Contents

Risk Management

Risk transfer

Counterparty risk securitisations gaining traction

Index-linked contingent CDS contracts have yet to gain traction, despite the introduction of standardised terms earlier in the year. Instead, counterparty risk securitisations appear to be making a come-back ahead of the implementation of Basel 3.

UBS most recently closed a counterparty risk transfer transaction, albeit the trade is said to be a "one-off". The deal is noteworthy for being funded and featuring a dynamic portfolio, unlike typical securitisations in the space. The coupon is understood to be high, at around 18% over Libor, with losses to be subtracted from the principal.

"It's unclear how the coupon was calculated or how the risk was quantified," notes Dmitry Pugachevsky, director of research at Quantifi. "The investor would have had to make its own assumptions about the correlation between counterparties in the underlying portfolio and across a number of different market factors. But this trade can't be hedged because underlying exposures aren't traded."

He suggests that the coupon would have to be high enough to compensate the investor for a number of factors. First, they are exposed to the second loss piece, with only a thin first loss (0%-1%) tranche below. If a systemic event occurs, the investor could lose their entire principal.

Second, the portfolio is almost impossible to unwind, so the investor will have to hold the trade for a long time. Finally, they are exposed to negative asset selection: although the portfolio is likely to be subject to certain replenishment criteria, UBS is incentivised to include its most risky trades.

Credit Suisse's 2011 Partner Asset Facility (SCI 26 April) is believed to be structured along similar lines. Pugachevsky says it would be interesting to learn how the Swiss regulator is approaching these transactions, given that they won't be counted as an eligible hedge under Basel 3.

"It's possible that the coupon is less than the capital charge that would have been levied on the portfolios. The transactions could be driven entirely by capital relief purposes," he observes.

Nevertheless, Pugachevsky is surprised that neither bank appears to have considered using index contingent CDS to hedge their counterparty risk. ISDA released standardised terms for the product in February (SCI 13 February), with the aim of increasing transparency and liquidity in the market.

But only a small number of index CCDS trades have been done since then. One reason for the lack of up-take could be that banks are still looking for clarification from regulators about using the product. Another reason could be that the definitions are too narrow.

"It's more straightforward to offload counterparty credit risk via a CCDS contract than a counterparty risk securitisation, with terms being standardised. But CCDS are only written on a single counterparty or on a pre-specified index, whereas it's possible to unload the risk of a substantial portion of your book in one hit with a UBS-style transaction," Pugachevsky adds.

However, he points out that CCDS counterparties need to have deep pockets to reimburse any losses. "In this sense, institutional investors would make ideal counterparties to take the other side. Hopefully, once regulators are convinced about CCDS and when banks see how much they have to pay in capital charges otherwise, the market will become more liquid."

Away from Swiss banks, Deutsche Bank and RBS are also believed to be prepping counterparty risk securitisations. RBS was last in this market with its Score 2011-1 trade (SCI 25 November 2011), which was reportedly pulled at the beginning of this year.

CS

CLOs

Mixed messages for Euro CLOs

The European CLO market appears to be slightly subdued, following a couple of days of strongly contrasting BWIC activity. After beginning the month slightly weakly, the market tightened remarkably on Thursday.

"This week the market has not been very busy, but we know we may be missing things. There are some BWICs from banks that only deal with dealers, for example. From what we have seen though, especially last week, the lists have been very interesting," reports one trader.

The reception for Wednesday's bid-list was far weaker than for the one on Thursday. The trader expected Thursday to show continued weakening, but the HSAME 2006-IIX D tranche was covered at 58.5, as shown by SCI's PriceABS BWIC data.

"That is kind of an average deal and then on Thursday it came out at 58.5, which is about 11.60 DM. For a triple-B rated bond, that is very, very tight to where the market was. The whole list traded really well; it was quite incredible," the trader says.

He continues: "On Wednesday a Dryden triple-B tranche traded at that level. Dryden CLOs are great trades, so it was a surprise on Thursday to see names getting as tight as that."

While the trader notes that Thursday took everybody he has spoken to by surprise, the lack of supply means that prices have been going up and up - despite all the negative news in Europe. "If you look at where the levels are now, triple-Bs are around 1150-1400. That is quite tight for this year. The last time it was like this was back in September 2011," he adds.

Away from BWICs, the trader reports that there has been interesting buying activity for equity pieces, possibly from a new market entrant. "There was one piece we were looking to trade and it was one of the best we have seen, but the guy selling it got a ridiculous bid. We were looking at the piece and it was worth somewhere in the 50s at the very best, but he got a bid of well over 60."

He concludes: "It is a great piece, but - with where the market is - it was amazing to see a bid in the 60s. There is definitely someone out there. I do not know whether it is a new player or someone who desperately needs cash returns for yields, but it certainly seems there is some paying up going on."

JL

CMBS

CMBS supply running steady

Generic US CMBS spreads were mostly unchanged yesterday, but AM tranches did grind about 5bp tighter. Interactive Data figures place BWIC volume for the session at US$418m, with around a quarter of the paper focused in 2006/2007 vintage AJs. Trading flows have slowed over the last few days after July proved a particularly active month, continuing a rally that started six weeks ago.

Out of close to 100 CMBS line items for the session, SCI's PriceABS BWIC data shows some interesting trades, including activity in BACM 06-4 AJs. The tranche was talked around the 85 mark and covered at 90.02 yesterday, having been bid at 88 earlier in the week.

SCI's PriceABS BWIC data also reveals that the CSMC 06-C5 A3 tranche was variously talked between 135 and 150 and ultimately covered at 142. It had been talked at 175 on 7 June.

Meanwhile, the LBUBS 05-C2 E tranche - which had been covered in the low 40s in the prior session - was again talked in the low 40s yesterday.

JL

Structured Finance

SCI Start the Week - 6 August

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

Pipeline
A good number of deals joined the pipeline last week with two ABS, one RMBS and one CMBS remaining on Friday. The ABS comprised a music royalties deal (US$300m SESAC series 2012-1) and a student loan transaction (US$402m North Carolina State Education Assistance Authority Series 2012-1). The RMBS was A$300m FirstMac Mortgage Funding Trust Series 1-2012, while the US$336.25m WFRR 2012-IO accounted for the CMBS.

Pricings
Over three times as many deals went on to price last week. Six ABS deals dominated the prints, but one ILS, three RMBS, two CMBS and two CLOs were also issued.

The ABS comprised an auto deal (US$1.4bn Nissan Auto Receivables 2012-B), onestudent loan transactions (US$115.2m Brazos Education Loan Authority Series 2012-1), two credit card ABS (US$650m Discover Card Execution Note Trust 2012-5 and US$1bn Discover Card Execution Note Trust 2012-6), a consumer loans deal (A$242.5m Flexi ABS Trust 2012-1) and a tax receipts deal (US$66.75m New York City Tax Lien 2012-A).

The ILS was US$275m Vita Capital V Series 2012-1, while the RMBS consisted of A$750m Medallion Trust Series 2012-1 and US$970m Springleaf Mortgage Loan Trust 2012-2. The CMBS prints comprised US$340m MSC 2012-STAR and C$230m Institutional Mortgage Capital 2012-2, while issuance was rounded out by the two CLOs - US$188.3m Muir Woods CLO and US$417.75m Symphony CLO X.

Markets
US ABS spreads were flat to slightly tighter over the week, according to securitised products strategists at Bank of America Merrill Lynch. Private student loans tightened a full 10bp, marking the second consecutive week in which the private student loan ABS market outperformed CLOs and CMBS A4 tranches. The incremental spread offered over CLOs is now 25bp and over CMBS A4s is 75bp.

Spreads in US CMBS were marginally tighter last week. Deutsche Bank CMBS analysts note that this was driven by disappointment at Mario Draghi's latest comments and the FOMC statement. "Bid list volumes in the US remained around US$1.5bn this week and LCFs comprised half the volume and several large lists increased agency CMBS volume. European activity slowed dramatically after last week's rally, volumes were minimal and prices were largely unchanged," they add.

In US RMBS, agency mortgages tightened in the days leading up to the FOMC meeting and held their gains after it, say Barclays Capital RMBS analysts. "FNCL 3s and 3.5s outperformed Treasury hedges by hedged by 1-2 ticks and swaps by 2-4 ticks," they note.

Non-agency prices rallied in both the cash and synthetic spaces, with cash prices up a point and the ABX indices up by between a point and a point and a half.

Deal news
• Transaction notices for the Titan Europe 2006-1, 2006-2, 2006-3 and 2006-5 CMBS shed some light on how parties to the transactions expect the cash management agreements to operate going forward (SCI 25 May). The cash manager, servicer, special servicer, liquidity facility provider and note trustee for all four deals entered into an MOU, whereby they agreed on the interpretation of certain "ambiguous" provisions of the liquidity facility, cash management and servicing agreements.
• Moody's has downgraded to A2 the ratings of 257 securities across 169 Italian ABS and RMBS. It has also placed on review for downgrade the ratings of 83 Italian ABS and RMBS securities and confirmed the ratings of four Italian RMBS securities.
• The volume of US CMBS earmarked for auction via note sales in August appears to have dropped compared with previous months. About US$236m of CMBS conduit loans are out for bid this month, compared with US$815m in July.
• Fitch has updated its criteria assumptions for assessing credit risk for Irish residential mortgage loan pools. The updated criteria assumptions are expected to result in negative rating actions on a number of RMBS transactions, especially those that were rated prior to the onset of the credit crisis and have a relatively low level of credit protection.
• Moody's has placed on review for upgrade the ratings of 34 US RMBS tranches guaranteed by Syncora Guarantee, impacting approximately US$1.4bn of securities. The action is due to the review for possible upgrade of the monoline's Ca insurer financial strength rating, following its recent settlement with Countrywide.
• The results of the final Maiden Lane III CDO auction for July have been announced. The New York Fed unloaded assets from across nine transactions on 31 July, bringing the total for the month to 20.

Regulatory update
• The FHFA has outlined various initiatives currently being pursued by the agency, two of which likely have near-term implications for MBS markets. First, gradual adjustments in the guarantee fee structure will be introduced, with further details to be released towards the end of this month. The second initiative involves clarifying rep and warranty guidelines.
• Freddie Mac has announced plans to amend its Relief Refinance Mortgage Program, which includes HARP 2.0, by aligning requirements for mortgages LTV ratios that are equal to or less than 80% with those for mortgages with LTV ratios greater than 80%. The alignment change is designed to eliminate many representation and warranty responsibilities on the original loans being refinanced, regardless of the borrower's LTV ratio.
• The Federal District Court in Kansas has denied the majority of the defendants' motions to dismiss in connection with the NCUA's lawsuits over losses from MBS purchased by US Central Federal Credit Union. As liquidating agent for the failed US Central, the agency filed two lawsuits against RBS, Wachovia and nine other defendants that were involved in issuing 29 RMBS bonds purchased by the bank.
• The CPSS and IOSCO have published for public comment a consultative report on the recovery and resolution of financial market infrastructures (FMIs). It follows a report on principles for FMIs published in April, which called for FMIs to have effective strategies, rules and procedures to enable them to recover from financial stresses (SCI 16 April).

Deals added to the SCI database last week:
Avis Budget Rental Card Funding series 2012-3; FREMF 2012-K19; GE Dealer Floorplan Master Note Trust 2012-3; Global SC Finance II series 2012-1; Golden Bar (Securitisation) 2012-1; GSMS 2012-SHOP; Nelnet Student Loan Trust 2012-3; Silk Road Finance No. 3; SLM Private Education Loan Trust 2012-D; & WFRBS 2012-C8.

Deals added to the SCI CMBS Loan Events database last week:
CSFB 2001-CKN5; DECO 2005-C1; DECO 2007-C4; DECO 9-E3; ECLIP 2006-3; EMC 6; FHSL 2006-1; FLTST 2; JPMCC 2007-CIBC20; MSC 2006-IQ12; MSCI 2007-XLF; OPERA SCOT; RIVOL 2006-1; TITN 2005-CT1; TITN 2006-CT1; TITN 2007-3; TITN 2007-CT1; TMAN 3; TMAN 4; TMAN 7; WINDM VII; WINDM XI; & WTOW 2007-1.

Top stories to come in SCI:
CDS basis trade opportunities
July EMEA CMBS maturity outcomes
CLO documentation
Non-performing loan CMBS

CDO

'Healthy' secondary CDO activity seen

In an attempt to enhance transparency in the secondary CDO market, CDO analysts at JPMorgan have released an analysis of TRACE data from inception (11 May 2011) to 17 July. They observe that bid/offer spreads for US CLO triple-A and mezzanine tranches have generally tightened to about an eighth of a point due to lack of supply, versus 1-2bp pre-crisis and multiple points in 2008.

TRACE reports US$98bn CDO trade volume in aggregate over the period, with a 60% non-investment grade/40% investment grade split. Daily average volume is US$332m, with spikes of US$5bn-US$7bn on a few days, and the weekly average is US$677m. The data indicates that on average 81 unique security IDs circulate per week, reflecting the diversity of trades.

TRACE volumes tend to spike around liquidations, such as the Maiden Lane auctions, as well as at quarter- and year-end. Some US$21bn traded in June, for example, mostly across non-investment grade assets (accounting for US$19bn).

JPMorgan's rough estimates for year-to-date BWICs suggest a total mixed (CLOs, CDOs, Trups) volume of around US$45.2bn and CLO-only volume of about US$12.2bn. The analysts suggest that CLOs could account for 30%-40% or US$30bn-US$40bn of TRACE volume since May 2011.

Real money dominated secondary CDO activity in 1H12 at 45.7% of buying volume, followed by banks at 29.4% and hedge funds at 24.9%. The data shows that real money participation has broadly continued to rise since 2008.

"The TRACE data indicate a secondary market in the tens of billions, which to us seems a healthy amount of activity. Barring any large liquidations, there appears to be the capacity for volumes to pick up as investors hunt for yield," the analysts conclude.

CS

CMBS

Titan Europe MOU signed

Transaction notices published last week for the Titan Europe 2006-1, 2006-2, 2006-3 and 2006-5 CMBS shed some light on how parties to the transactions expect the cash management agreements to operate going forward (SCI 25 May). The cash manager, servicer, special servicer, liquidity facility provider and note trustee for all four deals entered into an MOU, whereby they agreed on the interpretation of certain "ambiguous" provisions of the liquidity facility, cash management and servicing agreements (see SCI's CMBS loan events database).

Under the MOU, a 'loan shortfall' includes interest due on a loan in respect of the collection period in which the most recent due date falls, as well as any overdue interest that was not previously paid and that remains outstanding. Barclays Capital European CMBS analysts suggest this clarifies that liquidity can be drawn for all interest due and unpaid, and not only the interest overdue in the most recent period.

Another clarification made under the MOU is that the liquidity facility may not be drawn in respect of a loan for which all properties securing the loan have been sold. Further, the issuer is permitted to roll over liquidity draws only to the extent that funds are not available to repay the outstanding liquidity drawn on the relevant IPD.

"In our view, this is a crucial element of the memorandum of understanding because it means that a liquidity facility draw can be repaid in a given period, using cash from other loans or principal proceeds," the Barcap analysts note.

In addition, the servicer or the special servicer on each due date following sales of properties or upon receipt of a new valuation will recalculate the appraisal reduction and the appraisal reduction factor and notify the cash manager. This point clarifies who is responsible for determining the appraisal reduction and the appraisal reduction factor, but is also supposed to protect the liquidity facility provider from funding interest shortfalls as a result of property sales.

Finally, the cash manager will calculate the liquidity facility commitment on each calculation date, taking into account the appraisal reduction factor.

The dispute between the liquidity facility provider and other transaction parties in Titan Europe 2006-1 and Titan Europe 2006-5 shows that liquidity facility agreements in outstanding CMBS are often overly complex, according to the analysts. "In many cases, the complexity arises from issuer-level liquidity facilities being structured as 'loan-level' facilities but repayable like 'issuer level' facilities. We think that pure 'issuer level' liquidity facilities are easier to understand and easier to handle."

CS

ABS

Securitisation partner enlisted

Kenneth Wright has joined SNR Denton as capital markets partner. He was at Skadden, Arps, Slate, Meagher & Flom and will be based in SNR's New York office, reporting to Stephen Kudenholdt.

Wright represents issuers, underwriters and dealers and his practice focuses on a range of traditional securitisation asset classes and structures, including trade accounts payable, auto loans and leases, equipment leases, credit cards and insurance-backed securities.

Structured Finance

Bank builds new credit group

HSBC has appointed Dermot Murphy and Mahmoud Atalla as mds in its newly-formed credit situations group. The group will source, analyse and risk manage the opportunities being presented by European financials deleveraging and corporates restructuring.

Murphy joins from UBS, where he was co-head of sub-investment grade trading, while Atalla moves internally from the principal investments group. The pair will be based in London and focus on the trading of special credit situations in the bond and loan space. They will both report to Asif Godall, head of European credit trading.

Structured Finance

Law firm hires securitisation partner

Keith Krasney has joined Locke Lord's New York office as partner. He will also chair the firm's securitisation and structured finance group.

Krasney's practice focuses on the securitisation and financing of servicer advance receivables, residential mortgage loans, commercial mortgage loans, credit card receivables, equipment leases, student loans, re-securitisations, CDOs and other assets. He joins from Nixon Peabody, where he led the securitisation and structured finance team.

CLOs

US debt partnership announced

3i Group has announced a strategic transaction with WCAS Fraser Sullivan Investment Management to establish 3i's US debt management platform. The transaction builds on 3i's existing European business and provides access to the US credit markets, although the CLO funds currently managed by Fraser Sullivan and FS COA Management will be unaffected.

Following completion of the transaction, all new US debt management business for both 3i and Fraser Sullivan will be implemented through 3i Debt Management US, which will leverage the resources of the Fraser Sullivan management team and its investment professionals.

3i Group will initially hold an 80% equity interest in 3iDM US, with the balance held by John Fraser, Tighe Sullivan and three other partners. That 20% will be subject to put and call arrangements which are expected to see 3i own 100% of the equity after three years. Fraser and Sullivan will be appointed co-heads of 3iDM's US operations.

CLOs

CLO analyst moves on

Justin Pauley has joined Brigade Capital Management as an investment analyst. He was most recently at RBS, where he was a CLO analyst, and before that he worked at Wachovia as a CDO research vp.

CMBS

Ex-Freddie CRE lawyer joins

Soha Mody has joined the real estate practice of Shapiro, Lifschitz & Schram. She joins as senior counsel and will be based in Washington DC.

Mody will focus on CRE transactions, real estate finance and lending matters and related litigation. She was most recently associate general counsel at Freddie Mac and has previously worked at the real estate practices of Pillsbury Winthrop Shaw Pittman as well as Mohr, Hackett, Pederson, Blakley & Randolph, Hymson & Goldstein and Dushoff & McCall.

RMBS

More arrivals for Gleacher

Gleacher & Company Securities has further boosted its MBS and rates team. Michael Lanigan joins as md while David Philbin joins as director, following hot on the heels of a team of seven others recruited at the end of last month (SCI 31 July).

Lanigan becomes head of MBS and rates sales for the Chicago office. He was most recently executive director of MBS sales at Mizuho Securities and has also held senior posts at Citadel Securities, JPMorgan and Merrill Lynch.

Philbin joins the New York office. He was most recently at Tradition Asiel Securities, where he was a securities broker. He has also worked at Rosenthal Collins Government Securities, Lendesbank Baden Wuerttemberg, Société Générale, Dresdner Securities and Barclays Capital.

RMBS

BNY builds RMBS group

BNY Mellon Capital Markets has recruited an eight-person RMBS team from Ally Securities. The team will be led by Dave Piersol as head of MBS sales and Joe Gaziano as head of MBS pass-through trading.

Piersol held senior sales roles at JPMorgan, Bank of America, Greenwich Capital and Morgan Stanley before Ally. Also joining the sales team are David Clifford, Thomas Daly and Sean Conroy.

Gaziano has held senior trading posts at Wells Fargo, Citigroup and Morgan Stanley. He is being joined by Nathan Baruch, Bruce Graham and David Rios.

RMBS

REIT recruits securitisation vet

James Mountain is joining ARMOUR Residential REIT as cfo, effective from the start of next month. He joins from Deloitte & Touche and will replace Jeffrey Zimmer, who will continue to serve as co-ceo and co-chairman alongside Scott Ulm.

Mountain is currently an industry professional practice director for Deloitte, overseeing the professional and quality control aspects of the firm's practice. He has been involved in the securitisation market since its inception, helping to develop Deloitte's securitisation practice.

ABS

Pick-up seen in secondary ABS

Activity in the secondary US ABS market has picked up, following light volumes last week, albeit with spread levels remaining firm. Credit card, auto and student loan paper was out for bid yesterday.

Among the auto ABS circulating during the session, SCI's PriceABS data shows that US$5.28m in face of the AMOT 2011-1 A1 tranche was covered at 35. The same bond was covered at 46 on 30 April.

Meanwhile, student loan paper appeared to be limited to dealer inventory. Of these bonds, US$2.62m in face of the SLMA 2007-1 A3 tranche was covered at 99.3, according to SCI's PriceABS records.

Structured Finance

Repo risk, rewards highlighted

A Fitch review of collateral within the tri-party repo market highlights some of the inherent liquidity risks associated with financing less liquid securities through this short-term funding mechanism, the agency notes.

According to Fitch's analysis, structured finance repos are typically collateralised by pools of securities that are: lower credit quality (rated triple-C and below); deeply discounted; and relatively small in size (a median value of US$800,000). The agency based its analysis on repo transaction data sourced from the 10 largest US prime money market funds (MMFs), as of end-February 2012, with a sample representing approximately US$116bn in repo collateral.

Approximately 50% of Fitch's sample consists of legacy CDOs and subprime and Alt-A RMBS. Much of this issuance was originated by financial institutions that experienced severe distress related to their securitisation and mortgage-related exposures during the US credit crisis. The survey also found that approximately 60% of structured finance repos within the sample were conducted with three financial institutions, each of which have been active in the New York Fed's Maiden Lane auctions of crisis-era RMBS and CDOs.

Structured finance repos provide a potentially attractive return opportunity for some money funds in the current low-yield environment. However, US prime MMFs - which act as repo lenders within the US tri-party repo market - are short-term and highly risk-averse investors, as demonstrated by the severe decline in structured finance repo during the height of the US financial crisis. Funding relatively less liquid, more volatile assets through repos creates potential liquidity risks for both repo borrowers and the underlying asset class, Fitch concludes.

Structured Finance

Italian sovereign ceiling lowered

Moody's has downgraded to A2 the ratings of 257 securities across 169 Italian ABS and RMBS. It has also placed on review for downgrade the ratings of 83 Italian ABS and RMBS securities and confirmed the ratings of four Italian RMBS securities.

The rating downgrades follow Moody's decision to lower the Italian country ceiling to A2, in connection with its downgrade of Italy's government bond ratings to Baa2 from A3 on 13 July. Italy's new country ceiling reflects the agency's assessment that the risk of economic and financial instability in the country has increased.

The weakness of the Italian economy and the increased vulnerability to a sudden cessation in funding for the sovereign constitute a substantial risk factor to other issuers in the country, as income and access to liquidity and funding could be sharply curtailed for all classes of borrowers. Further deterioration in the financial sector cannot be excluded, which could lead to potentially severe systemic economic disruption and reduced access to credit, Moody's notes.

Finally, the country ceiling reflects the risk of exit and redenomination in the unlikely event of a default by the sovereign. If the Italian government's rating were to fall further from its current Baa2 level, the country ceiling would be reassessed and likely lowered at that time.

The three main drivers for the rating review placements, meanwhile, are Moody's intention to: reassess credit enhancement adequacy for each of the rated notes, given the increased risk of economic and financial instability; assess the impact of strong linkage to counterparties; and assess the impact of increased set-off risk, given the reduced likelihood of systemic support being available for deposit-taking institutions, as a result of the sovereign downgrade.

The agency has concluded its review of 23 ratings that were placed on review due to their strong counterparty linkage or the implementation of a revised approach to set-off risk in Italian structured finance transactions. It has concluded that the impact of the linkage to the counterparty or the exposure to set-off risk is already captured in the current rating of these notes.

Structured Finance

Junior SIV ratings hit

S&P has lowered its credit ratings on all of Mazarin Funding's junior senior notes. These rating actions include the correction of an administrative error on the series 2010-21 junior senior notes. At the same time, the agency has affirmed all of the SIV's A-1+ short-term ratings on the commercial paper programmes and repurchase agreement notes and the triple-C minus ratings on the fast- and slow-pay income notes.

The rating actions follow S&P's analysis of Mazarin Funding's performance under its 2012 criteria for CDOs of pooled structured finance assets and the application of its 2012 counterparty criteria. The agency says that the overall credit quality of the underlying assets in the portfolio has deteriorated since its previous review in September 2010.

For example, it considers approximately 16% of the assets in the current portfolio to be rated triple-A, compared with 27% at its previous review. In particular, the migration of the ratings on the assets in the underlying portfolio has been most visible in the structured finance portion of the pool, especially among RMBS and CMBS exposures.

S&P's updated methodology and assumptions for pools of structured finance assets indicates that all classes of notes in Mazarin Funding now face higher assumed losses and liquidity constraints, as well as a significantly increased probability of default at each rating level. The credit deterioration in the underlying portfolio, combined with the agency's updated assumptions, has meant that the junior senior notes issued by Mazarin Funding are unable to maintain their previous rating levels.

Meanwhile, at the previous review, S&P erroneously assigned a single-B plus rating to the 2010-21 junior senior notes notes, instead of a single-B minus rating. Based on its most recent assessment, the agency has therefore lowered to triple-C minus its rating on these notes.

Structured Finance

Enhanced granularity offered

Interactive Data Corporation has enhanced the FINRA-Interactive Data structured trading aggregate reports available in Vantage, its web application. With additional layers of granularity, financial institutions can now obtain a more complete view of trading activity related to securitised products, the company says.

A new agency hybrid ARMS trade reporting summary and more granular trading tables are now available via Vantage. In addition, the application now includes lower coupon ranges (2.5% and 3.0%) and settlement dates as far out as four months.

CDO

Duke auction set

An auction of Duke Funding High Grade I CDO collateral has been scheduled for 22 August. The portfolio comprises US$1.74bn of paper, divided into agency RMBS, Alt-A RMBS, subprime RMBS and CMBS sub-pools.

The trustee will sell the assets only if the sale results in proceeds greater than or equal to an auction call redemption amount. Settlement is due on 29 August.

CDO

Mezz ABS CDO supply due

The latest Maiden Lane III sale - which saw US$4.45bn of current face across nine high grade ABS CDOs trade (SCI 1 August) - was met with strong demand from retail accounts looking to add exposure to the sector, especially given the recent rally in non-agency RMBS. AIG has also emerged as a large acquirer of assets from the sales.

In its latest earnings release, the firm disclosed that it purchased US$7.1bn (market value) of CDOs from Maiden Lane III at an acquired yield of 9.7%. This is in addition to US$2.8bn of RMBS from Maiden Lane II.

Following the string of sales last month, only mezzanine ABS CDOs remain in the ML3 facility. The New York Fed is expected to announce sales of these remaining positions in the near term. Although these assets should also trade well, ABS analysts at Bank of America Merrill Lynch suggest that demand for the paper may not be as robust as in recent auctions, given the smaller deal sizes and weaker underlying collateral.

CDS

Absolute return fund launches

Ignis Asset Management has launched the Ignis Absolute Return Credit Fund, which is designed to produce positive performance in all market conditions. The fund is managed by Chris Bowie, head of credit, and his 14-strong credit team.

It is a pure alpha, market-neutral fund targeting a low level of volatility (2%-6%), zero duration and zero interest rate risk and a low correlation to other asset classes. The fund invests globally in investment grade and high yield credit via highly liquid credit default swaps (CDS).

The Ignis credit team identifies pricing dislocations between credits and exploits relative value opportunities through a portfolio of 10 to 30 pair-trades. The fund implements strict downside risk controls where losing positions are quickly cut, most likely at -25bp and automatically at -50bp. It has been seeded with approximately £20m of internal and third-party assets.

CDS

FpML swap coverage strengthened

ISDA has published its Recommendation for FpML version 5.3, with the aim of establishing a robust technical framework for global regulatory reporting requirements. The focus in this version is coverage of the CFTC reporting requirements to swap data repositories and for real-time reporting purposes.

Besides the coverage for specific CFTC-mandated data fields, work has been ongoing to represent the unique swap identifier (USI), legal entity identifier (LEI) and the interim CFTC compliant identifier (CICI). The ISDA taxonomy was also integrated into the standard. Additionally, the Recommendation includes enhanced support for clearing messages and enhanced support for a variety of commodity products and processes.

CLOs

Middle-market CLOs touted

A recent Wells Fargo study suggests that on average middle-market CLO senior notes have amortised by more than 33% within one year of the conclusion of the reinvestment period. Senior notes from middle-market CLOs that are between one and two years beyond the reinvestment period are almost all paid down by more than 75%.

The study further shows that the average senior note factor for middle-market CLOs less than one year past the reinvestment period is 20 percentage points lower than similarly aged broadly-syndicated loan (BSL) CLOs. For older CLOs, the gap is more than 30 percentage points.

CLO analysts at Wells Fargo believe this is due to several factors. First, middle-market loan repayment rates are higher than the overall loan market.

Next, BSL CLOs are typically managed by asset managers who purchase assets on the secondary and primary market. Middle-market CLOs can be used as financing vehicles by loan originators. Therefore, managers may take a different view of prepayments: middle-market CLO issuers may let CLOs amortise and then launch a new deal with more recently originated assets, whereas BSL CLO managers may extend the lives of their transactions through purchases.

Finally, middle-market CLO structures may be stricter regarding reinvestment post-reinvestment.

Middle-market CLO assets yield almost 125bp more than BSL CLO assets. However, middle-market loan spreads imply a 12-month forward default rate of 10.6% compared to 6.4% for the large corporate loan market.

Almost US$2bn in new CLOs priced in July, bringing 2012 issuance to nearly US$20bn. There has been strong buying across the capital stack in recent weeks, as investors looked to add yield. The analysts believe the next sectors to rally will be the more esoteric parts of the CLO world, specifically CLO-squared bonds and middle-market CLOs.

CLOs

Spanish counterparties replaced

Counterparty exposures following the downgrade of Spanish banks have dominated rating actions in the SME sector over the past month, according to Fitch's latest SME CLO Compare publication. As a result of the bank downgrades, many Spanish SME transactions were left exposed to direct support counterparties that were ineligible to support ratings up to double-A minus, the highest rating achievable for Spanish structured finance transactions.

The 30-day period to implement remedial action to cure these ineligible counterparty exposures expired during July, resulting in 212 Spanish SF transactions being placed on rating watch negative (SCI 17 July). Additionally, the recent bank downgrades have reduced the number of Spanish banks that can support double-A minus as eligible counterparties in Fitch's view.

Gestoras have begun to replace Spanish banks that held direct support roles with non-Spanish financial institutions or their foreign affiliates. Barclays Bank and Santander UK in particular have been introduced as replacement account banks in a large number of transactions, Fitch notes. In the case of FTA Santander 1, 2, 3 and 4, the gestora has replaced Banco Santander with its UK affiliate Santander UK.

Separately, Fitch last month assigned triple-A ratings to Grecale, a €839.2m cashflow securitisation of loans to Italian SMEs originated by Unipol Banca. The transaction features several hedging mechanisms to manage interest rate mismatches between assets and liabilities, a dedicated liquidity reserve as a mitigant against payment interruption and amortisation of the most senior note through excess spread that is independent of portfolio default levels.

CMBS

CRE loan ratings sought

Fitch notes in its latest quarterly EMEA Structured Finance Snapshot publication that insurance companies and other institutional investors are considering mortgage lending opportunities in European commercial real estate, in a bid to fill part of the void left by bank deleveraging and the absence of a vibrant European CMBS market.

The agency says it has been approached by investors seeking ratings for good quality commercial mortgage loans. Insurance companies, in particular, are exploring the use of ratings in order to meet capital adequacy rules prescribed under forthcoming Solvency 2 regulations.

In response to these enquiries, Fitch is in the process of extending its CMBS rating methodology to address the particular attributes of single loans. One of the key differences is that loans do not have a tail period that allows for mortgage enforcement proceeds to be realised. Accordingly, credit analysis is constrained by the likelihood of repayment through refinancing or voluntary extension, which means ratings are capped at no higher than single-A.

The agency says that investment grade ratings may be assigned to high quality loans with low leverage, secured on 'defensive' collateral yielding stable cashflow - such as prime real estate or highly diversified portfolios - and made to bankruptcy-remote borrowers.

CMBS

CMBS auction volume drops

The volume of US CMBS earmarked for auction via note sales in August appears to have dropped compared with previous months. CMBS analysts at Barclays Capital estimate that about US$236m of CMBS conduit loans are out for bid this month, compared with US$815m in July.

The bulk of the supply is accounted for by two large loans: the US$80.5m Pier at Caesars, securitised in MSC 07-HQ13, and the US$76m Astor Crowne Plaza in GSMS 2005-GG4. The Pier at Caesars retail complex in Atlantic City has been in REO since October 2011 and the latest available appraisal pegged the value of the property at US$56.6m. Auction.com has set a starting bid of US$20mn on the asset.

The Astor Crowne Plaza in New Orleans first transferred to special servicing in May 2009. The minimum bid on this asset has been set at US$105m, indicating that the loan could pay off in full.

CMBS

Unusual IO resecuritisation marketing

Wells Fargo is in the market with WFRR 2012-IO, a US$336.25m resecuritisation of 104 CMBS interest-only securities. The collateral has a current aggregate notional balance of US$16.3bn and is sourced from 97 different fixed rate CMBS that were issued between 1997 and 2012.

Kroll Bond Rating Agency has assigned preliminary triple-A and triple-B ratings to the US$304.5m class A and US$31.75m class B notes respectively. The rating agency expects the collateral to generate a lifetime cashflow of US$375m, according to its baseline scenario. None of the collateral securities contribute more than 5.9% to KBRA's lifetime baseline cashflow and the ten largest contributors represent 42.6%.

The portfolio comprises a diverse mix of IO security types, including WAC, senior WAC, subordinate WAC, support, PAC and fixed interest strips. As payments on the WFRR 2012-IO securities are entirely dependent on the cashflow generated by the IO collateral securities, which have no principal balance, KBRA stressed the future payment stream of the collateral IOs under various scenarios.

The scenarios were designed to test the ability of the collateral securities to generate enough cashflow to pay the rated securities, assuming different levels of default and loss on the underlying mortgage loans. The tests also assumed different recovery periods for the defaulted loans.

CMBS

Insurer investment performance underlined

CRE Finance Council and Trepp have released the results of a recent survey of commercial mortgage investment performance within the insurance company sector. The survey was used to gather previously unavailable industry data for use in assessing investment performance during the downturn and for general benchmarking purposes.

Insurance companies representing nearly half of the industry's total mortgage exposure, with US$150bn in combined commercial mortgage assets, took part in the survey. Participating companies contributed data for 1 January - 31 December 2011, covering both their general account and any subsidiaries.

The results indicate the continuation of the superior investment performance achieved by US insurance companies through allocations to commercial mortgages. The average commercial mortgage holdings of companies participating in the survey was 11.37% of total invested assets, ranging from a high of 17.81% to a low of 4.0%.

Total realised losses from the commercial mortgage holdings of participating companies retreated to a level of only 6bp, according to the survey, with no companies reporting realised losses greater than 1%. This is a loss rate typically associated with very high-quality corporate bonds.

Realised losses were contained primarily in first mortgage investments at 83.24% of all company losses reported. Minor losses were reported from investment in higher yielding subordinated debt instruments (14.10% of all losses) and construction loans (2.66% of all losses), where much lower levels of exposure are held.

The office property type accounted for 31.61% of all realised losses from participating companies, followed by multi-family at 23.43%, retail at 11.04%, industrial at 21.93% and hotels at 2.34%. For the realised losses that were recorded, 17.16% were generated from distressed note sales, 15.61% from foreclosures, 21.18% from discounted payoffs and 31.74% from either write-downs or restructures.

Meanwhile, the severity of realised losses for insurance companies averaged only 9.19% of the par balance for first mortgage investments. Severities ranged from a high of 12.87% for multi-family to a low of 8.54% for office. Retail loss severities were recorded at 9.71% and industrial at 12.57%.

The average commercial mortgage LTV held within participating company portfolios was 60.6% at year-end. Only 2.3% of loan exposure for all companies was above a 100% loan-to-value.

The average debt service coverage ratio within portfolios was 1.8 times. Also, 93.6% of all exposure held was above a 1.0 times debt service coverage ratio. Total loan delinquencies (30 days or greater) recorded by participating companies within their general account holdings and subsidiary entities averaged 0.43%.

CMBS

CMBX.6 prepped

Markit is believed to be readying CMBX.6, which will reference post-crisis CMBS transactions. The new index is expected to launch by the beginning of 2013 and comprise of six sub-indices corresponding to the triple-A, AS, double-A, single-A and triple-B minus tranches of 20-25 CMBS 3.0 deals.

CMBS strategists at RBS suggest that CMBX.6 may serve as a more efficient hedging vehicle for CMBS 3.0 loans and allow market participants to express relative value views on CMBS 3.0 bonds across the capital structure. "CMBX.6 may mitigate some of the basis risk and produce higher correlations to CMBS 3.0 bonds. These benefits, coupled with the structure and mechanics of CMBX.6, potentially make the index a superior hedging instrument compared to the IG, HY, CMBX.NA.AAA and TRX.II indices," they explain.

They add: "While relative value trades are often put on in CMBX 1 to 5, they have been difficult to achieve in new issue CMBS 3.0 bonds aside from outright buying and/or selling cash bonds. This may change with the advent of CMBX.6, since it allows investors to synthetically buy and/or sell CMBS 3.0 tranches with an active two-way market."

The RBS strategists' primary recommendation is to consider having the index listed with a clearing house in order to mitigate the risk of settlement failures and to isolate the effects of a market participant failing.

CMBS

CMBS loan refinanceability analysed

Nearly 1,900 US fixed rate conduit CMBS loans totalling US$24bn in Fitch's rated universe are expected to mature within the next twelve months. The agency reports that 41% (59% by balance) of upcoming maturing loans would be unable to refinance under its defined stressed refinance parameters. However, it does not anticipate any immediate ratings impact, since potential maturity defaults are currently accounted for in surveillance reviews.

Under Fitch's fixed rate CMBS surveillance methodology, a loan with a debt service coverage ratio below 1.25x would be considered unable to refinance and would default at maturity. This DSCR calculation assumes a refinance interest rate of 8% and a 30-year amortisation schedule and is considered a 'stressed DSCR'.

The weighted average coupon for recent Fitch-rated CMBS conduit transactions has ranged between 5% and 6%. Assuming a current market refinance rate of 6% and a 30-year amortisation schedule, 26% (41% by balance) of these loans would be unable to refinance.

Based on Fitch's surveillance methodology, 80% (83% by balance) of all 2007 vintage loans that mature in the next 12 months would be unable to refinance. This compares to 27% (23% by balance) for the seasoned ten-year loans originated in 2002.

Though fewer in number, the loans that mature in the upcoming year from the 2005 and 2006 vintages are also likely to face difficulty. The agency finds that 57% (68% by balance) of loans originated in 2005 and 69% (81% by balance) of loans originated in 2006 would be unable to refinance under the stressed parameters.

The results are as anticipated by property type, with hotels having the highest potential defaults. The percent of upcoming maturing loans predicted to default at maturity, by number and by balance, are: 60% by number and 78% by balance for hotel; 50% and 64% for office; 49% and 73% for multifamily; 32% and 44% for retail.

Retail currently demonstrates better performance among the property types. But Fitch remains cautious of retail loan performance due to risks of tenant lease rollovers, recent store closures and big box tenant exposures, as well as the gap between current rents and those underwritten at the peak of the market.

Similar concerns apply to the office property type, according to the agency. Not surprisingly, the failure rate for its refinance test for office loans located in primary MSAs is significantly lower than that for loans located in secondary or tertiary markets, at 28% compared to 68%.

The majority of the multifamily potential maturity defaults are backed by properties located in troubled or overbuilt states, such as Texas, Florida, Ohio, Michigan and Nevada.

The largest loans that were unable to meet Fitch's refinance test are: the US$173m Galileo NXL Retail Portfolio 3, securitised in ML-CFC 2006-1 (retail); US$170m Miami Center, securitised in LBUBS 2007-C7 (office); US$340m Maryland Multifamily Portfolio, securitised in GCCFC 2005-GG5 and GSMS 2006-GG6 (multifamily); and the US$215m Hilton Washington DC, securitised in MSCI 2007-IQ15 (hotel).

CMBS

CMBS payoff rate drops

The percentage of US CMBS loans paying off on their balloon date hit a 12-month low last month, according to the Trepp July 2012 Payoff Report. Only 26.3% of loans reaching their balloon date paid off in July.

By comparison, in May the payoff rate registered a paltry 29.4% - the lowest reading since October 2010, when the payoff percentage was 22.3%. The July total of 26.3% was well under the 12-month average of 41.6%.

By loan count as opposed to balance, 53.3% of loans paid off. On the basis of loan count, the 12-month rolling average is now 52.2%. The disparity between the volume-based total and the count-based total indicates that it was mostly small balance loans that managed to payoff in June.

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

RMBS

Irish RMBS hit

Fitch has downgraded 10 tranches from six Irish RMBS transactions and affirmed a further 29 tranches from nine transactions. The downgrades affect Celtic 11, Emerald 4, Kildare, Pirus and Lansdowne 1 and 2, given that more recent deals benefit from higher levels of credit enhancement. The outlook on all tranches remains negative due to the ongoing uncertainty surrounding the Irish mortgage market.

Fitch notes that arrears are reaching double digits and impacting the entire Irish RMBS universe, albeit with differing levels of severity. Additionally, despite the fact that Dublin has demonstrated mild resistance to house price depreciation in recent months, Irish house prices are currently 50% lower than their peak.

Moreover, the vast majority of the collateral in the 15 affected Irish transactions are loans originated prior to 1 December 2009 that are affected by the 3Q11 Justice Dunne Start Mortgages judgement. The ruling contributes to increased assumptions for foreclosure costs and timing and adds a layer of complexity to the repossession process in Ireland, the agency says.

For transactions such as Kildare, Celtic 11 and Emerald 4 - which have very little or no exposure to residential investment property (RIP) loans - the rate of increase in delinquent borrowers has been slower at between 2%-5% over the past year. The current stock of those borrowers in 3m+ arrears is also lower, compared to other Fitch-rated Irish transactions, at 7%-10% of the outstanding collateral balance.

For transactions such as Phoenix 2- 4, Pirus and Fastnet 8 - which have material exposure to RIP loans - the rate of increase has been faster at between 7%-12% per annum and the current stock of those borrowers in 3m+ arrears is high at 15%-17% of the outstanding collateral balance. Finally, the two non-conforming transactions - Lansdowne 1 and 2 - have shown unprecedented arrears levels, which are currently greater than 65% of the outstanding collateral balance.

RMBS

REO-to-rent approaches evolving

In response to inquiries about REO-to-rental transactions, Fitch has offered insight as to how it would consider key risks associated with the securitisation of single-family rental properties (SFRs). A securitisation framework has yet to be developed for the asset class and the agency notes that its approach is still evolving.

With the private label RMBS market stalled and the number of foreclosed homes and distressed borrowers at or near record highs, institutional interest appears to be strong for converting single family REO inventory into rental properties and securitising the cashflow streams (SCI 25 July). "The SFR product may provide an alternative investment opportunity to non-agency buyers while offering families displaced by foreclosure a comparable alternative," comments Fitch senior director Suzanne Mistretta.

Noting the lack of performance data, the agency expects to place a strong emphasis on reliable data obtained from independent sources for determining rental prices, vacancy rates, supply and demand data and other pricing fundamentals. Even so, the lack of historical data and ambitious growth strategies by regional operators is expected to make high investment grade ratings on these transactions difficult to attain.

Fitch views the SFR product as a cross between commercial and residential properties. This is because the rental cashflows and the value of the underlying property may both be needed to support a transaction's debt service.

Its analysis of the cashflows will likely resemble that of multifamily properties in CMBS, while property values will be assessed using its RMBS sustainable home price (SHP) model. Prospects for actual securitisation could materialise by the end of this year or early 2013, the agency believes.

Fitch's analytical approach contemplates four key factors in the context of the operators' articulated strategies for operating the properties and servicing and repaying the securitisation debt. "Expertise and continuity of the manager, durability of cashflow, stability of value and the transaction's liquidity and structure will go a long way toward shaping our opinion," explains Fitch md Dan Chambers.

RMBS

German resi criteria tweaked

Fitch has updated its criteria assumptions for German residential mortgage loan pools. The updated assumptions are not expected to result in rating actions on existing RMBS or covered bond transactions.

Given that there has been no major deterioration on important economic indicators and unemployment is expected to remain at historical low levels, no changes have been made on the foreclosure frequency side. Consequently, neither Fitch's base-case foreclosure frequency assumption nor the respective rating multipliers have changed.

However, German property prices have increased in the past two years following a long period of stagnating house prices. Metropolitan areas in particular have benefited from this positive development.

Since the agency expects prices for German properties to continue to rise, it has maintained the single-B house-price-decline assumption at 0% - thus no changes have been made to the market value decline (MVD) assumption. For rating scenarios above single-B, the agency has slightly increased its MVD assumptions to reflect recent price increases. The impact on the respective rating scenarios is marginal.

RMBS

Secondary RMBS levels up

US non-agency RMBS bid-list activity was yesterday slightly down on the prior session, but still remained active. SCI's PriceABS BWIC data shows that spread levels held firm, however, with certain names being talked up.

A couple of line items particularly catch the eye. The AMSI 2003-13 M1 tranche had been talked at low/mid-70s on Wednesday before being talked higher in the mid/high-70s and covered in the mid-70s yesterday. The CWL 2004-12 MV3 tranche also stands out, having been talked at mid/high-70s for Wednesday's session and then talked up at low/mid-80s yesterday.

RMBS

Irish RMBS assumptions updated

Fitch has updated its criteria assumptions for assessing credit risk for Irish residential mortgage loan pools. The updated criteria assumptions are expected to result in negative rating actions on a number of RMBS transactions, especially those that were rated prior to the onset of the credit crisis and have a relatively low level of credit protection.

The main changes to the criteria include increased foreclosure frequency assumptions to reflect the deterioration of the Irish economy and its impact on mortgage performance. In addition, the agency has increased its market value decline (MVD) assumptions to reflect its more conservative house price expectation.

Fitch now expects 20% (previously 15%) of the mortgages in a typical portfolio to default and house prices to fall by 60% (previously 50%) compared to their peak in 2007. Currently, prices on average are around 49% below the peak level. In a stressed scenario, equivalent to a double-A rating level, foreclosures are expected to reach 40% and house prices fall by 72% from peak levels.

There has been a sharp increase in mortgage arrears since the last criteria review. More importantly, the delay in economic recovery, the austere fiscal consolidation and falling house prices mean the speed at which arrears are increasing is unlikely to slow in the near future, Fitch says.

The agency expects house prices to reach their low point at the end of 2013, although it will take many years for demand to meet the supply created during the housing bubble, especially in rural areas.