the Harbourmaster funds and will form a combined platform with GSO's existing European leveraged loan business to develop new European-focused funds for their global investor base. The combined European leveraged loan platform will have approximately €11.5bn in assets under management, supported by a combined team of 40 professionals in both Dublin and London.

Bennett Goodman, senior md and co-founder of GSO, comments: "Harbourmaster Capital is widely recognised as a market leader in Europe, an extremely well managed firm whose investment style and philosophy is completely consistent with ours. By merging our European platforms, we are creating one of the largest alternative managers in Europe, strategically positioning us to capitalise on the growing number of investment opportunities in the European corporate credit markets."

The combined GSO and Harbourmaster Capital European leveraged loan business will be overseen by Debra Anderson, Alan Kerr and Mark Moffat. The parties expect to close the transaction in early 2012 following receipt of regulatory and certain third-party approvals.

CLOs

Financing platform enhanced

H.I.G. Capital has acquired certain assets of WhiteHorse Capital, a Dallas-based CLO manager with assets under management of over US$1.7bn, and formed H.I.G. WhiteHorse to provide flexible financing solutions to profitable and performing small and middle market companies.

With more than US$1bn of capital available to deploy into businesses in the US and Europe, H.I.G. WhiteHorse has a broad mandate to provide senior, second lien, uni-tranche, mezzanine and subordinated debt for refinancings, growth capital, acquisitions and balance sheet recapitalisations. The transaction marks a significant expansion of H.I.G.'s existing credit platform, which currently manages in excess of US$4bn.

H.I.G. WhiteHorse will benefit from WhiteHorse's extensive credit experience, its large and experienced investment team and its strong track record in the leveraged loan market. It will also draw upon H.I.G.'s private equity experience and resources developed over 18 years of investing in and working with small and mid-cap companies.

WhiteHorse will continue to actively manage leveraged credit structures in the broadly syndicated loan market, including its five CLOs and a long-only credit fund.

CLOs

Credit manager plots European growth

Stone Tower Capital has formed Stone Tower Europe, headquartered in Dublin, to enable the firm to expand its European operations and serve its growing investor base. Tim Richards has been appointed md to oversee the firm's European expansion, along with Alan Kelly as a director.

Richards joins from LBBW Asset Management Ireland, where he held the role of ceo from 2007 to 2011. Previously, Richards worked with WestLB Group between 1998 and 2007 in roles as md at Brightwater Capital, as well as global head of credit products and global head of new issues. Prior to this, he held senior capital markets roles at BNP and Swiss Bank Corporation, as well as at the Bank for International Settlements.

Kelly joins Stone Tower with responsibility for seeking investment opportunities and marketing the firm's services in Europe. Previously, he spent ten years as a senior portfolio manager with LBBW and its asset management subsidiary in Ireland, focused on credit products.

Both Richards and Kelly will source regional assets and help manage portfolios along with other members of Stone Tower in both Europe and the US.

CMBS

Servicer buys advisory firm

Helios AMC, a special servicer sponsored by Ranieri Partners, has acquired global CRE advisory The Situs Companies. The combined company will operate as The Situs Companies.

Helios ceo Keith Johnson will serve as ceo of the combined platform. The Situs principals will assume leadership positions, with co-founder Ralph Howard serving as the president of Europe, Steve Powel serving as president of North America and co-founder Martin Bronstein serving as president of Situs Asset Solutions. The Helios AMC principals - led by Eric Lindner, co-founder and executive md, and John Maute, co-founder and md - will continue in their current roles, overseeing the distressed asset acquisition and special servicing business.

Risk Management

Advisory staffs up

Kinetic Partners has appointed three new professionals to its London office. Patrick Crumplin, Martin Duff and Emily Benson join the firm's regulatory consulting and compliance team.

Crumplin has been named a director, specialising in regulatory and other financial investigations and litigation support. He has over 13 years of forensic accounting, litigation support and regulatory investigations experience across a range of different industries, including structured finance.

Duff joins Kinetic Partners as a consultant, following four years in New York advising on a diverse range of risk, regulatory and compliance projects, as well as drafting expert witness testimony in respect of a number of hedge fund failures. Benson joins as a director, from a major retail bank, where she worked as a regulatory specialist.

Risk Management

Vendor strengthens research effort

Quantifi has appointed Dmitry Pugachevsky as research director, responsible for managing the firm's global research efforts. He brings more than 18 years' counterparty credit and cross-asset modelling experience to Quantifi.

Pugachevsky joins from JPMorgan, where he was head of counterparty credit modelling and was responsible for developing new models for calculating CVA across different asset classes and supporting credit portfolio trading. Before starting with JPMorgan in 2008, he was global head of credit analytics at Bear Stearns for seven years. Prior to that, he worked for eight years with the analytics groups of Bankers Trust and Deutsche Bank, developing models for credit, fixed income and equity derivatives.

RMBS

RTC vet strengthens advisory practice

Timothy Kruse has joined Milestone Advisors' advisory practice as an md based in the firm's Washington, DC headquarters. His primary focus will be on providing advisory services and asset sales advice to the GSEs, US regulatory agencies and other governmental entities, as well as the banking and mortgage finance sectors.

Kruse previously held a number of high-level jobs at the FDIC, serving as both manager, seller finance and also as a senior capital markets specialist in the Division of Resolutions & Receiverships since December 2008. In these roles, he was part of the team responsible for developing and implementing the sale of real estate secured assets through the FDIC's structured transaction programme. He also led the team responsible for structuring and selling the FDIC guaranteed notes to investors, which are offered in conjunction with the structured transaction programme.

Prior to joining to the FDIC, Kruse held a number of positions in the field of finance, with a particular focus on mortgage finance. Among these roles, he valued and securitised both performing and non-performing portfolios for eight years at the Resolution Trust Corporation.

ABS

Italian government-linked deals hit

Moody's has downgraded the ratings of the notes issued by six Italian ABS transactions, following the downgrade of the Region of Lazio, the Region of Abruzzo, the Region of Campania and the Autonomous Region of Sicily. It has also downgraded the ratings of four transactions that are directly linked to the Italian government: two repacks, one balance sheet CDO and one ABS. The move follows the agency's downgrade on 5 October of the rating of the government of the Republic of Italy to A2 with a negative outlook, from Aa2.

ABS

Improved performance continues for cards

US credit card ABS collateral performance improved yet again last month, according to Fitch's latest credit card index results.

"Credit quality has improved significantly for credit cards and we're seeing the results of that continue to play out in ABS performance," says Fitch md Michael Dean. "That said, the pace of improvement is showing signs of levelling off and we expect to see stabilising trends going forward."

Losses have retreated from persistently high levels over the past year, while excess spread has strengthened to twice the pre-recession average. "The current dynamics are prompting investors to question how much lower these metrics can go with the threat of a double-dip recession looming in the background," adds Fitch senior director Cynthia Ullrich.

Delinquencies have settled at levels last seen in 2006, after the late buckets were washed out by consumers' rush to file before the 2005 bankruptcy law change. Additionally, late payments and defaults touched five- and three-year lows respectively.

Fitch's Delinquency Index for September stands at 2.3%, a 35% drop-off compared to last year. Losses fell by 9bp to 6.32% from 6.41%. Since the inception of the Fitch index in 1991, losses have averaged 6% and experienced a peak of 11.52% in September 2009.

Three-month average excess spread has hit yet another record high of 11.38%, compared to an average of 5.82% since exception. This marks the 10th straight month of double-digit readings.

Monthly payment rate performance bounced back up to set a new record at 21.88%, well above the long-term index average of 16.3%. Gross yield remains strong at 20.03%.

CDS

Irish Life CDS settled

The final prices for the CDS senior buckets 1 and 2 in the Irish Life & Permanent August restructuring credit event auction today were determined to be 86 and 75 respectively. 14 dealers submitted inside markets, physical settlement requests and limit orders to the bucket 1 auction and 13 did for the bucket 2 auction. Deliverable obligations are denominated in euros, sterling and US dollars.

CDS

Sovereign credit risk report released

CMA has released its Global Sovereign Debt Credit Risk Report for the third quarter of 2011, in which it names the top-ten most and least risky sovereigns, as well as the best and worst performers.

In an extremely volatile quarter, the credit markets saw a significant rise in the cost of protection across all regions. The market responded to downgrades by rating agencies in the US, Japan and Italy, a slow-down of growth in China and Eurozone debt concerns affecting the broader region.

Among the key highlights of the report, the cost of debt protection in the US is shown to have remained relatively stable throughout the quarter, despite the downgrade which threw global equity markets into turmoil in August.

Unsurprisingly, Greece remains the most risky sovereign debt as the market prices in an almost certain default event. In addition, Scandinavian countries saw a significant widening as the size of the fund required to stabilise the Eurozone escalated. However, Norway remains the least risky sovereign by just 1bp, as the cost of protection rose to 55bp from 21bp.

Meanwhile, emerging markets spreads saw a gradual widening in Q3 as the market took profit and reduced risk in the region. Spreads in China spiked on the last day of the quarter.

Finally, Australia and New Zealand widened to the end of the quarter as metal prices collapse.

CDS

CDS trade-date clearing offered

MarkitSERV has launched trade-date clearing for interdealer credit default swap trades through its trade matching and routing service.

Deutsche Bank, JPMorgan and Morgan Stanley were the first institutions to use the new system to match and route credit trades for clearing, in close to real time. The trades were cleared by ICE Clear Credit.

The vast majority of cleared CDS trades are currently cleared in batches on a five-day cycle. MarkitSERV's real-time trade processing platform now allows each trade to be individually routed to the clearinghouse and cleared immediately following execution.

Using the new service, counterparties approve and route each trade for clearing immediately after execution. Trade details submitted electronically by counterparties to MarkitSERV are verified, matched and transmitted directly to the clearinghouse. After the trade is successfully cleared, parties are notified via the service.

MarkitSERV also supports real-time submission of trades by interdealer brokers and electronic trading platforms.

The platform has been certified by or established links to CME, ICE Clear Credit, ICE Clear Europe and Eurex for direct submission of credit derivative transactions for clearing, as well as to LCH.Clearnet, CME, SGX and IDCG for direct submission of interest rate derivative transactions for clearing. It is also engaged with over a dozen other clearinghouses worldwide and will link to more as they launch.

CLOs

CLO manifest error corrected

An investor notice was released yesterday advising of a manifest error in the documentation for the recently priced Mesena CLO 2011-1 (see SCI CDO database). The error is contained in the sections entitled 'Article 122a of the Capital Requirements Directive' and 'Description of the Portfolio Servicing Agreement' of the prospectus, dated 27 September.

These sections state that the originator has undertaken to retain until maturity €4.25m of the class D notes, representing the net economic interest of not less than 5% of the nominal value of the securitised exposures in accordance with option (d) of Article 122a of the CRD. However, this figure actually only represents 5% of the nominal amount of the class D notes.

The trust deed and PSA have consequently been amended to delete any reference to this figure.

CLOs

Euro CLOs face 'increasing pressure'

Fitch says that European leveraged loan CLOs are likely to come under increasing pressure in 4Q11.

The agency's newly-published October 2011 European Leveraged Loan CLO Tracker reveals that the triple-C bucket has increased to 8.7% from 7.4% in January 2011 and two new defaults were recorded in 3Q11. At the same time, the average triple-A OC test cushion - excluding Melepard CDO 1 Limited, which has experienced a large prepayment (37%) of its senior note in the last quarter - is 10.58%, which is virtually unchanged from 10.55% in June 2011. These trends indicate that it will be difficult for CLOs to maintain the performance improvement experienced over the past year, according to Fitch.

The agency notes that there is a time lag between the data reported in the investor reports and current market conditions. Current macroeconomic conditions have dented the gains European leveraged loan prices have made over the past year.

According to Markit, the average European loan bid in the secondary market increased to a high of 93 in March 2011 from a price of 87 in November 2010, before falling back down to 87 in 3Q11. Fitch expects CLOs' OC tests to come under increasing pressure if the underlying leveraged loans' negative rating migration gathers pace, combined with volatile and falling leveraged loan prices.

Fitch observes that structural features have helped the average CLO perform largely as expected, with excess spread providing support to the senior rated notes. For instance, an increase in the triple-C bucket or defaulted assets could be mitigated by the breaching of OC tests, which diverts excess spread for reinvestment or to redeem the senior rated notes. Nevertheless, CLOs remain susceptible to a clustering of defaults due to the approaching refinancing wall and lower than expected recoveries, as evidenced by the negative outlooks Fitch has assigned to the majority of its rated CLOs mezzanine and junior notes.

Meanwhile, the vast majority of pre-crisis CLOs allow the reinvestment of certain proceeds, such as unscheduled principal proceeds, past the reinvestment period. Fitch believes this provides flexibility to CLO managers to continue reinvesting past the 2013-2014 refinancing wall, but the flexibility would decrease with the passage of time if reinvestment is subject to a maximum weighted average life test or as market conditions worsen and tests start to be breached.

Equity noteholders usually have the option to call the CLO just before the reinvestment end date, when the cost of funding would become less favourable to the equity noteholders as the senior less-costly notes start to delever. The non-call period ends on average 4.5 years after the deal closes among Fitch-rated CLOs. The non-call period has ended for 16 of the 28 Fitch-rated CLOs and it will expire for a further 11 CLOs within the next 12 months.

CLOs

Euro CLO overlap examined

A renewed pick-up in defaults is likely to put downward pressure on European CLO ratings, according to S&P. This comes as the agency releases its study on the degree of overlap between different portfolios and concentration risk within them, based on a sample of 211 CLO portfolios on which it conducts regular surveillance.

"We have observed a significant overlap between European CLO portfolios and, on average, any two transactions that we rate have about 27% of their portfolios in common," says S&P credit analyst Arnaud Checconi. "In fact, some corporate obligors feature in almost all transactions' collateral pools. Thirty corporate obligors feature in more than half of our sample of 211 transactions."

Among the other key findings of the portfolio overlap study is that obligor concentrations are generally limited: only nine obligors in S&P's dataset had a maximum exposure of greater than 10% in any CLO. However, industry concentrations within individual CLO transactions can be significantly higher in some cases, with three CLOs in the sample having exposure to a single industry of more than 30%. Finally, the UK constituted the largest aggregate country exposure in the sample, accounting for just less than 20% of the underlying debt.

Checconi concludes: "We envisage that the combination of an uncertain economic outlook and a tighter debt funding environment will likely translate into a renewed pick-up in defaults from 1Q12. This view reflects the refinancing challenge for many overleveraged leveraged buyouts, initially financed in the 2006-2008 boom. And the question also remains if there will be a role for CLOs in funding this refinancing need."

CMBS

GRAND restructuring delayed

The projected timetable regarding a restructuring of the GRAND CMBS is to be delayed slightly, leading to suggestions that it was over-optimistic to begin with. Deutsche Annington (DAIG) met with the ad-hoc group of noteholders on an unrestricted basis on 7 October to discuss a revised timetable and process for agreeing the commercial terms of a solvent scheme of arrangement.

DAIG says it intends to launch a scheme during this calendar year, with the expectation that it will be implemented during the first quarter of 2012. The borrower had informed noteholders in August that it was aiming to have the scheme of arrangement implemented by 31 December 2011 and to finalise all commercial negotiations on the proposal by early October.

CMBS

Hotel resolutions push delinquencies down

The continued turnaround of hotels helped precipitate another decline for US CMBS delinquencies, according to the latest Loan Delinquency Index results from Fitch.

Approximately US$604m in resolved hotel-backed loans resulted in a slight drop of 5bp for CMBS late-pays, bringing the overall rate to 8.6% from 8.65%. Aside from hotel sector gains, September proved to be a quiet month for both new delinquencies and resolutions.

In fact, Fitch says the US$1.5bn of new delinquencies in September represents the lowest volume of new defaults in almost three years (when the index stood at 1.28% at February 2009). After hitting an all-time high of 9.01% in July, CMBS delinquencies are now down for each of the last two months.

"Roughly four years after the economic crisis began, signs of stability are slowly emerging for commercial real estate," says Fitch md Mary MacNeill. "Though office and retail-backed loans are lagging as expected, hotels are now benefiting from their ability to reset rates on demand, resulting in enhanced liquidity and renewed investor interest."

Roughly one-third of September's resolutions from the delinquency index corresponded to 19 hotel-backed loans. The two largest were: the US$252.9m RRI Hotel Portfolio loan, which was previously 90 days delinquent and its notes were sold for a loss of just over 50%; and the US$170.6m Jameson Inns Pool loan, which was previously non-performing matured and is now performing matured.

In its monthly analysis, Fitch also removed from the index two hotel-backed loans displaying as delinquent that in fact are current but suffered from a reporting lag: the US$250m (combined A and B notes) Four Seasons Resort Maui loan, which was reported as 60 days delinquent, but brought current in connection with a modification executed in June; and the US$165m Longhouse Hospitality Pool, which was reported as non-performing matured, but is current based on execution of its extension through June 2012.

No other loan with a balance in excess of US$100m entered or exited the delinquency index in September.

Fitch adds that the hotel-specific delinquency rate now stands at 12.42% (from 14% one month prior), the lowest since 2009 and well off the September 2010 peak of 21.31%. Conversely, office loans fared worse last month, with 50 loans totalling US$594.5m being added to the index. Additionally, 57 retail-backed loans totalling US$422.5m were newly added.

CMBS

CMBS loan liquidations jump

The balance of US CMBS conduit loans liquidated in September jumped to US$1.26bn - an increase of almost 25% from the low August reading, according to Trepp. At US$1.26bn, the volume is very close to the 12-month rolling average for the volume of loans liquidated each month, whereas the average loss severity was down more than 4% but still remains above the 12-month rolling average.

In total, 141 loans were liquidated in September (compared to 159 loans and US$1bn in face amount in August). The losses from the September liquidations were about US$573m - representing an average loss severity of 45.4%. In August, the average loss severity was 49.9%.

"The September loss severity average is above the average loss severity of 42.4% over the last 21 months and relatively close to the 12-month rolling average of 40.2%. The special servicers have been liquidating at an average rate of about $1.03bn per month since the beginning of 2010 and US$1.21bn on the basis of the 12 month rolling average," Trepp says.

Regulation

Volcker Rule on the agenda

The FDIC is to hold a public meeting on 11 October to discuss the implementation of the Volcker Rule under the Dodd-Frank Act. The rule restricts the proprietary trading and private investment fund activities of US banks and bank affiliates, as well as foreign banks with banking operations in the US.

The rule contains limited exceptions for: transactions involving US government, agency and GSE securities; underwriting or market-making activity; risk-mitigation and hedging activity; transactions done on behalf of clients; and 'de minimis' holdings of sponsored investment funds. However, lawyers at Schulte Roth & Zabel note that based on the statutory language, it is unclear how broadly these exceptions will be applied.

While the federal regulators have not yet published a proposed version of the regulation that would implement the Volcker Rule, various news outlets have released what purports to be a confidential internal draft of the regulation dated 30 September. According to this version, proprietary trading would be defined in a broad manner, buoyed by a three-step approach that would allow regulators to classify impermissible proprietary trades and positions.

Further, the plan would severely limit instances where a banking entity could hold an 'ownership interest' in hedge and private equity funds. The plan would also require banking entities that may be affected by the rule to install internal controls and monitors that would assist with compliance with the rule's prohibitions and restrictions.

SIFMA warns that the draft proposal seems to have some complex and potentially burdensome provisions that may impede Congress's stated intent to allow for traditional market-making activities and the asset management alternative fund business. "The document raises important questions related to the costs and burdens of complying with certain aspects of the proposal and SIFMA appreciates the opportunity to work with regulators to ensure proper economic analysis is undertaken," comments SIFMA president and ceo Tim Ryan.

He adds: "Importantly, we understand that this draft may be subject to revision before formal publication and we look forward to the full proposed rule. Given its magnitude and impact on US markets, it will be subject to significant comment and hopefully consideration by the regulators to insure against undermining the depth, liquidity and viability of US financial markets."

The regulation was due to be promulgated by 21 October, but is unlikely to be in place by then. Once the regulation is finalised, banking entities will have until 21 July 2014 to comply, with the Fed empowered to grant up to three one-year extensions.

Regulation

RFC issued on Volcker Rule

The FDIC has requested public comment on the proposed Volcker Rule regulation (SCI 7 October), pertaining to section 619 of the Dodd-Frank Act.

The regulation generally prohibits two banking entity activities: engaging in short-term proprietary trading of any security for a banking entity's own account; and owning, sponsoring or having certain relationships with a hedge fund or private equity fund. It also prohibits banking entities from entering into any transaction or engaging in any activity that would: involve or result in a material conflict of interest; result in a material exposure to high-risk assets or high-risk trading strategies; pose a threat to the safety and soundness of the banking entity; or pose a threat to the financial stability of the US.

The proposal - which will be issued jointly with the Fed, the OCC and the SEC - clarifies the scope of the Act's prohibitions and provides certain exemptions to these prohibitions. It is anticipated that the CFTC will issue a comparable proposal in the near future.

The proposed rule would require banking entities to establish an internal compliance programme that is designed to ensure and monitor compliance with the statute's prohibitions and restrictions, subject to oversight by the banking entity's board of directors and appropriate federal supervisory agency. The proposal also requires banking entities with significant trading operations to report to the appropriate federal supervisory agency certain quantitative measurements designed to assist them in identifying prohibited proprietary trading in the context of exempt activities.

Transactions in certain instruments, including GSE obligations, are exempt from the statute's prohibitions. Activities exempted include market making, underwriting and risk-mitigating hedging. The statute also permits banking entities to organise and offer a hedge fund or private equity fund, subject to a number of conditions.

Comments on the proposal will be received through to 13 January 2012.

Risk Management

Buy-side clearing challenges examined

A new report from Celent confirms that the move from bilateral to counterparty clearing of OTC derivatives will require significant resources, especially for buy-side participants.

The buy-side has historically not had much involvement with central clearing. Now, it will have to ensure that relationships are in place with an appropriate number of executing and clearing brokers, along with connectivity to the main swap execution facilities (SEFs) and CCPs.

In terms of the precautions being put in place to ensure better safety of the client's collateral in case of default by a clearing member or client, account portability and segregation of collateral are important. Portability would allow a buy-side firm to move its trades from one clearing member to another without losing any collateral.

However, it is not clear what costs the buy-side would have to incur to ensure that portability is available for their transactions. The margin that clearing brokers might have to put up, as the backup brokers enabling portability, might lead to higher costs for them and for their clients.

Similarly, segregation of collateral will ensure the default of a client does not affect a buy-side member. However, using segregated accounts instead of an omnibus account has its own costs and might not be cost-effective for the smaller buy-side firms.

Another issue might be dispute resolution, according to Celent. Buy-side trades generally have higher chances of disputes and so clearing via CCPs will require a complex dispute resolution procedure in which the interests of both the trading parties would have to be taken into account without compromising the interest of the CCP itself.

Another major factor, notes the report, is the effect on collateral management and margin requirements (SCI 26 September). "The level of collateral is expected to go up because CCPs are going to be more conservative in their margin requirements," it states. "A lot of assets will be tied up as collateral and the special treatment that the larger clients enjoyed in bilateral clearing will not be possible, at least in the early days. Cross-margining will also be difficult for various reasons - the main being that not every product would be traded at each CCP and another being that regulations might not permit cross-margining as extensively as before."

RMBS

Morningstar RMBS ratings launch nears

Morningstar is set to unveil its RMBS ratings and surveillance analytics service next week. The new offering is designed to improve market transparency, ratings stability and timeliness of surveillance reviews.

"Before the recent credit crisis, the traditional rating agencies considered a transaction to be performing normally unless it broke an 'exception' threshold, in which case it would then be subject to a full surveillance review," comments Robert Dobilas, president of Morningstar's structured credit ratings business. "In today's dynamic post-crisis mortgage world, the passive surveillance routine of the past is no longer acceptable. Investors are demanding a surveillance process that is proactive, timely and transparent."

Each Morningstar RMBS rating will undergo a rating review every month. In addition to the rating agency's monthly DealView analysis and letter ratings, the new service will feature an interactive statistical model with investor-driven assumption capabilities, updated performance data, default probabilities and loss severity projections.

RMBS

Negative equity weighing on prime borrowers

The sputtering US housing market will result in more prime borrowers being pushed further underwater on their mortgages, according to Fitch. Recent analysis by the agency shows that more than a third of all prime borrowers in private-label securitisations are currently in a negative equity position on their mortgages.

Despite some recent modest gains, home prices have further to fall before any sustained recovery takes hold, according to Fitch md Grant Bailey. "With home prices likely to decline another 10%, roughly half of prime borrowers will wind up underwater on their mortgage," he says.

Fitch also found that over 12% of all prime borrowers are seriously delinquent on their mortgages. "Prime mortgage default rates will stay elevated as home prices fall further and unemployment remains high," adds Bailey.

The combination of declining equity, rising delinquencies, growing payment shock risk and the application of Fitch's updated criteria led to further negative rating actions on prime RMBS transactions in the agency's latest ratings review. While it either affirmed or upgraded 58% of prime RMBS ratings, 42% of prime RMBS ratings - primarily those already rated single-B or below - were downgraded further. Approximately 97% of investment-grade classes that Fitch downgraded were already on rating watch negative prior to the rating revision.

Fitch has cited borrower equity as the pre-eminent driver of mortgage default performance in its new rating model (SCI passim).