Contents

RMBS

High time for hybrids

Agency hybrid ARMs provide compelling investment case

Investors are having to work harder to find value in the US RMBS market. CMOs are becoming steadily less attractive, but agency hybrid ARMs - relatively cheap, with superior yield - could provide a neat solution.

The past couple of years has seen steady agency ARM issuance of around US$1bn-US$2bn a month. "That is a lot less than a few years ago. Between 2003 and 2007 it was a growth product, but now there is only about US$350bn total outstanding, so it is a relatively small product type relative to the fixed agency world," says Alexis Vilimas, FTN Financial Capital Markets strategist.

Hybrid ARMs combine the features of fixed-rate mortgages and ARMs by having a coupon fixed for a certain number of years before resetting annually. Vilimas notes that 5X1s (where the coupon is fixed for five years before annual resets) are most in demand and are issued the most frequently, but 3X1s are popular as well, with 7X1s and even 10X1s also available.

"The important consideration for hybrid ARMs is what the rate environment is at the time that they come to their reset. After five years (or three years for 3X1s), the borrower has to make a decision about whether or not to continue with their ARM piece and reset or whether it makes sense to refinance into a fixed rate or into another ARM," says Vilimas.

Fed chairman Ben Bernanke's pronouncement that rates will not rise until at least 2014 means borrowers are all fully aware of how unattractive a fixed rate is at present. With rates as low as they are, the cost associated with 3X1 borrowers switching to a fixed rate loan is not worth it.

Walter Schmidt, FTN Financial Capital Markets svp, explains: "Even though rates are historically very low, if you are a 3X1 or a 5X1 borrower, once you become fully indexed and reset then you have to pay 150bp or more to go into a fixed rate loan. You also have to pay up 75bp at least to go from your currently indexed rate to a new 3X1. The shape of the yield curve and the way ARMs are being priced relative to fixed mortgages means there is not much incentive there to lock into a fixed rate."

Prepayments on agency hybrid ARMs are considerably higher pre-reset than they are post-reset, precisely because of how unattractive refinancing becomes once the loan has reset. This low level of post-reset prepayments is one of the characteristics that makes the product so attractive.

"The other key attraction comes from a relative value standpoint. Whether you are looking at spreads or available yields, then the CMO market had a lot to offer six to 12 months ago. It was more attractive than the ARM market - or at least the new issue ARM market - but since then banks have been big buyers of CMOs and that product has gotten very expensive," says Schmidt.

The factors weighing in agency hybrid ARMs' favour should provide a compelling case for investors. There could be a couple of explanations as to why they have been slow to get involved.

"Liquidity is an issue. There is really only about US$350bn outstanding and they tend to trade in small pool sizes. A typical pool size for an ARM is around US$20m-US$75m, whereas a typical fixed rate pool is going to be in the hundreds of millions," says Schmidt.

He continues: "The second thing is that prepayments used to be a lot faster than for fixed and that created uncertainty. It is not so much the case anymore, but most fixed income investors have fairly long memories and they remember when ARM speeds were 50 or 60 CPR and fixed speeds were more like 30 or 40 CPR, so you have some of that perception issue as well."

The fact remains though that hybrids are cheap compared to CMOs and post-reset bonds are now prepaying at around 5-15 CPR. A return of interest in the space could even see a TBA market established - a prospect that came close to realisation just before the crisis hit.

"There were proposals put forward to look at quarter coupon increments for the TBA market a few years ago. That came pretty close to launching. But the ARM product became persona non grata for about a year and a half and nobody would issue. If we had had a TBA market, it would have helped liquidity a lot," says Schmidt.

The GSEs have since been less willing to guarantee ARM product, but in a couple of years the situation could have progressed. From an asset/liability standpoint, banks would certainly be in favour of issuing. With the right conditions, a guaranteed ARM product in a few years could be popular enough for a TBA market to be established.

Finally, Schmidt is also seeing far more interest from outside the US for agency MBS more generally. He concludes: "Seven or eight years ago you really could not broach fixed rate MBS with London-based or Frankfurt-based managers, but after the crisis they have come round to thinking that floating rate is not always the greatest option. A lot of investors are starting to visit the fixed rate MBS market. With enough liquidity, that could certainly evolve into looking at a hybrid ARM product."

JL

CMBS

Counterparty issues

CMBS liquidity facility disputes set to rise

Counterparty issues in CMBS have been relatively rare in Europe. But a recent dispute over liquidity facilities could mark the beginning of a series of issues involving the obligations of SPVs in the sector.

Certainly, European securitisation analysts at Deutsche Bank believe that 2012 is the year where the workings of liquidity facilities will come under scrutiny. "In particular, because of the paucity of the description of liquidity facility agreements in offering circulars, we think their workings in practice may cause a great deal of negative surprise to investors (and, we suspect, amongst issuers too)," they note.

HSBC, as liquidity facility provider for Titan 2006-1 and 2006-2, caused a stir earlier this year when it disputed the trustee's decision to use loan recoveries to pay down senior bonds in both transactions rather than pay down outstanding liquidity facilities (see SCI's CMBS loan events database). The liquidity facility was reinstated in the former deal, following an agreement to repay HSBC. But the parties are still discussing how the liquidity facility and cash management agreements should operate going forward for the latter deal.

Assuming that the TITN 06-2 payments were made in error, European asset-backed analysts at RBS indicate that the best possible outcome is for the trustee and HSBC to come to an amicable settlement. This could involve clawing the money back from senior bondholders and paying back HSBC over several quarters, or paying an additional fine or interest.

Alternatively, since an EOD would adversely affect the junior bondholders, another possibility is for them to come up with the cash to make HSBC whole. "In the worst case, having to make a payment of €3m-€4m to HSBC in one period could cause the deal to miss interest payments on the class A bond, which could trigger a note event of default and hence enforcement," the RBS analysts continue. "Given the high LTV of the other loans - Margaux at 101%, Petrus at 111%, Labrador at 91% and Velvet at 154% - this could result in considerable loss to the junior noteholders."

They add: "Finding a solution is complicated by the fact that it has become uneconomical to provide liquidity facilities. As a result, the provider has no incentive to compromise to find a solution."

Meanwhile, S&P has placed three other Titan transactions (TITN 2006-2, 2006-3 and 2006-5) on negative watch due to concerns over potential non-payment of outstanding liquidity draws. In addition, the publication of the investor report for DECO 6 UK2 has shed light on another liquidity facility issue.

The transaction came close to a note EOD on the April IPD. The Deutsche analysts explain that a revaluation of the Brunel loan caused an appraisal reduction, which impacted the ability of the loan to draw on liquidity.

Further, instead of this solely impacting liquidity going forward, it applies retrospectively to liquidity draws already made. Consequently, the repayment caused a shortfall on more senior notes. A one-off adjustment was made and a gradual unwinding of the deferred interest payments is now expected over the coming months.

However, the Deutsche analysts observe that the transaction is very sensitive to retaining its rent-producing assets, given the ability to draw liquidity is severely impacted. "A workout strategy based on retaining rent-producing assets is pretty much the mirror image of what is viewed as the optimal tactic to use in liquidating a defaulted loan, where normally the best assets are sold first, while the worst assets are 'asset managed'," they conclude.

CS

Structured Finance

Slow summer for Euro ABS

It has been a fairly quiet couple of weeks for European ABS, but liquidity could suffer further as the summer progresses. Unfolding events in Greece and the implementation of the ECB's loan-level data initiative are both expected to put a dampener on activity.

"The ABS market has been pretty quiet for a bit and there is not a huge amount of flow, especially in off-the-run names. More liquid paper is down, too - in the RMBS sector, Granite triple-Bs are two or three points lower on the week and the seniors are trading lower as well," reports one trader.

He continues: "Dealers are certainly showing some flexibility on pricing, but - despite that flex - there is still not too much trading at lower levels. For example, in spite of offers of between 1.5-2 points lower than a week or so, the non-conforming market has remained very quiet."

While volumes are "incredibly low", the ongoing JPMorgan saga has stolen some of the limelight from Greece. The trader notes that the bank has been one of the main buyers for senior paper so far this year, so other participants are now waiting to see how its recent troubles affect the market.

He adds: "JPMorgan would not be a buyer of Granite triple-Bs, but the market might move on the back of its potentially precarious situation. Personally, I think the bank will be fine, but that is just my opinion; the rest of the market may disagree."

Looking ahead, the summer is expected to be a quiet and illiquid time for the market because of Greece and ongoing eurozone tension. Post-summer, originators will be focusing on gearing up for the ECB's loan-level data initiative.

The ECB demands will entail a lot of work and expense for many, but the trader notes that the Bank of England's loan-level initiative shows that it can be done. The ECB's version will be more wide-ranging though, because it covers every eurozone bank.

"UK banks that have adopted the BOE's initiative are typically more sophisticated and were already reporting under their master trust programmes, whereas medium-sized European banks will likely struggle with the ECB requirements," says the trader.

He continues: "It is all pointing to a difficult time. If Greece leaves the euro, then anything could happen, but there will be some selling pressure for sure. Where things then settle down is anyone's guess. If Greece does not leave, then we will continue as we are, with a new headline every day and gradually mark things down without really trading at lower levels."

JL

Structured Finance

Redenomination risk analysed

Redenomination risk should be factored into bond valuations for Greece, Ireland and Portugal at the very least, according to European asset-backed analysts at RBS. They outline in recent research a number of potential consequences of any eurozone break-up and redenomination.

First, the RBS analysts note that the immediate consequence of redenomination would be that mortgages - which are local contracts - would be unilaterally redenominated in the new currency. They cite Hungary as one precedent: over half of the US$21.3bn mortgage market in the country was denominated in Swiss francs, but the government recently passed a law allowing borrowers to pay their mortgages in Hungarian Forints at favourable exchange rates (see also SCI 5 March).

A second potential consequence is that euro-denominated bonds that are governed by local laws would be legally changed to the new currency. "Hence, there may be no formal default and waterfall allocations will continue as previously, although investors may only receive a fraction of their investment in euro terms. Most Portuguese and Spanish bonds would fall in this category," the analysts explain.

However, foreign law bonds can only be legally redenominated under a multilateral agreement. In the absence of such an agreement, foreign law bonds seem likely to default in most cases, causing the waterfall to turn sequential.

Greek RMBS are typically issued under English law. But, given the serious consequences of redenomination, the analysts anticipate that multilateral agreements would be established - followed by legislation in all countries concerned, as well as at the European Commission level.

A fourth consequence is that performance can be expected to weaken. As imports become prohibitively expensive and affordability drops, higher levels of delinquencies and defaults in mortgage and other consumer debt are likely in the short to medium term.

The final consequence is currency devaluation. The implications for RMBS investors depend on the degree of depreciation of the currency, according to the analysts.

In terms of currency devaluation, a number of variables should be considered, including the possibility of an over-reaction to redenomination that might take years to stabilise. For example, when Argentina abandoned the dollar peg in 2001, the peso dropped to 3.8 to the US dollar before stabilising at around 2.8.

Fundamental factors, such as net trade and current account balance, are another consideration. The analysts indicate that fundamentals are currently unfavourable for all the peripheral countries, but particularly for Greece.

The impact of monetary policy is also a consideration. Governments will presumably keep interest rates high to minimise the flight of capital.

CS

Structured Finance

SCI Start the Week - 28 May

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

Pipeline
It was another steady week for the pipeline, with seven new deals remaining on Friday. Freddie Mac is in the market with the US$1.213bn FREMF 2012-K708, its seventh K Certificate transaction of the year. It is not the only CMBS circulating, as the US$159.5m S2 Hospitality Series 2012-LV1 is also marketing.

The US$285.5m Garrison Funding 2012-1 was the only CLO to enter the pipeline last week, but it was joined by four ABS - A-BEST 7, Glacier Credit Card Trust series 2012-1, SCARD 2012-1 and MEFA Education Loan Revenue Bonds Issue J Series 2012.

Pricings
The week saw one CMBS, one CLO, five ABS and a single RMBS print. The CMBS transaction was US$270m JPMCC 2012-WLDN, while the CLO was the US$311.46m ECP CLO 2012-4.

Auto deals accounted for the bulk of ABS issued last week, with US$1.224bn Ally Auto Receivables Trust 2012-3, US$419m ARI Fleet Lease Trust 2012-A and A$684.4m-equivalent Series 2012-1E REDS EHP Trust all pricing. These were joined by one equipment deal and one student loan deal - US$632.8m GE Equipment Small Ticket Series 2012-1 and US$1.135bn SLM Private Education Loan Trust 2012-C respectively. The RMBS was the €763.5m STORM 2012-III.

Markets
It was a quiet week in the European markets. European ABS market participants are not sure whether to focus on Greece, JPMorgan's woes or the ECB's upcoming loan-level data initiative, as SCI reported on Thursday.

"It is all pointing to a difficult time. If Greece leaves the euro, then anything could happen, but there will be some selling pressure for sure. Where things then settle down is anyone's guess. If Greece does not leave, then we will continue as we are, with a new headline every day and gradually mark things down without really trading at lower levels," says one trader.

European RMBS saw paper generally trading a couple of points lower on the week. JPMorgan analysts note that for STORM 2012-III - Obvion's third deal of the year - the A1s came at 5bp inside guidance, while the A2s sold at the wide end of guidance. Secondary market activity was limited.

Deutsche Bank analysts note that it was also "a relatively quiet week in the secondary markets" for European CMBS. However, high quality sterling front-pays are still in demand at or around 300 DM.

In US RMBS, meanwhile, agency MBS underperformed, report Barclays Capital analysts. Rate movements calmed down and the 10-year rate ended only "a touch wider" than the week before. Mortgages underperformed and coupons were off five or six ticks against the curve.

"While 15s have given up some ground during the past few weeks, lower coupons staged a moderate comeback relative to 30s. This was especially true for FNCI 2.5s, where the roll heated up. Somewhat surprisingly, though, this demand was driven by REITs and money managers, rather than banks," the analysts note.

The secondary US ABS market was also relatively quiet ahead of the Memorial Day holiday. Several off-the-run student names were offered and met with strong demand. Spreads were 1bp-2bp tighter for auto ABS and generally unchanged elsewhere.

Deal news
• The recent court-approved modification of the Westin Portfolio loan, securitised in JPMCC 2007-C1 and JPMCC 2008-C2, has taken the market by surprise. The modification extends the loan by 15 years and slashes its coupon to zero.
• Freddie Mac has announced US$330m of buyouts from various pools due to the resolution of certain "contractual matters". The move is likely to renew concerns about buyouts driven by policy changes.
• RBC recently filed a registration statement with the US SEC for the first public offer of covered bonds in the US. The filing was made in reliance on a no action letter issued by the SEC staff that addresses the conditions under which the covered bonds could be registered.
• Citi and Credit Suisse emerged as the respective winning bidders for the US$1.67bn Duke High Grade Funding CDO and US$690.5m Putnam Structured Products CDO assets auctioned last week by the New York Fed from its Maiden Lane III portfolio.
• Principal payments for Aire Valley UK RMBS are likely to be disrupted over the next couple of months by a £72.5m reserve drawing to meet the expected maturity date of the last bullet bond in April. European asset-backed analysts at RBS note that the drawing will be recouped from principal receipts (accounting for £30m) and excess spread (£4.6m) until it returns to its £380m target size.
• Restructuring talks for the £429m City Point loan, securitised in Ulysses (ELOC No. 27), have been terminated. The transaction had been subject to restructuring discussions since October 2011 and was granted a number of standstills to remedy the interest payment default (see SCI's CMBS loan events database).
• New York Mortgage Trust (NYMT) has completed a resecuritisation of multifamily CMBS. The REIT received net cash proceeds of approximately US$26.1m after deducting expenses associated with the transaction.
• Morningstar has added the US$53m Ardenwood Corporate Park loan, securitised in CSMC 2007-C3, to its watchlist following a notification from the collateral's largest tenant (Logitech) of an intention to vacate its leased space. The firm accounts for roughly 48% of the gross leasable area (GLA) and 37% of effective gross income (EGI).

Regulatory update
• The FHFA last week released for public comment its strategic plan for 2013-2017. The plan provides more detail on proposals to increase the guarantee fee and create a new securitisation platform.
• The FDIC, as receiver for Citizens National Bank and Strategic Capital Bank, has filed three separate lawsuits against a group of major banks - including JPMorgan, Citi, Bank of America Merrill Lynch, Credit Suisse, Deutsche Bank, Ally Financial, RBS, HSBC and UBS. The agency alleges that the banks made numerous misrepresentations and omissions regarding the credit quality of loans underlying RMBS that they underwrote.
• FINRA has fined Citigroup Global Markets US$3.5m. The fine is for providing inaccurate mortgage performance information, supervisory failures and other violations relating to its subprime RMBS.
• IOSCO's Technical Committee has published a consultation report, describing certain internal controls and procedures that credit rating agencies (CRAs) use to promote the integrity of the credit rating process and address conflicts of interest, with a view to promoting a better understanding of these practices. The views of stakeholders and CRAs on these questions will assist IOSCO with further analysis of the internal controls and procedures used by CRAs, it says.
• ISDA has published a paper entitled 'Netting and Offsetting: Reporting Derivatives Under US GAAP and Under IFRS'. The paper examines how and why derivatives are treated differently under IFRS and US GAAP and their impact on the new Basel 3 leverage ratio.
• The RMBS Working Group has launched a new website to report fraud and established a coordination team to facilitate the various investigations underway around the US.

Deals added to the SCI database last week
BlueMountain CLO 2012-1
Chase Issuance Trust 2012-A1
COMM 2012-CCRE1
Fosse Master Issuer series 2012-1
Gracechurch Card Programme Funding series 2012-3
GSMS 2012-GCJ7
Kramer Van Kirk CLO 2012-1
LCM XI
Nissan Master Owner Trust Receivables Series 2012-A
Nissan Master Owner Trust Receivables Series 2012-B
Sugar Creek CLO
Triton Container Finance III series 2012-1
Venture X CLO

Deals added to the SCI CMBS Loan Events database last week:
BACM 2002-PB2; CSMC 2007-C1; DECO 2007-E5; ECLIP 2007-2; EMC VI; EURO 27; GCCFC 05-GG3 & GSMS 04-GG2; GCCFC 2007-GG9; JPMCC 2005-CB13; JPMCC 2006-LDP9; LBUBS 2007-C1; OPERA CMH; REC 4; TAHIT 1; THEAT 07-1 & 07-2; TITN 2007-CT1; WBCMT 2003-C9; and WINDM XI.

Top stories to come in SCI:
ABS risk management
European CDO update
Valad Europe profile
Leadenhall Capital Partners profile
Corporate trust survey

CMBS

BauBeCon sale sets valuation benchmark

Deutsche Wohnen is set to acquire the BauBeCon Group for a reported €1.24bn. CMBS analysts at Barclays Capital suggest that the purchase provides insight into the achievable value for large German multifamily portfolios of not necessarily prime quality, as well as evidence of debt availability for such assets.

The BauBeCon Group owns approximately 23,500 German multifamily units, of which 82% are in metropolitan areas. The acquisition is expected to be financed through a combination of equity and debt, whereby "an LTV ratio of less than 60% shall be maintained in the mid-term post-completion of the transaction".

A 60% LTV matches what the Barcap analysts believe is currently the available LTV for large German multifamily portfolio financing, given the likely Pfandbrief-eligibility of the loans. Assuming the purchase price is equivalent to the lending value, the new BauBeCon debt would amount to €744m.

The purchase price implies a contracted net rent multiple of 13x for the residential units, with the net cold rent of the portfolio amounting to approximately €95m. A net cold rent multiplier of 12x-13x appears to be the current benchmark for German multifamily portfolio sales, the analysts suggest.

Thus, using a net cold rent multiplier of 12.5x and the most recently reported annual net cold rent, they have extrapolated value estimates for the properties securing other large German multifamily loans. The value of the properties backing the GRAND CMBS, for example, is boosted from €7.71bn (as at March 2006) to €8.28bn based on this scenario.

Further, valuations for the Velvet, Labrador, Petrus and Margaux loans securitised in Titan 2006-2 respectively jump from €134.6m (September 2011), €47.9m (February 2011), €209m (December 2011) and €272m (December 2009) to €169m, €49m, €225m and €290m. However, the value of the Woba Dresden loan - securitised in WINDM IX and DECO 14 - drops from €1.85bn (March 2006) to €1.59bn.

The analysts note that these estimates do not represent their base-case value assumptions for the respective properties due to the paucity of standardised reporting of net cold rent, as well as other factors that purchasers would take into account, such as location, operating costs and necessary capex. "However, assessing the portfolios based on recently traded net cold rent multipliers can provide a preliminary benchmark, in our view," they conclude.

CS

Structured Finance

Capital markets head joins

Neil Wessan has joined CIT Group as head of capital markets, overseeing the structuring, pricing and distribution of all financial products originated by CIT. He reports to corporate finance co-heads Pete Connolly and Jim Hudak.

Wessan joins CIT from Gleacher & Company, where he was also head of capital markets. He was previously founding principal at Halsey Lane Holdings and served as co-head of the leveraged loan capital markets and syndications group at Jefferies.

Structured Finance

Capital markets principal appointed

Adriaan van der Knaap has joined StormHarbour as principal and md. He will be based in New York and assume US financial institutions capital markets responsibility.

Van der Knaap joins from UBS, where he was responsible for coverage of banks, restructuring and structured solutions. He has previously served as UBS' global structured capital markets chairman and head of DCM for the financial institutions group. Before UBS he was head of new products at Merrill Lynch and also worked at Citicorp.

Structured Finance

Avoca expands to target European opportunities

James Hatchley has joined Avoca Capital Holdings as co-ceo. He has already worked with Avoca on several projects over the last four years as the company has expanded its European structured credit and ABS capabilities.

Hatchley will split his time between the Dublin and London offices, targeting growth opportunities in the European credit markets. He joins from Freeman & Co where he was md and coo for Europe.

CMBS

Dewey CMBS specialists depart

Dewey & LeBoeuf's former European restructuring head, Mark Fennessy, has joined Proskauer in London. He joins with Hazel Miller and a team of ex-Dewey lawyers as Proskauer grows its global capabilities.

Fennessy and Miller both focus on corporate restructuring and special situations, including structured products. As well as financial and corporate mandates they have particular experience in CMBS restructurings.

Insurance-linked securities

ILS vet takes senior role

Frederick Schlosser has joined Forum National Investments as director. He has more than 30 years of experience in structured finance, with almost a decade in the life settlement industry. Schlosser was most recently md at Solstice Strategies and was previously partner at Brevet Capital investing in ILS.

ABS

FUEL exchange triggered

Moody's recent upgrade of Ford Credit to investment grade has triggered the exchange of the Ford Upgrade Exchange-Linked (FUEL) ABS notes for the firm's senior unsecured debt. The US$1.5bn series 2011-1 and US$1bn series 2011-2 auto loan ABS were structured to mandatorily exchange upon Ford achieving an investment grade rating from two rating agencies during the transactions' five-year revolving period (SCI 13 April 2011). Fitch upgraded the credit last month.

The main purpose of the transactions was to free up assets previously pledged to secure the ABS notes upon the conditional mandatory exchange. The majority of the FUEL notes were purchased by investment grade corporate buyers. The programme allowed these investors to access the Ford name, despite their portfolio restrictions on non-investment grade companies.

Structured Finance

IOSCO opens CRA consultation

IOSCO's Technical Committee has published a consultation report, describing certain internal controls and procedures that credit rating agencies (CRAs) use to promote the integrity of the credit rating process and address conflicts of interest, with a view to promoting a better understanding of these practices. The views of stakeholders and CRAs on these questions will assist IOSCO with further analysis of the internal controls and procedures used by CRAs, it says.

The consultation report is based on an IOSCO review of CRAs that focused on the internal controls established by CRAs to enhance the integrity of the credit rating process and on the procedures to manage conflicts of interest. The internal controls and procedures described by the report are divided into six categories: quality of the rating process; structural support to ensure the quality of the rating process; monitoring and updating; integrity of the rating process; managing firm-level conflicts; and managing employee-level conflicts.

The closing period for responses to this consultation is 9 July.

CDO

Duke CDO sold

Citi has emerged as the winning bidder for the US$1.67bn Duke High Grade Funding CDO assets auctioned yesterday by the New York Fed from its Maiden Lane III portfolio. Deutsche Bank, Goldman Sachs, Guggenheim Securities, Bank of America Merrill Lynch, Morgan Stanley and RBS were also invited to bid.

CDS

Derivatives net presentation favoured

ISDA has published a paper entitled 'Netting and Offsetting: Reporting Derivatives Under US GAAP and Under IFRS'. The paper examines how and why derivatives are treated differently under IFRS and US GAAP and their impact on the new Basel 3 leverage ratio.

It notes that the terms of netting, offsetting and set-off are often used to express the same notion but they are very different concepts. A better understanding of the terminology and the way in which derivatives are traded, managed and settled provides an understanding of why US GAAP accounting standard setters have consistently agreed that derivatives be reported on a net basis instead of on a gross basis on the balance sheet and why this differs from reporting derivatives under IFRS. Historically, the Europe-based IASB has permitted significantly less balance sheet offsetting than the US-based FASB.

ISDA believes that net presentation, in accordance with US GAAP, provides the most faithful representation of an entity's financial position, solvency and exposure to credit and liquidity risk. Individual derivative transactions that are subject to enforceable master netting agreements should be eligible for netting in the balance sheet on the basis that such financial statement presentation is most faithfully representative of an entity's resources and claims and provides the most useful information for investment decisions.

CDS

Publisher auction scheduled

The auction to settle the credit derivative trades for Houghton Mifflin Harcourt Publishing Company CDS is to be held 30 May. The company filed a pre-packaged restructuring plan on 21 May designed to eliminate US$3.1bn of debt through a debt-to-equity transaction.

CDS

Failure to pay determined

ISDA's Asia Ex-Japan Credit Derivatives Determinations Committee has resolved that a failure to pay credit event occurred in relation to Sterling Biotech. The Committee determined that an auction will not be held in respect of outstanding CDS transactions on the name.

CLOs

US CLO managers eye Euro exposure

Grohe and Misys are the latest European companies to launch US dollar-denominated leveraged loans. Fitch suggests that this trend may spur US CLO managers to increasingly invest in European credits.

The rating agency notes that many US CLO managers have either developed or acquired capabilities to perform due diligence in the European credit markets. At the same time, European companies have diminished European financing options and may seek cross-border solutions, while US CLO investors may see this as a diversification opportunity.

However, overseas due diligence has regional challenges that may not be appropriate for every US CLO manager, according to Fitch. The agency recommends that CLO investors match their manager's experience and expertise in the relevant markets to the degree of flexibility allowed to make investments to non-US companies when making their CLO investment decisions.

In the past year, large firms like GSO/Blackstone, Babson Capital and Ares have opened offices, acquired other firms or created alliances in European countries. "We believe this level of local expertise is necessary to effectively select and manage European credits in a US CLO portfolio," Fitch concludes. "New US CLO proposals with increased portfolio concentration limitations allowing for non-US exposures in excess of the typical 10% to 20% may be a positive trend for both the European corporate credit and the US CLO market."

CMBS

Delinquency rate reaches all-time high

The US CMBS delinquency rate set an all-time high this month, according to Trepp, jumping by 24bp to 10.04%. Whether the rate creeping into double digits for the first time carries some psychological impact on the market remains to be seen.

The increase was driven by large losses to hotel and industrial loans. Overall, four of the five largest property types saw delinquencies rise. Only the apartment sector improved and that was only by a single basis point.

Over US$1.5bn in loss resolutions were seen in May. The removal of these loans from the delinquent loan category attributed approximately 26bp of downward pressure on the delinquency rate. In addition, loans that were cured put 41bp of downward pressure on the rate.

On the other hand, loans that were newly delinquent (over US$5bn in total) put upward pressure of about 85bp on the rate. Added together, the impact of the loan resolutions, the effect of loans curing and the effect of newly delinquent loans created a net increase of 18bp in the rate. The remaining difference is a result of additions and subtractions to the denominator due to new CMBS issuance being added, loans paying off and other factors.

Trepp notes that one category to keep an eye on is loans that are past their balloon date but are current in their interest rate. This category now accounts for 1.18% of loans in the database. If these loans were to be considered as late, the delinquency rate would have been 11.22%.

On a more positive front, the five-year loans originated in 2007 were heavily front-loaded, meaning that by the end of June the number of these loans reaching their maturity date starts to dwindle. As a result, the upward pressure that this has put on the delinquency rate should come to an end, Trepp suggests.

CMBS

'Risk-off' weighing on CMBX

CMBX spreads remain at elevated levels but are still tight to October 2011's record wides. In addition to recent 'risk-off' sentiment, increased supply from the MAX CDO liquidation has weighed on the cash and synthetic AJ markets, according to CMBS analysts at Citi.

They note that the CMBX.4.AJ and CMBX.3.AJ indices are now respectively down by 13.1% and 6.2% year-to-date, after each being up by over 14% earlier in the year. The MAX CDO - which was auctioned on 26 April - contained over 13% of the outstanding face of the 2007 AJ market, provoking a spike in AJ.4 volume for the week ending 27 April.

More senior parts of the capital structure have also experienced significant depreciation, with all triple-A and AM tranches now either negative or flat on the year. The Citi analysts suggest that an extreme market event, like Greek exiting the eurozone, could see the CMBX re-test last year's wides. Equally, if a recovery takes place after such an event, CMBX AJs could outperform the rest of the market.

CMBS

CMBS loan events updated

23 new loan events have been added to the SCI CMBS loan events database. These include:

24/05/2012
Deal: THEAT 07-1 & 07-2
Property: 36 Hospitals
Balance: £377m & £251m
Event: borrower hasn't yet agreed to meet with servicer to discuss impending maturity; servicer engaged Paul Hastings as legal counsel
Description: borrower engaged NM Rothschild as financial advisor; servicer began discussions with a number of financial advisors to prepare for response to any borrower proposal

May
Deal: JPMCC 2006-LDP9
Property: 7 Penn Center
Balance: $38.5m
Event: loan granted 39-month extension to Feb 2015; split into $21.5m/$17m A/B note; $2m equity injection

May
Deal: LBUBS 2007-C1
Property: Bethany Maryland Portfolio
Balance: $296.6m
Event: loan returned to delinquency category (30 days), 2y after being modified
Description: borrower seeking 2nd modification

There are now 1,787 searchable loan events, dating back to March 2011, on the database. Click here for more.

CMBS

FVMO 'rarely exercised'

Fitch reports that special servicers rarely exercise the fair value market purchase option (FVMO). A survey conducted by the agency found that, since 2001, the FVMO was exercised in US CMBS transactions just 11 times. On nine of those occasions it was exercised by an affiliate or interested party.

Fitch expects these events to remain rare as they are complex to execute and exercising the option creates a negative market perception for special servicers. The agency believes that, of the conflicts of interest inherent in the role of special servicer, FVMO should be a very low priority.

The survey included nine active special servicers and captured data beginning in April 2001. The data collected included whether the options were exercised on the servicer's own behalf, assigned to an affiliate or 'interested party', or if the controlling class holder had exercised the option.

Pooling and servicing agreements require a fair market determination (FMD) on all defaulted loans. Once option holders are notified of a defaulted loan, they generally have between 60 and 90 days to exercise or assign their option to purchase.

If an option holder turns out to be an 'interested party' and wants to purchase the loan, then the FMD must be made by a party other than the special servicer. The process is usually conducted by the master servicer, with the trustee confirming the FMD.

CMBS

Ardenwood loan on watchlist

Morningstar has added the US$53m Ardenwood Corporate Park loan, securitised in CSMC 2007-C3, to its watchlist following a notification from the collateral's largest tenant (Logitech) of an intention to vacate its leased space. The firm accounts for roughly 48% of the gross leasable area (GLA) and 37% of effective gross income (EGI). Commentary from the master servicer indicates the available space within the Ardenwood Corporate Park is not large enough to accommodate Logitech, which is the basis for its forthcoming departure at lease-end.

For the nine-month period ended 30 September 2011, the net cashflow DSCR was 1.56x, with net cashflow of US$4.6m. The NCF DSCR for the 12 months ended 31 December 2010 was 1.65x, with net cashflow of US$6.5m. Projected occupancy will fall to only 52% without Logitech as a tenant, with a substantial impact to net cashflow on a pro-forma basis, Morningstar notes.

Loan maturity is scheduled for November 2016, with an estimated US$49.7m balloon. Morningstar has assigned a low to moderate default risk to the loan.

"Our concern increases in the months following the scheduled departure of the largest tenant," it explains. "Should the Logitech space remain vacant for an extended period, we would expect the NCF DSCR to fall below breakeven."

A preliminary Morningstar analysis of the collateral suggests a value of about US$67m (US$218/sf), yielding an 80% LTV based on in-place cashflow. Based on pro-forma net cashflow assuming the Logitech space remains vacant for an extended period and a stressed cap rate, it derives a value of about US$43m (US$140/sf), which would generate a US$10m deficiency.

CMBS

Multifamily resecuritisation completed

New York Mortgage Trust (NYMT) has completed a resecuritisation of multifamily CMBS. The REIT received net cash proceeds of approximately US$26.1m after deducting expenses associated with the transaction.

The US$35m RB Commercial Trust 2012-RS1 class A note - rated triple-B (high) by DBRS, with a coupon of 5.35% - was privately-placed with an institutional investor. The pool comprises certain privately-placed first-loss securities from three separate Freddie Mac Multifamily K-Series securitisations, two of which were acquired during 2011 and the third was acquired on 22 May. The securities are collateralised in aggregate by 247 mortgage loans on 251 multifamily properties located throughout the continental US.

As of the closing date of the resecuritisation, the market value of the multifamily CMBS was estimated to be circa US$47.7m for securities with a face amount of approximately US$155m. The REIT is applying substantially all of the net proceeds from the transaction to the purchase of the multifamily CMBS purchased on 22 May.

NYMT retained a class B note, as well as the trust ownership certificate.

CMBS

CPPI returns

Moody's and Real Capital Analytics (RCA) have launched the Moody's/RCA Commercial Property Price Indices (CPPI), a new series that measures price changes in US commercial real estate through advanced repeat-sale regression (RSR) analytics. Composed of a suite of 20 indices, the offering is based on transaction data from and a methodology developed by MIT professor David Geltner, in conjunction with Moody's and RCA.

Moody's published the first RSR index for commercial real estate, the Moody's/REAL CPPI, from 2007 to 2011. This offering was optimised for derivatives trading, which failed to develop and REAL elected to discontinue the series. Moody's/RCA CPPI, on the other hand, has been optimised for information and aims to enhance transparency in the sector.

The new indices show that US commercial real estate prices were flat in March. After recovering 28.2% since the January 2010 pricing trough and retracing approximately 47% of its peak-to-trough decline, price appreciation has decelerated, advancing only 1.8% over the last three months.

"Commercial property price appreciation decelerated during the last three months following a series of strong gains after the trough roughly two years ago," says Tad Philipp, Moody's director of CRE research. "The increased cost and decreased availability of capital market debt in the wake of ongoing Euro area sovereign stress has filtered its way into the prices of recently closed transactions."

Among the national all-property composite segments of the CPPI, the growth in apartment prices has significantly outpaced that in the core commercial property types over the past twelve months, with apartment prices rising 18.0% against 10%. Improving apartment fundamentals and the continuous supply of attractively priced debt capital made available by the GSEs have led to the better performance.

Apartment prices in major markets have shown the strongest recovery, according to Moody's. The prices in this sector are down by just 2.8% from the new peak pricing level that they achieved in February.

Central business district (CBD) offices in non-major markets, meanwhile, have been the worst performing category of commercial real estate. During the recession, their prices fell by 52.9% from peak to trough and remain 45.6% below peak levels.

The Moody's/RCA CPPI shows major markets recovering more quickly than non-major ones. For example, major market CBD office has led the price recovery of the core commercial component of the national all-property index. Major market CBD office is up by more than 50% since the trough, roughly double the 24% recovery of the core commercial sector as a whole.

In all, properties in the major markets have appreciated by 37.5% since the January 2010 price trough, compared with 21.4% for properties in non-major markets. In the past three months, however, non-major markets outpaced the major markets slightly in their price improvement - 2.5% versus 0.9% - as capital moves beyond the gateway cities in search of higher yields.

Risk Management

Pricing service adds CMBS

Markit has added US CMBS to its evaluated bond pricing service. CMBS prices will be supplied by Trepp.

With the addition of CMBS, Markit now offers access to independent prices across the whole universe of US structured finance securities. The move comes as the changing regulatory and accounting environment - along with the intense focus on transparency - have increased demand for high quality independent pricing data for use within price discovery, valuations and risk management processes.

Other recent additions to the range of structured finance securities covered by Markit's ABS pricing service also include non-agency securities, agency pass-throughs, agency CMOs, as well as credit card, student loan and auto securities.

RMBS

Rep and warranty suits filed

The FDIC, as receiver for Citizens National Bank and Strategic Capital Bank, has filed three separate lawsuits against a group of major banks - including JPMorgan, Citi, Bank of America Merrill Lynch, Credit Suisse, Deutsche Bank, Ally Financial, RBS, HSBC and UBS. The agency alleges that the banks made numerous misrepresentations and omissions regarding the credit quality of loans underlying RMBS that they underwrote.

Two of the lawsuits were filed in the Southern District of New York, seeking a combined US$77m. The third lawsuit was filed in Los Angeles federal court, seeking US$15m.

RMBS

Equity supporting Canadian house prices

Average Canadian households can withstand a housing price decline of 40%, according to a new DBRS study. However, increasing household leverage and stretched housing affordability remain a concern.

By the end of 2011, the average Canadian home price had appreciated by 141%, but aggregate national mortgage debt had grown by 374% to C$1.1trn. Total household debt, including HELOCs, had also grown by 381% to C$1.6trn.

The faster debt accumulation relative to GDP or average household income drove up both home prices and household leverage in Canada. Between 1990 and 2011, the average home price in the country increased from 3.4 times to 4.9 times the average gross family income; similarly, household debt-to-personal disposal income increased by 73% to 153%.

The result of this continued rise in leverage is reduced housing affordability, with pressure on day-to-day cashflow for average Canadian households, leaving them little room to deal with unexpected expenses and more vulnerable to liquidity and cashflow shock. "However, from the perspective of lenders or investors in securitisation, potential losses on defaulted mortgages would be mitigated by household net worth - which includes the equity embedded in the underlying properties - and therefore any rating impact would be subdued," says Kevin Chiang, svp at DBRS.

Another key point of the study centres on the myriad of ways used in Canada to assess household financial health and leverage. "We would emphasise that affordability measurements based on average numbers are not representative and do not recognise regional or market-specific preferences, differences or property types," notes Chiang.

He adds: "Having said that, the real estate market for most Canadian cities appears balanced based on sales activities and housing inventory supply, but moderately overvalued in terms of price-to-income and affordability. Barring a nationwide economic downturn, the impact of an interest rate increase or any price correction on mortgage defaults should be localised, with more elevated risk in certain markets and segments."

RMBS

Working Group given new resources

The RMBS Working Group has launched a new website to report fraud and established a coordination team to facilitate the various investigations underway around the US.

"The RMBS website is a new call to those insiders who know about fraud that occurred in the RMBS market, who know it's time to expose that fraud, and who want to help us hold accountable those individuals and institutions who broke the law in pursuit of bigger paydays," comments acting Associate Attorney General Tony West. "Although the working group and its members have done a tremendous amount of investigative work already - including having issued more than 25 civil subpoenas - we know that hearing from insiders is particularly valuable. There are scores of people who worked in the RMBS market who acted responsibly but who also may have witnessed greed and misconduct that crossed the legal line and created havoc for investors, homeowners and our economy. We want to hear from them."

To facilitate communication and coordination among the various agencies conducting RMBS investigations nationwide, the five co-chairs and the Task Force's executive director have appointed a coordinating team. Matthew Stegman, a career white-collar prosecutor, is the RMBS Working Group's coordinator. Other team members include criminal prosecutors and civil attorneys, analysts and FBI investigators.