Contents

CMBS

Going soft?

Changing underwriting standards pose CMBS threat

The loans backing this year's US CMBS issuance exhibit looser underwriting standards than the market has become used to in the aftermath of the financial crisis. While such a loosening of standards should not be ignored, it does not appear to have the market overly concerned either, as investor appetite for the product remains strong.

The underwriting standards typical of CMBS 2.0 transactions in 2010 were perhaps too conservative to last forever. Rather than now becoming too loose, standards are instead moving towards a more historical level, argues Tom Zatko, capital markets md at Cornerstone Real Estate Advisers.

"Comparing to 2010 is hard because that is an anomaly. To start a comparison from there is not really fair because those were very conservative times. As investors, we would have loved to see those 2010 numbers stay low, but it was a unique confluence of events that allowed lenders to get those terms," he says.

CMBS analysts at Citi note that maximum LTVs have crept up from 65%-70% late last year to 75% at present, with the minimum DSCR required for refinancing having decreased to 1.25x. They note that "underwriting standards have loosened significantly this year and are now more lenient than levels seen in early 2011" and warn investors to remain vigilant of this slippage.

Although Zatko is satisfied with the current level of underwriting standards, he also notes that it is important to ensure they do not loosen too much further. "We are watching it very closely and we are not being naïve about these changing statistics, but it is a little early to ring the alarm and say we are back to where we were [pre-crisis]. Having said that, it certainly could get too far and that is the concern. If there are a lot of people competing for a very high quality loan, then you may see some of the underwriting criteria slide."

The property mix seen in CMBS has also shifted. While retail property remains the dominant exposure, hotel concentration has increased markedly - from 9.2% in multi-borrower deals from 2010-2011 to between 16.3% and 19.8% in the first four multi-borrower transactions seen this year.

The retail and property sectors are the two that are most dependent on economic sentiment as they are directly linked to discretionary consumer spending. While it therefore may not be an ideal situation to have CMBS so reliant upon them, especially if economic perceptions become more negative, it is not necessarily immediate cause for alarm either.

"In a perfect world, we would love to see all property types equally represented and to have perfect geographic diversity, but reality does not work out that way. You have to look at deals individually. The fact that a portfolio might contain a preponderance of retail or hotel properties is not in itself a good or bad thing; you have to look through the quality of the actual underlying properties," says John Lonski, Cornerstone capital markets vp.

Anecdotal evidence suggests that investors are now more willing to dig into deals and examine portfolios than they used to be. This vigilance is encouraging and Zatko adds that it is refreshing to see such close attention being paid to trends such as changing underwriting standards.

He notes: "We have seen some instances of investors pushing back on certain deals or getting concessions where they have viewed deals to be aggressively underwritten. In those cases, investors are voting with their dollars. That stands in stark contrast to a few years ago, where anything that went to market was sold out."

Along with the changing underwriting standards, the Citi analysts indicate that bankruptcy risk is also becoming a more significant factor, with many prospectuses showing "that some borrowers are not even special purpose entities". However, Zatko is not overly concerned by this development.

"With all things being equal, you would want to see clearly spelled-out legal protections, but they are not a guarantee and the quality underlying the deal is what really counts. Whenever a property loan winds up in a court of law, there is a bit of a wildcard element to it, depending on many circumstances surrounding it," he says.

He adds: "While it is somewhat of a concern, if you came to me with a very strong property, a very strong borrower and a very strong reason for the property to exist, but with no SPE, then that is preferable to a more tenuous property with a riskier borrower where there is an SPE."

A potential upside of the loosening underwriting standards, aside from easing issuance, is that more lenient criteria are encouraging for refinancing. This will be particularly relevant for those maturing legacy loans written during the market peak.

Ultimately, for all the perceived changes in underwriting standards, Lonski notes that investor appetite is very strong. "The market seems to be coming back and deals are occurring. From the buyer's standpoint, most of the deals that have happened this year seem to have been met with tremendous acceptance, with tranches getting oversubscribed very quickly."

He concludes: "In spite of a perceived slight setback in quality, there has been a diverse set of buyers, which have been out there in very strong numbers. Triple-A bonds have been three or four times oversubscribed and there really appears to be a strong demand for the product."

JL

RMBS

Solid progress

Mix of US mortgage funding sources eyed

The pricing of four non-agency RMBS transactions over the last month suggests solid progress in the space. However, it is becoming clear that the future of mortgage finance in the US depends on a more diverse mix of funding sources.

CSMC Trust 2012-CIM1, Prudential Covered Trust 2012-1, Sequoia Mortgage Trust 2012-2 and Springleaf Mortgage Loan Trust 2012-1 have all priced over the last month (see SCI's deal database). The key to the success of the current crop of private label RMBS originators, such as Redwood Trust and Springleaf, is their ability to selectively cherry-pick assets from a variety of sources to create a portfolio that meets both rating agency and investor demands. The pools typically comprise full documentation loans, with conservative underwriting standards and the occasional jumbo mortgage loan to boost yields.

Indeed, the SEMT transactions are widely seen as a proxy for the new underwriting standard that has emerged in the US non-agency RMBS sector (see also box). Structured product strategists at FTN Financial note that compared to the 2003/2004 vintage, 2010/2011 deals have: almost zero delinquencies/modifications and no realised losses so far; much faster lifetime voluntary CPRs; much higher FICO scores and average loan balances; slightly higher IO percentages; and virtually no low-doc loans.

However, current low origination volumes - especially of loans that have these characteristics - effectively cap the number of issuers active in the sector. "Good quality borrowers already have mortgages and are likely to have refinanced down, so the number of new borrowers will naturally be limited. Slightly looser underwriting standards could widen the borrower base, but this will only occur once consumer balance sheets are cleaned up and economic metrics improve," notes Dan Castro, a structured finance consultant.

The FTN strategists agree: "If this is truly the future of the non-agency RMBS market, it is going to be a very small one indeed. There just are not that many 750-plus FICO, US$750,000-plus average loan balance 1-4 family loans out there to securitise. There are potentially a few more deals to do, but this is not the face of the future of mortgage finance in the US."

While the four newly-issued transactions are indicative of the current state of the US RMBS market, it amounts to "pruning around the edges" without any direction on the next new phase, the strategists add. "The RMBS market desperately needs legislative and regulatory support and clarification if the intention is to allow a private market - whether in covered bond or RMBS form - to flourish," they say.

Certainly another factor affecting origination is competition with agency mortgages, which effectively have zero credit risk due to the government guarantee. "The reality is that there are no longer any subprime mortgages to speak of - the GSEs have cornered this market. It's simply too easy for borrowers to choose the agency route," Castro observes.

Panellists at a recent S&P conference agreed that the private-label RMBS market is unlikely to revive in earnest until the housing market is no longer a drag on the economy and the GSEs undergo reforms. The GSEs have absorbed roughly 95% of total mortgage loan originations through purchases and guarantees and generated nearly 100% of RMBS new issuance since 2007. They now account for 56% of the total US$10.3trn in US residential mortgage debt outstanding at the end of 2011.

The panellists believe that the future of mortgage finance will probably ultimately include a diverse mix of funding sources, including private-label RMBS, as well as covered bonds, REITs, bank direct investments, other sources of private capital and likely some sort of hybrid government- and privately-guaranteed mortgages. It has also been suggested that REITs could step in to fill some of the funding gap (SCI 13 April 2011).

But Lisa Sarajian, md and analytical manager in S&P's real estate companies group, said that this is unlikely to occur in a meaningful way because of current low mortgage interest rates and the spread investment nature of equity and mortgage REIT vehicles. She noted, however, that REITs could begin investing in previously foreclosed homes-for-rent, which could help stabilise house prices.

Castro reckons that deal economics is the biggest obstacle for the US private label RMBS market at present. He cites as an example the Springleaf 2012-1 transaction, for which credit enhancement was sized at 45% for the senior classes of notes.

"Credit enhancement at these levels is required by rating agencies, but is tough in terms of deal economics, given current low mortgage coupons," Castro explains. "For more issuers to enter the market, there needs to be a greater differential between underlying rates and where investors get paid. However, mortgage rates are unlikely to increase any time soon."

He adds that even if all of these barriers were removed, the size of the private label mortgage market can be expected, at best, to only be half the size it was at its peak in 2007.

In the meantime, appetite remains for resecuritisations of previously downgraded RMBS securities. Additionally, real estate owned (REO) for rental programmes may prove to be a way of providing liquidity to the housing market while helping to manage the inventory of foreclosures. Although market participants have yet to propose structures for securitisations in this space, S&P says it is actively reviewing the potential for such transactions.

CS

Structured Finance

SCI Start the Week - 23 April

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

Pipeline
Four new deals joined the pipeline and remained there last week. A US$400m CLO from Sankaty Advisors is marketing (Race Point VI), while there is also a US$103.68m ABS in the market (Conn's Receivables Funding I series 2012-A). In Europe, a €400m auto lease ABS from Athlon Car Lease Nederland (Highway 2012-I) and a UK RMBS deal (Leofric No.1) are also circulating.

Pricings
Once again it was a busy week for pricings. Five auto ABS deals printed last week: US$1bn BMW Vehicle Lease Trust 2012-1; US$1bn FCT Eurotruck Lease II; US$2.038bn Ford Credit Auto Owner Trust 2012-B; US$1.5bn Honda Auto Receivables 2012-2 Owner Trust; and US$514m Wheels SPV 2012-1. One US$753.14m equipment ABS (CIT Equipment Collateral 2012-VT1) also priced.
Three CLOs printed as well: US$356m Marathon CLO IV; US$307.86m NXT Capital CLO 2012-1; and US$623.75m Symphony CLO IX. Finally, two CMBS priced: US$412m Fontainebleau Miami Beach Trust 2012 Series 2012-FBLU and US$1.1bn JPMorgan Chase 2012-C6 Commercial Mortgage Pass-Through Certificates.

Markets
It was "a bumper week" for the CLO market, say JPMorgan CLO analysts. The primary market saw three CLOs totalling US$1.3bn pricing. CLO credit performance is improving in the US, while they note that European CLO deterioration also appears to be stabilising.

Meanwhile, the agency RMBS market remained roughly flat over the week, leading Barclays Capital securitised products analysts to view non-agencies more favourably. In the agency space, they note: "Origination was on the heavier side early in the week and real money buyers remained on the sidelines. Fed purchases remained strong, with purchases of US$7bn over the week."

The US CMBS market saw legacy spreads tighten last week, largely reversing the widening that was seen earlier in the month, report Bank of America Merrill Lynch CMBS strategists. This tightening has come despite light bid-list volume and appears to be dealer-driven. They add that investors "appear to be waiting for next week's MAX CRE CDO sale by the NY Fed before adding any significant risk".

All eyes in the European CMBS market were on the Opera Finance (Uni-Invest) vote last week. Deutsche Bank CMBS analysts believe the credit bid option was the inevitable choice, but are reluctant to draw too many lessons from the resolution for the broader market. A new €625m Vesteda multifamily issuance also caused some excitement in the sector.
 

Deal news
• The New York Fed has initiated a competitive bid process in response to several reverse inquiries for the MAX CDO holdings in the Maiden Lane III portfolio. The move comes amid surging interest in the ABS CDO sector.
• Opera Finance (Uni-Invest) class A noteholders approved the credit bid option presented by TPG and Patron Capital, following their rejection of the consensual restructuring option. Class B, C and D noteholders voted in favour of the latter proposal, but the resolution required approval by 75% of each class.
• Of the large German multifamily CMBS portfolios, only Grand will extend, suggest ABS analysts at Deutsche Bank. The analysts cite GAGFAH's recent upbeat conference call on both the €1.1bn WOBA loan (split equally between WINDM IX and DECO 2007 E5X) and the €2.2bn GAGFAH 1 loan (securitised in GRF 2006-1), which mature in 2013, as a basis for this view.
• The sale of the final remaining two properties under the Keops loan, securitised in Juno (Eclipse 2007-2), has resulted in the full repayment of the outstanding amount of the senior loan. The loan was outstanding by €13.35m-equivalent - accounting for 3.09% of the pool - before the repayment.
• THL Credit Advisors is set to acquire McDonnell Investment Management's Alternative Credit Strategies (ACS) group. ACS manages approximately US$2.5bn in broadly syndicated bank loan and high yield bond assets in CLOs, separate account, long-only and opportunistic fund formats.
• Torchlight Debt Opportunity Fund II, the directing certificate holder on GECMC 2007-C1, intends to exercise its rights pursuant to Section 7.01(c) of the Pooling and Servicing Agreement (PSA) to replace LNR Partners as the special servicer and to appoint Torchlight Loan Services as the successor special servicer.
• A €6m senior bond issued by Geipel, which was purchased by PULS CDO 2007-1, has been declared as a defaulted obligation under the transaction's definitions. The move is in response to the lack of clarity around the company and whether it will meet its payment obligations in the future.
• HCA, the fourth largest CLO holding, is launching a loan extension. Securitisation analysts at S&P view the move as a credit negative for some transactions.

Regulatory update
• The SEC has adopted a new rule to define a series of terms related to the OTC swaps market. The rules, written jointly with the CFTC, implement provisions of the Dodd-Frank Act that established a comprehensive framework for regulating derivatives.
• In a comment letter filed with the CFTC on its proposed Volcker Rule, SIFMA and other financial trade associations reiterated the view that the proposal may unnecessarily constrain permitted activities, including market making, reducing liquidity in many markets and thus harming the US economy.
• IOSCO has asked for comments on a series of questions about structured finance surveillance, one of which is whether variations in disclosure increase uncertainty and lack of comparability for investors. Fitch believes differences in the quality and quantity of information reported, as well as the definitions used, makes it harder to directly compare performance.
• IOSCO and CPSS have published three documents that promote global efforts to strengthen financial market infrastructures (FMIs). These are: a report entitled 'Principles for financial market infrastructures'; a consultation paper on an assessment methodology for these new standards; and a consultation paper on a disclosure framework for the standards.

Deals added to the SCI database last week:
A5 Funding CLO
AmeriCredit Auto Receivables Trust 2012-2
Bank of America Auto Trust 2012-1
Centro delle Alpi series RMBS 2012-1
Discover Card Execution Note Trust 2012-2
EMOT 2012-1
Fraser Sullivan CLO VII
GE Capital Credit Card Master Note Trust series 2012-3
Holmes Master Issuer series 2012-2
ICE Global Credit CLO
Rialto Capital series 2012-LT1
Springleaf Mortgage Loan Trust 2012-1
Textainer Marine Containers series 2012-1
Toyota Auto Receivables Owner Trust 2012-A

Deals added to the SCI CMBS Loan Events database last week:
BACM 07-2, BSCMS 07-PW16, MSC 07-IQ14 & 07-HQ12, WBCMT 07-C31 & 07-C32; CGCMT 07-C6 & 06-C5, CWCI 06-C1 & 07-C2, CD 06-CD3 & 07-CD4; CSFB 2003-CPN1; ECLIP 2007-2A; GCCFC 2002-C1; GSMS 2007-GG10; JPMCC 2007-LD11; LBUBS 06-C6 & 05-C7; LBUBS 2007-C6; Lehman 2007-LLF C5; MLCFC 2006-4; MLCFC 2007-6; OPERA UNI; TITN 2007-3X; TMAN 7; and WINDM XIV.

Top stories to come in SCI:
US CMBS underwriting trends
Credit hedge fund activity
Counterparty risk management survey
Outlook for US private label RMBS
Structured credit recruitment trends

Risk Management

Regulatory inconsistencies muddle CVA mandates

Inconsistent approaches between accounting and regulatory authorities appear to be creating confusion over the mandate of CVA desks. Accounting standards focus on managing P&L volatility, while the Basel 3 CVA charge means that capital optimisation is a priority for many.

"There is tension between whether CVA desks are principally for P&L management or for optimising regulatory capital charges," confirms Alexandre Bon, head of credit risk at Murex. "The two objectives are hardly compatible, predominantly because the regulatory charge - which is supposed to put aside a capital buffer that will absorb mark-to-market losses on the CVA component in times of market stress - uses a different definition of CVA to the one in the latest accounting norms (FAS 157 topic 820 and now even IFRS 13), which warrant the use of DVA."

He cites a simplistic example of an average bank with relatively balanced CVA versus DVA positions. When a systemic stress causes credit spreads to rise, the accounting P&L can remain reasonably balanced since a DVA gain will offset the CVA loss.

Nevertheless, the bank would still be required to hold a significant capital buffer against that scenario, since the CVA charge focuses only on the CVA volatility. But if the bank had pure credit-spread CVA hedges in place for capital relief, it would experience larger P&L swings as the hedges move in the same direction as the DVA - which is ironically what the CVA charge was meant to cover.

Other such inconsistencies include the exclusion of sovereign and some corporate positions from the CVA charge under CRD 4, which is currently under discussion, according to Bon. "This would reduce very materially the CVA charge for European institutions and should help prevent future sovereign CDS feedback loops induced by CVA hedging," he notes.

He adds: "Whether other jurisdictions will follow that path and adjust the Basel 3 CVA charge is clearly not obvious, since removing the sovereign risk from the equation undermines the whole idea of the CVA charge, given that sovereign spreads represent a major exposure for most CVA desks. But in that case, this regulatory discrepancy would provide a real competitive advantage to EU-based operations."

CS

Insurance-linked securities

Seeking yield

John Wells, chairman of Leadenhall Capital Partners, forecasts increasing demand for and issuance of catastrophe bonds in Q2

2011 will go down in history as one of the costliest years on record for insured losses from natural catastrophes, with Swiss Re estimating it to be the second worst to date, given losses of around US$116bn. With global news media focusing on an astonishing array of earthquakes, tsunamis, floods and tornadoes that have severely dented the balance sheets of insurance businesses around the world, investors could be forgiven for thinking that putting their money into insurance-linked investments was a bad idea.

As counterintuitive as it may seem, even in the face of last year's extraordinary losses for the insurance industry, insurance-linked securities (ILS) - including catastrophe bonds - are continuing to deliver excellent results. They have certainly showed a markedly better performance than both equities and fixed income investments. The Swiss Re BB Catastrophe Bond Index has shown that between its launch in 2002 and the end of 2011, cat bonds have delivered average returns of around 9% per annum.

The first quarter of 2012 has seen record numbers of cat bonds issued. Figures from Aon Benfield in April show that ILS achieved a record US$1.49bn first quarter issuance - the highest figure ever recorded, as investors deployed additional capital into the sector.

Cat bonds and other ILS are instruments that allow insurance companies to transfer some of the risk linked to catastrophic events, such as major earthquakes or windstorms, to investors in the capital markets. The bonds are created through SPVs, which are then sold on to investors with the capital held in trust, usually for three years, although some are as short as one year.

An increasing number of institutional investors such as pension funds are turning to ILS because of the attractive returns and because they help to diversify their portfolios away from poorly performing equities markets and the comparatively low returns of fixed income investments. At a time of extreme uncertainty and volatility in the equities markets, the low correlation of cat bonds to these markets makes them a very attractive asset class for institutional investors.

In the event of a catastrophe, an insurance company will pay out claims using its own funds, supplemented, if necessary, by any reinsurance cover it has purchased. It is only in very extreme events, when all the normal sources of insurance and lower levels of reinsurance cover have been exhausted, that a cat bond is triggered and investors face losing some or all of their capital.

In most cases the likelihood that a weather event is so extreme that it results in a cat bond being triggered is very remote. According to statistics from Willis Group, only nine cat bonds out of 194 issued between 1996 and March of this year have been triggered.

Last year, for the first time, three cat bonds were total losses. One was related to Japanese earthquake claims and the other two related to US tornadoes.

Apart from these bonds, the other six that were triggered only had partial losses. Thus, even if an individual cat bond is triggered, a portfolio that is diversified with other insurance-linked instruments may still perform well.

After a big catastrophe such as a US hurricane, premiums on reinsurance normally go up as there is a rush of insurance companies seeking cover, which provides much-needed capital for insurers and reinsurers. As a result, the demand for cat bonds also rises, as do the yields available. In line with this trend, following the record losses in 2011, prices have been rising for catastrophe cover in reinsurance and cat bond issuance has been following apace.

At the annual SIFMA conference on insurance and risk-linked securities in New York in March, estimates of issuance of cat bonds for 2012 ranged from US$5bn to US$7bn, compared to a reported issuance of US$4.3bn in 2011.

Cat bonds are undoubtedly an increasingly attractive asset class for institutional investors, but the cat bond market itself is relatively small, worth around an estimated US$14bn-US$15bn. To put that in context, the global property catastrophe reinsurance market is worth an estimated US$400bn-US$500bn, and private placement on notes and reinsurance derivatives is about US$30bn-US$35bn.

Because of the attractive returns and low correlation to other markets, more and more investors are taking an interest in cat bonds and the wider range of ILS and we are seeing this interest crystallise into solid investments in this asset class.

Over the past three years, investors have realised that returns from property and casualty reinsurance are attractive, and we are confident demand for ILS will continue to grow because uncertainty in both the equity markets and credit markets is simply not going away. For investors who require daily or weekly liquidity, cat bonds are a very good asset class to have in their portfolio.

Other investors seeking an illiquidity premium may want to build in other insurance-related instruments, such as catastrophe swaps and collateralised reinsurance private placements, that provide a wider range of risks than cat bonds and, in some cases, can offer higher rewards. With a lack of yield from traditional markets, going into the second half of the year, we will continue to see more investors looking at ILS as the search for yield goes on.

ABS

Aircraft ABS specialist recruited

Esteban Tripodi has joined Lease Corporation International as evp for the Americas. He will be based in New York, working across the marketing and capital markets divisions for both helicopters and fixed wing aircraft.

Tripodi joins from Aircastle Advisor, where he was capital markets svp. He has previously worked at Guggenheim Capital Markets and began his career as ABS vp at Pegasus Aviation.

ABS

SEC alleges rating agency misrepresentations

The US SEC has charged Egan-Jones Ratings Company (EJR) and its owner and president, Sean Egan, for material misrepresentations and omissions in the company's July 2008 application to register as an NRSRO for issuers of ABS and government securities. EJR and Egan are also charged with misrepresentations in other submissions to the SEC and with NRSRO record keeping and conflict of interest violations.

EJR had already registered as an NRSRO for financial institutions, insurance companies and corporate issuers in 2007. In its 2008 application, the SEC alleges EJR falsely stated that it had 150 outstanding ABS issuer ratings and had been issuing credit ratings for ABS as a credit rating agency on a continuous basis since 1995. At the time of its application it had not issued any such ratings.

The SEC further alleges other misstatements and omissions in submissions to the SEC, including not disclosing that two employees had signed a code of ethics different to the one EJR disclosed and inaccurately stating that EJR did not know whether subscribers were long or short a particular security.

It is also alleged that EJR violated other rules governing NRSROs. The company failed to enforce conflict of interest policies and allowed two analysts to determine credit ratings for issuers whose securities they owned. The company also failed to keep adequate records, including any detailed records of how it determined credit ratings.

Egan is accused of signing submissions to the SEC and certifying that they were "accurate in all significant respects" when he knew that to be untrue. He also failed to ensure EJR's compliance with the record keeping requirements and conflict of interest provisions.

Structured Finance

Trio set up credit hedge fund

A new credit hedge fund is launching to focus on investing in global credit opportunities, with an emphasis on Europe. Meehan Combs is being set up by Eli Combs, Matt Meehan and Jim Plohg and will be based in Greenwich, Connecticut.

Combs will be president of the new firm. He was previously at Alden Global Capital, where he was a founding member and spent four years. He began his career at Goldman Sachs and has also worked for Caxton, Dickstein Partners and Eos Partners.

Meehan, who worked alongside Combs at Eos, will be cio and concurrent portfolio manager. He specialises in the European credit markets and managed Eos' credit opportunities funds from 2004 to 2011 and was credit strategies portfolio manager from 2002 to 2011.

Plohg will be coo and general counsel for the new firm. He was a founding member of Alden alongside Combs and served there as general counsel and chief compliance officer.

Structured Finance

StormHarbour strengthens Spanish coverage

Gonzalo Chocano has joined StormHarbour as a principal and md, responsible for driving client coverage in Spain across the core businesses of sales and trading, structuring and advisory, and capital markets. He is based in StormHarbour's London office and was most recently md of debt markets and head of global futures & derivatives clearing services at Bank of America Merrill Lynch in New York.

Structured Finance

Broker enlists industry vet

Mark Pibl has joined Cortview Capital Markets in New York as md for credit strategy and research. He was most recently at Jefferies, where he held a similar role.

Pibl has two decades of experience in the industry, including structured credit portfolio management roles at NewOak Capital Advisors and Clinton Group and structured credit and securitisation roles at Barclays Capital, Merrill Lynch, JPMorgan and Prudential Securities.

CDS

GFI, QUICK in CDS agreement

GFI Market Data has extended its relationship with QUICK Corp. GFI, which already supplies QUICK with FX options market data, will now also supply credit derivatives market data.

CDS

Capital markets firm forms Asian alliance

TABB Group has announced a new "exclusive strategic alliance" to extend its reach beyond the US and Europe. The firm's new relationship is with Singapore-based AsiaEx Consulting and will expand TABB's research and strategic advisory services to firms across Asia.

AsiaEx specialises in OTC markets as well as futures and options, equities and commodities. It covers the Asia-Pacific region from India to Australasia, including China, Japan, Korea and Southeast Asia.

CLOs

Alternative credit group acquired

THL Credit Advisors is set to acquire McDonnell Investment Management's Alternative Credit Strategies (ACS) group. ACS manages approximately US$2.5bn in broadly syndicated bank loan and high yield bond assets in CLOs, separate account, long-only and opportunistic fund formats.

Led by James Fellows, Brian Good, Robert Hickey and Michael Herzig, the ACS team will join THL Credit Advisors' capital markets investment business to create and lead THL Credit Senior Loan Strategies. The firm will have approximately US$3bn of assets under management and 46 employees following the closing of the transaction.

Risk Management

Insurance co promotes SF specialist

Endurance Specialty Holdings has promoted Nicholas Campbell to evp and chief risk officer. He will be based in Bermuda and report to ceo David Cash.

Campbell is a structured finance and underwriting specialist as well as a trained actuary. Before joining Endurance he was chief risk officer and chief actuary at RCS Limited, working in the structured credit, finance and insurance collateral markets.

RMBS

Subprime originator settles

The US SEC has charged H&R Block subsidiary Option One Mortgage Corporation with misleading subprime RMBS investors in several offerings by failing to disclose its deteriorating financial condition. Option One, now known as Sand Canyon Corporation, has paid US$28.2m to settle the charges.

The SEC says Option One promised to repurchase or replace mortgages that breached reps and warranties for more than US$4bn of RMBS that it sponsored in early 2007. However, it did not tell investors about its worsening financial position at that time or inform them that it could not meet these repurchase obligations on its own.

Option One originated more than US$40bn of subprime loans in its 2006 fiscal year. Although it was generally profitable prior to 2007, the SEC notes that the subprime market decline which started in the summer of 2006 led to hundreds of millions of dollars in margin calls.

The company relied on H&R Block to provide a line of credit in order to meet its margin calls and repurchase obligations, but Block had no obligation to provide that funding. Investors were unaware that Block had never guaranteed the loan repurchase obligations. Moreover, Block was in the process of negotiating a sale of Option One.

Option One has neither admitted nor denied the SEC's allegations, but has agreed to pay disgorgement of US$14.25m, pre-judgement interest of US$3.98m and a penalty of US$10m.

ABS

IOSCO queries SF surveillance

The International Organization of Securities Commissions (IOSCO) has asked for comments on a series of questions about structured finance surveillance, one of which is whether variations in disclosure increase uncertainty and lack of comparability for investors. Fitch believes differences in the quality and quantity of information reported, as well as the definitions used, makes it harder to directly compare performance.

"We believe that complete disclosure should include not only required figures, but the definitions and calculations used to create the reporting. In this way investors can ensure that comparisons between the performance of different deals and particularly across jurisdictions are made on a like-for-like basis," says Fitch. "To take arrears as an example, there are numerous ways the amounts, timing and provisions are defined and these can have a significant effect on the reported numbers."

Some transactions calculate the length of arrears as the time since a missed payment. Other transactions calculate it as payments outstanding divided by the payments due. On a floating rate loan this can alter the reported length of time a borrower has been in arrears. Counter-intuitively if interest rates increase and the payment due goes up, then the length of time the borrower is considered to have been in arrears decreases. In yet other transactions, the length of arrears is calculated from the end of any grace period the bank has extended. This makes borrowers appear as if they are only one month overdue when they may not have made a payment for two months.

The notional amount in arrears can also be reported in different ways, notes Fitch. The industry standard is to report the whole loan as delinquent. In some jurisdictions however, only the size of the missed payment is reported as being delinquent. This makes a large difference to the reported figures.

The last area of difference in arrears reporting is how provisions are calculated. In some transactions, delinquent loans that have been provisioned against are removed from the portfolio. In others, the loan remains and in yet others proportions of the loans are removed depending on the size of the provisioning.

ABS

Non-conforming boost for ABS fund

Volta Finance, the permanent capital vehicle managed by Axa Investment Managers Paris, has reported a March mark-to-market valuation of +139.1% for its ABS positions, thanks in part to six UK non-conforming ABS deals in its portfolio resuming payment of significant cashflows. The value of these six deals increased by €4.7m or €0.15 per share in March.

"Thanks to the Bank of England's low rate policy, even borrowers in significant arrears have shown themselves able to pay substantial parts of their monthly payments and servicers have reduced cases of so-called 'fire-sales' in repossession of homes," notes the company. "As a result, several UK non-conforming deals have seen their reserve funds being replenished and even provided excess spread throughout 2011. This is actually the case now for all but one of Volta's' non-conforming ABS investments; they produced £1.4m in Q411 and £1.3m in 1Q12."

However, the company adds that the borrowers currently paying their monthly instalments remain an issue for these deals and the situation is still far from being resolved. Furthermore, Volta Finance considers that these cashflows remain too volatile and dependant on rates and servicers' policies in the medium term.

"Nevertheless with the global economic situation and low growth forecast, we can reasonably consider that rates will remain at their record low for the following quarters, and the servicers' practices of the past year reassure us they will likely continue to pursue this course of action during the coming months," it adds. "Thus, the decision has been taken to estimate one to three years of current excess spread on these deals, in a reasonably conservative manner, revising the valuation of such UK non-conforming deals that collectively went from €0.2m at the end of February to €4.7m at the end of March."

ABS

Container ABS criteria published

Kroll Bond Rating Agency has released its methodology for rating marine container leasing ABS. KBRA says the criteria are unique because they are the first to be issued by a rating agency that are dedicated exclusively to container leasing ABS.

The methodology incorporates an assessment of the leasing company or manager, the container fleet and the leases included in the securitisation, as well as a legal and structural analysis of the transaction. It also features background on the industry and describes fundamental industry-wide changes that have reduced fleet utilisation volatility and increased cashflow stability.

Structured Finance

MBIA 'transformation' trial scheduled

At the 20 April hearing in the New York State Supreme Court (SCI 10 April), Justice Barbara Kapnick ruled that a trial should take place starting on 14 May in the Article 78 action against MBIA and the New York State Insurance Department (NYID) over the US$5bn restructuring of MBIA Insurance in February 2009. Four weeks have been set aside for the trial, which will take place over four days each week.

Key witnesses will include former NYID Superintendent Eric Dinallo and Jack Buchmiller, the lone NYID employee who reviewed MBIA Insurance's financial condition. Justice Kapnick asked the parties to confer on the other witnesses who would be called.

Structured finance policyholders are asking the court to annul the approval by Dinallo of MBIA's application to the NYID to split MBIA Insurance into a 'healthy' insurer for municipal bond insurance policyholders and a 'dying' insurer for structured finance policyholders. In the three years since the approval of MBIA Insurance's 'transformation', MBIA Insurance 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.

Robert Giuffra, lead counsel for the policyholders and a partner at Sullivan & Cromwell, said after the hearing: "We're confident that, on the law and the evidence, this approval cannot stand. We look forward to proving just that."

Structured Finance

Call for Volcker Rule re-proposal

In a comment letter filed with the CFTC on its proposed Volcker Rule, SIFMA and other financial trade associations reiterated the view that the proposal may unnecessarily constrain permitted activities, including market making, reducing liquidity in many markets and thus harming the US economy.

Among the points made in the letter is that the costs of the proposal substantially outweigh the benefits, with the association noting that the Commission's cost-benefit analysis is insufficient. Further, they state that the swap dealing markets are not well described by the hard-coded criteria in the proposal's permitted activities. These criteria should be recast as guidance incorporated in policies and procedures overseen by the regulators through metrics and examinations.

In addition, the proposal's implementation of the market making-related permitted activity is overly narrow and does not encompass the market making-related activities of Commission-registered swap dealers, according to the letter. The proposal's implementation of risk-mitigating hedging permitted activity is also overly narrow and does not accord with the use of swaps as hedges or congressional intent to maintain the critical swap dealing function of banking entities, it says. Finally, the associations call for the Volcker Rule regulations to be re-proposed before finalising them.

CDO

Trups CDO defaults, deferrals rise slightly

Defaults on US bank Trups CDOs in 1Q12 finished slightly higher than the previous quarter, while deferrals saw a more pronounced increase, according to the latest index results from Fitch. Defaults increased to 16.82% from 16.78%, while deferrals increased to 15.89% from 15.07%. The combined default and deferral rate for bank Trups CDOs rose to 32.71% from 31.85%.

Two new banks defaulted last month, totalling US$15m of collateral in two CDOs. Both banks were previously deferring. Additionally, March saw nine new bank deferrals, representing US$403.75m of collateral in 30 CDOs. Three deferrals, representing US$287m of collateral in 22 CDOs had cured in prior months and are now exercising their option to defer interest payments for a second time.

Fitch also notes that during the month of March five banks, representing US$87m of collateral in nine CDOs, resumed interest payments and repaid accrued interest on their Trups.

Through the end of last month 201 bank issuers, representing approximately US$6.3bn held across 83 Trups CDOs, were in default. Additionally, 376 deferring bank issuers were impacting interest payments on US$6bn of collateral held by 84 Trups CDOs.

CDO

Trups deferral cures anticipated

About one-third of all deferring banks in Trups CDO portfolios have the financial capacity to resume their Trups interest payments and become current on their cumulative deferred interest in the near future, according to Moody's in its latest Structured Credit Perspectives publication. The agency estimates that 370 banks are currently deferring interest on their Trups, affecting 87 Trups CDOs with a total exposure of US$5.8bn.

Since the beginning of 2010, 44 deferring banks in Moody's-rated Trups CDOs have resumed their Trups interest payments, becoming current on their interest payments in 1.5 years on average. These banks have three strong key credit metrics based on 3Q11 financial data: 36, or 82%, have Texas ratios of 50% or less; all have Tier 1 capital ratios between 7% and 21%; and 41, or 93%, ranked high on Moody's internal credit score estimates.

Using these three credit metrics, the agency estimates that of the 370 deferring banks in Moody's-rated Trups CDOs, 123 are in relatively strong financial health, with a Texas ratio of 50% or lower, a Tier 1 capital ratio higher than 7.98% and a credit score equivalent to an average rating of Ba1/Ba2. Moreover, 50 of the 123 banks started deferring interest in 2008-2009 and - since the end of their five-year grace period is approaching - those with strong capital ratios are expected to cure their deferrals.

CDS

Eircom auction scheduled

The auction to settle the credit derivative trades for Eircom LCDS is to be held on 2 May. The move follows Eircom Group's application to the High Court in Dublin for its subsidiary to be placed in Irish examinership.

CDS

Hawker auction scheduled

The auction to settle the credit derivative trades for Hawker Beechcraft Acquisition Company LCDS is to be held on 26 April. A failure to pay credit event was determined on the credit, following the firm's entry into a forbearance agreement with lenders.

CDS

Swap dealer rule credit positive for CDPCs

The CFTC/SEC final rule on swap dealer designation (SCI 19 April) exempts CDPCs and DPCs, at least during its phase-in period. The rule is credit positive for existing CDPCs as it exempts them from collateral posting requirements, but the rule is credit negative for DPCs because it eliminates regulatory minimum capital requirements that the market had expected would apply, according to Moody's latest Weekly Credit Outlook.

The final rule is credit positive for existing CDPCs because it exempts them from collateral posting requirements that might otherwise have exposed them to market value and liquidity risk. As structured now, CDPCs do not post collateral to counterparties. Having to post such collateral - the amount of which would depend on the market value of an entity's CDS portfolio - would expose a CDPC to collateral calls that it might not be able to fulfil.

Moody's notes that in the depths of the financial crisis of 2008, when CDS market valuations were fluctuating wildly, the unrealised market value losses of some CDPCs' CDS exceeded the value of their assets - even though actual credit loss payments were far less and within the CDPCs' capabilities to pay.

Meanwhile, DPCs currently are capitalised only to levels commensurate with their counterparty ratings. The originally proposed exemption threshold of US$100m notional annual trading volume would have designated many DPCs as swap dealers and the regulatory requirements would have enhanced the DPCs' creditworthiness.

The collateral posting rule, however, is not credit negative for DPCs. Unlike CDPCs, they routinely post collateral to counterparties.

In addition, DPCs hedge the market risk of their trades with counterparties by entering into back-to-back trades with their sponsors. Sponsors post collateral to DPCs if the back-to-back trades are in-the-money from the perspective of the DPC.

As a DPC's trading volume increases, it could exceed the rule's threshold and cause the vehicle to become a regulated swap dealer. Given the current level of their annual transaction volume, existing CPDCs and DPCs are all exempt from the designation of swap dealers.

To be exempt, the aggregate gross notional amount of the swaps an entity has entered into over the prior 12 months in connection with transaction activities must not exceed US$8bn during the initial phase-in period and US$3bn thereafter.

CDS

CDS Marketplace enhanced

ISDA's CDS Marketplace has been strengthened by the addition of Fitch Solutions' CDS pricing data, liquidity scores, indices, market commentaries and implied ratings. This means that users of the website now have access to relevant data from all the leading CDS data providers in one place.

"The inclusion of Fitch Solutions' CDS pricing data, liquidity scores, indices and implied ratings on ISDA CDS Marketplace provides users with further new insights into the direction of credit risk and also helps increase transparency within the global credit derivatives market," comments Ian Rothery, Fitch Solutions' global head of third-party distribution and partnerships. "It also enables us to broaden market access to Fitch Solutions' credit risk and research products and services."

CDS

Swap terms defined

The SEC has adopted a new rule to define a series of terms related to the OTC swaps market. The rules, written jointly with the CFTC, implement provisions of the Dodd-Frank Act that established a comprehensive framework for regulating derivatives.

The joint rules define the terms 'security-based swap dealer' and 'major security-based swap participant' as part of the Securities Exchange Act of 1934. In developing these definitions, the SEC staff was informed by existing information regarding the single name CDS market, which will constitute the vast majority of security-based swaps. They also relied on the dealer-trader distinction, which informs determinations regarding dealer status in the traditional securities market and which already is used by participants in that market.

The final rule will become effective 60 days after the date of publication in the Federal Register.

CDS

Sino-Forest auction due

The auction to settle the credit derivative trades for Sino-Forest Corporation CDS is to be held on 9 May. This follows the determination of a bankruptcy credit event by ISDA's Asia Ex-Japan Credit Derivatives Determinations Committee.

CLOs

Bicent default hits CLOs

Bicent Power, which has exposure in 80 CLOs, defaulted last Friday after a missed debt payment. Securitisation analysts at S&P note that this is a slight credit negative for deals with exposure.

No transaction has more than 2.1% in the credit and six have more than 1%. CLOs hold a little more than 60% of Bicent's US$130m second-lien loan due June 2014, S&P estimates.

In February, the agency downgraded the credit from triple-C plus to double-C after an unfavourable arbitration, which requires a US$21m payment from the issuer. The default raises the S&P/LSTA Leveraged Loan Index default rate to 0.93% by issuer count and 0.61% by principal amount.

CLOs

Investors debate SME CLO supply

Investors that are willing to invest in SME CLOs alongside other structured finance asset classes have cited concerns about a lack of liquidity on the secondary market that could prevent or delay investment.

In a recent seminar hosted by Fitch, investors also indicated a general lack of triple-A SME CLO supply as most European SME CLO transactions are retained by originators for use as ECB repo collateral. At present, retained transactions for repo collateral tend to offer a more economic funding option for the originator compared to selling the senior tranche at current market spreads.

However, a recently-issued SME CLO from Lloyds TSB Bank - Sandown Gold 2012-1 (see SCI database) - has witnessed significant market interest in the class A notes, according to Lloyds.

CLOs

Vintage CLOs targeted in loan refi

Ineos, one of the largest obligors in the CLO universe, is set to refinance about US$3.6bn of its outstanding senior loan facilities via a combination of a US$1.5bn cov-lite loan issue and a US$2.2bn secured bond issue. A total of 107 CLOs hold €624m of the issuer's existing term loan debt, of which 41 - equivalent to circa 33.84% of the TLB loan debt holders or €211bn - will not be able to reinvest in the refinanced debt due to the end of their reinvestment periods, according to CLO analysts at RBS.

However, a US$300m three-year term loan tranche is said to have been specifically carved out of the six-year cov-lite term loan in order to target older vintage CLO vehicles. Structured finance analysts at S&P note that Ineos is the fifth corporate issuer to shop a loan with a tranche targeting CLOs nearing the end of reinvestment periods, following First Data, Gettyimages and Infor in 2012, and Kinetic Concepts last year.

CLOs

Clio buy-back agreed

A sale agreement with the noteholders of Clio European CLO has been completed, pursuant to which all of the debt assets in the portfolio were sold to the noteholders. Noteholders surrendered to the issuer €179.27m class A1 notes, €59.38m class B notes, €39.1m class C notes and €134.71m subordinated notes with a principal amount outstanding equal to €412.47m. These notes were subsequently cancelled.

Deloitte, acting as receiver on the transaction, has retained funds to cover the costs of the receivership and by way of provision against various contingencies. It is unclear at this time whether any further distribution will be payable from this retention, however.

CMBS

EMEA CMBS loan transfers continue apace

The total number of loans in special servicing across EMEA CMBS large multi-borrower and single-borrower transactions monitored by Moody's decreased by one loan to 132 as of end-March, according to the agency's monthly update on the sector. Two loans were newly transferred during the month, while three loans have been removed from special servicing as their workouts were completed.

Among the highlights for the month was the transfer of the €431m MPC Portfolio loan (securitised in Titan Europe 2007-2) to special servicing (see SCI's CMBS Loan Events database). With a whole loan-to-value ratio of 155%, the loan was not refinanced by its maturity date in January 2012.

It has been the subject of restructuring discussions for several months and was granted a temporary extension by the primary servicer until April 2012. However, due to the lack of a consensual restructuring and an imminent risk of default at the extended maturity date, the loan was transferred into special servicing.

Another highlight was the announcement of the final recovery determination of the SQY Ouest loan securitised in Titan Europe 2006-3 (originally €110m), since the special servicer decided not to pursue a valuation negligence claim.

The underlying property was sold in February 2011 and recoveries were allocated to the class A notes of the issuer. The loss on the loan (74% severity) will result in a write-down of classes H, G, F and class E notes (partially) of the issuer.

Meanwhile, following a transfer into special servicing in February 2012, the Ventura Park Loan securitised in Titan Europe 2007-3 was worked out via a discounted pay-off. A principal loss of £9m (31% severity) has been realised on the loan and will be borne by the class D and E notes.

Recent repayments and prepayments of loans contributed to the increasing share of non-performing loans in EMEA CMBS, according to Moody's. The balance of specially serviced loans reached almost 18% of the total volume of loans captured in the report as per end of March 2012. The weighted average Moody's Expected Principal Loss for loans in special servicing is 36%.

CMBS

Significant loss for Gullwing loan

The final property in the Gullwing Portfolio, securitised in the Eclipse 2007-1 CMBS, was sold on 18 April. Trepp expects the loan to be hit with a loss of more than 75% as a result.

The Gullwing Portfolio is the tenth largest loan in ECLIP 2007-1A, with a current balance of £10.18m and an original maturity date of 17 January 2011. The loan was backed by three UK industrial properties located in Stockport, Runcorn and Blythe.

Following an EOD, due to failing to repay in full at maturity, LPA Receivers were appointed to facilitate the disposal of the properties. The Stockport property sale was completed on 12 December at the gross sale price of £3.22m (see SCI's CMBS Loan Events database). Recovery principal of £2.95m was applied to the loan on the January IPD.

The Runcorn property sale was completed on 2 March at the gross sale price of £675,000. The sale of the final property at Blythe was completed at the gross sale price of £1.85m.

Expected proceeds from the Runcorn and Blythe properties will result in a principal loss of approximately £7.66m or 75% of the current loan balance, according to Trepp. This is expected to result in the balance of class D notes being written down to £42.5m or around 15% of the outstanding class D balance.

CMBS

Maryland Multifamily on watchlist

Morningstar has added the US$340m Maryland Multifamily Portfolio to its watchlist for near-term maturity. The senior debt is pari passu across two CMBS transactions - Greenwich Capital Commercial Funding Corp Series 2005-GG5 (accounting for US$200m of the deal) and GS Mortgage Securities Trust 2006-GG6 (US$140m).

Net cashflow DSCR for the 12-month period ended 31 December 2011 ranged from 1.28x to 1.83x across the nine properties collateralising the loan, with a weighted average of 1.58x. Net cashflow for the same 12 months was US$28.5m for the entire portfolio. Occupancy was reported at 94%, as of 31 December.

The NCF DSCRs for the 12 months ended 31 December 2010 ranged from 1.29x to 1.72x, with a weighted average of 1.47x. Net cashflow for the same 12 months was US$26.5m for the nine properties. Occupancy was reported at 94% at the end of the period.

The seven-year fixed rate interest-only loan has an interest rate of 5.22% and is scheduled to mature in July. Appraisals conducted between March and May 2005 valued the portfolio at US$447.68m (US$81,000/unit), which yielded a 76% LTV at issuance.

Morningstar considers the scheduled balloon date a low to moderate maturity concern based on the size of the whole loan and the availability of funds to take out the debt. While the strength of the sponsors (Sawyer Realty Holdings and Lubert-Adler Capital Real Estate Fund III) mitigates some risk, the agency's conservative preliminary analysis of the collateral yields a value of about US$324m (US$59,000/unit), suggesting a US$16m value deficiency on the senior securitised debt.

This preliminary analysis was based on a stressed 8.5% cap rate and blended year-end 2010 and 2011 net cashflow results. If a 7% cap is applied to the blended net cashflow, it yields a value of about US$392.5m (US$71,000/unit).

"Although there is not a value deficiency when considering the lower cap rate, there is some concern over the high 87% LTV for the portfolio," Morningstar concludes.

CMBS

Special servicer switched

Torchlight Debt Opportunity Fund II, the directing certificate holder on GE Commercial Mortgage Corporation Commercial Mortgage Pass-Through Certificates Series 2007-C1 (GECMC 2007-C1), intends to exercise its rights pursuant to Section 7.01(c) of the Pooling and Servicing Agreement (PSA) to replace LNR Partners as the special servicer and to appoint Torchlight Loan Services as the successor special servicer.

Moody's has reviewed the proposal and says that, at this time, replacement will not result in a downgrade, withdrawal or qualification of the current ratings to any class of certificates rated by Moody's on the transaction.

CMBS

Strong recovery seen in Japanese property sales

Fitch expects the Japanese property sales market to remain active in 2012, based on a strong recovery in property sales in 2H11. The total value of properties sold from Fitch-rated Japanese CMBS portfolios throughout 2011 exceeded that of 2010 by ¥22bn and in 4Q11 alone was ¥76bn - the highest since 1Q09.

"Although residential and office properties comprised the majority of sales in 2011, other property types - including retail and hotels - accounted for a larger share of the total than in the preceding two years. Furthermore, the concentration of sold properties in Tokyo has gradually reduced," comments Naoki Saito, director in Fitch's Japanese structured finance team. "The increased interest among real estate investors across property type or location will facilitate the sale of the remaining properties."

Sales values in 2011 were on average 40% lower than Fitch's initial expectations. The agency believes that this fall was exacerbated by the majority of sales being made on properties where the underlying loan had defaulted.

However, two-thirds of sold properties backing defaulted loans saw higher values than the Fitch value adopted in its latest rating action for the respective transactions. Properties sold with values that were 10% or more lower than the latest Fitch valuation accounted for 10% of sold properties backing defaulted loans.

Capitalisation rates of sold properties were lower in 2011 than 2010 and 2009. This reflects the reduced risk premium for real estate investment and is an indication that the Japanese property market is approaching its bottom, according to Fitch. Cap rates for office properties in Tokyo also remained higher than those for residential properties, reflecting relatively higher volatility in office property cashflow.

Since June 2008, 90% of properties backing defaulted loans have been sold within 24 months of the default date. Of properties that remain in the workout process, 45% have been in workout in excess of 12 months. However, these include properties for which servicers have already found prospective buyers and which are likely to be sold in the near future.

CMBS

Rise in NPL CMBS volume predicted

The recent Rialto securitisation of non-performing commercial real estate (CRE) loans represents the beginning of a trend, according to Fitch, given the volume of distressed CRE lingering with servicers and lenders and the increased use of loan sales to dispose of troubled CRE loans.

Since 1Q09, US$161bn of CMBS loans have been transferred to special servicing and, since 2010, the volume of loans in special servicing has consistently exceeded US$90bn. Bank balance sheets also contain a significant volume of non-performing CRE loans; for FDIC-insured institutions, approximately US$77.7bn were non-current at the end of 2011. Over the next five years, as the worst performing and peak origination vintage loans reach maturity, Fitch expects the pressure on lenders and servicers to work out loans to intensify.

While common resolution strategies for troubled CRE loans include modification, foreclosure and liquidation, discounted payoff and loan sales, the agency has observed an increased use of loan sales, particularly for smaller balance loans. Bulk purchases of non- and sub-performing loans are the most likely candidates for non-performing loan (NPL) securitisations and Fitch expects near-term NPL transactions to originate with investor purchases of troubled bank loan portfolios.

Earlier in the financial crisis, lenders were slow to conclude loan sales, given bank capitalisation issues and to accept losses based on heavily discounted purchase offers. As banks' capitalisation has improved and property values have stabilised, loan sale resolutions may be increasingly favoured given the certainty of recovery and recovery timing and the ability to avoid adding workout staff relative to other resolution strategies.

As investors acquire portfolios of troubled loans, NPL securitisation provides efficient matched-term financing and even modest leverage can significantly enhance returns, Fitch concludes.

CMBS

Fannie Mae sees robust multifamily issuance

Fannie Mae issued US$7.1bn of multifamily MBS in 1Q12 backed by new multifamily loans. The agency also resecuritised US$2.6bn of DUS MBS through its Fannie Mae Guaranteed Multifamily Structures (Fannie Mae GeMS) programme in the first quarter.

"The strength of the Agency CMBS market is evidenced by robust volumes coincident with improving credit quality," says Kimberly Johnson, Fannie Mae vp of multifamily capital markets. "Issuance in the first quarter of this year is up 44% over last year's first quarter, and outstanding Multifamily MBS is nearly US$110bn. Resecuritisation activity is also increasing. We are on pace to exceed US$10bn in GeMS issuance this year."

"Fundamentals in the rental housing market remain strong. New construction is subdued and tight supply is supporting rent growth as vacancy rates continue to decline," adds Jeff Hayward, Fannie Mae svp and head of multifamily.

Fannie Mae's DUS MBS securities provide market participants with easily-modelled cash flows and call protection in defined maturities of five, seven and ten years. Fannie Mae's GeMS programme consists of structured multifamily securities created from collateral specifically selected by Fannie Mae Capital Markets. Features of Fannie Mae GeMS have included block size transactions, collateral diversity and pricing close to par through Fannie Mae's multifamily REMICs (ACES) and multifamily Mega securities.

CMBS

EMEA CMBS subordination scrutinised

Widespread structural flaws in EMEA CMBS transactions undermine the intended subordination of junior to senior noteholders, Fitch notes.

In particular, loans failing to repay at maturity expose senior noteholders to interest rate risk. This is not allocated solely to junior investors by standard priorities of payments, which tend to be separate for interest and principal.

The underlying interest rate risk associated with floating rate funding of largely fixed return property can be contained by adopting structural features frequently seen in other structured finance asset classes, such as principal deficiency ledgers and combined waterfalls, according to the agency.

Risk Management

Bank credit risk indicators launched

Fitch Solutions has launched a new suite of bank credit risk indicators to assist credit risk managers, CVA desks and corporate treasurers in managing their regulatory, capital adequacy and risk mitigation requirements. The suite of proprietary data will allow subscribers to manage their levels of credit and counterparty risk exposure towards financial institutions.

The offering comprises bank financial data and credit ratings, along with additional credit risk indicators - including financial implied ratings, implied CDS spreads and CDS indices - to validate and benchmark results from internal models. The set of credit risk indicators is delivered via an integrated data delivery platform, enabling easy integration into internal systems.

Risk Management

Counterparty risk rebalancing tool prepped

TriOptima has developed a new post-trade service that mitigates risk concentration which emerges because credit exposure of cleared trades can no longer be netted against bilateral trades across different asset classes that are ineligible for clearing. Dubbed triBalance, the platform aims to reduce sources of contagion risk in both cleared and bilateral counterparty relationships by rebalancing counterparty credit risk exposure driven by future market movements.

In collaboration with nine OTC derivative dealers, pilot tests of triBalance reduced counterparty risk exposure in the participants' portfolios of cleared and uncleared trades by 33%. The service generated an aggregated reduction of US$2.7bn in potential future exposure across the participants, assuming a 10bp move in interest rates. In periods of extreme market volatility, the potential risk reduction is expected to be even greater.

Utilising the TriOptima multilateral optimisation engine, triBalance calculates an optimal counterparty risk-reducing set of rebalancing trades for all participants to execute that offsets existing risk versus central clearing counterparties (CCPs) and bilateral counterparties simultaneously. The firm says that reducing risk exposure to bilateral counterparties and CCPs will reduce initial margin requirements, regulatory capital, margin volatility, CVA hedging costs and close-out risk while contributing to a decrease in systemic risk and a simplification of the CCP's default management process. triBalance cycles will be held periodically to reduce and maintain a low potential future exposure to market movements.

RMBS

Discounted sales weigh on Spanish RMBS

Fitch reports that achieved sales prices on repossessed properties in Spain are 48% lower, on average, than the valuations conducted at the time of loan origination. The agency has analysed loan-by-loan repossession data on Fitch-rated Spanish structured finance transactions, the majority of which relates to residential properties.

"The significant discount of achieved sale prices from initial valuations reflects the distressed property market conditions. Downward pressure on values is set to remain as home prices are still high relative to average incomes, credit is in short supply and there is a huge overhang of unsold stock," says Carlos Masip, director in Fitch's RMBS team in Madrid.

The agency notes that the analysed data is entirely comprised of transactions resulting from distressed loans; in addition, the majority of the properties are associated with loans with high original LTV ratios and origination dates in 2005 and 2006. To a certain extent, these characteristics can explain the large gap between the observed value declines and those implied by the House Price Index (HPI). Nonetheless, the differential is significant enough that it cannot be entirely explained by variations between the dataset of repossessed properties and those included in the HPI.

"Fitch expects property prices to continue falling, due to the recessionary environment and severe dislocation of the Spanish property market," says Juan David Garcia, senior director and head of Fitch's structured finance team in Spain. "The speed of the additional correction in prices will largely be driven by financial institutions' foreclosure management strategies."

RMBS

Short sales positive for US RMBS

The trend towards more short sales of distressed residential real estate loans in the US is gaining momentum, according to Fitch. The Federal Housing Finance Agency's (FHFA) recent announcement that government-sponsored enterprises (GSEs) will implement rules to expedite short sales should further drive activity.

"Expanded use of short sales could be positive for RMBS trusts, as this strategy could improve and shorten liquidations and lower loss severities," says the rating agency. On Tuesday 17 April, Lender Processing Services Inc. announced that the number of short sales exceeded the number of foreclosures for the first time in January.

Fitch expects the increase in short sales to continue because of the potential benefits afforded to both lenders and borrowers. Some borrowers may prefer short sales because, though they cannot stay in the property, they often walk away with cash incentives from lenders and healthier credit reports unmarred by foreclosure. For lenders, short sales provide a more efficient and cheaper alternative to the increasingly lengthy and costly foreclosure process.

Short sales on non-agency RMBS are currently getting completed 20 months after the last payment made on the loan, approximately 10 months less than the average time to foreclose. Shorter timelines reduce lenders' carrying costs (i.e. accrued loan interest and property taxes, insurance, and maintenance) and eliminate most of the legal expenses associated with foreclosure and liquidation. As a result, loss severities tend to be considerably lower. Historically, for loans with similar attributes, short sales have severities 10%-15% less than REO sales. As the proportion of short sales increases, we expect average loss severities to improve further.

The FHFA's and GSEs' development of strategies to facilitate short sales, deeds-in-lieu, and deeds-for-lease beginning this June, which include the requirement for final decisions on short sales to be made within 60 calendar days, is likely to speed up this process. Fitch also expects servicers to apply these practices to non-agency mortgages. For this reason, the agency views this as a positive development that could have a favourable impact on US RMBS. Benefits include shorter liquidation timelines and improved loss severities, as well as another alternative that can be helpful in clearing the overhang of distressed inventory that continues to weigh on home prices.

RMBS

Article 77 proceeding gets go-ahead

The Supreme Court of the State of New York determined, at a hearing held yesterday on the US$8.5bn Countrywide settlement, that BNY Mellon can move ahead with an Article 77 proceeding. The alternative would have seen the case being heard through a plenary action.

The Article 77 proceeding is expected to narrow the scope of discovery and shorten the timeframe for the case. But MBS analysts at Barclays Capital suggest that the judge still has a fair amount of discretion on how detailed the discovery could be, with further details on the final review becoming available only in early May.

The other issue at the heart of the hearing was whether the New York and Delaware Attorney Generals would be admitted as intervenors, according to the Barcap analysts. "This is important to the timing of the case because it could extend discovery to issues such as whether the servicing changes proposed are beneficial to borrowers and/or whether the settlement amount is fair compensation. No immediate decision was made, but a final decision is likely in coming weeks."

Overall, the court's decision is considered to be somewhat positive. On one hand, a final decision is unlikely to extend beyond 1-2 years. On the other, it seems likely that even under an Article 77 proceeding, the judge might go with a somewhat broader discovery process than BNYM proposed.

RMBS

Mexican RMBS opportunity outlined

Fitch believes that the origination of Mexican fixed-rate mortgages and their subsequent peso-denominated securitisation presents an opportunity, albeit with some manageable risks.

Mexico's state lender Infonavit announced that it will begin originating fixed-rate mortgages in June. Fitch anticipates that peso-denominated RMBS could follow six to 18 months later. While this effort is being promoted by current President Felipe Calderon, the agency believes the plans should move forward regardless of the results of the Mexican election in July.

Infonavit has issued for eight years and is the biggest issuer in Latin America. The majority of its issuance is in government inflation-linked bonds called Udibonos (Udis). Its most recent entrance to the market was in February when it sold MXN5bn at 4.5%.

Fitch views these types of bonds as exceptional, because the mortgage payments on the debt underlying them are deducted from the mortgage holder's paycheck automatically. This asset class has performed very well during the recent downturn in Mexico: there have been no downgrades, compared to other RMBS transactions that were sponsored by non-bank mortgage originators.

But some risks remain, according to the agency. While the mortgage payments are adjusted by a minimum wage index, the structures are adjusted by Udis constantly. This sometimes leads to a small misalignment due to lags in minimal wage adjustments.

The performance of these assets is highly correlated to unemployment levels, as the automatic deduction removes the willingness to pay. The bigger risks are that these mortgages are typically targeted to lower income borrowers. As Infonavit is a government-sponsored entity, recovery rates are expected to be lower and loss severity higher, as there may be lower incentives to evict these owners.

Fitch expects Infonavit's fixed-rate peso-denominated mortgages to be very well received by potential borrowers. The current overnight rate is 4.5% and the central bank has left it unchanged for the past 25 meetings. Last month, it indicated this rate could possibly be adjusted down in the near future.

RMBS

Take two for DOURM

A second Douro RMBS tender offer from Banco BPI was the highlight of last week's European buy-back news. DOURM sent the focus on peripheral RMBS tenders into overdrive in January with the Portuguese market at the time rallying by 6-7 points, yet ultimate take-up at just 7% of bonds outstanding proved to be disappointing (SCI 17 January).

With prices now around 7%-10% above the first tender levels and the auction itself changed from fixed price to unmodified Dutch auction, participation is expected to be higher this time around. ABS analysts at Deutsche Bank recommend switches out of DOURM paper at 6.5% yield into other Portuguese programmes offering around 10%-11% yield.

"While deal consolidation status is important to consider for tender upside, switching into non-consolidated bonds for a significant pick-up in yield may also prove attractive. In all, we favour more highly enhanced bonds from earlier vintage transactions, such as LUSI 2 and MAGEL 2," they note.

RMBS

ML II prices disclosed

The Federal Reserve last week disclosed the amount it received from Credit Suisse and Goldman Sachs in the Q1 Maiden Lane II auctions. Credit Suisse paid US$6.81bn (52%) on the US$13bn in current face that it purchased in the first and third auctions, while Goldman Sachs paid US$3.53bn (57%) on the US$6.2bn in current face that it purchased in the second auction, according to Barclays Capital figures. Cusip-level prices will be released next month.

Meanwhile, the Fed placed approximately US$680m face value of option ARMs from the Maiden Lane I portfolio out for bid last week. The vehicle was originally created to hold Bear Stearns mortgage-related assets when JPMorgan purchased the bank in March 2008. It holds about US$1.5bn market value of non-agency RMBS, as of 31 December 2011.

RMBS

UK master trusts winding down

Lloyds TSB has reportedly purchased at par plus accrued interest its target amount, which was undisclosed, of Mound and Pendeford RMBS notes under the recent tender offer (SCI 20 March). Together with the redemption of a number of Lothian bonds yesterday, the move is expected to result in the number of UK master trusts dropping from eight to five by the end of the year.

Further issuance from the Mound and Pendeford vehicles is unlikely, albeit Lloyds is expected to ensure that all remaining notes pay according to schedule. The call dates for PENDE 2007-1X 5A and MFPLC 4X 5A are in August and November 2012 respectively, at which point the bonds are anticipated to be redeemed - meaning that all publically placed notes from both programmes will have been paid off.

Similarly, the A3, B, C and D notes from Lothian Mortgages No. 4 - the only notes outstanding from the older issuances - paid off yesterday. Consequently, European ABS analysts at Barclays Capital expect that by the end of the year all non-retained bonds from Mound, Pendeford and Lothian will have paid off. This would leave Arkle, Fosse, Gracechurch, Granite, Holmes, Lanark, Permanent and Silverstone as the only remaining UK RMBS trusts with publicly placed outstanding notes.