Contents

RMBS

Rental market

REO-to-rent securitisation generates interest

The US government is keen to find a way to unload the foreclosed REO properties currently owned by Fannie Mae and other GSEs. REO-to-rent securitisation could play a leading role in tackling the overhang.

S&P estimates that around 500,000 properties were REO at the end of 1Q12, with this figure expected to rise over the next few years. A further US$268bn in REO properties could be added, considering all the 90-days delinquent loans and loans in foreclosure.

An REO-to-rent securitisation solution to the property overhang would not only allow banks to move assets off their balance sheets, but would also provide investors with a new product to invest in. However, translating the concept into a workable structure may not be entirely straightforward.

"There are a few challenges inherent in making REO rental securitisations successful. By definition, for securitisation, you need some level of scale. REO rental is not that easily amenable to scale because you have a lot of separate individual homes," says Morningstar Credit Ratings RMBS analyst Lawrence Kwoh.

He continues: "You do have separate properties in a regular RMBS, but generally it does not require the kind of hands-on involvement of service providers like property management companies you would need in an REO rental securitisation. That is a major operational challenge, as are issues of concentration."

While a regular RMBS will often be widely dispersed, an REO-to-rent securitisation will see more concentration in states such as California, Michigan, Nevada and Florida, where there is an overhang in underwater property. The lack of diversification within any potential deal could be a problem, Kwoh notes.

Another issue is the lack of modelling history, which could put off both investors and rating agencies. Private deals are an alternative, but otherwise a lot of data is necessary to achieve a rating.

"REO rental is so new that there is no real data for us to use for a securitisation. We do not know enough about remarketing risk, lease risk or tenant turnover. Without that data, we as an agency cannot get comfortable and investors cannot get comfortable. Until more robust rental data is available, market interest is going to be minimal," says Kwoh.

Tranching could help investors to get comfortable with the risk they are taking on. Exactly how any potential deal would be structured is still not clear though, and there are different ideas as to how an REO-to-rent securitisation might work, with different implications for each.

Kwoh explains: "It is still not clear what collateral would actually be securitised. You could securitise the actual properties or just the rental receivables. If you transfer the actual property, you have more of a traditional RMBS transaction. One of the challenges is that it is not entirely clear what structure is being proposed."

S&P suggests that another possibility would be closer to triple-net-lease securitisations, with a hybrid structure in which the lease payments - rather than underlying mortgages - are pledged as collateral.

The fact that REO-to-rent securitisation could help to tackle the shadow inventory is one of the strongest arguments in its favour. Brian Grow, Morningstar Credit Ratings md, says a securitisation solution could certainly go some way towards achieving this.

"Assuming all of the fundamental challenges are addressed and overcome, a successful REO rental securitisation programme could provide for faster relief for the shadow inventory of foreclosed homes. However, for the properties to be attractive to investors on a bulk scale, they will need to be discounted significantly," he says.

Grow continues: "This will likely have a short-term negative impact on home prices in regions where these REO properties are concentrated. Also, nobody knows the current condition of these REO properties and many of the properties currently in foreclosure status have been non-performing for a long time. Rehabilitating these properties so they will attract renters may be challenging."

Should these challenges prove surmountable, there certainly appears to be interest in turning REO-to-rent securitisation from a good idea to a workable reality. "Conceptually, people are very interested in the idea, because if you can overcome the hurdles then you can make a good return on this. It would be helpful for decreasing the shadow inventory, but I am not sure how much. It certainly will not be a panacea," says Kwoh.

He concludes: "The concept of renting REO properties has a lot of merit. You are going to get some pretty interesting returns. To maximise those returns, you want to look at where you can buy the REOs to get the largest discount or possibly sell them. But maintenance and repairs can be big expenses, so how well you can manage variables like those is critical for determining the kind of return you can get."

JL

RMBS

Summer slowdown for Euro RMBS

The European RMBS market is still searching for a spark, but has continued ticking along regardless. Primary issuance has not dried up completely, although the secondary market is slow.

"In the primary market the biggest talking point has been Lanark series 2012-2, which was a fairly sizable deal and priced yesterday. It had a three-year tranche which priced at about 145bp and a five-year tranche at 165bp," reports one trader.

He continues: "There is also a Silk Road deal which is just being brought out by the Co-operative Bank. That one was announced this morning. It is a UK RMBS which looks like it will be roadshowing next week. There is no size for that yet - it is unlikely to be £3bn, which is what their first deal was a few years ago, but it might be closer to their last £1bn deal."

Meanwhile, the secondary market has been very quiet, the trader says. He does note some movement on the back of GRAND, the German CMBS, but otherwise spreads are unchanged. "Seniors are up about five or 10 points and some mezz tranches are around 20 points up. We do not have exposures to that deal, but the market seems firmer on the back of it," he says.

As for why the market is so quiet, the trader says the recent Aire Valley, Granite and Whinstone tenders (SCI 6 July) have had a quietening effect, but that a larger part of reason the secondary market is so slow is simply seasonal.

"The Granite tender removed a lot of the traded paper from market so secondary flows this week have been low volume. Between that and the summer holidays both in Europe and the US, it makes for a quiet market," he says.

The trader concludes: "There will probably be a trickle of prime RMBS primary until the Olympics ends. Obviously we would prefer to see things a little busier, but it should be enough to keep us going."

JL

RMBS

Secondary RMBS supply spikes

US prime hybrid and alt-A hybrid RMBS secondary supply spiked yesterday, coming in at nearly quadruple the prior session's total. Interactive Data figures suggest that overall non-agency RMBS BWIC volumes hit an eye-watering US$2.72bn on the day, driven by a large all-or-none list.

Notably, a concentration of Countrywide senior bonds were out for bid. SCI's PriceABS BWIC data comprises 22 Countrywide line items from the session, including the CWL 2004-1 M3 tranche (US$7.5m current face), which was covered in the 70 area.

SCI's PriceABS BWIC data also shows that the prime fixed rate CWHL 2005-5 A7 tranche (US$15m) was talked at 100 area, while the option ARM CWALT 2006-OA10 4A1 (US$210m) and CWALT 2006-OA21 A1 (US$115m) bonds were talked at mid-50s and low/mid-50s respectively. The latter was talked at high-40s/50 area on 18 June.

The moves follow Walnut Place's withdrawal as intervenor in the Article 77 proceedings to ratify the Countrywide RMBS settlement (SCI 24 July).

CS

Structured Finance

SCI Start the Week - 23 July

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

Pipeline
Last week saw a great number of deals join the pipeline and price by Friday, but four transactions remained come the end of the week. These included a €1.08bn auto lease ABS (Auto ABS FCT Compartiment 2012-1), an ARS110m consumer loan deal (Supervielle Personales 6), a US$150m ILS (Embarcadero Re 2012-2) and one CMBS (US$625m GSMS 2012-SHOP).

Pricings
It was a very busy week for pricings, with a particularly large volume of ABS deals printing, alongside RMBS, CMBS and CLO transactions.

Auto-related deals dominated in ABS, with US$731m Ally Master Owner Trust Series 2012-3, US$175m Ally Master Owner Trust Series 2012-4, US$211m American Credit Acceptance Receivables Trust 2012-2, US$247m DT Auto Owner Trust 2012-2, US$1.61bn Ford Credit Auto Owner Trust 2012-C, US$675m Harley-Davidson Motorcycle Trust 2012-1 and US$1.5bn Honda Auto Receivables 2012-3 all pricing. Three credit card deals (US$1.5bn Chase Issuance Trust 2012-A4, US$650m Golden Credit Card Trust Series 2012-3 and US$500m Golden Credit Card Trust Series 2012-4) and two consumer loan deals (€5.075bn Sunrise 2012 and €227m Atlantes Finance No. 5) were also issued.

The remaining ABS prints were: C$515m CIT Canada Equipment Receivables ULC Series 2012-1 (equipment), US$158m JGWPT XXVI (structured settlements), US$300m Sierra Timeshare 2012-2 (timeshare), US$1.25bn SLM Student Loan Trust 2012-5 (student loans) and US$76m TAL Finance I 2012-A (container ABS). The two RMBS joining those ABS deals were A$333.7m Buloke Funding Trust No. 1 Repo Series No. 1 and US$1.325bn Lanark series 2012-1, while the CMBS deals consisted of US$1.17bn UBS-Barclays Commercial Mortgage Trust 2012-C2 and US$1.05bn WFRBS 2012-C8.

Finally, the CLOs that printed last week included: US$409m Fortress Credit Funding V, US$174m Fortress Credit Funding VI, €1.884bn FTA PYMES Santander 3, US$313m JFIN 2012 and US$400m Neuberger Berman CLO XII.

Markets
Activity in the US CLO market picked up this week as investors continued their hunt for yield, according to Bank of America Merrill Lynch securitised products strategists. BWIC volumes topped US$590m, making it one of the busiest weeks in the past three months.

"There was a large triple-A list that came to market on Wednesday that was met by strong demand, particularly due to the larger block sizes. More recently, the market has seen an increase in end customer bids lending further support to the strength of the latest rally," they say.

It was also a busy week for US CMBS, as SCI reported on Tuesday. The market continues to see strong primary issuance, although the secondary market has been quiet.

"Spreads in the secondary market have been holding in, even when equity widened. I think people are coming to the realisation that basically rates are going to stay low and there are not too many places you can get yield, so as that sinks in we should see more stabilisation," says a trader.

Weekly BWIC supply was the highest since May for non-agency US RMBS as well, securitised products analysts at Citi note. "The market has absorbed the increased supply well, with a significant fraction of the bonds trading and cash prices increasing across all sectors. Synthetics began to see some weakness on Tuesday and Wednesday as dealers looked to hedge the increased supply."

Elsewhere in US ABS, Barclays Capital securitised products analysts report that primary issuance reached US$8bn, while the secondary market was also busy. "After a slow start to the week, secondary market activity picked up rapidly in the past few days. Investors continue to search for yield, resulting in strong bids for many off-the-run asset classes."

Activity in European CMBS was more muted, according to Deutsche Bank CMBS analysts. They see continued investor interest in participating in loan restructure plays and note that both the Orange and Peach loans backing TMAN 6 failed to qualify for extensions, increasing the likelihood of enforcement and therefore price appreciation in the senior bonds.

European RMBS has also been searching for a spark, as SCI reported on Thursday. There is a steady supply of primary issuance, but the recent Granite tender has removed a lot of paper from the secondary market, slowing activity right down. 

Deal news
• Fannie Mae issued US$6.7bn of multifamily MBS in 2Q12 backed by new multifamily loans, slightly less than the first quarter total of US$7.1bn. It also resecuritised US$1.2bn of DUS MBS through its Fannie Mae Guaranteed Multifamily Structures (Fannie Mae GeMS) programme.
• Credit card ABS could be negatively affected by a recent agreement between credit card companies and merchants that accept card payments. The agreement allows merchants to introduce surcharges for paying by credit card. Fitch believes the likely increased costs for consumers could negatively affect credit card ABS pools in the future.
• The occurrence of mortgage delinquencies in Japan during the global financial crisis was more closely correlated with employment status than with high LTV ratios. Japanese lending criteria places more emphasis on occupation and income than on LTV ratios.
• The share of HARP refis as a percentage of total refinancings reached an all-time high of 20% in May. The average from January to April had been 16% and for the whole of 2011 had been 13%.
• Fitch has updated its US tobacco settlement ABS criteria and placed 150 of the 230 tobacco tranches it rates onto rating watch negative. The agency expects to resolve these watches within a month, with most downgrades expected to be by one or two notches.

Regulatory update
• Mortgage Resolution Partners' proposal to use eminent domain to acquire mortgage loans would be unconstitutional, says SIFMA. The association has released a legal memo drafted by O'Melveny & Myers, which says the proposal would not survive a legal challenge.
• The US SEC has charged Mizuho Securities USA and three former employees with misleading CDO investors. The commission says dummy assets were used to inflate the credit ratings of a deal backed by subprime bonds.
• MERSCORP has reached a settlement with Delaware Attorney General Joseph Biden. MERSCORP has agreed not to file as plaintiff any mortgage foreclosure actions in the state and agreed to quality control and transparency requirements. Under the settlement, MERSCORP will more closely monitor the integrity of its signing officer process to avoid a repeat of robo-signing and will conduct semi-annual audits, which will be provided to Delaware's Department of Justice consumer protection unit.
• Syncora Guarantee has reached a US$375m settlement with Countrywide Financial and its parent Bank of America. The settlement ends an RMBS suit that Syncora and MBIA brought in 2009, in which Syncora alleged Countrywide had misrepresented the quality of loans securitised in order to induce the insurers to insure the securitisation.
• ICE Clear Credit has been designated as a systemically important financial market utility by the Financial Stability Oversight Council. The announcement follows the US SEC's adoption of rules for systemically important clearing houses last month (SCI 29 June).

Top stories to come in SCI:
REO-to-rent securitisation potential
ILS market update
Structured credit recruitment trends

CMBS

MPG Q2 highlights reviewed

Maguire Properties has released its second-quarter results, shedding light on a number of CMBS properties sponsored by the company.

Among the results' highlights is Maguire's confirmation that it has agreed with the special servicer to keep title of Two California Plaza, which secures a US$470m loan securitised in GSMS 2007-GG10, until a buyer for the property is found or a foreclosure is completed. CMBS analysts at Barclays Capital suggest that the move could avoid the imposition of transfer taxes twice. The property is expected to be sold by the end of the year.

The latest appraisal, from January 2011, pegs the value of the property at US$350m. Eventual loss severity will likely be 30%-35% if the property sells near its appraisal value, after taking into account advances and ASERs.

With regard to the US$44m 3800 Chapman loan - also securitised in GSMS 2007-GG10 - the MPG quarterly report discloses that Maguire was able to be released from the recourse agreement by settling for US$2m, thus allowing the foreclosure to proceed faster than expected. The latest appraisal values the property at just US$22m, suggesting that severities could reach 55%-60% if the loan accrues significant advances and ASERs.

The report also indicates that Maguire sold its US$52m Stadium Gateway property, securitised in CD 2006-CD2, on 12 July for net proceeds of US$1m. The new buyer assumed the mortgage, which matures in 2016.

"The sale is a near-term positive for the property, as a new buyer is more likely to try to add value to it by increasing occupancy, which has fallen to 71% as of the end of February. The sale also indicates that the loan remains highly leveraged and that performance must improve for the loan to pay off on time in 2016," the Barcap analysts note.

Finally, MPG states that the special servicer is proceeding with the foreclosure of the US$125m Glendale Center (WBCMT 2006-C27) and the US$100m Stadium Towers Plaza (JPMCC 2007-LDP11) properties. The servicer expects to complete the foreclosure for the former this month, with losses likely to be 35%-40% if the property is liquidated near the appraisal value (US$86m). Stadium Towers Plaza completed the foreclosure process on 18 May and is now in REO.

CS

Structured Finance

Identifying asymmetries

Charlotte Valeur Adu, chair of Brevan Howard Credit Catalysts Limited, answers SCI's questions

Q: When and why did Brevan Howard launch a listed credit fund?
A: The Brevan Howard Credit Catalysts listed fund began trading on the London Stock Exchange on 14 December 2010 and now has US$172m assets under management. The listed fund, in turn, invests all of its assets in the US$2.5bn Brevan Howard Credit Catalysts Master Fund that commenced trading on 1 June 2009, managed by David Warren of DWIM, a boutique that spun out of Brevan Howard.

Brevan Howard recognised that it was difficult for investors with smaller balances or tighter liquidity requirements to access the opportunities being seen with the Credit Catalysts Master Fund, which is a long/short credit hedge fund. So Brevan decided to launch a listed fund that would diversify the owner base in that fund, as well as provide longer duration and a stable base of capital for the manager.

The Master Fund focuses on European and US corporate credit, ABS and MBS. Its aim is to generate high absolute returns by investing in a diversified manner.

Q: How do you differentiate yourself from your competitors?
A: The connection with both DWIM and Brevan Howard is a significant differentiator. It's rare to have the involvement of such a strong credit manager in a listed fund together with a macro manager known for disciplined risk management. The listed fund has benefited from the incorporation of Brevan Howard's risk management and macro research into DWIM's micro, catalyst-driven credit shop - a particular advantage, given that the world has become so macro and risk on / risk off.

Q: What are your key areas of focus today?
A: The interest for the fund has been good from a range of different investors and we are monitoring the market to ascertain the potential for further issuing of shares, to give the fund more liquidity and to meet investor demand - the listed fund traded at a premium to NAV for most of last year.

It has since slipped into a small discount, which is also being monitored closely. The board discusses what measures to have in place to control a potential discount and what to do to avoid a discount arising in the first place.

In terms of the investment proposition - investing in the underlying BHCC Master Fund - the investment manager tries to identify catalysts that could generate value, from both fundamental and technical perspectives. These can range from a company filing for bankruptcy or an earnings surprise, to an MBS experiencing higher prepayments than expected. The definition of what constitutes a 'catalyst' is broad - there aren't enough hard events to be otherwise - but they typically have a 12-month horizon.

In practise, the BHCC Master Fund's portfolio construction is very flexible. For example, at the peak of the 2009 default cycle, about a quarter of the assets and under half the risk were in distressed corporates. But now distressed corporates account for less than 5% of its assets and 10% of the risk because the opportunity set has dwindled for the moment. If there is a surge in bankruptcies, however, those figures could change again. For now though, corporate default rates are expected to remain low.

Similarly, when index tranches became interesting earlier this year, the fund grew its exposure to that sector. But when it started normalising in April and May, David Warren reduced the exposure significantly.

The listed fund's performance is up by 6% year to date, and it will be similar for the Credit Catalysts Master Fund, largely because of the shift in risk to structured securities in 3Q11 in anticipation of the opportunities that 2012 would bring in this sector. This year, the Master Fund made money in index and bespoke tranches, as well as its MBS holdings, based on careful portfolio construction. The strategy has generated returns in both the 'risk on' and 'risk off' months - the listed fund has never had a down year - indicating that the strategy is truly long/short.

Q: What major development do you need/expect from the market in the future?
A: The investment manager views much of the developed world as being in a prolonged deleveraging cycle, encompassing governments, businesses, and individuals. Most market participants are used to positive short-term interest rates, allowing central banks the option to cut rates. With rates cut to zero or nearly so, central banks are left with 'non-standard' monetary measures, which have been very difficult for the market to appreciate as the effects of quantitative easing work their way through the economy. Fiscal policy could possibly help, but many governments are frozen due to already high debt loads, or political differences preventing action.

The investment manager continues to focus research efforts on individual security selection within the fund's macro framework. As markets could tip one way or the other based on strong macro forces, Warren is aiming to find securities (and related hedges) that can provide absolute returns with appropriate downside protection through most outcomes.

CS

ABS

PCS Secretariat makes appointment

Mark Lewis has become md at the PCS Secretariat in London. He was previously global head of structured capital markets at UniCredit.

Lewis spent a decade at UniCredit working across Europe, the US, Asia and Australia. He will now work under Ian Bell, who was named Secretariat head last month.

Structured Finance

Distressed credit firm founded

Vladimir Jelisavcic has launched Bowery Investment Management, based in New York. Jelisavcic leads Bowery's portfolio management team and is joined by Bill Gushard, John Brecker and Bradley Max.

Jelisavcic was a founding partner of Longacre Fund Management and Bowery will now manage the Longacre Opportunity Fund. The fund has been solely managed by Jelisavcic and is focused on niche special situation credit opportunities, such as trade claims, private obligations and overlooked or under-followed capital structures.

Gushard is managing partner, having joined from Paulson & Co, where he was responsible for distressed bank debt trading. He will oversee Bowery's trading and risk management as well as supporting the overall portfolio management process.

Brecker will mainly focus on sourcing unique and off-the-run credit opportunities, while Max will focus on trade claims. In total, the investment team consists of two distressed traders, four dedicated research analysts and two senior debt sourcers.

Structured Finance

Katten adds SF partner

Stanford Renas has joined Katten Muchin Rosenman as structured finance and securitisation partner. He joins from Linklaters and has previously had stints at Cadwalader, Wickersham & Taft and Milbank, Tweed, Hadley & McCloy.

Renas focuses on CDOs, CLNs and structured derivatives trades as well as alternative risk transfer insurance products such as longevity trades and catastrophe bonds. He will be based in New York.

CDO

Mizuho settles CDO charge

The US SEC has charged Mizuho Securities USA and three former employees with misleading CDO investors. The commission says dummy assets were used to inflate the credit ratings of a deal backed by subprime bonds.

The SEC says Mizhuo made approximately US$10m in structuring and marketing fees for Delphinus CDO 2007-1, which defaulted in 2008. Mizuho employees submitted to S&P a portfolio containing "millions of dollars in dummy assets that inaccurately reflected the collateral held by Delphinus" to meet the agency's recently revised criteria, the SEC charges.

Without accepting or denying the SEC's claims, Mizuho has agreed to pay US$127.5m to settle the charges. Former employees Alexander Rekeda, Xavier Capdepon and Gwen Snorteland have also agreed to settle the SEC's actions against them.

CDS

Assenagon credit group going it alone

Assenagon Credit Management has announced it is splitting from Assenagon Group and will operate independently and under a new brand name. All funds managed by Assenagon Credit Management will be rebranded to reflect this change.

Assenagon Credit Management will continue in its role as investment manager of the Assenagon Credit Basis, Assenagon Credit Basis II and Assenagon Credit Debt Capital funds. Further to regulatory approval, Assenagon Asset Management will transfer its responsibility as administrator of these funds to an as yet unannounced new fund administrator later this year.

CLOs

Board appointments at CLO manager

Avoca Capital Holdings has made two board appointments. Darren Carter joins as non-executive director and Clayton Perry becomes executive director.

Carter was formerly ceo of KBC Financial Products and is an existing partner and non-executive chairman of Avoca's convertible bonds business. Perry has been with Avoca for two years and has overall responsibility for business development across all of Avoca's products, having previously been head of Credit Suisse's global CLO business.

The Avoca board now consists of co-CEOs Alan Burke and James Hatchley, executive chairman Donal Daly, Perry and Carter.

CMBS

CRE expansion continues

Walker & Dunlop has hired Michael Lee and Matthew Lund, who will each be based in a newly-opened office in Madison, Wisconsin. Lee and Lund each join as vp and focus on financing all types of income-producing properties.

Lee and Lund join from Grandbridge Real Estate Capital, where they specialised in originating and structuring CRE financing for all property types. Lee has broad experience of origination, structuring, placement and closing for a variety of product types and has previously worked at Collateral Mortgage Capital and LJ Melody & Company. Lund was responsible for the origination, analysis and placement of debt, equity and structured finance for CRE assets nationwide at Grandbridge and has previously also worked at Cohen Financial.

ABS

AESOP modelling error corrected

Moody's has upgraded Avis Budget Rental Car Funding series 2010-6 variable funding notes to Aa2 from A1, following a correction to its rental car ABS model. The correction has no impact on any other outstanding classes or series of other rental car ABS, however.

During the course of an internal review, Moody's discovered that the model erroneously applied a haircut to the value of programme vehicles in simulated model runs in which the manufacturer was deemed to be: either not in bankruptcy; or in bankruptcy, but having affirmed its programme agreement. The correction eliminates the collateral haircut that was applied to programme vehicles in those instances.

While the correction is credit positive, it has a more pronounced effect on the higher-rated senior classes because they are subjected to more stressful assumptions.

ABS

Italian sovereign-linked ratings hit

Moody's has downgraded the ratings of 11 tranches in seven Italian ABS, due to their direct linkage to the ratings of the Italian sovereign and sub-sovereigns. The move follows the downgrade of Italy to Baa2 from A3 on 13 July and subsequent downgrades of 23 sub-sovereign entities on 16 July.

The Italian government and several of the downgraded Italian regions - including the Region of Lazio, the Region of Abruzzo, the Region of Campania and the Autonomous Region of Sicily - are the obligors for the seven Italian ABS transactions affected by the rating actions. The assets are unsecured, direct obligations of the sovereign or sub-sovereign entities.

Of the affected tranches, the POSILLIPO FINANCE II series 2007-1 A2 note remains on review for downgrade, pending the conclusion of the review on the guarantors' (Assured Guaranty) ratings. In addition, the ratings of five Cartesio series 2003-1 notes remain on review for downgrade, due to the high linkage to Dexia Crediop.

Separately, Moody's downgraded the ratings of six structured credit securities that are linked to the ratings of Italy and Unicredit, which was downgraded from A3 to Baa2 on 17 July. The agency also downgraded one balance sheet CLO (C.P.G. Societa di Cartolarizzazione) exposed to Italian state and public sector entities.

ABS

Mezz ABS fund minted

Prytania Investment Advisors has launched the Galene Fund, an actively managed fund focusing on investment grade structured finance assets. It aims to build a diversified portfolio generating a stable yet attractive return in excess of 450bp over one-month Euribor per annum.

The fund seeks to exploit the attractive risk-adjusted return of ABS through relative value opportunities, mispriced risks and identification of under-valued sectors. The vast majority of Galene's assets are floating rate, with limited duration risk.

The first close of the Galene Fund, with just over US$100m-equivalent, extends Prytania's current suite of global structured finance funds. Mark Hale, cio of Prytania Investment Advisors, comments: "Few investors are currently focused on the mezzanine risk positions in structured finance that we currently favour for our Galene Fund, resulting in limited competition for our target assets. Real money investors prefer the low risk/low return characteristics of senior notes, which we buy for our Metreta Fund, and hedge funds and other 'fast money' accounts are drawn to the equity-style returns potentially available from the junior risk positions we favour for our Athena Fund."

He continues: "The new issue market is also seeing increased issuance of mezzanine notes, especially in the CLO sector. These notes are typically offered with coupons significantly higher than pre-crisis peers, despite the fact they are structurally better protected from loss, in order to attract a smaller current investor base. The Galene Fund is designed to capture just these types of overlooked opportunities."

Structured Finance

APRA first-loss rule welcomed

Moody's has welcomed the Australian Prudential Regulation Authority's (APRA) requirement for banks to deduct from their common equity Tier 1 holdings subordinated tranches of securitisations originated by a third party. The rating agency suggests in a recent Credit Outlook publication that such a conservative measure will support bank stability by ensuring there is adequate capital to cover first-loss positions.

The capital deduction for third-party-originated subordinated tranches is one of a series of measures that APRA has implemented since the financial crisis to reduce the potential for capital arbitrage by means of securitisation. Moody's notes that this latest measure goes beyond merely discouraging the swapping of subordinated tranches between originators.

"Instead, APRA stipulates that unless a bank can sell subordinated tranches outside the Australian banking system, the originator should retain those tranches. The new rule effectively argues that APRA believes the originator is in a better position to understand the risks in these securities than its competitors," the agency explains.

APRA's definition of 'subordinated tranches' is conservative: they are defined as "any tranche that is exposed to the bottom 10% of the initial capital structure, unless that tranche is also the most senior". The regulator also states that subordinated tranches that are only partly exposed to the bottom 10% must be deducted in whole. By way of comparison, in many Australian securitisations subordinated notes compose only the bottom 5%-8% of the capital structure.

While the new measure will not affect the country's major banks that aren't active securitisers, it is expected to affect regional banks - such as Bendigo & Adelaide Bank, Bank of Queensland and Suncorp-Metway - and some larger building societies and credit unions that still tap the securitisation market.

APRA has invited comments on the wording of the requirement. Subject to additional feedback, the measure will become effective on 1 January 2013.

Structured Finance

European distressed credit fund closes

Oak Hill Advisors has closed its OHA European Strategic Credit Fund, which will focus on distressed debt and corporate restructurings in Europe. It is Oak Hill's first dedicated European distressed investment vehicle.

The fund closed at its US$1.35bn cap, despite the manager only initially targeting US$750m. Portfolio manager Scott Krase says it is evidence of the firm's confidence in the quality of the European distressed opportunity and growing commitment to the European credit markets.

The fund's limited partners include a wide group of institutional investors, including sovereign wealth funds, corporate and public pension plans, endowments and foundations, insurance companies and family offices. They include both new and existing Oak Hill relationships, the firm says.

CDO

CRE CDO late-pays decline again

US CRE CDO late-pays declined for a second straight month, according to Fitch's latest index results for the sector. Delinquencies fell to 12.3% last month from 13% in May, while only five new delinquencies were added to the index with 15 assets removed.

Of the 15 assets removed from the index, eight interests were disposed of at full to partial losses. These losses contributed to the US$115m in realised losses reported by asset managers in June, which is the highest monthly total in 2012.

The largest loss was related to the full write-off of REIT debt from an affiliate of the asset manager. The asset was modelled with a full loss in Fitch's analysis of the related CDO.

The next largest loss was related to the discounted pay-off of a defaulted whole loan secured by an office portfolio located in Memphis, Tennessee. The portfolio had a reported occupancy of only 58% and the loan failed to repay at maturity in January.

In June, land and construction loans led all property types with the highest delinquency rates. However, non-cash flowing property types only comprise 7% of total CRE CDO collateral, which is down from 10% of collateral in June 2011. Of the more traditional property types, hotel loans have the highest delinquency rate at 16%, which is up from 12% a year ago.

Thirty CRE CDOs rated by Fitch reported delinquencies ranging from 0.2% to 53.4% last month. Additionally, 38% of the transactions were failing at least one overcollateralisation test.

CDO

ABS CDO liquidations mooted

Fortress Investment Group is seeking to liquidate the remaining assets in the Eurocastle CDO II and III transactions, prior to redeeming the notes on 20 September. For it to proceed, written resolutions must be executed by the holders of at least 75% in principal amount of each class of notes.

The move follows the passing of extraordinary resolutions by Barclays Bank - the class A1 and A2 noteholder in both deals - last September, which resulted in a restructuring of the CDOs. In accordance with the extraordinary resolutions, a considerable percentage of the portfolios were sold to Barclays at below par prices, with a substantial portion of the sale proceeds used to pay down the class A1 notes of both transactions.

The terms and conditions of the notes were also amended. First, interest payment due on the class A1 and A2 notes is to be paid from interest proceeds from the remaining portfolio only. Any unpaid interest is deemed to be paid and hence will not cause an event of default.

In addition, Barclays has undertaken to pay any interest or principal amounts that would have been due to the classes B, C, D and E notes under the interest and principal waterfalls, if the assets had not been sold pursuant to the September 2011 extraordinary resolutions. The amounts that Barclays has undertaken to pay would come from the interest proceeds, as well as scheduled and unscheduled principal proceeds from the sold assets.

The below par sale of the assets to Barclays has caused the issuers' remaining portfolios to be lower than the outstanding notional of the class A1 of both transactions, according to Fitch. The agency says it has downgraded the ratings on both deals to or affirmed them at single-C and subsequently withdrew them, due to the structural changes and inadequate reporting.

CDO

ML3 results in

Credit Suisse has emerged as the successful bidder on four of the Maiden Lane III tranches auctioned on 19 July (SCI 13 July) - the US$689.19m Adirondack 2005-1, US$949.3m Adirondack 2005-2, US$679.57m Laguna ABS CDO and US$699.71m Toro ABS CDO I. RBS bid successfully for the US$893.29m Sierra Madre Funding assets. Barclays Capital, Citi, Deutsche Bank, Goldman Sachs, Bank of America Merrill Lynch and Morgan Stanley were also invited to bid for the collateral.

CDO

Six more CDOs sold

Credit Suisse has emerged as the successful bidder on two CDO tranches offered in the latest Maiden Lane III sale - Broderick CDO 1 (for a face amount of US$724.58m) and Mercury CDO II (US$620.86m). Citi also scooped two of the assets: Margate Funding I (US$474.62m) and Mercury CDO 2004-1 (US$213.38m). Bank of America Merrill Lynch won the auction for G Street Finance (US868.83m), while Goldman Sachs scooped the Hout Bay 2006-1 asset (US$634.25m). Barclays Capital, Deutsche Bank, Morgan Stanley and RBS were also invited to bid for the collateral.

CDS

ICE to clear EM CDS

ICE Clear Credit has launched real-time, trade-date clearing of the Markit CDX.EM index for buy-side and dealer-to-dealer trades. The launch of CDX.EM series 16 and 17 augments the list of over 40 cleared North American indexes available for client clearing at the CCP.

In October 2011 ICE Clear Credit became the first central counterparty to clear sovereign CDS, with the introduction of Argentine, Brazilian, Mexican and Venezuelan single names. CDX.EM is comprised of 15 sovereigns, including the four already cleared by ICE Clear Credit.

In the first weekly clearing cycle for the two CDX.EM series, US$14.5bn gross notional value was cleared and open interest stands at US$2.7bn.

CDS

Clearing house 'systemically important'

ICE Clear Credit has been designated as a systemically important financial market utility by the Financial Stability Oversight Council. The announcement follows the US SEC's adoption of rules for systemically important clearing houses last month (SCI 29 June). As a systemically important agency, ICE Clear Credit will be subject to tighter regulation.

CLOs

Call for CLO standardisation

The standardisation of defined terms and structural features in future CLOs could speed the primary issuance process, says Fitch. The agency believes there will also be a knock-on benefit for the secondary market, where due diligence requirements would be lower and valuations would be easier to understand.

Fitch notes that CLO documentation is currently particular to each deal, with bankers and issuers negotiating between the debt and equity investors often being a relatively lengthy process. The agency notes terms such as 'discounted securities' can have more than one meaning, which makes documentation a challenge for investors. Standardisation would streamline these processes and ease issuance.

CMBS

EMEA CMBS work-outs reviewed

Moody's has released its latest update on EMEA CMBS specially serviced loans. The weighted average Moody's expected principal loss for loans in special servicing remains stable at 36%.

The most recent addition to the EMEA specially serviced loans that the agency tracks is the £6m Chesterton Commercial loan, representing 1% of the pool balance in Deco 12 - UK 4. The loan was transferred into special servicing in May 2012 due to non-payment at maturity (see SCI's CMBS loan events database).

No loans were removed from special servicing in June, according to Moody's. However, several loans underwent property sales, including the £70m Greater London loan securitised in Indus (Eclipse 2007-1). As of end-June, the agency tracked 16 loans - representing 22% of all loans in special servicing by balance - as being in their final stages of work-out.

Work-out of the single loan securitised in Opera Finance (Uni-Invest) continues, with the note trustee submitting a request to the Dutch court for approval of a private pledge enforcement sale of the senior loan. A court hearing on the matter is scheduled for today (23 July).

Finally, the special servicer of the €59m Bulgarian loan, Sofia Business Park, securitised in Deco 14 - Pan Europe 5 was changed from Hatfield Philips to Capita upon the request of the operating advisor. The operating advisor is currently the B-lender with a €8m stake outside the securitisation.

CMBS

Euro CMBS 2.0 principles released

CRE Finance Council Europe has published a consultative document outlining principles for new CMBS issuance. Entitled 'Market Principles for Issuing European CMBS 2.0', the document aims to help bring confidence back to the European real estate capital markets and stimulate the further development of European CMBS.

The principles draw on the specific lessons learnt from previous European CMBS transactions. One key area addressed in the principles is disclosure requirements for pre- and post-issuance information (including who has the controlling interest in a transaction), as well as improved investor reporting, valuations and cashflow models. A noteholder forum could be one way of facilitating communication with noteholders, for example.

Another key area is CMBS structural features, such as controlling party rights and voting provisions, and the monetisation of excess spread. Here, the aim is to avoid excess spread generating profit when a deal hits maturity and fails to pay out. One way of achieving this would be to no longer have a class X tranche at the top of the cashflow waterfall and rather have it act more like a skim in the banking market.

Finally, the role of the servicer and other counterparties is addressed in the principles. Tweaks to the current model are envisaged, rather than drastic change. But one example could be giving noteholders a veto when a controlling party seeks to replace the special servicer, especially where the controlling party is out-of-the-money and a special servicer replacement is believed to be negative for bondholders.

"The size of the commercial real estate debt funding gap facing European property markets...presents a considerable opportunity for the capital markets," comments Nassar Hussain, chair of CREFC-Europe's CMBS 2.0 Committee and managing partner of Brookland Partners. "The new principles address the weaknesses exposed in historical CMBS structures, such as the need for greater transparency, and provide a more equitable and workable framework for future CMBS issuance. The ultimate goal will be to create not only more market liquidity, but also assist in laying the foundations for a new capital markets debt model moving forward."

The consultation period is open until 18 September.

CMBS

Italian CMBS hit

Moody's has downgraded the ratings of 12 notes from five CMBS exposed to assets located in Italy. The move follows the agency's decision to lower the Italian country ceiling to A2 from Aaa on13 July and the increased risk of asset performance deterioration. The affected transactions are: FIP Funding, Imser Securitisation 2, Island Refinancing, Taurus CMBS No.2 and Infinity 2006-1 Classico.

Moody's downgraded Italy's government bond rating to Baa2 from A3 on 13 July. The agency notes the increased risk that the factors driving the sovereign's downgrade will lead to a significant and uniform deterioration in asset performance. In particular, the default probabilities of the underlying loans at the point of refinancing are driven by constrained commercial real estate lending and low investor demand for assets in Italy.

Risk Management

CVA exposure-centric analytics touted

Numerix has published its latest quantitative research, entitled 'Algorithmic Exposure and CVA for Exotic Derivatives'. The paper establishes a new algorithmic method for calculating counterparty exposure for exotic portfolios and automates its application to computing Monte Carlo simulated measures for market risk and counterparty risk.

"This paper introduces a theoretical framework that can be used to reconcile various approaches to computing risk with the same level of speed and accuracy as pricing, helping to create a common language for the front and middle offices," comments Serguei Issakov, svp quantitative research & development at Numerix. "While there is a consensus on how to compute price, there are various approaches to achieve risk computations - which don't always agree with each other. We found that by calculating exposure in parallel with pricing, a unified, more efficient approach can be taken to computing complex risk measures."

Fundamental to this approach is the concept of exposure-centric analytics, which generalises the existing price-centric analytics, as a rigorous framework for computing market risk and counterparty risk. As such, this method also naturally lends itself to computing economic scenario generators by applying economic variables to the scenario generation framework, the firm says.

Assuming a portfolio is priced by the backward (American) Monte-Carlo method, the approach allows credit exposure to be calculated as a pricing by-product, essentially without modifications in the usual pricing procedure. In particular, for the exposure calculation of callable instruments, a cumbersome aggregation of exercise indicators is avoided by applying them sequentially in parallel with the main pricing.

Further, the paper explains how the obtained exposure can be integrated into CVA, based on the extension of the pricing model with a counterparty credit component. The presented approach to the exposure computation is formulated in an arbitrary probability measure. To perform the measure change, Numerix uses cross-currency model semantics and calibrates the model to the real-world measure using index projections.

RMBS

RFC issued on servicer updates

Moody's has requested comment from market participants on its updated approach to assessing the ability of US residential mortgage servicers to prevent defaults and maximise recoveries, through their collections, loss mitigation, foreclosure timeline management and loan administration practices. Under the new approach, the agency will use additional data in its evaluation of servicer performance.

It would augment the current loan-level portfolio data that it uses with data from securitisation trusts. Moody's will also use GSE performance data, if appropriate.

The updated methodology would also make data on re-defaults of modified loans part of the performance analysis. In addition, loan administration would be promoted to being one of the agency's major evaluation categories. The other categories would remain collections, loss mitigation, foreclosure timeline management and servicer stability.

The servicers covered by the methodology include those that service prime loans, subprime loans, Alt-A loans, second-lien loans, high LTV loans and manufactured housing loans.

Implementation of the proposed changes could lead Moody's to change some SQ assessments or place some on review for upgrade or downgrade. Although a change in a servicer's SQ assessment can have credit implications, it is unlikely in itself to prompt a rating action on any RMBS, the agency notes.

RMBS

Countrywide RMBS settlement reached

Syncora Guarantee has reached a US$375m settlement with Countrywide Financial and its parent Bank of America. The settlement ends an RMBS suit which Syncora and MBIA brought in 2009 in which Syncora alleged Countrywide had misrepresented the quality of loans securitised in order to induce the insurers to insure the securitisation.

RMBS

Market risk dichotomies highlighted

Interactive Data has released an analysis of current credit ratings and evaluated price levels for non-agency CMO securities, which highlights a number of what it describes as dichotomies with respect to market risk. The study comes as the industry digests US bank regulators' recently released proposals for implementing the Basel 3 framework for market risk capital rules.

The non-agency CMO universe is dominated by below-investment grade credit ratings, with sizable majorities of bonds backed by collateral types other than 15-year fixed rate being rated double-B or lower by at least one major rating agency. Still, even among subprime RMBS, some are rated as high as triple-A.

During the past six months, credit ratings of non-agency CMOs on the whole continued a downward trajectory that began with the financial crisis. In particular, many bonds moved during this period from the single-C to the single-D category.

In its analysis, Interactive Data observes that fixed rate bonds have higher evaluated prices, on average, than adjustable-rate bonds - due in part to their higher bond coupons. Among subprime RMBS currently rated triple-A, all securities with evaluated prices above US$80 were identified as fixed rate bonds, while those below US$80 are floating rate bonds.

Generally, bonds with lower loss coverage ratios were also shown to have lower evaluated prices, since their delinquency percentage is closer to their level of subordination. "The example of a legacy subprime security - which is still rated triple-A by all three major rating agencies - with an evaluated price of US$70 illustrates that credit ratings do not necessarily reflect market risk," the firm notes. "Similarly, we highlight a security due to mature in a couple of months' time currently evaluated at par and rated single-C."

Finally, the analysis confirms that bonds with a longer weighted average life generally have lower evaluated prices.

RMBS

Countrywide settlement remains on track

The Walnut Place investor group has withdrawn as intervenor in the Article 77 proceedings to ratify the Countrywide RMBS settlement. The group had previously sought to extend the scope of the discovery by reviewing thousands of loan files, while BNY Mellon - as trustee - had argued that this was not required (SCI passim).

Consequently, the settlement is expected to be finalised in the first or second quarter of next year, with cash flowing to deals within three months afterwards. However, ABS analysts at Barclays Capital warn that Walnut Place is not the only intervenor to the proceeding and other parties could still pursue discovery aggressively.

"In terms of extending discovery, we believe that investors need to pay attention to any documents filed by the larger investors still in the proceeding, such as AIG, as well as the roles played by the New York and Delaware attorneys general," they explain. "Finally, since this settlement cash needs to be paid through the REMIC structure, approval of the IRS and state tax authorities will also be required and the eventual cashflows could still get delayed if those are not forthcoming."

RMBS

JHF guarantee proposal 'credit positive'

The proposed change to loan guarantee fees by Japan Housing Finance Agency (SCI 6 July) will be credit positive for JHF-guaranteed RMBS, Moody's says. The agency believes that a guarantee fee based on pool performance will encourage originators to underwrite JHF-guaranteed loans to the same high standards applied to non-guaranteed loans.

Moody's has observed that JHF-guaranteed RMBS pools show worse performance than general private sector Japanese RMBS. Furthermore, even for JHF-guaranteed RMBS pools, performance varies widely.

In order for the underlying loans of RMBS transactions to secure a JHF guarantee, they must meet certain basic quantitative measures, such as maximum LTV or certain debt-to-income levels. In view of the absence of any large differences in their quantitative aspects, the bad performance of JHF-guaranteed RMBS is due to poor underwriting or a failure to sufficiently assess the payment abilities of borrowers, Moody's notes.

In addition, loans originated by less-than-reputable real estate agents are present in some poor performing pools. In JHF-guaranteed RMBS, most loans are originated through real estate agents who sell houses or flats to homeowners. Hence, the screening of real estate agents is also important.

RMBS

PPIF winding down

Western Asset Management Company has begun winding down its legacy securities PPIF, pursuant to an agreement with the US Treasury. The firm opted to end the fund's investment period on 15 July, rather than extend it to 5 November. Western Asset Mortgage Defined Opportunity Fund invests indirectly in the PPIF, which accounts for approximately 31.6% of its total investments, as at 30 June.

Western Asset says that it will continue to seek to maximise the value of the PPIF's assets, begin to return capital to investors and manage dispositions prudently. Accordingly, the opportunity fund will receive distributions from the PPIF, which will in turn be invested directly in MBS in accordance with its investment objectives. The manager also anticipates utilising direct borrowing to replace the implicit leverage it currently has as an investor in the PPIF to effect its direct purchases of MBS.