Contents

CMBS

CMBS rally stalls

The strong rally in the US CMBS market has eased off over the last two weeks. Trading is currently concentrated around AM and AJ tranches, with activity expected to pick up again in the near future.

"The CMBS market has changed a lot over the last week or so. There have not been any large block trades and activity has decreased. What we are seeing is AMs and AJs trading. Parts of the capital stack that outperformed really strongly as the year started are now being sold into," reports one trader.

The market had been in 'risk-on' mode since the beginning of January, but started to top out a week and a half ago and then really began to slow down, the trader adds. He continues: "We are now starting to see folks shedding some risk. In CMBS in the AM and AJ categories, where stuff has been up anywhere from 10-25 points, buying has turned to selling. We are definitely seeing a bit of a give-back there."

The trader says the rally has temporarily run out of steam, not least because the Greek debt situation remains unresolved. The lack of clarity appears to have driven investors to re-evaluate their stance and hedge up, although the outlook in the market is still positive.

"It feels like earnings are doing well enough and balance sheets across the board are relatively healthy. In the paradigm of incredibly low rates, there is still plenty of opportunity for money managers and insurance companies to jump to safe yield that will give them some semblance of spread," says the trader.

In the longer term, he is confident that the market will rally again and that this is more of a blip than anything else. "Last year, January and February were off the charts and went to new highs. Then March came and the year from there on out really was not what had been expected. That is still in sight in the rear-view mirror for people right now."

The trader concludes: "Our view is that this is going to be a short-term thing. Greece will resolve itself one way or the other before long. If it does not, though, then all bets are off."

JL

Structured Finance

SCI Start the Week - 20 February

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

Pipeline
It has been another busy week for the pipeline, with six new deals remaining on Friday. Two auto ABS (R$930m Driver Brasil One FIDC and €92.3m TruckLease Compartment No 2), two cell tower CMBS (US$107m GTP Cellular Sites series 2012-1 and US$175m series 2012-2), another CMBS (US$1.2bn Morgan Stanley Capital I Trust 2012-C4), one CLO (€1.44bn IM Cajamar Empresas 4) and one ILS (Mystic Re III) all began marketing last week.

Pricings
In addition, eight transactions priced last week, the majority of which were auto-related ABS. At US$1.69bn and US$1.54bn respectively, the largest prints were Honda Auto Receivables 2012-1 Owner Trust and Nissan Auto Receivables 2012-A Owner Trust.
A further two auto ABS priced - the US$150m American Credit Acceptance Receivables Trust 2012-1 and US$150m First Investors Auto Owner Trust 2012-1 - as well as two floorplan deals (US$887.3m Ally Master Owner Trust series 2012-1 and US$750m GE Dealer Floorplan Master Note Trust 2012-1).
Finally, two non-auto deals were issued: a US$625m CMBS (COMM 2012-9W57) and a £1bn whole business securitisation (CPUK Finance).

Markets
Last week saw another generally positive, albeit quieter, week in the global structured finance secondary markets.
The tone of the US non-mortgage ABS secondary market remained firm last week, according to ABS analysts at Barclays Capital, with buyers again outnumbering sellers. "As evidence, each new bid-list that comes out generally serves to reset the market tighter, as demand for bonds far outstrips supply. This is also evident from the 'food fights' that tend to characterise new issues," they say.
However, the Barcap analysts add: "Despite the strong new issue pipeline and demand, secondary positions continue to trade about 5bp through new issue levels. Investors' appetite for short-term paper with spread remains robust as the quest for yield continues."
Similarly in the US CMBS market, there was little movement in spreads last week as recent issue as well as the more seasoned bonds remained unchanged week on week, according to structured products research analysts from Wells Fargo. "Weaker credit 2007 vintage A4 tranches are still at 245bp to swaps and 2011 vintage ten-year triple-A tranches with 30% credit support are at 110bp to swaps," they say.
Citi securitised products analysts add that US CMBS secondary trading volumes last week were about two-thirds of recent levels - just under US$1bn versus a year-to-date average of US$1.6bn. "Investors may have been focused recently in non-CMBS sectors such as non-agency RMBS, given the recent ML II sales," they suggest.

Deal news
• Opera Finance (Uni-Invest) became the first European CMBS to fail to repay by its legal final maturity, after it defaulted on 15 February. A senior noteholder steering committee has been involved in discussions about resolution options.
• The Retreat at Stonebridge Ranch loan securitised in the Freddie Mac SPC Series K-704 CMBS was transferred to special servicing on 13 February. It is believed to be the first time this has happened to a large loan securitised in the Freddie Mac K series.
• Further details have emerged on CIFC Corp's sale of DFR Middle Market CLO (SCI 9 February). The rights and obligations to the transaction under the management agreement have been assigned to DWM Management, an affiliate of Fortress Investment Group.

Regulatory update
• In a comment letter filed with the SEC, SIFMA expressed its appreciation for the intent of Section 621 of the Dodd-Frank Act and agreed that certain reforms may be necessary to ensure that securitisation transaction parties are not creating and selling ABS that are intentionally designed to fail or default and profiting from the failure or default. At the same time, however, the association urged the SEC to create a framework that still allows for the issuance of ABS without the uncertainty of overly broad or vague regulations or undue restrictions or prohibitions.
• The Monetary Authority of Singapore (MAS) is conducting a review of the regulatory oversight of the OTC derivatives market in Singapore and is seeking public comments on its proposals. In developing these proposals, MAS says it has taken into consideration international developments - such as the G20 commitments and Financial Stability Board recommendations - to improve the regulation and supervision of the derivatives market.
• SIFMA has criticised President Obama's proposal to include a tax on financial institutions in his budget, under the guise of recouping lost TARP funds. The association says that it is an "ill-considered and ill-timed concept", noting that this latest proposal is nearly double the cost of previous proposals.
• 13 February marked the deadline for public comment on the Volcker Rule, which has seen a flurry of criticism from industry players. The final rule - which prohibits institutions from trading certain securities and making certain investments in funds for their own accounts - is set to take effect on 21 July.

Deals added to the SCI database last week:
Ares XXIII
BAA Funding
Berica ABS
CarMax Auto Owner Trust 2012-1
Claris ABS 2011
COMM 2011-FL1
DECO 2012-MHILL
Ford Credit Floorplan Master Owner Trust A series 2012-1
Ford Credit Floorplan Master Owner Trust A series 2012-2
Golden Credit Card Trust series 2012-1
Golden Credit Card Trust series 2012-2
MondoMutui Cariparma series 2012
Titrisocram Compartment 2012-1

Top stories to come in SCI:
UK cross-border credit card issuance trends
Evolution of Asian covered bonds
Focus on emerging market ABS
Basel 3 liquidity issues

CLOs

CLO resiliency keeps equity attractive

RBS analysts have run a series of scenarios to investigate the impact of another credit cycle similar to the one seen in 2008-2011. They find CLOs to be highly resilient during periods of high defaults and advocate investing as far down the capital stack as possible.

The analysts put 370 US CLO deals from 2005-2007 vintages through three scenarios: a scenario with the same default and prepayment rates experienced during the financial crisis; a scenario with twice as many defaults as that period; and finally a scenario with three times as many defaults.

Should the market experience a repeat of 2008-2011, the base-case scenario showed that none of the 1,899 tranches in the analysts' sample would be expected to lose any principal. Median cash-on-cash return to equity would be 114%.

In the second scenario, with twice the default rate of 2008-2011, only 25 tranches lost any principal. Of those tranches, one was originally rated triple-B and the others were all originally double-B. Only 9% of the double-B tranches took losses and, of those tranches, the median principal loss was 17%.

As would be expected, at three times the base-case default rate, there were higher losses. In the third scenario, 92% of double-B tranches took losses (with a median principal loss of 69%) and 29% of triple-B tranches took losses (with a median principal loss of 21%).

Although the last scenario is considered extremely unlikely, the analysts point out that even if it were to happen, losses for new issue deals would likely be even lower than those for the secondary tranches in the sample. The double-B tranche on Ares XXIII (SCI 6 February) has 11% subordination, for example, higher than 237 out of 239 of the tranches that lost principal in the third scenario.

Given the high resilience of double-B tranches and the fact that the spread difference between double-A and double-B tranches is 600bp or greater, the analysts suggest that those notes would provide superior value for investors who cannot buy equity. Triple-A paper, meanwhile, remains cheap relative to other asset classes and is well enhanced with strong protection from loss.

Equity remains the analysts' favourite part of the capital stack, however. They conclude: "With CLO equity trading at 17%-22% yields at 2 CDR and averaging 31% annualised cash-on-cash returns, it remains our favourite part of the capital structure. Moreover, given the front-loaded nature of equity cashflows, we believe returns will remain attractive - even if we go through another credit cycle with high defaults."

JL

CMBS

CMBS ETF launched

Blackrock's iShares has launched an exchange-traded fund referencing the Barclays Capital US CMBS (ERISA Only) Index. Should the product grow significantly from its initial size of US$7.4m, it could prove a useful addition to the array of trading instruments available to CMBS investors.

Blackrock says the iShares Barclays CMBS Bond Fund is the first ETF to provide exposure to investment grade CMBS. "The new iShares ETF can complement the iShares Barclays MBS Bond Fund and help investors express tactical views on the commercial real estate market," it adds.

The ETF is the second new product to launch in the space in the last six months, following the TRX II index. Deutsche Bank CRE Debt analysts comment: "Although the two instruments will serve different purposes, the more instruments available the better. While the fund is small in size today, we expect it to grow and could become an interesting tool to hedge cash positions, especially while the historical cash/synthetic basis remains unusable as a RV tool."

The iShares Barclays CMBS Bond Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Barclays Capital US CMBS (ERISA Only) Index. The underlying index measures the performance of investment grade CMBS and, as of 31 January 2012, consisted of 1,087 securities with a weighted average maturity of 3.75 years and yield to maturity of 3.19%.

Further, the Deutsche analysts say that the fund is not actively managed and does not attempt to take defensive positions under any market conditions, including declining markets. The fund will use a passive approach to try to achieve the investment objective and uses a representative sampling indexing strategy, so it may or may not hold all of the securities in the underlying index.

MP

RMBS

BoE RMBS loan tapes analysed

UK RMBS issuers began providing loan-level data and cashflow models to investors - as required by the Bank of England (SCI 31 October 2011) - in November. JPMorgan ABS strategists have analysed the loan tapes, with the aim of providing a broader overview of performance trends in the sector, and find that they offer additional clarity into the master trusts.

The JPMorgan strategists reviewed loan files of three of the regular UK RMBS issuers in the US market: Arkle (sponsored by Lloyd's), Holmes (Santander) and Silverstone (Nationwide). They note that Silverstone - the largest of three master trusts with US$21.6bn-equivalent in outstandings - has the pool with the most consistent and cleanest characteristics.

Across vintages present in the trust, 85%-90% of borrowers are employed, with current LTVs ranging between 50% and 60% and 30+ delinquencies hovering around 0.80% for the 2006 to 2008 vintages and lower for the more recently issued loans. Judging by the same metrics, the strategists point out that the Holmes pool is the worst of the three master trusts and Arkle is in the middle.

Further, there doesn't appear to be a difference between the quality of loans originated post-crisis versus those originated pre-crisis. "The employed borrowers, current LTV and average balances do not change significantly across the various vintages present in the three master trusts. Although the 2009-2011 vintage loans have lower delinquency rates, they are also less seasoned than the pre-2008 originated loans," the strategists observe.

However, while they welcome the availability of loan level data, they note that a few key obstacles need to be overcome before it can be widely used by investors. First, each issuer reports the data in different websites across a variety of formats and, because of the size of the datasets, aggregating the data can be cumbersome.

Second, there is currently, at most, two months' worth of history available in the form of loan tapes. For any historical analysis, investors will still need to turn to historical remit reports.

Data from the remit reports also show that performance trends have generally been very stable for the Arkle, Holmes and Silverstone programmes. Excess spread for all three master trusts have hovered between 0.75% and 2.3%. In addition, 30+ delinquency rates have been stable, with Silverstone coming in at 0.5%-0.9%, Arkle at 3%-3.5% and Holmes the highest at 4%-5.5%.

Given the stable performance trends and the clean portfolio of loans in the master trusts, the strategists believe that UK RMBS continues to offer an attractive spread premium over other US consumer asset classes.

CS

RMBS

Balancing act

Relative merits of covered bonds versus RMBS discussed

Interest in covered bonds continues to grow, partly due to favourable regulatory treatment. However, panellists at a recent covered bond seminar hosted by S&P highlighted the potential dangers of over-promoting the instruments at the expense of other asset classes, such as RMBS.

Neil Calder, head of investments - credit, treasury at the EBRD, noted during the seminar that RMBS transactions have 'hard-wired' or in-built mechanisms that offer protection for investors if things don't go quite as expected. "Recent legislative developments in covered bonds have increasingly emphasised almost 'RMBS-lite' structural enhancements - such as asset-coverage tests, eligibility criteria and limits on loan-to-value ratios. Still, if the originating bank fails, it's questionable if covered bonds would have as much protection as some RMBS transactions," he said.

Gareth Davies, head of European ABS & covered bond research at JPMorgan, agreed that what happens when a covered bond originator defaults is less clear-cut than in securitisations. "In many respects, covered bonds resemble securitisations in 2007, where the market didn't think anything was going to go wrong, despite that fact that they had never been tested," he explained. "So, while covered bonds are a well-established product with over 200 years of history, that's not what credit investors should be focusing on. We should ask: what happens in a tail event?"

The choice between RMBS and covered bonds depends on the jurisdiction, Davies continued. "In Ireland, I would rather own a covered bond than RMBS. However, in the UK it would depend on the collateral quality and the likely degree of regulatory intervention. It comes back to the frequent argument over whether covered bonds are a credit product or a rates product."

The general perception of covered bonds is that they are safe and non-complex investments. "As credit investors, we would probably argue that this is not quite the right perception to have," Calder said. "But there is this sense of familiarity with covered bonds that naturally makes them a more liquid product than RMBS. Additionally, the proposed changes to bank and insurance regulation over the past few years have favoured covered bonds and new jurisdictions have been coming online."

TwentyFour Asset Management partner Rob Ford observed that many covered bonds are now trading wider than triple-A RMBS tranches. "I would generally prefer to buy RMBS over covered bonds. But if I can now buy a covered bond 50bp-75bp cheaper than a triple-A rated RMBS from the same institution, then maybe I will look at covered bonds as an alternative."

He added that if an investor can swap fixed into floating and there is a compelling difference in the relative value between the same types of assets from the same institutions - between a covered bond and an RMBS - then that may be enough for them to consider both instruments.

Davies said that both covered bonds and RMBS have advantages, and suggested that a more varied approach to bank funding should be considered. "If there was a disruption in the covered bond market and we lost access to that particular investor group, then Europe's banks would lose funding without the ECB's support. We may be over-promoting covered bonds to the detriment of the European banking system," he warned.

Although Ford believes there is a valid argument for giving regulatory support to securities that are structurally simple, like covered bonds, he noted that some ABS have stronger support mechanisms than covered bonds. "I don't believe that one consideration should balance the other out exactly, but I think the difference in treatment between the two in some of the current regulatory proposals is so enormous that it doesn't make sense."

Meanwhile, whether single-A will become the new triple-A depends on how the market perceives spread and cost. Ford said that if spreads remain close to where they've been for the last two or three years, the price of issuing senior notes at double-A is too high. If spreads fall over time, then potentially the market could start to sustain lower-rated senior securities.

Further, if the market evolved to a stage where sovereign ratings across major countries were generally at double-A (see also SCI 7 February), then acceptance of double-A ratings on covered bonds and senior RMBS would be seen as much more tenable.

ABS

ILS chief to head US operations

Liz Frederick has been made md of Kane (USA), effective from March. Frederick is currently global practice head for Kane's ILS business and will continue to perform this role in tandem with running US operations.

Frederick is currently based in the Cayman Islands. She has extensive experience in the structuring and management of a range of ILS and captive structures, including catastrophe bonds, side cars, segregated account transformers, pure captives, rent-a-captives and special purpose financial captives.

Kane recently raised additional funding from its principal shareholder, CBPE, to invest in a new office in New York and enhance and invest in its product offering in its life, pension and investment business. It is also in the process of expanding its Cayman Islands team.

ABS

NY law firm hires auto ABS specialist

Christopher Horn has joined Baker & McKenzie as a partner in the firm's New York office. He was most recently a partner at Mayer Brown.

Horn represents both issuers and underwriters on structured finance transactions and specialises in the securitisation of auto receivables. He also has considerable experience in ILS, including catastrophe risk bonds and life insurance reserve funding facilities.

Structured Finance

Distressed specialist recruited

Bertrand Fry has joined Pryor Cashman's investment management group. He becomes co-head of the group alongside Jonathan Shepard.

Fry's practice focuses on structuring private investment funds and counselling fund managers. He specialises in distressed, venture capital and real estate investing, debt origination and quantitative trading of securities.

Fry joins from D.E. Shaw, where he was svp and served for a period as acting general counsel. Before D.E. Shaw, Fry worked at Dechert in London and Paul, Weiss, Rifkind, Wharton & Garrison LLP in New York.

Structured Finance

Bank boosts SF team

Neil Kindness has joined Aldermore's structured finance team as associate director. He now reports to Ian Flaxman, head of structured finance, and will be responsible for negotiating deals in London and Scotland.

Kindness joins the bank from Close Invoice Finance where he was regional sales director for Scotland. He has previously held positions within Landsbanki Commercial Finance, GE Commercial Finance and GMAC Commercial Finance.

CDS

Credit manager hires for US expansion

Muzinich has made two senior appointments to its New York office. Mike McEachern joins as senior investment officer and Sam Zona joins as director of business development for North America.

McEachern joins from Seix Investment Advisers, where he was president and head of the high yield team. He has previously worked for American General Corporation and Capital Holding Corp.

Zona also joins from Seix, where he was director of client service and marketing. Before that he was marketing vp at Daiwa International Capital Management and has also worked at JPMorgan.

The specialist credit manager is expanding its US footprint, having previously focused on developing the European side of the business. The firm manages a variety of credit strategies, including dedicated investment grade and high yield credit strategies.

CDS

Trading platform adds sales head

MarketAxess Holdings has appointed Robert Hammond as head of sales and dealer relationship management for Europe and the Middle East. He will report to Paul Ellis, head of MarketAxess Europe.

Hammond will be responsible for driving sales and building the firm's institutional network of fixed income investors and dealers. He joins from CME Group, where he was head of listed rates and OTC clearing solutions. He has previously held senior positions at Bank of Tokyo Mitsubishi, WestLB, Barclays Capital and JPMorgan.

CDS

Credit hedge fund in US partnership

LNG Capital has agreed a partnership with Palmer Square Capital Management, Montage Investments and Atlantic Asset Management. The long/short European credit firm, based in London, gains investment capital and access to Montage and Atlantic's distribution channels.

The relationship with Palmer Square will improve LNG's ability to offer US investors the opportunity to invest in the European credit markets. Christopher Long, Palmer Square president, comments: "There are very few managers that focus specifically on European credit as an asset class. Given the recent economic turmoil affecting Europe, we are excited to partner with a group that has built their careers on investing in this segment of the global credit market."

CLOs

New arrival to build structured credit team

Nicolas Boutar has joined Dinosaur Securities as structured credit sales director. He is responsible for setting up Dinosaur's structured credit team in the CEEMEA region and organising bids or offers on CLOs and CSOs.

Boutar joins from BNP Paribas and is based in London. As well as serving as a credit structurer and portfolio manager at BNP Paribas, he has also worked as a ratings analyst at S&P.

CMBS

Purchase to create CRE 'powerhouse'

Grubb & Ellis has agreed to sell substantially all of its assets to BGC Partners. The acquisition will bring Grubb & Ellis the enhanced scale and resources it has been seeking since it began looking for a buyer almost a year ago (see SCI 23 March 2011).

"Following a thorough and rigorous process and the evaluation of all available options, we determined that a partnership with BGC provides the best platform for our brokerage professionals, employees and clients," says Thomas D'Arcy, Grubb & Ellis president and ceo.

BGC also recently acquired Newmark Knight Frank. Uniting the firms should "create a powerhouse in the CRE space", D'Arcy notes.

Grubb & Ellis intends to implement the transaction as an asset sale under Section 363 of the US Bankruptcy Code. It has commenced Chapter 11 proceedings and expects business to continue without disruption as it completes the sale process.

RMBS

Knight grows mortgage credit team

Knight Capital has hired several former MF Global mortgage credit sales and trading personnel in part of an effort to grow its structured products business. The arrivals boost Knight's existing mortgage credit team and further hires are expected soon.

Michael Corsi joins as mortgage sales md and Rus Margolin joins as non-agency trading md. Miguel Vazquez and Doug Adelman both join as non-agency trading directors.

RMBS

MBS team boosted

The PrinceRidge Group has made two additions to its RMBS division. Kate Lee joins from BNP Paribas and Jason Huey joins from Nomura. Both Lee and Huey will report to RMBS head Barry Berkeley.

Lee joins as a director. She will lead the firm's new issue CMO effort and will also trade mortgage derivatives. Huey joins as a director and MBS salesperson, similar to the role he held at Nomura. He has also worked as an analyst at Blue Mountain and JPMorgan Chase.

ABS

Container ABS ratings ceiling mooted

New US container ABS transactions are seeing a resurgence following a three-year lull, Fitch notes. But the agency warns that the sector remains susceptible to a high degree of systemic, industry and specific credit risks.

Fitch expects more new container deals over the course of this year as economic growth returns and industry funding needs increase. Performance of existing container ABS has historically been steady, even as the recession hit a crescendo in 2008-2009.

That being said, the highly cyclical nature of the industry calls for close scrutiny of transaction mechanics, the agency says. This is particularly true with respect to the level of credit enhancement: specifically, Fitch believes that higher credit enhancement is appropriate for new container ABS deals.

Advance rates on new issues remain above 80%, in spite of challenging industry dynamics. Nonetheless, the risks inherent in the container industry are sizeable. This makes it unlikely that Fitch would be able to assign ratings higher than single-A on new container ABS transactions.

ABS

Innovative whole business deal prices

Center Parcs has priced its £1.2bn whole business securitisation, CPUK Finance. The transaction has a number of noteworthy features.

Rated by Fitch and S&P, CPUK Finance comprises two tranches of triple-B notes. The £300m five-year class A1 notes printed at 390bp over Gilts, while the £440m 12-year class A2s came at 465bp over. The deal was arranged by Barclays Capital, HSBC, Lloyds and RBS.

The transaction is notable because it blends a securitisation of the Center Parcs operating business with a £280m subordinated high-yield issuance (the class B notes). The proceeds of the class A notes will be on-lent to the borrowers via intercompany loans, which are intended to fully amortise from Center Parcs' operating cashflows.

S&P expects the deal to effectively function as two separate transactions: the class A and class B notes will each be subject to separate terms and conditions governed by an intercreditor agreement, although sharing in the same ultimate security. This feature is believed to be the first of its kind in the European WBS market.

In addition, the CPUK Finance structure provides for the class B noteholders to take control of the topmost company in the Center Parcs corporate structure, if the business fails to repay the class B loan at expected maturity. The concept of expected maturity dates is also notable, according to S&P.

The expected maturity dates are designed to reduce refinancing risk by providing opportunity and incentive for management and equity to refinance the debt ahead of these dates. If the business is unable to refinance its intercompany debt at this time, the transaction is structured such that existing debt will have the opportunity to fully amortise through a cash sweep before legal final maturity.

The deal refinances the present liabilities of the Center Parcs group, including the £750m CPUK Mortgage Finance CMBS and the existing hedging arrangements of the borrower under the CMBS.

ABS

Lebanese auto deals closed

BSEC - Bemo Securitisation recently closed two Lebanese securitisations. The transactions will finance the business growth of two local companies, both operating in the auto sector.

The first deal - dubbed Gear 1 SIF - is a true sale operating lease securitisation arranged on behalf of MECAR/Avis Lebanon. It comprises two classes of notes: class As that have an expected WAL of 3.9 years and pay a yearly fixed return to investors; and subordinated class Bs retained by MECAR for credit enhancement purposes. The structure provides for a revolving period, during which additional operating leases may be transferred to the fund by MECAR.

The second deal - Rymco Drive 1 (Compartment 2) - is RYMCO's second revolving auto loan ABS, backed by Nissan, Infiniti and GMC receivables. The transaction also consists of two tranches of notes: the class As have an expected WAL of four years, while the class Bs will be retained by Rymco. The structure provides for a three-year replenishing period, during which the fund may purchase additional auto loans subject to certain preset criteria.

The majority of investors in the deals are said to be banks and financial institutions.

Structured Finance

Euro downgrade severity improves

The European structured finance upgrade rate rose and the downgrade rate fell for the second consecutive year in 2011, according to S&P's latest transition study.

"The overall downgrade rate decreased to 22.3% in 2011 from 25.4% in 2010, as most countries saw a revival in economic growth over much of the year," says S&P credit analyst Mark Boyce. "The upgrade rate rose to 8.5% from 5.6%."

The report suggests that the credit performance of structured finance transactions reflected both macroeconomic trends within the region and changes to S&P's rating methodologies. "Rating trends continued to vary along regional lines, with generally greater credit quality deterioration in countries such as Spain, Greece, Portugal and Ireland," adds Boyce. "Methodological changes to our criteria also played a role in ratings migration: we lowered the ratings on some 25% of RMBS and CMBS tranches after our revised criteria for assessing counterparty risk took effect in January 2011."

He continues: "However, we expect that credit quality in European structured finance transactions should remain broadly stable this year - barring another severe recession."

Among the report's other findings is that structured credit registered the highest upgrade rate of any asset class, in part because of transaction deleveraging, shortening weighted-average portfolio maturities and improving asset quality. On the other hand, CMBS exhibited the highest downgrade rate, largely because the difficult lending environment and declining capital values in the European commercial real estate market have led to refinancing difficulties for borrowers in many transactions.

Of the 634 ratings S&P raised during the year, 430 were in structured credit, 118 in RMBS, 46 in ABS, 24 in CMBS, nine in structured covered bonds and seven in corporate securitisations. Of the 1,660 ratings the agency lowered during the year, 684 were in RMBS, 386 in structured credit, 292 in CMBS, 202 in ABS, 54 in structured covered bonds and 42 in corporate securitisations.

The average downgrade severity improved during 2011, however, with the average net downward move standing at about three notches - less severe than the average 4.1 notches in 2010. The average change in overall credit quality rose to -0.5 notches in 2011, from -0.9 notches in 2010.

Structured Finance

ABSXchange strengthened

S&P Capital IQ has made various enhancements to its ABSXchange structured finance analytics platform. These improvements include allowing clients to assign liquidation schedules to loans, set loans to add interest shortfalls to the principal balance and view cashflow projections for individual loans.

The platform has been strengthened further by enabling faster delivery of the portfolio analytics application, while the updated Excel add-in interface now only shows fields relevant to the deal under observation. In addition, three template sheets for RMBS, CMBS and ABS have been introduced that allow users to display all the data relevant to a deal by entering the ISIN, Cusip or Ticker Series Bond.

Structured Finance

Ratings ceilings lowered, on review

Moody's has lowered the highest achievable structured finance rating in Italy and Spain to Aa2 from Aaa, and in Portugal to Baa1 from A2. The rating action was prompted by the downgrade of the sovereigns on 13 February.

Moody's decision to lower the highest achievable structured finance rating will likely impact all outstanding Italian and Spanish tranches currently rated above Aa2, and Portuguese tranches currently rated above Baa1, except in very limited circumstances. The highest achievable structured finance ratings are set at or below the relevant country ceiling and will generally not exceed the sovereign bond rating by more than a limited number of notches.

Moody's says it has identified several other developments that could exert negative pressure on European structured finance ratings in the near future. First, it placed on review for downgrade the ratings of multiple European and global banks on 15 February. The creditworthiness and therefore the ability of entities eligible to act as transaction parties may decline following the conclusion of the rating agency's review.

Second, Moody's is reassessing the euro area's single 'country ceiling', which currently implies that the debt of any euro area entity - regardless of its country of domicile - could potentially achieve a Aaa rating. The agency will consider reintroducing individual country ceilings for some or all euro area members, which could affect further the maximum structured finance rating achievable in those countries.

Finally, it is also continuing to consider the impact of the deterioration of sovereigns' financial condition and the resultant asset portfolio deterioration on mezzanine and junior tranches of structured finance transactions.

Moody's will review all ratings of affected structured finance transactions and announce any rating actions in the coming weeks. It says it will continue to approach its credit analyses of structured finance transactions on a case-by-case basis for each country that comes under stress.

Structured Finance

Sovereign-linked ratings hit

Moody's has downgraded the ratings of structured finance securities that are directly linked to the ratings of Italy and Spain, which the agency downgraded on 13 February. At the same time, it has placed on review for downgrade structured finance securities that are directly linked to the ratings of certain European and US banks, which were placed under review on 15 February.

The rating actions affect 160 tranches - including three ABS, six RMBS, 39 repackaged securities in Europe and 112 structured notes and CDOs in the US - from 107 transactions. Moody's explains that each affected rating is essentially a pass-through of the rating of the underlying security, guarantor or reference credit. Noteholders are exposed to the credit risk of the underlying entity and therefore the rating moves in lock-step in each case.

The agency further notes that the affected transactions are subject to a high level of macroeconomic uncertainty, which could negatively impact the ratings of the notes.

Structured Finance

ABS disclosure principles released

IOSCO's Technical Committee has published a consultation report containing principles designed to provide guidance to securities regulators that are developing or reviewing their regulatory regimes for ongoing ABS disclosure. Dubbed the 'ABS Ongoing Disclosure Principles', the objective is to enhance investor protection by facilitating a better understanding of the issues that should be considered by regulators in developing or reviewing their ongoing disclosure regimes for ABS.

The principles recommend disclosures for securities that are primarily serviced by the cashflows of a discrete pool of receivables or other financial assets - either fixed or revolving - that by their terms convert into cash within a finite period of time. These principles would not apply to securities backed by asset pools that are actively managed, such as securities issued by investment companies or CDOs, or that contain assets that do not by their terms convert to cash.

The ABS Ongoing Disclosure Principles complement the 'Disclosure Principles for Public Offerings and Listings of Asset-Backed Securities', issued in April 2010, which provides guidance on disclosure regimes for offerings and listings of ABS but do not expressly address continuous reporting disclosure mandates or requirements to disclose material developments.

Structured Finance

Further Italian, Spanish rating actions taken

Moody's has taken further rating action on structured finance deals exposed to assets located in Italy and Spain, following the lowering of the highest achievable structured finance ratings in the jurisdictions (SCI 20 February). The agency has downgraded the ratings of 478 notes and placed on review for downgrade the ratings on five notes from across 387 structured finance transactions.

Moody's has downgraded to Aa2 tranches rated Aaa and Aa1, having considered the presence of specific structural features - such as financial guarantees - which may limit the impact of severe events. It has placed on review for downgrade the Aaa ratings of five ABS notes guaranteed by the European Investment Fund while it analyses how these guarantees would perform in the remote but not implausible event of debt redenomination.

The rating actions affect 127 ABS, 255 RMBS and five CLOs.

CDO

ABS CDO cuts likely on criteria change

S&P has revised its methodologies and assumptions for rating global ABS CDOs. The agency says the move represents a significant recalibration of its CDO criteria and is designed to enhance the comparability of CDO ratings with ratings in other sectors. These criteria apply to all new and existing cashflow, synthetic and hybrid CDOs backed by pools of structured finance assets and becomes effective on 19 March.

The publication of the revised criteria follows a proposal outlined in a request for comment (SCI 13 October 2011). Although a number of market participants provided written comments regarding the RFC, S&P says it received no additional data or information that caused it to modify the proposed parameters in finalising the new criteria.

Based on sample testing, these criteria will result in downgrades to existing transactions by one or more rating categories. The level of change will be primarily driven by the ratings on the assets relative to the ratings on the CDO liabilities.

The lower the ratings on the assets, relative to the existing rating on the ABS CDO liabilities, the higher the downgrade expected under the criteria. However, some transactions that already have their liabilities rated in the triple-C rating category will likely not be materially affected.

The new criteria adopt the same basic methodologies, assumptions and modelling parameters currently used to rate corporate cashflow and synthetic CDOs, with a number of changes driven by the characteristics of SF assets. These include: modifying the previous SF debt asset type classification and reducing the number of SF asset types to 10 from 22; modifying the supplemental stress tests to reflect the characteristics of SF debt; capping the maturities used in modelling SF assets based on general prepayment and seasoning history; eliminating the geographic diversification credit given to corporate CDOs; increasing most of the correlation modelling parameters between different SF asset types; lowering the recovery rate parameters for cash SF assets depending on the economic scenario applicable to each rating level; and applying a zero recovery rate to expected defaulted SF assets that have ratings two rating categories or more below the CDO liability rating.

S&P will update its CDO Evaluator default model to reflect the new criteria and make the model available prior to their effective date.

CDO

CRE CDO concentration risk highlighted

US CRE CDO delinquencies began the year higher primarily due to maturity defaults, according to Fitch's latest index results.

CRE CDO late-pays rose in January to 13.2% from 12.5% in December 2011, with asset managers reporting 16 new delinquent assets during the month. While Fitch's analysis already takes into account expected losses and potential future increases in delinquencies, ratings on the most junior classes remain subject to volatility as losses continue to accumulate.

Among the new delinquent assets were 12 new matured balloon loan interests, one foreclosure and three new credit-impaired securities. Offsetting these new delinquencies, ten assets were removed from the index in the month, including five assets disposed of at a loss.

The matured balloon loans include five B-notes secured by the Kerzner portfolio, which includes the Atlantis Resort in the Bahamas and two smaller resorts. These interests are contributed to five different CDOs, which are managed by two different asset managers. Another three newly defaulted B-notes secured by the same New Jersey office property are contributed to three affiliated CDOs.

Fitch notes that January's new delinquencies, in particular, highlight the concentration risk in CRE CDOs with many of the same loan exposures appearing across several transactions.

CRE CDO asset managers reported approximately US$105m in realised losses from the disposal of credit-impaired assets in the January reporting period. The weighted average loss was 57%. The largest loss, approximately US$55m, was related to the sale of a defaulted portfolio of eight multifamily properties located across five states.

In January, 31 of the 33 CRE CDOs rated by Fitch reported delinquencies ranging from 1.3% to 61.7%. Additionally, 40% of rated CRE CDOs were failing at least one overcollateralisation test.

CDS

Tranche recovery metrics completed

S&P has completed its framework for estimating recoveries on tranched corporate credit default swap indices. The set of supplementary analytics, called synthetic tranche recovery metrics (STRM), is intended to provide S&P's view of what publicly traded CDS indices may recover under varying economic environments. The agency says it will use these supplementary analytics to provide recovery estimates on an aggregate level for several publicly traded market indices.

S&P requested feedback on its proposed tranche recovery metrics in July 2010 (SCI 21 July 2010). After considering the feedback, the agency has made a number of determinations in relation to the STRM framework.

First, S&P expects to provide a thinner tranche distribution when running the STRM framework on the proposed indices. This will allow market participants to better compare their own holdings with the indices, it says.

Second, the agency will provide the STRM values in percentage form. Finally, it expects to publish the STRM values on a monthly basis.

STRM is a set of analytics that supplement S&P's synthetic CDO (SCDO) ratings, enabling users to estimate recovery prospects for tranched CDS indices under various stress scenario assumptions. The STRM framework is designed to complement the agency's 'first dollar loss' approach in ratings, where it generally focuses on the likelihood of default as the single-most important factor affecting its view of creditworthiness.

The STRM framework provides estimates of a tranched CDS index's recovery prospects, given a set of hypothetical future reference portfolio default and recovery assumptions. The framework uses two different sets of metrics: scenario-based metrics and simulation-based metrics.

Scenario-based metrics comprise: a portfolio loss metric, tranche exposure and scenario recovery. The simulation-based metrics consists of: expected tranche loss, expected loss given default and expected recovery.

The scenario-based metrics apply a single stress scenario, based on actual historical default rates, to determine the portfolio loss metric (PLM), tranche exposure (TExp) and scenario recovery on a CDS tranche. The simulation-based metrics use a Monte Carlo simulation of many different stress scenarios to generate an expected tranche loss (ETL), expected loss given default (ELGD) and expected recovery on a CDS tranche.

CDS

State Street preps SEF

State Street Corporation has launched a swap execution facility (SEF), dubbed SwapEx. The firm says the service will provides the first step in a global end-to-end solution that reduces operational risk through the automation of the many stages of derivatives processing - including execution, clearing, collateral management, risk reporting, valuations and the reconciliation of positions.

State Street plans to file its SwapEx registration with the US CFTC when the application window opens later this year. In preparation for the launch, State Street has entered into an agreement with National Futures Association (NFA) to perform regulatory services for the SEF.

CDS

Derivatives reporting solution minted

Lombard Risk Management has launched its Dodd-Frank Act Engine service, which aims to address Title VII of the Dodd-Frank Act - concerning the reporting of swap data throughout the lifecycle of the trade. The offering is a rules-based, workflow technology and software solution that meets both real-time and event-driven reporting to the regulators, automatically collating and mapping reportable data from different source systems.

The regulation will come into effect for CDS and interest rate swaps in July, with other asset classes to follow later in the year. Lombard Risk says it has been working closely with several large global banks in the US and Europe to analyse the impact of this regulation on their businesses.

CLOs

Loan extension 'test' due

UPC's request for lenders to respond to its proposed TLS debt maturity extension ends today. The move is being seen as a test of CLO managers' attitudes towards loan extensions with no margin pick-up.

UPC - the largest obligor in the European CLO universe - is proposing to extend the TLS, which currently matures in December 2016, by three years in return for a 25bp consent fee and no margin uplift from the current cost of 375bp. European CLO analysts at RBS suggest that the proposed A-E terms to the lenders are relatively mediocre, as average consent fees to lenders post-crisis have been around 60bp with a spread pick-up of 150bp.

The RBS analysts believe that CLO managers will still be amenable to these terms, particularly due to the lack of primary market activity, which thus presents fewer reinvestment opportunities. "As more CLO vehicles start to lose reinvestment rights and CLO managers' AUM optimisation pressures increase, we expect a greater number of the top leveraged loan borrowers will attempt to refinance at more attractive terms and take advantage of the need for CLO managers to remain fully invested."

Of UPC's outstanding €1.7bn TLS debt, 51% is currently represented across 146 CLO transactions.

CMBS

Special servicer fee warning

Fitch has warned that the trend for some special servicers charging fees for loan modifications potentially presents risk to bondholders, borrowers and the recovering CMBS market. The agency's concern is not so much the size of any fee that a borrower pays, but the philosophy of the fee itself - it argues that special servicers have a fiduciary duty to the trust and bondholders and any fee charged to a borrower implicitly puts that fiduciary duty at risk.

"These fees may be allowed within the framework of the loan documents or the pooling and servicing agreement (PSA). PSAs include specific fee structures for special servicing, liquidation or workout fees. They do not specifically disallow special servicers from charging ancillary fees - such as modification, assumption or extension fees - nor do they usually suggest guidelines on those fees," Fitch says.

Moreover, it adds that the documents do not require special servicers to disclose these ancillary fees collected from the borrower. This, the agency suggests, makes the additional fees difficult to accurately quantify.

However, Fitch reports that it has been made aware of instances where modification or extension fees have been charged to the borrower and some were far higher than expected. "Most troubling was that they were not readily disclosed to investors. A fee charged to a borrower and not disclosed to bondholders, especially when the fee is a large one, has the potential to call into question the real rationale behind the modification or extension for which the fee was charged," it says.

Fitch plans to examine this issue in more detail, including whether ancillary fees adhere to the spirit of the documents and the servicing standard, and determine if a simple fix is to encourage special servicers to explicitly state fees charged borrowers so investors are fully aware, even if they don't agree with them.

CMBS

Keops liquidation progresses

An update on the progress of the liquidation of the Keops portfolio, securitised in Juno (Eclipse 2007-2), has been released. A total of 147 properties have been sold for a price of Skr4.103bn, compared to a gross valuation of Skr4.242bn.

The latest set of sales of 128 properties has been completed, with proceeds received for all of them. A contract for sale on the sole remaining property not sold in the auction has been signed and was due to complete on 28 January. However, new terms are being negotiated for the sale, which are expected to be settled in due course.

Proceeds have been distributed to the senior lender, with the amount outstanding now Skr40.5m. Structured finance strategists at Chalkhill Partners estimate that recoveries average 96%.

A payment of €205.8m was applied on a sequential basis to the transaction on the 20 February IPD, reducing the amount of class A notes outstanding from 70.8% to 40.4%. The €218m Keops loan was the largest exposure in the Eclipse 2007-2 pool on closing, accounting for 28.6% of the CMBS.

CMBS

CMBS LFM risk identified

European asset-backed analysts at RBS have identified another European CMBS that is at risk of not paying off at legal maturity in April 2013, following the default of Opera Finance (Uni-Invest) last week. However, the likelihood of other deals defaulting at legal final beyond that date appears harder to predict.

The convention in European CMBS has been to set legal final maturities two to three years after the maturity date of the longest loan underlying the transaction. The default of OPERA UNI at maturity raises the question of whether there are other deals that could potentially hit their legal maturity dates. A quick survey of these transactions undertaken by the RBS analysts suggests this is unlikely in the next year, although they note that EuroProp (EMC 4) has a "real risk" of not paying off in April 2013.

The Sunrise loan, the only remaining EuroProp loan, has been in special servicing since July 2010 after it defaulted due to various covenant breaches. The special servicer is currently disposing of the properties in an orderly manner via an asset sale. Five sales were completed by the end of 2011 and 55 assets remain in the portfolio.

In addition, it is unclear whether the White Tower 2006-3 class E notes will be able to pay the remaining balance off. This transaction already defaulted for other reasons, but the properties were sold and classes A to D repaid in full, as well as about 80% of the class Es.

Two other deals with legal finals due over the next year - Colonnade Securities and Marlin (EMC-II) - are expected to repay on time and without incident.

CMBS

DQT dips by 2bp

The delinquency rate on loans included in US CMBS conduit/fusion transactions slipped by 2bp in January to 9.3%, according to Moody's Delinquency Tracker (DQT). The rate of loans in special servicing, as measured by Moody's Specially Serviced Loan Tracker, increased by 1bp in January to 11.98%.

January was the 13th consecutive month that delinquencies in the US have been above 9%, according to Moody's. January saw approximately US$6.4bn in newly delinquent loans. Although the amount was the highest one-month inflow recorded to date, it was outpaced by US$7.2bn in loans that were resolved.

January marks the eighth of the last 11 months that the total balance of delinquent conduit loans declined. March 2011 was the first post-financial crisis month to see a decline in the delinquent universe.

With no CMBS conduit issuance in January to counterbalance dispositions, the overall CMBS universe declined by US$6.5bn to US$576.3bn. The decrease was the largest for any month since May 2009 and the fourth largest recorded.

By property type, the retail sector was the only one to record an increase in its delinquency rate during the month, up 36bp to 7.58%. This rate is the lowest among the five core property types. Conversely, the property type with the highest delinquency rate - multifamily - saw its rate decrease the most, as it fell by 68bp in January to 13.77%.

The two property types that recorded the highest historical delinquency rates in December - office and industrial - both experienced declines. The rate for the office sector fell by 12bp to 8.53%, while the rate for industrial properties fell by 17bp to 11.93%. The delinquency rate of the remaining sector - hotels - changed little during the month, falling by 1bp to 12.95%.

By region, the East had the largest decline in its delinquency rate, falling 54bp to 7.57% - the lowest rate for any region. The workout of a single loan, 666 Fifth Avenue in New York City, was responsible for much of the decline, Moody's says.

The West and Midwest regions experienced increases in delinquency in January, while the rate for the West rose by 42bp to 8.66% and the rate for the Midwest rose by 33bp to 10.35%. Delinquencies in the South saw a 0.4bp decline in January, slipping to 11.37%.

RMBS

Langton restructured

The Langton UK RMBS master trust has been restructured. Under the restructuring, Santander has: repurchased around £18bn of trust collateral; repaid £18.4bn of triple-A rated notes and £3.5bn of unrated Z notes outstanding under the Langton Securities 2008-1 and 2010-1 issuers; and reduced the size of the shared funding reserve fund from £43m to £20.5m. Additionally, the Langton Securities 2008-1 and 2010-1 issuer reserves have been reduced from £200m to £100m and from £245.4m to £107.9m respectively.

The loans that are being repurchased have been selected at random, according to Moody's, and the characteristics of the pool will be similar. The portfolio expected loss of 1% of original balance at closing and MILAN Aaa credit enhancement of 9% remain unchanged.

Following the restructure, the credit enhancement for the Aaa rated notes is 17.4% for Langton Securities 2008-1, 18.8% for Langton Securities 2010-1 and 19.5% for Langton Securities 2010-2. This represents an increase compared with between 14.4% and 17.2% at the closing of Langton Securities 2010-2.

RMBS

Chilean RMBS criteria enhanced

Fitch has updated its rating methodology for assessing credit risk in Chilean residential mortgage loan pools that back RMBS. The main changes focus on a more forward-looking approach, increased market value decline (MVD) assumptions, increased expected foreclosure frequency and adjustments for specific product and borrower characteristics.

In particular, the updated criteria place an emphasis on Fitch's performance expectations, especially at lower rating levels. Loss expectations derived for lower rating levels are likely to be more 'point in time' and vary in line with changes in the agency's expectations as influenced by actual asset performance. The higher rating scenarios are relatively more remote and are intended to show rating stability through all aspects of an economic cycle, it says.

Fitch has increased MVD assumptions across all rating scenarios. The MVD encompasses house price decline and forced sale discount assumptions.

The agency will request loan-by-loan repossession data from lenders at the time of ratings analysis. If this data suggests that forced sale discounts and loss severity values for a particular lender are not in line with its expectations, further adjustments to MVDs may be made on a case-by-case basis.

Meanwhile, analysis of defaulted loans indicates that some product types and features have seen a greater degree of performance deterioration. Consequently, Fitch has increased its foreclosure frequency expectations and adjustments for certain borrower and product types.

The criteria assumptions will be used for rating both new and existing RMBS transactions. They are not expected to result in rating actions on existing transactions, however.