Contents

RMBS

Lessons learned?

Higher standards seen in new resi loan originations

The forthcoming expiry of the six-year statute of limitation for 2007-vintage US RMBS has sparked a sense of urgency among investors seeking to file representation and warranty suits. At the same time, demand for forensic reviews of newly originated loans is increasing as the housing market improves.

Richard Barrent, president and coo of the Barrent Group, confirms that his firm has seen an up-tick in fact finding mandates as investors prepare potential complaints. "Many recognise they need to raise their concerns before the statute of limitation expires. Similar issues are still being identified, with the focus being on underwriting defects and misrepresentations, as well as fraud."

GSE and private-label securities R&W claims at Bank of America, JP Morgan, Citi and Ally Financial totalled US$29.4bn at 30 June, up by almost 49% since 2Q11, according to Fitch. Reserves-to-outstanding claims coverage has in turn jumped to 75%, from 61% one year earlier. BofA continues to report the highest amount of claim activity, primarily reflecting its repurchase dispute with Fannie Mae.

Claims activity has also risen recently at the large and mid-tier regional banks and mortgage originators, such as PNC Financial Services Group, US Bancorp, SunTrust Banks and PHH Mortgage. Total outstanding claims for these institutions were US$2bn at 30 June, compared to US$1bn one year earlier. Fitch believes the GSEs, in particular, will increasingly focus on smaller originators.

Claims overwhelmingly represent loans originated in 2006 and 2007. Given the significant GSE resources dedicated to repurchase activity, the agency expects the scope of loans in review for these vintage years to expand, placing the burden of proof on mortgage originators. It believes the GSEs' review of potential repurchase candidates will not be limited to non-performing loans for these vintage years.

Further, courts have recently ruled that merely the existence of an R&W violation could initiate a repurchase. Fitch consequently believes that if such causation does not have to be proven, the level of claim activity could increase significantly in the medium term.

Away from buy-backs, Barrent says that many of the representation and warranty lessons learned from legacy loans are also now being applied to new originations. He adds that these loans are generally higher quality full-documentation loans, but originators are still potentially liable for bad underwriting, misrepresentations and fraud. Consequently, buyers of loans must continue to scrutinise what they are purchasing.

"The standards for newly originated loans have certainly been raised: they typically have greater controls in place and represent a shift back to the basics of lending," Barrent explains. "However, certain issues still need to be covered, both for whole loan pools and RMBS loans. Clients are either buying and selling whole loans or pooling them for securitisations."

Among the key requirements for originators of new residential loans is to scrutinise the Internal Revenue Service Form 4506T. "There is a big focus on a borrower's ability to repay, so verifying income and employment is important. The value of a property is another key issue: given the significant decline in home prices, the appraisal must be undertaken by a fully licensed appraiser and the result must obviously support the valuation. As well as high down payments, it helps if a borrower has assets in reserve, so lenders analyse savings patterns and credit scores too," Barrent observes.

Although the GSEs still account for the majority of residential mortgage origination in the US, Barrent notes that activity among buyers and sellers of non-agency loans is picking up, especially in prime jumbo paper. "The market appears to be gearing up as the housing situation improves and a greater need for loan origination is anticipated," he concludes.

CS

CLOs

CLO progress

CLO 2.0 market booming as documentation evolves

US CLO issuance this year is on course to reach double 2011's volume, having already matched it by the end of June. With the advent of 'CLO 2.0', evolution in CLO documentation is keeping pace.

Although there have been many changes made for the new breed of so-called CLO 2.0 deals, they generally fall into the category of adjustments rather than revolutionary developments, argues DLA Piper partner Richard Reilly. "I do not think CLO 2.0 and 1.0 are significantly different. A lot of the differences are driven by the fact that CLO 2.0 has a different and smaller investor base, particularly in the triple-A class and equity class."

The triple-A tranche in CLO 2.0 deals has typically accounted for the largest piece of the capital structure. While the investor base has become narrower, it has also become increasingly specialised, and deals are being more heavily geared towards the triple-A and equity tranches than their predecessors.

"We are seeing a lot of negotiation with the triple-As. They are becoming more sophisticated and demanding. At the same time, we are also seeing at the equity-end investors buying a controlling stake of the equity," confirms Reilly.

Several of the new features in CLO 2.0 deals have been driven by the change in the investor base. But there is also an element of clarifying aspects that did not work so well before.

"Having lived with CLO 1.0, little things come up. For example, there was a court decision in the US, which addressed the question as to whether an acquisition of loan assets could be agreed before the end of the reinvestment period but settled post-reinvestment period. The judge in that case rejected that proposition based on his strict interpretation of the relevant indenture provisions," Reilly explains.

He adds: "One of the new previsions in CLO 2.0 clarifies that, subject to certain conditions and limitations, CLOs can acquire an asset before the end of the reinvestment period and settle after the end of the reinvestment period."

Reinvestment periods have also become shorter. CLO 2.0 deals now allow investment periods of three to four years, as opposed to the five- to seven-year periods common among CLO 1.0 deals. There are more post-reinvestment period restrictions as well, albeit with variations from deal to deal.

Trading plans are another new feature which provide some extra flexibility, allowing a manager to engage in a package trade, aggregating trades together to get around the issue of separate trades violating various CLO tests. A trading plan typically allows up to 10 business days to complete a package trade.

"It is probably in response to the fact that these days assets are sold as part of a BWIC, so loans are not being sold one loan at a time. The new documentation gives some flexibility and allows for that to happen," Reilly notes.

There is also more flexibility being provided by the introduction of a re-pricing mechanism, which introduces the ability to re-price tranches to reduce spreads on liabilities without redeeming the entire CLO. It can be forced on investors unless they choose to opt out of the deal completely.

"The investors are given a pricing notice, which is typically triggered by a majority of the equity class or the collateral manager, and after a period of time the spread on the notes is reduced. If the investor does not want their interest rate reduced, then they are taken out at par," Reilly explains.

A host of other changes - such as more explicit guidelines for amend-and-extend, clarification around note cancellation and liquidation rights for triple-A noteholders in an event of default - have all also been added. In addition, the upcoming FATCA rules have influenced CLO documentation.

The fact that FATCA has not been finalised is a challenge, but it is one which documentation is dealing with. FATCA provisions are still evolving and generally a collateral manager has broad scope to amend documents to comply with FATCA.

"CLOs have been building in language that makes them more like non-CLO investment funds, which provide that if the fund manager needs to identify US investors and they refuse - causing the fund to be penalised - then the non-compliant investor will bear that penalty. What CLOs are now doing is anticipating some of the requirements that FATCA will impose," says Reilly.

Year-to-date CLO supply has been strong and a full-year target of US$30bn is still expected by JPMorgan analysts. While it is hard to quantify the effect of the shift from CLO 1.0 to 2.0 in boosting issuance, confidence seems to be a key factor.

"The triple-A and equity investors are critical to CLO volume. Those investors have got their requirements and to do a deal CLOs have to meet their demands and requirements," Reilly notes.

He continues: "The volume depends on a much smaller population of investors, who are repeat investors and know what they are doing. The only people who could do CLOs a year ago were the very biggest managers. Now we are starting to see smaller players. The market has opened up beyond the top ten."

Reilly believes that European interest is also growing. "In the early days of CLO 2.0, the European bid was not a very big part of the market. It is still the case that US deals are not always structured to satisfy 122a, but we are starting to see more US CLOs sold into Europe."

Martin Bartlam, partner at DLA Piper, confirms that Europe has been quiet so far, but believes a change in fortunes could come. "Changes in documentation are being driven by the US market because there is not a lot happening on the European side. Concerns as to the future for the eurozone and the increased regulatory costs of holding structured assets is resulting in a focus on managing portfolio holdings and achieving value in portfolio sales, rather than structuring the profile of the underlying assets," he says.

Bartlam continues: "What is clear, however, is that there will be a number of refinancings that need to be done when existing assets reach maturity - so there must be a refinancing solution in the next two or three years."

While high yield bonds have rallied this year, high yield bank lending is still depressed, adds Bartlam. This is because of both the high cost of bank funding and changes to the regulatory capital treatment of lower-rated assets. As the US market picks up, he remains hopeful that the increased interest will also carry over into Europe.

"This is an asset class that works. This has been the busiest August in a long time and, while the arbitrage in Europe is not there and rating agency criteria is such that it is hard to get the diversity of credit, that will all come around at some point," Reilly concludes.

JL

ABS

SLABS paper trades in secondary

Secondary market supply remained strongly elevated yesterday, with 480 line items represented in SCI's PriceABS BWIC data. Student loan ABS paper, in particular, was circulating and attracting interest at tight levels.

The SLMA 2011-A A2 tranche was covered in the N+150/160 range, coming tight from its talk earlier in the day of N+170/180. Fellow Sallie Mae private student loan tranches SLMA 2012-A A2 and SLMA 2011-B A2 were talked at N+170/185 and N+170/183 respectively.

In addition, a UK student loan bond - HNRS 2 A1 - made a rare appearance yesterday. The tranche was talked at 84 and covered marginally wider at 84.03.

Structured Finance

ABS bucks quiet secondary trend

After a run of elevated supply, secondary trading in the US tailed off at the end of last week and remained comparatively quiet on Monday. RMBS volumes, in particular, are muted as investors digest remittance reports. Activity in the ABS sector has ticked up, however.

SCI's PriceABS BWIC data shows fewer RMBS line items than usual for yesterday's session, albeit hybrid names were well represented. Countrywide paper continues to do the rounds, with a US$34.8m CWHL 2005-HY10 5A1 tranche talked in the high-70s, while other bonds - such as SARM 2004-16 5A1 - were talked at the mid/high-90s. WFMBS 2005-AR13 4A1, which was traded on 18 July and offered last week at 94, was yesterday talked at the mid-90s.

Meanwhile, auto ABS bonds had a good showing yesterday. ALLYA 2012-1 A4 and HART 2012-B A4, for example, were talked at +10 and +8 respectively.

CMBS

CMBS BWIC composition switch

The strong supply seen in the US CMBS secondary market last week appears to be continuing this week. However, bid-list composition has changed.

A recent Babson Capital client memo notes that while AM/AJ classes represented almost 60% of volume during the previous week, last week their share was down to 35%, with most of the lists comprising legacy super-seniors and shorter-duration CMBS 2.0/3.0 classes. But AJ tranches have again accounted for nearly half of the bonds out for bid so far this week.

A large number of both AJ and AM bonds are represented in SCI's PriceABS BWIC data for yesterday's session. For example, a US$10m AM tranche of BSCMS 2007-PW17 was talked at low-300s and covered at 340, while a US$10m AJ tranche of MLCFC 2007-7 was talked at high-30s and covered at 38.

One noteworthy name was also circulated yesterday - MSC 2012-STAR - which priced at the beginning of this month (see SCI's deal database). A US$1m slice of the A2 tranche was talked at +120a.

The Babson Capital memo suggests that end-investor purchases have not been able to keep up with supply, with TRACE data over the past two weeks indicating increased dealer inventories.

CS

CMBS

Secondary CMBS softens slightly

US CMBS spreads widened yesterday, with bid-list supply dropping to around half of Tuesday's total. SCI's PriceABS BWIC data still shows 74 CMBS line items for the session, with a mix of new and familiar names.

Interactive Data reports that Wednesday's total CMBS BWIC volume was US$235m, with GG10 dupers quoted around 210/205 over swaps, slightly wider than Tuesday's close at 207 over. Legacy fixed seniors and AMs, as well as re-REMIC seniors and juniors were 2bp-5bp wider.

Wednesday saw the B through E classes of the CGCMT 07-FL3A deal out for bid with mid-90s price talk. The B tranche was talked at 96, C at 94, D at 92 and E at 91. Each bond is a new entrant to the PriceABS archive, although the K tranche appeared when it was talked around the mid-60s two months ago.

Meanwhile, the US$11.553m MSC 2007-IQ16 AJ tranche traded at an 87 handle last week and was circulating again yesterday, talked in the mid/high-80s and at 88, but ultimately did not trade. A noteworthy name from the day was the US$22.373m GCCFC 2007-GG11 A4 tranche. It was talked at 185 and covered at 179, having been covered at 286 back on 4 June and at 270 on 24 May.

JL

RMBS

Dramatic tightening for European RMBS

European RMBS spreads have continued to grind tighter and will carry on doing so, according to one trader. Both new deals and the secondary market are reaching remarkable levels.

"Spreads have been moving for a few months now and they are still getting tighter. There are a lot of people in the market looking for the same type of bonds - typically short Dutch prime and UK prime - and that is driving the market," the trader reports.

He notes that one-year Dutch bonds are now as tight as 60bp, with three-year bonds also rallying to around 70bp-80bp. UK paper has also tightened, probably boosted by the government's funding for lending scheme.

"Those bonds are moving tighter and tighter, so we also see spill-over in other areas, such as non-conforming and peripherals. Most activity is still in the seniors and we are only seeing limited risk-taking in the mezz tranches," he adds.

What has particularly struck the trader recently is the pricing on the Co-operative Bank's non-conforming Leek transactions. "The bonds were issued around the height of the market in 2005 and 2006 and when their call date came up in 2011 the Co-op decided to restructure instead of calling [SCI 14 April 2011]," he says.

He continues: "The lender injected 50% gilts into the pool of assets and added a bit of a premium to the coupon, which created a bond with really low credit risk. That made a great deal for investors and when this restructuring was being finalised the bonds were priced at about 250DM or maybe even a touch wider."

While such a bond seemed "incredibly rich" at the time, over the past few weeks the DM has fallen from 210 to about 140 now. The trader notes that it is far from a limited example of the spread tightening that has been occurring more broadly.

New issuance has also been pricing at tight levels. The trader points to Santander's new Holmes Master Issuer series 2012-4, which achieved the tightest print since 2008.

"That three-year bond was placed entirely with a single investor at something like 75bp. That is the lowest we have gone in the post-Lehman market," he says.

Finally, the trader expects the tightening trend to continue. "This has been a busier summer than normal and there has been a fair amount of activity coming through the BWICs. There has been a lot of paper and spreads have been driven tighter and tighter."

He concludes: "There may not be a bottom for spreads and they can definitely go tighter, because there is hardly anything on offer. This is not a liquid market and spreads are getting bid down by a couple of basis points each day. I certainly cannot see it going wider because there are no alternatives."

JL

CMBS

CMBX rally overdone?

With CMBX total returns increasing by an average of 3.4% over the last three months, CMBS analysts at RBS question whether the market has rallied too far too fast. Many CMBX.AAA, AM and AJ prices are trading at or near their highest prices in nearly a year, after increasing an average of 2.4, 3.3 and 4.1points respectively during this period.

The RBS analysts suggest that the rally has been driven by a combination of: lack of bad news from Europe; hopes for further monetary stimulus; and impressive demand for longer duration fixed rate assets. "We believe the current price levels may reduce the likelihood of a further sustained rally through year-end, even if market conditions remain relatively stable. Supporting this is the heavy selling - particularly in higher beta AM and AJ tranches - observed last week, as some market participants sought to take profits."

The potential for a spike in volatility, driven by renewed global macro concerns, may also temper the recent rally. Volatility is currently hovering near its lowest levels since 2007, with the VIX touching 13.7 last week.

For these reasons, the analysts recommend that investors anticipate better entry points in the future. "We suggest unwinding long AM.2, as our linear regression analysis of historical CMBX prices suggests that AM.2 may be one of the richest CMBX tranches. Indeed, the tranche is trading at its highest level in over a year at 88.94, which is 3.7 points above its trailing 10-month average."

CS

CDS

Hungarian OTC partnership formed

Pricing Partners and Mockingbird Kft have formed a partnership to deliver Pricing Partners' Price-it solution in Hungary. Mockingbird is a consulting firm based in Hungary, while Pricing Partners offers solutions for OTC derivatives products valuation, pricing tools and risk analytics.

CDS

Credit vet recruited as PM

Michael Hünseler has joined Assenagon Group as md. He takes responsibility for setting up the new credit business area, including a focus on tapping innovative investment segments such as corporate lending.

Hünseler was previously head of corporate credit portfolio management at HypoVereinsbank and credit risk strategy for UniCredit. Before that he was responsible for the structured credit funds at Deka Investment.

CMBS

CCRE names new chairman

Steven Kantor has been appointed as chairman of Cantor Commercial Real Estate (CCRE). He was previously Cantor Fitzgerald's global head of investment banking and co-founded CCRE. Jeffrey Lumby and Charles Edelman replace him as co-heads of the investment banking business.

Before joining Cantor Fitzgerald three years ago, Kantor was md at Credit Suisse, where he was head of global securities. He was also co-head of Credit Suisse's illiquid alternatives business, head of credit products and head of CRE.

Risk Management

MountainView expands, forms alliance

MountainView Capital Holdings has acquired Clayton IPS, the independent pricing service of Clayton Holdings. It has also appointed Andrew Platt to its executive team as head of business development.

The newly-acquired IPS unit provides fixed income managers and investors with third-party pricing for securities such as ABS, RMBS and CMBS. The team also values residential whole loans, CDS, secured corporate debt and structured debt transactions.

The employees and proprietary tools of Clayton IPS are now part of MountainView's analytics division in Denver. The team operates under the name of MountainView IPS and will continue to be led by svp Scott Gibson.

MountainView and Clayton Holdings have also formed a strategic alliance whereby they can each offer their respective clients integrated access to the broad range of services provided by both firms.

Platt was previously md and head of specialty finance in the financial institutions group at Cantor Fitzgerald. He has also held senior structured finance and residential finance posts at UBS, Banc of America Securities and Lehman Brothers.

RMBS

Katten adds RMBS specialist

Stephen Esko has joined Katten Muchin Rosenman's structured finance and securitisation practice in New York. He becomes partner and will focus on RMBS.

Esko's experience includes issuer and underwriter representation in public and private securitisations, asset sales and financings, structured note issuances and credit derivatives work. He joins from Sidley Austin.

ABS

Tobacco review completed

Fitch has completed the review of its tobacco portfolio accounting for the amount of Master Settlement Agreement (MSA) payment received by each securitisation trust in 2012. For 2012, the aggregate MSA payment was 1.97% higher than the amount in 2011.

The agency last month published updated tobacco settlement ABS criteria (SCI 17 July), which included a change in the base-case assumption for the MSA payment from +1% to 0%. The rating scale was recalibrated to reflect this change and, as a result, there were several downgrades.

The downgrades were taken on turbo and capital appreciation bonds (CABs), which are typically subordinated and more leveraged. No serial bonds were downgraded.

Of the downgrades, 74 resulted solely from changes in the criteria. For these bonds, the breakeven output actually increased since last year. The other 10 downgrades resulted from continued performance deterioration.

Three tobacco transactions - Buckeye Tobacco Settlement Financing Authority 2007 (Ohio), Golden State Tobacco Securitization Corporation UNITED STATES Series 2007-1 and Niagara Tobacco Asset Securitization Corporation - are not being reviewed at this time. These transactions have drawn on their reserve accounts below the required minimum balance and require additional analysis.

ABS

Technical bump for charge-offs

US securitised credit card charge-offs increased to 4.56% in July from 4.27% in June, according to Moody's Credit Card Indices. One-time technical factors explain the rise, the agency says, and the charge-off rate index is expected to resume its downward trajectory next month.

The 29bp rise in the charge-off rate index was the result of increases Moody's had expected from the Chase and Citibank trusts, which collectively constitute approximately 45% of the overall index. For the Chase trust in particular, this month's 87bp increase was largely the result of a technical change to the trust sponsor's charge-off recognition policy. Each of the other four largest credit card ABS trusts posted monthly declines in their charge-off rates.

A clear indication that charge-offs will continue to decline is the further drop in the delinquency rate in July, which reached a new low of 2.36%, down from 2.4% the previous month. However, the early-stage component of delinquencies ticked higher in the month to 0.66% from 0.65%.

July typically marks the seasonal low for early-stage delinquencies, so an increase in early-stage delinquencies in the coming months would suggest a return to seasonal behaviour, Moody's suggests. It would also be a leading indicator that charge-off rates were approaching a floor.

Also in July the payment rate rose to 22.37% from 22.01%, returning to the record high it set two months ago. The high payment rate reflects the strong credit quality of the receivables compromising trusts today, the agency adds.

The yield index increased to 18.49% from 18.29% in June. Despite the increase, the yield index has remained 150bp-200bp below its year-ago level for the past three months. Expiration of most issuers' principal discounting initiatives has led to the lower yields, as they received an artificial boost.

Finally, excess spread decreased in July, to 11.12% from 11.25% in June. Even with this month's decline, which was a direct result of the higher charge- offs, the excess spread index remains near historically high levels. Because of the end of discounting, however, the excess spread index is slightly below the record-highs of last year.

ABS

Polish auto ABS marketing

A rare Polish auto loan ABS has hit the market. Dubbed GNB Auto Plan, the transaction is originated by Getin Noble Bank and securitises approximately 33,800 standardised loans, of which 52% is secured by new cars and the remainder by used cars up to five years old.

The loans were mainly originated via Getin Noble Bank's external car dealer network, with 49% being made to private individuals and the remainder to SMEs. The majority of vehicles are German, French, Japanese and Korean brands.

The transaction comprises a PLN557.99m floating-rate tranche provisionally rated Aa3 by Moody's. An unrated subordinated loan facility is also expected to be issued.

Moody's notes that the deal benefits from a highly granular portfolio with good geographic diversification, notification of assignment being provided to the borrowers within seven days of each transfer, a back-up up servicer (Idea Bank) appointed at closing of the transaction and a back-up servicer facilitator (Citi).

However, credit weaknesses include the legal uncertainty of technical insolvency risk of the issuer due to potentially ineffective non-petition and limited recourse language with respect to the rated notes. In addition, legal counsel has confirmed that certain loan agreements forming approximately 38% of the closing portfolio which were originated before 31 August 2011 may not fully comply with Polish consumer protection legislation. To mitigate the risk to the transaction, only the principal receivables relating to these loan agreements have been assigned by Getin Noble Bank to the issuer.

The transaction has an 18-month revolving period, unless terminated earlier due to the occurrence of an early amortisation event.

ABS

Prime auto ABS stress tested

The majority of outstanding triple-A rated US prime auto loan ABS notes are comfortably able to withstand a hypothetical recession and material declines in used vehicle recovery rates, according to recent stress tests conducted by Fitch.

Under the moderate scenario, the agency would expect all triple-A rated notes to remain rated investment grade. Nearly three-quarters of these ratings are expected to remain rated triple-A, while nearly 90% would stay in the top two rating categories.

Fitch believes the likelihood of the severe scenario (unemployment rising to 20% and recovery rates dropping to 25%) occurring is extremely remote. However, if this were to occur its analysis found that the scenario would likely cause 67% of outstanding triple-A rated notes to be downgraded to non-investment grade, while the remaining 33% would be expected to remain rated IG.

Fitch subjected its ratings on prime auto loan ABS to two stress scenarios - moderate and severe - by stressing the two factors that most directly affect asset performance: US unemployment, which drives loss frequency; and recovery rates on used vehicle values of defaulted and repossessed loans, which affects loss severity. The moderate scenario mimics conditions observed in the US during the recessionary 2008-2009 period. The severe stress scenario was calibrated to be substantially more stressful, as it assumes unemployment well above peak US levels and reduces wholesale vehicle values well below the historical lows recorded in 2008-2009.

To gauge the impact on outstanding triple-A ratings, Fitch stressed unemployment from a base level of 6% to 12% under the moderate scenario and 20% for the severe case. It reduced assumed wholesale vehicle values from an historical average of 50% down to 40% under the moderate case and 25% for the severe case.

Seasoned transactions (2006-2008 vintages) that are producing some of the highest loss rates to date can withstand even the severe stress, since they are largely paid off and have built significant enhancement. 2009-2012 transactions, which are producing some of the lowest loss rates to date, are more susceptible to downgrades under the severe scenario but mostly will be able to withstand even this stress.

The moderate scenario was designed to be consistent with that observed in 2008-2009. The severe scenario assumed a dramatic downturn in the US economy, with unemployment rising to 20% accompanied by an immediate decline in vehicle values to levels never seen before.

ABS

SLABS issuance defies market changes

US student loan ABS issuance has increased this year and ratings performance has remained stable, despite significant changes in the sector, according to S&P.

The changes have centred on shifts in how government-guaranteed student loans are funded, which has put a sizable dent in government-backed student loan ABS issuance. Despite this setback, Sallie Mae, a handful of municipal issuers and other issuers seeking to refinance previous debt have brought US$15.7bn in new FFELP-backed and private transactions to market this year - accounting for roughly 85% of the US$18bn in issuance for full-year 2011.

"Given the current pipeline and anticipated issuance volume, we expect student loan ABS volume to exceed US$20bn this year, topping 2011 issuance by approximately 11%," says S&P credit analyst John Anglim. "We expect the balance of this year's issuance to reflect a combination of refinancing activity and new originations."

The agency currently maintains ratings on nearly US$250bn of student loan ABS: approximately US$200bn was issued through the dismantled Federal Family Education Loan Program; US$39bn is private student loan ABS; and US$11bn contains a mix of FFELP and private collateral. "We expect the ratings on FFELP ABS to remain stable, assuming no further changes to the US sovereign rating," comments S&P credit analyst Frank Trick. "On the private student loan ABS front, we expect higher underlying collateral losses to continue, especially on pre-2009 issuances. However, we expect rating actions to be limited going forward because we recently completed a review of nearly all rated private student securitisations from ABS issuers."

In light of the elevated unemployment rate and uncertain global economy, S&P maintains a negative outlook on private student loan collateral within rated ABS trusts.

ABS

Indian CV ABS stress tested

Fitch says that Indian commercial vehicle (CV) loan ABS are resilient, even under a severe slowdown in the Indian economy. The agency has subjected its ratings on CV loan ABS to moderate and severe stress to assess their impact on asset performance.

The stress factors against which the ratings were analysed are a slow-down in industrial production, which leads to reduced freight demand and a contraction in the operating margin of CV operators arising from their inability to increase freight rates when faced with increased fuel rates. These are expected to lead to a surge in defaults and drop in recovery rates on vehicle values of defaulted and repossessed loans, increasing loss severity.

In the moderate stress scenario, Fitch has assumed that diesel prices will rise by 12%-15%, without a commensurate increase in freight rates and the Index of Industrial Production (IIP) will experience a 0% to negative 3% year-on-year change over the next 18 months due to a sluggish industrial activity. This is expected to lead to a two-fold increase in default rates from those observed currently and recovery rates dropping by 10% from the agency's current estimates. Under this scenario, 63.6% of the tranches rated triple-A would continue to maintain their ratings and none would migrate to ratings below single- A.

For severe stress, Fitch has assumed that IIP will experience a negative 10%-12% year-on-year change over the next 18 months and that diesel prices would surge by over 25%, without an equivalent hike in freight rates. However, the agency believes that such a scenario is highly unlikely and well beyond the realm of more plausible downside scenarios. The default rates are expected to increase to four to five times of the current peak defaults and recoveries to be 30% lower than those seen today.

Fitch expects that in the severe stress scenario, almost three-quarters of the tranches rated triple-A would be downgraded. Of this 75%, almost 40% are expected to remain above triple-B. More significantly, none of the tranches would fall below single-C or worse, implying that these highest rated tranches would still not face any loss.

In both scenarios, Fitch expects the ratings issued before 2011 to be less affected by the stresses, reflecting the higher level of credit enhancement build-up in these transactions compared with newer vintages of 2011-2012.

Structured Finance

Cheyne fraud claim to proceed

US District Judge Shira Scheindlin has denied motions for summary judgment that Moody's and S&P filed in a lawsuit related to the failed Cheyne SIV. The decision finds that the ratings constituted actionable misstatements under New York law, meaning that the plaintiffs' claim for common law fraud can proceed.

A recent Lowenstein Sandler client memo notes that in rejecting the agencies' arguments that ratings are merely opinions that should be afforded First Amendment protection, Judge Scheindlin concluded that ratings are best characterised as 'fact-based opinions'. Citing instant messages in which an S&P analyst stated "it could be structured by cows and we would rate it," Judge Scheindlin found that plaintiffs had offered sufficient evidence from which a jury could infer that the ratings were both misleading and disbelieved by the rating agencies when issued.

A group of 15 institutional investors in 2008 sued Morgan Stanley, Bank of New York Mellon (the SIV's administrator), Moody's and S&P. The plaintiffs alleged that Moody's and S&P knew that the ratings they gave Cheyne did not accurately reflect the vehicle's risks.

Judge Scheindlin dismissed plaintiffs' claims for negligence and breach of fiduciary duty in May, while denying the rating agencies' motions to dismiss the negligent misrepresentation claims, finding that the ratings qualified as actionable misstatements under New York law.

Structured Finance

Chrome portfolio sold

Berwin Leighton Paisner (BLP) has disclosed that it acted for a joint venture between Development Securities and The Pears Group on its acquisition of the £103m Chrome portfolio from NAMA. The transaction involved innovative structuring and will allow the JV to realise the repayment of the loans through the sales and repositioning of the assets in the market through change of use, refurbishment works and other asset management initiatives, the law firm says.

The portfolio comprises loans secured against a mix of 39 commercial and residential properties in the UK. It was previously owned by Irish developer Gerry Gannon.

The BLP team was led by real estate finance partner Andrew Flemming, corporate funds partners Antony Grossman and Kate Binedell and real estate partner Robert Bindless. They were assisted by Gordon McMillan, Liron Meister and Elasah Mastin.

Structured Finance

Bank resolution regime established

The Spanish government last week published the new Royal Decree-Law on bank resolution. The law establishes standards for restructuring viable banks and the resolution of non-viable ones.

For banks undergoing restructuring, the FROB will be able to provide them with funding guarantees and a capital injection. They will have to return this within five years, potentially extendable by another two.

The restructuring process may also include banks that are non-viable but could cause harm to the whole banking system if not supported. RBS credit analysts note that this is positive for Bankia, but a negative for the Spanish budget.

As expected, orderly resolution will include burden-sharing on equity and sub debt. In particular, the FROB will be able to initiate tender offers, exchanges into equity, reduction in principal or prepayment of hybrid and subordinated debt securities - although the last two measures will require bondholder approval. It will also be able to sell assets from banks in resolution, transfer them to a bridge bank or to an asset management company.

The RBS analysts note that a couple of grey areas still need to be clarified: whether the asset management company will be run independently; and how bad bank assets will be priced. "These are two crucial points: the more Spain will pay above market prices to buy bad bank assets and to inject capital, the more the recapitalisation plan will weigh on public finances."

Structured Finance

Euro rating transitions examined

By mid-2012, only 1.11% of European structured finance notes outstanding in mid-2007 had defaulted, according to S&P. Meanwhile, the 12-month rolling default rate edged only slightly higher to 0.5%.

Even amid the deteriorating European economy, worsening collateral performance and the application of some updates to S&P's ratings criteria, the rise in the 12-month rolling downgrade rate slowed to only 30.8%. Capital structure positioning and asset class remain key indicators of default and ratings transition trends, the agency observes.

Higher-rated notes have outperformed those ranked junior in the capital structure, with only 0.82% of ratings on triple-A issuance defaulting since mid-2007. Consumer-related securitisations have also outperformed those backed by corporate loans, with cumulative default rates since mid-2007 of 0.03% and 3.59% respectively.

Nonetheless, cumulative downgrade rates have risen primarily in ABS and RMBS. S&P lowered its ratings on 41 ABS notes, for example, following its downgrade of Spain. Subsequent rating actions on Spanish banks and the lack of remedial actions by affected transaction counterparties, combined with poor collateral performance, also triggered some downgrades.

In RMBS, most downgrades resulted from the application of the agency's 2011 UK RMBS criteria and, in some cases, deteriorating collateral performance.

By contrast, S&P estimates that more than 58% of notes outstanding in mid-2007 have fully redeemed. But Europe's economic woes could have a more pronounced effect on future ratings performance, as an increasingly likely double-dip recession could further weaken collateral and ultimately transaction performance, the agency warns.

Structured Finance

RFC issued on surveillance challenges

IOSCO has published a consultation report, entitled 'Technological Challenges to Effective Market Surveillance: Issues and Regulatory Tools', which seeks public comments on a series of proposed high-level recommendations aimed at helping market authorities improve market surveillance. The report is based upon the results of an IOSCO survey, as well as presentations made to the organisation by operators of trading venues, market authorities and industry representatives.

It sets forth a number of questions for consultation and outlines proposed recommendations to assist market authorities address the challenges posed by the latest technological developments to effective market surveillance. In particular, this is with respect to: improving surveillance capabilities on a cross-market and cross-asset basis; and making more useful to market authorities the data collected for surveillance purposes.

IOSCO notes that trading of securities has become more dispersed among exchanges and various other trading venues. Risks posed to markets by illegal or otherwise inappropriate conduct can be substantially increased by automation and the speed at which trading occurs impacts the ability to monitor effectively markets in the traditional sense.

Current surveillance techniques - including the collection, storage and accessibility of data - may be insufficient to capture in a timely manner all of the information necessary to efficiently monitor trading activity. The absence in many jurisdictions of certain market surveillance tools seems to be one of the more significant problems facing the markets in light of these technological developments, according to the organisation.

Comments on the consultation report are sought by 10 October.

CDO

Duke redemption delayed

The auction call redemption amount was not met in yesterday's Duke Funding High Grade I sale (SCI 7 August). Consequently, the transaction won't be redeemed - as expected - on the 6 September quarterly distribution date. The trustee will conduct an auction prior to each subsequent quarterly distribution date, unless the collateral manager states that a sale is unlikely to be successful due to market conditions.

CDO

ML3 wound down

The final Maiden Lane III auction was held yesterday, 23 August, comprising 21 mezzanine ABS CDO tranches. The New York Fed's management of the portfolio is expected to result in a net gain of approximately US$6.6bn, including US$737m in accrued interest on its loan to the vehicle.

Of the collateral sold in yesterday's auction, Bank of America Merrill Lynch was the successful bidder on the Gemstone CDO IV (US$229.98m in face value), Ischus CDO II (US$171.15m), Independence VI CDO (US$338.68m), Neptune CDO II (US$132.75m), Pine Mountain CDO (US$154.92m), Montauk Point CDO (US$222.63m) and Vertical ABS CDO 2005-1 (US$192.52m) assets. Credit Suisse won the Ayresome CDO I (US$48.17m), Bluegrass ABS CDO II (US$92.5m), Dunhill ABS CDO (US$91.38m), Gemstone CDO III (US$68.2m) and MKP CBO V (US$369.64m) tranches.

Morgan Stanley took down the River North CDO (US$82.09m), Sherwood Funding CDO (US$204.5m), Sherwood Funding CDO II (US$275.61m), Straits Global ABS CDO I (US$30.37m) and TABS 2005-4 (US$200.7m) collateral. RBS won the Lexington Capital Funding (US$122.45m), MKP CBO IV (US$78.92m) and Neptune CDO 2004-1 (US$154.18m) assets, while Citi successfully bid on the Diogenes CDO I (US$168.39m) tranche.

Barclays Capital and Guggenheim Securities were also invited to bid for the assets.

Net proceeds from past sales conducted by BlackRock Solutions (SCI passim) - as well as cashflow the securities generated while held by ML 3 - enabled the full repayment of the New York Fed's loan, plus interest, on 14 June and AIG's equity contribution to the vehicle, plus interest, on 16 July.

Maiden Lane II was wound down in February, which resulted in a net gain of approximately US$2.8bn for the taxpayer. This followed the January 2011 termination of the New York Fed's extension of credit to AIG, which produced approximately US$8.2bn in interest and fees. When added together, the total net profit to taxpayers from the New York Fed's assistance to AIG and AIG-related facilities was US$17.7bn.

CDO

PREPS 05-1 junior notes cut off

The €4m profit participation agreement with Portfolio Company No. 1, securitised in the PREPS 2005-1 SME CDO, has been sold for a net purchase price of €2.48m. As a result, no future payments will be made to the junior noteholders.

The maximum realisable return for the junior notes for the entire term of the transaction will remain -39.5%. However, the class B notes will be fully repaid by the outstanding amount of 4.1% of the nominal value, plus interest due, on the 4 February 2013 IPD. The class A notes have now been fully paid.

CMBS

CMBS loss severity spikes

While CMBS conduit loan liquidations ticked up by a modest 4% this month, loss severity jumped from 37.96% to 53.29%, according to Trepp. That reading represents an increase of 1,533bp from July and nearly 10 percentage points above the 12-month moving average of 43.3%.

Servicers picked up the pace somewhat in August as liquidations hit US$1.44bn, relative to the 12-month moving average of US$1.34bn. The 141 loan liquidations during the month resulted in US$767m in losses.

Since January 2010, servicers have been liquidating at an average rate of US$1.13bn per month. The 12-month average pace of loan liquidations, meanwhile, is 143.

While the resolved loan count fell from July's 163, the average size of liquidated loans in August spiked to US$10.21m from US$8.48m month-over-month. The 12-month average for liquidated loan size sits at US$9.35m.

CMBS

DRA/Colonial JV falls through

The US$741.9m DRA/Colonial Office Portfolio loan has been transferred to the special servicer - C-III Asset Management - because the borrower indicated it would no longer be able to make debt service payments. One of the loan's sponsors, Colonial Properties Trust, is understood to have withdrawn from its joint-venture agreement with the other sponsor - DRA G&I Fund VI Real Estate investment Trust.

DRA is consequently looking for another equity partner to assist in funding tenant improvements and leasing commissions needed to bring the portfolio back to full occupancy. The borrower projects that re-leasing and capital expenditure costs will total approximately US$30.7m for 2012 and US$25.7m for 2013.

Three CMBS have exposure to the loan, at US$247.3m each: MLMT 2007-C1; BSCMS 2007-PWR17; and BSCMS 2007-PWR18. The loan is secured by a fee interest in 17 office properties consisting of 4.86m square-feet in Alabama, Florida, Georgia, North Caroline and Texas; one 125,742 square-foot shopping centre in Alabama; and one 237,191 squar-foot office/retail mixed-use property in Florida.

The loan has a debt service coverage of 1.21x based on a net operating income basis, as of 31 March. However, when tenant improvements, leasing commissions, capital expenditures and declining occupancy are factored in, the DSC is expected to decline to 0.62x by year-end 2012.

Overall occupancy for the portfolio had declined to 80.6% as of 31 March, from 85% a year earlier. In addition, 26% of the leases in the portfolio's rent roll expire within the next three years. But re-leasing efforts are anticipated to boost occupancy to 90% by year-end 2013.

According to the respective July remittance reports for the three transactions, the loan is current. The loan matures on 1 July 2014.

S&P notes that the transfer of the DRA/Colonial Office Portfolio loan to special servicing does not affect its outstanding ratings on the three affected US CMBS at this time. However, the agency believes it is possible that this transfer could trigger potential interest shortfalls to the respective trusts related to special servicing fees and expenses.

NPLs

NPL portfolio acquired

Sabal Financial Group has acquired a non-performing CMBS loan portfolio from CWCapital. The underlying real estate assets are located across the US.

Sabal will provide loan servicing and asset management for the portfolio. The firm says it is rapidly expanding its operating platform in response to the growing market of performing and non-performing loan portfolios for sale and an increase in asset valuation assignments. It has nearly doubled its loans under management and its employee base over the last year.

In June 2012 Sabal entered residential builder lending, in part to fill a void that was once filled by regional and community banks. The firm now offers non-recourse acquisition, development and construction loans for homebuilders in California, Washington and Portland.

Risk Management

Pricing service enhanced

SIX Financial Information has released a new Evaluated Pricing Service (EPS) after a year of infrastructure development, review and testing. The comprehensive, transparent and independently-validated EPS arms portfolio managers with consistent pricing information to fulfil regulatory and accounting obligations, the firm says.

The launch features significant improvements and enhancements to EPS to increase the defensibility, consistency and coverage of illiquid and hard-to-price instruments. Among the highlights of the release are: the addition of new currencies, including many of the emerging markets; and the integration of broader asset classes, including hybrid securities and essential OTC derivatives.

The firm has also established an evaluations team based in Frankfurt, Germany to value European financial instruments and support European clients.

RMBS

Resi loss severities diverging

Despite recent positive home price and residential mortgage default trends, prices for foreclosed and distressed real estate continue to impede an overall US housing market recovery, according to S&P.

Distressed and foreclosed properties are typically sold at pronounced discounts relative to current market prices, which ultimately translate into notable mortgage losses. The severity of the losses, however, varies by state and hinges on whether states can pursue foreclosure action without involving the courts.

"Overall, we found that loss severities have been higher in judicial states because of distressed sale discounts and foreclosure costs," says S&P analyst Jacques Alcabes. "As prices for distressed properties drop, subsequent recoveries begin to fall, which drives up mortgage losses."

The difference in loss severity between judicial and non-judicial states hovered at about 5% during the start of the mortgage market crisis in 2008, but the trend has diverged since 2009. While loss severities in non-judicial states appear to have stabilised and are currently at mid-2009 levels, they have been steadily increasing in judicial states.

Loss severity tends to increase as foreclosure timelines grow. However, the rate of increase in loss severity has been very different between the judicial and non-judicial states, S&P notes. As of 2Q12, the loss severity rate in judicial states had reached a record high of 78%, well above the rate of 61% in non-judicial states.

RMBS

REO-to-rent risks outlined

Moody's has commented on the main types of risks that REO-to-rent securitisations would present, including the performance of an operator/manager of the properties and the variability of cashflows from the rental and ultimate sale of the properties. The lack of historical data on the single-family rental market is another concern, it says.

Market interest in REO-to-rent securitisations has increased over the past several months, driven in part by the sizable inventory of REO properties held by GSEs, RMBS trusts and various financial institutions (SCI 25 July). "Numerous real estate market participants have asked how we would analyse the credit quality of these securitisations," says Kruti Muni, a Moody's vp. "No-one has yet presented a specific transaction or deal structure to us; therefore, we have not yet completed development of a formal methodology."

But the agency says the transactions would likely incorporate two key structural elements: an operator or manager that will be in charge of renting, maintaining and ultimately selling the underlying properties in the transaction; and having the rental and then the sale of the properties as sources of cashflow. The presence of a manager that actively handles all aspects of the properties would be similar to cell tower or container lease ABS. The transaction would also likely benefit if the operator is the sponsor and its economic interests are aligned with those of investors.

The potential cashflow risks include rental rates declining in weak markets, meaning that rental income is insufficient to cover expenditures and meet ongoing liabilities. Another concern is the possibility that proceeds from the sale of properties will be insufficient to repay the noteholders' principal.

As with any new type of securitisation, the lack of historical data is a concern for Moody's. "Despite the wide availability of information on property prices for single-family residences, including sales in distressed markets, there is little historical data on the single-family rental market," says Muni.

Additional considerations for the agency in evaluating such deals, if they are proposed, are: the substantial ongoing expenses the property owner would face regardless of the amount of their rental income, which would demand provisions for maintaining liquidity; and which legal entity actually owns the properties - the borrower or the transaction itself.