Contents

Structured Finance

Partial benefit

TRACE data having mixed liquidity impact

The US structured trading activity and pricing information that FINRA has made available to the market over the last few months has broadly boosted liquidity, particularly for agency MBS. However, more granular detail is required to make the data on other ABS segments equally as valuable.

The information FINRA is releasing is based on TRACE data (SCI 18 October 2011). A review of the published trading volumes should, say MBS analysts at Deutsche Bank, make investment choices clearer than ever before.

Structured finance consultant Dan Castro believes that TRACE and the associated data has been a modest positive for the market. "For the agency paper, there was already good information and pretty good liquidity and TRACE has added modestly to that. Unfortunately, the non-agency information is still a bit too general to be really useful."

FINRA publishes two sets of data: one on pricing information and one on trading activity. The former dataset gives greater clarity, according to Castro, although he argues that - for agency MBS at least - visibility was pretty good even before the TRACE data was disseminated.

The trading activity report is what Castro believes is particularly useful. He says: "That is valuable for market participants because you see the number of trades and the dollar amount of trades. You can see just how active the market is and, if you look at the stuff on a daily basis, you can see if the market is slowing down or activity is picking up."

The pricing data allows broker-dealers to see what their rivals have traded. By comparing their own trades to the activity of the market as a whole, they can see their market share, which can also be particularly valuable.

Castro explains: "When I worked at Merrill Lynch, they were the biggest player in a lot of those markets, but I only saw their share of the market. It was a bigger share than anyone else, but it still was not the whole market. Now you can see the whole market."

By collecting the pricing data and having it all in one place, it is also now possible to build personalised databases. In that sense, what is being published is more than a daily snapshot because the data can be collected and correlations can be run against it.

The main area where the FINRA data has been helpful is for agency MBS liquidity. Castro says: "You can see with pretty much absolute transparency where everything is trading - by coupon, product type, all of that. A lot of that was already available from the dealers, but this is crystal clear information. When you have such complete information, it can only help liquidity because you have no doubt where the bonds are trading."

Information for other ABS sectors is, at present, still rather vague. Pricing data presented for non-agency ABS includes average price and the average price for the bottom-five and top-five trades, but not whether these high or low prices are in autos, credit cards or any other segment.

This may be a boon for those trading non-agency ABS and CDOs, who can benefit from the opacity in the market as it leads to wider bid-ask spreads and thus more profit potential. However, investors want increased transparency and greater knowledge of market activity.

The fact that the non-agency data is not broken down into sub-sectors is a real problem and limits its usefulness, says Castro. He notes: "It does not have that level of detail. The information would only be useful by sub-sector."

He continues: "But even within autos and credit cards, you want to see one-year bonds, two-year bonds, three-year bonds, because they are all going to trade at different places. It is the same in CMBS, where the data does not show super seniors, AMs or AJs, but just generically CMBS. It does not give you the detail that you need."

Although Castro believes the pricing data is far more useful for agency MBS than it is for non-agency ABS, he says the trading volume report is useful for both. Again, though, overall ABS is not broken down into its constituent sectors. Castro would like to see more detail here and says that loan-level information would make a difference.

"I heard that the agencies are going to start providing loan level information, which they have not done in the past," he comments. "That will change things because all of a sudden the quant teams who do all the analysis on the non-agency stuff are going to start doing it for agency as well. It is almost like an employment act for the quant guys."

Arguably, FINRA is only just beginning the push towards that greater transparency, particularly on trade volume. The regulator has historically taken a gradual approach to introducing ABS TRACE data, with the aim of reducing market disruption (see SCI 7 October 2009), and says its dissemination is "the first step FINRA plans to take toward increased transparency in the securitised product market".

Castro appreciates that it is a positive start, but says more can still be done. He concludes: "Now they need to get some more detail. They show really good detail on the agency stuff, so that is more useful. But I am not sure this is really helping liquidity in the other sectors of the market because there is not enough information there - with such broad categories - to make things truly transparent."

JL

Structured Finance

Euro RMBS outshines CLOs, CMBS

Activity in the European securitisation market has been mixed so far this year. RMBS has made a promising start and one trader reports that renewed primary issuance is expected soon, but secondary trading in the CLO and CMBS markets is occurring only at low levels.

"The RMBS market is off to a better start than we ended 2011. At the end of last year, short Dutch triple-A RMBS had become a bid-only market because it can be used in ECB repos," says the trader.

He continues: "Now we are seeing that starting to translate into bids for some longer-dated paper as well, albeit mainly in the benchmark names like Storm and Arena. To that extent, it seems like the ECB tender is working."

The trader also believes that more primary issuance is just around the corner, particularly for Dutch RMBS. He notes that Obvion is road-showing a new Storm transaction, which he expects to launch soon. This joins Santander's latest RMBS - Holmes Master Issuer series 2012-1 - in the pipeline.

The European CLO market, meanwhile, has not started the year so strongly. The trader notes that the market remains dislocated, with the low level of trades making it difficult to validate marks.

He says: "The CLO market rallied significantly in the second quarter of last year, but it really tanked around year-end to levels that were even lower than those seen in 2010. The lack of ability to validate the prices is really putting people off buying, even though fundamentally the asset class has done pretty well."

The trader adds: "There has been some suspension of equity coupons, but generally transactions are paying down. Hopefully at some point the fundamentals will mean prices go back up. Or perhaps the market is right and it is preparing itself for a really poor fundamental outlook this year and next year. We will see."

Finally, the CMBS market has already seen one BWIC do the rounds and receive a good response, although the trader notes that it is not necessarily great news for sellers. "Pretty much everything on the BWIC traded, which goes to show that if you have a willing seller then you can get things done," he says.

"But the prices that they traded for were very low, with covers down in the 20s and 30s. These are the sort of prices one would have to accept to sell mezz CMBS right now and there are not that many sellers out there who are willing to accept these kind of levels," he concludes.

JL

Structured Finance

SCI Start the Week - 16 January

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

Pipeline
The number of deals entering the pipeline is picking up, with five new transactions remaining at the end of last week. A €1.44bn RMBS from Crédit du Nord (FCT BS CDN PPI) led the way and was joined by a second RMBS after Santander announced Holmes Master Issuer series 2012-1. These were followed by a US$276m student loan ABS (South Texas Higher Education Authority 2012-1) and a US$150m ILS (Vitality Re III 2012-1). Finally, Crédit du Nord also announced a €1.4bn SME CLO (FCT BS CDN ENT).

Pricings
As well as five deals entering the pipeline, five transactions priced. Three of the deals (US$1.6bn Ally Auto Receivables Trust 2012-1, US$226m MMCA Auto Owner Trust 2012-A and US$775m Santander Drive Auto Receivables Trust 2012-1) were auto ABS transactions. Additionally, a US$1.2bn-equivalent credit card ABS (Arran Cards Funding UK 2012-1) and a US$765m student loan ABS (SLM Student Loan Trust 2012-1) printed.

Markets
A positive tone was seen across the majority of the structured finance secondary markets over the past week.
In the US ABS markets, securitised products analysts at Barclays Capital say: "This week's secondary trading was characterised by better buying, with non-mortgage ABS investors in full fledged risk-on mode. The search for spread/yield continued across all non-mortgage asset classes, with broad-based investor participation, resulting in a general spread tightening trend for the sector."
In generic consumer ABS, credit card and retail auto ABS were up to 5bp tighter at the senior level, with mezzanine and subordinate paper 10-15bp tighter week on week, depending on name. In addition, FFELP student loan paper tightened 5bp across average lives, following the pricing of the new issue SLMA 2012-1 transaction.
US CMBS spreads have also continued their move tighter over the past two weeks. "The respite in market volatility over the past few weeks combined with relatively strong economic prints have contributed to the CMBS rally," Citi's securitised products analysts explain. "Spreads widened out a bit on Thursday on news of further liquidations out of the Maiden Lane portfolio, but are still generally much tighter than at year-end," they add. Generic legacy dupers have come in 55bp since year-end, GG10s have tightened by 25bp, AMs are in by 125bp and CMBS 2.0 triple-Bs are in by 75bp.
Last week finally saw the European CMBS market come to life as well. Deutsche Bank CRE debt analysts report: "The European CMBS market has started 2012 on a positive tone, with benchmark names TMAN 6 A and TMAN 7 A both up 3-4 points. BWIC volumes for the week were around €25m, with the majority of activity being over the counter driven."
Meanwhile, the US RMBS market last week saw a continuation of the optimism seen the previous week. US residential credit analysts at Barclays Capital say: "Last week's positive sentiment continued into this week as equities and corporate credit both rallied amid strong government bond auctions in Europe and reduced liquidity concerns in the European banking system. Non-agency cash bonds participated in the rally, with prices generally rising by 1-2 points week on week. In synthetics, the ABX remained relatively flat, while prices in PrimeX rose 1-2 points."
They continue: "Trading volumes picked up as accounts, especially real money, looked to deploy capital in the new year, with the fixed-rate prime and alt-A sectors attracting particularly heavy investor interest. Generally, average daily trading volumes reported by TRACE in the past week have been roughly 50% above the levels of the previous three months."
The European CLO market remains considerably quieter, however. Strategists at Chalkhill Partners say: "2012 opened much as 2011 ended for the European CLO market, with activity muted as expected and volumes low. In the last couple of weeks, activity has been muted as most holders of CLOs are figuring out the strategy for 2012, although there were a couple of BWICs punctuated by DNTs."

Deal news
• Anchorage Capital's chapter 11 plan for the liquidation of the Zais Investment Grade VII CDO has been approved, becoming the first-ever involuntary prepackaged case brought under the US bankruptcy code. It is also the first and only use of chapter 11 to unwind a CDO.
• Assured Guaranty (Europe) has replaced Ambac Assurance UK as financial guarantor and controlling creditor on Worcestershire Hospital SPC, a £97.2m UK Private Finance Initiative bond issue. The move is expected to enhance the creditworthiness of the bonds and was approved by 100% of the voting bondholders.
• Markit iTraxx LevX market makers have determined that a failure to pay credit event occurred in respect of SEAT Pagine Gialle, a constituent of the index and the subject of single name LCDS trades. They have voted to hold an auction in respect of SEAT, scheduled for 17 January.
• A noteholder meeting is being convened on 24 January to discuss and approve two proposals related to the Monastery 2006-1, Monastery 2004-1, Chapel 2003-1 and Chapel 2007-1 transactions. The meeting follows one week after a scheduled meeting to discuss improving reporting and accountability of the security trustee for Chapel 2003-1.

Regulatory update
• The Group of Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision, met on 8 January to discuss Liquidity Coverage Ratio (LCR) proposals and its strategy for assessing implementation of the Basel regulatory framework more broadly.
• Fitch suggests that the recommendations in a recent Federal Reserve white paper on the US housing market are challenging, but some may benefit the private-label RMBS sector. The Fed's commentary recommends policies that limit the growth of the inventory of foreclosed homes and make mortgage credit easier to access.
• GreySpark Partners has released a report examining the expected impact of OTC derivatives clearing from the buy-side, sell-side and third-party vendor perspectives. The report looks at the regulatory picture in Europe and the US, focusing on the MiFID review, European Markets Infrastructure Regulation (EMIR), Basel 3 and the Dodd-Frank Act.

Deals added to the SCI database last week:
Adriano Lease Sec
AyT Celeris Hipotecario I
AyT Goya Hipotecario FTA V
BBVA Empresas 6
CIT Railcar Funding Company series 2011-1
FirstMac Mortgage Funding Trust Series 2-2011
Liberty Series 2011-1 Auto
2011 Popolare Bari SPV

Top stories to come in SCI:
TRACE and ABS liquidity
CDS documentation
US CMBS modification trends
Asian CLOs
Developments in CDS clearing
Future of the infrastructure sector
Recruitment trends

CMBS

Special servicer fees scrutinised

CMBS investors are becoming increasingly concerned about post-maturity loan pay-offs that generate workout fees despite only spending a few months with the special servicer, according to US CRE Debt analysts at Deutsche Bank. They cite the pay-off of the securitised loan on the 50 South Tenth Street building in Minneapolis as a notable recent example of the issue.

"50 South Tenth Street (US$76.2m) in BACM 2007-2 paid off this month, on its scheduled maturity date, but still managed to take a US$780,000 loss. This occurred despite the loan being transferred to the special servicer in October because the borrower did not believe that the loan would be paid off by the maturity date and wanted an extension. More interestingly, the performance of the 500,000 sq ft class A Minneapolis CBD office which secures the loan has been fantastic," the analysts say.

Prior to the transfer, the loan had never been delinquent and the most recent financials showed a 1.97x NOI DSCR, 99% occupancy and an 11% debt yield. But the special servicer, Situs, charged a 1% workout fee.

Although most investors will not be directly affected by this loss, the Deutsche analysts argue that - given the large number of CMBS loans scheduled to mature this year (US$50bn) - the potential for losses totalling tens of millions and perhaps even exceeding US$100m is not insignificant. In addition, the analysts expect an increase in realised losses due to more dispositions; if so, the original equity tranche in many deals will soon be written off and expose the B piece to losses.

"Given that many of the bonds are 1% thick, there is a good chance that by themselves workout fees charged on 'good' loan payoffs will cause more than a few bonds to get written off," they say.

"Especially disconcerting for the credit bond holders, this type of loss not only writes down their position, but also does not reimburse any missed interest as these loans are performing before being paid off. While clearly we were not privy to the details of the negotiation process, on face it certainly appears that CMBS investors should have been spared paying the fee or at a minimum should have been charged a reduced fee," the analysts conclude.

MP

ABS

Law firm adds SF specialist

Berwin Leighton Paisner has added a structured finance specialist to its banking and capital markets group. Prashanth Satyadeva joins from Clifford Chance, where he was a securitisation partner.

Satyadeva advises banks, funds, corporates and others on securitisations and asset-backed finance structures across several sectors. He will report to Paul Severs, also formerly of Clifford Chance.

Structured Finance

Firm appoints SF partner

Schulte Roth & Zabel has named a new structured finance partner. David Karp, based in the New York and London offices, is promoted to the role after six years with the firm.

Karp's practice focuses on corporate restructuring, special situations and distressed investments, distressed mergers and acquisitions and the bankruptcy aspects of structured finance. He leads the distressed debt and claims trading group.

Structured Finance

Mexican SF specialist enlisted

Juan Manuel Gonzalez Bernal has joined Greenburg Traurig's newly established Mexico City office as a shareholder. He joins the global energy and infrastructure practice.

Gonzalez practices in DCM and advises on structured financings and cross-border banking and securities transactions. He joins from the law firm of Galicia Abogados and is licensed to practice law in both Mexico and New York. He has previously worked at White & Case and Valuacion y Venta de Activos.

Structured Finance

EM investor joins new Swiss office

Alexander Nagel has joined Global Evolution with a focus on formulating absolute return strategies within emerging markets debt and FX. He will join the company in Switzerland, where it is currently establishing an office.

Nagel was most recently at EM Quest Capital in London where he focused on global emerging markets fixed income. He has also previously held senior portfolio manager positions at UBS Global Asset Management and Deutsche Asset Management.

CDS

Thames River restructures credit team

Thames River has made changes in its global credit team, which is headed by Stephen Drew. Brett Golledge and Jennifer James both join in senior roles as part of the reorganisation.

Golledge will become co-manager of the credit team's funds alongside Drew. He joins from UBS where he was head of credit trading and brings two decades of experience, including posts at Swiss Bank, Deutsche Bank and RBS specialising in credit derivatives and iTraxx credit index trading.

James also joins as the global credit team's head of credit research. She arrives from Gruss Asset Management where she was a partner and head of credit research, focusing on credit and distressed debt opportunities.

As a result of the restructure, Mehrdad Noorani, portfolio manager, and Chris Currington, coo, will be leaving Thames River.

CLOs

Oak Hill promotes partners

Oak Hill Advisors has named four new partners, who will join the six existing partners in leading the firm and directing investment in the North American and European credit markets. The new partners are Alexandra Jung, Adam Kertzner, Jeffrey Kirt and Thomas Wong.

Jung is co-head of European investments and co-manages the firm's European distressed investment fund. She joined the firm in 2009 and has previously worked for Goldman Sachs and Greywolf Capital Management.

Kertzner is a member of the North American portfolio management team, responsible for high yield, distressed debt and other trading activities. He joined the firm in 2002 and previously worked for Credit Suisse First Boston.

Kirt is a senior member of Oak Hill's distressed investment group with a focus on North America. His primary expertise is in aerospace, autos, defence, financials and transportation. He joined in 2002 and previously worked for US Bancorp Libra and UBS Securities.

Wong is a member of the North American portfolio management team and leads the firm's telecommunications, media and cable industry research. He joined in 2001 and previously worked in Deutsche Bank's DCM group.

CMBS

Industry vets form CRE firm

A new firm has launched in the CRE space, offering a source of capital solutions and expertise. SL Capital is an affiliate of The Lynd Company, providing capital from US$3m to US$200m-plus for commercial loan programmes and non-performing notes.

The company offers a variety of national loan programmes including CMBS, multifamily financing, mezzanine debt, preferred equity, bridge loans and senior financing for non-performing notes. It has also been designated a correspondent lender of Cantor Commercial Real Estate, offering fixed- and floating-rate loans from US$5m to US$200m-plus for stabilised commercial properties.

Michael Boggiano leads the team as company president. He is joined by Steve O'Shaughnessy, vp for sales and business development, and Jonathan Mettel, also vp for sales and business development.

CMBS

HFF appoints debt placement director

Holliday Fenoglio Fowler (HFF) has added a director to the debt placement group in its New Jersey office. Tom Graziano was most recently vp at Keefe, Bruyette & Woods in New York.

In his new role, Graziano will focus on debt, structured finance and joint venture equity transactions for office, retail, multi-housing and industrial properties throughout the northeastern US. Before Keefe, Bruyette & Woods he held positions at Ackman-Ziff and Capmark Finance.

Risk Management

Bank appoints CVA head

Lloyds Bank has recruited Cris Kinrade as head of counterparty exposure management and solutions in London. He will report to head of trading Richard Moore, who is also joining in March.

Kinrade has over 20 years of experience performing roles across wholesale and trading businesses. He joins from RBS where he was head of derivatives funding and he has also worked for UBS, Bank of America and ABN Amro.

Risk Management

Risk executive hired

RiskSpan has appointed John Lynch as executive of its independent pricing service. He was most recently vp and head of valuations at Alliance Bernstein.

Lynch has previously worked for Blackrock, AIG, UBS and EJV in a series of senior pricing and valuation roles and while at EJV he was responsible for building a pricing business from scratch.

Risk Management

Risk specialists team up

RangeMark Financial Services and Cooperstein Analytics (CA) have established RangeMark Analytics (RA). RA will license its analytics platform to financial institutions, investors and government agencies for valuation and risk assessment of mortgage loans, RMBS and CMBS.

RangeMark has acquired the exclusive rights to CA's fixed-income valuation platform. Richard Cooperstein will become president of the RangeMark affiliate and Colin Strasser will also join as head of IT. CoreLogic will be the company's exclusive data provider.

Before founding his own firm, Cooperstein was head of modelling and portfolio valuation for US mortgages at HSBC Securities and chief risk officer at Republic Mortgage Insurance Corporation. Amongst other roles he also spent nine years at Freddie Mac.

Strasser was president of software development company U2i and managed its financial services business. He has been involved with front office trading systems for HSBC and Fannie Mae, securitisation models for Lehman Brothers and fixed income risk management systems to Prudential Bache Securities.

RMBS

SEC fines UBS investment arm

The US SEC has charged UBS Global Asset Management with failing to properly price securities in three mutual funds it managed, resulting in a misstatement to investors of the NAVs of those funds.

The misconduct was discovered during an SEC investigation, triggered by a referral from SEC examiners. The investigation determined that during a two-week period the company did not follow the mutual funds' fair valuation procedures in pricing certain securities.

UBS Global Asset Management purchased approximately 54 complex fixed-income securities in June 2008 on behalf of the mutual funds, at an aggregate purchase price of approximately US$22m. Most of the securities were subordinated tranches of non-agency MBS, but there were also ABS and CDOs.

The SEC's order finds that following the purchases, all but six of the securities were then valued at prices substantially in excess of the transaction prices. The valuations were provided by pricing sources which did not appear to take into account the prices at which the securities had been purchased by the mutual funds, with some broker-deal quotations based on the previous month-end pricing.

Further, the SEC says the company did not price the securities at fair value until it held a meeting of its global valuation committee more than two weeks after receiving price tolerance reports identifying the price discrepancies. Failure to implement proper procedures caused the funds to violate Rule 38a-1 of the Investment Company Act.

As the securities were not properly or timely priced at fair value, the NAVs of the funds were misstated between one cent and 10 cents per share for several days and therefore the funds sold, purchased and redeemed shares based on inaccurately high NAVs, says the SEC.

UBS Global Asset Management has agreed to pay US$300,000 to settle the charges without admitting or denying the SEC's findings.

ABS

Negative outlook for US ABCP

Moody's credit outlook for US ABCP in 2012 is negative, although its outlook for the credit quality of assets funded by ABCP is neutral to improving. The volume of outstanding commercial paper will likely decline this year.

"Our outlook for ABCP is negative primarily because of our negative outlook for the global banking sector," says Everett Rutan, a Moody's svp. "Furthermore, both the economy and regulatory uncertainty remain negative factors for outstandings. The number of conduits and total outstandings are at best likely to be flat in 2012 and more likely to continue to decline. In 2011, for example, we rated only two new US conduits and withdrew the ratings on nine, and there's no pipeline of new conduits."

Credit quality of the banks is the main driver for the credit quality of ABCP because almost all conduits rely on liquidity facilities from the banks for timely repayment. Moody's credit outlook for the banking sector worldwide is negative, with only a few exceptions.

"US-based ABCP conduits feature a variety of sponsors, such as US, European, Canadian and Japanese banks, and many European-based ABCP conduits fund in the US ABCP market," says Rutan. "Therefore, there are opportunities out there for investors to diversify their exposures."

Asset credit quality has generally not been an issue in the multi-seller ABCP conduits that now dominate the US market and sponsors have removed troubled assets from their conduits. More than 50% of multi-seller conduits consist of consumer debt, with the share of corporate assets such as trade receivables, equipment loans and leases, and corporate loans at just over 40%. Securities holdings continue to amortise and make up the remainder, at nearly 8%.

The level of commercial paper outstanding declined steadily throughout 2011, although it stabilised somewhat towards the end of the year. "Facility utilisation remains below 40% for the US multi-sellers," notes Rutan. "Depending on the pace of economic activity, low utilisation could either portend further declines or facilitate a rapid rise in outstandings if demand increases."

Although regulatory factors have not affected the credit quality of ABCP conduits, they have raised the costs of programmes and led to changes in conduit structures. In addition, ongoing uncertainty over the wording, interpretation and enforcement of new regulations, such as the Volcker rule, will be a negative factor for both outstandings and new conduit formation.

ABS

Vitality III marketing

Goldman Sachs and BNP Paribas are marketing the third Vitality Re medical benefit claims ILS. Vitality Re III 2012-1 is a two-tranche deal, comprising US$105m class A notes preliminarily rated triple-B plus by S&P and US$45m class B notes currently rated double-B plus.

As with the previous Vitality Re transaction, S&P says the preliminary ratings are based on a model developed by Milliman specifically for these transactions. The notes cover claims payments of Health Re - and ultimately Aetna Life Insurance Co (ALIC) - relating to the covered insurance business to the extent the medical benefit ratio (MBR) exceeds 103% for the class A notes and 97% for the class B notes. The MBR will be calculated on an annual aggregate basis.

The initial annual ceded premium is currently targeted at US$750m, although this could change prior to closing. The initial MBR attachment point for the class A notes will be US$772.5m and the attachment point for the class B notes will be US$727.5m.

ABS

Loan defaults weigh on SME ABS

Moody's expects deterioration in the credit quality of European banks to negatively affect new and existing SME ABS transactions, leading to a rise in loan defaults in 2012. The impact will be most acute in transactions without additional structural features or more credit enhancement to compensate for the reduced credit quality of counterparties.

"Sovereign turmoil and banking sector stresses will continue to take their toll on the credit quality of counterparties that play critical roles in SME ABS deal structures, particularly account banks," says Stefan Augustin, a vp-senior credit officer/manager in Moody's structured finance group. "The shrinking universe of sufficiently highly rated counterparties will magnify counterparty risk for new transactions as fewer banks become counterparties in increasing numbers of deals."

Operational risk will also increase in existing transactions where counterparties face deteriorating credit quality. Moody's expects new deals in 2012 to have more straightforward structures with static pools and with no basis swaps, which will make them more transparent.

In addition, the rating agency expects such deals to include better quality underlying collateral. They will include either more recent loans originated according to tighter underwriting criteria or more seasoned loans that have had time to weather a period of economic stress and de-lever.

"The credit quality of existing portfolios will deteriorate in 2012, as defaults rise and recoveries fall or are delayed," adds Augustin.

Transactions heavy with peripheral euro area SME loans and/or exposure to the real estate sector in particular are expected to suffer. SMEs focused on exports to growing economies such as Asia and Latin America may be afforded some protection, but they will likely face challenging domestic macroeconomic conditions coupled with a slowing rate of growth in their export markets.

Key among challenges for European SMEs will be access to and the cost of bank funding in order to refinance as the banking system outlook remains negative in all major European SME ABS markets. Various government initiatives have been launched to boost liquidity to the sector, but Moody's expects their palliative effects to be limited in 2012.

Despite such challenges, the agency expects to see many originators returning to market - particularly from Spain and Italy - driven by secured funding needs amid the continued effective seizure of the senior unsecured markets. The vast majority of new deals will be for ECB placement and they will therefore largely be structured to meet the reduced minimum eligible rating for repo to minimise the cost of funding to the originator.

ABS

Mixed outlook for aircraft ABS

Fitch's outlook for aircraft ABS performance in 2012 remains mixed. While base-case expectations call for relatively stable aircraft values and lease rates, a eurozone debt crisis-driven recession could substantially affect that outlook. Downgrades on aircraft-related securitisations will likely surpass upgrades in 2012, particularly among older vintage transactions, the agency notes.

Fitch expects that despite the upcoming delivery of newer technology narrowbody aircraft in 2015-2017, demand will remain strong for current generation Boeing 737 and Airbus A320 aircraft. Large concentrations in theses asset types should support stable rating performance on post-2002 vintage securitisations under most scenarios. Meanwhile, heavy concentrations in less popular aircraft types will hamper collections on pre-2002 vintage securitisations, particularly in a recessionary scenario.

New aircraft ABS issuance may pick up in 2012 as the availability and attractiveness of traditional funding sources - such as European commercial banks and export credit agencies - declines.

ABS

ABCP PWCE criteria changes proposed

S&P has published a request for comment (RFC) on proposed changes to the methodologies and assumptions it uses to rate fully and partially credit-enhanced multiseller ABCP conduits. The RFC focuses specifically on proposed criteria for the minimum amount of programme-wide credit enhancement (PWCE) required to maintain an A-1+ or A-1 rating on commercial paper issued by multiseller ABCP conduits.

If adopted, the proposed minimum PWCE would be calculated based on:

• An assessment of asset credit quality;
• The amount of any allocations of PWCE to specific transactions;
• For large pools, the results of a largest asset default test subject to a floor;
• For small pools, the results of a small-pool adjustment to the largest asset default test; and
• The terms and conditions for funding under the liquidity facility that may affect the severity of loss on a defaulted asset.

The proposed criteria would align the multiseller ABCP conduit criteria with the proposed SF CDO criteria, adjusted for market and structural differences where relevant. Written comments should be submitted by 31 March.

ABS

Assurant returns with latest Ibis Re deal

Assurant is to sell a third issuance of notes from its Ibis Re II programme, having last tapped the market in April 2010. Ibis Re II 2012-1 will issue approximately US$70m of double-B minus rated class A three-year notes and US$30m of single-B minus class B three-year notes, covering US hurricane risk.

The transaction has been structured by Aon Benfield and Deutsche Bank, with the modelling, reset and calculation agent being AIR Worldwide Corp. The previous Ibis Re transactions were modelled using RMS.

The following areas will be covered by the transaction: Alabama, Arkansas, Connecticut, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Mississippi, Missouri, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Vermont, Virginia, West Virginia, the District of Columbia and Puerto Rico. It is the first such transaction from Assurant that has exposure to losses in Puerto Rico.

ABS

CatVest launches ILS, ILW tools

CatVest Petroleum Services has launched its EnergyRisk Model and Industry Loss Index. The firm's modelling services are specifically designed to assist with the transfer of risks to the capital markets through the use of financial instruments, such as ILS and ILWs.

CatVest has devised a suite of modelling tools that it claims allows for accurate estimation, analyses, calculation and indexing of catastrophic losses in the offshore and onshore oil and gas energy and chemical industries worldwide. This model is tailored specifically for the purposes of creating industry loss indices for the energy sector. These energy industry loss indices can be used to assist with the design, structuring and triggering of cost-effective ILS or ILWs.

The firm says it is currently working on a large North Sea offshore energy industry-loss warranty (ILW) transaction with one of the world's largest reinsurance brokers for a major global reinsurer.

ABS

Zenkyoren returns

A new Japanese quake catastrophe bond has begun marketing on behalf of Japan's National Mutual Insurance Federation of Agricultural Cooperatives (Zenkyoren), whose Muteki Re cat bond suffered a 100% loss after last year's Tohoku earthquake.

The Single tranche US$150m Kibou transaction is being arranged by GC Securities on behalf of risk counterparty Hannover Re and reinsurer Zenkyoren. The series 2012-1 class A notes have been given a preliminary rating of double-B plus by S&P.

Kibou will be exposed to earthquakes in Japan between February 2012 and February 2015. It will cover losses in excess of an event index value of 1,050 and below a value of 1,150. In addition, the notes will have a dropdown feature. If the event index value from the first event is equal to or greater than 270, the notes will provide coverage for any subsequent events from the dropdown effective date onward in excess of an event index value of 490 and below a value of 590.

S&P says: "In contrast to other per-occurrence structures, the probability of a first dollar loss increases with the passage of time. If a dropdown activation event occurs, then the notes could be downgraded to single-B plus, depending on the timing of the event."

When an event occurs, Hannover Re can choose to send an event notice to Kibou, the indenture trustee, and AIR within 35 days of the event and request AIR to provide an event report. On the 75th day after the event, AIR will obtain the event-specific data from Kyoshin Net (K-NET), the system that gathers strong-motion data obtained from over 1,000 observatories deployed all over Japan. AIR will establish whether a covered event has occurred using the transaction's definition of an earthquake event. AIR will then calculate the event index value, using the reported peak ground acceleration figures reported at each calculation location.

The deal's collateral will be invested in US Treasury money market funds.

Structured Finance

EFSF downgraded

S&P has lowered the triple-A long-term issuer credit rating on the European Financial Stability Facility (EFSF) to double-A plus and affirmed the short-term issuer credit rating at A-1+. The ratings were also removed from credit watch, where they had been placed with negative implications on 6 December 2011. The outlook is developing.

The move follows rating actions on 16 eurozone countries, including the lowering to double-A plus of the long-term ratings on two of the EFSF's previously triple-A rated guarantor members - France and Austria. The outlook on the long-term ratings on France and Austria is negative, indicating that S&P believes that there is at least a one-in-three chance that it will lower the ratings again in 2012 or 2013. The agency affirmed the ratings on the other triple-A rated EFSF members: Finland, Germany, Luxembourg and the Netherlands.

Following the downgrade of France and Austria, the rated long-term debt instruments already issued by the EFSF are no longer fully supported by guarantees from the EFSF guarantor members rated triple-A by S&P or triple-A rated liquid securities. The agency considers that credit enhancements that would offset what it views as the now-reduced creditworthiness of the EFSF's guarantors and securities backing the EFSF's issues are currently not in place.

The developing outlook on the long-term rating reflects the likelihood that S&P may either raise or lower the ratings over the next two years.

EFSF member states are understood to be exploring credit enhancement options. If the EFSF adopts credit enhancements that in S&P's view are sufficient to offset its now-reduced creditworthiness - in particular, if the EFSF's long-term obligations are fully supported by guarantees from EFSF member-guarantors rated triple-A or by securities rated triple-A - it would likely raise the EFSF's long-term ratings to triple-A.

Conversely, if the agency concluded that sufficient offsetting credit enhancements are unlikely to be forthcoming, it would likely change the outlook to negative to mirror the negative outlooks of France and Austria.

CDO

CRE CDO late-pays dip

Late-pays for US CRE CDOs finished the year at a lower level than in 2010, according to the latest Fitch index results. CRE CDO delinquencies for December came in at 12.5%, down from 13.6% at December 2010 and a 14.8% peak in April 2011.

The senior-most tranches of 68% of Fitch-rated CRE CDOs have either a stable or positive outlook. However, ratings on the most junior classes remain subject to volatility as losses continue to accumulate.

As of year-end 2011, only one-third of Fitch-rated CRE CDOs were still in their reinvestment periods. Total CRE CDO collateral is down by US$2.3bn since 2010, including cumulative reported realised losses of approximately US$710m (3.4% of the total collateral) over the same period.

An estimated US$1.1bn accounted for recoveries on defaulted assets, with close to US$500m in repayments. All remaining Fitch-rated CRE CDOs exit their reinvestment periods in 2012.

Non-cash flowing property types - including loans on land, condominium conversions and construction properties - continue to have the highest overall delinquency rates in the Fitch CRE CDO universe. However, the total balance of these property types has declined by 34% since last year - a large percentage of which is due to the disposal of assets that had realised losses.

Office properties, which have the lowest overall delinquency rate, continue to comprise the largest portion of CRE CDO collateral. Multifamily, the third largest asset type in CRE CDOs, had one of the most significant declines in delinquency over the last year; a figure that should continue to drop as Fitch expects apartment fundamentals to continue improving.

In December, asset managers reported nine new delinquent assets. Among them were two repurchased assets, three matured balloon loans, one term default and three new credit-impaired securities. Offsetting these new delinquencies, seven assets were removed from the index in the month.

CRE CDO asset managers also reported approximately US$60m in realised losses from the disposal of credit-impaired assets during the month. The weighted average loss on these assets was 44%. The largest single loss was related to a B-note and mezzanine interest on a defaulted hotel located in Puerto Rico. Both interests were written down to zero by the asset manager.

CDO

ZING unwind approved

Anchorage Capital's chapter 11 plan for the liquidation of the Zais Investment Grade VII CDO (SCI passim) has been approved, becoming the first-ever involuntary prepackaged case brought under the US bankruptcy code. It is also the first and only use of chapter 11 to unwind a CDO.

"The Zais case proved that distressed CDOs, previously thought by some to be immune to bankruptcy, can in fact be successfully reorganised in bankruptcy," comments Gerard Uzzi, a partner in White & Case's global financial restructuring and insolvency practice who represented Anchorage.

Prior to the filing of involuntary petitions placing Zais in bankruptcy proceedings, three Anchorage entities solicited acceptance of their plan of reorganisation for Zais using two provisions of the bankruptcy code previously thought mutually independent. "Prior to Zais, most people had not even considered the possibility of linking the provisions of the code allowing for involuntary petitions with those allowing for prepackaged plans in a single one-step process," continues Uzzi.

The US Bankruptcy Court for the District of New Jersey granted an order for relief against Zais and terminated its exclusive right to file a plan, paving the way for confirmation of the prepackaged Anchorage plan by US Bankruptcy Judge Raymond Lyons. That plan became effective on 6 January.

The move is expected to result in substantial economic benefit for the senior notes, the majority of which are said to be owned by Anchorage. "Value was indisputably created here," adds David Thatch, a partner in White & Case's global capital markets practice who also advised Anchorage. "Stakeholders and senior noteholders, in particular, will now receive materially higher cash recoveries through an actively managed liquidation by Anchorage, as the post-petition investment manager, than if the CDO were to continue in default outside of bankruptcy."

CDS

Clearing committee announced

ISDA has announced the membership and charter of its Industry Clearing Committee (ICC). The ICC, which consists of a broad cross-section of OTC derivatives industry market participants, was formed in June to meet current and emerging industry needs in respect of clearing.

Specifically, the ICC will assist in coordinating industry efforts to reach optimal levels of central counterparty clearing and to address obstacles in achieving those levels. It will also provide recommendations on central counterparty clearing practices across multiple OTC derivative asset classes.

The aims and functions of the ICC are to:

• Be representative of the sell-side, buy-side, CCPs and FCMs in order to deliver collaborative solutions;
• Extend the reach of clearing in terms of both eligible product types and clearing participants;
• Act as a forum where the industry discusses potential CCP product offerings and specifications with the applicable CCPs;
• Challenge and overcome obstacles to clearing through appropriate means, including utilising targeted working groups to address specific issues;
• Explore the capital implications of clearing; and
• Liaise with supervisors, supra-national governmental agencies and other relevant bodies on clearing matters relating to the OTC derivative markets.

The composition of the ICC includes approximately 40 sell-side, buy-side, CCPs and FCM market participants. The structure of the ICC is divided into three primary elements: a plenary group; an organisational group; and working groups formed to deal with specific issues and tasks.

CDS

SEAT LCDS auction due

Markit iTraxx LevX market makers have determined that a failure to pay credit event occurred in respect of SEAT Pagine Gialle, a constituent of the index and the subject of single name LCDS trades. They have voted to hold an auction in respect of SEAT, scheduled for 17 January. The move follows an auction held for CDS trades on 9 December (SCI passim).

CDS

OTC compression rates rise

TriOptima's triReduce compression service for both interest rate and credit default swaps terminated US$62trn in OTC derivative notional principal outstanding in 2011. This included US$56.4trn in interest rate swap notional principal, of which US$48.3trn were cleared swaps in LCH SwapClear, and US$5.6trn in CDS notional principal. This represented a 14% increase over 2010 levels overall and a 23% increase in interest rate swap terminations.

OTC derivative dealers supported the triReduce compression cycles in both cleared and uncleared interest rate swap transactions, and also continued to compress uncleared CDS transactions where possible. "We developed a strong partnership with LCH SwapClear and its members that resulted in significant terminations of cleared IRS transactions," comments Peter Weibel, ceo of triReduce. "In some months, like October, we actually eliminated more existing IRS notional principal from the clearinghouse than the aggregate notional of new trades submitted to clearing during the same period. We are working to sustain these results in 2012 within the clearinghouse, while continuing our expansion in non-cleared currencies around the globe."

Currently, TriOptima runs triReduce compression cycles in 25 IRS currencies globally and a range of CDS product types, including credit index swaps, single names and credit index tranches.

CDS

SEAT LCDS price determined

The final price for trades referencing SEAT PAGINE GIALLE was determined to be 45 during yesterday's SEAT LCDS auction. Three dealers submitted initial markets, physical settlement requests and limit orders to the auction administered by Creditex and Markit.

CDS

Markit adds CDS sensitivities

Markit is supplementing its end-of-day prices for credit default swaps with a new sensitivities report that is designed to give clients valuable information about the relationship between a CDS price and other market variables.

The new Markit CDS Sensitivities service gives clients the ability to understand how sensitive a particular CDS spread level is to changes in interest rates, credit quality and recovery assumptions. The report is comprised of seven variables and covers all 2,600 five-year, single name CDS and CDS indices (on- and off-the-run) priced by Markit.

Armins Rusis, md and global head of data, indices and research at Markit, says: "CDS Sensitivities is another example of how Markit is expanding its core data sets to include derived data that provide more context for clients. Having independent data to enable analysis of the relationship between price and variables like interest rates and credit quality is very valuable in giving additional metrics for quantitative and qualitative assessment of the potential volatility of a portfolio."

CDS

OTC trade repository recommendations released

CPSS and IOSCO have published their final report on the OTC derivatives data that should be collected, stored and disseminated by trade repositories (TRs). The committees support the view that TRs, by collecting such data centrally, would provide authorities and the public with better and more timely information on OTC derivatives. The aim is to make markets more transparent, help to prevent market abuse and promote financial stability.

The final report reflects public comments received in response to a consultative version of the report published in August 2011 (SCI 24 August 2011). Following the consultation exercise, the report was expanded to elaborate on the description of possible options to address data gaps. The report was also updated to reflect recent international developments in data reporting and aggregation requirements stemming from the Legal Entity Identifier (LEI) workshop in September 2011 and other efforts under the auspices of the Financial Stability Board (FSB), in support of a request by the G20 to advance the development of a global LEI.

However, some questions remain regarding how best to address current data gaps and define authorities' access to TRs. As requested by the G20, two internationally coordinated working groups will address these questions in the coming year. The FSB will establish an ad hoc group of experts to further consider means of filling current data gaps, while the CPSS and IOSCO will establish a joint group to examine authorities' access to trade repositories.

CLOs

Downgrades likely on SME CLO criteria change

S&P has issued a request for comment on a proposed revision to its methodology and assumptions for rating SME CLOs. The agency is proposing to adopt the global methodology for rating corporate CDOs, where appropriate, and adapting for the European SME market and the characteristics of the securitised portfolios. The aim is to enhance ratings comparability across sectors, the agency says.

One of the main changes is the introduction of the concept of an 'archetypical' (or average) European SME pool, for which S&P has assigned an average credit quality assessment of single-B plus that serves as the starting point for the triple-A default analysis. The proposed criteria would calculate the triple-A scenario default rate (SDR) for a specific European SME portfolio by adjusting the single-B plus average credit quality assessment to determine loan-level inputs and applying the triple-A targeted portfolio default rates from the corporate CDO criteria. Adjustments would be made for three factors: portfolio selection bias; loan distribution; and originator.

Furthermore, the proposed criteria would calculate the single-B SDR based primarily on an analysis of historical SME performance data and forward-looking analysis. The default rates for rating levels in between single-B and triple-A would be interpolated.

The proposed criteria would apply to new and outstanding European SME CLOs and would likely lower current ratings by an average of approximately four notches, based on the sample tested. The proposed criteria would affect investment-grade ratings more than speculative-grade ratings. Furthermore, the proposed criteria would affect older transactions more than recently rated transactions.

Comments on the proposed criteria should be submitted by 24 February. Once the comment period is over, S&P will review the comments and publish the updated criteria.

CMBS

TITN 2006-4FS steps up

The borrower behind the Titan Europe 2006-4FS CMBS has given notice in connection with the Four Seasons loan that it will not meet the minimum prepayment amount. As a result, investors will receive a step-up in coupon for both the class A1 and A2 notes.

The borrower intends to retain the investment properties that were going to be sold to finance the minimum prepayment, following the Southern Cross restructuring and recovery of possession of the properties leased to it. In accordance with the loan documents, the margins on the Facility A1 and Facility A2 loans will consequently increase on 18 January to 7.881% and 9% per annum respectively.

Strategists at Chalkhill Partners comment: "Whilst the decision to not meet the minimum prepayment condition was to some extent expected, our view is that this adds to the existing difficulties of a successful refinancing of the loan. This follows from the increasing leverage as the loan approaches maturity in September 2013, as step-up interest is accrued and unpaid. We see leverage increasing to above 8x at loan maturity and, given an 8x valuation at the restructuring date, our view is that a further restructuring is likely."

CMBS

Apollo refinances TALF debt

Apollo Commercial Real Estate Finance has utilised additional capacity under its master repurchase agreement with Wells Fargo Bank to refinance all of its TALF debt outstanding.

Prior to the refinancing, Apollo had TALF borrowings totalling US$250.3m with a weighted average cost of funds of 2.8%. Those borrowings were secured by triple-A rated CMBS with a face amount of US$298.6m.

By moving the CMBS to the Wells facility, the REIT was able to increase the advance rate and lower the cost of borrowing, resulting in US$264.4m of borrowings with a current weighted average cost of funds of approximately 1.9%. Apollo entered into interest rate swap agreements with an initial aggregate notional of US$56.3m.

Apollo increased the size of its Wells facility from US$250m to US$506m during December 2011. Borrowings resulting from the additional capacity will bear interest at 150bp over Libor. The facility matures in August 2013.

Risk Management

FDIC acts on stress test, resolution rules

The FDIC has approved a notice of proposed rulemaking (NPR) that would require certain large insured depository institutions to conduct annual capital-adequacy stress tests. It has also approved a final rule requiring an insured depository institution with US$50bn or more in total assets to submit periodic contingency plans for resolution in the event of the institution's failure.

The NPR, which implements section 165(i)(2) of the Dodd-Frank Act, would apply to FDIC-insured state non-member banks and FDIC-insured state-chartered savings associations with total consolidated assets of more than US$10bn. The stress tests would provide forward-looking information that would assist the FDIC in assessing the capital adequacy of the banks covered by the rule. The banks that would be required to conduct the stress tests also are expected to benefit from improved internal assessments of capital adequacy and overall capital planning.

The NPR defines 'stress test' as a process to assess the potential impact of economic and financial conditions on the consolidated earnings, losses and capital of the bank over a set planning horizon - taking into account the current condition of the bank and its risks, exposures, strategies and activities.

Meanwhile, the contingency plans required under the final rule will inform the FDIC's ability - as receiver - to resolve the institution in a manner that ensures that depositors receive access to their insured deposits within one business day of the institution's failure, maximises the NPV return from the sale or disposition of its assets and minimises the amount of any loss to be realised by the institution's creditors. The plans will supplement the FDIC's own resolution planning work with information that would help facilitate an orderly resolution in the event of failure.

RMBS

KBRA debuts RMBS presale

Kroll Bond Rating Agency has published its inaugural RMBS presale report, having assigned preliminary ratings to eight classes of mortgage pass-through certificates from Sequoia Mortgage Trust 2012-1. The transaction is secured by two pools of first-lien residential mortgage loans secured by one-to-four family residential properties, condominiums, coops, planned unit developments and townhouses.

Pool 1 comprises 120 hybrid ARM mortgage loans - with fixed periods of five, seven or ten years and a 30-year original term to maturity - and 78 fixed rate mortgage loans, with a 15-year original term to maturity. The aggregate balance of Pool 1 is approximately US$195.89m.

Pool 2 comprises 248 fixed rate mortgages with a 30-year original term to maturity. The aggregate balance of Pool 2 is approximately US$219.83m. All of the mortgage loans are.

The loans were originated by First Republic Bank (accounting for 54.54% of the pool), PrimeLending (19.40%), PHH Mortgage Corporation (11.16%), Wintrust Mortgage Corporation (3.40%), Flagstar Capital Markets Corporation (7.66%), Sterling Savings Bank (2.30%), Cole Taylor Savings Bank (0.82%) and Guardhill Financial Corporation (0.72%). The loans will be serviced by First Republic Bank (54.54%), Cenlar FSB (19.47%), PHH Mortgage Corp. (11.16%) and Select Portfolio Servicing (14.83%).

KBRA's analysis of the transaction included a loan-level analysis of the mortgage pools, using its Residential Mortgage Default and Loss Model, together with a review of the transaction parties, legal and financial structure and loan files.

RMBS

'Credit positive' reforms for INFONAVIT

Recent reforms of the INFONAVIT Law should result in better asset quality in new mortgage loans that are eligible for securitisation in the future, according to Moody's. One of the most significant items from a credit perspective is that INFONAVIT will be able to originate peso-denominated mortgage loans.

Peso-denominated mortgage loans provide more payment certainty for borrowers than indexed loans because the outstanding balance of a peso loan does not automatically increase as it does with indexed loans. This is a powerful feature that will enhance a borrower's willingness and ability to pay, Moody's says, especially if a borrower loses their job and INFONAVIT cannot continue to make automatic payroll deductions for mortgage payments.

In addition, peso loans will minimise structural risk in future INFONAVIT RMBS, as they will not have currency mismatches between the pool of assets and the notes if such RMBS are also issued in pesos. All of INFONAVIT's RMBS to date are subject to currency mismatches because the loans are denominated in minimum wage, which is updated once a year, while the bonds are denominated in UDIs that are updated daily.

In a separate development, INFONAVIT also announced that it will include credit bureau information in its Risk Index mortgage underwriting model. In Moody's view, this initiative is credit positive for its origination procedures and future RMBS securitisations. This enhancement will also help the organisation tailor its collection campaigns and customer service strategies.

RMBS

LTV linked to Spanish RMBS defaults

Moody's highlights in a new special report that Spanish mortgage loans most likely to default are those with high LTV ratios, securitised in arrears of up to 30 days, made to foreign residents or originated via a broker. LTVs are shown to be the main driver of default frequency, with a dramatic increase in default probability for mortgages with LTVs of more than 80%.

At this level, one in 20 loans that do not have any adverse characteristics can be expected to default. These results confirm the strong relationship between LTV and wider default probability in the Spanish RMBS market, the agency says.

Moody's notes that while it is unsurprising that securitised loans delinquent by up to 30 days at closing should show weaker performance, their default probability is almost five times that of a performing loan. Loans to residents not native to Spain are the next riskiest, followed by broker-originated loans.

The agency observed other characteristics that significantly raised the default probability of Spanish mortgage loans, including a high loan-to-income ratio or loans on second homes. In contrast, a number of other characteristics demonstrated little predictability with a loan's default probability - such as the debt-to-income ratio, borrower income level, instalment amount, property value and the borrower's age.

RMBS

Strategic defaults weigh on private-label RMBS

The credit performance of private-label RMBS in the US continues to face many challenges in 2012, Moody's says in its annual outlook report on the sector, with strategic defaults posing a major risk. The performance of the loan pools backing outstanding RMBS has been stabilising, however, and the agency's 2012 loss expectations for US RMBS are mostly unchanged.

"Although delays in loan liquidation timelines and an increase in distressed sales will continue to dampen housing prices and limit recoveries on delinquent loans, they will not have a material impact on RMBS recoveries, given our already high loss expectations on RMBS pools," says Debash Chatterjee, a Moody's associate md.

Delinquency levels among loan pools have been flat or even dropping largely because of loan modifications. Moody's notes that re-default rates on modified loans have been declining, largely because payment reductions in the modifications have increased.

Strategic defaults will continue to pose a big risk in RMBS in 2012, as housing prices continue to decline. Moody's perceives the risk as greatest in the prime jumbo sector, where more than half of the borrowers who have so far been making their mortgage payments regularly are under water on their mortgages - a proportion that has risen significantly since late 2010.

The subprime sector, on the other hand faces, the lowest potential for significant performance deterioration in 2012 because more of its weaker borrowers already have defaulted, leaving less room for losses to increase substantially. The risk of performance deterioration in the Alt-A and option ARM sectors is less than that of the jumbo but greater than that of the subprime sectors, with option ARM loans facing greater risk of strategic defaults.

"The practices of the servicers will continue to play a major role in determining loan performance," says William Fricke, a Moody's vp and senior credit officer. "Although modifications that include principal forgiveness are a key way to prevent strategic defaults, we continue to expect servicers to be reluctant to employ principal forgiveness - given that the GSEs do not permit it - and that many private label RMBS carry provisions limiting the practice."

Servicing is undergoing a transformation, however, with servicers establishing single points of contact for delinquent borrowers and increasingly transferring servicing to special servicers. Moody's says both developments are credit positives.

The agency expects the issuance of private label RMBS to be modest in 2012 owing to GSE dominance and regulatory uncertainty. The deals that do take place will feature more comprehensive reviews of originators, better quality and more reliable loan level data, and strong mechanisms for enforcing breaches of representations and warranties. They will also better address legal issues relating to foreclosure challenges.

RMBS

Dutch RMBS performance softening

Fitch reports that the low level of completed foreclosures in prime Dutch RMBS transactions is adding to the pressure on collateral performance. This follows the agency's review of 51 prime Dutch RMBS transactions, which resulted in 173 tranches being affirmed, two being upgraded and 22 being downgraded.

The performance of Dutch RMBS loans has softened over recent quarters, according to Fitch. This is mainly evidenced by an increase in the proportion of loans in arrears, particularly late-stage arrears. While Dutch RMBS transactions have historically reported extremely low arrears, an increasing proportion of transactions are now reporting three-month plus arrears in excess of 1%.

"Increased arrears are only partly a result of deterioration in the fundamental credit quality of Dutch residential mortgages," says Ibrahim Kamara, analyst in Fitch's European RMBS team. "They also reflect a reluctance of servicers to sell properties at auction in current stagnant market conditions. Certain transactions have not reported a single completed foreclosure for quarters at a time."

The Dutch mortgage market is characterised by high LTV ratios. Consequently, the majority of loans in arrears are also in negative equity.

Reported loss severities are typically higher on loans that have been foreclosed upon through a court auction process. However, the low level of activity in the residential market means that consensual sales have become more difficult to complete. These factors combine to not only reduce the incentive for servicers to complete foreclosures through forced sales, but also to reduce the volume of consensual sales.

"It is important to note that absolute arrears levels remain relatively low, despite the recent increases - particularly when compared to other European jurisdictions," says Gavin Crawford, associate director in Fitch's European RMBS team. "However, the increase in late-stage arrears, which Fitch expects to persist in 2012, is causing a build-up in potential foreclosure stock."

Dutch RMBS transactions do not explicitly define what constitutes a loan default. Consequently, provisioning mechanisms are only activated upon realisation of a loss, meaning that no provisions are currently being made for the loans in late-stage arrears.

Most transactions feature guaranteed excess spread. Instead of being used to make provisions, these funds are instead flowing through the waterfall and being released back to the originator.

Should completed foreclosures increase in the future, this could affect not only the balance of reserve funds, but also the most junior and/or uncollateralised note classes. These considerations drove the majority of Fitch's negative rating actions taken on 16 January on Dutch RMBS.

RMBS

MLANs debut

Freddie Mac has priced a 2.06% US$3bn mortgage-linked amortising note (MLAN) security due on 15 January 2022. MLANs are senior unsecured debt obligations whose cashflows mimic the principal payments of referenced agency mortgage-related securities held in Freddie Mac's mortgage-related investments portfolio. The mortgage-related security referenced by MLANs may be a specific Freddie Mac Giant, Participation Certificate (PC), a combination of PCs or REMIC tranches, or any other agency mortgage-related security.

Monthly payments on a MLAN will consist of principal payments and interest payments. The principal payments will be based on the monthly publicly disclosed factor of the referenced mortgage-related security, while the interest payments will accrue and be paid at a fixed rate.

MLANs will have a maturity date shorter than the stated maturity date of the referenced mortgage-related security. A MLAN security is non-callable by Freddie Mac, but may be retired earlier than its maturity date if the referenced mortgage-related security repays principal at a rapid rate due to prepayments.

The security is being offered by Goldman Sachs, with co-managers Credit Suisse and JPMorgan.

RMBS

Douro tender disappoints

Banco BPI is set to purchase only €149.3m from its recent fixed tender offer for over €2bn of Douro RMBS (SCI 11 January). With a take-up rate of less than 7%, far fewer bonds were tendered then had been expected.

ABS analysts at Barclays Capital suggest that this is because the fixed tender offer prices were not attractive, investors were unaware of the tender offer or they were unable to tender their bonds. "The last point above could be one reasonable explanation, with the recent expansion of the ECB repo facility resulting in many bonds currently with the ECB and investors unable to meet the tender offer deadlines. Or alternatively, the bonds may have been repo'd in other private arrangements by investors, again restricting their involvement."

It is likely that the tender offer has not met the requirements that Banco BPI set out with. The analysts say they wouldn't be surprised to see further tender offers in the future, with possible adjustments made to the tender offer type, valuation levels and longer timeframes to help accommodate any repo arrangements.