Contents

ABS

Cards from abroad

US investors hungry for UK credit card ABS

Barclays last week priced its latest UK credit card ABS, with the largest tranche denominated in US dollars. US accounts are increasingly looking to invest in UK credit card paper for several reasons and that interest is expected to continue.

Barclays' Gracechurch Card Programme Funding 2012-1 - whose US$450m 2.93-year class A1 notes printed at 70bp over one-month Libor - follows Gracechurch 2011-5 and Arran Cards Funding 2012-1, which both also had dollar tranches. UK credit card ABS offers US investors diversification without tying them too strongly to the fortunes of the euro, but that is not the only attraction of the sector.

Greg Branch, cio at SCIO Capital, notes that the trend of US investors taking an interest in UK credit cards is an extension of what is being seen throughout European ABS at the moment. "We are seeing the US crossover buyer looking to take advantage of the very significant basis between where US structured product and European structured product is currently trading."

There is a current shortage of US credit card paper, which is another factor attracting US investors to European product. Kevin Ingram, partner at Clifford Chance, says: "US banks generally have reduced exposure to European banks, including UK banks. However, the concerns that US regulators have expressed about over-exposure to European banks does not appear to extend to European assets."

He adds: "It will be interesting to see whether it continues, but there seems to be less concern about US entities investing in European assets. Considering the sweet spot for investors seems to be shorter tenor at the moment, credit card collateral is ready-made for those investors looking at European ABS."

The basis between US and European structured products is thought to be a function of uncertainty about the future of the euro and the 9% Core Tier 1 ratio required of banks by the European Banking Authority. Branch explains: "Historically, similar asset classes in the US and Europe have typically traded roughly in line with one another. But over the last six months the uncertainty regarding the single-currency has kept the US guys sidelined."

He continues: "However, following the launch of the ECB's LTRO programme in 3Q11, we have witnessed dollar investors wading in as concerns relating to the euro abate, in order to take advantage of what is - quite frankly - an unprecedented amount of spread basis."

Further, the familiarity of UK credit card ABS is a key attraction for US investors. "The structures are very similar: it is an asset class that is very well known in the US and is relatively liquid. There has been a lot of US placement of UK credit card paper since the first Barclays Gracechurch deal accessed the US investor base for the first time back in 1999," notes Ingram.

US and UK credit card transactions are similar in their terminology and how they operate. The differences between them are mainly in connection with legal and tax structures, not economics.

Ingram explains: "You will use a trust in the UK structure and that trust will have an SPV declaring the trust as trustee, whereas my understanding is that in the US the trust has a separate personality and it is typically declared by a professional trust company, for example. The way the trust operates is pretty much the same in economic terms, but the legal structure is different. There is quite a lot of that sort of detail, but at the level most investors look at, they are extremely similar."

Banks are the largest holders of structured credit in Europe, but they are under pressure to reach the 9% capital target by 30 June. They are effectively forced sellers, making European paper very attractive for US buyers.

"Regulators are effectively forcing the banks and insurance companies via CRD 3, CRD 4 and Solvency II to sell these products for non-economic reasons. The banks would not be selling at these distressed levels, if the regulations were not making structured credit so expensive for them to hold," says Branch.

With many European assets currently attractively priced, credit cards provide a familiar asset class to invest in. Likewise, for many US investors, the UK provides a familiar jurisdiction for issuance. It also benefits from being slightly removed from the ongoing euro currency concerns.

"Lining up on the euro may be a step too far for many dollar investors, but the crossover buyers could certainly see value in sterling-denominated paper. There are positive numbers coming out of the UK, with retail sales on an up-trend, inflation decreasing and manufacturing rising," notes Branch.

He continues: "The UK is a similar recovery story to the US. In Europe the situation is less clear, but in the UK you can to a greater extent take the currency out of the equation. That makes paper from the UK attractive and if it is credit card paper that is available, then investors will buy that."

While US investors may lessen their involvement in the UK credit card sector once US issuance picks up again, Ingram notes that it is a market they have invested in over a long period and in his view they are unlikely to pull out completely. "US investors have been in this market since 1999. There have obviously been periods of relatively fallow issuance as well as booms, and I think you will have peaks and troughs in terms of issuance over time," he says.

Ingram adds: "The idea of US investors investing in European assets is likely. European assets have generally performed better than US assets. That said, it is unlikely you will have full SEC-registered transactions going forward, due to the material requirements of that process for non-US issuers. So, it is likely to be a 144A market for the foreseeable future."

Although UK deals will remain attractive to US investors, much interest in deals from other European jurisdictions is not expected. Ingram notes that there is not a very big credit card market in European countries outside of the UK.

"The size just is not there because the way people use credit in many European countries is different to the UK and US. It is hard to have multi-jurisdiction credit card deals in Europe for legal, tax and currency reasons, so it is unlikely for there to be a big enough portfolio in one country to do a number of issuances from that portfolio into the US," says Ingram.

One concern going forward is the extent to which US regulation and legislation will apply to non-US collateral. Ingram believes that regulation probably will not preclude US investors, although it may act as a disincentive.

"The likelihood is that US regulations will apply to buying European paper. It should not stop US investors, but it is certainly a consideration. Investors will have to do additional diligence and European issuers may be disincentivised too," says Ingram.

He continues: "That is the big elephant in the room for the ongoing health of the market. Often US regulation is only really intended for US domestic issuance, but the extent to which it applies to international issuances - both placed into the US and not placed into the US - is and will be one of the most important concerns outside of pricing."

For all the future possibilities, investors right now are making the most of the opportunities that UK credit card paper presents US investors. Branch concludes: "Ultimately, it comes down to what your base currency is. On a relative value basis, the question for US guys is where you line up today. It is an easier sales pitch to your senior management to say you are going to take advantage of the basis in the sterling structured product than in the euro structured product."

JL

RMBS

Currency conundrum

Kazakh RMBS highlights EM ABS redenomination risks

A decision by the Supreme Court of Kazakhstan to prevent the indexation of mortgage balances to the US dollar has highlighted the continuing legal and currency risks involved in emerging market securitisations, particularly during time of economic stress. Meanwhile, prospects for new cross-border RMBS from Russia and the CIS remain dim, but the domestic market continues to progress.

The Supreme Court of Kazakhstan ruled against the indexation of mortgage balances in the Kazakh mortgage market to the US dollar in late December, following a similar move by the Hungarian parliament. The court also stated that the existing mortgages subject to such indexation should be redenominated into Kazakh tenge (KZT) using the exchange rate in effect at the time of origination of those mortgages. As a result, US dollar-linked mortgages securitised in Kazakh MBS 2007-1 were redenominated into KZT and the portfolio suffered an immediate 12% loss plus an un-hedged exposure to the USD/KZT exchange rate, since the notes in the transaction are denominated in US dollars.

"There is significant uncertainty surrounding the issue of redenomination as it is not something we have really seen before in an RMBS transaction," says Olga Gekht, vp at Moody's. "However, the [Kazakh MBS] transaction in itself is quite strong: it has paid down significantly and has a very large reserve fund available in US dollars. There is also both subordination and overcollateralisation in the transaction."

According to Gekht, one of the main uncertainties for the transaction following redenomination is related to developments in the USD/KZT exchange rate. The USD/KZT exchange rate is managed by the National Bank of Kazakhstan, which aims to keep the rate within a narrow range. The bank changed this range in early 2009, which led to a subsequent depreciation of the tenge by almost 20%.

"Any further large depreciations of the tenge against the US dollar will result in further losses to the asset portfolio and may lead to losses on the notes," she says. "For example, a further 50% depreciation of tenge six months from now would result in an 89% loss on the class C notes and a 37% loss on the class B notes. The class A notes would not be affected due to the large credit enhancement under this note (52.1%)."

The transaction is also exposed to the legal risk of the issuer being obliged to pay additional compensation to the borrowers. For instance, the borrowers were required to make payments on an indexed basis, while their cases were considered in court.

Gekht explains that the court first began reviewing cases in March 2011, when the Kazakh parliament passed the law prohibiting the indexation of new mortgages. "The exact amount of the compensation to be paid is still unclear. But - assuming that the borrowers claim for principal repaid on the indexed basis, as well as any interest accrued on this amount from March 2011 until the indexation was removed in December 2011 - the estimated compensation would equal approximately 3%-4% of the outstanding balance of the mortgages, including any mortgages that were prepaid during this time," she says.

Any future actions or court decisions that could affect the level of compensation or identify further reasons to compensate the borrowers may lead to losses on the notes and may negatively affect the ratings of the transaction. Moody's stresses in its recently-published Credit Insight that the experience in Kazakhstan and Hungary shows that, during a time of economic stress, there is a high probability that mortgage assets denominated in a foreign currency will be exposed to redenomination.

The agency currently rates six EMEA RMBS transactions backed by US dollar-denominated portfolios, totalling US$225.7m. Four of them are Russian RMBS, one is Ukrainian RMBS and one is a Latvian RMBS.

"Most of the other emerging market deals with USD-indexed mortgages have been around for quite some time and have built up a lot of subordination, which would provide protection against potential redenomination," says Gekht. "When we initially rated these types of deals, we did take into account that redenomination of the mortgages was a risk and the Kazakh MBS deal has defined that risk for us."

Konstantin Kroll, partner at Jones Day in Moscow, says that if foreign currency is used in a securitisation, he would recommend that there is some sort of hedge mechanism to counter it. "We recommend the use of these in structured finance deals in Russia," he says. "You need to be aware of the currency exchange risk and, to prevent this risk, you need currency swaps. However, these can often increase the cost of doing a deal."

He adds: "In any emerging market securitisation, there is always going to be a certain amount of country risk - for example, certain laws being changed retrospectively, such as the redenomination of USD-indexed mortgages in the Kazakh MBS."

New cross-border RMBS issuance from Russia and the CIS looks unlikely to return for the foreseeable future, however, as international investors concentrate on the more mainstream asset classes. "Cross-border securitisations from Russia are pretty much dead at the moment," confirms Kroll. "There are a handful of domestic deals being done, but nothing compared to pre-crisis levels when it really was a growing market."

Kroll suggests that once the wider economy improves, there may be a new wave of securitisations, however. "Lenders are continuing to grow their mortgage portfolios, their loan portfolios and their credit card portfolios, so it would make sense to securitise them," he says.

In the interim, the Russian mortgage market is being buoyed by issuance in the domestic market, thanks to the continued provision of government-sponsored funds that have been specifically mandated to buy the asset class (see SCI 8 September 2011). Just recently, the country saw issuance from a small independent bank with a relatively low rating (Ba3) - the first time a deal from such a bank has hit the market since the financial crisis.

Mortgage Agent Vozrozhdenie 1 Russian RMBS is the first securitisation of mortgages originated by Vozrozhdenie Bank. It is understood that the transaction was issued specifically for purchase by one of the government-sponsored funds.

There are currently two government-sponsored funds in place to buy MBS securities with investment-grade ratings - one from the Agency for Housing Mortgage Lending (AHML) and another from the state development bank, Vnesheconombank (VEB).

VEB can invest up to RUB50bn of its own funds and up to RUB100bn of the funds of its pension fund in RMBS, while AHML can invest up to RUB20bn through its programme. This is the second instalment of the AHML programme; subscription to the first instalment closed in the end of 2010, with a RUB39bn take-up.

"There has been recent new RMBS issuance in the domestic Russian market and this is something we would definitely expect to continue," concludes Gekht. "Government-sponsored programmes mandated to buy MBS securities with investment grade ratings are due to run for another two years, so we expect this to encourage MBS activity."

AC

Structured Finance

SCI Start the Week - 5 March

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

Pipeline
Last week saw several deals enter the pipeline and price within days, although a few new names remained on Friday. Domino's is in the market with a US$1.675bn whole business securitisation (Domino's Pizza Master Issuer Series 2012-1), while two student loan ABS (US$824m SLM Student Loan Trust 2012-2 and US$393m Edsouth Indenture No 2 2012-1) are also marketing. Additionally, Doral Leveraged Asset Management is marketing a US$400m CLO.

Pricings
There were over a dozen pricings last week, including two large CMBS and five auto-related deals. Two credit card ABS, one timeshare ABS, one ILS and two CLOs rounded out the issuance.
The CMBS comprised US$941m COMM 2012-LC4 and US$1.1bn Freddie Mac SPC Series K-017. Two auto lease (US$1.175bn Ford Credit Auto Lease Trust 2012-A and €1.275bn VCL 15) and three prime auto loan (US$1.3bn Huntington Auto Trust 2012-1, US$1.354bn Hyundai Auto Receivables Trust 2012-A and US$154m TruckLease Compartment No 2) ABS made up the auto issuance.
In credit card ABS, US$425m Cabela's Credit Card Master Note Trust 2012-I and US$450m Gracechurch Card Programme Funding Series 2012-1 both printed. Those transactions were joined by US$160m Orange Lake Timeshare Trust 2012-A and US$75m Queen Street V, the timeshare ABS and ILS respectively.
Finally, the two CLOs were US$410m AMMC CLO X and US$362m ING IM CLO 2012-1.

Markets
The US ABS secondary market saw another week of tightening, according to ABS analysts from JPMorgan. Single-A rated fixed credit card ABS spreads tightened by 5bp, while subprime auto subordinates tightened by 10bp to 50bp. Triple-A FFELP student loan spreads narrowed by 5bp across the board and triple-A three-year and seven-year private credit student loan ABS spreads tightened by 10bp and 50bp respectively.
"Bids have been getting stronger across asset classes. In particular, off-the-run ABS bonds have seen better demand consistent with the broader rally in the credit markets," the JPM analysts add.
At the same time, US CMBS spreads continued to tighten sharply this week in line with broader credit and equity markets, say US CMBS research analysts at Barclays Capital. Generic 2007 LCFs ended Thursday at 175bp over swaps, levels last seen in mid-2011. The benchmark GG10 dupers tightened nearly 25bp over the week to finish at 216bp over swaps.
"Spread compression was also in evidence lower down the capital structure: 2007 vintage AMs tightened by more than 30bp over the week and were pricing at 485bp over swaps, as of Thursday's close. After moving sideways for the past couple of weeks, AJ bonds also resumed their climb: 2007 vintage AJs gained 3-4 points over the week to finish at 70c to the dollar," the Barcap CMBS analysts note.
There was less movement in US RMBS, where residential credit analysts at Barclays Capital say that - despite continued strong sponsorship in the sector - non-agency cash prices were generally flat again. However, the synthetic indices rallied in tandem with the broader markets, with the ABX indices up by 0.5-1 point week on week, while the PrimeX indices were higher by 0.5-1.5 points over the same timeframe.
Most of the market's focus during the first half of the week was on the third round of sales from the Federal Reserve's Maiden Lane II portfolio, the Barcap analysts say. "Trading volumes were heavy in the second half of the week as the Maiden Lane II assets were digested by the market and investors continued to express demand for non-agency cashflows."
Last week was another relatively uneventful week in the US CLO market, according to CLO research analysts at Bank of America Merrill Lynch. "CLO product has seen the continuation of the same themes as in previous sessions, namely: robust liquidity across the entire capital structure, range-bound spreads with a tightening bias and the beginning of a standard bullish compression move - whereby investors reach for yield further down the quality spectrum, leading out-of-favour shelves to gain back some of the ground lost to the upper tier performers in the space," the BAML analysts say.

Deal news
• US special servicer activity has risen over the past two months, resulting in approximately US$3.7bn newly-modified loans. With term extensions being the most common modification strategy, investors are increasingly looking to CMBS extension trades to boost yields.
• The remaining securities in the Maiden Lane II portfolio have been sold. The New York Fed's management of the ML II portfolio will result in full repayment of its US$19.5bn loan and generate a net gain for the benefit of the public of approximately US$2.8bn, including US$580m in accrued interest.
• The Carlyle Group has completed the acquisition of four management contracts on €2.1bn in European CLO assets from Highland Capital Management. The acquisition brings Carlyle's CLO assets under management to US$16bn via 32 transactions. Financial terms were not disclosed.
• Kohlberg Capital Corporation has acquired Trimaran Advisors, along with equity interests in certain CLOs managed by the firm. Trimaran Advisors currently manages four CLOs with aggregate assets under management of approximately US$1.5bn.
• ISDA's EMEA Determinations Committee unanimously decided that a credit event has not occurred in respect of the two questions relating to the Hellenic Republic restructuring.
• Bank of America's US$8.5bn Countrywide RMBS settlement case has returned from federal court to New York state court, likely hastening its approval. A resolution of the settlement is expected to provide a blueprint for similar cases against other large originators.
• Traccr has announced that a Swiss client executed a US$5m bespoke CLN via its electronic platform. The client benefited from live CLN axes posted by dealers to their respective networks of clients - a unique feature recently added to the Traccr offering.
• An auction is set to be conducted on 20 March in respect of Capital Guardian ABS CDO I collateral. However, the sale will only be consummated if the trustee receives two or more bids to purchase all of the securities.

Regulatory update
• The securitisation industry remains hopeful that highly rated ABS will ultimately be eligible under the Basel 3 liquidity coverage ratio (LCR). In the meantime, steps are being taken to address the treatment under the LCR of unused bank commitments that support ABS structures.
• The US Federal Reserve has released action plans for supervised financial institutions to correct deficiencies in residential mortgage loan servicing and foreclosure processing. It also issued engagement letters between supervised financial institutions and independent consultants retained by the firms to review foreclosures that were in process in 2009 and 2010.
• The IOSCO Technical Committee has published a report detailing its recommendations that authorities should follow in establishing a mandatory clearing regime for standardised OTC derivatives in support of the G20's commitments to improve transparency, mitigate systemic risk and protect against market abuse in these markets.
• The UK Supreme Court on 29 February upheld the UK Court of Appeal's 2 August 2010 ruling regarding the scope of, and participation in distributions from, the Lehman Brothers International (Europe) pool of client money. This landmark decision applies to all customers who agreed with their investment firm counterparty that their money would be treated as client money under the UK's FSA rules, regardless of whether such money was actually segregated by the investment firm.

Deals added to the SCI database last week:
Avalon IV Capital
Exeter Automobile Receivables Trust series 2012-1
IM Cajamar Empresas 4
John Deere Owner Trust 2012-A
Lanark Master Issuer series 2012-1
OCP CLO 2012-1
Octagon Investment Partners XII
Queen Street V

Top stories to come in SCI:
Focus on emerging market ABS
Focus on German multifamily CMBS
Impact of principal reduction across European RMBS

CDS

CDS recoveries scrutinised

The difference in average CDS recoveries and average bankruptcy recoveries is four points, according to credit derivative strategists at Morgan Stanley. They point to the frequent misconception that CDS settlement represents the true 'recovery' for a corporate entity, when in fact credit events settle fairly early in the typical lifecycle of a bankruptcy workout.

Based on 27 corporations that have been through a full bankruptcy restructuring process and also had CDS settlement for unsecured debt, the Morgan Stanley strategists find that the average CDS recovery was 20.6% and the average final recovery in the bankruptcy process was 24.6%. The difference represents a return of about 19%, they note, which is in line with what many investors demand from a workout process. For secured debt, the average CDS recovery was 59.9% (based on 12 names) and the average final recovery was 61.9%, representing an average two point return during the bankruptcy process.

Numerous changes to CDS documentation have been made to increase fungibility and standardisation, but credit event triggers remain the primary drivers of valuation. A contract with more potential triggers is generally more valuable or riskier than one without.

While many participants understand the process for single name CDS, there is less appreciation for credit event settlement on portfolio products, including indices, index options, baskets and tranches. The strategists consequently outline how credit events impact various credit derivative products.

Upon default, a single name CDS or first-to-default basket contract pays out immediately following an auction and then terminates, with no future coupon streams. An index contract, on the other hand, pays out commensurate with the weighting of the name and recovery. The contract does not terminate and the coupon is instead reduced via a smaller notional amount.

For standard credit index options, a principal payment is not immediate post-default and only takes place if and after the option is exercised. However, the breakeven strike at which the option buyer would exercise will shift.

Finally, the impact on a tranche trade can include principal loss, reduction in subordination, loss of coupon or a combination of these, depending on the tranche and where it is in the capital structure.

CS

CLOs

Bank downgrades threaten trustee roles

The negative rating outlooks for many banks that serve as trustees on CLOs raises the possibility that at some point certain counterpaties may no longer be eligible to service CLOs and will have to be replaced by the deal's issuers. In Moody's latest CLO Interest publication, the rating agency notes that a change in trustee could lead to servicing delays and operational mistakes - although it also says potential mistakes would ultimately be correctible.

On 15 February, Moody's placed its ratings on a number of banks and securities firms - including Deutsche Bank Trust Company of Americas (Aa3), Bank of New York Mellon (Aaa) and Citibank (A1) - on review for downgrade. Several others were put on negative outlook. Furthermore, in recent weeks, other rating agencies have lowered their credit ratings on a number of global financial institutions while maintaining their negative outlooks.

US CLO deal documents lay out specific ratings eligibility requirements and resignation guidelines for deal parties. Documents require generally a BBB+/Baa1 rating threshold for trustees.

"In the event of a downgrade to below Baa1, the trustee of a US CLO may have to resign immediately," says Andrew Worthington, analyst at Moody's. "However, the trustee must provide written notice of its resignation to the co-issuer, the noteholders and rating agencies at least 60 days before the effective date. If the trustee does not resign, a vote by the majority of the noteholders can remove the trustee at any time."

The issuer can also remove a trustee by issuer order. Upon acceptance of the trustee's resignation, the issuer must promptly appoint a successor trustee after obtaining the consent of the majority of the controlling class.

Likewise, European CLOs generally stipulate that deal parties such as the account or custodian bank maintain certain eligibility criteria, like a Moody's short-term rating of P-1 and a long-term senior unsecured debt rating of A2. However, unlike US CLOs, when this requirement is breached some documents recommend that the deal use 'reasonable endeavors' to replace the affected party while others suggest that this can be remedied by a RAC rather than requiring an immediate resignation.

"Future downgrades may trigger breaches in the ratings eligibility of one or more banks at the same time, forcing an issuer to seek a successor trustee from what could be a shrinking pool of eligible candidates," says Worthington.

Although this situation may be a serious problem for some, the effective date of the transfer of responsibilities to the successor trustee may well be manageable for all related parties. Moody's cites a recent example of a successful transfer in 2011, when US Bank replaced Bank of America in a number of CDO deals at the same time.

"In this case, the risk of a trustee downgrade presented more of an operational challenge than any credit risk to the deal," Worthington concludes.

AC

RMBS

FHA refi changes announced

President Obama has announced changes to the FHA streamlined refinance programme, which the market has been expecting for some time (SCI passim). The changes are intended to spur refinancing by exempting borrowers from certain payment requirements.

The plan will see borrowers whose loans were originated before 1 June 2009 pay an annual mortgage insurance premium (MIP) after refinancing of 55bp, which is half the current rate. Upfront MIP will be set at only 1bp for these borrowers, but will be 175bp for all other borrowers.

Almost 3 million FHA loans were originated before the June 2009 cut-off date. MBS analysts at Bank of America Merrill Lynch note that those loans have prepaid slightly faster than newer loans but have also faced higher default rates. The average mortgage rate is about 1% higher for loans created before the cut-off than after.

The BAML analysts believe the changes bring the mortgage refinancing process closer to the ideal that was outlined by the President in his State of the Union address (SCI 25 January). A small increase in GNMA prepayment speeds is anticipated.

The analysts note: "We expect that the increase in speeds resulting from this change will be minimal. The changes will only impact 4.5s and above from 2009 and earlier; and we expect to see a pick-up of less than five CPR on these coupons. Any change in prepayments would be visible mid-summer or later."

Unlike HARP, there has never been an LTV cap on refinancing for the Ginnie Mae streamlined programme. The refinancing incentive is particularly increased for high-LTV borrowers. The effective rate drop between the lower annual MIP and reduced up-front MIP will be around 75bp.

The analysts calculate the average WAC of loans originated before the cut-off to be just over 5.75%, with very few loans having a WAC below 5%. "In other words, these borrowers are not just able to refinance, but most have an incentive to refinance - even without the 75bp drop in effective mortgage rates," they observe.

The change in voluntary prepayments for a 75bp increase in incentive is not expected to be high, with historical data suggesting a change of "a couple CPR". Most affected loans already have an incentive of around 100bp.

Last week separate changes to the structure of MIP were announced. Annual MIP was increased by 10bp and up-front MIP was scheduled to increase by 75bp. These changes are anticipated to have a much larger impact on prepayments than Obama's latest announced alterations.

Finally, the analysts recommend an up-in-coupon trade in Fannie Mae paper in the near-term. They note that 30-year Fannie 3.5s and 4s have tightened by 1bp-2bp since the end of February, while 5.5s and 6s are 3bp-4bp wider.

"While this would typically suggest that there has been a large buyer of forward-month production coupons, the April/May rolls have weakened as well - both are down by over about 3/4 tick from their high-water mark," they say.

The analysts expect 5.5s and 6s to outperform over the coming days as the latest prepayment developments favour higher coupons. High coupons GNs and G2s should also offer value.

They say: "Concerns over changes to the GNMA streamlined refi programme have pushed GN-FN swaps down by about a half-point in the past few weeks. With the administration's final plan now out in the open, it appears that the actual changes will fall short of the market's worst fears."

Based on this imbalance, they reckon 4.5s or 5.5s are currently poised to tighten relative to 4s. Investors seeking an offsetting down-in-coupon trade could look to the 15-year market - where up-in-coupon looks overpriced - and particularly into 4.5s.

"In this coupon, almost half of the existing float was originated in 2005 or earlier. The low-WAM deliverable is at odds with the high dollar prices. Recent outperformance has only exacerbated the mismatch," the analysts conclude.

JL

Structured Finance

Firm announces new partner, China office plans

Ashurst has appointed Patrick Phua as a partner in its China practice. It is also applying for a licence to operate a fully practising office in Beijing.

Phua is an experienced finance lawyer specialising in derivatives and structured products. He joins from the Beijing office of Mallesons Stephen Jaques, where he was head of the derivatives, structured finance and banking practice in China.

Phua has experience of advising both corporate and financial institutional clients in relation to derivatives and structured products, including Chinese government-controlled financial agencies, Chinese and international commercial banks, and Chinese state owned enterprises.

Ashurst formally merged with Blake Dawson in Asia yesterday (1 March) and Phua's appointment is part of an ongoing strategy to grow in the Asia-Pacific region. The firm already has offices in Hong Kong and Shanghai.

Structured Finance

Law firm promotes four

Chadbourne & Parke has promoted a number of its structured finance lawyers. Alejandro Landa and Daniel Spencer each become international partners, based in Mexico City and Sao Paulo, respectively, Jeff Browne becomes international counsel in Moscow and Joseph Giannini becomes counsel in New York.

Landa counsels companies and financial institutions on financial, securities and corporate transactions including ABS and future flow transactions. He also has extensive experience advising clients in connection with structured loans, bridge financings and the design and implementation of financing structures for real estate, hospitality and infrastructure projects.

Spencer advises financial institutions and corporations with respect to their Latin American finance and commercial transactions. His practice areas include project finance, structured finance, trade finance, bank finance and general commercial contract work.

Browne specialises in complex cross-border and domestic finance and corporate transactions, with particular emphasis on structured finance, capital markets and derivatives, acquisition finance, syndicated lending and project finance.

Giannini focuses on representing domestic and international clients in connection with banking, finance and related corporate transactions. He is experienced in asset-based lending, working capital facilities, structured finance and bankruptcy-related matters.

Structured Finance

Debt products head named

BMO Capital Markets has promoted Luke Seabrook to head of financial products and debt products, effective from the end of the month. He will be based in Chicago and Toronto and continue to report to Pat Cronin, global head of trading products.

Seabrook will become responsible for all of BMO's global fixed income and money market sales and trading activity, as well as continuing to be responsible for the company's cross-asset derivatives trading and origination, structured products, structured finance and commodities businesses.

Structured Finance

Client development division boosted

Rosie Brooke-Taylor has joined Wilmington Trust's corporate client services group in London. She is responsible for presenting the company's full range of specialised trust and administrative services to corporate clients throughout Europe.

Brooke-Taylor reports to John Traynor, European business development md, and Christophe Schroeder, corporate client services executive md. She joins from Capita Group, where she was a business development relationship manager specialising in capital markets and structured finance, and has previously held business development roles with both Moody's and Fitch.

Structured Finance

SF lawyer joins NY firm

Howard Mulligan has joined Kleinberg, Kaplan, Wolff & Cohen as of counsel in the firm's corporate department. His practice focuses on structured finance and business restructurings.

Mulligan has 17 years of experience in structured finance, securitisation, derivatives and mergers and acquisitions involving structured products. He has previously practiced in the New York offices of law firms McDermott Will & Emery, Dewey Ballantine and Milbank, Tweed, Hadley & McCloy.

Structured Finance

Trading vet resurfaces

Alan Packman has joined Knight Capital Group as head of structured credit trading. Packman was most recently at UBS Investment Bank, where he was head of CDO trading for Europe.

The trader has considerable experience across structured finance and has previously worked at Aladdin Capital Management, Hoare Capital Markets, Dresdner Kleinwort, Lloyds TSB and WestLB trading ABS, MBS, CDOs and CLOs.

Structured Finance

Regulatory specialist recruited

Lisa Ledbetter has joined SNR Denton in Washington DC. She becomes a partner in the firm's financial institutions regulatory practice.

Ledbetter comes over from Freddie Mac, where she spent 13 years, most recently as vp and deputy general counsel. Prior to that she held several senior positions at the FDIC and has also worked in the banking and finance team at the US Treasury Department, American Bankers Association and Independent Community Bankers of America.

Structured Finance

EMEA SF ratings chief named

S&P has promoted Michelle Weston to regional practice leader for structured finance ratings in EMEA. She will report to Paul Coughlin, executive md for global analytics and operations and global practice leader for structured finance ratings.

Weston previously held both analytical and management roles within the organisation. Her most recent role was as general manager for structured finance and she has also served as the manager of the EMEA real property group encompassing RMBS, CMBS and covered bonds.

CDS

Bank boosts European trading team

HSBC has appointed Jose Mosquera as head of European financial credit trading. The bank has also hired Michael Bogecho as a financial CDS trader and Filippos Katsilides as a credit derivatives index options trader. All three will be based in London.

Mosquera will be responsible for the bank's financial credit trading franchise and will target a larger share of the vanilla credit derivatives market. He has 14 years of experience on both the buy- and sell-side, including spells at Breogan Global Financials, Barclays Capital and UBS.

Mosquera will be supported by Bogecho, who joins from Deutsche Bank. He will report to Asif Godall, head of credit trading, who joined the bank last month (SCI 9 February).

Katsilides joins from Credit Suisse, where he was a credit trading vp. He will report to Haider Ali, head of index trading.

CLOs

Trimaran acquired

Kohlberg Capital Corporation has acquired Trimaran Advisors, along with equity interests in certain CLOs managed by the firm. The purchase price consisted of approximately US$25m in cash and 3.6 million shares of Kohlberg Capital common stock.

Trimaran Advisors currently manages four CLOs with aggregate assets under management of approximately US$1.5bn. The firm focuses primarily on below investment grade corporate debt, using primary credit research to identify attractive investment opportunities and monitor the credits in the investment portfolios.

"This is an important transaction for KCAP which significantly expands our existing asset management business," comments Dayl Pearson, president and ceo of Kohlberg Capital. "With this transaction completed, Katonah Debt Advisors and Trimaran Advisors will have over US$3.4bn of combined assets under management. Trimaran Advisors has an outstanding track record, and the combination is expected to result in significant synergies and will provide a platform to grow KCAP's business."

As part of the transaction, KCAP entered into a US$30m credit facility with Credit Suisse that will allow it to add a moderate amount of leverage to its balance sheet. "The new credit facility positions us to grow our direct lending business and we believe that the cost synergies to the operations of our asset management affiliates, as well as the returns from the additional CLO securities will more than offset any potential dilution from the issuance of new shares in the transaction," adds Michael Wirth, cfo at the firm.

Jay Bloom and Dean Kehler, principals of Trimaran Advisors, will continue as employees of Trimaran Advisors and have joined KCAP's board. Dominick Mazzitelli, the portfolio manager of the Trimaran Advisors CLOs, will continue in that role and be assisted by additional Trimaran Advisors investment professionals expanding and enhancing the current Katonah team.

See SCI's CDO manager transfer database for more recent activity in this space.

CMBS

CRE vet joins board

Arbor Realty Trust has appointed William Green to its board of directors as an independent member, effective immediately. He has 29 years of experience in CRE, including as co-founder and managing partner of Tannery Brook Partners and co-founder and managing member of Cazenovia Creek Investment Management.

Green has previously served as member at Starwood Capital Group responsible for the debt investments business and md at Wachovia Securities, where he managed the CRE securitisation and structured finance functions for the investment banking division. He has also held several commercial md positions at Banc of America Securities.

CMBS

Real estate debt head named

John Feeney has joined Henderson Global Investors as head of real estate debt in its secured credit team. He will work with the firm's property business and fixed income team to drive business growth in real estate debt.

Feeney has been involved in CRE since 2004. He was a co-founder of Bank of America's European and Asian real estate lending platforms and most recently headed Bank of America Merrill Lynch's Asia real estate special assets group.

Risk Management

Numerix completes Euro expansion

Numerix has announced five hires and opened two new offices in Europe. The new offices are in Frankfurt and Milan, while the Stockholm, Paris and London offices have also been expanded.

Wolfgang Porada joins as regional sales manager, responsible for managing and expanding Numerix's client base across Germany, Austria and Switzerland from the Frankfurt office. He specialises in potential future exposure and CVA. Porada joins from QuIC, where he was regional manager for Northern Europe.

Maurizio Busetti joins as regional manager, responsible for Italian operations. He joins from Thomson Reuters, where he was based in Milan and Boston focusing on trading and risk management practices and solutions.

Johan Stromberg joins as Nordic regional sales manager, based in Stockholm. He previously worked for Thomson Reuters Sweden and EFG Bank.

Nicolas Thevenet joins as regional sales manager for France, Belgium, Luxembourg and Iberia, based in Paris. He joins from SunGard where he sold risk management solutions to Western Europe.

Helena Frumson Belitsky joins as regional sales manager for the UK, Ireland, Central and Eastern Europe, based in the London office. She also joins from SunGard.

The hires follow the recent appointments of Udi Sela and Rene Anger, who joined Numerix's Paris office from SuperDerivatives and Pricing Partners, respectively.

RMBS

Broker fined for CMO fraud

The former ceo of Brookstreet Securities Corp has been ordered by a federal judge to pay a maximum US$10m penalty in a securities fraud case. The US SEC had brought charges against Stanley Brooks and Brookstreet for systematically selling risky MBS to customers with conservative investment goals (SCI 16 December 2009).

The SEC says Brooks and Brookstreet developed a programme through which the firm's registered representatives sold risky and illiquid CMOs to seniors, retirees and other investors for whom the securities were unsuitable. Brooks had received several warnings about the potential dangers of the investments.

Brooks and Brookstreet were found liable for violating Section 10(b) of the Securities Exchange Act of 1934 as well as Rule 10b-5. In addition to the US$10m penalty, Brooks was also ordered to pay US$110,713.31 in disgorgement and prejudgment interest.

The SEC is also awaiting a court decision in a separate Brookstreet enforcement action filed in federal court in Florida. In that case, it charged 10 former Brookstreet registered representatives with making misrepresentations to investors in the purchases and sales of risky CMOs, two of whom have since settled.

RMBS

MBS vet becomes REIT president

Byron Boston has been promoted to president and appointed to the board of directors at Dynex Capital. He joined Dynex four years ago as cio and will retain those duties alongside his new role.

Boston has three decades of experience in the industry, having begun as a banker and MBS trader for Chemical Bank, Credit Suisse First Boston and Lehman Brothers. He also headed the mortgage portfolio management group at Freddie Mac and served as evp at Sunset Financial Resources before joining Dynex in 2008.

ABS

Auto ABS criteria published

Kroll Bond Rating Agency (KBRA) has released its methodology for rating auto loan ABS, following its request for comment last November (SCI 23 November 2011). The new methodology contains no substantive changes to the methodology described in the RFC.

KBRA says its rating of an auto loan ABS transaction addresses the quality and expected performance of the underlying collateral; the originator and servicer's business model and operational strength; and the transaction terms, including the capital structure, credit enhancement and legal structure. "KBRA's approach emphasises a focus on prevailing industry and credit trends, the integration of originator and servicer evaluations with the transaction analysis, and timely post-issuance surveillance of pool performance, servicer operations and market conditions," the agency says.

ABS

Container ABS performance indicators outlined

Recent results reported by shipping companies can act as a potential indicator of future container ABS performance, Fitch notes.

Maersk, for example, reported this week that its 2011 profits were diminished by challenges in container shipping. While the firm shipped 11% more containers, lower shipping rates - combined with higher fuel costs - pushed its liner business to a loss. Maersk fleet ships approximately 16% of global container shipping capacity.

The current oversupply of ships is supporting container utilisation rates. Maersk plans to use 'superslow-steaming' more extensively, which lengthens transit times of containers and pushes up utilisation rates.

However, shipping companies are the lessees of containers. Weakness in their sector also pushes down lease prices.

Over the long term, prolonged weakness in shipping could directly impact performance of container ABS, according to Fitch. The shipping industry is highly concentrated, with the top eight companies by 20-foot equivalent (TEU) representing more than half of the industry.

If one of those very large companies should cease operations, a large number of containers could require re-leasing in an environment with fewer lessees. And recovering containers from all over the world and in a range of legal environments could be time consuming and costly.

Fitch views global trade flows as the primary drivers of performance in container ABS. World gross domestic product (GDP) is the best proxy for it.

"Container overproduction is a key risk for container ABS," the agency says. "Unlike shipping vessels that require long lead times - a main factor in today's vessel glut and, therefore, low shipping rates - the barriers to container production are very low and they can be produced quickly. Overproduction of containers could lower utilisation rates and further depress lease rates."

ABS

Mystic Re III closes

Liberty Mutual's Mystic Re III (SCI 14 February 2012) has closed providing US multi-peril cover totalling US$275m. The two tranche deal is based on the ultimate net losses of the ceding insurer from US hurricanes and earthquakes, including fire following, on a per-occurrence basis.

Mystic Re III's US$100m series 2012-1 class A notes priced at 900bp over Treasury money market funds and the US$175m class Bs at 1200bp over. S&P has rated the notes double-B and single-B respectively.

The class A notes will cover a 30.03% of losses in excess of US$2.1bn up to US$2.433bn. The class B notes will cover 21.875%of losses in excess of US$1.3bn up to US$2.1bn.

The covered area for hurricane is the following US states: 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, and the District of Columbia. The covered area for earthquake is all 50 states and the District of Columbia, though the class A notes do not cover losses in California from earthquakes.

There will be two annual resets effective 1 January 2013, and 1 January 2014. These will be based on the cedents' exposures as of 1 July 2012 and 1 July 2013, respectively. On each reset date, the attachment points for each class of notes will be reset to keep the probability of attachment and expected loss at 1.51% and 1.38% for the class A notes and 3.01% and 2.17% for the class B notes, provided that the updated exhaustion level for the class B notes is equal to the updated attachment point for the class A notes.

Structured Finance

LBIE ruling 'may impact' MF Global claims

The UK Supreme Court on 29 February upheld the UK Court of Appeal's 2 August 2010 ruling regarding the scope of, and participation in distributions from, the Lehman Brothers International (Europe) pool of client money. This landmark decision applies to all customers who agreed with their investment firm counterparty that their money would be treated as client money under the UK's FSA rules, regardless of whether such money was actually segregated by the investment firm. Schulte Roth & Zabel notes in a recent client alert that the ruling thus may impact not only holders of client money claims against LBIE, but also similarly situated holders of client money claims against MF Global UK.

The Supreme Court's decision: expands the pool of client money, which is afforded priority treatment, to now include money that LBIE should have but failed to properly segregate as client money; and permits clients whose money had not been actually segregated to have the same rights to distributions from the client money pool as clients whose money had been segregated properly. The decision affirms the Court of Appeal's ruling, which had reversed a High Court decision that held that unsegregated customers weren't entitled to participate in the customer money pool, but would be subject to other tracing remedies available under UK law.

According to SRZ, the decision likely will result in the dilution of the segregated clients' expected distributions from the customer money pool and will lead to increased uncertainty - and potentially litigation - over exactly which (previously unsegregated) funds should be added to the customer money pool and precisely who is entitled to a share of the pool. "The decision represents a positive development for the estate of the US broker-dealer, Lehman Brothers Inc, whose liquidation trustee has been urging client money protection for property of LBI customers whether properly segregated or not," the law firm notes. "It is also a welcomed decision for certain customers of MF Global UK, who claim that their funds should have been, but were not, properly segregated prior to the commencement of that firm's special administration proceedings."

Structured Finance

Credit hedge funds: not shadow banks

AIMA has published a report outlining the reasons why credit hedge funds should not be considered part of the 'shadow banking' sector. The move comes amid heightened debate about what constitutes a 'shadow bank', given the Financial Stability Board's mandate to develop recommendations to strengthen the oversight and regulation of the shadow banking system.

"Credit hedge funds - and hedge funds in general - do not operate in the shadows," comments AIMA ceo Andrew Baker. "Managers are extensively regulated, are subject to reporting requirements and do not engage in any significant sense in credit, liquidity or maturity transformation, so their activity is not 'bank-like'. Credit hedge funds do not belong in the same category as banks, let alone 'shadow banks'."

Credit hedge funds are part of the asset management community and exist to serve pension funds, endowments, unions, family offices and other investors, AIMA states.

The report highlights crucial differences between the key functions of a traditional bank and those of credit hedge funds and other non-bank financial institutions. It notes that credit hedge funds do not take deposits, do not offer daily liquidity nor otherwise hold themselves out as guaranteeing the return of the invested principal.

Additionally, credit hedge funds manage their liquidity profiles by agreeing investor redemption terms that correspond to the liquidity profile of the underlying investments. Crucially, they do not benefit from implicit or explicit taxpayer guarantees.

The report also attempts to quantify the extent of hedge fund credit transformation activity in order to understand whether it should be accounted for in any systemic risk concerns. It notes that policymakers might consider select hedge funds as contributors to maturity/credit transformation because of direct lending strategies or through the chain of credit intermediation in purchasing ABS on behalf of their clients. While such transformations may occur in the small subset of credit hedge funds involved in direct lending, special situation 'loan to own' strategies or through ABS positions, credit hedge funds only account for approximately 1% of non-bank credit intermediaries as indicated by the FSA.

Further, it is estimated that direct lending activities and ABS only account for a small subset of this total. Legacy assets in European ABS are held by a variety of non-bank credit intermediaries, of which hedge funds make up a small percentage.

In addition, since 2008, the degree to which credit hedge funds have employed direct lending as an investment strategy has diminished considerably. Most funds that are still involved in this practice are structured as private equity vehicles rather than hedge funds to ensure that the liquidity profile of their underlying assets matches that of the relevant finance vehicle. AIMA estimates that only a small number of large alternative investment firms have small private equity style funds.

CDO

ABS CDO auction due

An auction is set to be conducted on 20 March in respect of Capital Guardian ABS CDO I collateral. However, the sale will only be consummated if the trustee receives two or more bids to purchase all of the securities.

CDS

Greek questions decided

ISDA's EMEA Determinations Committee has unanimously decided that a credit event has not occurred in respect of the two questions relating to the Hellenic Republic restructuring.

The first submitted question asked whether the holders of Greek law bonds had been subordinated to the ECB and certain NCBs whose bonds were acquired by the Hellenic Republic prior to the implementation of new Greek legislation such that such subordination constitutes a restructuring credit event. The EMEA DC unanimously determined that the specific fact pattern referred to in this question does not satisfy either limb of the definition of subordination as set out in the ISDA 2003 Credit Derivatives Definitions and therefore a restructuring credit event has not occurred under Section 4.7(a) of the 2003 Definitions.

The second submitted question asked whether there had been any agreement between the Hellenic Republic and the holders of private Greek debt that constitutes a restructuring credit event. The EMEA DC determined that it had not received any evidence of an agreement that meets the requirements of Section 4.7(a) of the 2003 Definitions and therefore based on the facts available to it, the EMEA DC unanimously determined that a restructuring credit event has not occurred.

The EMEA DC noted, however, that the situation in the Hellenic Republic is still evolving and today's EMEA DC decisions do not affect the right or ability of market participants to submit further questions to the EMEA DC relating to the Hellenic Republic nor is it an expression of the EMEA DC's view as to whether a credit event could occur at a later date, in each case, as further facts come to light.

CDS

Muni CDS protocol launched

ISDA has launched the 2012 US Municipal Reference Entity CDS Protocol. The purpose of the Protocol is to make similar changes to US municipal CDS transactions to those made to corporate and sovereign CDS under the 2009 'big bang' protocol (see SCI 15 April 2009). It is intended to align the US municipal CDS market with the corporate and sovereign CDS markets.

The protocol will incorporate auction settlement terms into standard documentation for new and existing US municipal CDS trades. The changes include the addition of the concept of auction settlement as a settlement method, eliminating the need for physical settlement of US municipal CDS transactions.

The resolutions of the ISDA Credit Derivatives Determinations Committee for the Americas have also been incorporated into the terms of standard US municipal CDS contracts. Finally, credit event and succession event 'look back' provisions (or backstop dates) have been added that institute a common standard effective date for US municipal CDS transactions.

The adherence period for the protocol will run until 2 April, with the market practice changes set out in the protocol taking effect on 3 April. The protocol is open to ISDA members and non-members alike.

CDS

Elpida credit event called

ISDA's Japan Credit Derivatives Determinations Committee has resolved that a bankruptcy credit event occurred in respect of Elpida Memory Inc. An auction for outstanding CDS transactions will be held in due course.

CDS

OTC software development kit offered

Numerix has announced the availability of its LiquidAsset SDK (Software Development Kit). The offering is designed to scale as an institution's modeling or investment requirements grow and integrate Numerix's market standard analytics into the institution's own system or that of a third party using a C++ interface. C# and Java interfaces are due to be added to the service in the coming months.

As part of the new release, LiquidAsset SDK features the Numerix Function Reference that provides comprehensive documentation for all trade types, including pricing methodology, model and calibration. Instrument support is available for the most commonly traded OTC derivatives, including CDS.

CDS

Greek debt swap decision awaited

Private investors decide tomorrow (8 March) whether to accept the Greek debt swap proposal for their existing government bonds, with the results due to be discussed via teleconference the next day. Following this, ISDA's EMEA Determinations Committee is expected to be asked to determine once again whether a restructuring credit event has occurred.

But the DC may be asked to consider a further Greek credit event in connection with the €14.5bn note coming due on 20 March, according to Michael Kondas, associate director of fixed income indices at S&P Indices. If the note is not paid in full, a failure to pay could trigger the CDS contracts.

Greek CDS currently trade on a percentage upfront basis, with the base coupon of 100 running for the life of the trade. CMA Datavision shows that the mid upfront percentage peaked at 75% on 2 March for five-year protection on Greek bonds.

"This implies that it costs US$750,000 on settlement date and US$10,000 annually to insure US$1m in Greek debt for five years. This also implies that market participants are assigning a probability of default for Greek bonds well over 90%," Kondas explains.

CDS

CDS spreads firming

Fitch Solutions reports that global CDS liquidity continued to increase over the last month to 2 March, with CDS on developed-market sovereigns continuing to trade with the most liquidity.

"Sovereign CDS liquidity is being driven by rising market uncertainty over Greek CDS triggers for a credit event and the potential wider impact of this for other peripheral eurozone CDS contracts," comments Diana Allmendinger, director at Fitch Solutions in New York.

Fitch's suite of CDS indices also show that spreads firmed across all regions and sectors over the period, buoyed by some encouraging economic reports. The last month has also seen a noticeable tightening in the spread differential between financial institutions and industrial companies, with markets currently pricing in less credit risk for financial institutions.

"Credit protection on debt issued by financials is now pricing, on average, at a 28% premium to CDS on non-financial corporate - just outperforming the one-year moving average for the first time since July 2011. It remains to be seen whether this trend will prove sustainable, as concerns surrounding changing regulatory oversight for financial institutions and the sector's exposure to sovereign debt are likely to continue to weigh on market sentiment in the coming months," adds Allmendinger.

CLOs

Spanish SME delinquencies on the rise

Fitch notes in its latest version of SME CLO Compare that there has been a significant increase in the 90+ delinquency rates for Spanish SME transactions. The 90+ delinquency index now stands at its highest level of 3.2%, based on outstanding portfolio balance, having risen fairly rapidly from 2% at the beginning of last year.

Default levels are still in line with Fitch's base-case expectations, but are likely to increase over the medium term, given the relatively high volume of impairments in the delinquency pipeline. The agency expects portfolios with high real estate concentration to be particularly vulnerable to a further wave of defaults, as recovery expectations on such portfolios are low due to the substantial decline in property prices and the macroeconomic dynamics in Spain.

At the same time, current defaults have been rising continuously, pointing to the low level of workouts that banks in Spain are currently carrying out. This is also reflected in low realised recoveries across the board and, in particular, seasoned portfolios backed by a high degree of mortgage collateral and low LTVs.

CMBS

'Quiet' month ahead for Euro CMBS maturities

Fitch says in its latest European CMBS bulletin that like February, March 2012 will be a quiet month for scheduled loan maturities.

Only one loan is due to mature, The Zeloof Partnership, securitised in Victoria Funding (EMC-III) and serviced by Capita Asset Services (Ireland). The servicer has indicated that the borrower's intention is to repay the loan in full at maturity.

Only ten of the 32 loans that were originally scheduled to mature in 2012 have repaid at maturity, Fitch says. This means a total debt of €13.5bn is in workout, in standstill or has been extended since the onset of the credit crisis.

"This statistic does not bode well for the April 2012 maturities. Although February and March have only three loans scheduled to mature between them, significant volumes become due in April (€2.3bn across 24 loans), a similar amount to January," Fitch warns.

CMBS

Multifamily contradiction highlighted

An apparent contradiction in US multifamily CMBS performance has emerged over the last few years, according to Fitch.

"As an asset class, multifamily has been one of the fastest types of commercial property to bounce back from the effects of the 'Great Recession'. Occupancies have increased, rents have begun to increase and concessions such as free rent have decreased. Yet, at the same time, multifamily has been one of the worst performing property types in terms of delinquencies in Fitch-rated CMBS," the rating agency observes.

Fitch says that one theory for the contradiction is that multifamily housing in CMBS transactions should be performing inversely to residential housing in the same geographic area. "Multifamily performance should be stronger where residential performance is weaker and vice versa. As people lose their house to foreclosure etc, one of their options is moving into rental housing, traditionally provided by multifamily apartment units," it says.

The agency cites the example of New York City: "Despite being the second-best performing city in the Case-Shiller index, the city has four big problems in multifamily CMBS: Stuyvesant Town/Peter Cooper, The Belnord, The Savoy and Riverton - the underperforming loans of which total US$3.6bn."

CMBS

CMBS delinquency rate falls in February

The Trepp delinquency rate for US CRE loans in CMBS fell by 15bp in February to 9.37%. The value of delinquent loans is now U$56.4bn.

In February, the value of loans being resolved with losses was under US$1bn and, while significantly less than the US$1.6bn in January, contributed about 15bp of downward pressure on the delinquency rate. The rate was pushed down further by the effects of loans curing (60bp) and new CMBS issuance and loans paying off in full (3bp combined), while newly delinquent loans put 63bp of upward pressure on the rate.

Some of the overall improvement in the February delinquency rate, however, can be attributed to a change in status of approximately US$900m of loans. These loans are past their balloon date but are current in interest payments and thus no longer classify as delinquent. Had these loans factored into the overall delinquency rate, the rate would have been 10.57% - up by 22bp for the month.

"The resolution of these performing, but past maturity loans will likely determine whether the delinquency rate rises or falls over the next 12 months," says Manus Clancy, senior md at Trepp. "The rate should remain fairly stable if they are modified or refinanced, but watch out if these loans slide into foreclosure."

With respect to property types, the multifamily delinquency rate fell by 74bp in February, yet remains the worst performing major property type at 14.65%. Industrial continued to be the second-worst performing sector in February, with its delinquency rate up by 23bp to 12.37%.

The lodging delinquency rate finished the month down 104bp at 11.05%, an improvement of 350bp within the last 12 months, while the office delinquency rate rose to 9.04% - an increase of 14bp. Despite a modest 12bp delinquency rate increase to 8%, retail remained the best performing property type.

CMBS

WOBA dispute settled

Gagfah and the City of Dresden have agreed an amicable settlement to end the legal dispute over the WOBA loan securitised in Windermere IX and DECO 14 - Pan Europe 5. The settlement is subject to approval by the City Council of Dresden and clearance by the City's legal supervision authority, which is expected to be finalised by 15 March.

The settlement agreement provides for the withdrawal of all lawsuits and the mutual waiver of all claims made in connection with the litigation. It has been agreed that in the future disputes between the parties will be handled through an extrajudicial settlement process and a cure period will be employed to avoid contractual penalties.

Furthermore, the City of Dresden and the WOBA companies have agreed on several changes to the social protection provisions - the Social Charter - of the WOBA Privatisation Agreement. Certain defined social charter protection provisions will be extended by five years until April 2021.

The current contractual annual minimum repair and maintenance investments for the properties of the WOBA companies will be raised from €5 per square meter to €7.56 per square meter (net). The City's occupation rights will also be raised by 2,000 to 10,000.

In addition, the City of Dresden will receive nine annual payments for the period between 2012 and 2020 of €4m per year, of which 40% will be invested in social projects that are to benefit Gagfah's tenants in Dresden. The WOBA companies will also reimburse the City of Dresden for the City's litigation costs up to an amount of €4m.

Gagfah says it had already made provisions for litigation expenses of €8m as of 30 September 2011. The asset strategy of the WOBA companies will not be impacted by the settlement, the firm says.

Risk Management

FVA supported

Quantifi has announced the latest release of its pricing and risk analysis software, Quantifi Version 10.2. The firm says the release delivers significant enhancements across its entire product range, including the latest counterparty risk innovations, expanded intra-day risk management, broader asset coverage and simplified data management capabilities.

Rohan Douglas, Quantifi ceo, comments: "Funding is a key component in analysing the exposures and profitability of a trade. Funding valuation adjustments (FVA) is the latest market innovation that measures this cost for collateralised, uncollateralised and centrally cleared trades. Our support for FVA continues a long track record of partnering with clients to deliver first-to-market support for the latest market innovations."

V10.2 also comprises additional improvements to counterparty risk management, including CVA VaR, AMC pricing of exotics and improved marginal pricing tools.

Risk Management

CVA focus

FINCAD has launched F3 2.2. The firm says its new release addresses market needs around the effects of counterparty credit risk on valuation, whether via the impact of collateral on curve building in a multi-currency framework or via CVA. It also extends the ability to build discount curves and forward curves in multiple currencies, consistent with the rate payable on any collateral, as well as with the cross-currency swap market.

RMBS

European housing recovery predicted next year

S&P anticipates a significant recovery in European housing markets in 2013, as the macroeconomic situation improves and unemployment rates start to fall. The agency believes this will boost both consumer demand and valuations for residential property.

"In our view, the UK, Germany and France remain the largest and most attractive developed housing markets, while Russia is the most prominent emerging market," comments S&P credit analyst Anna Overton.

Mortgage lending activity continued to slow in Q411, according to the ECB, with a 29% decline compared with an 18% decline in the preceding quarter. Nevertheless, house prices remain quite high relative to incomes in France and the UK, with the price volatility of the past five years mainly reflecting these high levels. By contrast, house prices in Germany have remained stable, due to generally lower house price-to-income ratios.

"We maintain a stable outlook for rated homebuilders in Europe," adds Overton. "That's because they are currently well capitalised to withstand mid-term risks relating to consumer confidence and the availability of consumer credit. We take this into account in our rating methodology, as well as the risk that working capital can become volatile over long operating cycles."

S&P believes that companies in this sector are likely to become active in tapping the debt capital markets, as bank lending across Europe declines. This should help smooth out the volatility in working capital, according to the agency.

Although S&P expects a renewed recession in Europe this year, the agency believes it will be a mild one, with a gradual return to growth - thanks to rising consumer demand in emerging markets, resilient demand in the developed countries and a restoration of investor confidence. Its baseline forecast is for flat growth in the eurozone as a whole, with 0.5% growth in France, 0.6% in Germany and 0.5% in the UK.

RMBS

EMEA RMBS losses remain low

Only a single EMEA RMBS transaction has realised losses to date, according to Fitch, with total credit losses in the sector expected to remain low. Transaction performance varies across vintages and jurisdictions, but the dominant prime UK and Dutch RMBS sectors aren't expected to generate any losses.

"Credit losses for EMEA RMBS transactions - both realised and expected - are far below the average for structured finance as a whole," says Andrew Currie, md in Fitch's EMEA structured finance team. "The Fitch-rated EMEA RMBS tranches outstanding at the onset of the credit crisis have realised principal losses of only 0.02% of their original balance of €470bn. Even after including Fitch's expectation of future credit losses, the proportion remains low at 0.7%."

Losses result not only from the underperformance of the underlying residential mortgages, but also from counterparty-related issues. The latter drive approximately 40% of Fitch's loss expectations.

Losses on EMEA RMBS transactions have been particularly exacerbated by the Eurosail series, which lost currency swaps following the default of Lehman Brothers (SCI passim). Through a combination of asset underperformance and counterparty issues, these transactions alone contribute over 40% of all losses expected on EMEA RMBS and all of the losses expected on tranches rated triple-A in July 2007. Excluding the Eurosail series results in lower total EMEA RMBS losses of 0.4%.

"Performance has varied significantly between jurisdictions and loan types," says Gioia Dominedo, senior director in Fitch's EMEA structured finance team. "In particular, UK non-conforming and Spanish transactions account for nearly 90% of Fitch's overall loss expectation for EMEA RMBS. In contrast, Fitch does not expect losses on any of the prime UK or Dutch RMBS tranches that were outstanding in July 2007."

Across jurisdictions, Fitch's loss expectations show a strong vintage effect, as transactions backed by mortgages originated at or near the peak of the market are most exposed to weaker origination standards, larger house price declines and consequently losses. As a result, the total loss across EMEA RMBS is highest for 2007-vintage transactions (at 2%). The vintage effect is particularly pronounced in Spain, due to the severity of the housing market crash, with a total loss of 5.0% for 2007-vintage Spanish RMBS transactions.

RMBS

Call for targeted principal reductions

The benefits that principal reductions may offer need to be weighed against the potential for an increase in moral hazard risk, which may - over time - precipitate higher mortgage defaults, according to Fitch.

The State Attorneys General recently-announced settlement with major mortgage servicers includes an agreement to offer principal reductions to help struggling borrowers keep their home (SCI passim). On the surface, this seems to be a sensible approach as loan modifications with principal reductions have performed better than other types of modifications, Fitch notes. However, if not implemented carefully, a wide-ranging principal reduction programme could actually increase voluntary defaults.

A large number of deeply underwater prime borrowers are currently performing, as are over 50% of alt-A and subprime borrowers. While equity remains a key performance driver in these sectors, other risk factors are contributing to defaults that cannot be addressed by principal forgiveness. This is most evidenced by the number of borrowers with positive equity that are having trouble keeping up with the mortgage payment.

While principal reduction mods perform better than those with a rate or payment cut, re-defaults among those with deep balance cuts still remain north of 20%, Fitch says. Most mortgage re-defaults arise from borrowers being sizably weighed down with non-mortgage debt after their loan has already been modified.

To make the mod payment sustainable, servicers may begin using back-end debt ratios to determine the principal balance cut. Such an action may effectively force the first lien investor to subsidise the repayment of the borrower's consumer debt, thus increasing the potential incidence of defaults among over-leveraged or marginally underwater borrowers looking to qualify for such a reduction.

If applied judiciously, Fitch believes that a targeted plan that determines borrower eligibility for principal reduction would be effective if the mortgage payment decrease is limited to a reasonable payment-to-income ratio. This approach would be more effective in keeping at-risk borrowers in the homes without significantly increasing moral hazard risk, the agency concludes.

RMBS

Servicer 'action plans' released

The US Federal Reserve has released action plans for supervised financial institutions to correct deficiencies in residential mortgage loan servicing and foreclosure processing. It also issued engagement letters between supervised financial institutions and independent consultants retained by the firms to review foreclosures that were in process in 2009 and 2010.

The action plans are required by formal enforcement actions issued by the Federal Reserve last year (SCI passim). The enforcement actions direct mortgage loan servicers regulated by the Federal Reserve to submit acceptable plans that describe how the institutions will strengthen communications with borrowers by providing each borrower the name of a primary point of contact at the servicer; establish limits on foreclosures where loan modifications have been approved; establish robust, third-party vendor controls; and strengthen compliance programmes. Further, they require the parent holding companies of mortgage servicers to submit acceptable plans that describe how the companies will improve oversight of servicing and foreclosure processing conducted by bank and non-bank subsidiaries, as well as provide appropriate remediation to borrowers who suffered financial injury as a result of errors by the servicers.

The engagement letters describe the procedures that will be followed by the independent consultants in reviewing servicers' foreclosure files to determine whether borrowers suffered financial injury as a result of servicer error.

RMBS

Dutch RMBS restructured

NIBC has restructured its Sound II RMBS, effective as of 2 March. Moody's confirms that the restructuring will not result in a reduction or withdrawal of the current ratings on the notes.

Under the restructuring, new class S notes have been issued against the partial redemption of the class A notes, increasing the credit enhancement available to senior noteholders from 2.6% to 4.2%. Additionally, the savings mortgage sub-participation arrangements have been standardised, the collection foundation structure has been formalised and the swap counterparty will be allowed to set the mortgage interest rates in certain circumstances.

The €10.4m of new unrated class S notes rank junior to the class A notes, but senior to the class B and C notes. The issuance proceeds from the class S notes are used to partially redeem the class A notes on a pro-rata basis, although the total note balance remains unaffected.

RMBS

Housing finance framework unveiled

The National Association of Home Builders (NAHB) has put forward what it describes as a comprehensive framework for US housing finance reform that would transition Fannie Mae and Freddie Mac to a new mortgage securitisation system for single-family and multifamily conventional mortgages. It says the system must include: private, federal and state sources of housing capital; offer a reasonable menu of sound mortgage products that is governed by prudent underwriting standards and adequate oversight and regulation; and provide a federal backstop to ensure that 30-year fixed-rate mortgages are available at reasonable interest rates and terms.

As part of the framework, Fannie Mae and Freddie Mac would be replaced with a new securitisation system for conventional mortgages backed by private capital and a privately funded federal MBS fund must be done in an orderly fashion over time. During this phase-in period, Fannie Mae and Freddie Mac would remain operational until the alternative system is fully functioning.

Under this scenario, the GSEs would be gradually replaced by private housing finance entities (HFEs) that would be chartered to purchase single-family and multifamily mortgages from loan originators and package the loans into securities for sale to investors worldwide. The federal government would guarantee the securities, not the mortgages.

The HFEs would only purchase mortgages that are well understood and have reasonable risk characteristics, such as standard 30-year fixed-rate loans. The HFEs would operate under the oversight of a strong independent regulatory agency to ensure all aspects of safety and soundness. NAHB believes the 12 regional Federal Home Loan Banks could serve as HFEs.

Federal support to the conventional mortgage of the future would consist of a privately funded insurance fund, where the government would guarantee its solvency in a manner similar to the FDIC's backing of the fund that insures savings deposits. Under this system, mortgage originators would pay premiums to capitalise the insurance fund, which would cover losses and ensure full payment to investors. The federal government would be required to pay investors only if the insurance fund was depleted.

NAHB's housing finance reform blueprint also proposes to: restart a carefully regulated fully private MBS system; continue the role of the federal government housing agencies; enhance the position of state and local housing finance agencies (HFAs) as a source of housing funds; and repair flaws that produced the housing boom and bust. To this end, the association believes that reforms are needed in terms of rating MBS and it is supporting the development of new securities rating agencies that would use criteria developed by securities investors to assure objective evaluations and avoid conflicts of interest.

Further, the NAHB notes that it is important to close the gaps in standards and oversight that allowed and facilitated the improper and illegal activities in financial and mortgage markets. This should be done by: undertaking a series of comprehensive reforms to ensure sound mortgage products and prudent underwriting; requiring sound mortgage securities structures and full transparency for investors; and imposing adequate oversight on previously unregulated segments of the mortgage and financial markets.

RMBS

Fannie loan-level data released

Fannie Mae has released loan-level data for its newly issued single-family MBS as part of its loan-level disclosures initiative.

"We believe that disclosing loan-level data is an important step towards meeting our investors' desire for enhanced transparency," comments Laura Simmons, vp MBS disclosure policy and operations. "In subsequent releases, we expect to be able to provide additional data elements in the loan-level at issuance file and provide monthly updates to the loan-level data."

The loan-level data files are hosted on the newly released enhanced PoolTalk, Fannie Mae's online disclosure application.