Contents

CMBS

Multi variety

Diverse German multifamily CMBS outcomes expected

The German multifamily sector accounts for about 20% of all securitised assets in European CMBS. Deal performance in the sector has been mixed, with noteholders frequently facing extensions and sometimes losses.

Geography is a highly significant factor in German multifamily CMBS, as property location is often a major driver in loan performance. Aside from a few notable exceptions, East German loans have performed far more poorly than those for properties in West Germany.

Patrizia Pirinoli, CMBS analyst at Goldstar Research, comments: "East German loans are performing worse than West German loans and therefore there is the chance of a loss which cannot be discounted. However, many of the larger loans are likely to payoff with some extensions."

Titan Europe 2006-2 provides an interesting insight into the mixed fortunes within the sector. All four of the remaining loans underlying the CMBS have passed their maturity date or are in work-out. The Labrador portfolio and Velvet portfolio loans have defaulted, while the Petrus portfolio and Margaux portfolio loans have been extended to April and July of this year.

Pirinoli does not believe further extensions will be possible for the Margaux or Petrus loans. Without noteholder involvement, CMBS analysts at Barclays Capital agree that there is not much scope to extend the loans.

The servicer and special servicer are not allowed to extend the loan maturity beyond three years before the CMBS maturity date, which is January 2016. Without noteholder consent through an extraordinary resolution, therefore, the latest extended loan maturity date would be January 2013.

In the case of either an extension or a loan default, the Barcap analysts expect principal repayment to occur in 2014-2015. The senior-most classes are expected to receive full repayment between 2013 and mid-2015.

Considering this, the analysts believe the senior notes are very attractive, particularly the class A notes. They comment: "DM is 700bp, which is higher than the extension-adjusted DMs of 200bp-450bp for other German multifamily CMBS senior classes."

The class E noteholders in Titan Europe 2006-2 are expected to suffer a small loss, while classes F, G, H and J are expected to suffer a full loss.

Another deal where Pirinoli sees problems ahead is Titan 2006-5. "This is the second deal that we think is really in trouble. The DIVA multifamily portfolio loan underlying Titan 2006-5 has defaulted. The LTV is over 100% and the DSCR is below 1x. The bond investors are going to be looking at taking a loss on both of these Titan deals," she says.

As for the prospective outcomes of other German multifamily CMBS deals, much of it comes back down to location. Pirinoli explains: "With Eastern German multifamily there are two issues. One is refinancing and the other is credit."

She continues: "With the West German assets, if the LTV is high, the problem is normally refinancing. With East German multifamily, the issue is with credit as much as refinancing because of the quality of the assets."

For West German assets, the issue of refinancing is paramount. It is hard to refinance in the current climate, especially for large loans. With that in mind, the size of the loan portfolio underlying GRAND could present a serious challenge (SCI passim).

GRAND is the largest German multifamily transaction, with more than twice the outstanding balance of the next largest transaction, GRF 2006-1. Some extension is expected, but Pirinoli warns that refinancing will not be easy.

"GRAND has €4.5bn outstanding at the moment. LTV is 74%, which is not bad, and DSCR is 1.23x - which, again, is quite good. However, the loan maturity is up in January 2013 and the sheer size is going to be a problem," she says.

The proximity of the loan maturity date, with legal maturity just two years later, means that refinancing GRAND is a pressing matter. Ultimately Pirinoli expects that a default will be avoided and the deal will pay off, but certain steps need to be taken for that to happen.

She explains: "Refinancing will involve some changes in the structure. There will have to be a change in the legal structure to allow the portfolio to be refinanced in small pieces rather than in a larger size. There will have to be property disposals as well."

Such actions should leave a reasonable outstanding amount that is small enough to be refinanced in one piece and in full. The junior tranches are not expected to take a loss because there is a lot of equity in the transaction, although they may see sizable extensions.

Other large transactions - such as Immeo 2 (€537m outstanding), Quokka Finance (€564m) and GRF 2006-1 (€2.169bn) - are largely expected to pay off. Despite being backed entirely by East German properties, SMPER 2006-1 - a synthetic securitisation originated by Eurohypo - has seen super-senior bonds paying off steadily and limited loan defaults are not expected to have a strong impact on the transaction.

Eclipse 2005-3 (€583m outstanding) is also performing reasonably well. The Bremische, GAB, GEWG and KWG loans are all expected to payoff - although the BBG loan, due to mature in October, may require an extension.

Pirinoli says: "The BBG loan has the highest LTV in the pool and might be extended. The other underlying loans are looking in better shape."

German multifamily CMBS has almost €10bn of assets outstanding. Although some are facing extensions and losses, the larger transactions are among the most liquid in the market. Outcomes will be mixed, but the opportunities involved are also numerous.

JL

RMBS

Forbearance fears

European principal forgiveness schemes unnerve investors

Ireland and Spain are set to introduce new debt forgiveness legislation in the coming months that will not only impact their domestic mortgage markets, but may also have ramifications for the associated RMBS. Investors are keeping a close eye on developments, particularly with regards to whether the forbearance measures become compulsory.

"Potential debt forgiveness programmes in Ireland and Spain are making investors nervous, particularly when looking at mezzanine tranches of securitisations," says Peter Nowell, head of ABS trading at BNP Paribas. "A lot of mezz RMBS deals in Ireland and Spain are already trading at very distressed prices because they are seeing losses in the underlying deals approaching the attachment point for these bonds: anything that makes losses worse, including any degree of principal forgiveness, will wipe them out quite quickly."

The Spanish government announced in late February that it was proposing a 'code of good practice' aimed at helping families struggling with mortgage repayments to stay in their houses and clear some of their debt. While the proposals are still to be ratified, the government's main plan would involve the handing-over of properties to lenders in order to cancel debts. It is understood that the code would prevent banks from reclaiming additional money from mortgage borrowers, especially where their major asset is their home, and would apply to families with few assets and where no family member is working.

The Irish government's proposed new Personal Insolvency Bill, meanwhile, is expected to provide for some debt forgiveness for mortgages borrowers struggling with other debts under a Personal Insolvency Arrangement (PIA), without them being declared bankrupt or leaving their homes. The prevalence of debt forgiveness would most likely depend on the stance taken by the Personal Insolvency Trustee charged with drafting the PIA, and on creditors, who would have the right to reject it.

Investors may be heartened by developments in the US, however, where forbearance has been a hot-button issue for the past three years (SCI passim) and has seen a number of proposals on debt forgiveness. "At the end of the day, in the US - where problems are even worse than in Europe on assets such as sub-prime loans - the US government has not forced through compulsory principal forgiveness on any mortgages," says Nowell. "It has all been voluntary schemes or encouraging banks to waive principal on mortgages that they still hold on balance sheet, rather than forcing it across the entire asset class, which would lead to losses on mortgages that that bank had sold years ago and are now merely servicing."

He adds: "If the US won't force principal forgiveness measures through, do we really think that Ireland and Spain will force through losses on assets that are no longer held by banks? I don't know. It's a fear, but I don't think anyone wants to be the first to do it."

Securitisation strategists at RBS suggest that the Spanish government will likely pressure domestic banks into adopting the code of practice, which should stem popular discontent at the number of evictions currently taking place. However, they also believe it is unlikely that the Spanish government will adopt a blanket mortgage debt forgiveness for defaulted borrowers.

Moody's views the Irish proposal as credit negative for Irish RMBS because many mortgage loans will be written down and many borrowers will become discouraged from maintaining their mortgage loan repayments. The rating agency estimates that a quarter of all Irish mortgage debt is susceptible to a write-down under the proposal.

"As it is just the draft general scheme of the proposed Irish Personal Insolvency Bill that has been published, it is really too early to say what the effect on Irish RMBS will be," says Conor Houlihan, partner at Dillon Eustace. "Even without the debt forgiveness measures in the proposed legislation, I think the general expectation in terms of Irish mortgage performance is that the level of defaults will increase."

He continues: "As such, in some respects the proposed Personal Insolvency Bill may be a welcome development if it offers a formal, non-judicial process for resolving distressed mortgages. If the process is designed and implemented correctly, it should provide an alternative for those debtors who can't - as opposed to won't - pay, while ensuring the best possible recovery for the lender."

Houlihan says it does not currently appear that lenders will be under an obligation to accept debt forgiveness in any particular case, but to do so may well be the best option in many situations, where the alternatives of personal bankruptcy and/or enforcement action are not realistic or attractive. "The attitudes and behaviour of borrowers and lenders once this new regime is in place will be an important determinant in terms of assessing the impact of the legislation on investments in Irish mortgages, whether through RMBS or otherwise," he observes.

Fitch, meanwhile, notes the precise impact of debt forgiveness on Irish RMBS transactions remains highly uncertain and echoes that it will ultimately depend on how it affects lender and borrower behaviour and how any resulting increase in losses affects the structural workings of transactions. "If debt forgiveness were approved and the interest collected subsequently fell, this could lead to reserve fund draws to cover not just debt write-offs but interest payments on junior notes, potentially decreasing credit enhancement," says the rating agency.

It adds, however, that there is very little clarity at present on this structural impact. For example, it is not clear when lenders, servicers and the operators of RMBS transactions would consider the affected mortgage debt to be written off, particularly as creditors would remain entitled to proceeds that might arise from any subsequent increase in house prices.

"A decision to write down the full amount at the point a PIA is entered into could have a very different impact with regard to reserve fund draws and excess spread leakage than a decision to delay a write down," Fitch explains.

The Irish government intends to publish the Personal Insolvency Bill in full by the end of April, while the Spanish proposals remain under consideration. Greece and Italy are also said to be exploring whether to introduce forbearance measures.

"Clearly, we have not seen the end of this," the RBS analysts conclude. "Forbearance measures of different kinds are on the agenda of several countries and are only likely to intensify if the housing crisis continues."

AC

RMBS

Dealers drive RMBS prices up

European primary RMBS issuance may have been limited lately, but spreads in the secondary market have tightened considerably. Dealers have been driving secondary prices up and one trader believes that spreads may tighten even further.

The trader is very positive about the secondary market and says the tone is "really positive". He notes: "Dealers before were complaining about lack of supply, but they never bid the prices up. That has now changed a bit and that is a good thing."

He continues: "Storm is a solid benchmark for the market. The four- or five-year term has been bid up from 150bp to around 130bp or 135bp. There is still a way to go, but it is definitely improving."

"The shorter ones up to two years, inside LTRO, can easily go sub-100bp. For Storm, it is firmly below 100bp," he adds.

What the trader would ideally like to see is more sellers entering the market. Supply at the moment is being dominated by bid-lists.

"We are still seeing page after page after page of bids and only a handful of offers. It is similar in other asset classes too. There has been a lot of BWIC activity and that is where much of the supply is coming from," says the trader.

He continues: "Unlike a couple of years ago, there are not many forced sellers left. There are a couple of institutions and a couple of Northern European bad banks that are starting to offload assets in somewhat better markets. Execution there is pretty good, albeit with heavy discounts on an absolute basis."

Primary issuance, however, remains light. The pipeline for new issuance is not very busy and the trader says the level of issuance so far has been disappointing.

"We have only seen two Dutch transactions this year. One would think that now is as good a time as any to issue, but we are not seeing it," the trader says.

He continues: "There was also a small club deal from Friesland Bank, which was a kind of private placement. It was in the news a bit, but did not get much attention. That was done two days before the LTRO, so anybody who bought it could have done a straight carry trade."

Finally, the trader reckons one deal to look out for is ALBA 2012-1, a non-prime UK RMBS in the market at the moment. "As far as the primary market goes, that is all there really is out there right now," he notes.

JL

Structured Finance

SCI Start the Week - 12 March

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

Pipeline
Last week saw four new deals enter the pipeline and remain there on Friday. Banco Santander is in the market with Santander Empresas 11, a €3.392bn SME CDO. The transaction was joined by a US$195m drug royalties CDO from DRI (Drug Royalty 1 series 2012-1), as well as a Sfr300m auto lease ABS from GE Money (Swiss Auto Lease 2012-1) and a UK non-prime RMBS from GMAC RFC (ALBA 2012-1).

Pricings
Like the week before it, last week saw over a dozen prints. The largest deal to price was Domino's whole business securitisation (US$1.575bn Domino's Pizza Master Issuer Series 2012-1).
That was joined by two auto ABS deals (US$1.814bn Ally Auto Receivables Trust 2012-2 and US$500m SMART Series 2012-1US) and two FFELP student loan ABS deals (US$824m SLM Student Loan Trust 2012-2 and US$391.5m Edsouth Indenture No.2). One stranded asset ABS (US$800m AEP Texas Central Transition Funding III) and one heavy equipment ABS (US$642m Volvo Financial Equipment Series 2012-1) were also issued.
In addition, three RMBS deals (€1.067bn Pelican Mortgages 6, €425m Spoleto Mortgages 2011 and €178m Principal Residential Investment Mortgages 1) and a single CMBS (US$1.07bn Morgan Stanley Capital I Trust 2012-C4) hit the market. Finally, the issuance was rounded out by a pair of CLOs (US$510m Carlyle Global Market Strategies CLO 2012-1 and US$413m Madison Park Funding VIII).

Markets
In secondary US ABS trading, spreads continue to grind tighter with every new issue transaction pricing, according to consumer ABS analysts at Barclays Capital. "Investors continue to chase yield, resulting in selling pressure among shorter average life paper in a bid to move into longer paper with incremental spread pick-up. At least some of this selling is related to positioning for new issue transactions," they say.
"Demand for auto and credit card subordinate classes remains high, as these are two of the only sectors in generic consumer ABS that offer compelling spread, in our view. Slightly more off-the-run asset classes, including dealer floorplan, fleet leases, rental fleet and timeshare ABS also continue to trade well, as investors continue to hunt for yield," the Barcap ABS analysts add.
Last week US CMBS pricing held on to gains made the previous week, say CMBS & CRE analysts at Wells Fargo Securities, with on-the-run 30% ten-year paper changing hands at 105bp over swaps. On-the-run triple-B paper at 550bp is 175bp tighter from 1 January levels, while A4 bonds from the 2007 vintage are trading at a range of 155bp-220bp over swaps depending on the credit quality.
Meanwhile, Deutsche Bank CRE debt analysts say that the European CMBS market picked back up again last week, with trading volumes tripling from the prior week and now back in line with average volumes from earlier in the year. "Execution continues to remain strong and we saw some banks selling mezzanine classes, but that supply was easily absorbed by fast money. The €12.7m block of GRND 1 As traded in the low-mid 90s on Monday's list," they report.
In the US RMBS market non-agency cash prices did not display any up-down moves and were flat on the week, according to residential credit analysts at Barclays Capital. "Synthetic indices fell along with the broader market, but lagged in the recovery, with the ABX 07 triple-A indices down 1-2 points week on week and the PrimeX indices lower by 0.5 point over the same timeframe," they add.
In secondary CDOs, JPMorgan CLO analysts say that after February's record US$5.8bn BWIC volume, March is already running at a US$3.7bn pace. On the week spreads moved slightly tighter or stayed flat in the US, with double-As and above coming in 5bp and no week-on-week change lower in the capital stack. In European CLOs triple-As were unmoved but double-As, single-As and triple-Bs tightened by 25bp, 75bp and 50bp respectively.

Deal news
• Substantial progress has been made in discussions between Deutsche Annington (DAIG) and the ad hoc noteholder group over restructuring the GRAND CMBS. A plan to extend the transaction through a solvent scheme of arrangement is "near finality" and is expected to be proposed to all noteholders in the coming weeks.
• Empirasign has filed a successful Freedom of Information Act request and obtained the contents of the secret auction of Maiden Lane II securities that took place on 19 January. In a highly unusual move, participants in this auction were required to sign a non-disclosure agreement to keep the list contents and execution prices confidential for one year.
• 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.
• 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.
• 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 UK Environment Agency has put the South East of England on drought status, with reservoir levels in the region already 20% lower than normal. To help fund additional capital expenditure - both to mitigate the impact of the drought and to manage long-term operating costs - a number of water companies are expected to tap the securitisation market this year.
• 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.
• The negative rating outlooks for many banks that serve as trustees on CLOs raises the possibility that at some point certain counterparties 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.
• 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.
• Prudential Mortgage Capital Company has transferred to Prudential Investment Management its duties and responsibilities under the collateral management and servicing agreements for ROCK 1 - CRE CDO 2006. Moody's has determined that the assignment won't cause the ratings of the notes to be reduced or withdrawn.

Regulatory update
• A new marked-up version of CRD IV has sparked hopes that high quality RMBS will be included as an eligible asset under the liquidity coverage ratio (LCR) after all. A version of the draft directive published in late January contained language that, while initially raising optimism about the prospect, ultimately caused confusion.
• The CFTC has issued under the Dodd-Frank Act its final rules requiring FCMs and derivatives clearing organisations (DCOs) to segregate customer collateral with respect to cleared swaps. The CFTC adopted the legal segregation with operational commingling (LSOC) model, which prohibits FCMs and DCOs from commingling customer collateral with their own funds, but permits FCMs and DCOs to commingle customer collateral in accounts with other cleared swap customers.
• President Obama has announced changes to the FHA streamlined refinance programme, which the market has been expecting for some time. The changes are intended to spur refinancing by exempting borrowers from certain payment requirements.
• A series of higher regional court decisions regarding loan handling fees for German consumer loans could expose securitisations to additional set-off risk. The court rulings invalidate administration fees that were charged to set up a loan. The risk to German ABS transactions is that borrowers will claim this money back by setting off handling fees they have already paid to the lender against loan repayments that have been securitised.

Deals added to the SCI database last week:
Cabela's Credit Card Master Note Trust 2012-1
COMM 2012-LC4
Ford Credit Auto Lease Trust 2012-A
Freddie Mac SPC series K-017
Gracechurch Card Programme Funding series 2012-1
Huntington Auto Trust 2012-1
Hyundai Auto Receivables Trust 2012-A
Mystic Re III 2012-1
Orange Lake Timeshare Trust 2012-A
TruckLease Compartment No. 2
VCL 15

Deals added to the SCI CMBS Loan Events database last week:
CSFB 2005-C5; CSMC 2007-TFL2; ECLIP 2005-2; ECLIP 2007-2; EURO 27; GRND 1; JPMCC 2007-LDP12; LBUBS 2007-C7; MSC 2006-IQ12; NEMUS 2006-2; TITN 2007-3; TITN 2007-CT1; Various (Mills); WBCMT 2006-C27; and WINDM XIV.

Top stories to come in SCI:
Focus on German multifamily CMBS
Impact of principal reduction across European RMBS
US CLO issuance trends

CDS

'Few major surprises' expected in iTraxx roll

The iTraxx family of credit indices is set to roll on 20 March. While new rules introduced by Markit are unlikely to create any major surprises, constituent changes are expected to drive the Main and HiVol tighter and the Crossover index slightly wider.

For the past three rolls, Markit has used a new process that moves the roll away from dealer discretion to a rules-based approach. Citi credit analysts note that new rules related to the Crossover help to strengthen ways of introducing less liquid credits, such as a rule specifying that only issuers/guarantors with €100m minimum debt with maturity of 30 years or less are eligible to be included in the index.

On 20 March three names will leave the iTraxx Main index - Finmeccanica, ArcelorMittal and Banco Popolare. The two industrials will be replaced by Bouygues and Rhodia and Banco Popolare by HSBC. All three replacements are less liquid than their predecessors.

"With a three-name change in the index, we expect a 4bp change in five-year spread level. This can be explained by the 8bp tightening due to compositional change being partially offset by 4bp widening due to roll-up in the index," the Citi analysts note.

The iTraxx Crossover will see four replacements: SAS is leaving the index due to the introduction of the 30-year maturity restriction to the €100m required debt criteria. Smurfit Kappa Funding, Fresenius SE and Clariant are also leaving the index due to not meeting the minimum spread level criteria. They are being replaced by Finmeccanica, ArcelorMittal, Deutsche Lufthansa and Jaguar Land Rover.

The biggest changes are expected for the iTraxx HiVol, with a net expected change to intrinsic of -9bp. Nine names are leaving the index: Finmeccanica, ArcelorMittal, Adecco, Vinci, Anglo American, ENI, Next Plc, PPR and Lanxess. These nine names are set to be replaced by Carrefour, Ericsson, Vivendi, BAE Systems, Cap Gemini, Gecina, Metso, UBM and Unibail-Rodamco.

Banco Popolare will be leaving the iTraxx Financials index - as a result of its exit from the Main - and will be replaced by HSBC. Net expected change to intrinsic for five-year iTraxx Financials Seniors is -9bp, according to Citi.

AC

CMBS

Stale CMBS loans to improve

The balance of stale US CMBS loans - loans in special servicing for longer than 24 months - has tripled over the past year. However, a new report from US CMBS & CRE analysts at Wells Fargo Securities suggests that the trend is likely reverse and that the balance of stale loans should improve over the next 12 months.

At the end of February 2011, the Wells analysts counted US$6.1bn stale loans, but now the balance stands at US$25.6bn. However, they note that flows out of special servicing have outpaced flows in over the past 12 months.

"Loans in special servicing now total US$77.5bn, down 7% from the US$83.7bn special servicing balance at February 2011, according to Intex data. On a monthly basis, we find transfers into special servicing have averaged 172 loans summing to US$2.5bn. Outflows, in turn, have averaged 164 loans summing to US$2.7bn per month, by our estimate," they say.

According to the report, smaller-balance loans are less likely to reach the stale loan category. Measuring by loan count, loans with a balance of US$5m or less make up 36% of the overall special servicing stock but a reduced 26% of the stale subset.

While small-balance loans may be less likely to stagnate in special servicing, the composition of stale loans is weighted toward US$10m-US$50m loans. These loans make up 40% of the stale loan count, compared with 32% of the overall special servicing population.

In terms of asset type, multifamily loans have been more likely to reach stale status, whereas office loans are underrepresented in the category. Apartment loans make up 20% of all loans in special servicing, but account for 31% of stale loans. In contrast, office loans make up 35% of overall special servicing stock, but account for 24% of the stale loan inventory.

The report adds: "The flow data point to a change in trend for these two property groups. For office loans, inflows over the measuring period (US$13bn) exceeded outflows (US$9.8bn). For multifamily, inflows (US$4bn) were less that outflows (US$7.2bn).

A review by vintage indicates that 2006-2008 loans dominate inflows, with loans from these vintages accounting for 70% of inflows. Seasoned loans from the 2005 vintage and earlier represent 47% of outflows.

As may be expected, seasoned loans are more likely to be resolved through payoff or liquidation (74%). For the recent vintages, 44% of servicing exits came through payoffs or liquidations, indicating that more of these loans are likely to be resolved through modifications.

Finally, the report highlights the loans that have been in special servicing the longest. Topping the list is the Sunrise Living Properties Portfolio in GMACC 1998-C1.

The loan transferred to special servicing in October 2001. Subsequently, the borrower filed for bankruptcy in 2002 and confirmed a plan to liquidate the loan properties. Of the original 87 properties, 43 remain in the loan pool.

The Wells analysts conclude: "We believe the proportion of stale loans in special servicing should decline over the next year, as fewer loans roll into this bucket. The effect, however, is not likely to be equally beneficial by property type, loan size and special servicer. Because loss severities are positively correlated to time in special servicing, a decline in stagnant loans may be a positive to recoveries."

MP

CMBS

GRAND plan nears

Substantial progress has been made in discussions between Deutsche Annington (DAIG) and the ad hoc noteholder group over restructuring the GRAND CMBS (SCI passim). A plan to extend the transaction through a solvent scheme of arrangement is "near finality" and is expected to be proposed to all noteholders in the coming weeks.

DAIG reportedly plans to refinance €500m of the deal per year, after splitting the property portfolio into smaller sub-portfolios, and expects an increase in the loan and note margins in return for the debt extension. At present, if the borrower fails to repay the loan at its maturity date in July 2013, only three years will remain to recover full note proceeds (note maturity is in July 2016). But S&P suggests that if current market conditions persist, it could take more than three years to refinance or sell the portfolio, even if it is split into smaller chunks.

Indeed, the agency has taken rating actions on the transaction due to the significant refinance risks associated with the upcoming loan maturity and - given the size of the portfolio - the relatively limited timeframe of three years to repay the loan. S&P has consequently lowered its credit ratings on GRAND's class A and B notes. At the same time, it affirmed its ratings on the class C, D, E and F notes, and removed from credit watch negative the rating on the class A notes.

The current securitised loan balance is €4.52bn and the whole-loan balance is €5.67bn. S&P notes that the loan continues to perform well, with stable financial ratios. The whole-loan LTV ratio is 73% and the securitised LTV ratio is 59%, while the whole-loan interest coverage ratio is 1.15x against a covenant of 1.05x.

DAIG has continued to sell individual properties, with the number of residential units now totalling 162,053 - down from 164,365 at closing. During the third and fourth quarters last year, 818 and 1,147 units were sold respectively. At the portfolio level, rents increased to €5.13/sqm at the end of 4Q11 from €5.07/sqm in the previous quarter, while the vacancy rate has declined to 4.53% from 5.11%.

Based purely on the loan's credit metrics, S&P considers that the senior classes of GRAND notes could achieve higher ratings than those assigned. However, the specific nature of the transaction results in a much higher refinance risk when compared to smaller transactions, it says. Thus, in the agency's opinion, the increased risk outweighs the positive credit indicators.

CS

CMBS

Lease rollover risk scrutinised

Near-term lease expiries appear to be a manageable risk for many of the five-year US CMBS loans maturing this year, according to CMBS strategists at Citi. However, lease expirations ramp up dramatically from 2015, with office expirations for example jumping to 19.7% that year from 11% in 2014.

Citi research suggests that, in aggregate, leases on about 10% of occupied space expire in each of the next three years. Yet several individual deals have high exposure to lease rollover risk; for instance, 87% of the five-year loan balance maturing in 2012 in MLMT 2007-C1 has leases on at least 20% of the underlying square feet that expire in the next two years.

Equally, several maturing large loans that are likely to refinance based on their sizing parameters face significant rollover risk. The matured US$331m Pacific Shores loan securitised in BACM 2007-1 and GECMC 2007-C1 was a notable recent example. Other loans, such as the US$106m Nestle 94 pool in WBCMT 2007-C34 or the Midway Business Center in BACM 2007-5, could face similar refinancing hurdles.

"We found 19 deals that have 2012-maturing five-year balloons that comprise 10% or more of their outstanding balance," the strategists note. "For example, the largest such deal - JPMCC 2007-LD11 - has 23.7% exposure, with US$1.25bn of five-year loans maturing in 2012."

For the transactions with significant near-term loan maturities, the exposure to near-term lease expiries on the maturing loans ranges from zero all the way to 87%, according to Citi's research. At the top of this range, MLMT 2007-C1 has US$479.8m - representing 12.9% of the deal - of maturing five-year loans. Of those, 87% have leases that come due within two years on at least 20% of the rentable area.

The strategists also point to a few smaller loans that warrant attention, such as the US$13.5m Oakton Corporate Center securitised in WBCMT 2007-C31. The loan has 73% exposure to leases that expire in the next two years; the lease of the property's top tenant expires in April and the loan matures in March.

Investors typically don't have access to the contractual rents that tenants have in place, nor the inception date of the leases, which would allow them to estimate an in-place rent. But the strategists suggest some rules of thumb across property types to approximate them.

First, office leases are generally five to ten years. But smaller tenants sometimes sign leases for three to five years.

Second, retail has a wide range of lease terms. The average lease for tenants at strip centres is three to five years, while for in-line mall tenants it is typically five to ten years. Anchor tenants generally sign leases in the 10- to 20-year range.

Finally, industrial leases are usually longer than those for office. While five- to ten-year terms are common for industrial, there will also be many longer-term leases for up to 20 years.

For any expiring leases that began about five years ago, effective rents are down by 6%-11.1% across property types, meaning that as these leases roll the tenants will likely be able to negotiate down their contractual rate. However, rents are actually higher for office and retail leases that began about ten years ago by 6.5% and 7.7% respectively. Thus, these tenants may see an increase in their contractual rates.

CS

RMBS

LCR uncertainty removed?

A new marked-up version of CRD IV has sparked hopes that high quality RMBS will be included as an eligible asset under the liquidity coverage ratio (LCR) after all. A version of the draft directive published in late January contained language that, while initially raising optimism about the prospect, ultimately caused confusion.

The latest 816-page draft appears to remove this uncertainty, according to ABS analysts at Barclays Capital. The marked-up version states: "EBA shall, by 30 June 2013, report to the Commission on appropriate uniform definitions of high and of extremely high liquidity and credit quality of transferable assets for purposes of Article 404. The report should also consider other categories of central bank-eligible assets - for example, RMBS of high liquid and credit quality - and other non-central bank-eligible but tradable assets; for example, equities listed on a recognised exchange and gold."

"Specifically stating that 'RMBS of high liquid and credit quality' should be considered is a clear reaction to the uncertainty the previous report raised and is clearly an indicative comment that certain forms of RMBS should be allowed in the LCR," the Barcap analysts observe. "To meet the 'high liquid and credit quality' requirement, this is almost certainly to be a form of RMBS issuance where a "kite mark" of some form will be required, such as those suggested by the Prime Collateralised Securities (PCS) initiative."

Among the criteria that EBA is expected to test are: minimum trade volume of the assets; minimum outstanding volume of the assets; transparent pricing and post-trade information; proven record of price stability; average volume traded and average trade size; maximum bid/ask spread; remaining time to maturity; and minimum turnover ratio.

The analysts believe that ABS eligibility under the LCR is a key risk for the future of the ABS asset class (see also SCI 27 February) and, while this latest draft doesn't confirm its inclusion, it is certainly a step in the right direction.

CS

RMBS

AG settlement impact illuminated

Further details have emerged on the US$25bn servicer settlements that the US federal government and attorneys general agreed with Ally, Bank of America, Citibank, JPMorgan and Wells Fargo (SCI 15 February). The largest impact is expected to be on deals serviced by Bank of America.

The settlements have been filed for approval in federal court. The documents cast light on the new servicing criteria and required documents to be able to foreclose on loans. Most of the changes were expected, but they are likely to slow the foreclosure process in the near term as servicers adapt to comply with them.

The settlement documents also provide criteria for the mods that securitisation analysts at Barclays Capital say are broadly in agreement with HAMP 3.0 criteria. These criteria include: at least 85% of the loans are below the 2010 conforming loan size limits; loan is delinquent or at imminent risk of default; current LTV is more than 100%; and it has a maximum post-mod DTI of 31 and a maximum post-mod LTV of 120%. If the loan is more than 180 days delinquent, DTI requirements can be waived as long as payment is reduced by at least 20% and LTV reduced to at least 120%.

If the first lien is modified and the related second is owned by the servicers in the settlement, the second also has to be modified. Finally, if the forgiveness mod is eligible for the HAMP PRA incentives, credit is available after netting out the effect of the incentives. A minimum of 30% of these credits should be used for first-lien modifications.

For portfolio loans, reductions in the greater-than-175%-LTV range will generate 50 cents of credit per dollar reduction, while below 175% LTV there will be one dollar credit per dollar reduction. Forgiving forborne amounts on existing mods earns 40 cents per dollar reduction (not to exceed 12.5% of the total), earned forgiveness over a period of up to three years for LTV over 175% is 45 cents per dollar and over a period of up to three years for LTV under 175% is 85 cents per dollar.

For loans serviced on behalf of others, there will be 45 cents of credit per dollar reduction for principal forgiveness on first-lien. For earned forgiveness up to three years above 175% LTV credit is 20 cents per dollar and for LTV under 175% it is 40 cents per dollar.

For second liens on portfolio loans, liens that are 0-90 days delinquent receive 90 cents per dollar reduction, loans 90-179 days delinquent generate 50 cents per dollar and 180 days delinquent second liens generate 10 cents of credit per dollar. For enhanced borrower transitional funds, there will be one dollar credit per dollar in excess of US$1,500 if the servicer pays and 45 cents per dollar in excess of US$1,500 if the investor pays.

For short sales, there will be one dollar credit per dollar of payment if the servicer pays an unrelated second-lien holder. Servicers that forgive deficiency and release the lien on first-liens will earn 45 cents per dollar, while if the investor forgives deficiency and releases the lien on first-liens it will be 20 cents per dollar. Finally, deficiency waived on first- or second-liens will generate 10 cents per dollar in write-down.

The required forgiveness credits are US$0.2bn for Ally, US$7.6bn for Bank of America, US$1.4bn for Citibank, US$3.7bn for JPMorgan and US$3.4bn for Wells Fargo. As it is less costly to forgive balances on behalf of private investors and still receive credit for it, the Barcap analysts expect that is what the banks will aim to do.

"As such, while they only receive US$0.40/US$0.45 of credit per US$1 of reduction rather than the full quota they receive on portfolio loans, to the extent that the servicers determine that these mods are negative NPV (even after considering the new PRA incentives), servicers have the incentive to try to pass off most of the mods on loans in non-agency securitisations," they say.

The analysts add: "Of course, if the mods are positive NPV, banks will continue to have incentive to perform those mods on their own portfolio and claim credit for them. This also saves them from any potential liability from investors/trusts suing them if the investors feel they have been victims of arbitrary and negative NPV mods."

Ally, Citibank and Wells Fargo have all said they will be limiting the settlement mods to portfolio loans, at least for now. Meanwhile, Bank of America is understood to be intending to provide an average of US$100,000 in forgiveness to 200,000 borrowers.

"If these modifications were done on portfolio loans, BAC would accrue credit far in excess of the US$7.6bn required. As such, our initial read is that BAC is planning to modify a substantial proportion of these loans from its private label rather than owned portfolio," the analysts observe.

The total private label outstanding for Bank of America is US$307bn, with delinquencies of around US$98bn. Achieving its required credit purely through modifying private label delinquent loans would see as many as 70% of these borrowers modified. The analysts believe that such a proposal is far-fetched.

"To the extent that all the signatories are HAMP servicers, they were/are required to do an NPV analysis on all borrowers anyway and a new programme announcement with similar NPV requirements in place should not cause more modifications. Of course, in reality servicers have some flexibility to use their own NPV models and may be able to tweak those to desired results," they add.

The analysts thus believe the impact for Bank of America-serviced deals will be the greatest. The impact for Ally-, Citi- and Wells-serviced deals on the private label side should be small: the servicers are largely expected to continue to modify as before, although changes are likely for higher mods due to the new HAMP PRA incentives. The impact for JPMorgan deals is less clear.

The effect for Countrywide deals is that junior and mezzanine bonds in Alt-A/POA/Jumbo sectors should be written down, although wrapped mezzanine bonds with currently-paying monolines could benefit. The analysts suggest that super seniors are also likely to benefit from a principal recovery standpoint.

Finally, the settlement-related mods should hasten crossover and could hurt front-pay bonds from implied pro-rata structures. The analysts conclude: "Many of the CWL subprime deals stay sequential after crossover and the settlement could end up lengthening the front pays more than anything."

JL

ABS

Willis appoints Europe md

Andrea Bellone has joined the European team of Willis Capital Markets & Advisory as md. He is based in London and reports to Michiel Bakker, head of WCMA Europe.

Bellone is now responsible for WCMA clients in continental Europe, with a particular emphasis on Italy. He joins from Leadenhall Capital Partners and has 18 years of experience in insurance and financial services investment banking, including previous roles at Shroders, Citigroup and Fox-Pitt, Kelton.

ABS

ILS team, funds acquired

LGT Group is buying Clariden Leu's ILS business. A team of 10 specialists and the Clariden Leu (CH) Cat Bond Fund, Clariden Leu (Lie) Cat Bond Fund, Clariden Leu (Lux) - Cat Bond Fund and Clariden Leu (Gue) ILS Plus Fund will be transferred to LGT Capital Management as part of the deal.

The acquisition increases LGT Capital Management's AUM to more than Sfr22bn. The transaction is expected to close in 2Q12.

Structured Finance

New role for former Dynamic Credit ceo

James Finkel has been appointed as leader of Duff & Phelps' financial crisis disputes practice, based in New York. He was previously leader of the firm's complex asset solutions team.

Finkel has more than 25 years of experience within structured finance and joined Duff & Phelps in late 2010 as part of the acquisition of the US consulting business of Dynamic Credit Partners, where he was ceo (SCI 16 December 2010). In his career he has originated, structured, restructured, traded, distributed, analysed and managed a variety of structured credit products.

Structured Finance

Securitisation chief moves on

Richard Reilly has joined DLA Piper's global investment funds practice as a partner. His securities practice focuses on investment fund formation in the US and Europe and represents credit hedge funds and private equity-style funds as well as placement agents.

Reilly will be based in New York. He joins from White & Case where he was global co-head of the securitisation group, a partner in its investment funds practice and the founder of its structured finance practice in London.

Structured Finance

Investment firm expands, enters partnership

Four Wood Capital Partners has announced a number of hires and entered into an exclusive partnership with Stratum Capital Advisors. Stratum chief Andrew Yorks will now serve as senior advisor to Four Wood's portfolio management group.

Yorks has 20 years of experience as a fixed income portfolio manager specialising in alternative credit and derivatives. Before founding Stratum he was md and head of investment grade structured credit at BlackRock.

Yorks is joined by Stratum portfolio manager Marios Tsiptsis, who has previously worked at Newton Capital Partners, Deutsche Bank and BlackRock. The expertise of Yorks and Tsiptsis will be further complemented by the appointment of Fred Scott to Four Wood's portfolio management group as md.

Scott's core emphasis at Four Wood will include due diligence, manager and product selection and asset management responsibilities for the firm's real estate business. He has previously worked for Strategic Capital Partners, Longwing, Lazard Frères and Prudential Securities.

The firm has also boosted its global client group with eight new appointments. The group now includes Kieran Stirling, Jeffrey Bauer, Joseph Iwanczewski, Matthew Kessler, Peter Bergen, Derryk Madsen, Andrew Park and Zachary Lerman. Four Wood ceo Steven Baffico says there will be further expansion in the near future.

CDO

Internal transfer for CRE CDO

Prudential Mortgage Capital Company has transferred to Prudential Investment Management its duties and responsibilities under the collateral management and servicing agreements for ROCK 1 - CRE CDO 2006. Moody's has determined that the assignment won't cause the ratings of the notes to be reduced or withdrawn.

For other recent assigments, see SCI's CDO manager transfer database.

RMBS

SEC charges ex-Thornburg executives

The US SEC has charged former executives at Thornburg Mortgage Inc with hiding the company's deteriorating financial condition at the start of the financial crisis. It says the executives engaged in a scheme to deceive Thornburg's auditor and investors into believing that the company had successfully met all its margin calls.

Former ceo Larry Goldstone, cfo Clarence Simmons and chief accounting officer Jane Starrett are accused of deliberately overstating the company's income and recording a false profit in its 2007 annual report. The company had actually been unable to make timely payments and was about to face fresh margin calls which it would be unable to meet.

The SEC cites email correspondence between Goldstone, Simmons and Starrett in which they discuss deliberately not informing Thornburg's auditor about the margin calls the company was receiving. After quickly satisfying the outstanding margin calls, the executives timed the filing of the report to occur just hours later in order to precede additional margin calls and avoid full disclosure.

When further margin calls were received soon after filing the annual report, the executives were unable to raise cash quickly enough to meet them. Defaulting on the margin calls forced the company to disclose its situation in 8-K filings with the SEC and its stock price collapsed, eventually causing the company to file for bankruptcy.

"Thornburg's executives schemed to drop a disingenuous annual report into the public realm at the most opportune moment possible while knowing it was merely the calm before the next storm," says Donald Hoerl, SEC Denver regional director.

Thornburg was considered the second-largest independent mortgage company after Countrywide. As well as its lending business focused on jumbo and super-jumbo ARMs, the company purchased and held ARM securities and securitised ARM loans.

Thornburg received more than US$300m in margin calls in the weeks leading up to its annual report filing. The executives did not include US$400m in market value losses related to its ARM securities in the company's income statement.

The SEC's complaint charges Goldstone, Simmons and Starrett with violations of the antifraud, deceit of auditors, reporting, record keeping and internal controls provisions of the federal securities laws. The complaint seeks officer and director bars, disgorgement and financial penalties.

ABS

German set-off risk warning

A series of higher regional court decisions regarding loan handling fees for German consumer loans could expose securitisations to additional set-off risk. Fitch says it will review the potential impact on existing ratings on a transaction-by-transaction basis.

The court rulings invalidate administration fees that were charged to set up a loan. The risk to German ABS transactions is that borrowers will claim this money back by setting off handling fees they have already paid to the lender against loan repayments that have been securitised. This would reduce the proceeds received by SPVs.

Only a Federal Supreme Court decision, which might occur in the second half of 2012, could provide some legal certainty. However, the cases presented to courts are not identical to the loans included in German consumer ABS transactions, so it will not be possible to draw direct conclusions.

To date arrangers of recent transactions have been unable to provide a clear legal opinion on this matter. As a result, Fitch will assess the materiality of potential set-off risk. If the exposure is considered to be material, the agency says it may assume the worst case and analyse transactions as if borrowers can set-off the fee.

In the absence of a legal opinion, recently rated transactions have addressed the risk in different ways. In one transaction, a higher credit enhancement is available to cover the notional value of the loan handling fee. Another transaction mitigated the risk by posting a dedicated set-off reserve that fully covers the total handling fees from closing.

Additional credit enhancement could cover some of the losses expected from the set-off of any administration fees in existing transactions. They may also be able to fall back on the seller's obligation to fully reimburse set-off claims. A set-off risk would only materialise if the seller were unable to settle this payment.

Because of the legal uncertainty, some lenders have stopped charging handling fees. In the long term lenders are likely to increase the interest rate they charge on the loan to compensate for not being able to charge a handling fee.

ABS

East Lane Re V upsizes

The fifth catastrophe bond from Chubb's East Lane programme has closed with its junior tranche upsized. East Lane Re V's series 2012 class A and class B notes initially targeted US$75m and US$50m (SCI 22 February 2012), but the class Bs ended up at US$75m

The four-year deal priced at 900bp over Treasury money market funds for the class A notes and 1075bp over for the class Bs. S&P rated the notes double-B and the double-B minus, respectively.

The notes cover losses from hurricanes and severe thunderstorms in the covered area on a per occurrence basis. The covered area for both perils is Alabama, Florida, Georgia, Louisiana, Mississippi, North Carolina, South Carolina, and Texas. Covered losses are for personal lines property exposures only and will be based on the ultimate net losses of Chubb.

The class A notes cover 50% of losses in excess of US$1bn up to US$1.15bn and the class B notes cover 75% of losses in excess of US$850m up to US$950m. The deal's joint bookrunners are Citi, Deutsche Bank and Goldman Sachs with GC Securities and Willis Capital Markets as co-managers.

ABS

Allianz cat bond marketing

Swiss Re and GC Securities are marketing a catastrophe bond from a new Allianz programme - Blue Danube.

The as yet unsized series 2012-1 class A and B notes will be exposed to US, Caribbean and Mexico hurricane risk; and US and Canada earthquake risk between 3 April 2012 and 2 April 2015. S&P has given the deal's notes preliminary ratings of double-B plus and double-B minus.

The A and B notes will cover industry modelled losses in excess of an index value of 200 and 112.5, and up to a value of 225 and 162.5, respectively, on a per-occurrence basis during the risk period. The deal's collateral will be invested in IBRD floating-rate notes.

ABS

Typhoon cat bond launches

A new Japanese wind and storm catastrophe bond is being marketed by Swiss Re Capital Markets - Akibare II.

Swiss Re will be the counterparty to the risk transfer contract but the US$90m single-tranche deal will ultimately provide protection to the reinsured - Mitsui Sumitomo Insurance. The deal will be exposed to typhoons and tropical storms in Japan between March 2012 and March 2016 and have been given a preliminary double-B rating by S&P.

The series 2012-1 class A notes will cover losses in excess of an index value of 1180, and up to a value of 1830. Following an event, calculation agent AIR will gather event parameters such as location, central pressure, and precipitation data to create a map of the area affected by the typhoon from the reporting agencies (Japan Meteorological Agency, Regional and Mesoscale Meteorology Branch and the Tropical Rainfall Measuring Mission). This information will be formatted for use in AIR's model and run through the notional portfolio to determine the modelled notional loss. Based on the modelled notional loss, AIR will calculate the event percentage and the corresponding event payment.

Akibare II's collateral will be invested in US Treasury money market funds.

Structured Finance

Draft counterparty criteria released

Fitch has published its exposure draft of criteria for analysing counterparty risk in structured finance transactions (SCI 14 February), with a number of proposed amendments. The agency does not expect any direct rating impact for existing ratings in the event of the proposals being adopted in revised criteria; nor will it expect documentation changes to be made to existing transactions to reflect revised criteria once finalised. Transaction counterparties may elect to incorporate any proposals that are subsequently adopted in revised criteria.

The main proposals upon which feedback is sought are extended rating eligibility thresholds, changes to collateral posting calculations and the examination of more collateral types. Fitch is proposing to establish additional rating eligibility thresholds for direct support and derivative counterparties in transactions where the highest rated note is lower than triple-A.

The agency is also proposing amended collateral posting formulas, applicable where a derivative counterparty elects to post collateral, in order to more closely reflect the combination of counterparty and note ratings. Finally, it is proposing to extend the range of eligible collateral posted by derivative counterparties beyond cash and highly rated sovereign bonds. Subject to feedback received, Fitch anticipates specifying eligibility criteria and advance rates for structured finance, covered bonds and/or corporate bond collateral.

The agency is inviting feedback on the proposals during a one-month consultation period that will expire on 13 April. It will continue to apply its current criteria until the finalisation of revised criteria, which is expected to be published in May.

Structured Finance

Singapore issues covered bond guidelines

The ability of Singaporean banks to issue covered bonds is one step closer, following the release of a Monetary Authority of Singapore (MAS) consultation paper on the asset class.

MAS is proposing that banks incorporated in Singapore may issue covered bonds subject to the aggregate value of assets in the cover pool being capped at 2% of the value of the total assets of the bank. This, the authority says, will keep risks contained while allowing banks to tap an additional source of longer-term funding.

In comparison, Australian regulators have restricted the combined value of assets in the cover pools by an authorised deposit-taking institution (ADI) to 8% of the value of the ADI's assets in Australia, while Canada limits covered bond issuance by deposit-taking federally regulated financial institutions to 4% of total assets.

MAS stipulates that only mortgage loans secured by residential property (with an 80% LTV limit) and derivatives held for the purpose of hedging risks arising from issuing covered bonds can be included in the cover pool. If the LTV exceeds 80%, the value of the loan for the purpose of including it in the cover pool shall be reduced by the amount of the excess. The value of assets in a cover pool must also be at least 103% of the face value of the covered bonds secured by the assets at all times and that the bank cannot issue covered bonds through foreign incorporated entities.

In addition, it is proposed that banks must notify MAS a month prior to the issuance of covered bonds, providing information on the size, tenor and terms of the issuance, as well as the type and amount of assets used to back the covered bonds. MAS also requires that an independent cover pool monitor is appointed by the bank to certify that the bank has complied with the proposed 2% cap and other regulatory requirements on covered bonds.

MAS is inviting views and comments on the proposals by 10 April.

Covered bond activity in the Asia Pacific region has stepped up a gear in recent months, particularly following the successful launch of several covered bond programmes in Australia (SCI 23 February). Significant issuance is expected out of South Korea in the coming months following the release of covered bond guidelines in 2011, while Thai, Malaysian and Japanese governments are also understood to be in the early stages of exploring issuance options.

Structured Finance

TARP wind-down continues

The US Treasury has agreed to sell 206,896,552 shares of its AIG common stock at US$29 per share, with the aggregate proceeds expected to be approximately US$6bn. AIG will purchase 103,448,276 of the shares, representing half of the expected proceeds from the sale.

"We're continuing to move forward to wind down TARP and exit our stakes in private companies as soon as practicable," comments assistant secretary for financial stability Tim Massad. "[This] is another important step in our efforts to recover the taxpayer's investment in AIG."

Treasury also announced an agreement with AIG that provides for the repayment of the government's remaining US$8.5bn preferred equity investment in the AIG-owned AIA SPV. Combined with the common stock offering, these proceeds will reduce Treasury's remaining investment in AIG to US$35.7bn. Also still outstanding is the New York Fed's US$9.3bn loan to Maiden Lane III - albeit it is collateralised by assets with a current value well in excess of the loan balance.

More than 77% (US$319bn) of the US$414bn funds disbursed for TARP had previously been recovered to date through repayments and other income.

Structured Finance

Portuguese deals hit

S&P has taken credit rating actions on various Portuguese RMBS and ABS transactions. The move follows the downgrade on 13 January of the long-term rating on the Republic of Portugal to double-B from triple-B minus.

The agency says it has subsequently revised its assessment of Portuguese country risk and how it might affect the ratings on the notes of Portuguese securitisations. Consistent with this revision, S&P believes that in some cases potential losses on certain rated tranches of Portuguese RMBS and ABS could increase by up to 30% over the initial loss expectations for each rating level.

Consequently, S&P has: affirmed its ratings on 65 tranches in 36 RMBS transactions; lowered its ratings on 40 tranches in 17 RMBS transactions; lowered and removed from credit watch negative its rating on one RMBS tranche in one transaction; placed on credit watch negative its ratings on three RMBS tranches in one transaction; kept its rating on one tranche in one RMBS transaction on credit watch negative; withdrawn its rating on one tranche in one RMBS transaction as the tranche has paid down; affirmed its ratings on 16 tranches in 10 ABS transactions; and lowered its ratings on three tranches in two ABS transactions.

CDO

EM CDO criteria reviewed

S&P has published an advance notice of proposed criteria change in relation to a comprehensive review of the assumptions and methodologies it uses to rate securitisations backed predominantly by loans or bonds issued by emerging market corporate entities. The revisions are intended to enhance the comparability of EM CDO ratings with ratings in other sectors, such as corporate CDOs, and to more explicitly promote credit stability.

The scope of the review may include correlation parameters, recovery levels and timing, event risk and model risk. Furthermore, S&P's review will include how transfer and convertibility (T&C) risk is assessed. Under political or economic stress, governments may impose exchange controls to avoid an outflow of hard currency.

The effect that these potential changes could have on the ratings on a particular security will depend on the final criteria adopted, the agency's analysis of the credit quality of the underlying portfolio of assets and the structural features of the CDO.

CDS

Focus shifts to Portugal CDS

The S&P/ISDA International Developed Nation and Eurozone Developed Nation Sovereign CDS indices have been re-versioned with the removal of Greece as a constituent. As a result, the weighted average spread for each index dropped significantly, with the spread of the Eurozone index now at 246bp.

In comparison, Portugal, Ireland, Spain and Italy (ranked highest to lowest) all have CDS par spreads north of 300bp, according to CMA Datavision figures. At the other end of the spectrum, Norway's CDS spread is south of 30bp.

Portugal CDS are trading on an upfront basis: the midlevel for the upfront quote was 35.4%, as of Monday night. This implies that market participants are assigning a cumulative probability of default for the debt at over 60%.

CDS

Chinese derivatives regulation evolving

The availability of new products and domestic financial institutions' entry into overseas markets is driving rapid change in the Chinese derivatives market, according to a new report from Celent. The report finds that while Chinese regulation is strict, it is evolving towards a more open, orderly derivatives market.

New regulations are affecting the Chinese derivatives market structure deeply, according to the report. For instance, many hedge funds have been established as trusts or private equity funds and some wealth management institutions have launched products that use hedge strategies to invest, such as First Capital and Guotai Junan. Celent estimates the assets of hedge funds will grow by 500% if they are deregulated.

The firm also expects more asset management and proprietary firms to be founded. Prop trading currently accounts for a third of securities firms' total income. Two prop trading firms were founded in 2010 and six securities firms applied for licenses in 2011.

At present, however, insurers cannot participate in the derivatives market directly. If an insurer wants to hedge risk, it needs to buy a third-party structured product.

Celent identifies brokers as the new drivers for the industry, as competition in this sector is fierce. Their size and the fact that they have more capital to trade has impacted the market structure.

The Chinese derivatives market exhibits many advanced features, according to the report. Technology is one such area. For example, the Shanghai Futures Exchange can support most product types and provides an advanced infrastructure in terms of capacity and latency.

Equally, cross-border trading is increasing. There are many drivers for Chinese firms trading in overseas markets, including: enhanced margins, large international trade, lack of products in the Chinese market, foreign exchange deregulation, appreciation of the Chinese yuan, the internationalisation of the Chinese yuan, inflation in China, deregulation of brokers' cross-border trading, larger contracts available in the overseas market, growth of institutional investors in China and the introduction of QFII (whose assets account for US$34bn).

The regulator is encouraging Chinese corporations to trade overseas derivatives, allowing six brokers to establish overseas branches and three brokers to provide overseas derivatives trading services to domestic corporations. But major barriers to trading in the overseas markets remain, including: foreign exchange control; poor derivatives knowledge among Chinese corporations; and license requirements for investors.

In addition, investment instruments remain underdeveloped in the country. For example, deposits account for 70% of total retail assets. Stock index futures and CDS are new products that are expected to grow significantly (SCI passim), however.

CDS

Greek CDS trigger expected

ISDA's EMEA Determinations Committee is meeting at 1pm GMT today to determine whether a credit event has occurred with respect to the Hellenic Republic. The move follows yesterday's successful PSI debt swap - albeit collective action clauses (CACs) were activated on Greek law bonds, which are expected to trigger CDS contracts.

€152bn out of €177bn Greek law bonds were tendered (accounting for 86% - below the 90% threshold for a 'voluntary' swap), together with €20bn out of €29bn of international law bonds (69%). Holders of international bonds that have not yet tendered are due to meet on 23 March to submit potential consents to the tender.

Credit analysts at RBS believe that triggering Greek CDS is unlikely to be a concern for systemic risk, given that investors have been unwinding contracts over the past few months. "In addition, the CDS net notional has dropped to US$3.16bn from US$5.6bn a year ago. EBA data suggests banks have already written down their Greek exposure and concentration risk on CDS contracts appears to be relatively low."

Meanwhile, credit strategists at Bank of America Merrill Lynch anticipate that a successful PSI outcome in Greece will clear the way for credit spreads to rally further in March. They attribute this to investors being light risk, bank funding stress being further reduced by the latest LTRO and economic indicators slowly turning up in Europe.

"After the Greek uncertainty of the last week, CDS has significantly underperformed cash bonds in the high grade market, leaving many bonds trading with a positive basis," the BAML strategists explain. "Year-to-date, cash spreads have been remarkably resilient as retail inflows have supported spreads. On average, we see the largest positive bases at present in senior banks, industrials, utilities and retailers."

CDS

LSOC benefits outlined

The CFTC has issued under the Dodd-Frank Act its final rules requiring FCMs and derivatives clearing organisations (DCOs) to segregate customer collateral with respect to cleared swaps. The CFTC adopted the legal segregation with operational commingling (LSOC) model, which prohibits FCMs and DCOs from commingling customer collateral with their own funds, but permits FCMs and DCOs to commingle customer collateral in accounts with other cleared swap customers. It also restricts a DCO's ability to use non-defaulting customers' collateral to cover a defaulting customer's obligations.

The effective date of the collateral rules is 9 April and all parties must be in compliance by 8 November. While implementation may involve considerable operational changes at DCOs and FCMs, lawyers at Schulte Roth & Zabel expect that most fund managers won't have to make significant changes to their current practices in order to comply with rules.

"In the case of a bankruptcy of an FCM due to a double default under the LSOC model, the most significant benefit to customers of the FCM is their protection (assuming that they are a non-defaulting customer) against fellow-customer risk," they add. "In addition, the adopted model improves on the current futures model by requiring customer account data to be transmitted to the DCO daily, thereby providing up-to-date information on which to base account transfers and liquidations, and therefore increasing the portability of non-defaulting customers' positions to other FCMs."

CDS

Greek CDS auction scheduled

As expected (SCI 9 March), ISDA's EMEA Credit Derivatives Determinations Committee on Friday resolved unanimously that a restructuring credit event occurred with respect to The Hellenic Republic, following the exercise of collective action clauses to amend the terms of Greek law governed bonds. An auction will be held in respect of outstanding CDS transactions on 19 March. The association has published a list of obligations issued or guaranteed by The Hellenic Republic, which the EMEA Determinations Committee is currently in the process of reviewing.

Separately, the auction to settle the credit derivative trades for Lafarge Roofing/ Monier LCDS is to be held on 28 March.

CLOs

CLO supply supporting loan fundamentals

The pick-up in CLO volumes early in 2012 is supporting an improvement in leveraged loan market fundamentals, Fitch notes. The agency expects the growing pipeline of CLO deals to keep loan spreads relatively tight, leading more leveraged borrowers to tap the loan market in order to refinance heavy 2013 and 2014 maturities.

The improved tone of the leveraged loan market, balanced against ongoing macro risks and a tepid US growth outlook, may contribute to further reductions in borrowing costs for leveraged issuers moving into the spring. Some loans issued in 2011 have recently been repriced to capture the benefits of better demand.

BJ's Wholesale Clubs, for example, repriced to a spread of 400bp compared with 575bp in its previous loan. GoDaddy Group realised a similar cut in spreads in its recent deal.

Fitch estimates that US$3.6bn of new CLO transactions priced in the two months ending 29 February. The build in the CLO pipeline will likely continue to fuel robust demand for loans over the coming months. With loan investors competing for many of the same assets, spreads may tighten further and covenants could be relaxed in upcoming transactions.

Extension of some loan maturities to five and six years in the primary market appears to reflect broadening demand, with banks taking on more pro rata exposure and more refinancing of bonds with loans. Banks' participation in new loan deals has continued to rise relative to institutional demand in recent months and this trend appears to be continuing in 2012.

CLOs

Amend-to-extends proliferating

Cengage, the seventeenth largest corporate exposure and represented in about half of the CLO universe, is targeting a three-year extension on its 2014 loan. Participants in the amendment would benefit from a 30% loan pay-down, increased spread and a consent fee, according to LCD. The largest position any one CLO has in the credit is about 5%, with average exposure being 1%.

Actions to amend loans to extend maturities are up by 65% year-to-date relative to last year, which S&P views as a net negative for CLO credit. "For transactions in the post-reinvestment period, amend-to-extend can increase a portfolio's WAL or expose the CLO to market value risk if a loan matures after the CLO. New CLO structures have added language to restrict amendments in the post-reinvestment period if the WAL of the portfolio increases or if a deal fails a WAL test, but the specifics vary by deal," the agency notes.

CMBS

QUOKK 06-1 management structure revised

A number of changes have been made to the management structure of the €560m Quokka Finance, a German multifamily CMBS. These include a change of property manager and borrower general partner.

The original property manager, Krüger Immobilien, has been dissolved due to insolvency and its functions transferred to replacement property managers - Colonia, Pentaproperty, TAG and Hermes - to avoid any prejudicial effects to the noteholders. Additionally, to ensure that the asset management services originally performed by Babcock & Brown will be continued in compliance, these have been transferred to BGP Asset Management. The asset management fee has risen to 0.65% from 0.35% to reflect the increased workload.

Meanwhile, BGP Residential GP 6 has replaced BGP Property Partner 1 as the general partner of the KG borrowers. The move is designed to mitigate the risk of an insolvency of the old general partner caused by insolvency of the non-Quokka portfolio borrowers, according to European asset-backed analysts at RBS.

Under a new property management agreement, the borrower can grant power of attorney to any property manager to authorise it to dispose of amounts credited to any rent collection account. This should improve the collection of rental income and standard payment processes, as well as reduce the loss of rental income and collection costs, the RBS analysts note.

Finally, the master servicer is now responsible for delivering the quarterly servicer report no later than the last business day of the next month of each financial quarter.

CMBS

CMBS loan payoffs bounce

The percentage of US CMBS loans paying off on their balloon date posted their second highest reading since December 2008, according to Trepp's February payoff report. During the month, 61.6% of loans reaching their balloon date paid off.

Only September 2011 had a better reading since the credit crisis began: that month the payoff level was 64.4%. February marks only the fourth time since late-2008 that the percentage cracked 50%. The 61.6% payoff number was almost 21 points higher than the January reading.

A big part of the surge was due to one class of a 2007 loan paying off: the US$500m 9 West 57th Street loan was refinanced in February. That loan by itself represented 27% of the loans coming due.

The February number was well above the 12-month rolling average of 46.1%. By loan count, 64.9% percent of the loans paid off - up by over 13 points from January's reading of 51.2%. On the basis of loan count, the 12-month rolling average is now 51.7%.

Prior to 2008, the payoff percentages were typically well north of 70%. Since the beginning of 2009, however, there have only been four months where more than half of the balance of the loans reaching their balloon date actually paid off.

CMBS

Multifamily CMBS lags recovery

The recovery being seen in the US apartment sector hasn't trickled down to multifamily CMBS, according to a new report from S&P. The rating agency notes that despite a solid recovery that includes a 5% annualised rise in apartment rents through 4Q11, delinquencies for multifamily CMBS are still near record highs.

Although the delinquency rate had declined to 13.58% of the current aggregate outstanding principal balance of multifamily loans in December 2011, from 15.5% in June 2011, it is still well above the rate of 1.1% at the start of the last recession. "Even though multifamily delinquencies have improved a bit recently, we believe that a significant decline will remain elusive until rents firm and there are fewer concessions available among class B and C apartments, the weakest housing markets strengthen and troubled New York City rental conversion projects resolve their issues," says S&P credit analyst Larry Kay. "The path to recovery for multifamily CMBS will also depend on the level of job growth in the various markets, which will influence the timing and extent of the local property markets' progress."

In addition, S&P observes that 2012 is a big year for multifamily loan maturities, with over US$7bn scheduled to mature. Moreover, it adds that approximately US$3.8bn of these maturities are five-year term loans originated in 2007, when underwriting was very aggressive. The recent contraction in commercial real estate lending and investment activity could complicate refinancing of these loans and thereby push multifamily delinquencies up again, the report concludes.

CMBS

CMBS loan liquidations retreat

The volume of CMBS conduit loans liquidated in February retreated sharply, falling by 43% from January's reading, according to Trepp. In fact, the February reading was the lowest total since November 2010.

At US$893m, liquidations were about 32% below the 12-month moving average of US$1.31bn per month, Trepp says. Since the beginning of 2010, special servicers have been liquidating at an average rate of about US$1.08bn per month.

In February, liquidations came from 93 loans, compared to 168 loans that were liquidated in January. The 12-month moving average is 151 loans per month.

The average loan size for liquidated loans was US$9.6m in February. Over the last 12 months, the average size of liquidated loans has been US$8.7m.

As noted, there were 93 loans liquidated in February. The losses from the February liquidations were about US$228m - representing an average loss severity of 25.55%.

This was down by over 14 points from January's 39.54% reading. February represented the lowest level since March 2011.

The February loss severity reading is well below the average loss severity of 42.92% over the last 26 months and also below the 12-month rolling average of 42.27%.

CMBS

Servicer conflicts of interest scrutinised

S&P says it is monitoring potential conflicts of interest that may arise between special servicers, their affiliates and/or parents - especially when a servicer has changed ownership. The agency notes that several market participants, including CMBS investors, have expressed concern over special servicers' exercising 'fair market value' purchase options and the practice of charging additional fees in connection with loan restructurings.

If a special servicer exercises the fair market value purchase option and sells a defaulted asset to an affiliate or parent, the fair market value calculation may be questioned even if the value has been independently verified, S&P observes. When a special servicer uses an affiliate to provide an ancillary service, potential conflicts of interest regarding the quality of service, the fees charged and whether the best interests of the investors were served may exist. Equally, if a special servicer charges additional fees in connection with loan restructurings, some participants may believe the special servicer has an incentive to select the restructuring option that generates the largest fees, which may not be viewed as being in the best interest of the securities holders.

"We would take a negative view of servicer actions that are not in the best interest of the securities holders," S&P says. "We would also take a negative view of actions that fail to comply with the requirements of the loan-level documents and pooling and servicing agreements (PSAs), especially to the extent that such actions adversely affect cashflows available for distribution to the trust."

A change in ownership can raise questions about pre-existing servicing practices. Specifically, there is concern that certain new owners will have more aggressive return expectations than their predecessors. Such expectations could influence how a special servicer generates fees and arranges its workout strategies.

With regard to fair market value calculations, S&P believes transactions that require the special servicer's calculations to be reviewed by an operating advisor, for example, offer a measure of transparency and objectivity. Likewise, in the event a servicer engages an affiliate to provide ancillary services, the agency would expect the affiliate to possess the requisite qualifications to perform such duties. It would also expect fees charged by an affiliate to be at or below market rates.

Further, S&P believes the market would benefit from greater transparency surrounding payment of borrower fees. In the agency's opinion, special servicers should not base decisions to approve or deny a borrower's request for a modification based on fees.

CMBS

Atlanta offices drive CMBS delinquencies

Increasing difficulties for office properties, most notably in Atlanta, overshadowed what was otherwise a flat February for US CMBS delinquencies overall, according to Fitch's latest US CMBS Loan Delinquency Index results.

CMBS late-pays fell by 2bp last month to 8.3% from 8.32% a month earlier. The decline was led by a large hotel loan that was brought current. However, office properties - particularly in Atlanta - continue to struggle, with another large Atlanta office loan added to the index.

One Alliance Center (securitised in LBUBS 2007-C2) became 60 days delinquent last month. Add on to that the high-profile default in December of the US$363m Bank of America Plaza in downtown Atlanta, a staggering 37% of all Atlanta office properties in Fitch-rated deals are now considered delinquent.

One positive development was the conversion of the US$675m Innkeepers portfolio to current for the first time since March 2010. This drove the hotel delinquency rate down to 10.75% from 12.21% in January.

Current and prior month delinquency rates for each of the major property types are as follows: 13.3% for multifamily (from a revised 13.04% in January); 10.75% for hotel (from 12.21%); 10.54% for industrial (from 10.40%); 7.68% for office (from 7.30%); and 7.15% for retail (from 7.21%).

Risk Management

Enhanced CVA offering rolled out

SunGard has extended its Adaptiv suite of solutions to help customers not only calculate CVA, but also actively manage it, the firm says. Adaptiv CVA Studio includes a Monte Carlo calculation engine for measuring risk, as well as a trading-style interface to display counterparty and hedge positions in a single view of P&L and key risk metrics. The solution can run over one million valuations per second per processor core, helping customers achieve greater accuracy in their valuations by avoiding approximation techniques.

Juerg Hunziker, president of SunGard's Front Arena and Adaptiv business units, comments: "As the impact of Basel 3 on both profitability and earnings volatility is better understood, banks are establishing CVA functions to support compliance and improve how they manage P&L. Adaptiv CVA Studio can help by providing a complete view of CVA and transparency into credit risk using technology that can be quickly rolled out to traders and CVA managers across the organisation."

RMBS

MBS CCP to launch next month

The US SEC has approved the DTCC's application to operate a new central counterparty designed to reduce risk and costs in the US agency MBS market (SCI 13 December 2011). Starting on 2 April, the MBS division of DTCC's Fixed Income Clearing Corporation (FICC) subsidiary will begin guaranteeing settlement of all of its members' matched MBS trades and introduce pool netting that will further streamline settlement on the related delivery obligations.

The FICC guaranty will ensure completion of these long-settling trades, even if one of the trading parties defaults on its initial trade commitment or pool delivery obligation. "This is the first CCP to be created in US cash markets in more than a quarter of a century. We expect it will greatly reduce risk by offering pool netting services and streamlining the settlement of mortgage-backed securities trades," comments DTCC's president and ceo Donald Donahue.

FICC's MBS division is currently able to net down more than 90% of the MBS trades it processes. It has been testing the CCP for some time with a number of its member firms and a two-month phase-in period will start in April, as pool delivery obligations to fulfil guaranteed trades are subsequently submitted for netting. The phase-in will also allow member firms to adjust to new reporting and clearing fund requirements, as well as same-day collection of settlement debits and credits.

RMBS

Subprime RMBS review completed

Fitch has completed its review of the US subprime RMBS sector, covering 10,380 classes across 1,143 transactions. The agency has affirmed 86% of the classes, downgraded 12% and upgraded less than 1% as a result.

Of the downgrades, 93% were by 1-2 notches. Of classes with an outlook, 94% of downgraded classes were on rating watch or outlook negative prior to the review.

The negative rating revisions generally reflect enhancements to Fitch's rating methodology that have resulted in: a reduction in seasoning credit in the mortgage loss projection analysis; and a reduction in the projected interest cashflow and excess spread available to cover mortgage losses, primarily due to loan coupon deterioration and lower levels of servicer advancing. The reduction in seasoning credit in the mortgage loss analysis reflects the slowdown in the rate of improvement in the subprime sector over the past year, according to the agency.

Although the rate at which subprime borrowers become delinquent has improved notably since 2009, Fitch has observed recently that the improvement has tempered for loans originated from 2005-2007, while earlier vintage loans have shown little to no improvement. The slowdown in performance can be attributed in part to the changing composition of the collateral, which is leading to adverse selection.

The agency also finds that falling home prices are contributing to weaker subprime performance. Home prices declined by 4% nationally in 2011, with Fitch projecting a further 5%-10% decline to come.

The reduction in projected interest cashflow, meanwhile, resulted in downgrades of over 100 investment grade classes to double-B due to projected interest shortfalls - despite expectations of full principal recovery in rating stress scenarios above double-B. Interest shortfall sensitivity will likely continue to play an increasing role in rating revisions in the subprime sector due to high rates of modifications, continued declines in servicer advancing rates and servicing transfers, Fitch notes.

130 classes remain on RWN due to the pending acquisition of Saxon Mortgage Services by Ocwen Financial Corporation. Fitch believes Ocwen's rapid portfolio growth, outsized scale relative to the subprime industry and low cost staffing strategy may pose challenges to an orderly transfer of servicing from Ocwen if a transfer were necessary at some point in the future. The agency suggests that Ocwen's continued growth through acquisitions could potentially have further negative rating implications for related bonds.

Fitch's ratings on subprime RMBS are driven by historically high loss severities and relatively thin remaining credit enhancement. The agency cites high LTV ratios, relatively small loan balances and extending liquidation timelines as causes of elevated loss severities on liquidated loans (currently at 77%). Senior RMBS classes have lost credit enhancement through a combination of high collateral losses and the redirection of principal towards subordinate classes, it adds.

RMBS

Further action plans released

The Federal Reserve Board has released action plans for three supervised financial institutions - HSBC North America Holdings, Ally Financial and IMB HoldCo - to correct deficiencies in residential mortgage loan servicing and foreclosure processing (SCI passim). It also released the engagement letter between HSBC and the independent consultant the bank retained to review foreclosures that were in process in 2009 and 2010.

The action plans and engagement letters are required by formal enforcement actions issued by the Fed last year. Further engagement letters and action plans will be released in the coming weeks.

RMBS

Gap grows in resi liquidation rates

The large difference in liquidation rates between US states grew during 4Q11, according to S&P. The agency notes that the increasing timelines are primarily due to extreme foreclosure delays in states with judicial foreclosure procedures, with the number of estimated months needed to clear the supply of distressed homes rising by two months to 47 months.

"The volume of these distressed US non-agency residential mortgages remained extremely high, at US$371bn in the fourth quarter, but has declined in each quarter since mid-2010," S&P credit analyst Jacques Alcabes comments. "This latest number represents slightly less than one-third of the outstanding non-agency RMBS market in the US."

RMBS

ML II assets revealed

Empirasign has filed a successful Freedom of Information Act request and obtained the contents of the secret auction of Maiden Lane II securities that took place on 19 January. In a highly unusual move, participants in this auction were required to sign a non-disclosure agreement to keep the list contents and execution prices confidential for one year. The list comprises 160 non-agency RMBS bonds and is free to download from the firm's website.