Contents

CMBS

Maturity spike for Euro CMBS

April is set to be another important month for European CMBS. There are 16 transactions subject to loan maturities this month, six of which have more than one loan maturing. Over half of the loans are expected to remain outstanding at the end of the year, with German loans underperforming UK loans.

Discounting loans already in payment default or extended from January, CMBS analysts at Barclays Capital estimate that €2bn of loans will mature this month. They note that 54% (by loan balance) of the loans are secured by German assets, with 32% in the UK and the remainder in Finland, Switzerland and the Czech Republic.

The Barcap analysts expect 26% of the maturing whole loan balance to be repaid on time, with a further 16% repaid later in 2012 and 57% remaining outstanding at the end of the year. The four largest loans set to mature each have a whole loan balance of more than €200m or £200m.

The largest loan by securitised balance is the €350m Corleone loan in Fleet Street Three. It is not expected to repay on time, with a default predicted followed by standstill agreements.

The analysts add: "The largest UK loan maturing this month is the Regulator loan of Titan Europe 2007-3, for which we do not expect a timely repayment, but a full repayment over the course of 2012 (likely out of special servicing). In addition to the Corleone loan, another loan matures in Fleet Street Three: the Blue Star loan, which is already in covenant default and we do not expect repayment in 2012."

The fourth largest loan is the Petrus loan in Titan Europe 2006-2. This loan is also expected to remain outstanding, remaining in primary servicing until July, when the Margaux loan also securitised in Titan Europe 2006-2 matures.

Titan 2007-2 and DECO 9-E3 each have three loans maturing, representing 44.7% and 14.9% of their portfolios respectively. The other deals either have two loans or one loan maturing. EPRE 1 has only one loan maturing, but that one loan accounts for 100% of the portfolio.

Finally, UK loans should perform better than their German counterparts, according to the analysts. They expect 85% of the German maturing whole loan balance to remain outstanding beyond 2012, compared with just 10% for the UK.

JL

CMBS

CMBS gaps out on ML3 concerns

Supply concerns last week drove the first major widening in US CMBS spreads since the beginning of the year. The move follows rising expectations of potential sales from the Maiden Lane III portfolio.

Generic 2007 LCF and AMs gave up nearly 20bp-30bp over the week to finish Wednesday at 190bp over swaps and 450bp over respectively. The effect was felt the most in the AJ sector, where prices dropped as much as 4-5 points on the 2007 vintage. Widening pressures were also apparent in the synthetic sector, where CMBX.4 AJs dropped by four points over the week.

The near-term trigger was a change in the investment objective language on the New York Fed's Maiden Lane III website, according to MBS analysts at Barclays Capital, which indicated that it would consider a potential sale from the portfolio while "refraining from disturbing general financial market conditions". Most of the CMBS exposure in Maiden Lane III consists of US$7.5bn in A1 tranches from two CRE CDOs - MAX 2007-1 and MAX 2008-1.

Blackrock Financial has reportedly received offers on these assets and it appears that CMBS players are concerned the CDOs could potentially be collapsed, releasing a flood of supply of the underlying tranches into the market. Accordingly, AM/AJ bid-list volumes ticked higher over the past week - accounting for nearly 50% of all lists - as accounts looked to take profits in anticipation of a potential drop-off in prices.

However, the Barcap analysts expect potential buyers of the CDOs to manage the unwind process as opposed to conducting a one-time sale of the underlying bonds. In this scenario, the sales could be spread out over an extended period.

"As such, we expect the widening effect to be most felt in sectors where valuations look frothy on a fundamental basis," they add. "This includes weaker credit tranches such as AJs off 2007 vintage deals that, we believe, are pricing to slightly optimistic scenarios and will be prone to corrections if the broader economy shows signs of slowing. Given the high leverage to credit for these tranches, worse-than-expected economic data in the coming months could lead to bids drying up, which in turn could cause distressed supply [to hit] the market due to mark-to-market losses."

CS

Insurance-linked securities

Three cat bonds close

Three catastrophe bonds closed last week. All saw strong investor interest and finished larger than initial size projections.

Allianz's Blue Danube (SCI 13 March) saw its two tranches reach US$120m each. The class A notes priced at 600bp over the permitted investment yield (six-month Libor minus 32bp) and the class Bs at 1075bp over.

The series 2012-1 class A and B notes cover 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. S&P has confirmed its preliminary ratings of the two tranches at double-B plus and double-B minus.

The Blue Danube notes will provide three-year per occurrence protection to Allianz Argos 14, a wholly owned subsidiary of Allianz, against hurricanes affecting the US (including clash hurricane events that also affect the Caribbean, Central America and Mexico) and earthquakes affecting the US and Canada. The bond utilises a modelled industry trigger transaction (MITT) structure that weights PCS losses in the covered area by modelled losses to Allianz's notional exposure portfolio.

Meanwhile, Japanese typhoon bond Akibare II (SCI 13 March) priced at 375bp over Treasury money market funds for its US$130m single tranche, which had been upsized from US$90m. Swiss Re is the counterparty to the risk transfer contract but Akibare II ultimately provides protection to the reinsured - Mitsui Sumitomo Insurance. The deal is exposed to typhoons and tropical storms in Japan between March 2012 and March 2016 and has been rated double-B by S&P.

The series 2012-1 class A notes cover losses in excess of an index value of 1180, 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.

In addition, an unrated catastrophe bond has also closed - Pelican Re, the first issuance from Louisiana Citizens Property Insurance. The three-year single-tranche transaction is understood to have been upped from an initial US$100m to US$125m.

The Series 2012-1 notes priced at 1375bp over Treasury money market funds. It provides the cedant with indemnity-based cover for hurricanes in Louisiana on a per occurrence basis.

MP

RMBS

GSE principal forgiveness ruled out

FHFA acting director Edward DeMarco has commented on the use of Treasury incentives to forgive principal on underwater borrowers, affirming a preference for forbearance over forgiveness. The announcement effectively rules out any principal forgiveness for GSE loans.

Among his reasons for ruling out principal forgiveness, DeMarco notes that less than one million of the 11 million underwater borrowers would benefit from forgiveness and is keen to keep the remaining borrowers current on their mortgages rather than incentivising them to claim hardship or become delinquent.

DeMarco says the operational costs of rolling out forgiveness guidelines to servicers and opportunity costs relative to programmes such as HARP have also factored into his decision. He has also considered the NPV impact to US taxpayers, as Treasury incentive payments would be considered as an offset to the NPV benefits of a principal reduction modification.

"DeMarco expressed a clear preference for forbearance over forgiveness and indicated that forbearance is effectively a shared appreciation mortgage, with far fewer operational complexities than an explicit shared appreciation mortgage," comment MBS analysts at Bank of America Merrill Lynch.

They add: "We conclude from his preliminary remarks on the incentive approach to principal forgiveness of GSE loans that there will be zero to minimal scale of such an approach."

JL

Structured Finance

Japan capital markets team poached

White & Case has expanded its capital markets practice in Tokyo. Norifusa Hashimoto joins the firm as a local partner along with Seiji Matsuzoe and Aya Kurahashi, who join as counsel and associate, respectively.

All three join from Allen & Overy, where Hashimoto was partner and co-head of capital markets for Japan. Hashimoto specialises in debt private placements and repackagings, structured finance and securities as well as various asset securitisations, including auto loan, lease and consumer loan receivables.

Matsuzoe specialises in CDOs, credit-linked loans, warrant-backed loans and a wide range of securitisation transactions and derivatives. He has also worked closely with the Japanese Financial Services Agency in relation to the regulatory reform of the OTC derivatives market in Japan.

Kurahashi's practice focuses on capital markets and structured finance. She has assisted on CMBS transactions, refinancing, restructuring, mezz bonds and due diligence as well as being involved in structuring new schemes.

Structured Finance

Hedge fund intermediary service enhanced

Gamma Finance has enhanced its offering to include corporate finance services. The move is in response to increasing demand from private equity investors and real asset specialists seeking access to stakes held by hedge funds that have become illiquid.

When the firm was established in 2009, the hedge fund secondary market was characterised by high net-worth individuals engaging in distressed sales of hedge funds to meet cash calls elsewhere. Now the sector is characterised by institutional investors assessing their legacy illiquid holdings in light of regulatory initiatives or the need to wind down leveraged positions.

This situation has created several positive outcomes, according to Gamma Finance director and head of advisory Ben Keefe. First, the restructuring of credit hedge funds into portfolios of minority and controlling equity positions provides a new and previously untapped source of investments for the private equity sector.

Second, this benefits hedge fund managers because they can access a new pool of specialist capital that can be used to meet outstanding investor redemptions. Finally, it is positive for the underlying company, whose shares pass into the hands of experienced, long-term investors that are well-placed to help develop and maximise the potential of their business over time, without the immediate need to meet investor redemptions.

As well as trading fund shares, some institutional investors are exploring structured solutions, while others have begun to take more interest in opportunities contained within the actual hedge fund portfolio itself.

CLOs

Fund manager picks president

William Bohnsack has been promoted to president at Oak Hill Advisors. He has been coo at Oak Hill since 2001 and one of the firm's four senior partners since 2005.

Bohnsack joined Oak Hill in 1993 and became partner in 1999. During his time at the firm he has worked as a senior professional investing in performing and distressed debt, head of business development and coo. He has co-founded each of the firm's investment funds and is a senior officer for each of its management entities.

Insurance-linked securities

ILS specialist recruited

Stephen Rooney has joined Mayer Brown in New York as partner and co-leader of the insurance finance group and member of the firm's banking and finance practice. He specialises in ILS and was previously global chair of Dewey & LeBoeuf's structured finance group.

Insurance-linked securities

London law firm appoints partner

Prakash Paran has joined DLA Piper's London office as partner in the corporate group and member of the global insurance and reinsurance group. He is the latest in a string of departures from Dewey & LeBoeuf (SCI passim).

Paran specialises in insurance and ILS. He also has experience in mergers and acquisitions, joint ventures and corporate reorganisations and was at Simmons & Simmons prior to his time at Dewey & LeBoeuf.

RMBS

FINRA fines broker for CMO mark-ups

A FINRA hearing panel has ruled that David Lerner Associates (DLA) charged excessive mark-ups on municipal bond and CMO transactions. DLA has been fined US$2.3m and ordered to pay restitution of more than US$1.4m plus interest.

DLA head trader William Mason has also been fined US$200,000 and suspended from the securities industry for six months. FINRA found that DLA and Mason charged retail customers excessive mark-ups in more than 1,500 municipal bond transactions between January 2005 and January 2007 and in more than 1,700 CMO transactions between January 2005 and August 2007.

The panel says the excessive mark-ups were intentional and far lower prices were available in the market. Municipal bond mark-ups ranged from 3.01% to 5.78% and CMO mark-ups ranged from 4.02% to 12.39%. The extent of the mark-ups resulted in customers receiving lower yields than they could have.

FINRA also found DLA's supervisory system "inadequate on several levels". The firm has previously failed to address its pricing issues despite a letter of caution about mark-up practices in 2004 and Wells Notice in 2009.

ABS

Rehab SLABS liquidity risk warning

Fitch believes that the increase in rehabilitated student loans in some recent FFELP ABS transactions heightens near-term liquidity risk, despite the US government guarantee on these loans.

Rehabilitated student loans are those in which the borrower defaults but subsequently makes nine on-time payments during 10 consecutive months. In these situations, the collection costs - up to 18.5% of the outstanding principle and accrued interest - are built into the loan principal. A loan may be rehabilitated only once after 14 August 2008 under the common manual.

Fitch says it has seen an increase in rehab loans - which typically trade at a discount - in several recent FFELP ABS transactions, as supply has been ample following the financial crisis. From 2003 to 2010, the inventory of rehab loans tripled. The agency has also seen some transactions with 100% rehab collateral.

Rehab loans go through the same delinquency and default process as non-rehab loans. After 270 days of delinquency, the loan is classified as defaulted and the servicer submits a claim to the guarantor.

Provided the servicer meets the due diligence requirements, the guarantor will purchase the defaulted loan from a lender within 90 days following the receipt of a claim. However, Fitch assumes a payment lag of 540 days from the first day of default in all cashflow scenarios to account for possible delays in reimbursement to the trust, including those that could be caused by guarantor insolvency.

Given their history, rehab loans are more likely to default and do so more quickly than non-rehab loans. This creates higher near-term liquidity risk for transactions with a concentration of rehab FFELP collateral than for non-rehab FFELP transactions because a significant portion of loans will be non-performing while the delinquency and claims process occur.

Based on historical data from servicers and guarantors, Fitch estimates the base-case default rate for rehab loans to be in the 40%-60% range versus 10%-15% for non-rehab loans. This higher default risk is largely mitigated by the government guarantee.

In addition to higher default assumptions, Fitch also applies a more front-loaded default curve for rehab loans. The assumptions applied for default level and timing, as well as the payment lag, help mitigate the near-term liquidity risk from a high concentration of such loans in a transaction, the agency notes.

ABS

Stable outlook for US card industry

Moody's outlook for the US credit card industry remains stable, reflecting primarily card issuers' stronger asset quality and profitability in an improved macroeconomic environment.

"Card issuers' asset quality has improved significantly over the past year on the back of stronger employment numbers, higher monthly payments by cardholders and continued 'portfolio cleansing' by issuers," says Moody's vp Curt Beaudouin. "And we expect this trend to continue in 2012."

Indeed, while charge-offs peaked at 11% for the 'Big 6' issuers in the first quarter of 2010, they are expected to be down by a further 15%-20% this year. Beaudouin notes, however, that asset quality varies among the major issuers.

"Together with expected balance growth of about 5%, continued improvement in asset quality should lead to a significant increase in profitability this year, with pre-tax profits likely to go up by about 35%," Beaudouin says.

Reflecting their improved profitability, capital levels at the Big 6 issuers have remained strong. As a result, dividend and share repurchase increases began to take hold among the major issuers last year, with the exception of Capital One, due to its acquisitions.

Despite these positives, however, the industry does continue to face significant challenges. "Credit card issuers are under intensified political and regulatory pressures," Beaudouin explains. "Further, the US economy remains vulnerable to shocks from higher gas prices and geopolitical tensions, as well as from potential government policy changes early next year focusing on further fiscal tightening."

ABS

Survey highlights Solvency II concerns

A recent AFME survey of securitisation investors shows that the proposed Solvency II capital charges are likely to cause a permanent drop in securitisation funding, which could seriously reduce future growth in Europe. AFME is urging policymakers to delegate the assessment of securitisation capital charges to the EIOPA Technical Expert Group, or alternatively conduct further research.

AFME surveyed 27 Europe-based insurance companies and asset managers, who between them hold more than €5trn in global assets. Every respondent indicated the proposed rules would negatively impact their willingness to allocate funds to the securitisation sector, with a third saying they would stop completely.

Of those who said Solvency II would result in a reallocation of funds, 85% indicated at least half would be reallocated away from securitisation. If the respondents were to pull back from the market, 22% said they would never return, even if the charges were reduced. Of those who said they would return, 65% said the process would take more than a year and 19% said it would take more than three years.

Finally, 56% of respondents indicated the proposed capital charges would encourage them to develop their own internal models. However, 52% went on to say that they did not believe their regulator would approve their internal model if the results were materially different from those generated by the standardised approach.

Structured Finance

Further MBIA evidence revealed

Evidence made public yesterday in connection with the MBIA Article 78 action (SCI passim) shows that MBIA executives possessed but withheld from the New York State Insurance Department (NYID) financial projections indicating that MBIA Insurance was insolvent when MBIA asked then-Superintendent Eric Dinallo to approve its 'transformation'. Specifically, MBIA executives concealed from the NYID more than two dozen analyses showing that MBIA Insurance faced billions of dollars in projected losses on CDOs, CMBS and RMBS that were many times higher than the loss projections MBIA presented to the NYID.

The evidence was presented in the Sur-Sur Reply Brief submitted by policyholders in camera with the New York State Supreme Court on 16 March and filed on the public court docket yesterday. This Brief is the final substantive filing in the Article 78 action before the case goes to trial.

Justice Barbara Kapnick has ordered the parties to appear on 20 April for a substantive hearing on disputed issues for trial. The trial is presently scheduled to begin on 14 May.

The newly-revealed evidence discloses that MBIA executives concealed from the NYID highly material financial information, including a Lehman Brothers analysis - provided to MBIA in September 2008 - that concluded that MBIA's present-value losses on 15 insured ABS CDOs would be more than US$7.7bn, even if housing prices stopped declining immediately. An analysis from FSI Capital also estimates that MBIA would suffer losses of US$3.4bn on second-lien RMBS, which is more than three times higher than the losses generated when FSI Capital re-ran its model using MBIA's unreasonably optimistic assumptions.

Further, 24 internal MBIA analyses projected that the monoline would suffer between US$1bn-US$20bn in losses on insured CMBS pools. To secure Dinallo's approval, MBIA executives are said to have selectively provided the NYID with only five optimistic scenarios that predicted "zero losses" to MBIA on CMBS, at a time when MBIA had zero loss reserves on CMBS. Since February 2009, MBIA has suffered nearly US$3bn in losses on CMBS.

MBIA has now admitted that the critical "extreme stress" analysis that its executives prepared for the NYID was riddled with errors, including inflating MBIA Insurance's policyholder surplus by at least US$653m. Whereas MBIA's original "extreme stress" scenario showed that MBIA Insurance would retain positive surplus after the transformation, correcting this error makes MBIA Insurance's surplus become negative under "extreme stress" within less than one year after Dinallo's approval of the transformation, according to lawyers at Sullivan & Cromwell. Before learning of these "errors", the NYID and MBIA had told the Court that MBIA's retention of positive policyholder surplus post-transformation under MBIA's "extreme stress" scenario was an important factor in Dinallo's approval.

The latest disclosures are in addition to the evidence previously identified by MBIA's policyholders, including that unbeknownst to the NYID: a senior MBIA executive deleted information from a presentation to the NYID about the impact of MBIA's "manual overrides" on its CMBS loss models; MBIA used outdated data and assumptions to run the loss models for structured products that it provided to the NYID; and MBIA used an illegal discount rate to understate its loss reserves by hundreds of millions of dollars.

Robert Giuffra, lead counsel for the policyholders and a partner at Sullivan & Cromwell, comments: " Under settled principles of New York law, MBIA's 'transformation' cannot stand because MBIA executives secured then-Superintendent Dinallo's approval by concealing from NYID officials critical financial information and by providing misleading and admittedly erroneous financial information to those officials."

By withholding critical financial information and as a result of admitted errors, it is alleged that MBIA executives concealed that its loss reserves were woefully inadequate to protect MBIA Insurance policyholders. In the three years since the approval of MBIA Insurance's transformation, the company has spent more than US$9bn to pay claims and resolve liabilities - more than five times the US$1.7bn in reserves that MBIA executives told the NYID would be sufficient for the next 45 years. MBIA also recently had to borrow back at least US$1.1bn of the assets that were transferred to National Public Finance Guarantee Corp in February 2009 to fund settlement payments to structured policyholders.

Structured Finance

Vantage enhancements offered

Interactive Data Corporation has launched Version 2.0 of Vantage, its web application that aims to provide transparency into the fixed income market and the company's evaluated prices. The service now provides coverage for global structured securities and US municipal bonds, and also delivers dozens of enhancements that reflect client feedback from asset managers, mutual funds, insurance companies and accounting firms.

These enhancements include: expansion of instrument coverage to include more than 2.8 million daily security evaluations; a market depth indicator, which can provide clients with confidence in the level of market colour associated with each evaluation; an events panel, which provides a convenient source of non-trade and quote information that can impact fixed income pricing.

Interactive Data says it will continue to expand the transparency, portfolio and workflow tools available through Vantage. Capabilities to be added in future releases will support a broad range of risk management, trade reconciliation and pre-trade functions.

Structured Finance

Japanese SF macroeconomic drivers identified

S&P has identified five key macroeconomic factors that it believes are most relevant to the credit quality of Japanese structured finance securities. These factors are: Japan's unemployment rate; land prices; real GDP; equity returns; and the corporate credit risk premium.

Excluding CDOs, Japanese structured finance ratings averaged a 0.6-notch decline from January 2009 to December 2011, reflecting the most recent economic downturn in the country as well as transaction-specific factors. During the same period, S&P downgraded Japanese structured securities (ex-CDO) that had been rated triple-A by an average of only 0.2 notches, despite significant deterioration in some of the country's key macroeconomic factors.

The credit quality of Japanese structured finance securities (ex-CDO) has been reasonably stable over the past 10 years, the agency notes. It adds that the top-five macroeconomic factors tend to be leading indicators in the context of Japan and thus provide insight into the future state of the performance of collateral backing Japanese structured securities (ex-CDO).

CDO

Manasquan auction scheduled

VCAP Securities has been retained to act as liquidation agent for Manasquan CDO 2005-1. The collateral will be auctioned in two public sales taking place on 19 April.

CDS

Sino-Forest credit event called

ISDA's Asia Ex-Japan Credit Derivatives Determinations Committee has resolved that a bankruptcy credit event occurred in respect of Sino-Forest Corporation. An auction will be held in due course to settle outstanding CDS transactions.

CLOs

CLO survey highlights regulatory concern

JPMorgan has published the results of its latest CLO client survey, based on responses from 79 accounts. The results suggest that regulatory reform remains a key concern among market participants.

Indeed, respondents pointed to risk retention as the most damaging regulation to CLO new issues, noting that the market is still waiting for guidance on risk retention as set out in the Dodd-Frank Act. They are also very focused on risk capital regimes.

With regard to anticipated positioning, the ratio of buying divided by selling intention is 8.5 - the highest since JPMorgan's inaugural December 2009 client survey. About 63% of investor respondents plan to add, up from 50% in December 2011. The proportion looking to hold or reduce dropped.

Meanwhile, most respondents expect primary US CLO triple-A spreads to tighten to about 125bp over Libor. Around 40% anticipate spreads to dip to 120bp over or below.

Finally, the majority believe that the appropriate primary US CLO equity return is 15%. Overall, the 12%-15% return range accounts for about 75% of the votes.

"We find it interesting that there doesn't appear to be a major difference in views across respondent types, with a limited observable distinction between managers and investors. Perhaps the lack of equity or rising equity prices in secondary - along with the search for yield - has led to these results," JPMorgan CDO strategists conclude.

CMBS

New US CMBS defaults set to slow

The pace of new US CMBS defaults will slow again this year, as seen in 2011, according to Fitch's latest annual default study. The cumulative default number is expected to reach 14.5% by the end of 2012.

The cumulative CMBS default rate closed out last year at 12.7% (US$71.3 billion). New defaults finished 2011 38% lower (950 loans totalling US$13.7bn) than levels seen in 2010 (1,477 loans totalling US$22.1bn). Fitch anticipates the trend to continue this year, with general performance continuing to stabilise.

The agency notes how modified loans are helping mask CMBS default rates. Many loans are being modified by the special servicers without ever experiencing a monetary default. Taking into account those loans reported as modified, but never delinquent on debt service, the cumulative default rate would be 14.8% instead of 12.7%.

From the standpoint of specific property types, the biggest concern is office properties, Fitch says. For the first time in its default study, office loans had the highest levels of new defaults, surpassing multifamily loans with 38.6% of the total (US$5.3bn) in 2011. Multifamily came in third this past year with 20.1%, while retail finished second at 20.6%.

The 2007 vintage remains a lingering sore spot as well, with over half (50.2%) of last year's new defaults coming from these transactions, and the highest cumulative default rate of any vintage at 19%.

CMBS

'Bad boy' rulings net credit positive for CMBS

Michigan governor Rick Snyder last week signed into law the Nonrecourse Mortgage Loan Act, overturning two court rulings - known as the Cherryland/Chesterfield cases - that rocked the US commercial real estate space last December. The two decisions converted many 'bad-boy' non-recourse carve-out guaranties effectively into full credit recourse guaranties any time an SPE CRE borrower becomes insolvent, even if the guarantors did not cause the insolvency.

Moody's notes in its latest Weekly Credit Outlook that the act is a net credit positive for CMBS. "The legislation is credit negative for legacy CMBS because it removes a newly created tool from the arsenal of CRE lenders' remedies, reducing lenders' leverage. However, it is credit positive because it lessens the threat of substantive consolidation that the Cherryland and Chesterfield cases wrought, and reduces the risk that SPE owners will throw their subsidiaries into bankruptcy because they have nothing to lose."

The law faces a probable challenge as violating the US constitutional prohibition against state laws 'Impairing the Obligation of Contracts', Moody's suggests. In the interim and as the cases are appealed, there will be substantial uncertainty and litigation for legacy CMBS borrowers and bad boy guarantors in Michigan and in other states. However, the agency says that newly originated CMBS loans can easily navigate around the problem with a simple drafting fix to the language that caused the controversy.

The act was a swift expression of legislative dissatisfaction with the two finely reasoned court decisions that each made myopic end-runs around fundamentals of CRE nonrecourse lending. The Cherryland and Chesterfield courts both used strict tests of looking only at the "four-corners of the contract" between sophisticated, well-represented parties. But by declining literally to think outside the box, these cases hollowed out the essence of non-recourse CRE lending, Moody's concludes.

CMBS

Sharp drop for CMBS payoffs

The percentage of US CMBS loans paying off on their balloon date retreated sharply in March, according to Trepp's March Pay Off Report. This dip comes one month after the reading hit its second highest level since December 2008.

In March, 36.4% of loans reaching their balloon date paid off. Only May 2011 had a lower reading over the last 12 months.

The March number was well below the 12-month rolling average of 44.5%. By loan count, 43.1% of the loans paid off. On the basis of loan count, the 12-month rolling average is now 50.9%.

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

Solana delinquency drives CMBS late-pays

US CMBS late-pays last month rose by 13bp to 8.43% from 8.3% in February, according to Fitch's latest index for the sector. Helping to drive the increase was the continued underperformance of the US$360m Solana loan, now officially classified as 60-days delinquent. Prior to March, overall delinquencies had declined every month after hitting a high water mark of 9.01% in July of last year.

Solana, securitised in BACM 2007-1 and JPMCC 2007-LDP10, became 60-days delinquent last month after being reported as in foreclosure for some time. The loan was previously excluded from the index because it had remained less than 60 days delinquent and foreclosure sales had perpetually been called off.

The loan has been in special servicing since early 2009, having transferred for imminent default. Since December 2010, two forbearance agreements have been executed.

Currently, the loan's special servicer - CWCapital Asset Management - reports that modification negotiations are ongoing while foreclosure is also being pursued. The seven-year loan was scheduled to mature in December 2013.

Delinquencies of office loans, as expected, are continuing their steady upward trajectory following a 31bp increase to 7.99%. This increase does not include Solana, which is classified as a mixed-use property. However, due to its significant office component, if the loan was included in the office delinquency rate, that rate would jump 61bp to 8.29%.

Late-pays on industrial CMBS also rose (by 37bp) and are now the second-highest delinquency rate among all property types (behind multifamily) at 10.91%. In contrast, performance for hotel CMBS is continuing to turn for the better, with delinquencies falling another 40bp to 10.35%.

Current and prior month delinquency rates for each of the major property types are: 12.61% for multifamily (from 13.3% in February); 10.91% for industrial (from 10.54%); 10.35% for hotel (from 10.75%); 7.99% for office (from 7.68%); and 7.23% for retail (from 7.15%).

CMBS

CMBS concerns over low DSCR

The US$246m Atrium Hotel Portfolio loan has been put on Morningstar's watchlist because of worryingly low debt service coverage and the expiration of the loan's IO period. The loan is the largest in the ML-CFC 2006-3 transaction and represents 11% of the pool by unpaid balance.

The debt is secured by fee and leasehold interests in six full service hotels, including an independent Capitol Plaza Hotel in Kansas and five hotels flagged as Embassy Suites, which are in California, Florida, North Carolina, Oregon and West Virginia.

Morningstar reports that the weighted average net cash flow (NCF) DSCR for the properties over 2011 was 1.03x. Net cash flow over the same 12 months was US$16.3m. Only two of the hotels - the Embassy Suites in North Carolina and Oregon - reported DSCRs above breakeven for 2011, at 1.72x and 1.34x, respectively. DSCRs for the remaining properties ranged from 0.92x down to 0.58x for the Florida hotel.

For 2010 the weighted average NCF DSCR was 1.06x, with net cash flow of US$16.8m. Four of the properties had DSCRs above breakeven, with ratios ranging from 1.05x to 1.76x. The Florida hotel again had the lowest DSCR at just 0.51x.

The loan's five-year IO period expired in September 2011, which adds to Morningstar's concerns. The reported DSCR for 2011 included only three months of amortising debt service. Based on the net cash flow reported at year-end, a full twelve months of principal and interest payments would have resulted in a DSCR of around 0.89x.

DSCRs would also have been below breakeven for 2010 and 2009, at 0.91x and 0.98x, respectively. Including principal, annual debt service is now US$18.4m, as opposed to US$15.8 on an IO basis.

The 10-year, fixed-rate loan has an interest rate of 6.3% and is scheduled to mature on 1 September 2016, with an estimated US$232.2m balloon. The portfolio was appraised for US$345.8m in July 2006, yielding a 71% LTV at issuance.

"With revenues falling short of underwritten expectation and the DSCR below breakeven on an amortising basis, we consider this a moderate near term credit concern. A Morningstar preliminary analysis of the collateral assigns a value of about US$192m (US$130,000/key) which suggests a US$54m value deficiency," Morningstar concludes.

CMBS

CMBS loan takes mod loss

The US$81m Grand Traverse Mall loan securitised in GECMC 2005-C4 has taken a US$19m loss. The loss looks to be due to a modification associated with Rouse Properties' purchase of the GGP-sponsored asset in February.

As well as the mod resulting in the balance of the loan being reduced to US$62m, the loan maturity has been extended from October 2012 by almost five years to February 2017. Other changes will see monthly payments now be amortising based on a 30-year schedule and the loan made open to prepayment without any penalty or premium, while the borrower has also deposited US$2m into a TI/LC reserve account.

Barclays Capital securitisation analysts note that the modification has enabled GGP to transfer its interest to its spinoff, Rouse Properties. The were no changes to the loan coupon.

They add: "As a result of the mod, the deal took losses up to the M tranche. About US$151,000 in P&I advances due on the loan were reimbursed from principal cashflows this month; though the loan is still carrying US$291,000 in ASERs and US$689,000 in servicer advances, which we expect to be paid back in the coming remittance periods."

Insurance-linked securities

Florida cat bond marketing

Goldman Sachs is marketing a US$200m catastrophe bond on behalf of Citizens Property Insurance - Everglades Re. The single tranche hurricane deal has been assigned a preliminary rating of single-B plus by S&P.

Everglades Re covers ultimate net losses of Citizens from hurricanes in the state of Florida on a per-occurrence basis. Ultimate net loss does not include extra-contractual obligations and losses in excess of policy limits.

The notes will cover 20% of losses in excess of US$6.35bn up to US$7.35bn. The risk period for the notes will begin on the day after closing, tentatively April 2012, through May 2014.

There will be one annual reset, effective in May 2013, and it will be based on the cedants' exposures as of 31 December 2012. On the reset date, the attachment point for the notes will be reset to keep the probability of attachment and expected loss at 2.71% and 2.53%. The initial probability of exhaustion for the notes is 2.4%.

RMBS

RMBS downgraded on Saxon transfer

Fitch has downgraded 145 RMBS classes and affirmed one, following the transfer of certain mortgage servicing rights (MSRs) from Saxon Mortgage Services to Ocwen Financial Corporation. At the same time, all classes were removed from negative watch and assigned a negative outlook.

Of the 145 classes affected, 123 were part of Ocwen's legacy servicing portfolio, nine were part of the transfer completed on 2 April and 13 are in transactions in which Ocwen will act as sub-servicer on behalf of Saxon over the next several months. The downgrades reflect an increased risk of a servicing disruption in a high-stress scenario due to the unique characteristics of Ocwen's rapidly growing subprime servicing portfolio.

Saxon's parent, Morgan Stanley, has a Fitch long-term IDR of single-A with a stable outlook. In contrast, Ocwen has a long-rerm IDR of single-B plus with a negative outlook. Ocwen is rated RPS3, negative watch as a primary subprime servicer.

Fitch considered the risk of a servicer interruption in a high-stress scenario by conducting additional cashflow sensitivity analyses on bonds currently rated triple-As and double-A. A short-term servicing disruption was assumed to occur on all transactions where Ocwen services more than 30% of the mortgage pool. Classes that incur shortfalls under this analysis and are not expected to pay off in less than 12 months were downgraded to single-A.

With the purchase of Saxon's MSRs, Ocwen's overall servicing portfolio will have grown to over US$100bn, making it the largest servicer of securitised subprime loans. Fitch estimates that Ocwen will control the servicing on approximately 30% of all securitised subprime loans. The unique size and cost of Ocwen's portfolio could limit the number of other servicers willing and able to assume the loans without a disruption and will likely add legal and operational complexity if Ocwen were to have financial difficulty at some point in the future in a stressed scenario, the agency notes.

Saxon's servicing operations are expected to be terminated by July 2012. It is uncertain at this time who will assume the MSRs for the affected transactions.

RMBS

Non-agency payout discrepancies analysed

Discrepancies between expected cashflows on non-agency RMBS based on collateral and actual bond payouts have increased over the past few years. If measured versus a very simplistic CRR/CDR framework, the differential can be as much as 15%-20%, according to MBS analysts at Barclays Capital.

Such discrepancies, if not corrected, manifest themselves as over-predicting or under-predicting the cashflow on bonds. The Barcap analysts note that many discrepancies can be explained by stop advances and modification effects.

Since most are due to the treatment of delinquent loans, the differential is largest in the worse credit sectors, such as subprime, with more sporadic gaps in option ARMs and alt-a hybrids. Servicer idiosyncrasies amplify the discrepancies, with the biggest divergence seen across subprime servicers.

Nevertheless, some of the discrepancies remain unexplainable based on loan level data, the analysts suggest. Part of this is due to inherent errors in estimating advance rates for IOs and option ARMs, while the rest is due to the inconsistencies, errors and inadequacy of data in loan level reporting.

To overcome some of these issues, the analysts propose a technique of computing an 'implied' advancing rate by comparing bond payouts with collateral cashflow. Overall, they prefer deals serviced by larger bank servicers or those where the risk of servicing transfers to a worse servicer is smaller.

RMBS

Portuguese RMBS performance overestimated

Performance indicators for Portuguese mortgage loans securitised in RMBS transactions are misleading, says Fitch. The agency notes that originating banks' support for borrowers is masking the trust extent of past underperformance.

House price indices also appear to significantly understate the value declines seen on properties sold under forced circumstances and Fitch believes this is hiding the full extent of future risks for Portuguese RMBS transactions. Macro pressures, including increased unemployment, will see the performance of mortgage loans weaken further.

"The true extent of loan underperformance continues to be masked by support from the originating banks, through a combination of loan modifications, substitutions and repurchases," says Gioia Dominedo, senior director in Fitch's European structured finance team.

She continues: "On average, 11% of the collateral backing RMBS transactions has been affected by loan modifications, but this figure is as high as 50% in certain cases. In addition, an average of 12% of loans has been repurchased or substituted. This intervention makes estimating the real risks associated with the underlying mortgages far more challenging."

Fitch believes the pressure on transactions will result in higher arrears, defaults and losses. The Portuguese house price index reports a decline from the peak in 3Q10 of only 1.7%, but the agency believes this decline has been underestimated and notes some properties have been sold for values at an average of 20% below those implied by the index.

Few Portuguese RMBS transactions have generated significant recovery cash flows and loan level losses, which Fitch attributes to the lengthy judicial enforcement process and difficulty of selling collateral into the current market. Servicers are trying to avoid forced sales because they often result in higher loss rates. "Instead banks are increasingly using deed in lieu or payment in kind arrangements, whereby a bank takes direct control of the collateral and a borrower's obligations are extinguished, in order to avoid the lengthy repossession process," Fitch notes.

RMBS

Eurosail clarifications released

Issuer notices have been published for a number of Lehman Brothers-related UK RMBS transactions clarifying their positions in relation to claims against the company's estate in respect of various hedging agreements.

According to European asset-backed analysts at RBS, the issuers fall into three broad groups. First are those that have agreed a stipulated claim, for which payouts could commence as early as 17 April and would be used towards a suitably rated replacement hedge (comprising the ESAIL 2007-5, 2007-6 and 2007-PR1 deals).

Second are those where negotiations have as yet failed to come to an agreement and are still ongoing (ESAIL 2006-4, 2007-1, 2007-3, 2007-4, EUMF 2008-1 and MFD 2008-01). The final group consists of those where the debtors requested an indefinite adjournment of the hearing on the proposed assumption of certain contracts, but these requests have been rejected by the issuers (ESAIL 2006-1, 2006-2, 2006-3 and 2007-2).

RMBS

Fannie loan level data added

Lewtan has added Fannie Mae MBS loan level data through a partnership with Knowledge Decision Services, a provider of fixed income research tools. The web-hosted solution, dubbed agency MBS prepayment-on-demand (POD), is widely used across the financial industry, the two firms say.

POD contains nearly three decades of performance data. Data is available from Freddie Mac, Fannie Mae and Ginnie Mae at the pool level and Freddie Mac and Fannie Mae at the loan level. In addition to standard fixed-rate and ARM pass-through pools as well as CMOs and re-REMICs, various agency MBS derivatives are available: IO/PO strips and synthetic derivatives such as Markit IOS/POS/MBX.

POD is designed to enable the user to easily perform time-series analysis to analyse recent collateral behavioural trends, construct aging curves and refinancing S-curves, and analyse origination and issuance volumes to conduct supply and demand analysis.

RMBS

Divergent UK mortgage arrears

Mortgage arrears in the UK are rising faster in the north of the country than in the south, says S&P. 4Q11 data from a sample of 1.5 million loans backing UK RMBS shows mortgage borrowers in the north are around 30% more likely to be in arrears than those in the south.

The equity positions of UK borrowers have also deteriorated. Around 5.6% were in negative equity in 4Q11, up from 3.6% in 2Q10. The agency says 8.5% of northern borrowers were in negative equity at the end of 2011, compared to only 3.3% of southern borrowers.

These trends could have a negative effect on S&P's view of the credit quality of RMBS with collateral pools concentrated in northern UK regions. The trends seem to be linked to unemployment - which is more pronounced in the north of the UK - while house prices are also recovering at a slower rate than in the south.

"The UK economy has not yet turned the corner from the recent downturn, in our view. More borrowers throughout the UK could therefore come under financial stress in 2012," notes credit analyst Mark Boyce.

He adds: "Severe mortgage arrears may rise to a level close to their 2009 peak by end-2013 under what we consider to be realistic economic assumptions. In this environment, mortgage credit quality may well continue to diverge regionally."