Contents

ABS

Re-denomination risk re-examined

The once unthinkable prospect of a break-up of the eurozone has increased in likelihood over the past few weeks, forcing ABS investors to consider the implications of currency re-denomination. Should a country leave the eurozone, analysts at RBS expect significant consequences for related structured finance bonds, with large losses on mezzanine tranches and downgrades of senior bonds.

While the break-up of the eurozone remains more unlikely than likely at present, in practice it would probably only involve one country leaving rather than a complete break-up. At present, Greece is the most likely candidate to leave the single currency given the nation's controversial response to the eurozone plan.

If this were to transpire, RBS suggests a law would most likely be passed re-denominating all contracts within its jurisdiction to the new currency, while contracts made in other jurisdictions would remain technically binding. Mortgages and leases are local contracts which can be legally re-denominated by the government, as has previously happened in Hungary, Russia and Ukraine. For SPVs, whether the contracts can be legally re-denominated depends on their jurisdiction.

"Greek RMBS are generally done under English law. Hence, Greek RMBS bonds would technically default in the absence of sufficient cash flow from the mortgages," note the strategists. "By contrast, Spanish RMBS would not be in default since they would also be legally re-denominated. This will have implications for the allocation of cashflows in the transaction."

They clarify: "Where the SPV is local, such as Spain, there is no formal default on the bonds and the waterfall structure is not affected. Hence, pro-rata bonds may continue to pay pro-rata. Where the SPV is in English or other foreign law, there will likely be an event of default which will cause the deal to pay sequentially."

The analysts predict that in the event of Greece leaving the eurozone, some new borrower-friendly legislation could be possible. At the same time, they expect servicing would be largely undisrupted. However, in the context of currency depreciation and economic weakness they say the legal and structural issues in ABS are now almost secondary: the Greek currency would almost certainly see massive depreciation and the increased cost of imported goods would probably drive up delinquency and default rates.

Any peripheral country leaving the eurozone would require currency depreciation to be competitive internationally. In the case of Greece, RBS estimates devaluation could be as much as 10.1%, which would be sharper than for any other country leaving the single currency.

"It is clear that the impact [on ABS] will be very significant if a country such as Greece does leave the euro," the analysts conclude. Mezzanine bonds would be expected to suffer very large losses and senior bonds would probably have to be downgraded."

JL

ABS

US law firm adds three

Daniel Passage has joined Bingham McCutchen's structured transactions practice group as partner in its Los Angeles office. Passage has nearly two decades of experience advising issuers, underwriters and financial institutions on complex finance transactions, with an emphasis on securitisation and structured finance. He also advises issuers and underwriters in public offerings and private placements of equity, debt and convertible securities. Passage is involved in the development of the securitisation of insurance products, unusual loan products, solar leases and power purchase agreements and residential and non-residential PACE loans.

Francisco Flores has also joined Bingham's structured transactions practice group as counsel in its Los Angeles office. Flores has experience negotiating, structuring and documenting securitisation transactions and related financing arrangements. He also has vast experience in cross-border transactions in Latin America and has worked on secondary offerings of common stock for US corporations as well as convertible debt offerings for domestic and foreign corporations. He has represented issuers and underwriters in securitisations in various asset classes.

William Springer joins Bingham's structured transactions practice group as counsel in its New York office. Springer has a broad transactional practice focusing on structured finance, derivatives and renewable energy financing as well as life settlements, private equity and hedge funds, and other alternative asset financing vehicles in the United States, Latin America, Europe and Asia. He is also active in the renewable energy financing market and is one of the leading practitioners in the PACE bond market. Springer is currently active in alternative financing structures for startup companies and emerging markets.

ABS

Trader networking site launched

A beta website that offers fixed income market professionals a free venue to network and generate trade ideas has been launched by former FGIC executive, Alex Masri. BondsOdds.com offers market news, blog posts and community-driven bond-pricing thoughts. Information can be shared publicly or anonymously.

Having left broker-dealer Odeon Capital earlier this year where he focussed on European and Middle-Eastern fixed income sales, Masri launched BlackSteel Capital in New York - a venture capital business.

CDO

CRE CDO successor chosen

CWCapital Investments has been voted as the successor collateral manager for Sorin RE CDO 1, following Sorin Capital Management resignation as initial manager.

Fitch currently rates the highest-rated class in the transaction double-C, indicating that some type of default is probable.

CDS

Cantor beefs up in credit

Cantor Fitzgerald has expanded its credit markets team with three new hires. David Pilcher joins as co-head of credit fixed income, while Ron Adzima and Terran Miller both join the credit team at md-level.

Pilcher joins from Gleacher & Co, where he was co-head of the investment grade and hybrid business. He previously ran US credit trading at RBC and was co-head of global credit at Citigroup. He becomes credit fixed income co-head alongside Adam Vengrow and will be jointly responsible for sales, trading and desk analytics.

Adzima becomes md within credit trading, focused on hybrid, preferred and Tier 1 parts of the capital structure. He was previously co-head of credit trading at Citadel Securities and has worked in the credit business at Salomon Smith Barney.

Miller also joins as md, covering the utility space from investment grade through to distressed. He was previously md at Knight Capital Americas, where he provided analytical coverage of industry-wide topics. He has also served as executive director at UBS Global Credit Strategies and UBS Investment Bank.

CLOs

Euro CLO manager purchase confirmed

Black Diamond Capital Management has confirmed its acquisition of GSC Group's London team. Black Diamond's European office will be headed by Nick Petrusic, who, along with the other London based team members, will oversee its European Mezzanine and European CLO businesses.

Established in 2000, the UK-based business acquired from GSC Group has been a significant investor in the European leverage market, investing in first and second lien loans through its European CLO funds and arranging and investing primarily in subordinated mezzanine loans through its European Mezzanine Funds.

Black Diamond is an alternative asset management firm with over US$10bn in assets under management. Black Diamond manages complementary control distressed/private equity funds, hedge funds, mezzanine funds and CLO and other structured vehicles.

CLOs

CLO team reshuffle will not harm ratings

The proposed replacement of the key persons defined by Harbourmaster CLO's transaction documents in the wake of GSO Capital Partners' purchase of Harbourmaster Capital (SCI 6 October), will not affect its ratings, according to Fitch. GSO has purchased 100% of the share capital of Harbourmaster Capital.

The proposed key persons to replace Fabio Salvalaggio, Stewart Wilkinson and (where relevant) Anna Marie Horgan are Bennett Goodman, Dan Smith and (where relevant) Debra Anderson, from GSO. Alan Kerr and Mark Moffat will retain their key person roles on the various Harbourmaster CLOs.

Fabio Salvalaggio and Stewart Wilkinson will leave Harbourmaster on closing of the acquisition and will no longer hold any share capital in Harbourmaster.

The affected Fitch-rated Harbourmaster CLOs are Harbourmaster CLOs 3 to10 and Harbourmaster Pro-Rata CLOs 1 to 3.

CMBS

US CMBS lawyer hired

Global law firm Thompson & Knight has hired Benjamin Herd as counsel in its real estate and banking practice group in Dallas. Herd focuses his practice on real estate and banking matters, including the representation of special servicers in relation to defaulted or troubled loan workouts, maturity default resolution, collateral foreclosure, lease negotiation, and the sale of REO property.

In addition, he represents CMBS lenders in loan origination, whole loan sales, syndications, and b-note purchases. Herd also assists national and regional banks in complex commercial loan transactions, including ground leases, tenants-in-common, and acquisition and multi-tranche construction financing.

Prior to joining Thompson & Knight, Herd worked for Beal Bank.

CMBS

CMBS trading trio appointed

KGS-Alpha Capital Markets has expanded its CMBS trading team with the addition of Jeff Lewis, Kyle Wichser and Andrew Noonan. The firm has also introduced chief strategist Kamal Abdullah.

Lewis, who leads the CMBS team, worked for 17 years at Salomon Brothers/Citigroup and then headed the CMBS trading effort at Barclays Capital, ICP Capital and most recently Citadel Securities. Wichser and Noonan have joined Lewis on the trading desk. Wichser, a Bear Stearns alumnus, traded secondary CMBS with Lewis at ICP Capital and Citadel Securities. Noonan specialises in structuring and pricing CMBS loans and previously worked at GE Capital, Eurohypo and Citadel Securities.

Prior to joining the firm, Abdullah was head of RMBS and CMBS research at Citadel Securities. He began his financial career at Salomon Brothers and subsequently spent ten years at Lehman Brothers where he traded mortgages and was active in mortgage research. Hel then joined Merrill Lynch where he served four years as a client-facing strategist.

CMBS

CMBS origination team cut

Credit Suisse will close down its CMBS origination team and downscale other businesses that are not capital efficient. In its quarterly earnings call earlier this week, the bank confirmed the cutting of 1500 positions, 50 of which are in CMBS.

The bank's ceo Brady Dougan said CMBS is "[one of] those businesses where we cannot meet our return hurdle and we need to downsize or exit". Although the bank is exiting CMBS origination, it is understood the secondary market trading division will be retained.

"Our status as a first mover in the industry, we believe, has put us in a position of financial strength, it has given us advantages in a period of unprecedented market volatility and industry change, and having anticipated and adjusted to many of the regulatory developments we are ahead of the curve," said Dougan.

ABS

Marked improvement for US card collateral

The performance of receivables backing US credit card ABS transactions improved markedly in 3Q11, says S&P. However, SIFMA data shows the US$165.4bn of credit card ABS outstanding is less than half of its 2008 peak and S&P expects this to continue shrinking.

A new report by the rating agency shows loss rates fell to their lowest level since 2007 during the quarter. Loss rates for bank and private-label credit cards decreased to 4.6% and 6.3% in September, respective decreases of more than 56% and almost 50% from their peaks in February 2010.

Issuance has been low for the sector throughout 2011, although it did pick up in the third quarter. Annual volume is within S&P's full-year projection of US$10bn-US$15bn. Public credit card ABS issuance of US$9.4bn exceeded 2010's total volume of US$7.4bn.

"In our opinion, two primary factors could help to jump-start receivables growth and, therefore, issuance levels: credit card obligors could increase both their spending and borrowing, and credit card originators could extend more credit," comments S&P credit analyst Ildiko Szilank.

The large amount of maturing liabilities in credit card master trusts is expected to provide originators with enough principal receivables to back new ABS issuance. However, S&P expects outstanding credit card ABS to shrink further in 2012 as new issuance is unlikely to surpass the US$60bn worth of publicly offered ABS slated to mature.

ABS

GAM launches new cat bond fund

Alternative investment manager GAM has launched a UCITs-compliant fund investing in securitised insurance risks via a portfolio of 40 to 50 catastrophe bonds. The fund, named GAM Star Cat Bond, aims to deliver stable and attractive cash plus returns that are not impacted by the volatility and performance of more traditional equity and fixed income instruments.

The fund, which is the most recent addition to GAM's growing UCITS range, will be managed by Fermat Capital Management. Through its compliance with UCITS directives, the ILS market will be opened up to a broader investor base than has previously been able to access the asset class.

The underlying bonds in which the fund will invest transfer the remote risk of natural disasters from re/insurers to the capital markets and offer higher yields compared to similarly rated traditional securities. Returns from these bonds are driven by the absence of well-defined, extreme natural events. Their performance is therefore largely independent of financial market behaviour, and consequently they have a very low correlation to traditional asset classes even in times of crisis.

John Seo, co-founder and managing principal at Fermat Capital Management, says: "In today's investment environment, where the performance of traditional and even many alternative asset classes are converging, cat bonds have demonstrated their ability to produce attractive and stable returns across turbulent market conditions. The key is to construct and actively manage a portfolio with risks that are well-understood, extensively modelled and adequately compensated."

ABS

US SF losses 'surprising'

Losses are high in the most maligned US structured finance sectors, but surprisingly low in other segments, says Fitch. By far the most losses are being seen in RMBS and CDOs, although consumer ABS has performed well.

Fitch says RMBS and related structured finance CDOs have the most realised and expected future credit losses, while consumer ABS products such as auto loans and credit cards are expected to continue to defy the bleak economic outlook and keep losses low. Even CMBS is expected to experience lower losses than many anticipated.

Realised losses on US structured finance deals originated before mid-2007 are running at 2.6% of the original US$3.54trn balance. Fitch expects losses to increase to 10.6% of the original balance (US$376bn) by the time they reach maturity.

RMBS and CDOs are expected to continue to perform the worst and Fitch predicts them to eventually account for 91% of total structured finance losses. US RMBS total losses are expected to reach 12% and losses on CDOs are expected to reach 43% of original balance.

Losses on auto loans and credit cards have been very low and should remain so, with overall ABS topping out at just over 1%. Despite the drop in commercial real estate values, CMBS losses should be around 5% by the time the deals fully mature.

Although the outlook for losses is mixed, Fitch says ratings stability should come much sooner. The agency has changed several rating processes and models, which have "allowed Fitch to avoid questionable asset types in new deals entirely".

ABS

Cat bond issuance increasing, diversifying

There were four catastrophe bond issuances in 3Q11, representing US$676m of new risk capital, notes Willis Capital Markets & Advisory in its latest ILS market update.

The last quarter also saw a French energy company sponsor a corporate cat bond for the first time since 2007. Willis says the success of this deal combined with recent loss activity and the increasing use of the private deal format could make these transactions more common in the future

Despite the diversification, the report notes that the market remains heavily weighted towards US wind risk. In 2Q11 71% of capital covered such events, while 3Q11 saw the total decrease modestly to 67%. There is US$1.24bn in European wind exposure scheduled to mature in the first half of 2012 and Willis expects the trend of non-US wind issuance to continue.

Cat bond issuance in 3Q11 was up US$196m over the same period last year, when three deals totalled US$480m. Year-to-date new issuance has been lower this year than the last, with US$2.28bn so far compared to US2.98bn in the first nine months of 2010. This shortfall can be largely attributed to the uncertainty caused by model changes and large catastrophe losses earlier in the year.

Willis sees several catalysts for increased cat bond issuance, which should remain robust throughout 4Q11 and 1Q12 as the reinsurance market regains confidence. Pent up demand from prior quarters, tightening spreads and substantial maturities due in the first half of next year should all see issuance increase in the future.

"As is typical during the lead up to the peak of US hurricane season, we saw sponsors focus on deals with other perils. Looking ahead, most of the signs point to a busy year end and first quarter for cat bond issuance and related investor activity," comments Bill Dubinsky, WCMA head of ILS.

The 'no conflicts' regulation under Dodd-Frank and the proposed changes under SEC Regulation AB, which governs the registered issuance of securitisations, are causing uncertainty. The doubt caused by those pending regulatory initiatives could see deals brought forward, either to be done at the end of this year or start of 2012.

CDS

Parsing platform launched

CMA has released a parsing solution for the credit options market. CMA Parsing Credit Options builds on the firm's parsing technology for OTC markets and follows last weeks' ABS platform (SCI 27 October).

CMA says its new product extracts pricing data from emails, "enabling users to capture and compare a full set of pricing information with volatility surfaces for all quoted indices in real-time". It enables in-depth analysis of the credit options market and allows back-testing of options strategies.

CLOs

Euro fears slow US CLO issuance

The European unrest has had a negative impact on US CLO issuance despite a strong first half of the year, according to Fitch. However, the rating agency sees encouraging signs for the market going forward.

Six CLOs have come to the market during 3Q11, although only two have priced since August. Meanwhile, CDS spreads on those triple-As have widened 20bp-30bp compared to CLOs that were originated in 2Q11. However, Fitch says discounts on corporate loans should keep new issuance attractive for equity investors.

The continued stable performance of existing US CLOs is also encouraging. Fitch's rating actions last quarter were almost exclusively affirmations, not least because of the stable leveraged loan market and historically low defaults. The agency expects affirmations to continue into next year.

CMBS

US CMBS delinquencies near highs

The delinquency rate for US CRE loans in CMBS moved up by 21bp to 9.77% in October, according to Trepp's latest delinquency report. The CMBS delinquency rate is now at its second highest level ever - only the 9.88% reading in July 2011 was higher.

After experiencing a big dip in the delinquency rate in August, the rate has now increased for two straight months. If defeased loans were taken out of the equation, the overall delinquency rate would be 10.24%, up by 22bp. The percentage of loans seriously delinquent stands at 9.21%, up by 26bp.

CMBS

Uncertainty after care-home rent drop

Following the finalisation of restructuring plans in late September (SCI passim), the 249 UK care homes leased by Southern Cross were transferred to HC-One earlier this week. According to a notice from the issuer of the associated CMBS, Titan Europe 2007-1, HC-One also acquired Southern Cross' operations that provide back office support to the homes.

However, in a move that has surprised analysts, the borrower has re-set the rents payable in respect of the homes that have been acquired by HC-One to £40m per annum, a level that the borrower considers sustainable at the current time. CMBS strategists at Chalkhill estimate that the figure of £40m is a 38% drop from the rent payable by Southern Cross and somewhat larger than Chalkhill's initially estimated 20% to 25% drop.

The borrower says that trading at the homes deteriorated during the restructuring process, and that it is awaiting confirmation from HC-One of the 'transfer date' occupancy figures at the care homes.

"Our view is that the level of rent set by the borrower would allow for substantial rent cover to enable HC-One to retain as much cashflow as possible, with the excess (after capex) remaining at the borrower group," note the strategists. "This comes as no surprise given the special servicer's continued decision to allow for the deferral of payments to bondholders. After application of fees and expenses (including special servicing fees), we estimate that there would be a shortfall in cashflow of around £5m to £6m within the securitisation (before servicer advances and default payments), depending on the level of Libor."

A further servicer advance of £2.22m was provided by the backup advance provider in October, which, together with the £2.794m in July, presents further pressure on recoveries to the most junior tranches in the securitisation.

Chalkhill therefore currently values Class B to E notes as principal only securities, with no clear exit strategy for the borrower in the short term. "Given the considerable remaining term to legal final together with the lack of transparency from the special servicer with regard to the borrower's strategy, we believe that recoveries on the Class C to E notes will be largely jeopardised by the accruing unpaid payments on the periodic swap liability," they say. "With little transparency or bondholder consultation surrounding decisions made between the borrower and the special servicer, we think the junior debt in this transaction has been largely affected and the borrower has been given a free option on any potential equity value."

The market notice states that the level of rent will be reviewed periodically in line with trading performance and any surplus funds in HC-One above those required for operational trading and capex will remain in the borrower group of which HC-One is a subsidiary.

CMBS

CRE loan prices ease off

The aggregate value of CRE loans priced by DebtX that collateralise CMBS decreased from 85.9% as of 31 August to 85.0% as of 30 September. Loan values were 80.5% as of the end of September. DebtX priced 53,196 CRE loans in September, with an aggregate principal balance of US$633.6bn. The loans collateralise 643 US CMBS trusts.

"Commercial real estate loan prices eased in September after steady gains since the beginning of the year," says DebtX ceo Kingsley Greenland. "Prices dropped as credit spreads widened and secondary loan market investors demanded higher yields."

CMBS

Court ruling negative for StuyTown CMBS

Investors of CMBS bonds backed by Stuyvesant Town (ST) and Peter Cooper Village (PCV) collateral are likely to face negative consequences following a court ruling late last week. Tenants in the properties were granted permission to continue with their US$215m class-action lawsuit against MetLife and Tishman Speyer Properties by the New York Appellate Court, the original case having been dismissed in 2007.

The tenant class action seeks damages for past rent overcharges and legal expenses damages. MetLife and Tishman Speyer are accused of charging a number of apartments within the Manhattan complex market rates at the same time as receiving more than US$25m in tax breaks. Metlife sold the apartment complex to Tishman Speyer in 2006.

"The news has been the most significant in many months and is a negative for holders of the related CMBS debt," note CMBS analysts at Deutsche Bank. "The only real question is how negative."

According to the analysts, there are a number of unanswered questions regarding the judgment, primarily will there be a settlement for less than the US$215m claim, when will it be paid and how much of the final tally will the CMBS trusts be responsible for.

"To be clear, at this time there are no clear answers to these questions," they say. "The issue of settling for less is quite possible but due to the success the plaintiffs have had in the courts, we assume for now that full damages will be paid in full and in the next few months. Secondly, in terms of assessing the responsibility of CMBS trusts to pay the amount, we again assume the worst and assign a 100% share to the related CMBS transactions."

Given the as-yet unknown consequences of the court decision, Deutsche Bank expect the initial price reaction of all the related securities will be a move down. The magnitude of the decline will vary of course on where the bond falls in priority and the exposure to the ST/PCV loan.

"At a minimum we expect prices to decline a few points given the heightened level of uncertainty regarding not only the Trust's responsibility with the judgment but the related impact on the eventual workout of the loan."

CMBS

Sequential pay triggers inadvertently undermined

Servicer workout strategies in some EMEA CMBS transactions are inadvertently undermining sequential pay triggers designed to protect senior investors, according to Fitch.

"This is not to say that a servicer's workout decision is inappropriate," says the rating agency. "However, the documentation under which it has to act has proved contentious. There are examples of more tailored documentation catering to wider sets of circumstances that preserve the function of such triggers and may serve as useful templates for future transactions."

Although these triggers vary from transaction to transaction, most deals have triggers linked to the performance of the collateral portfolio. For example, transaction documentation will set out adverse credit events or outcomes that, were they to arise, would cause all principal receipts to be paid out sequentially.

Typically these events relate to the number or balance of loans in default or the realisation of loss in excess of a predetermined threshold. Combining these two tests with the application of principal recoveries on defaulted loans in a strictly sequential fashion (which is the norm) was intended to militate against credit enhancement declining once market conditions began to weaken.

"With commercial real estate in Europe in the midst of a sharp downturn, and the number of loans in default set to increase further due to limited availability of new lending, there is a clamour for sequential pay triggers to be activated," notes Fitch. "However, what may not have been considered in deal structures was how frequently loan restructuring would be deployed as a workout tool."

A familiar complaint among senior investors is that prolonged market value downside risk pinches credit protection. More recently, concerns have been voiced that by waiving covenant breaches or modifying loan terms, otherwise distressed loans may be treated as compliant in sequential pay trigger determinations.

Fitch says that in most cases, the interpretation of sequential pay triggers is rather ambiguous, proving a thorny issue for the parties tasked with interpreting documents. It is also a challenge for Fitch, since in its analysis the allocation of cash flows is material to the ratings.

"At any rate, an overriding principle is at stake: if these triggers were designed for any purpose it was to detect signs of deteriorating credit performance and tighten subordination rules accordingly," they add.

CMBS

US CMBS delinquencies drop again

October saw US CMBS delinquencies decrease for the third consecutive month, according to Fitch. The month saw limited defaults and loan resolutions and there were also encouraging peripheral signs of a positive turnaround.

CMBS late-pays declined 4bp from 8.6% to 8.56% as the US$1.6bn of new delinquencies were offset by US$1.7bn in resolutions. The new delinquencies consisted largely of smaller loans defaulting at maturity.

Fitch notes larger loan defaults are becoming more sporadic, which may be part of a developing trend. October's new delinquencies included 14 loans with a balance of US$25m or greater - although only one of those was over US$100m - which is in line with the last two months. The preceding two years had averaged 24 loans per month with a balance of US$25m or greater.

There are also fewer 30-day delinquencies in the pipeline. As of last month, US$1.5bn of loans with an average balance of US$8m were 30 days delinquent, down from US$2.2bn in September. Of those loans 30 days delinquent in October, US$790m had also been 30 days delinquent in September.

Delinquency rates for multifamily are 15.99%, 12.54% for hotel, 10.28% for industrial, 6.83% for retail and 6.29%for office. These are changes from 15.77%, 12.42%, 10.02%, 6.94% and 6.61%, respectively.

CMBS

Agency to change CMBS rating criteria

S&P is undertaking a review of the assumptions and methodology that it uses to rate European CMBS, according to an advance notice of proposed criteria change.

The goal of this criteria review is to increase the transparency of S&P's rating methodology, enhance the comparability of these ratings relative to other sectors, and to further address credit stability.

S&P says this review may result in changes to the methodology and assumptions it uses when rating European CMBS and, consequently, it may affect both new and outstanding ratings on European CMBS transactions.

Risk Management

DVA white paper published

Quantifi has published a short whitepaper entitled 'CVA, DVA and Bank Earnings' in response to recent bank earnings.

David Kelly, director of credit products at Quantifi, comments, "Debt Value Adjustment (DVA) has caused a lot of confusion because banks are allowed to record gains as their credit quality deteriorates. While there are pros and cons to including DVA in earnings, most people see it as accounting gimmickry which doesn't reflect any true economic value. We hope this paper will shed some light on the issue."

The paper provides an overview of DVA and highlights some of the results reported by larger banks, along with potential implications going forward. The paper addresses: the meaning of DVA and how it relates to CVA; Q311 DVA results for the five largest US banks, along with the increases in their respective CDS spreads that drove these gains; the subsequent tightening of spreads during October and the estimated monthly DVA loss; how much the DVA could move during Q411 due to movements in market factors other than credit spreads; and how some banks hedge DVA in order to reduce earnings volatility.

Dmitry Pugachevsky, director of research at Quantifi, says, "DVA is not only driven by the bank's credit spread but also by the underlying market risk factors of the portfolio. The volatilities of the individual risk factors contribute substantially to the volatility of DVA. We expect more banks to look more closely at hedging DVA to mitigate earnings volatility."

Risk Management

US bank risk model launched

Trepp has launched the Bank Navigator, a web-based product for financial institution surveillance and risk assessment. The new model provides risk ratings and financial forecasts for all 6,900 US banks by comparing past financial information, regulatory data and loan history with proprietary analytics and macroeconomic models.

Trepp has back-tested the product and says that, since September 2007, the model has successfully identified 96% of the commercial banks that have failed, often one or two years in advance of regulatory action. Bank Navigator is aimed at institutional investors, banks and any firms looking to identify distressed loan portfolios.

Risk Management

Standard CSA proposal outlined

ISDA has outlined key provisions to the Standard Credit Support Annex (SCSA) proposal as part of its drive to improve standardisation in OTC derivatives. The association says it is a market-driven initiative that "allows firms to move at the pace they deem appropriate".

The SCSA aims to standardise market practices by removing embedded optionality in the existing CSA, promote the adoption of overnight index swap (OIS) discounting for derivatives and align the mechanics and economics of collateralisation between the bilateral and cleared OTC derivative markets.

"ISDA will continue to lead standardisation initiatives in an effort to make global derivatives markets safer and more efficient," says Conrad Voldstad, ISDA ceo. "The Standard CSA is the next step towards simplifying and standardising market processes regarding collateralisation."

The SCSA proposal amends the collateral calculation of the current CSA so derivative exposures and offsetting collateral are grouped into silos of like currencies. Each currency silo is evaluated independently to generate a required movement of collateral in the relevant currency. This aligns bilateral collateral structures to be more consistent with the London Clearing House and others.

The proposal also considers the operational and technology impact of introducing the SCSA as well as the relationship between the new SCSA, existing CSAs and counterparty-level netting sets for termination and other purposes.

Risk Management

CCP capitalisation consultation continues

The Basel Committee has issued its second consultative paper on the capitalisation of bank exposures to central counterparties (CCP). The Committee's proposals cover both capital requirements for default fund exposures and trade-related exposures to CCPs.

The Committee's first consultation paper on the topic was released a year ago (SCI 21 December 2010) and the second paper takes account of responses to that first consultation paper as well as subsequent impact assessments.

The Committee intends to finalise the rules at year-end and expects they will be implemented in its member jurisdictions by January 2013. Any comments on the proposed rules should be submitted by 25 November.

RMBS

US RMBS mod performance improves, decelerates

Performance on recent US RMBS mortgage loan modifications has improved, but the number of new mods completed continues to decline, reports Fitch. The agency attributes the decline to fewer borrowers qualifying or accepting offers under current programmes.

There were 32,800 new mods in September 2011, compared to 86,400 completed in April 2009. The cumulative total of loans receiving at least one modification is now 24% of all non-agency RMBS by balance, while 48% of all subprime loans have been modified at least once.

The more recent mod efforts are posting better results than earlier programmes, which suggests standardisation of modification guidelines has helped create more sustainable modifications. Fitch's previous prediction of 50%-60% of all prime and 60%-70% of all subprime and Alt-A mods re-defaulting within 12 months has now been revised down to 45%-55% of all recent mods.

Fitch believes existing mod programmes will not resolve the most severely distressed borrowers. The agency says it remains to be seen whether any additional features or new programmes will be developed to address the high level of distressed loans in these products.

Although the use of methods such as short sales has increased and lowered loss severities compared to REO sales, the improvement is being offset by increasing timelines for the resolution of seriously delinquent loans as many borrowers choose to stay in the property longer.

Timelines have also been impacted by process concerns, documentation defects, moratoriums, required mediation and court delays, says Fitch. The agency expects this environment to continue in the near- to mid-term and the inventory of unsold homes to remain high, which will put further negative pressure on home prices next year.

RMBS

E-trading platform adds RMBS, CMBS

MarketAxess has added non-agency RMBS and CMBS to its e-trading platform. The products expand the suite of structured products available on MarketAxess, following the addition of ABS earlier this year (SCI 11 May).

Lou Violante, MarketAxess structured products manager, comments: "We have seen good traction in ABS trading over recent months and have introduced non-agency RMBS and CMBS in direct response to client demand to expand our menu of structured products."

RMBS

Foreclosure start rates rising

Foreclosure start rates on delinquent US mortgages are rising toward historical averages one year after industry-wide deficiencies were revealed in foreclosure procedures, according to the latest RMBS Performance Metrics report from Fitch.

According to Fitch, an increase to more normalised foreclosure initiation rates will ultimately add to the inventory of distressed properties on the market. This will in turn increase negative pressure on US home prices further supporting Fitch's view that home prices will likely see another 10% decline before they fully stabilise.

Foreclosure start rates on severely delinquent loans have increased to over 10% a month in the private-label RMBS sector. This is almost double the historical lows from a year ago, and is approaching the average rate between 2000 and 2010 of 14%.

The increase in foreclosure rates has been concentrated primarily in the most severely delinquent loans. Foreclosure initiation rates have nearly doubled in the last five months for borrowers that have not made a payment in over six months. Fitch has observed a more modest increase of roughly 25% for borrowers that have missed between three-and-six payments over the same time period.

How any change in foreclosure starts will affect the supply of distressed inventory may not be evident for over a year, says the rating agency. The foreclosure process is currently taking on average approximately eight months to complete in non-judicial foreclosure states and 15 months in judicial foreclosure states. Foreclosure completion rates in judicial states remain near historical lows. Driving these trends are servicers' continued loss mitigation efforts, a backlog in court foreclosure filings and weak demand in the housing market.