Contents

Structured Finance

Picking sides

Challenges and opportunities in search for relative value

Ongoing speculation about the future of Greece has dominated the market's attention, but it is not the only concern weighing on participants' minds. Nevertheless, European ABS still offers great value for those who know where to look.

"We are at a place where trading is gradually reduced. Secondary activity is down in Europe and the US as everybody watches Greece. In ABS we are going to be impacted if Greece leaves the euro and that is something that really worries investors," says Conor O'Toole, Deutsche Bank European securitisation research director.

He continues: "There are a lot of questions about ramifications and it is going to be a volatile summer, but a lot of people are looking to put money to work in the core as they stay clear of the periphery."

The core markets are unsurprisingly the most liquid, but investors are also able to take advantage of opportunities in the periphery. As the years since the crisis struck continue to pass, it becomes ever less practical for investors to stay on the sidelines.

"The great thing about ABS is that it offers investors options for all outcomes. If you think Greece will survive and stay in the euro, then you can invest in Greek RMBS. But if you think they will leave and there might be a break-up, then Portuguese RMBS has the largest redenomination premium," notes one senior ABS research analyst.

Gordon Kerr, head of European securitised products research at Citi, recommends a two-pronged strategy that combines short duration core investments - such as autos and credit cards - with the ability to dip into other sectors for added yield. "There is plenty of opportunity to take a view," he says.

Kerr continues: "We recommend a credit barbell approach, maintaining a core defensive portfolio augmented by higher-yielding asset classes. However, at the moment, we are fairly defensive and think people should shift back into the core countries and away from the peripheral trades, picking up yield in UK buy-to-let, UK non-conforming RMBS and select CMBS opportunities."

O'Toole also recommends looking at CMBS and UK RMBS. "There is a lot of interest in accounts buying double-A and single-A bonds, especially from the UK prime sector, but I do not think we will see much issuance. We have seen a couple of CMBS and may see a few more, while for CLOs it is hard to find new issue at attractive spread for the equity returns."

He adds: "CMBS senior bonds are good with short cashflows and you can get a good pick-up there. The other sector I like is Spanish RMBS - barring a euro exit, there is a lot of upside there. If you are looking for value, then it is also worth looking at issuers who have tendered but not been successful."

Overall, O'Toole expects largely similar issuance to last year. The recent PCS initiative (SCI passim) has the potential to provide a boost to the market and bring more confidence beyond the core, but the senior analyst advises monitoring its development.

Kerr seems to agree. He says: "PCS is not a structural change, but it is a hope for the market. We, as an industry, can potentially originate new transactions beyond core collateral. We have started to see the investor base diversify."

That diversity is threatened, however, by the current form of incoming regulations. Insurance companies could be severely restricted by Solvency II, for example (SCI 6 October 2011). Principal forgiveness could also have an impact.

"Principal forgiveness is a big risk for the market. There is a lot of pressure for the governments to go after the banks and make them implement principal forgiveness," notes Kerr. Whether they will bow to that pressure remains to be seen, but it is just one of many policymaker decisions the market is waiting for.

"Regulatory hurdles are very much to the fore. Solvency II is massive for the insurance companies. If the current rules come in, the market will have to evolve into whole loans and more opacity, which is exactly what the regulators do not want," warns O'Toole.

"This is a very important point for the future of our market," adds the senior analyst. "There are two things that could change the market: one is whether we can bring in new risk and the other is whether we can win the regulation battle."

He continues: "Banks seem to have come to appreciate securitisation better, but regulators still have not, so that remains a challenge. As for new risk, it is all well and good having UK and Dutch RMBS and auto ABS - which can certainly support a small market - but we need new risk as well if the market is going to grow."

JL

Structured Finance

Mixed blessings

Action needed to attract European investors

Some ABS traders in Europe are expecting to use their balance sheets more over the coming months to support clients. While the rise of BWICs is aiding execution for sellers, more needs to be done to attract a broader investor base to the market.

Increasingly heavy use of BWICs has been a mixed blessing for European ABS traders. While the popularity and attractiveness of bid-lists to sellers are clear, one investor believes that they are more valuable in a rising market than in a falling one. He also points to the rise of 'all-or-none' BWICs in the US since the Maiden Lane liquidations, which he does not want to see starting in Europe.

"BWICs have achieved fantastic execution for the sellers, but it is very frustrating for everyone else. Dealers and buyers could pull back and refuse to participate, but they have not done so and they show no sign of doing so," adds Andrew Bristow, head of ABS trading at Lloyds Banking Group.

Nevertheless, there are signs that some investors are pulling back from the market altogether. Bristow is concerned that the market's recovery phase has not seen a vast pool of new investors introduced.

He says: "There are about 10 key investors driving the market - with other guys playing their part - and that is just not enough. It is a structural issue and we need regulators to help us reinforce the message of how good securitisation can be."

The investor also warns that regulators need to act in order to reverse the dwindling investor base. He says: "People are exiting the sector. We need help or the securitisation market is going to shrink. Regulation and capital charges are hurting the CMBS, UK non-conforming and SME space."

With the banking crisis continuing, the timing is not helpful. Bristow believes that regulators and policymakers should be doing more to encourage the use of securitisation.

"It is an illiquid market because there are not many investors and at the minute it is not being helped by regulators," he says. "Securitisation will have to play a major part in allowing banks to finance themselves, but we would have to see a real encouragement of making securitisation attractive for anything to change."

Despite the Greek and regulatory uncertainties, the investor says most activity has been coming from fast money or from US accounts. "Last year it was obvious to be defensive, but this time you almost have to just make your bets and hope that they do not redenominate," he notes.

He adds: "Investors need direction, but there are pockets of high yield bonds that make sense if you choose them carefully. I think summer will be hard, but towards the end of the year I am optimistic because cash balances on the investor side are high. If you start seeing stability, then there are a lot of people looking to get involved."

Bristow, for one, expects his bank to use a bit more balance sheet over the next six months. In particular, he sees good value in Italian RMBS, which he describes as "easier to get your head around than the Spanish market".

The investor also says that RMBS is worth looking at, especially first-pay bonds. "The UK prime market is currently liquid. The German SME sector, with very short average life, is certainly something we like the look of as well and it should continue to give good return."

He concludes: "Some CMBS sectors are also very undervalued and worth investigating. CMBS is still essentially illiquid, but it is more liquid than it was and the yield you get from it outweighs the illiquidity. Liquidity is also good for non-conforming."

JL

CMBS

Euro CMBS sees spread recovery

After softening earlier in the month, the European CMBS market has recovered over the last week. The Global ABS conference seems to have marked a turning point, but events in the RMBS market also appear to be having an effect.

"Activity has definitely picked up lately, especially in senior CMBS. The real money guys have been looking for paper and we have sold decent sized positions to them," reports one trader.

The trader notes that hedge funds are also getting involved in the sector, but to a more limited extent. Largely they seem to be waiting on the sidelines, with ongoing eurozone uncertainty still holding them back.

He says: "Although they have big cash balances, they are mainly watching and waiting. CMBS looks cheap and the hedge funds do find that attractive. But if there is negative news on sovereigns, then it will get even cheaper, so they prefer to wait."

He adds: "A BWIC circulated yesterday with a decent amount of EURO 24 bonds that traded higher than expected [as archived in SCI's PriceABS BWIC service]. There was also a big one today with CMBS seniors as well, which were of more mid-quality and also traded surprisingly high. It was an interesting list because investors have mainly been looking at the higher quality stuff, so it is good to see that they were not put off."

Activity does seem to be limited to seniors, however. Mezz CMBS is still difficult to sell, with secondary property in the UK expected to take another leg down in the coming months. "Most people are staying away from mezz. They prefer something priced in the 20s, where you have the upside benefits but not too much of a downside. Going in the 40s for mezz carries the same kind of upside, but also opens you up to a much bigger hit," the trader notes.

Finally, spreads have tightened in the week since Global ABS. Following a couple of weeks earlier in the month during which spreads widened by a couple of points, the trader notes that names such as TMAN 7 have since recovered by a point or so.

He concludes: "Surprisingly, part of the gain seems to be a knock-on from the Granite and Aire Valley tenders [SCI 20 June]. It is not entirely clear why they should be linked, but it may be that it is the same buyer base for Granite triple-Bs as senior CMBS, because the yields are not that different."

JL

Structured Finance

SCI Start the Week - 25 June

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

Pipeline
Three RMBS deals remained in the pipeline at the end of last week - the $235m Tamweel Residential RMBS (Cayman) IV, $272m Sequoia Mortgage Trust 2012-3 and €848.3m Dutch Mortgage Portfolio Loans X. They were joined by two auto ABS - €800m Bavarian Sky Compartment 3 and €500m Red & Black Auto France 2012 - and one consumer loan ABS, €800m FCT Ginkgo Sales Finance 2012-1. Two CLOs - Madison Park Funding IX and CIFC Funding 2012-I - and one CMBS, $415m UBS-BAMLL Trust 2012-WRM, were also marketing.

Pricings
A trio each of auto ABS and credit card ABS priced last week. The auto transactions were: €852m Cars Alliance Auto Loans France 2012-1, $502m Navistar Financial 2012-A and $1.2bn AmeriCredit Automobile Receivables Trust 2012-3. The credit card deals were: $500m American Express Credit Account Master Trust series 2012-1, $857m-equivalent Turquoise Credit Card Backed Securities (Series 2012-1) and $425m Cabela's Credit Card Master Note Trust series 2012-II. The remaining prints comprised: $237.8m Marriott Vacation Club Owner Trust 2012-1, a timeshare deal; $219.9m Scholar Funding Trust 2012-A, a student loan ABS; and €1.19bn ELIDE FCC Compartiment 2012-1, an RMBS.

Markets
Despite the ups and downs in the broader markets, most structured finance secondary markets continued to be range-bound last week.
The US ABS market finished another solid week, with spreads firm to narrower, according to analysts at JPMorgan. "Bonds traded well and bid-lists saw strong demand," they say. "Of note, there was plenty of interest in FFELP, subprime auto subordinate and private credit student loan ABS."
Securitised product analysts at Bank of America Merrill Lynch report that US CLO volumes remained light as investors hold on to positions to retain their higher yield. They suggest that this is probably reflective of the start of summer and expect BWIC volumes to remain fairly muted in the coming weeks, especially as 4 July approaches.
At the same time, the US CMBS market got off to a slow start on Monday before picking up mid-week, according to CRE debt analysts at Deutsche Bank. "Activity picked up a bit from last week's conference-induced lull and the strong real money bid for good quality senior bonds remained. One of the more active names of late has been the EPOP ARL2 A," they note.
Meanwhile, as SCI reported on 21 June, the European CMBS market recovered last week from the softening seen in over the past month. "Activity has definitely picked up lately, especially in senior CMBS. The real money guys have been looking for paper and we have sold decent sized positions to them," reports one trader.
He goes on to suggest that there could be a link between CMBS market gains and RMBS activity, specifically the Granite and Aire Valley tenders (see below). "It is not entirely clear why they should be linked, but it may be that it is the same buyer base for Granite triple-Bs as senior CMBS, because the yields are not that different," he says. 

Deal news
• The New York Fed has scheduled two further Maiden Lane III auctions for this month: the first sale will take place on 25 June and the second on 28 June. They follow the successful sale of US$5.2bn of Maiden Lane III CDO assets on 15 June.
• Northern Rock Asset Management and Bradford & Bingley have announced tender offers for Granite, Whinstone 1 and 2 and Aire Valley subordinate notes. The two firms intend to purchase approximately £500m of notes via a modified Dutch auction by 3 July.
• Managers of rated US CLOs reduced their trading activity again in 1Q12, furthering a trend that began four quarters ago. Part of the declining activity can be attributed to CLOs exiting their reinvestment periods over the last 12 months, which has generally limited their managers' ability to reinvest.
• The US$90m Lembi portfolio, securitised in JPMCC 2007-LDP11, has been liquidated out of REO with full recovery. Both the associated US$25m B-note and US$17m mezzanine debt were held by Nomura.
• S&P reports that rating actions on banks and sovereigns were once again the major factors affecting its European structured finance ratings in 1Q12. Both downgrades and upgrades increased, with most downgrades affecting RMBS transactions.
• Fitch says that Asia-Pacific (APAC) structured finance (SF) tranches remain largely stable, with 85% of the tranches maintaining their ratings in 2011, unchanged from 2010. Downgrades outnumbered upgrades for the fourth year in a row and by an eight-to-one margin in 2011.

Regulatory update
• The European Commission earlier this month finalised its proposed bank recovery and resolution directive, reigniting concerns in the CDS market that forced write-downs may negate the application of the restructuring credit event to senior bank debt. However, it has emerged that ISDA is in the early stages of updating some sections of the credit derivative definitions, with the 'bail-in' mechanism forming part of that project.
• Evolution in the CDS industry is taking longer than many participants expected. Some blame the market's opacity, but the implementation of new rules is also being delayed by the complexity of clearing requirements.
• Different interpretations of simplified supervisory formula approach (SSFA) inputs under the Fed's market risk rule could result in significant variation in capital requirements. Recommendations have consequently been put forward on how SSFA inputs for CMBS should be calculated to optimise capital requirements.
• The European Parliament's Economic and Monetary Committee has voted in favour of draft legislation to regulate credit rating agencies and reduce reliance on their ratings. The legislation seeks to inject more responsibility, transparency and independence into credit rating activities, as well as help to enhance the quality of ratings issued in the EU.
• The OCC has adopted an interim final rule amending its lending limit rule to apply to certain credit exposures arising from derivative transactions and securities financing transactions.
• Thomas Butler has been appointed director of the SEC's new Office of Credit Ratings. The office was created by the Dodd-Frank Act and is responsible for overseeing the nine registered NRSROs.

Deals added to the SCI database last week:
A-Best 7; Academic Loan Funding Trust 2012-1; Ally Auto Receivables Trust 2012-A; ALM VI; Apidos CLO IX; AyT Celeris Hipotecario II ; BAA Funding A20; Babson CLO 2012-II; BBVA RMBS 11 ; Carlyle Global Market Strategies CLO 2012-2; CarMax Auto Owner Trust 2012-2; Cars Alliance Warehouse Italy; Chase Issuance Trust 2012-3; CLI Funding V series 2012-1; CNH Equipment Trust 2012-B; CPS Auto Receivables Trust 2012-B; Credit Suisse European Mortgage Capital series 2012-1 ; Discover Card Execution Note Trust 2012-3; Discover Card Execution Note Trust 2012-4; EFS Volunteer No. 3 series 2012-1; FCT Eurotruck Lease II; GE Capital Credit Card Master Note Trust series 2012-4; GE Capital Credit Card Master Note Trust series 2012-5; Gracechurch Card Programme Funding series 2012-4; Gracechurch Mortgage Financing series 2012-1; Green FCT Lease 2012-1; Hyundai Auto Lease Securitization Trust 2012-A; MMAF Equipment Finance 2012-A; Nelnet Student Loan Trust 2012-2; Phoenix Funding 5 (retained); Roof Russia DPR Finance Company series 2012; Series 2012-1 WST Trust; Slater Mill Loan Fund; SLM Student Loan Trust 2012-4; SMART Trust series 2012-2US; SNAAC Auto Receivables Trust 2012-1; Stichting Orange Lion VII RMBS ; Swiss Credit Card Issuance No. 1 (series 2012-1); Volkswagen Auto Lease Trust 2012-A; WFRBS 2012-C7; & World Omni Auto Lease Securitization Trust 2012-A.

Deals added to the SCI CMBS Loan Events database last week:
BACM 07-1 & 07-2; BACM 2006-3; BACM 2007-5; CGCMT 2006-C4; CGCMT 2007-C6; COMM 2006-FL12; CSMC 2007-C1; CSMC 2007-C2; CSMC 2007-TFL2; CSMC 2007-TFLA; DECO 2005-C1; ECLIP 2006-1; ECLIP 2007-1; ECLIP 2007-2; EPICP DRUM; EURO 21; EURO 24; GCCFC 05-GG3 & GSMS 04-GG2; GSMS 06-GG6 & GCCFC 05-GG5; GSMS 2007-GG10; JPMCC 2005-LDP5; JPMCC 2006-CB16; JPMCC 2007-CB18; JPMCC 2007-LDP11; LBCMT 2007-C3; LBUBS 2006-C3; LORDS 1; MALLF 1; MSC 2007-HQ13; MSC 2007-IQ16; OPERA UNI; REC 6; Several; TIAA 2007-C4; TITN 2007-2; TITN 2007-CT1; TMAN 7; WBCMT 07-C32 & 07-C33; WBCMT 2006-C27; WINDM X; WINDM XI; WINDM XIV; & WTOW 2007-1.

Top stories to come in SCI:
Pricing and valuations survey
TriMont Real Estate Advisors profile 

CMBS

REC 6 test case on the cards

Pearsanta, the junior lender in the Alburn Real Estate Capital (REC 6), has begun High Court proceedings to confirm the appointment of Solutus Advisors as special servicer on the deal. In what is believed to be a first for the European CMBS market, the judge will be asked to decide between the legal enforcement of a contract and fiduciary duty towards the outstanding noteholders.

The proceedings are against US Bank as trustee and NM Rothschild, the servicer on the transaction. Pearsanta believes it has the contractual right, as junior lender, to appoint a special servicer. However, the outstanding REC 6 class A noteholders - which are the only class still in the money - oppose the appointment.

Following an informal meeting with Solutus on 8 June, class A noteholders were unanimously of the opinion that the appointment of a special loan servicer under current circumstances would be "materially prejudicial to the maximisation of recoveries on the loan" (see SCI's CMBS loan events database). Noteholders also confirmed their preference for the loan servicer, Savills and Moorfield to continue with the managed disposal strategy currently being implemented.

The junior lender disagrees that this is the best course of action and is said to believe that Solutus will take a more strategic view. With no special servicer on board, the class A noteholders will receive some principal back via the disposals strategy, while the junior lender will receive nothing.

Hatfield Philips was appointed special servicer on the transaction at the beginning of this year, but walked away in April without comment, before Solutus became involved.

REC 6 matures on 15 October 2013 and has an outstanding balance of £180.3m. The latest valuation, as of April, stood at £118.2m - which is less than half the asset's original value.

"It's imperative that a judgement is reached soon. Both sides want a collective resolution," comments a Solutus spokesperson.

A decision on the hearing is expected soon. Pearsanta has asked to have the case heard on an expedited basis before the summer recess. If it isn't heard by the end of July, it could be heard as late as October.

CS

CMBS

CMBS SSFA calculations recommended

Different interpretations of simplified supervisory formula approach (SSFA) inputs under the Fed's market risk rule could result in significant variation in capital requirements (SCI 11 June). CMBS strategists at RBS have consequently put forward recommendations on how SSFA inputs for CMBS should be calculated to optimise capital requirements while standing up to potential regulatory scrutiny.

The SSFA requires that US banks measure delinquency rates as the share of a collateralisation pool that is 90 days or more past due, in bankruptcy, foreclosure or REO, has deferred interest payments of 90 days or is in default. Based on their assessment, the RBS strategists note that the calculation of this input is a non-trivial task for CMBS and requires careful implementation.

First, they point out that special servicers often 'dual track' workout negotiations by filing foreclosures contemporaneously to discussions with a borrower. When this occurs, the loan is reported as foreclosed, despite it potentially being less than 90-days delinquent. The analysts therefore recommend that loans classified as foreclosed only because of dual tracking but which are otherwise less than 90-days delinquent be excluded from the SSFA delinquency rate measurement.

Second, bankruptcy is not a designated status as reported in the CREFC Investor Reporting Package and instead only flagged in the monthly trustee reports. "This potentially results in double counting in vendor provided data of loans that are both bankrupt and 90 days or more past due, in foreclosure or in REO. We therefore recommend that input data be scrutinised to ensure such loans are only included once in the SSFA delinquency rate calculation," the strategists observe.

Third, while defeased loans are not specifically addressed in the final SSFA rule, it does indicate that cash may be included in the calculation of attachment points. Given this language, the use of defeased-adjusted credit enhancement is suggested, as loans defeased with treasuries have minimal default risk.

Fourth, the strategists note that inconsistent reporting of matured non-performing loans across data vendors creates confusion. However, while they suggest that further clarification is needed, they believe that including such loans in the SSFA delinquency rate input is consistent with the spirit of the rule.

Finally, the analysts point out that matured performing loans are also not specifically addressed in the SSFA. "These loans are not considered delinquent by third-party data providers or the master servicer in the monthly remittance reports, despite failing to repay principal at their scheduled maturity date. We again recommend regulator clarification on whether these loans should be considered as part of the calculation of delinquency rate," they conclude.

CS

Structured Finance

SF vet leads project finance team

Credit Agricole Corporate and Investment Bank has appointed Danielle Baron as head of the project finance NIP Latin America group. She becomes md and will be based in New York.

Baron has more than 16 years of structured finance experience. She moves over from London where she worked for Credit Agricole on infrastructure and power projects in EMEA. Before joining Credit Agricole she was at HSBC.

CMBS

CMBS partner scooped

Schulte Roth & Zabel has expanded its real estate practice with the addition of a CMBS lawyer from Dewey & LeBoeuf. Marshall Brozost is a partner in the New York office, where his practice deals with all aspects of commercial real estate, including purchases and sales, formation of joint ventures, real estate fund formation, mortgage and mezzanine financing, REIT structuring, workouts and leasing. His clients include a wide variety of real estate private equity funds, investment advisors, domestic and foreign institutional investors, lenders and developers.

CMBS

CREFC president named

Paul Vanderslice has been elected president of CRE Finance Council (CREFC) for the 2012-2013 term. Vanderslice is md and co-head of the US CMBS group at Citi. He succeeds Jack Cohen, ceo of Cohen Financial.

ABS

Conduits eye flexible execution

ABCP programmes have performed relatively well over the past five years, but issuance has declined significantly due to the global banking and evolving regulatory environments. ABCP outstanding has decreased by more than 70% since the beginning of 2008, according to S&P.

The agency says it has withdrawn more than 200 ABCP ratings globally over that time. During 2011 alone, 22 ABCP conduits that S&P rates stopped issuing and the overall amount of ABCP outstanding shrunk by 5.6% globally.

Even so, the agency notes that certain trends are emerging - particularly in North America, which accounts for 57% of the global ABCP market. Several North American-based multi-seller conduits introduced issuances with varying execution features, including callable, putable and extendible notes (SCI 27 February). These features are designed to help ABCP programmes manage their regulatory liquidity requirements and the duration of their liabilities.

ABS

Credit cards boosting US volumes

Year-to-date US consumer ABS volume stands at US$83.5bn, approximately 62% ahead of last year's pace of issuance. The recent flurry of credit card, student loan and equipment transactions (see SCI's ABS database) has shifted the composition of the market: the auto sector's share, for example, fell to 48.4% this month - the first time it has fallen below 50% since early 2010, according to Wells Fargo ABS analysts.

"In our view, an increase in securitisation from sectors outside of auto loans and leases is a strong positive for ABS market conditions," they note. "For example, credit card ABS has long been the driving force of liquidity in consumer ABS, in our view. A lack of new issue bonds and a decline in credit card ABS outstanding has been causing a withdrawal of liquidity from the ABS market."

The Wells Fargo analysts note that the increase in consumer ABS volume has been driven by a number of factors. Among them are increased consumer credit availability and the fact that strong demand has pushed spreads tighter, making ABS an attractive funding alternative for many issuers. Rising demand from non-traditional buyers appears to have been an important contributor to spread trends, as many investors continue to view consumer ABS as somewhat of a safe haven.

Issuers that have already accumulated enough collateral to complete a deal may also be bringing some issuance forward to avoid potential market disruption later in the year. Indeed, although the analysts view the consumer ABS market as fundamentally strong, they warn that issuance volume and timing may be subject to general economic and political conditions.

Credit card ABS issuance, in particular, has accelerated in recent weeks and now stands at US$11.3bn year to date. The analysts suggest that low interest rates, uncertain financial market conditions, a desire to diversify funding sources and a maturity schedule heavily weighted towards 2012 have driven the increase in volume. About US$30.6bn is set to mature during the second half of the year.

But as the market approaches quarter-end, the performance of new deal pricing is likely to be an important test of the resilience of the consumer ABS market, the analysts observe. "The results from deals issued over the past two weeks suggest that the supply and demand dynamics are in equilibrium," they conclude. "New deals offered...met with robust demand and four deals were upsized. Pricing spreads were generally inside of initial guidance and spreads for repeat issuers were tighter for senior and subordinated bonds."

ABS

Card charge-off spike reverses

US securitised credit card charge-offs declined by 31bp in May to 4.9% from 5.21% in April, according to Moody's Credit Card Indices. The drop more than reversed an anomalous one-month increase in April (SCI 22 May), says Moody's.

The May decline in the charge-off rate index is consistent with Moody's forecast that the index will continue to fall lower in the coming quarters to reach about 4% by the end of 2012. The delinquency rate and payment rate indices also improved in May, underscoring the exceptionally strong credit quality of securitised credit card receivables in the US, with the payment rate reaching a record high.

"Issuers have charged off accounts of weaker cardholders at record levels in the recent recession and originators have added few new accounts to securitisations," says Jeffrey Hibbs, a Moody's avp and analyst. "The improved credit quality of trusts' receivables will support strong credit performance in credit card trusts throughout the coming year."

In declining to 4.9%, the charge-off rate index fell to its lowest point since October 2007. In May, five of the 'big six' trusts posted monthly declines in their charge-off rates - including Citibank, which recorded a decline of 73bp and reversed much of the April jump.

The delinquency rate continued to improve in May, declining by 12bp to 2.47% from 2.59% in April. Typical for this time of year, the improvement led to a fourth consecutive monthly record low.

The early-stage delinquency rate also reached an all-time monthly low of 0.65% in May, down by a single basis point from 0.66% in April.

Meanwhile, the payment rate index more than reversed the seasonal decline it posted in April and increased 98bp to 22.47% in May from 21.49% in April. With the increase, the payment rate index reached a new record high, surpassing the prior peak it reached in March.

Each of the big six trusts experienced a monthly increase in their payment rates during May, according to Moody's. The payment rate index continues to be more than a full percentage point higher than it was a year ago.

The yield index increased slightly to 18.61% in May, up from 18.56% in April, but remains more than 200bp below the May 2011 level. The decline is in large part owing to the expiration of most issuers' principal discounting initiatives, which artificially boosted their trust yields.

Finally, lower charge-offs led directly to an increase in the excess spread index to 10.95% in May from 10.55% in April. The excess spread index remains healthy and well above historical norms, says Moody's.

Structured Finance

SF natural hedging examined

The number of European structured finance deals that use swaps to hedge interest rate mismatches may decrease as hedging costs rise and the number of eligible counterparties drops, Fitch suggests. This reduces the counterparty risk but can place more emphasis on credit enhancement if the resulting interest rate risk is not adequately mitigated, for example through natural hedges.

Various techniques have emerged to compensate for the absence of swaps. These typically consist of constructing a natural hedge by matching coupon payments on the notes as closely as possible to interest rate payments on the underlying loans.
For instance, the proportion of fixed-to-floating class A notes (83.1% to 16.9%) in the recent Dutch RMBS Candide Financing 2012-1 closely matches the proportion of fixed-to-floating mortgage loans (82.5% to 17.5%).

Matching note coupons to payments on underlying fixed rate loans depends on investor demand for fixed rate structured finance issues. This may be limited in the European market, which has been characterised by floating rate issuance. It is, however, becoming popular in retained transactions where the notes are kept to be used as collateral.

In deals where both underlying loans and notes pay floating interest rates, risks arise due to different floating base rates and reset dates. In the Candide deal, this risk is reduced by the originator's commitment to keep the weighted average rates on the variable and fixed rate mortgages at least equal to the coupons on the relevant notes.

Risks can also arise in transactions where the assets have an initial fixed rate that resets to floating at a later stage, while the liabilities have a fixed rate for their entire life. For example, in Mercurius Funding Compartment Mercurius-1, a Belgian SME CLO that Fitch rated in May, 17.5% of loans in the portfolio are fixed rate with resettable coupons after three, five or 10 years. The class A notes, rated single-A plus, pay a 3% fixed-rate coupon.

A similar situation arises when borrowers have the option to switch their interest rate from fixed to floating or vice versa.

Structured Finance

ECB repo eligibility broadened

The ECB is set to reduce the rating threshold and amend the eligibility requirements for certain ABS, thereby broadening the scope of the measures to increase collateral availability that were introduced on 8 December 2011.

Auto loan, leasing and consumer finance ABS and CMBS that have a second-best rating of at least single-A at issuance and at all times subsequently are now eligible for use as collateral in Eurosystem operations. These transactions will be subject to a valuation haircut of 16%.

Additionally, RMBS, SME, auto loan, leasing and consumer finance ABS and CMBS that have a second-best rating of at least triple-B at issuance and at all times subsequently are eligible. RMBS, SME and auto loan, leasing and consumer finance ABS would be subject to a valuation haircut of 26%, while CMBS would be subject to a valuation haircut of 32%. The higher haircuts aim to ensure risk equalisation across asset classes while maintaining the risk profile of the Eurosystem.

The newly eligible ABS must also satisfy additional requirements, which will be specified in a legal act to be adopted on 28 June. The measures will take effect as soon as the legal act enters into force.

Structured Finance

Bank downgrades hit SF, ABCP

Moody's has downgraded a number of structured finance notes directly exposed to the declining credit quality of certain US and European firms with global capital market operations that the agency downgraded on 21 June. At the same time, the ratings on approximately US$37bn of ABCP have been impacted.

The rating actions affect 110 tranches and 103 structured notes in the US, as well as 28 tranches in Europe and 21 transactions in Asia. Moody's cites the linkage between the ratings of the structured finance securities and those of the banks as the reason for the downgrades.

This linkage is due to the direct exposure of the structured finance securities to the declining credit quality of certain European and US banks, each of which acts as either the guarantor of the securities, the issuer of collateral securities or is the reference credit in the transaction. Because of the linkage, each rating is essentially a pass-through of the rating of the bank, the agency says.

Moody's notes that the affected transactions are subject to a high level of macroeconomic uncertainty, which could negatively impact the ratings of the notes, as evidenced by uncertainties of credit conditions in the general economy and the acute sovereign and banking crisis in the euro area, which is weakening the credit profiles of banks exposed to the currency union. This crisis accentuates challenges facing banks globally.

Meanwhile, Moody's downgraded to Prime-2 the ratings of seven US ABCP programmes and to Prime-2 the ratings of four US letter of credit-backed ABCP programmes. The action was prompted by its recent decision to downgrade the short-term ratings of the financial institutions that act as liquidity and/or credit support providers for the affected programmes.

These parties have obligations in certain circumstances to provide funds that would be used to repay maturing ABCP. The rating of each programme is therefore directly correlated with the rating of the support provider, the agency notes. For bank-sponsored programmes, the sponsor is not only the main or sole liquidity provider, but also plays various roles in the programme, such as those of administrator, hedging agent and hedging counterparty or account bank.

Structured Finance

Call for EU debt mutualisation

The Bank of Spain has released the first results of the independent review of its banking system (SCI 14 May). The numbers are higher - and deemed more realistic - than those from previous stress tests, but a number of concerns remain.

According to the reports from the external consultants (Oliver Wyman and Roland Berger), the Spanish banking system would need €16bn-€25.6bn of capital in a base-case scenario and €51bn-€62bn in a stressed one. But the base-case scenario is based on rather optimistic macro assumptions, according to ABS analysts at JPMorgan, while the CT1 target of 6% used in the stressed scenario is well below the required level.

The review was applied to 14 banking groups, representing 90% of the Spanish banking system. Spain formally requested EU aid yesterday, with information on the amount and the terms expected to be made available on 9 July.

With respect to the broader eurozone banking system, RBS credit strategists suggest that a plan to achieve debt mutualisation is necessary to achieve debt sustainability. "We think the banking reform should include earnings redistribution from strong to weak banks through a deposit guarantee fund and increased burden-sharing on bondholders," they explain. "The road to debt mutualisation is more complex and unlikely in the near term, as it requires a stronger fiscal and political union. Until then, the risk of subordination and financial repression for peripheral sovereign debt and bank debt will remain high."

Structured Finance

Draft CRA regulation voted in

The European Parliament's Economic and Monetary Committee has voted in favour of draft legislation to regulate credit rating agencies and reduce reliance on their ratings. The legislation seeks to inject more responsibility, transparency and independence into credit rating activities, as well as help to enhance the quality of ratings issued in the EU.

In particular, the aim is to strengthen rules on sovereign debt ratings and conflicts of interest. Since sovereign debt ratings affect the credibility of states and hence their borrowing costs, MEPs believe their quality, timing and frequency need to be regulated. Ratings should also reflect each country's specific characteristics.

Under the rules, each agency will have to prepare and publish an annual timetable of dates for publishing its sovereign ratings, so as to give states time to prepare for them. This timetable would have to comply with the general rule that sovereign credit ratings may be published only after close of business in all trading venues established in the EU and at least one hour before they reopen.

The rules also pave the way for developing an internal public rating capacity at EU level. The task of creating an independent EU creditworthiness assessment will be entrusted to the existing EU institutions. They will have to provide investors with all relevant, publicly-disclosed data and ratings regarding sovereign debt and key macroeconomic indicators.

At the same time, all regulated financial institutions would be required to develop their own rating capacities, to enable them to prepare their own risk assessments and thus not rely entirely on external ones. Furthermore, no EU law would be permitted to refer to credit ratings for regulatory purposes, while regulated financial institutions would not be permitted to sell assets automatically in the event of a downgrade.

Agencies themselves would be required to ensure that their ratings are impartial and of high quality. They could be held liable for their ratings in civil law, so that an investor whose interests were harmed when buying or selling a rated instrument could sue the rating agency if it could be shown that it had made methodological mistakes or committed other infringements specified in the EU regulation. The civil law rules applicable would be those of the investor's country of residence when the damage occurred.

ESMA would monitor rating methodologies and ratings themselves would have to be presented in numbers. They would also have to indicate the probability of default and be accompanied by an explanatory statement.

To reduce the scope for conflicts of interest, an agency would not be permitted to issue ratings on entities that own more than 2% of its capital or voting rights. Furthermore, no holder of more than 5% of an agency's capital or voting rights could hold shares in another rating agency. If such a situation arose, it would have to be disclosed by the agencies in question.

Mergers of credit rating agencies would also be subject to strict rules.

CDO

Counterparty criteria hits synthetic CDOs

S&P has placed on credit watch negative its credit ratings on 30 tranches in 30 funded synthetic CDO transactions. The actions are in connection with the agency's recently published counterparty criteria.

The affected transactions feature instruments and associated counterparty obligations (including collateral) that support all, or substantially all, of principal repayment. The structures include, for example, total return swaps, investment agreements or repurchase agreements. The minimum eligible rating for counterparties to these transactions is now no lower than one notch below the rating on the supported security, S&P notes.

A rating committee will determine the final rating decisions to resolve the credit watch placements, but the application of the agency's 2012 counterparty criteria is expected to result in downgrades of rated funded synthetic CDOs. S&P anticipates completing its reviews within the next 30 days.

CDO

ML 3 auction results in

The winning bidders for yesterday's Maiden Lane III CDO sale have been announced (SCI 19 June). Credit Suisse successfully bid for the US$1.37bn Davis Square Funding VI, US$615.69m Sheridan ABS CDO, US$1.07bn Monroe Harbor CDO 2005-1 and US$392.33m Streeterville ABS CDO assets. RBS successfully bid for the US$396.62m Davis Square Funding I CDO, while Morgan Stanley scooped the US$387.94m Lakeside CDO II.

A further ML3 auction is scheduled for 28 June, comprising the Jupiter High-Grade CDO (US$98.57m), II (US$578.71m) and III (US$1.33bn), as well as Kleros Preferred Funding (US$522.92m) and II (US$607.83m) assets. Barclays Capital, Citi, Credit Suisse, Goldman Sachs, BAML, Morgan Stanley, Nomura Securities and RBS will bid in this round.

CDS

EMIR consultation launched

ESMA has launched a consultation on its technical standards under EMIR. The measures are designed to reduce risks in the OTC derivatives market, improve transparency and ensure that sound and resilient central counterparties will be applied in practice.

The consultation paper contains draft regulatory technical standards (RTS) and draft implementing technical standards (ITS), which set out the specific details of how EMIR's requirements are to be implemented. In terms of reducing counterparty risks, the draft technical standards define the framework for the application of the clearing obligation; specify the risk mitigation techniques for OTC derivatives not centrally cleared; and lay down the requirements for the application of exemptions to non-financial counterparties and intra-group transactions.

With regard to CCPs, the draft provides a comprehensive set of organisational, conduct of business and prudential requirements for CCPs. Finally, to further transparency, it specifies the details of derivatives transactions that need to be reported to trade repositories; defines the trade repositories' data to be made available to relevant authorities; and sets the information to be provided to ESMA for the authorisation and supervision of trade repositories.

The consultation paper is based on the EMIR texts as adopted by the European Parliament on 29 March and by the Council on 11 April. The consultation closes on 5 August and the final draft standards are intended to be submitted to the EU Commission for endorsement by 30 September.

CDS

Bank credit exposure declines

US commercial banks and savings associations reported trading revenues of US$7bn in 1Q12, according to the OCC's 'Quarterly Report on Bank Trading and Derivatives Activities'. Net current credit exposure (NCCE) decreased by US$53bn, or 12%, to US$377bn during the quarter.

The OCC notes that the more favourable risk and economic environment outlook in Q1 pushed interest rates higher and credit spreads lower. Each of these factors resulted in lower fair values of derivatives contracts and therefore lower credit exposures. However, it says that risk appetite has changed significantly in the current quarter, as investors are concerned about potential consequences of bank and sovereign credit risk in Europe.

The report shows that the notional amount of derivatives held by insured US commercial banks and savings associations fell by US$3trn, or 1.2%, from the fourth quarter to US$228trn. The notional amount of derivatives contracts has fallen for three consecutive quarters, due to ongoing trade compression activities.

Banks hold collateral to cover 67% of their NCCE. The quality of the collateral is high, with 81% held in cash.

Derivatives contracts remain concentrated across a small number of institutions. The largest four banks hold 93% of the total notional amount of derivatives, while the largest 25 banks hold nearly 100%.

Derivative contracts also remain concentrated in interest rate products, which represent 81% of total derivative notional values. On a product basis, swap products represent 61% of total derivative notionals.

Credit default swaps are the dominant product in the credit derivatives market, representing 97% of total credit derivatives.

The number of commercial banks and savings associations holding derivatives increased by 213 in the quarter to 1,291.

CDS

Derivatives included in lending limit rule

The OCC has adopted an interim final rule amending its lending limit rule to apply to certain credit exposures arising from derivative transactions and securities financing transactions.

Effective from 21 July, section 610 of the Dodd-Frank Act revises the statutory definition of loans and extensions of credit for purposes of the lending limit to include certain credit exposures arising from a derivative transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction or securities borrowing transaction. The interim final rule adopted by the OCC implements this statutory change, which applies to both national banks and savings associations.

These institutions must comply with the rule's requirements as to derivative transactions and securities financing transactions by 1 January 2013. The OCC has provided a short-term exception under its lending limits authority to give them time to adjust for compliance with the new standard.

To reduce the burden of these new credit exposure calculations, particularly for smaller and mid-size banks and savings associations, the rule permits use in certain circumstances of look-up tables for measuring the exposures for each transaction type. This method permits institutions to adopt compliance alternatives that fit their size and risk management requirements, consistent with safety and soundness and the goals of the statute.

Comments on the interim final rule are due by 6 August.

CDS

Euro CDS spreads seen tightening

CDS on western European sovereigns are still retreating from levels reached earlier this month, moving in by 7% last week. Portugal led the move, with its CDS spreads tightening to levels not seen in nearly a year, according to Fitch Solutions.

"Spreads on Portugal tightened 19% to price at its tightest levels since the beginning of last summer," confirms Fitch director Diana Allmendinger.

The Netherlands and Ireland followed, with spreads 10% and 8% tighter respectively. Meanwhile, CDS on the UK, France and Spain tightened least, by 3%-5%.

Improved market sentiment may prove to be short-lived, however, as spreads on Germany, France, Spain and Italy moved back out by 2%-3% at the beginning of this week.

CMBS

EMEA special servicing activity reviewed

The number of EMEA CMBS loans in special servicing remained unchanged at 134 during May, according to Moody's, as no new loans entered special servicing and no loans were worked out. The weighted average Moody's expected principal loss for loans in special servicing is stable at 36%.

EMEA special servicing highlights for May include the €175m sale of the portfolio backing the €187m TOR loan securitised in MESDAG (Charlie). Approximately 84% of the proceeds, after deduction of work-out and swap breakage costs, will be applied to the Class A notes in July (see SCI's CMBS loan events database). The remaining recoveries will be paid to the noteholders once the conditions precedent are met for certain properties.

Also during the month a new portfolio valuation was disclosed for the €431m MPC Portfolio loan securitised in Titan Europe 2007-2. The LTV ratio for the securitised debt increased from 143% to 221%, following a 36% value decline for the Dutch office portfolio. The special servicer for the loan, Hudson Advisors, is currently evaluating its options with respect to the loan work-out.

Meanwhile, the AMG Portfolio loan - securitised in Windermere VIII CMBS - has been reclassified as worked-out without a loss. The senior liquidation fees that were originally borne by the most junior noteholders were reimbursed by the borrower in April.

As of May 2012, Moody's tracked 63 loans (representing €5bn or 30% of loans in special servicing) as undergoing liquidation, either through consensual property sales or enforcement. For an additional 16 loans (representing €3.5bn), the respective special servicers have already sold the underlying properties and are working towards finalising recoveries.

CMBS

CMBX fundamental value highlighted

The CMBX indices continue to closely follow the broader market as investors remain preoccupied with global and domestic macroeconomic concerns. However, Citi CMBS strategists note that the indices also continue to retain fundamental value, with almost all triple-A, AM and AJ tranches remaining cheap in their base and stress scenarios.

The S&P 500 fell dramatically in the week ending 1 June on concerns about Spain and a surprisingly weak non-farm payroll print. CMBX AJs also fell, albeit on very low volume.

"Investors apparently took this as a buying opportunity, as volumes and prices rebounded in the week ending 8 June," the Citi strategists observe. "During that week the broad market reacted to prospects of additional easing measures and a favourable outcome to the Greek elections. After this recent recovery most of the CMBX tranches are near their 2012 starting points after bottoming out in mid-May."

They suggest that renewed positive market sentiment could generate CMBX appreciation, although the fragile global economy poses significant downside risks that warrant caution with respect to riskier parts of the capital structure. "Fairly attractive entry points remain in various credit curve basis and vintage trades. For instance, the AJ.3/4 spread differential remains at the high end of its historical trading range and could present a solid opportunity in the event of a market rally."

CMBS

CMBS servicer reports expanded

Fitch has published the first of its expanded servicer reports for US CMBS servicers. The reports not only highlight industry best practices and servicer-specific deficiencies, but also now include a discussion of corporate governance and conflicts of interest, investor disclosure and affiliated companies.

The expanded servicer reports are in response to investor concerns regarding potential conflicts of interest among special servicers, the agency notes. The expanded reports provide investors with information obtained during Fitch's annual review of special servicers.

"We are spending a significant amount of time with special servicers, discussing information disclosure, the use of affiliates and fees, transparency of information on workouts and how conflicts of interest are mitigated," comments Adam Fox, senior director at the agency.

The latest report - issued for LNR Partners - contains Fitch's opinion on the use of an affiliate, Auction.com, for the sale of specially serviced assets. The agency reviewed loans disposed of via Auction.com and the fees ultimately paid by the trust to the affiliate.

The enhanced servicer reports will continue to be issued throughout the year as Fitch visits servicers. The agency expects the reports to continue to evolve as it actively solicits feedback from investors and market participants to improve them.

CMBS

Stable outlook for IG CMBS

Fitch's loss expectations for 2006-2008 vintage US CMBS transactions vary greatly by deal, the agency notes. Nevertheless, weighted average loss expectations for these three vintages total 12.3% of the original loan balance.

Fitch expects investment grade ratings to be stable. Of over 2,500 investment grade US CMBS ratings outstanding, it has a stable outlook on 93%.

The agency's surveillance methodology includes forward-looking projections of losses. Despite the uptick in loan resolutions over the past few years, realised losses on the 2006, 2007 and 2008 vintages totalled only 1.8%, 1.7% and 1.1% respectively as of year-end 2011, it says.

CMBS

CMBS loan events updated

12 new loan events have been added to the SCI CMBS loan events database today.

These include:

18/06/2012
Deal: ECLIP 2007-1
Property: Greater London Portfolio
Event: sale completed for gross price of £8.6m for Central House asset (a 6.2% premium to recent valuation)

June
Deal: WBCMT 07-C32 & 07-C33
Property: ING Hospitality Pool
Balance: $284m & $284m
Event: sponsor reportedly injected $68m of equity to secure $500m refinancing from Bank of America
Description: Bank of America expected to split note into senior $275m loan to be securitised & a $225m mezz note sold to H/2 Capital

June
Deal: CSMC 2007-C1
Property: Savoy Park
Balance: $210m
Event: property reportedly sold to New York Affordable Housing Preservation Fund
Description: loan expected to pay off with a single-digit loss, after fees, expenses & repayments of advances

There are now 1,899 searchable loan events, dating back to March 2011, on the database. Click here for more.

RMBS

Operation Twist extended

Operation Twist is set to last through to year-end, having been slated to end this month (SCI 22 September 2011). The FOMC yesterday directed the New York Fed's Open Market Trading Desk to continue its programme to extend the average maturity of the Federal Reserve's holdings of Treasury securities.

Specifically, the desk was directed to purchase Treasury securities with remaining maturities of six years to 30 years and to sell or redeem an equal par value of Treasury securities with remaining maturities of approximately three years or less. The continuation of the maturity extension programme will proceed at the current pace and result in the purchase, as well as the sale and redemption, of about US$267bn in Treasury securities by the end of 2012.

The FOMC also directed the desk to continue reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS, and to suspend - for the duration of the maturity extension programme - rolling over maturing Treasury securities into new issues at auction.

RMBS

QRM concern highlighted

Fitch believes that continued uncertainty relating to aspects of the Dodd-Frank Act has caused many traditional RMBS issuers to delay their issuance plans. Of particular concern are the details surrounding the definition and creation of an exemption from the risk retention requirements for qualified residential mortgages (QRMs). Some further clarity on the matter is hoped for in the third quarter of this year, the agency notes.

Since most potential issuers don't intend to create securities outside the aegis of QRMs, the final definition is important. Also, in its current form, the related premium capture reserve account that has been proposed could cause valuation and accounting difficulties.

The Consumer Financial Protection Bureau (CFPB) on 31 May opened another comment period pertaining to mortgage ability-to-pay, which would ultimately constrain Dodd-Frank's treatment of QRMs, with a closing of 9 July (SCI 6 June). The CFPB is expected to produce a revised proposal that will affect QRMs in the third quarter. It will be subject to further public comment and could be finalised after the presidential election.

Fitch believes the new proposal will largely resemble the initial proposal put forth in the inter-agency NPR (SCI 30 March 2011). However, certain features of the new proposal are likely to remain under close scrutiny and may be subject to further revision, including the premium capture feature.

RMBS

Competitive ResCap auction expected

The process to approve the stalking-horse bidder for the auction of ResCap's loan origination and servicing business suggests that it will be a fairly competitive final auction, likely in October. Berkshire Hathaway and Fortress Investment Group submitted multiple bids during the process, with Fortress finally approved last week after it raised its original offer by US$125m and cut its break-up fee to US$24m. Berkshire successfully replaced Ally's stalking horse bid for the loan portfolio, however, increasing its bid by US$50m.

By increasing their offer multiple times, Fortress and Berkshire appear to have signalled that there may be some more room to go in the final auction, observe ABS analysts at Barclays Capital. They indicate that increased compensation for assets should, in turn, improve the potential recoveries on the rep and warranty settlement that is being offered to investors by a small amount.

But the question of who wins the servicing rights on the loans is arguably more important for the valuation of these bonds. The impact of a servicing transfer to Nationstar can be better anticipated than if the servicing is moved to Berkshire, which has no history of non-agency servicing, according to the Barcap analysts. Meanwhile, other servicers could still enter the fray when the final auction is held later this year.