Contents

Structured Finance

Proactive participants

Trustees are embracing a more hands-on approach to issues from documentation to noteholder communication, as new challenges and opportunities arise. James Linacre investigates the role's continuing evolution

The trustee's role in the European securitisation market continues to evolve as lessons are learnt from the fallout of the financial crisis. Issues with documentation and bondholder communications continue to provide challenges, but there are opportunities too - particularly in emerging markets.

"Post the 2008 distress, there has been a very obvious change from pre-2008 when the trustee role was more passive. The stress in the market altered it in several ways, not least in changing it from a somewhat perfunctory role to being expected to act in a variety of circumstances, many of which were not contemplated," says Tom Cubitt, US Bank head of corporate trust Europe.

Cubitt believes the distress put more onus on trustees to use discretion to take decisions. Expectations about how swiftly and easily trustees could operate in these situations was sometimes unrealistic.

Helen Tricard, head of restructuring at BNP Paribas Securities Services, agrees: "In the early days of the financial crisis, deal parties would often approach the trustee extremely late in the restructuring process looking for an exercise of discretion and expecting that we could just do it in a few hours on the basis of it being a minor modification. Now deal parties are coming to trustees much earlier in the process to get an early indication of the trustee's view."

Greater dialogue with the rest of the market is one of the ways in which trustees have had to adapt their approach. It is part of a broader effort to be more proactive that has also led them to scrutinise documentation more closely.

"During the crisis we all talked about deficiencies in documents and we still see deals now that are failing to clear up some of those issues. There is good work going on, but some people have short memories and want to continue to work with precedent documents, regardless of the fact that those precedents may have failed in the past. Part of our job is educating participants that things have changed and perspectives need to change as a consequence," says Matt Barlow, Citi vp for agency and trust sales, EMEA.

Jillian Hamblin, director at Citicorp Trustee Company, adds: "When we review new transactions, we are willing to engage appropriately with legal counsel to amend documentary shortcomings to prevent or mitigate future difficulties. One example would be the drafting of 'evergreen' provisions - such as language covering ratings downgrades - to deal with potentially recurring events. We fully appreciate that these are commercial decisions for the transaction parties, but we aim to take a proactive approach in offering solutions."

There is a need for trustees to balance the responsibility to protect noteholders by making recommendations on documentation against the fact that they have not been brought in to do the work of actually putting the deal together. With that in mind, Tricard says that they do look to flag up potential issues when they spot them.

She explains: "The trustee needs to be commercial and we are certainly in favour of combining negative consent with other decision-making mechanisms in the documentation, rather than replacing the concept of noteholder meetings and trustee discretion altogether. It is a good move and something we will see more of."

Tricard continues: "We are seeing more thought around indemnities and pre-funding: drawing up indemnities at the outset of the deal or setting up a reserve fund at the outset of the transaction. This helps avoid the situation where the trustee needs to act but is in a situation where, for example, one investor holds things up."

The lessons learnt from testing documentation should be applied for new transactions. In the meantime, trustees are doing what they can under current constraints.

Another significant lesson has been the clarification needed in the differentiation between a trustee and an agent. "The market stress has created opportunity for potential conflict to occur between the trustee and agency functions. The segregation of those groups within organisations to ensure that there is independence is important," says Cubitt.

Once a deal is live, the ability of trustees to communicate with investors has long been a source of consternation. Cubitt believes that noteholder communication can only be improved through market participants working together.

He says: "It is a market-wide initiative that needs everyone to come together to make those changes. It needs the lawyers that are drafting the documents, the underwriters/lead managers and the investors. Some investors have been vocal around noteholder communication and it will be interesting as the market starts to recover to see whether improvements can be agreed upon and documented in new transactions."

The problem is that trustees cannot drive these changes alone, so those vocal investors are important to the process. Ultimately, it must be investors who push for change, because without a push from them the clearing systems are unlikely to put the required funding towards a solution.

"In the meanwhile it is something we work around. One of the solutions we use is to make sure that whenever we post an important notice, we also put a pointer notice on Bloomberg to alert investors. What we are trying to do is facilitate communication within an imperfect system," Tricard notes.

Hamblin notes that it has also been useful to arrange ad hoc conference calls for bondholders, while fixing an end date for action helps to get an increased response from investors. "In this way we have been working to improve the interim position, pending a full resolution of the wider issue of bondholder communications," she says.

Gary Webb, global head of sales and relationship management at BNP Paribas Securities Services, says another solution is to work with structurers to organise a direct relationship between the trustee and investors on deals where they know there will be buy-and-hold investors sticking around for the term of the deal. "On older transactions it has helped when we have known who the controlling noteholder is in a structure, so that amendments can be made more quickly. There are some issues where there is going to be a smaller number of investors - particularly in more esoteric structures - where the bondholder communications process can become more efficient purely by knowing each other."

For all the work that trustees do to facilitate communications, sometimes investors simply are not ready to communicate. Tricard observes: "One problem the trustee can have is when we pretty much know who the noteholders are or the deal is tightly held, but investors sometimes just do not want to talk to us. It is not always the case that the system for communicating is not working; sometimes it is simply that investors are not ready or willing to step forward and talk to the trustee. And that is the investors' prerogative."

When issuers come to choosing between trustees, Cubitt believes they value trustees with expertise who are not afraid to be proactive. "Many issuers when they appoint a trustee are also looking at the wider agency contribution; they are really looking at the experience of the group, the commitment to this area, but also they want a trustee that is capable to make the necessary decisions and be proactive in the market," he says.

Webb agrees that issuers value the wider abilities of a trustee. "As a corporate trust service provider, we have demonstrated that we have a strong ability to provide high quality servicing on complicated structures and we have built a strong reputation in the loan side of the industry for servicing those assets."

Webb stresses the importance of having localised knowledge within the European market. While BNP Paribas clearly has good connections in the French market, it also ensures that Italian structures are serviced out of Milan, for example, so that clients have access to people who understand local conditions.

He adds: "We also have a high degree of flexibility. In the past one RMBS structure may have looked very much like the previous one, but what we have seen over the last few years is more unique transactions coming to market, so a corporate trustee and agency services provider has to be able to adapt to what clients are looking for."

The number of trustees for issuers to choose between decreased after the crisis as several smaller players left the market. However, others have since stepped in to take their place as big banks seek opportunities not just for profit, but also to retain clients.

Part of the appeal for the global banks is that trustee businesses combine strong annuity revenue while being low users of credit, Barlow notes. They also help banks to maintain relationships with clients who they may not have had so much contact with in challenging economic conditions.

The fact that several trustees are competing for a relatively small number of deals also has the effect of keeping remuneration competitive. Fees have not increased since the crisis and Barlow does not expect that to change.

He adds: "If we as an industry have not been able to convince our clients over the last five years of the value that our services bring to the market and that we should be recompensed at a more appropriate level, then that is a failure of us as an industry. We have survived the crisis and stayed in business, so it is hard to justify higher fee levels for our bread-and-butter business when revenue compression is occurring across the board: arrangers, issuers and investors are all suffering as we are."

Looking ahead, Cubitt believes the next 12 months will be shaped by regulatory changes and events in the eurozone. He says: "Everyone is anticipating the market returning and that seems now to be a case of 'when' rather than 'if'. However, the volume of transactions will be strongly affected by issues in the capital markets and economy, so that is what everybody is watching."

"For trustees, the escalating eurozone crisis gives rise to some material problems for market participants, not least how bond and other documentation will operate in the event that a country were to depart from the European Monetary Union. There is no prescribed exit mechanism, of course, and this could pose major issues for trustees," says Hamblin.

Mark Jones, Citi Group director and product head for issuer services, EMEA, comments: "You could see a spate of defaults, or at best an impact to existing transaction documentation. Renegotiating documentation takes time and costs money. As a result, I believe corporate service providers will continue to look to diversify out of their core product range, maybe looking at servicing, at loans or at equity as opposed to just debt."

He adds: "Regulation continues to challenge the industry. In particular, the prospectus directive will be implemented later this year, which requires increased granularity around the products issuers are looking to sell into the market. Existing regulation requiring issuers to invest in their own securities continues to stymie growth in securitisation as it proves to remain an expensive product to invest in."

The amount of loan credit available could be set to decrease as banks get to grips with the capital requirements of Basel 3. Webb believes that provides an opening for the securities industry to provide funding to those organisations that would typically have gone to the banking industry - for example, with project finance transactions.

He says: "If there are fixed income securities funding a project finance transaction, then the role of the trustee becomes very important because a project finance deal is likely to experience a lot of amendments during its long lifetime. That could be a strong argument for a type of 'super trustee', with more routes to agree to changes."

The idea of a super trustee is one that Jones also sees growing in importance, spurred on by rating agencies' desire for trustees to take a more proactive approach to monitoring transactions. He says: "I can see a certain amount of proactive creep coming into the role, imposing upon trustees' responsibilities such as reviewing the audited accounts of issuers when they are produced and enhancing surveillance."

Hamblin notes that this leaves issuers with a decision to make between what they require and what they will pay for. She says: "Do they desire a so-called super trustee with added responsibilities (and related additional cost at the outset), where the issuer of the transaction may be paying for trustee functions which may not ultimately be required? Or are they more comfortable with a traditional trustee, which is able to exercise certain of the super trustee powers already available to it via the trust deed, and will require remuneration only as events dictate?"

A determinant in that decision could well be jurisdiction and asset type. A triple-A UK RMBS would present a less compelling case for a super trustee than a securitisation of Greek tax receipts, for example. This becomes more pressing as securitisation becomes a more significant funding tool in emerging markets.

"We are beginning to see evidence of this in jurisdictions such as Poland and Russia; however, these markets face challenges, such as developing their legal and regulatory frameworks in order to keep pace with the growth of this product. A further challenge revolves around issuers providing full disclosure with respect to their businesses as they seek to list securities. It is in markets such as these that one sees the emergence of the super trustee," says Jones.

He adds: "We have also seen the return of the high yield bond market as investor appetite for yield returns. Emerging markets therefore present both a challenge and an opportunity to trustees willing to take up those mandates."

The final big change anticipated is in technology. It is something that helps trustees better serve their clients and provides one more arena in which trustees can differentiate themselves.

"The industry is going to have to invest in technology. The speed at which everybody is going to need to move in the future is going to necessitate greater technology than it has done in the past. We have already done quite a bit of investment in our loan technology and it is something which is only going to grow in importance," concludes Webb.

JL 

Structured Finance

SCI Start the Week - 11 June

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

Pipeline
A handful of new deals entered the pipeline last week. The only such European transaction is €1.4bn BBVA RMBS 11 FTA, but it was joined by a US$1.24bn CMBS from Freddie Mac (FREMF 2012-K709), a US$511.96m CLO (Gramercy Park CLO), a US$700m student loan ABS (EFS Volunteer No. 3) and a US$761m auto lease deal (World Omni Automobile Lease Securitization Trust 2012-A).

Pricings
Several more deals departed the pipeline, with nine ABS pricing as well as one RMBS and three CLOs. The RMBS was €890m Phoenix Funding 5, while the CLOs comprised US$514m ALM VI, US$406.85m Babson CLO 2012-II and US$510m Carlyle GMS 2012-2.

Four auto ABS deals printed: US$92.63m Ally Auto Receivables Trust 2012-A; US$940m CarMax Auto Owner Trust 2012-2; US$500m SMART ABS Series 2012-2US Trust; and US$150m SNAAC Auto Receivables Trust series 2012-1. Issuance was rounded off by two student ABS transactions (US$323m Nelnet Student Loan Trust 2012-2 and US$1.491bn SLM Student Loan Trust 2012-4) and three credit card deals (US$800m Discover Card Execution Note Trust 2012-3, US$650m Discover Card Execution Note Trust 2012-4 and US$725m Gracechurch Card Programme Funding 2012-4).

Markets
Macro pressures are setting the agenda once again for US CMBS, say Citi analysts. Volatility has increased on the back of "the worsening European situation, prospects of slowing global growth and our own domestic macro worries", they say.

From as low as 14 in Q1, the VIX was as high as 28 last week, eventually dropping to the 21-23 area in response to the Chinese rate cut. CMBS spreads have widened in tandem with the VIX, with GG10 dupers hitting 275bp and 2007 AMs at 580bp.

Meanwhile, US CLO BWIC volume last week jumped to US$593m from US$125m the previous week, say Bank of America Merrill Lynch CLO strategists. They note: "The market remains bifurcated, with greater tiering based on managers, deals and duration. Top-tier managers and shorter-duration paper continue to trade well, along with equity. This week also saw a large block of equity that traded well in the mid-teen context." Spreads generally held in, although there was little mezzanine activity.

At the same time, Barclays Capital securitised products analysts report that the US ABS market experienced another busy week. "The non-mortgage ABS secondary market was active, with good two-way flows dominating trading for most of the week. In general, the tone was strong, despite the exceptional noise and volatility emanating from Europe," they note.

Finally, the European ABS market appears to be waiting for Global ABS in Brussels this week before taking firm views, say Deutsche Bank ABS analysts. They report low BWIC volume of just €270m and suggest that short-dated and front-pay prime paper continue to see robust demand in the secondary market, with spreads mostly unchanged.
 

Deal news
• Moody's has published updated assumptions and methodology used in its MILAN RMBS collateral analysis model, following its RFC on the proposals (SCI 9 December 2011). The ratings of 27 EMEA RMBS transactions are negatively affected as a result.
• Moody's has updated its approach to analysing set-off risk in relation to Italian structured finance transactions and covered bond programmes. Five deals have been placed on review as a result.
• Fitch has reviewed over 10,000 classes in 751 US Alt-A RMBS transactions. The agency is also set to release a revised mortgage loss model for the Alt-A sector within the next two months.
• Moody's has downgraded to Caa2 the ratings of the most senior securities in nine Greek structured finance transactions and to Caa3 the ratings of subordinated securities in six transactions. Moody's also placed all the Caa2 and Caa3 ratings of Greek SF securities under review for further downgrade.

Regulatory update
• The US Federal Reserve has invited comment on three proposed rules intended to help ensure banks maintain strong capital positions. Taken together, the proposals would establish an integrated regulatory capital framework, implementing the Basel 3 reforms and changes required by the Dodd-Frank Act.
• The Consumer Financial Protection Bureau (CFPB) is seeking public comment on new data and information that it has received as part of the Dodd-Frank Act's requirement for lenders to assess consumers' ability to repay mortgage loans before extending them credit.
• IOSCO has published a consultation report entitled 'Global Developments in Securitization Regulation', which seeks public comment on policy issues arising from the work of its Task Force on Unregulated Markets and Products (TFUMP). The paper is in response to a request from the Financial Stability Board as part of its work to strengthen oversight and regulation of the shadow banking system.
• New York state judge Justice Barbara Kapnick has granted a motion by the Attorneys General of New York and Delaware to intervene in the litigation relating to Bank of America Merrill Lynch's proposed US$8.5bn RMBS settlement with the Bank of New York Mellon (SCI 30 August 2011). The New York and Delaware AGs moved to intervene on the grounds that the settlement was an unfair and inadequate resolution of investors' claims against Bank of America.
• The Systemic Risk Council will convene this month to monitor and encourage reform of US capital markets, focusing on systemic risk. The council intends to issue a call to action on 18 June detailing its objectives and future plans.

Deals added to the SCI database last week:
Ally Auto Receivables Trust 2012-3
ARI Fleet Lease Trust 2012-A
Candide Financing 2012-1
Chase Issuance Trust 2012-A2
Cronos Containers Program I series 2012-1
ECP CLO 2012-4
FCT Autonoria Compartment Autonoria 2012-1
FREMF 2012-K708
GE Equipment Small Ticket series 2012-1
Holmes Master Issuer 2012-3
JPMCC 2012-WLDN
Kion CLO Finance No. 1
Kion Mortgage Finance No. 3
Long Point Re III
Malatesta Finance series 2012
REDS EHP Trust series 2012-1E
Residential Re 2012
S2 Hospitality series 2012-LV1
SLM Private Education Loan Trust 2012-C
Storm 2012-III

Deals added to the SCI CMBS Loan Events database last week:
BACM 2005-3; BACM 2007-2; CD 2005-CD1; CD 2007-CD5; CGCMT 2007-C6; CSMC 2007-C3; DBUBS 2011-C2; DECO 2007-C4; DECO 2007-E5 & WINDM IX; ECLIP 2007-1; EPRE 1; ESTON 2006-1; EURO 24; EURO 29; FTST 06-4TS & LBUBS 07-C1; GCCFC 2007-GG11; GCCFC 2007-GG9; GMACC 03-C1 & MSC 03-IQ4; GMACC 2003-C3; GMACC 2004-C2; GSMS 06-GG6 & GCCFC 05-GG5; GSMS 2003-C1; GSMS 2007-GG10; JPMCC 2004-C1; JPMCC 2007-LD11; JPMCC 2007-LD12; JPMCC 2007-LDP12; JPMCC 2007-LDPX; LBCMT 2007-C3; LBFRC 2007-LLFA; LBUBS 2003-C1 & GSMS 2004-GG2; LBUBS 2006-1; LBUBS 2006-C3; MALLF 1; MLCFC 2006-4; MLCFC 2007-9; MSC 2006-HQ8; MSDWC 03-HQ2 & 03-TOP9; NEMO 2006-2; PROMI 1; REC 6; TAURS 2006-1; THEAT 07-1 & 07-2; TITN 2006-2; TITN 2006-3; TITN 2007-CT1; TMAN 3; TMAN 4; TMAN 6; TMAN 7; UBSCM 2007-FL1; WBCMT 2006-C27; WBCMT 2007-C30; WBCMT 2007-C31; WBCMT 2007-C32.

Top stories to come in SCI:
REIT investment activity
CDS market infrastructure developments
Leadenhall Capital Partners profile
Corporate trust survey

Structured Finance

Market risk rule welcomed

The US Federal Reserve's final market risk capital rule (SCI 8 June) has generally been welcomed for reflecting industry feedback, albeit some concerns remain. Crucially, the final rule modifies the simplified supervisory formula approach (SSFA) by replacing the flexible floor with an adjustment to risk weightings based on delinquencies of the underlying assets.

"The final rule has addressed certain key concerns expressed by several market participants, including us," confirm ABS strategists at Morgan Stanley. "In our opinion, the final rule is a notable improvement relative to the proposal in the NPR, even though there are aspects in the final rule about which we continue to have concerns."

The flexible floors, which would have relied on realised pool losses, have now been replaced with a simpler and forward-looking measure based on significant delinquencies of the underlying assets. This scenario adjusts the capital requirement upwards or downwards from the base capital requirement as delinquencies increase or decrease respectively.

"This approach enables a better calibration of the risk-weighting factors for securitisations around the risk associated with the underlying assets of the securitisation. It seeks to apply higher capital requirements to more junior (and more risky) tranches and lower requirements to the more senior (and less risky) tranches, which is eminently sensible in our view," the Morgan Stanley strategists explain.

In general, thicker and more senior tranches with high absolute levels of attachment would require less capital under the final rule than under the ratings-based approach (RBA) in the Basel framework. Legacy non-agency RMBS and CMBS that have suffered severe ratings downgrades would fall into this category, the strategists suggest. This is expected to improve liquidity for this category of bonds.

On the other hand, securities that are currently triple-A rated but have lower absolute attachment points and are subordinated in sequential pay structures would have significantly higher capital requirements under the final rule, despite their historical track record of solid performance. Certain tranches of prime auto ABS would fall into this category.

However, at 1.6%, the minimum capital requirement for senior tranches under the final rule would be nearly three times the 0.56% minimum under the RBA. That regulators contend that securitisation should require more capital on a transaction-wide basis than would be required if the pool of assets had not been securitised remains bothersome, according to the strategists.

"The regulators believe this in effect would reduce the ability of banks to engage in regulatory capital arbitrage with securitisation," they conclude. "We disagree. In our view, the underlying premise of their contention is punitive and would be a significant deterrent to the re-emergence of a robust securitisation market, which would negatively affect credit availability in the economy."

CS

Structured Finance

Dealing with data

The operational challenges facing investors in an increasingly data-rich world

For years, structured credit and ABS investors have struggled to get access to comprehensive data for the assets in their portfolios. Now, driven by regulatory initiatives in Europe, the UK and US, there is far greater transparency of data on securitisations.

However, the job is far from complete. There are still gaps in the data set and, more importantly, investors need to work out how best to handle and make best use of the data now available to them.

The progress made in the availability of securitisation data generates three immediate challenges, according to Mark Hale, cio at the Prytania Group. "First is whether we can maintain progress and get data that is available across all jurisdictions."

Second, he adds: "We need to ensure the data quality is of the required standard to enable investors to make well-informed judgments and fair comparisons. Third, is the issue that even if we are seeing signs of progress in the primary market, which is being driven by regulatory impulse, we are still a long way from addressing the challenge of data on a historic basis."

Hale says there are no easy solutions, however. "Frankly it is an ongoing struggle from cradle to grave in structured credit to meet those challenges. At a time when markets are evolving, regulations are continuing to change and accounting standards, for example, are shifting the need for market participants to continuously invest in infrastructure remains paramount."

Hale continues: "The question that follows from improved access to data is can that data be assimilated easily? Can it therefore be standardised, can it be quality controlled before investors get it, so they are not forced to do so themselves? Also, can investors then use a variety of tools to make informed decisions, both about purchasing assets and monitoring the ongoing risk and, if necessary, selling assets?"

He says that thanks to the efforts made by a number of third-party providers in recent years, there has been a significant improvement in the quality and quantity of tools available for investors to utilise. Nevertheless, he adds: "It is extremely difficult for even the most experienced and well-resourced investors to meet that challenge right now."

Douglas Long, evp business strategy at Principia, says that for his firm this work has long been the focus. "What we are trying to do is to ensure that investors have the right infrastructure, the right tools and the right controls in place to make that data work for them and to run an efficient and effective business - drilling into information when they need to, rather than being awash in a sea of data."

The difficulties are exacerbated by the very nature of investors' often diverse holdings in the sector. A fixed income portfolio that includes structured credit, ABS and MBS products will have large numbers of different data components.

At the high level, getting a view across all exposures and portfolio positions is the first data challenge; beneath that detail on each different instrument type is required and below that comes ever changing deal-specific information - key performance metrics for the deals themselves and their collateral, combined with individual structural details such as the priority of payments, triggers levels and so on. Further, there is also pricing information for the investor to consider, not only in terms of where each deal's tranche is trading, but how liquid their pricing information actually is.

Consequently, Long notes: "Investors typically have a large variety of different data sources and types to contend with. Some of it is static, some of it is ongoing and very often it comes in very differently depending on the data partners they have."

He goes on to cite the example of results from Principia's new pricing survey, which indicates that 78% of investors use a combination of independent pricing services and at least one to two other pricing methods, such as broker-dealers, advisors or in-house calculations. So, even on the more straightforward question of 'what is the market price of my assets?' investors end up with more than three (and often many more) different sources of data and all, almost inevitably, with different formats, different timings and different assumptions attached.

With such a wide array of data now coming in, it is vital that investment firms develop the right infrastructure to cope. Fundamentally, Hale says: "You need a flexible platform that is able to take in multiple data types, sort them efficiently and use multiple cashflow models simultaneously at high speed."

To this end, he says that his firm's approach from its inception in 2003 has given it that flexibility. "From the outset, we set out to develop our own tools -such as software for assessing risk including cashflow models as well as data aggregation tools and bespoke credit models. We also developed products to enable the output of those analyses to be easily understood, whether they be web-based portfolio management tools that we can use for our funds or our advisory clients or graphical tools to make the complexities of path-dependant structures like CDOs readily accessible to non-expert users."

Hale concedes this is not necessarily an option for everyone. "We're fortunate that we were able to raise a great deal of money from our investors and JPMorgan to do that. To a degree, we have been much more focused on this issue than many for a long time and very fortunate in being able to hire specialist quants, programmers and portfolio experts to facilitate that."

He adds that Prytania has also used a range of third-party data sources and specialist tools. "We've taken in the best quality tools from the best providers in each of the different areas of structured credit to supplement our own efforts," he says.

Indeed, Hale believes that it is incumbent on investors to keep abreast of the latest developments in third-party services. "At Prytania, we continuously review whether it's appropriate to evolve our own tools or recognise that it is optimal to also use third-party tools going forward. In order to be on top of the risks you need to continually question whether you have the right mix and the economics of each service."

Long suggests that developments will move on apace in the months ahead. "With the issuers providing more of this data, we are getting closer to a commoditised platform for the data vendors and investors to utilise and disseminate the information in digestible formats."

He explains: "The ECB says that the data posted with the European Data Warehouse will have to be made available to all data providers, which means they will all have the same raw data. So, I anticipate that all the data vendors out there that used to source data themselves will look to provide value-added services to ease the burden in managing that richness of data. As an investor, you don't always need to get to the loan level data, and if a vendor can calculate performance statistics from the detailed loan information it will help streamline your processes."

Long continues: "It's about transferring issuer-provided, raw data into a usable format. One of the other things we've seen from our survey is the increasing degree to which the vendors are trying ramp up coverage in terms of asset class and geography in data they provide so investors in turn need to turn to fewer providers."

Notwithstanding such developments, there are still hurdles to overcome. As Long says: "Once you have the data in your system, that's when the operational challenges really start. Once an investor is on a level playing field in terms of the data it is getting in, the question is how to prove to regulators that you are doing the right things, can really understand each investment and are able to monitor the ongoing performance metrics tied to those securities."

To this end, Principia has been working with clients and developing its software offering to help firms bring in all the information required from multiple sources, perform detailed investment and bond analysis and then implement risk surveillance and compliance controls at a cross portfolio level. A risk or portfolio manager can query a portfolio to analyse all the deals matching any desired stratification. For example, an investor could specify that it wants to view all EU and US RMBS deals, issued before 2008, where delinquency has jumped by more than 40% over the past year. The system processes the universe of information available to the investor, integrating the pricing, performance data and cashflow models an investor may use, in a single operational environment.

Long explains: "The idea is to try and mine data more efficiently - highlighting the specific securities that need more time spent on them and looking at the fundamentals, rather than someone having to go through, say, a portfolio of 100 deals looking at every single one, tracking 25 different indicators and figuring out what action to take. Having internal guidelines to say in these situations you've really got to go the extra mile and drill down into a particular investment is one thing, but having a consolidated way to implement and actively manage compliance within those guidelines is where we help people."

Long adds that this approach speaks to another major aspect of investors' dealing with data. "One of the other most important pieces is that when you bring data into an operation, you really want to make sure it flows through the full lifecycle of a deal, adding and tagging all the information associated with that deal wherever it goes and layering on workflow and operational controls to manage that."

So, he says: "When you go from the quantitative analysis of a deal to flowing it through to operations, you need to maintain a history of what happened and control who does what - for example, where the people who value securities on a regular basis are not the people who perform the original trades. You need workflow controls to direct that deal through to the right people within an organisation. There is a flow of information that must accompany that and an audit trail that needs to be recorded. Again, the data is key - but without it sitting in an environment where you can control how that data is used and how it is manipulated, you lose sight of the controls and the checks that you need to have in place."

Hale is equally certain of the importance of focusing on data management. He says: "We can't stand still because data availability and volume continues to increase. Statistics will still emerge in raw format and problems such as a lack of common identifiers will remain. The ongoing challenge of assimilating data across a range of sources and producing a consolidated picture of risk remains critical for all investors and third party sources."

The issue may ultimately be even more fundamental, according to Long. He concludes: "If you really want to grow your business, you need to have a really strong grip on your portfolio. With so much data around, if you don't have the procedures and operational infrastructure in place to be efficient and scalable, and at the same time meet your due diligence requirements, it will be a struggle to grow a business that has a focus on ABS and structured credit investment."

MP

CMBS

One-stop shop

Christian Bearman, coo at Valad Europe, answers SCI's questions

Q: How and when did Valad Europe become involved in CMBS workouts?
A: Originally founded in the 1960s, Valad Europe has grown through the acquisition of a number of local businesses in different regions to create one of the largest fully integrated real estate investment management platforms in Europe. In recent years, the company was listed on the Australian Stock Exchange as part of the Sydney-based Valad Property Group, before being taken private last year by management with the financial backing of Blackstone's BREP VI fund. Valad Europe is therefore now completely independent and able to partner with its preferred capital partners on a deal-by-deal basis.

Valad Europe has 60 international institutional investors across 13 different funds and mandates, with over €4bn assets under management. The company employs 220 people in 22 offices in 12 countries across Europe, covering 650 properties and 6,000 tenants accounting for six million square-meters of real estate.

At a high level, our strategy is to match the most appropriate capital partner to the right real estate opportunity according to the risk/reward parameters of the deal in question. These opportunities can be in the form of single mandates, appropriate for large institutional investors or sovereign wealth funds, but also include CMBS/bank work-outs/recapitalisations, portfolio acquisitions and the acquisition of private/public companies, as well as loan books (e.g. NPLs).

Our core competencies are across multi-let light industrial, office and logistic assets, as well as certain retail warehouse properties. We cover Germany, the UK, Nordics, the Netherlands, France and Central and Eastern Europe.

Our capital partners are generally looking for equity, mezzanine and debt investment opportunities, ranging from 10% to 20%-plus IRRs on moderate levels of gearing, on a risk-adjusted basis. Our institutional investors seek a solid, stable yield of circa 8% on a cash-on-cash basis.

A key component of our strategy is to target bank workouts and problem real estate loan books. We aim to provide a one-stop shop, with a holistic approach to asset management and restructuring skills, combined with equity investment, to drive value in the assets and the recovery of debt and equity value for our stakeholder clients. CMBS restructurings are obviously an important - and growing - area within this strategy, with €45bn of CMBS due to mature in Europe over the next two to three years - many of which are stressed from an LTV or ICR perspective, or both.

We have a good track record in terms of CMBS/bank workouts, based on our experience with the Kefren IX (KEOPS) and ECREL mandates, as well as Uni-Invest.

Kefren Properties was a €480m Swedish portfolio of 150 assets, comprising 2,100-plus tenants. We were appointed by both Barclays Capital as the senior lender and the sponsor in July 2010 to manage the assets through an accelerated sell-down and auction process, while enhancing the rental income and capital value. All assets were sold by December 2011 and we achieved full recovery for the senior loan and part of the junior loan in the process.

ECREL is a €250m mixed commercial portfolio of assets spread across the Netherlands, Germany and the Nordics. We were appointed by the investors and senior lender in April 2010 to build sustainable value, before implementing a five-year disposal programme. We were able to negotiate a €200m refinancing package with Lloyds in June 2011, at which point we also acquired a 49% equity interest in ECREL alongside the original investors.

More recently, Valad Europe was selected by Uni-Invest noteholders as their preferred asset manager for the consensual restructuring option of the Opera Finance portfolio of 200 Dutch assets, under a dual-track noteholder selection process. Ultimately, class A noteholders opted for the upfront cash option of the credit bid, which included an immediate cash payment of 40% of the principal - despite the class B, C and D noteholders voting in favour of Valad's proposal.

One core competency of ours that has been reinforced by these bank/CMBS workouts and which is of growing importance in these challenging economic headwinds is the ability to manage complex real estate portfolios with limited cashflow for capital expenditure purposes, ensuring that capex is only invested where it has the largest positive impact on value/sale.

Q: How do you differentiate yourself from your competitors?
A: Valad Europe is unique in a number of ways. Our main differentiator is the scale of our business and the breadth of our platform: we are one of the largest independent real estate investment managers in Europe, which combines a flexible cost of capital with a range of different growth strategies. For example, while there would be plenty of asset/investment managers eyeing a mandate for a £100m UK bank workout, we would be one of only one or two in the running for a €500m European cross-border complex problem loan mandate.

Our network of 22 offices across 12 countries in Europe is vital to our success. Having teams of local people on the ground, who know the local market, speak the local language and build relationships directly with our tenants on a daily basis is invaluable.

Another differentiating factor is alignment of interest between management and our capital partners. As a private company, management is fully aligned to our investors and debt partners and our staff are similarly aligned and incentivised. This means our clients matter to us at all levels of our business.

Q: What are your key areas of focus today?
A: Asset management in work-out situations in the current real estate market demands a different mentality: we are not talking about asset management in the traditional long-term sense, but rather an intensive effort with limited capex resources to drive immediate value in the asset and shape a disposal strategy that allows for debt to be repaid in an accelerated timeframe. The need to trade assets quickly and profitably requires a fundamental change in psychology and approach to the traditional buy-and-hold approach of some firms.

In practical terms, strategic and active asset management in this sense can be achieved by dividing a portfolio up to identify assets to dispose of in the short term that have high vacancies or to invest limited capex in redevelopment potential. The idea is to identify assets with value that can be traded in the short to medium term in order to have a positive impact on debt repayment/recovery. It is a question of making a judgement call in respect of where capex can be best spent to achieve greatest benefit to drive value in the assets or improve cashflow through new lettings.

For example, where vacancies are high, lease re-gears can be implemented to retain existing tenants and new tenants targeted to reduce the void. Repositioning an asset takes longer, but can present meaningful upside and so we may seek to spend capex in these situations.

Finally, assets that are a drag on cash should be sold soonest if not improved. This involves an element of price elasticity and is a function of basic economics, where pricing on a distressed asset must reflect what it will take to sell it. You have to make a call about where to take the short-term pain for long-term gain.

We typically approach asset management by taking a bottom-up view on an asset-by-asset and tenant-by-tenant basis. Together with the amount of capex available, the market the asset is in and the underlying occupational and investment trends are all important considerations.

In an oversupplied office market like the Netherlands, for instance, the emphasis on tenant incentives is greater because - as there is more choice - you are competing on making the asset look good and to offer favourable terms that are attractive to a prospective tenant. Such incentives could involve giving tenants rent-free periods or contributing to a portion of their refurbishment costs. The aim is to maximise income and there are different ways of doing this in terms of lease lengths and rent levels.

At the same time, a buyer for each asset has to be identified. It is not always obvious who that may be, so it is important to understand the local market because it changes from region to region, what sales strategy to develop and how to market each asset best in that local market.

In some places, there may be good areas only 100 yards away from bad areas. Consequently, it is necessary to think creatively about the potential purchaser base, especially if there is a potential change of use with the asset.

Generally, the longer an issue remains unresolved, the greater the potential for asset deterioration and value destruction. If receivers take charge of an asset, for instance, they do not typically have the skill-set to actively asset manage it and - depending on the nature of the distress - it may be better to bring in a specialist asset manager. But even this may not have the necessary impact in the time required, if a more fundamental restructure of the capital structure is required in order to give the best chance of the asset management initiatives having the positive impact intended.

A solution can always be found. Even for a particularly poor asset, a buyer can always demolish the property and benefit from the value of the land, its alternative uses or a new more modern development.

Q: What is your strategy going forward?
A: Around €45bn of European CMBS is due to reach legal final maturity over the next two to three years, but a more proactive and nimble approach to asset management is required to deal with the real estate challenges this will present. We are in a good position to help special servicers, noteholders and banks by providing innovative solutions for their workout needs. Certainly, we have had much positive feedback following the role we played in the Uni-Invest resolution and it is important we build on this momentum.

One clear lesson from the Uni-Invest case is the importance of understanding the nature of capital that is represented by each class of noteholder: they all have different priorities, objectives and pressures. If a noteholder is invested in a number of different tranches in the same distressed deal, for example, they will typically prefer the consensual restructure 'work-out' option that offers greater long-term recovery prospects.

Hedge fund-type noteholders tend to be interested in the short to medium term and in making a trade with a higher upfront cash component in order to convert a bad loan in to a better or 'good' loan. Banks, on the other hand, tend to be capital risk weighting constrained under new regulations and are keen for a cash-based solution that provides liquidity and minimises their risk weighted assets (RWA) capital requirements.

The special servicer for the Uni-Invest loan (Eurohypo) recognised how difficult it was to corral investors with different views, so it appointed an adviser to run the dual-track process and give noteholders a choice of options. Having said that, if there are structural debt issues, it is very rare for a CMBS to hit legal final maturity without these being resolved in advance. I would expect this to happen only in extreme cases in the future, with problematic assets in difficult markets, given the abundance of private equity capital raised to tackle these types of opportunities and the increasingly innovative approaches to providing solutions.

Another lesson from the Uni-Invest case is the attractiveness of noteholder financing to acquirers because it is on more favourable terms than those derived from banks.

Q: What major development do you need/expect from the market in the future?
A: Commercial real estate portfolios of scale are being traded in this market at a 20% to 30% discount to net asset value across Europe. But many banks are yet to start liquidating their distressed assets - Dutch and German banks, in particular, have not taken the full mark-to-market hit on their portfolios - so prices will likely soften further going forward as supply to market grows. The 'bad banks' in Germany, Ireland and Spain are in the early stages of being able to address their portfolio issues, and most banks are disposing of non-core portfolios and refocusing on their core domestic markets.

Pricing is still moving out on some secondary and tertiary UK properties. By comparison, the Czech Republic, Germany, Poland and Sweden remain attractive, with decent liquidity. These regions are exhibiting good underlying economic growth, although it varies according to sector.

CS

ABS

Bank hires origination head

Matthew Cooke has joined Lloyds Bank Wholesale Banking and Markets as md and head of financial institutions origination for asset backed solutions. He is based in London and reports to Robert Plehn, head of asset backed solutions.

Cooke will lead and coordinate all securitisation and other asset backed funding and risk transfer origination activities for external financial institutions clients. He was most recently at Bank of America Merrill Lynch, where he led the European securitised products origination team before taking on a similar role for the Asia-Pacific region.

ABS

Asian investment manager formed

Harvest Alternative Investments Group has formed Harvest Northstone Capital, a structured credit manager focusing on high yielding asset-backed mezzanine investments supported by Asian consumer, SME and corporate assets. Investments will generally be privately sourced and structured.

The investment team is led by managing partner Gregory Park, who was formerly the head of securitised products Asia for Deutsche Bank. Before that, he led the Asian securitisation efforts at Credit Agricole and Credit Suisse.

Park comments: "With Harvest's strong institutional platform and experienced management team, Harvest Northstone Capital can build on its first mover position in the Asian structured credit sector. We are focused on creating high quality credit investments with an emphasis on granular asset diversification and cashflow consistency. We are now discussing our strategy with global institutional investors who desire Asian exposure, but with a measurable and transparent risk reward profile."

He is joined by partner Chris Werner, who was previously Standard Chartered Bank's consumer banking regional head for North East Asia. Additional partners include Carol Lee - a private equity veteran who was formerly with JPMorgan, Merrill Lynch and Henderson Global Investors in Asia - and Tor Trivers, an asset-based lending professional who joins from Natixis.

Werner says: "Asia Pacific has the fastest growing number of middle class consumers in the world. Consumer spending in Asian markets is expected to triple to almost US$15trn by 2020, representing more than 40% of global spending. With rising incomes and consumption patterns, consumers' and businesses' borrowing will accelerate strongly and generate prime asset collateral pools. Harvest Northstone Capital is well positioned to take advantage of this growth trend."

Structured Finance

Muni opportunity fund launched

Fundamental Advisors has launched Fundamental Credit Opportunities (FCO), which aims to capitalise on structural inefficiencies in the municipal market. The new strategy will be co-led by Hector Negroni, who previously led municipals at Goldman Sachs. He will serve as co-ceo and chief investment officer of FCO.

At Goldman Sachs, Negroni was an md overseeing municipal capital commitments, flow and proprietary trading, money markets, collateralised lending and issuer derivatives. He joined Goldman Sachs in 2005 and has more than 20 years of municipal portfolio management experience.

Structured Finance

Vendor scoops new evaluator

Domenico Picone has joined Interactive Data as a senior evaluator in its structured credit products valuation team. He reports into Paul Williams, senior manager at the firm. Picone was previously head of structured credit analytics at Commerzbank's portfolio restructuring unit and head of structured credit research at Dresdner Kleinwort.

CDO

Successor CDO manager named

Dock Street Capital Management has been named successor collateral manager to Istana High Grade ABS CDO I. The move follows ST Asset Management's resignation as collateral manager, effective on 11 May. Moody's has confirmed that it won't result in any adverse action with respect to the deal's current ratings.

CMBS

SEC issues CMBS fine

The US SEC has charged OppenheimerFunds and its sales and distribution arm with making misleading statements about two of its mutual funds. Oppenheimer has agreed to pay more than US$35m to settle the charges.

The SEC found Oppenheimer used TRS contracts to add CMBS exposure for the Oppenheimer Champion Income Fund and Oppenheimer Core Bond Fund in 2008 without adequately disclosing the leverage used in the Champion fund or the subsequent losses that both funds encountered.

When CMBS market declines drove down the NAVs of the funds and Oppenheimer was forced to reduce its exposure, it disseminated misleading statements about the funds' losses and recovery prospects. Despite being forced to sell securities into an increasingly illiquid market in order to raise cash for TRS contract payments, Oppenheimer told investors the funds had only suffered paper losses and their holdings and strategies remained intact.

Oppenheimer will pay a penalty of US$24m, disgorgement of US$9,879,706 and prejudgement interest of US$1,487,190. It has neither admitted nor denied the SEC's findings.

CMBS

CRE firm continues expansion

James Cope and Patrick Dempsey have joined Walker & Dunlop as svps in the firm's new Milwaukee office. The pair will focus on financing all types of income-producing properties including office, apartments, hotels, industrial and retail in the Midwest.

Cope and Dempsey each join from Grandbridge Real Estate Capital where they specialised in originating and structuring CRE financing for all property types. Their hires follow those of another Grandbridge team acquired by Walker & Dunlop in Florida earlier in the quarter (see SCI 16 April).

CMBS

BGC boosts real estate team

Garett Stoffels has joined BGC Partners as senior md and head of equity capital markets for the real estate capital markets group. He will be based in New York and report to Michael Lehrman, global head of real estate.

Stoffels was previously global head of Cantor Fitzgerald's private capital group. He has also worked as co-head of direct private placements for Atlantic-Pacific Capital's real estate group and as md in the real estate and lodging investment banking group at Bear Stearns.

CMBS

CRE acquisition announced

Walker & Dunlop has agreed to purchase CWCapital for US$220m. Michael Berman, CWCapital ceo, will take a senior leadership role at Walker & Dunlop.

The purchase price includes US$80m in cash and around US$140m in Walker & Dunlop stock, subject to potential adjustment based on changes in the stock price pending closing. Walker & Dunlop say the combined company will be one of the largest CRE lenders in the US.

CMBS

Special servicing head joins

John D'Amico has joined TriMont Real Estate Advisors as director of special asset management. He will head the firm's special servicing division and be based in Atlanta.

D'Amico was previously general counsel of ARCap REIT and Centerline Holdings and has also been an officer, board and executive committee member of the CRE Finance Council.

Insurance-linked securities

Law firm appoints cat bond specialist

Matthew Feig has joined Stroock & Stroock & Lavan as special counsel in the structured finance and insurance practice groups in New York. He joins from Cadwalader, Wickersham & Taft where he focused on risk-linked securities and structured and corporate finance.

Feig specialises in catastrophe bonds and cell tower transactions. Before Cadwalader he was an associate at Cravath, Swaine & Moore.

Risk Management

Independent council examines systemic risk

The Systemic Risk Council will convene this month to monitor and encourage reform of US capital markets, focusing on systemic risk. The council intends to issue a call to action on 18 June detailing its objectives and future plans.

The council was formed by The Pew Charitable Trusts and CFA Institute and is led by former FDIC chair Sheila Bair. It expects to evaluate regulators' efforts to implement a global oversight function and will provide reports to the US Financial Stability Oversight Council and its member regulators.

Bair comments: "As evidenced by the 2008 crisis and even recent headlines, we need a more effective and efficient early-warning system to detect issues that jeopardise the functioning of US financial markets before they disrupt credit flows to the real economy. And two of the most critical tasks are how to impose greater market discipline on excess risk taking and effectively end the doctrine too-big-to-fail."

RMBS

Mortgage credit md appointed

Maureen Stewart has joined NewOak as mortgage credit and compliance services md. She specialises in mortgage credit underwriting and forensic analysis and will help build the firm's credit advisory services platform.

Stewart has over 30 years of experience at major banking institutions across consumer mortgage loan products. She was most recently senior audit manager for Bank of America.

ABS

Russian DPR programme minted

ZAO Raiffeisenbank (RBRU) has established a new diversified payment rights (DPR) securitisation programme in Russia. The first issuance under the programme - dubbed ROOF Russia DPR Finance Company - comprise US$125m series 2012-A and series 2012-B notes, which have been assigned single-A minus ratings by Fitch.

The notes are backed by the collections generated from future and existing US dollar- and euro-denominated DPRs originated by the bank, mainly related to exports of oil and gas and other commodity flows made by Russian companies.

The ratings reflect the strength of DPR flows and the transaction's legal structure, which provide it with a one-notch uplift above the bank's local currency issuer default rating of triple-B plus to a level consistent with its going concern assessment score of GC3. The expected tested collections debt service coverage levels for the programme are above 200x for this issuance, Fitch notes.

The three main correspondent banks used by RBRU have signed irrevocable acknowledgement agreements whereby any collections in those bank accounts are controlled by the programme agent for the benefit of the noteholders. As all collections are trapped offshore, the structure mitigates sovereign risks - such as transfer and convertibility risks - and the risk that the sovereign interferes with the DPR flows.

ABS

SLABS trusts hit

Fitch has taken various actions on 10 FFELP student loan ABS trusts that are currently on rating watch negative. The actions include both downgrades and affirmations.

The trusts were reviewed due to the prominence of a unique multiplier function and its usual determination based on lowest rating assigned to the notes by any rating agency (see also SCI 28 September 2011). This feature - in conjunction with recent actions taken by other agencies, as well as parity being sustained only voluntarily in some cases at levels substantially in excess of cash release levels - has led Fitch to re-evaluate the risk in these transactions. Trusts that are being downgraded have been determined to be vulnerable to this multiplier function, with presently undercollateralised trusts faring worse under the applied stress.

Since the failure of the auction rate securities market in 2008, the maximum auction rate (MAR) has been in effect for these transactions. The MAR includes a multiplier or applicable percentage that increases depending on the rating.

Typically, the applicable percentage is between 150%-175% of the linked index for ratings of single-A or better and 200%-265% of the linked index for lower ratings. The applicable percentage is usually based on the lowest rating on the bonds.

Fitch analyzed the effect on the trusts if a bond's applicable percentage were to increase from 175% to 265% due to a ratings downgrade while simultaneously applying the LIBOR up interest rate stresses also used for new transactions. In this scenario, the bond's coupon will increase by about 50%, which will compress excess spread and possibly erode parity. Fitch has downgraded tranches that become impaired under this scenario and have a higher risk of principal shortfall.

ABS

PCS securitisation label launched

AFME and the European Financial Services Round Table have launched the Prime Collateralised Securities (PCS) initiative. The non-profit project aims to develop a label for high quality securitisations which meet best practice for quality, transparency, simplicity and standardisation.

The PCS initiative will comprise a two-tier governance structure, with the PCS Association comprising independent non-industry directors and industry professionals and then the PCS Secretariat responsible for the day-to-day administrative and managerial operations. The PCS Secretariat will grant the PCS label to securities, certify a transaction and monitor the label after it is issued.

The initiative is intended to provide the basis for a definition of agreed market standards, as well as an enforcement mechanism of these agreed standards, based on a label which can be granted and withdrawn depending on compliance and as verified by the PCS Secretariat. The first label is expected to be granted by the PCS Secretariat towards the end of the year.

"PCS will bring added quality, transparency and standardisation to the market, which will deepen the securitisation investor base in Europe and, in turn, improve overall liquidity. Europe needs a healthy securitisation market and we are confident that this initiative, alongside regulatory changes, will provide a significant boost to the market," comments Rick Watson, AFME head of capital markets.

Structured Finance

Basel Committee issues implementation update

The Basel Committee has published its report to the G20 on the implementation of its banking standards across member countries, ahead of the G20 Leaders Summit on 18-19 June.

"With this report, the Basel Committee is following up on the commitments made by the G20 Leaders in Cannes to have Basel 3 implemented fully and consistently, and within the agreed timetable," comments Stefan Ingves, chairman of the Committee and governor of the Sveriges Riksbank. "To date, significant progress has been made, but there are a number of countries that have missed the globally-agreed implementation dates for Basel 2 and 2.5, and where their ability to meet the Basel 3 implementation deadline of 1 January 2013 could prove a significant challenge."

The Basel Committee's implementation review process includes three levels of review: level 1, which ensures the timely adoption of Basel 3; level 2, which ensures regulatory consistency with Basel 3; and level 3, which ensures the consistency of outcomes initially focusing on risk-weighted assets (RWA). Preliminary level 2 assessments of domestic rules in the EU, Japan and the US have identified areas of divergence between domestic regulations and the Basel standards.

The level 3 assessments are analysing consistency of RWAs in the banking book and trading book across banks and jurisdictions. The Basel Committee describes work as "exploratory at this stage" but notes it could lead to policy recommendations in the future.

Level 1 progress reports will continue to be published twice a year. The full results for the first level 2 assessments of the EU, Japan and US are expected to be published by the end of September, with the first level 3 assessments of RWAs expected by the end of the year.

Structured Finance

Ocala investor rights upheld

US District Court Judge Robert Sweet last week ruled in the ongoing Ocala Funding litigation (SCI passim) that ABCP investors can sue over claims arising in documents, even though they were not parties to those documents, when their agent refuses to sue or allow the investors to sue. Moody's notes in its latest Weekly Credit Outlook publication that the decision is credit positive as it holds that investors can step into a recalcitrant agent's shoes to enforce their rights, particularly since investors often rely on entities that play multiple roles in a single transaction and whose actions and inactions can significantly influence losses. The Ocala litigation also continues to shed light on often seen but little tested language in securitisation agreements, the agency says.

Judge Sweet issued a written opinion allowing the investors to sue Bank of America in certain of its capacities, since the bank - as indenture trustee and collateral agent under the security agreement - refused to sue itself in its additional roles as depositary, collateral agent and custodian under other transaction documents. Ocala's two sole investors, Deutsche Bank and BNP Paribas Mortgage Corp, claim that BofA's failure to perform its duties in its various capacities caused them to collectively suffer over US$1.6bn in losses. They state that BofA's experience and reputation and its agreement to play key roles in the Ocala ABCP programme were essential factors in their decision to purchase the ABCP.

Previously, in a 23 March 2011 opinion the judge found BofA responsible in the transaction documentation for safeguarding the Ocala collateral. But at the same time, he ruled that the investors lacked standing to sue BofA for contractual breaches of its custodian, collateral agent and depositary roles because these agreements failed to name the investors as direct parties or third-party beneficiaries. However, the judge ruled that BofA as indenture trustee and collateral agent possessed such standing.

This decision upholds the terms of the documents and helps mitigate the conflicts of interest among different key transaction party roles, according to Moody's. "In many types of finance transactions, a single entity often wears multiple hats," it says. "Obligations are often defined in multiple agreements and investors may not be explicitly named as direct parties or third-party beneficiaries in every agreement. Those investors benefit from this latest Ocala opinion."

Structured Finance

Spanish ratings cap lowered

Fitch has downgraded 234 tranches related to 156 Spanish structured finance (SF) transactions, following the downgrade of Spain's long-term foreign currency issuer default rating to triple-B from single-A. The affected tranches comprise 150 RMBS, 58 structured credit, 23 ABS and three CMBS classes from across 101 RMBS, 40 structured credit, 14 ABS and one CMBS deals. Additionally, the agency has revised the outlook on 10 tranches of 10 Spanish SF transactions to negative and has placed one CMBS tranche on rating watch negative.

The downgrades apply to tranches at Fitch's ratings cap for SF transactions from Spain. Following the sovereign downgrade, the agency has revised its ratings cap on Spanish SF transactions to double-A minus from triple-A, thereby maintaining the five-notch differential between the sovereign IDR and the highest achievable SF ratings.

The ratings cap reflects the agency's concerns that the weakening sovereign increases the likelihood of extreme macroeconomic events that could undermine the performance of the securitisations. The negative outlook assigned to all tranches rated double-A minus reflects the outlook on the sovereign rating.

Tranches that are currently on RWN because of ineligible counterparty exposures will remain on RWN, Fitch says. If such exposures continue or increase as a result of further downgrades of financial institutions and effective mitigants are not implemented, further downgrades of the affected SF tranches are likely.

Structured Finance

Chinese pilot programme revived

Further details about the revival - following its suspension in 2008 - of China's Credit Asset Securitisation Pilot Programme have emerged (SCI 4 April). The size of the programme is understood to be RMB50bn.

Regulators will require trustees involved with the programme to publicly disclose the performance of the underlying asset pools periodically, which will bring more transparency to the banks' credit underwriting and the quality of similar assets in bank portfolios, Moody's suggests in its latest Weekly Credit Outlook publication. Issuers will also need to obtain monitored ratings from two domestic rating agencies when applying to issue under the programme.

The agency notes that this latest reiteration of the pilot programme differs from its two predecessors in several ways. First, it targets assets tied in with the priorities the government outlined in its twelfth five-year plan, including infrastructure loans, rural loans, SME loans and loans to local government financing vehicles (LGFVs). Banks with high exposure to these loans are expected to participate in the initiative, including China Construction Bank Corporation, Agricultural Bank of China and China Development Bank.

Second, the programme expands the potential investor base to non-bank institutions, including insurance companies, mutual funds and social security funds. Finally, it implies only a partial transfer of risks from banks: issuers are required to retain at least 5% of the first-loss tranche. The initiative excludes resecuritisations and synthetic securitisations.

Moody's expects the move to benefit in particular joint stock commercial banks with loan-to-deposit ratios close to the regulatory requirement of 75% and weaker capital positions, if regulators approved them to securitise. These banks include China Merchants Bank, Shenzhen Development Bank Co and China Everbright Bank.

Structured Finance

Greek country ceiling lowered

Moody's has downgraded to Caa2 the ratings of the most senior securities in nine Greek structured finance (SF) transactions and to Caa3 the ratings of subordinated securities in six transactions. Moody's also placed all the Caa2 andCaa3 ratings of Greek SF securities under review for further downgrade.

The rating actions follow Moody's lowering of its Greek country ceiling to Caa2 to reflect the heightened risk of a euro area exit and the near-automatic effect of currency redenomination on default of those obligations. As a result, the highest rating for outstanding Greek SF securities is now Caa2, down from B2 previously.

The agency explains that this risk holds true regardless of the jurisdiction in which the debt obligations are issued and the law governing them. Although most structured finance securities benefit from diversification of revenue sources and are issued by non-Greek issuers under UK law, collateral assets are governed under Greek law and are therefore all exposed to redenomination risk. Structured finance transactions also rely on Greek banks to provide servicing functions and other financial roles and are therefore vulnerable to the kind of banking sector distress that would be generated by Greece exiting the euro area.

Moody's rating review for the affected securities will consider the outcome of the 17 June Greek parliamentary elections, as these will be a key driver of the probabilities and speed of a euro area exit. Following these elections, it is possible that the risk of a euro exit will increase further. If that were to occur, the Caa2 maximum rating assigned to securities issued in Greece or backed by Greek assets would fall further, the agency says.

Structured Finance

Investor perceptions surveyed

JPMorgan has surveyed changes in investor perception of the consumer ABS market since September 2011. The results confirm that benchmark ABS asset classes - such as the auto loan and credit card sectors - enjoy the highest participation rates, while the more esoteric and riskier asset classes are less liquid.

Banks generally invest in less esoteric and more triple-A rated paper, while money managers and insurance companies invest across the product spectrum, according to the JPMorgan survey. "Currently, investors are overweight auto loan ABS, followed by esoteric ABS, UK RMBS and subordinates. This mirrors our top picks in consumer ABS, which are subprime auto, benchmark subordinates and certain esoteric ABS," note ABS analysts at the firm.

In particular, the participation rate in UK RMBS has increased since September 2011 from roughly 40% to 50%. Conversely, student loan ABS experienced a decline in investor participation for both the FFELP and private sectors. While both UK RMBS and student loan ABS are cheap to benchmark ABS, the analysts indicate that they prefer UK RMBS for its solid fundamentals and improving liquidity.

Structured Finance

Risk retention recommendations made

IOSCO has published a consultation report entitled 'Global Developments in Securitization Regulation', which seeks public comment on policy issues arising from the work of its Task Force on Unregulated Markets and Products (TFUMP). The paper is in response to a request from the Financial Stability Board (FSB) as part of its work to strengthen oversight and regulation of the shadow banking system.

The FSB asked IOSCO, in coordination with the Basel Committee on Banking Supervision, to conduct a stock-taking exercise on the requirements for risk retention and measures enhancing transparency and standardisation of securitisation products, and to develop policy recommendations as necessary. The paper makes policy recommendations addressing: differences in approaches to risk retention; improvements in transparency; and measures to standardise disclosure.

TFUMP co-chair and chairman of the Australian Securities and Investments Commission Greg Medcraft comments: "The consultation paper continues the leading role IOSCO has played in supporting the sustained recovery of securitisation markets globally. It again focuses on the importance of securitisation as a market-based source of finance and the role cross-border issuances play in deepening markets and supporting growth in the real economy."

Comments on the consultation paper are sought by 6 August.

Structured Finance

RFC issued on reg cap rules

The US Federal Reserve has invited comment on three proposed rules intended to help ensure banks maintain strong capital positions. Taken together, the proposals would establish an integrated regulatory capital framework, implementing the Basel 3 reforms and changes required by the Dodd-Frank Act.

The rulemaking is divided into three proposed rules to minimise the burden on smaller and mid-sized banking organisations and to allow firms to focus on the aspects of the proposed revisions that are most relevant to them. Comments are requested on the three NPRs by 7 September 2012.

The first NPR - entitled 'Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy and Transition Provisions' - would apply to all depository institutions and bank holding companies with total consolidated assets of US$500m or more, as well as savings and loan holding companies. Consistent with the international Basel framework, this NPR would: increase the quantity and quality of capital required by proposing a new minimum common equity tier 1 ratio of 4.5% of risk-weighted assets and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets, and raising the minimum tier 1 capital ratio from 4% to 6% of risk-weighted assets. It would also: revise the definition of capital to improve the ability of regulatory capital instruments to absorb losses; establish limitations on capital distributions and certain discretionary bonus payments if common equity tier 1 capital buffers are not met; and introduce a supplementary leverage ratio for internationally active banking organisations.

The second NPR, entitled 'Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements', also would apply to all banking organisations. This NPR would revise and harmonise the Fed's rules for calculating risk-weighted assets to enhance risk sensitivity and address weaknesses that have been identified over the past several years.

The third NPR, entitled 'Regulatory Capital Rules: Advanced Approaches Risk-based Capital Rule; Market Risk Capital Rule', would apply to banking organisations that are subject to the banking agencies' advanced approaches rule or to their market risk rule. This NPR would enhance the risk sensitivity of the current rule for internationally active firms to better address counterparty credit risk and interconnectedness among financial institutions. It also would apply the advanced approaches rule and market risk capital rule to savings and loan holding companies that meet the relevant size, foreign exposure or trading activity thresholds.

The Fed has also approved a final rule to implement changes to the market risk capital rule, which will be incorporated into this NPR, effective on 1 January 2013. The rule requires banking organisations with significant trading activities to adjust their capital requirements to better account for the market risks of those activities, implementing changes the Basel Committee made to its market risk framework between 2005 and 2010. The aim is to reduce pro-cyclicality in market risk capital requirements, enhance sensitivity to risks that are not adequately captured by the current regulatory methodologies and increase transparency through enhanced disclosures.

The final rule does not include aspects of the Basel Committee's market risk framework that rely on credit ratings. Instead, it includes alternative standards of creditworthiness for determining specific risk capital requirements for certain debt and securitisation positions. These standards are consistent with the requirements of the Dodd-Frank Act, under which all federal agencies must remove from their regulations references to, and requirements of reliance on, credit ratings.

Structured Finance

Spanish bank capital positions examined

Spain's double-dip recession will accelerate domestic banks' accumulation of problem assets in 2012 and 2013 and significantly lift associated loan losses, in S&P's opinion.

"We estimate in our base-case scenario that Spanish banks' loan losses to be recognised in 2012 and 2013 will range between €80bn-€112bn," comments S&P credit analyst Elena Iparraguirre. "These amounts include losses pending recognition at year-end 2011, which we estimate at €5bn-€16bn. The need to absorb these high credit losses will, in our view, lead the financial system as a whole and many individual financial institutions to post losses - ultimately impairing their capital positions."

S&P estimates that the financial system could absorb €60bn of these losses through pre-provision operating profit this year and next. This would leave a potential shortfall of €20bn-€52bn, or €14bn-€36bn net of taxes, by year-end 2013 under the agency's base-case scenario. Of these amounts, it estimates that €10bn will be absorbed by Spain's Deposit Guarantee Fund through the asset protection schemes that it already provided in the sales of Banco CAM and Unnim Banc.

Additionally, banks are expected to cover part of this shortfall by generating extraordinary gains from asset disposals, absorbing losses through hybrid securities and consuming capital buffers. The Spanish government or the EU would likely need to cover the remainder, in S&P's opinion. In this context, the capital support that the Spanish government or the EU would provide to Spanish banks would be manageable and concentrated in a limited number of institutions.

"We note, however, that pressure is building for Spanish banks to recognise provisions against the likely losses in both 2012 and 2013 already this year," the agency concludes. "If the recognition were to occur this year, we think Spain's banks would require substantial capital to continue complying with current minimum regulatory capital ratios. This would consequently increase the likelihood of support from the Spanish government or the EU."

Structured Finance

Set-off risk approach revised

Moody's has updated its approach to analysing set-off risk in relation to Italian structured finance transactions and covered bond programmes. Five deals have been placed on review as a result.

Under the revisions, the agency no longer gives full value to the Italian deposit compensation funds, given that the credit quality of the funds is no longer Aaa rated following the deterioration of the Italian sovereign's credit rating. Moody's now also takes into account 'deposit flight', which can decrease the potential set-off risk. In addition, it has introduced a correlation assumption between the performance of the funds and the performance of the pool.

Under Italian law, reciprocal debt obligations may be set-off against each other to the extent they are both due and payable. Even after a debt is assigned to a third party, such as a securitisation issuer, the debtor may still set off claims owed to it by the originator. However, set-off rights against securitised debt are limited to the amount of claims that exist when the notice of assignment is published in the Italian Official Gazette.

CDO

ABS CDO auction due

Dock Street Capital Management has been retained to act as liquidation agent for Orchid Structured Finance CDO II. The collateral will be auctioned at two public sales on 19 June.

CDO

ML3 sales absorbed 'comfortably'

Last month's Maiden Lane III activity appears to have had "little to no" impact on spreads, according to Interactive Data, supporting the New York Fed's objective of not being an overtly disruptive market force. Indeed, the auctions seem to have been comfortably absorbed by the market.

MAX CDO CMBS spreads, for example, remained mostly unchanged around the day of the sale. Although they widened over the course of May, their movement appeared to track the overall CMBS market in which spreads generally widened, following the sell-off of broader equity markets.

The five separate ML3 sales that began in late April (SCI passim) amounted to more than US$12bn, primarily in the form of 14 CDO tranches, which comprised about 25% of the entire ML3 portfolio. The market was generally receptive to the higher-yielding assets, igniting a flurry of dealer activity to re-structure and re-offer some of the CDO tranches.

CDO

Defaulted obligation declared

A €7m Meyer & John senior bond, purchased by PULS CDO 2007‐1, has been declared a defaulted obligation in accordance with the transaction's prospectus. The move follows the company's inability to meet its April 2012 interest payment and the deferral of its other financial obligations.

The company is currently negotiating with its lenders in order to avoid insolvency. Capital Securities Group, the manager of the PULS CDO, expects a balance sheet restructuring to occur and a partial repayment of the notional.

This is the third bond to be declared a defaulted obligation by the transaction (SCI passim).

CDO

Psion CDO tender announced

DEPFA Bank has launched a tender offer to purchase, for cash, Psion Synthetic CDO I notes via open-market transactions. The bank is offering to pay 84% per €100,000 in nominal principal amount for class A notes, 80% for class Bs, 78% for class Cs, 75% for class Ds and 70% for class Es. The tender expires on 25 June.

CDS

Sovereign CDS tighten on Spanish bailout

The EU's bailout of Spain's banking sector has led to a "mini rally" in sovereign credit default swap spreads, according to Fitch Solutions. Overall, the firm reports that CDS on European sovereigns tightened by 3% last week.

"Portugal led all Western European sovereigns, with spreads coming in 11%," comments Fitch director Diana Allmendinger. "Conversely, Germany bucked the trend, with spreads widening 6%."

The rally also extended to CDS on European financial institutions, which tightened by 2.8%, led by French and Italian banks. "Biggest movers included Rabobank Nederland, Societe Generale, Credit Agricole, Credit Lyonnais and BNP Paribas," adds Allmendinger.

At the same time, average CDS liquidity for developed and emerging market sovereigns converged, reversing the longstanding trend observed for most of 2012. "While CDS liquidity for developed market sovereigns had outpaced that of emerging market sovereigns since the beginning of 2012, CDS contracts on emerging market sovereigns are now, on average, more liquid," Allmendinger explains.

Fitch Solution's developed and emerging market sovereign CDS liquidity indices closed last week at 7.82 and 7.78 respectively, versus 8.36 and 8.66 on 3 January 2012.

CDS

Dodd-Frank 'roadmap' released

The US SEC has issued a policy statement describing the order in which it expects Dodd-Frank rules to take effect. It is requesting public comment on its plan to phase in final rules regulating security-based swaps and security-based swap market participants.

The phased-in approach is intended to avoid the disruption that could occur if all the new rules took effect simultaneously. To date, the SEC has proposed nearly all the rules required under the Act and already has begun to adopt those rules.

In addition, the policy statement discusses the timing of the expiration of the temporary relief the SEC previously granted to securities-based swap market participants. Much of this relief is due to expire when certain final rules under Title VII become effective.

The SEC will seek public comments for 60 days after the date of the policy statement's publication in the Federal Register.

CDS

CDS tear-ups continue apace

ISDA has released its analysis of the OTC derivatives market based on year-end 2011 statistics. It shows that adjusted volumes of OTC derivatives declined by 10.3% from June 2011 to US$440trn, taking into account double-counting of cleared transactions and excluding FX volumes.

Cumulative compression activity in the interest rate swap and credit default swap markets have reduced notionals by just over US$200trn, according to the analysis. "The increase in central clearing, the effectiveness of netting and collateral, and portfolio compression all work toward the same goal - reducing counterparty credit risk," comments Robert Pickel, ISDA ceo. "Our continued progress toward this goal reflects the commitment of ISDA and the industry to help make the derivatives markets safe and efficient for all users of derivatives products."

Adjusted CDS volumes fell by 12.5% from June 2011 to US$25.9trn, the lowest level since year-end 2006. ISDA estimates the total amount of trades that cannot be electronically confirmed is no more than US$2.8trn as of year-end 2011. Only US$530bn of these are multi-name transactions.

Approximately 10.6% of adjusted CDS have been cleared as of year-end 2011. CDS compression totaled US$82trn on a net, cumulative basis as of year-end 2011.

The analysis also shows the risk mitigation benefits of netting and collateral. Gross credit exposure was 14.3% of gross market value and 0.6% of notionals outstanding because of netting agreements. Collateralisation further reduces credit exposure to 4.1% of gross market value and 0.2% of notional value. The benefits of netting reduced credit exposure by 85.7% globally and by 92.1% among US banks, ISDA notes.

CDS

Low recovery for Res Cap CDS

The final price for Residential Capital CDS was determined to be 17.625. Twelve dealers submitted initial markets, physical settlement requests and limit orders to yesterday's auction to settle trades across the market referencing the entity.

CLOs

SME funding gap emerging

Fitch notes in its latest European SME CLO Performance Tracker that the reduction in bank lending has led to significant strains on SME funding in Europe. Structural initiatives by European governments to stimulate lending have fallen short of addressing the funding gap that is critical to the financial viability of SMEs, the agency says.

In particular, SME securitisation economics are currently unfavourable for banks as investors align their expectations with RMBS spreads while dismissing the higher credit enhancement (CE) levels in SME CLOs. The underlying asset spreads are too low to support those on the notes and spreads on senior tranches seem to be primarily driven by liquidity and, to a lesser extent, the intrinsic credit risk. While Fitch believes that investors are comfortable with the fundamental credit risk in SME CLOs, their restricted supply is causing a lack of liquidity in the secondary markets.

In terms of performance, German SME portfolios exhibit low and stable defaults and this trend is expected to continue through the medium term. In terms of access to finance, Germany beats the trend, with fewer SMEs reporting a restrictive credit policy by the banks.

Current default levels remain low for Fitch-rated SME transactions in Italy, as cumulative defaults have remained stable and recoveries from worked-out assets are picking-up. Delinquency rates remained low for all transactions until December 2011; however, during 1Q12 delinquencies spiked for two of the four Fitch-rated SME transactions. The increase in delinquencies was mainly attributed to obligors concentrated in the real estate sector.

CLOs

CLO maturity profile lengthens

The average maturity profile of the underlying loans across Fitch-rated European CLOs has been pushed out by manager trading activities and amend-and-extends. Loans maturing in the 2013/2014 bucket have dropped to 21.9% from 42.5% over the past year, with a corresponding increase in the 2016-2019 bucket (46.8% from 24.84%).

Defaults have increased since May 2011, with the current average defaulted balance being 2.2%, an increase from 0.3%. This represents 10 credits in the larger CLO universe portfolio. Average OC cushions at the original double-B level have remained relatively constant over the past year, while OC cushions at the triple-A level have improved slightly, driven by the rapid pay down of the senior most tranche in Melepard CDO I.

Fitch has recently completed its review of its 28 rated CLOs, which resulted in the affirmation of 164 tranches, upgrade of two tranches and the downgrade of 49 tranches. Of the downgraded tranches, 29 were by more than one notch and were predominately tranches originally rated triple-B or lower. The driver of these downgrades was the presence of long-dated buckets in a number of older vintage transactions, as well as certain transactions failing back-loaded default scenarios.

The outlooks on the mezzanine and junior notes remain negative, reflecting their vulnerability to a clustering of defaults and negative rating migration in the European leveraged loan market due to the approaching refinancing wall.

CMBS

Loan pay-offs plummet

The percentage of US CMBS loans paying off on their balloon date plummeted to the lowest level since October 2010, according to Trepp's latest pay-off report. Only 29.4% of loans reaching their balloon date paid off in May, well under the 12-month average of 43.6%.

By loan count as opposed to balance, 57.3% of the loans paid off. On the basis of loan count, the 12-month rolling average is now 51.9%. The big difference between the volume-based total and the count-based total indicates that it was mostly small balance loans that managed to pay off in May, Trepp notes.

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

CMBS

California loan drives CMBS late-pays

US CMBS late-pays rose by 12bp in May to 8.65% from 8.53% in April, according to Fitch's latest index results for the sector. Driving the increase was the failed modification attempt of a US$470m loan secured by Two California Plaza (see SCI's CMBS loan events database).

The loan, securitised in GSMS 2007-GG10, had previously been characterised as in foreclosure but Fitch had excluded the loan from its index while modification talks were ongoing. However, the special servicer (CWCapital Asset Management) reported last month that modification negotiations were unsuccessful.

At the end of May, the building's owner announced it had entered into an agreement with the special servicer whereby a receiver will continue to manage the property, with a consensual foreclosure to occur before year-end. The building is owned by MPG Office Trust.

The company's other notable downtown Los Angeles loans include the US$550m Wells Fargo Tower (also in GSMS 2007-GG10), the US$458m Gas Company Tower (WBCMT 2006-C28 and JPMCC 2006-LDP8) and the US$273m 777 Tower (BACM 2006-6). Of MPG's eight CMBS loans, three - including Two California Plaza - are in special servicing and three are currently on servicer watchlists for performance concerns. The Wells Fargo Tower loan had been in special servicing but was returned to the master servicer as resolved.

Larger loans contributed significantly to the direction of delinquency rates for the major property types, Fitch notes. Two California Plaza, now the second largest loan in the agency's index behind Stuyvesant Town/Peter Cooper Village, fuelled a 28bp worsening of the office rate.

Hotel late-pays jumped by nearly one percentage point in May due to the addition of the US$194m Marriott Waikiki (JPMCC 2007-FL1) and US$82m MSREF Luxury Resort Portfolio (UBS 2007-FL1) to the index. In contrast, a nearly 30bp improvement in the multifamily rate was recorded, due in part to the liquidation in May of the US$82m Beyman Multifamily Portfolio III (GECMC 2006-C1).

The worsening industrial rate was largely attributable to the US$74m Airpark Business Center (BSCMSI 2007-PWR16) entering the delinquency ranks. At the same time, retail late-pays remained stable, sliding by just 6bp from the prior month.

Current and prior month delinquency rates for each of the major property types are: 11.35% for multifamily (from 11.64% in April); 11.15% for hotel (from 10.20%); 10% for industrial (from 9.34%); 8.64% for office (from 8.36%); and 7.45% for retail (from 7.39%).

CMBS

CMBS stress tested

Triple-A rated US CMBS classes generally would be able to withstand a hypothetical severe recession and further deterioration in the real estate markets, according to recent stress tests conducted by Fitch. While the agency would expect a significant level of downgrades in a severe stress scenario, its prospective analysis shows that 67% of triple-A ratings would remain investment grade.

Fitch subjected its rated CMBS to two stress scenarios - severe and moderate - by stressing property cashflows and commercial property cap rates. The severe stress scenario was calibrated to be significantly worse than the agency's expectations.

Given that current property cashflows are at or near the trough from the recent recession, the severe stress scenario simulates an extreme peak-to-trough decline in average property cashflow. It further assumes that property cap rates rise from the average market and property specific cap rates used in Fitch's surveillance analysis. In the severe stress scenario, approximately 85% of triple-A tranches would be able to pay in full, with 40% remaining triple-A rated.

Seasoned transactions (2002-2004 vintages) are particularly resilient, even in the severe hypothetical scenario, with 93% of the triple-A tranches retaining an investment grade rating. In contrast, as expected, recent vintages (2005-2008) are more susceptible to downgrades in higher levels of hypothetical stress, with only 35% of triple-A tranches remaining investment grade in the severe scenario.

In the moderate scenario, Fitch modeled property cashflows to experience a sharp peak-to-trough decline, while property cap rates remain similar to those used in its surveillance analysis. The moderate scenario would be akin to a severe double-dip recession, in which operating cashflow would decline sharply across all property types. The moderate stress scenario surpasses expected levels of stress beyond the agency's current outlook and is in addition to the stress that the collateral has already absorbed during the most recent recession.

In the moderate scenario, all triple-A rated bonds would be able to redeem in full following the stress period. In terms of ratings migration, 77% of triple-A tranches would remain triple-A and only 3% would migrate below investment grade. The rating migration for the moderate scenario is comparable to the actual rating migration experienced during the credit crisis.

Approximately 88% of CMBS tranches rated triple-A by Fitch as of January 2008 remain triple-A or were paid in full.

CMBS

Dewey building watchlisted

Morningstar has added the US$420m 1301 Avenue of the Americas loan - securitised in LBUBS 2006-C1 - to its watchlist, following the bankruptcy filing of the property's second largest tenant, Dewey & LeBoeuf. The law firm represents roughly 23% of the gross leasable area.

For the 12-month period ended 31 December 2011, the net cashflow DSCR was 2.65x, with net cashflow of US$60.7m. Occupancy was reported at 96%.

The NCF DSCR and net cashflow for the 12 months ended 31 December 2010 were 2.76x and US$63.1m respectively. Occupancy was reported at 100%.

Assuming Dewey& LeBoeuf vacates the property and the space remains unoccupied for an extended period, Morningstar expects the NCF DSCR to remain well above breakeven at roughly 2x on an IO basis. Occupancy would fall to about 73%.

Despite the likely departure of the second largest tenant, the agency considers this a low near-term default risk based on expected stable net cashflow and the location and quality of the asset. A preliminary Morningstar analysis of the collateral suggests a trust debt LTV ratio of about 61%, indicating that there is no value deficiency associated with the asset.

CMBS

Euro resecuritisation programme debuts

Credit Suisse has launched a new US$5bn-equivalent European CMBS resecuritisation programme, believed to be the first since 2010. Dubbed Credit Suisse European Mortgage Capital (CSEMCL), the first issuance under the programme comprises €78.98m class A1 and €20.9m A2 series 2012-1 notes, rated double-A minus and single-A respectively by S&P.

At closing, CSEMCL purchased at a discount from Credit Suisse €99.88m of class A notes issued by Windermere XIV, which are currently rated single-A. The structure provides for future purchases of Windermere XIV class A notes, funded by additional pro-rata note issuances.

CSEMCL's payments of principal and interest on the class A1 and A2 notes are dependent on receipt of principal and interest from Windermere XIV's class A notes. Principal receipts are paid sequentially: as the class A1 notes have a senior claim to principal receipts, they are rated higher than the Windermere XIV class A notes.

CMBS

Trio of note sales scheduled

Auction.com has released details of three commercial note and REO auctions scheduled for this month, which include an estimated US$600m of US CMBS exposures.

The first auction - taking place on 4-13 June - comprises more than US$270m across 63 CMBS properties, according to CMBS analysts at Barclays Capital. Most of the loans appear to have been serviced by CWCapital and are being offered through its recently-acquired brokerage Rockwood Real Estate. The largest loan out for bid in this auction is the US$12.9m Marshall Town Center, securitised in WBCMT 2005-C17.

The second auction comprises US$165m of CMBS loans concentrated in the Northeast. The largest loan in this auction is the US$30m Clearwater House, securitised in GCCFC 2007-GG11.

Finally, the third auction is scheduled for 28 June and consists of about US$162m of mobile home parks securitised in CMBS. The largest loans are the US$36m Morgan 7 RV Park Portfolio in MLCFC 2007-9, as well as the US$35m Wild Acres, Indian Creek, and Wagon Wheel loan in COMM 2006-C8. In addition, the auction lists 23 mobile home properties that form a part of the US$1.5bn Farallon Portfolio, securitised in MLCFC 2007-9, MLCFC 2007-8, MLMT 2008-C1 and BALL 2007-BMB1.

CMBS

Mall credit analysis warning

With the performance gap between stronger and weaker retail malls growing, Moody's notes that malls whose ongoing viability is not assured require careful scrutiny in their CMBS credit analysis and may merit a recovery-based approach. While the vast majority of the CMBS loans collateralised by regional malls that the agency has reviewed have been high quality, it says it has seen an increase in the share of malls that are not well suited to its standard approach because of concerns about their long-term viability.

"If Moody's determines that a mall's long-term viability is in doubt, we may introduce stress scenarios beyond those contemplated in our usual rating approach, which assumes long-term operational viability of the mall as the benchmark," says Tad Philipp, Moody's director of commercial real estate research.

Moody's notes that when a marginal mall defaults, the losses on its loans can be well above those typical for a commercial loan. Renovating or reconfiguring an underperforming mall costs many millions of dollars and, should the location lose its viability for retail altogether, value would revert to land less demolition cost for an even greater loss.

Although the majority of loans within CMBS have 10-year terms, they also generally have a significant balance outstanding at maturity that will need to be refinanced. Therefore, Moody's looks at the viability of property over the next 20-plus years.

The agency says that strong malls have benefitted from a flight to quality properties among retailers and are enjoying tenant renewals and expansions. Weak malls, in contrast, have been struggling against pressures such as the sluggish economic recovery and more competition for shopping dollars - not only from online merchants, but also other brick-and-mortar retail formats like outlets.

To differentiate between strong and weak malls, Moody's has identified numerous characteristics that help identify which regional malls will be able to retain or attract tenants. These attributes include being the dominant or only mall within a trade area, having four or more department stores as anchors and tenant sales averaging greater than US$450 per square foot.

Risk Management

OTC compliance service, protocol prepped

ISDA and Markit are developing a technology-based solution that enables counterparties to amend their OTC derivatives documentation for the purpose of facilitating compliance with Dodd-Frank regulatory requirements. The solution is expected to be enhanced to facilitate compliance with regulatory requirements in other jurisdictions as they are finalised.

ISDA is leading an industry-wide initiative to produce a series of amendments to existing documentation and provide standardised counterparty questionnaires, facilitated by an ISDA Protocol. Unlike with previous ISDA protocols where amendments were effected solely with delivery of an adherence letter, this Protocol will include additional bilateral delivery requirements as each party that signs up to the Protocol must also deliver a completed questionnaire to each relevant counterparty for the amendments and compliance to be effective. As a result of these additional bilateral delivery requirements, ISDA sought to develop a technology-based solution to automate the information-gathering process and provide sharing of submitted data and documents to permissioned counterparties.

The new compliance service is based on the Markit Document Exchange platform. Markit's selection as the service provider for this initiative was the culmination of a public request for proposals process.

An electronic questionnaire and reporting structure is expected to be operational by 1 August in order to facilitate compliance with Dodd-Frank External Business Conduct rule October deadlines, with successive iterations available prior to other regulatory implementation deadlines.

RMBS

Aussie RMBS performance report debuts

Moody's has introduced a new quarterly report tracking the performance of the Australian RMBS market. The first report contains performance data for 1Q12, covering the prime and non-conforming sectors.

"In response to investor feedback, the report is excel-based and covers the delinquency and loss performance of Moody's-monitored RMBS transactions, as well as several other key indicators," says Alena Chen, a Moody's analyst. "One of the advantages of the new report is that it includes the underlying data, along with the performance charts, which improves transparency."

The quarterly report will be published as soon as the agency receives the performance data on the transactions, which is typically two months after each quarter. The current report shows that delinquencies rose during 1Q12, despite the easing of monetary policy that occurred in late 2011.

Prime 30-plus arrears marginally increased to 1.58% in March 2012 from 1.57% in December 2011. However, low doc and non-conforming deals saw a larger increase. Low doc 30-plus arrears increased to 5.03% from 4.58% during the same period, while they increased to 12.06% from 10.63% for non-conforming transactions.

RMBS

Alt-A RMBS ratings targeted

Fitch has reviewed over 10,000 classes in 751 US Alt-A RMBS transactions. The agency is also set to release a revised mortgage loss model for the Alt-A sector within the next two months.

As a result of the review, the agency has: affirmed 82% of the classes; downgraded 9%; and placed on rating watch negative 9%. Of the downgrades, 99% are by 1-2 notches; of classes with an outlook, 95% of downgraded tranches were on rating watch or had a negative outlook prior to the review.

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

The agency's revised mortgage loss model for the Alt-A sector incorporates updated regression analysis and more conservative rating stress scenarios consistent with its prime loss model released last year. The results of the model in development were considered in this review in addition to the existing model criteria.

All classes on RWN, except those serviced by GMAC Mortgage, are expected to be resolved upon completion of the new loss model.

RMBS

MILAN methodology updated

Moody's has published updated assumptions and methodology used in its MILAN RMBS collateral analysis model, following its RFC on the proposals (SCI 9 December 2011). The ratings of 27 EMEA RMBS transactions are negatively affected as a result.

Key changes to the methodology include: the introduction of a transaction minimum credit enhancement level; an updated approach to determine house-price stresses; updated seasoning adjustments; and updates to various settings for Spanish and Italian RMBS. The overall MILAN credit enhancement is now subject to two separate floors, namely the minimum portfolio MILAN CE and the minimum expected loss multiple.

The minimum portfolio MILAN CE is set at a different level for each country and incorporates general market uncertainties, such as system-wide event risk and asset correlation. A minimum multiple of the expected loss is applied to ensure that extreme loss scenarios have an adequate probability of occurrence in the analysis.

In addition, seasoning adjustments will be determined by the amount of time a loan has been performing rather than by the amount of time since the origination of the loan. Finally, the default frequency curve, origination channel and nationality adjustments have been updated for Spanish and Italian RMBS. An adjustment for temporary workers has also been included for the former, while adverse credit history adjustments and increased differentiation of regional default risks have been introduced for the latter.

RMBS

AG interventions granted

New York state judge Justice Barbara Kapnick has granted a motion by the Attorneys General of New York and Delaware to intervene in the litigation relating to Bank of America Merrill Lynch's proposed US$8.5bn RMBS settlement with the Bank of New York Mellon (30 August 2011). The New York and Delaware AGs moved to intervene on the grounds that the settlement was an unfair and inadequate resolution of investors' claims against Bank of America. In granting the motion to intervene, Justice Kapnick found that New York Attorney General Eric Schneiderman and Delaware Attorney General Beau Biden provided adequate reasons for intervening, including that they seek both to protect public investors who may find themselves bound by the settlement and to protect the integrity of their states' financial marketplaces.

RMBS

Mexican RMBS criteria updated

S&P has published its revised criteria for rating Mexican RMBS, which are effective immediately but aren't expected to have any impact on outstanding ratings. The changes update the credit and liquidity assumptions for RMBS backed by Fovissste residential mortgage pools and clarify the application of foreclosure frequency curves in cashflow scenarios under certain conditions.

The revised criteria address employer concentration risk for issuances backed by Fovissste-originated residential mortgages, which S&P will no longer assess as a default risk. Rather, the agency will assess the liquidity risk associated with the concentration of public-sector employers due to Fovissste's ability to enforce payment through the Mexican Federal Treasury.

S&P also typically applies a front-ended and concentrated default curve for all Mexican RMBS transactions, but the back-loaded foreclosure curve is specifically relevant when testing a target overcollateralisation level in transactions that release funds after reaching a target credit enhancement. In these instances, the agency says it would generally apply this curve only to new Mexican RMBS. It may also test back-loaded foreclosure curves on transactions with certain structural characteristics.

RMBS

CRA expands RMBS methodologies

Morningstar Credit Ratings has released its new issue and surveillance rating methodologies for US non-agency, prime, alternative-A and subprime RMBS. The agency says that, in response to growing investor demand for greater rating agency transparency, it is providing investors with the economic scenarios that drive specific rating categories. Its RMBS analysts will use both the published rating scenarios and a proprietary loan-level credit model to analyse seasoned and newly issued RMBS securities.

RMBS

Ambac motions approved

Following a hearing held on 4 June, the Circuit Court for Dane County, Wisconsin approved the two motions submitted by the Wisconsin Commissioner of Insurance, acting as the rehabilitator of the Ambac Assurance segregated account (SCI 18 May).

The first motion sought to allow the segregated account to begin paying in cash 25% of each permitted policy claim that has arisen since the commencement of the rehabilitation proceedings and of each policy claim submitted and permitted in the future. The monoline anticipates beginning to make these claim payments in 3Q12.

The second motion sought approval to permit Ambac Assurance to exercise two call options to purchase approximately US$789m of its surplus notes. It has consequently issued exercise notices relating to one call option on US$500m of surplus notes that expired on 7 June. The remaining call option will be exercised before its expiry date on 30 November.

RMBS

Rating agency lowers Greek ratings cap

S&P has taken various credit rating actions on the Greek RMBS and ABS notes it rates. All ratings are now capped at single-B minus as a result of the agency's updated assessment of Greece's country risk and the implications of the country leaving the eurozone.

S&P says it previously considered structured finance transactions backed by Greek assets to have a low sensitivity to country risk, but now considers there to be a one in three chance of the country leaving the eurozone shortly after its elections this month. The agency says the adoption of a new currency "would result in a rapid devaluation of the real effective exchange rate" and lead to personal and corporate bankruptcies, leading to severe cash flow reductions.

The agency has: lowered 23 tranches in nine RMBS transactions from double-B plus to single-B minus; lowered from double-B to single-B minus one RMBS tranche; lowered from single-B plus to single-B minus one RMBS tranche; and affirmed the triple-C rating of one ABS tranche.

RMBS

Lending standards key for RMBS

A low interest rate environment at the time an Australian mortgage loan is written is not a significant guide to future performance, says Fitch. The agency believes lending standards are a more relevant factor in determining a loan's performance over the long term.

"Fitch analysis suggests there is little correlation between delinquency rates and the interest rate at loan origination. For instance, loans written between 2004 and 2008 were originated at higher rates than current loans, yet they have consistently shown higher levels of arrears when compared to earlier or later vintages. This in turn reflects generally looser lending standards compared to more recent years," says James Zanesi, Fitch structured finance director.

Loans issued between 2004 and 2008 tend to be the worst performing in Australia, with 30-plus day arrears in the 1.5% to 2.5% range. Loans originated from 2009 onwards have performed better than average and are in line with pre-2003 vintages, with 30-plus day arrears in the 0.5% to 1.0% range.

Fitch notes that delinquency rates generally increase in the first 12 to 24 months after origination, after which the number or new loans falling into arrears decreases. Delinquency rates for the 2008-2009 period are currently in line with or below the delinquency rates for 2004-2007 loans, although they have not yet shown signs of stabilisation.