Contents

CDO

Euro CDOs circulate

On thin volumes due to Labor Day in the US, over half of the BWIC line items captured by SCI's PriceABS service yesterday were European CDO tranches. A couple of them have appeared in the archives before.

A €4m slice of the WODST III-X D tranche was talked at low-50s during yesterday's session and a €3.5m slice of the bond was covered at 50.4 on 2 August, according to SCI's PriceABS data. Additionally, a €2.5m DALRA 2-X D tranche was talked at mid-50s yesterday, whereas it was covered at 43.5 on 31 May.

Other noteworthy names circulating during the session include PULS 2006-1 A2B and BACCH 2006-1 A1. A €12m piece of the former was talked in the 20 area, while at the other end of the scale a €4.92m slice of the latter was talked in the mid-90s.

A number of other bonds were talked at mid-60s, including JUBIL VI-X C, QNST 2006-1X C1, AVOCA VII-X C1 and RMFE V-X III A2.

RMBS

RMBS secondary activity restarts

The US non-agency RMBS market picked up yesterday as traders returned to their desks, although SCI's PriceABS BWIC data shows that activity was light by recent standards. PriceABS shows 71 RMBS line items for Tuesday's session, with offering levels generally only moving very slightly.

The 2005-2 M1 tranche of Popular ABS moved the most: it was talked yesterday at mid-60s, distinctly lower than the low-70s it was talked at on 16 August. By contrast, WAMU 2007-HY7 4A2 is fractionally higher than it was about a month ago. The bond was talked yesterday at mid-80s, compared to the low/mid-80s on 31 July.

Other names are largely unchanged from last month, with CMLTI 2006-AR 6 1A1 talked between mid-80s and 90 area back on 9 August and talked at mid/high-80s yesterday. OPMAC 2006-1 2APT was talked on Tuesday at low/mid-90s, which is the same as it traded for on 23 August.

The fixed-rate prime FHASI 2005-8 1A8 (talked around 100) and option ARM AHMA 2006-2 1A1 (talked at low/mid-50s) tranches also circulated. Both are new names for PriceABS. A subprime tranche (OOMLT 2005-4 M1), which traded in the mid-70s in late July, is also understood to have traded pre-list yesterday.

JL

RMBS

Liquidation boosts RMBS supply

US non-agency RMBS bid-list activity ticked higher yesterday, driven by a large subprime CDO liquidation of 2005-2006 vintage mezzanine bonds. Levels remain firm ahead of the end of the month.

BWIC volume stood at US$696m for the session, up from US$387m on Tuesday, according to Interactive Data figures. CITM 2007-1 was one of the subprime RMBS circulating yesterday: SCI's PriceABS data shows that a US$1m slice of the 2A2 tranche was covered at 94 handle. The same bond was talked in the mid-80s on 1 August.

Strong trade execution was also noted in fixed-rate RMBS, with the majority of lists comprising seasoned higher coupon paper. Among these items was a US$9.9m piece of the Alt-A BSABS 2005-AC9 M1 tranche, which was talked at low double-digits.

Meanwhile, hybrid RMBS supply declined to less than half of Tuesday's total. Most of the activity was concentrated in an all-or-none mezzanine payment option ARM list.

Structured Finance

SCI Start the Week - 3 September

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

Pipeline
The pipeline saw limited activity last week, with three new deals announced. These deals were a A$750m Australian RMBS (Apollo Series 2012-1 Trust), a French consumer loan ABS (FCT COPERNIC Compartment COPERNIC 2012-1) and a UK auto loan deal (Motor 2012).

Pricings
A fair mix of new issuances priced during the week, comprising two ABS, one RMBS, two CMBS and three CLOs. The ABS were US$1.03bn John Deere Owner Trust 2012-B and US$111m Rhode Island Student Loan Authority Series 2012-1, while the RMBS was A$800m Progress 2012-2 Trust.

The CMBS prints consisted of US$466.25m JPMCC Trust 2012-FL2 and US$336.25m Wells Fargo Resecuritization Trust 2012-IO, while the CLOs were US$719m Ares XXIV CLO, US$413m CENT CLO 16 and US$404m Shackleton I CLO.

Markets
It was a week of further spread widening for US CMBS, with trading volumes dipping in advance of Labor Day. Barclays Capital CMBS analysts note that generic 2007 LCFs are now 10bp wider over the month, with AJs having dropped three or four points in the same period.

They say: "The steady flow of supply during the past few weeks, along with some emerging signs of deterioration in credit, has put pressure on spreads. Generic LCFs continued to leak wider; we are now 10p off recent tights in the 2007 vintage, while AMs are about 20bp wider."

US RMBS benefited from a CDO liquidation of 2005-2006 vintage mezzanine bonds, with non-agency BWIC volume up from US$387m on Tuesday to US$696m on Wednesday, as SCI reported last week (SCI 30 August). SCI's PriceABS BWIC data shows strong market appetite for subprime paper, with CITM 2007-1's 2A2 tranche covered at 94 handle, up from mid-80s talk at the start of the month.

Spreads continued to tighten in European RMBS. Securitisation analysts at JPMorgan report that UK prime triple-A reached 85bp last week, with Dutch triple-As at 105bp. It is not just core jurisdictions that are tightening, with peripheral spreads such as Italian and Spanish RMBS also tightening on the back of improved sentiment with regards to the sovereign crisis.

Auto paper really caught the European ABS market's attention last week. A flurry of secondary paper was put out for bid on Thursday and attracted strong covers, as SCI reported last week (SCI 31 August). The demand generated by the activity even appeared to spark a similar situation in the US, as traders looked to capitalise on the situation.

Deal news
• A bankruptcy auction of the remaining MSR Resorts properties, currently scheduled for 25 October, is expected to pay off the entire outstanding CMBS debt. Four of the properties back a US$857.6m loan securitised in COMM 2006-CNL2.
• Two European CLOs - Axius European CLO and Neptuno CLO III - have had changes made to their collateral management agreements. 3i Debt Management Investments has replaced Invesco Senior Secured Management as manager on the former deal, while Bankia has resigned as lead investment manager on the latter.
• In a move that has been described as nonsense given the deal's low LTV and material outperformance, Fitch has placed the triple-A ratings of the Annington Finance No. 4 class A notes on rating watch negative.
• Blackrock has been removed as collateral manager of Toro ABS CDO II. Under the transaction's collateral management agreement, the manager may be removed without cause upon 90 days' prior written notice at the direction of holders of a majority-in-interest of preference shareholders.
• Morningstar has added the US$52.8m Sprint Data Center loan, securitised in the MLCFC 2006-1 CMBS, to its watchlist ahead of the 1 October anticipated repayment date (ARD). The loan is collateralised by a 160,000 square-foot class A data centre built in 2001 in Silicon Valley.
• Fitch says that the proposed amendments to the GRAND CMBS (SCI 10 July) are likely to have a neutral to positive impact on the ratings. Following preliminary analysis of the publicly available information, the agency has confirmed that it doesn't view the proposed amendments as constituting a distressed debt exchange.
• Sabal Financial Group has acquired a non-performing CMBS loan portfolio from CWCapital. The underlying real estate assets are located across the US.

Regulatory update
• 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.
• ISDA and the Futures Industry Association have published the FIA-ISDA Cleared Derivatives Addendum, a template that can be used by US futures commission merchants (FCMs) and their customers to document their relationship with respect to cleared OTC swaps.
• 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.
• The forthcoming US Foreign Account Tax Compliance Act (FATCA) could have wide-ranging implications for global structured finance transactions, Fitch says. In particular, the FATCA status of SPVs and counterparties handling payments will be a key issue.

Deals added to the SCI database last week:
American Express Credit Account Master Trust Series 2012-2 ; American Express Credit Account Master Trust Series 2012-3 ; BCC SME Finance 1; Belgian Lion SME II; Claris SME 2012-1; CoCo Finance II-1; E-Carat Compartment No. 4; FCT GIAC Obligations Long Terme; FirstMac Mortgage Funding Trust series 1-2012; GE Capital Credit Card Master Note Trust series 2012-6; Highbridge Loan Management 2012-1; Holmes Master Issuer series 2012-4; Lafayette CLO 1; Padovana RMBS; Quadrivio SME 2012; Salina Leasing; TICC CLO 2012-1; and Voba N.4.

Deals added to the SCI CMBS Loan Events database last week:
BACM 07-1 & 07-2; BSCMS 07-PWR17 & PWR18 & MLMT 07-C1; BSCMS 2007-PWR18; COMM 2006-CNL2; CSMC 07-C5 & 08-C1; CSMC 2006-C3; CSMC 2007-C5; CSMC 2007-TFLA; CSMC 2008-C1; DECO 2007-C4; ECLIP 2005-1; ECLIP 2006-2; ECLIP 2006-3; ECLIP 2007-1; ECLIP 2007-2; EMC 6; EPC 3; EURO 19; EURO 21; EURO 22; GRF 2006-1; GSMS 07-GG10 & JPMCC 07-LD11; GSMS 2006-GG6; JPMCC 2006-LDP9; MLCFC 2007-5; MLMT 2007-C1; MSC 2006-IQ12; MSC 2007-HQ13; PROMI 2; TITN 2006-CT1; TMAN 3, 5, 6 & 7; TMAN 6; UBSCM 2007-FL1; Various (September auctions); WBCMT 2005-C21; WINDM IX & DECO 2007-E5; and WINDM XI.

Top stories to come in SCI:
Focus on Irish distressed debt
US housing market outlook
Recent iTraxx index trends
GN/FN swaps valuations
Narrow Road Capital profile

CMBS

'Foreclose and file' tactics exposed

A bankruptcy auction of the remaining MSR Resorts properties, currently scheduled for 25 October, is expected to pay off the entire outstanding CMBS debt. The case highlights what happens when a mezzanine lender succeeds to foreclose and file, and is provided with an extensive exclusivity period.

The proposed auction includes a stalking horse bid from Government of Singapore Investment Corp (GIC RE), which is committed to offer up to US$1.5bn in cash and credit. The bid deadline - which follows a 10 September court hearing - is set for 23 October.

Four of the properties back a US$857.6m loan securitised in COMM 2006-CNL2. The performance of the properties has improved over the past couple of years, with NOI increasing to about US$69m at year-end 2011 from US$65.8m a year earlier.

If the auction results in a full payoff in the near term, Citi CMBS strategists suggest that the Chapter 11 process significantly delayed that payoff for bondholders. The bondholders are also unlikely to receive their full default interest, unless there is cash overbid.

The property owners - a Paulson & Co and Winthrop Realty Trust joint venture - held a junior mezzanine position and filed for bankruptcy protection in February 2011 on the eve of the mortgage maturity. Court documents mention that the debtors resisted earlier pressures from creditors to put the assets up for sale.

Indeed, throughout the process, Midland - the special servicer on the COMM deal - objected to the extension of the debtor's exclusivity period and to agreements the debtors reached with other senior mezz lenders. Additionally, GIC RE late last year had already proposed to purchase the assets and pay in full all creditors, except some junior mezz lenders. As such, bondholders will likely be frustrated that they had to wait almost two years for a payoff that could have been received much earlier, the Citi strategists explain.

"It is hard to assess if CMBS trusts will be able to use in courts the CNL case to bolster their objections to mezz lenders' 'foreclosure and file' tactics," they conclude. "But the various obstacles the debtors encountered throughout the MSR case, along with the general dissatisfaction courts have recently expressed with mezz lenders apparently trying to take advantage of Chapter 11 suggest the market may see fewer cases of foreclose and file."

CS

CMBS

Technical rating action panned

In a move that has been described as nonsense given the deal's low LTV and material outperformance, Fitch has placed the triple-A ratings of the Annington Finance No. 4 class A notes on rating watch negative. The agency says it is concerned about the transaction's structure, in particular the timing of bond maturities in relation to the loan due date.

A loan maturity EOD for Annington would occur 12 months before the bond's legal final maturity date. Fitch views this as too short a time period for the administrative receiver to realise sufficient enforcement proceeds. Under its CMBS criteria, the agency identifies an insufficient tail period as one of several possible constraints on ratings.

Without a restructuring of the loan, Fitch is likely to downgrade the bonds within three months. European securitisation analysts at Barclays Capital believe that this is a "harsh interpretation", noting that the Annington offering circular obliges the borrower to seek to refinance in the two-year period prior to the maturity date of the class A notes. Given the limited cost to the sponsor of changing the underlying loan maturity date, they expect the ratings to be maintained at triple-A.

"Spreads on the ANNFIN 0 22 bonds at gilts plus 190bp already price significantly wider than other government-linked CMBS, such as SCEPFU 5.253 27 at gilts plus 105, and any further weakening from here in ANNFIN would represent a buying opportunity," the Barcap analysts observe.

Since the transaction was last tapped in 2004, gross rental income has increased by 20.4% and gross debt has decreased by 14%. The number of properties that the MOD rents from Annington isn't expected to drop below 30,000 units after the defence review, which sets a floor on rent of circa £120m per annum paid by the government, after including the current 58% discount to market rents.

"With government-backed rent of £120m per annum, this gives an exit debt yield of 8% on £1.5bn of class A bonds, which should be easily refinanceable for government-backed risk. Further, from 2021 the 58% discount to market rent will be unwound over a period of five years, which would give an exit debt yield on the class As of 19%," the analysts conclude.

CS

Structured Finance

Bridging the debt gap

Jonathan Rochford, portfolio manager at Narrow Road Capital, answers SCI's questions

Q: How is Narrow Road Capital involved in structured credit in Australia?
A: Narrow Road Capital is an Australian high yield and distressed debt asset management business, targeting investments primarily in loans, bonds, structured credit and listed notes. Structured credit is a key part of what we invest in, with the deal flow more regular and often having better risk/return characteristics than the deal flow from the bond, loan and listed note markets.

Narrow Road invests in both primary and secondary transactions in the Australian structured credit space, with particular interest in RMBS and CDOs. The Australian RMBS market has been gradually improving over the last few years, with larger deals and lower pricing, and is regularly finding a solid buyer base at triple-A levels.

Narrow Road typically targets investments paying at least 5% over the base rate, which means that we are looking at assets with ratings of triple-B and below. We will also look at CMBS and ABS transactions; issuance in these asset classes is, however, much more sporadic.

For CDOs, there is a rump of outstanding transactions that were issued in 2005-2007, which are now either defaulting and seeing their principal wiped out or are approaching their maturities with capital to be returned in the next 2-3 years. The buyer base for these transactions was not a typical institutional buyer base, so from time to time there are opportunities from sellers who have a particular reason for needing liquidity.

Q: How do you differentiate yourself from your competitors?
A: Narrow Road differentiates itself from our main competitors in three key ways. First, we are on the ground in Sydney and that allows us to see a much greater Australian deal flow than our primarily Hong Kong- and Singapore-based peers.

It also allows us to have a much broader understanding of the people and processes involved when we are considering investments. While we are well connected into the broker community here, we are not reliant upon the brokers for deal flow and source most of our transactions independently.

The second differentiator is that we target ticket sizes of up to US$20m, which limits the number of competitors in our key investment areas. We target mid-market and large cap deals, so as an example we are happy to invest US$5m into a US$300m transaction. In targeting the smaller ticket sizes, we find that we are much more helpful to the originators and the brokers, and also get better pricing relative to the same risk for a larger ticket size.

Finally, we have a track record of making and managing investments in Australia in our target asset classes over the last eight years that stands above the vast majority of our peers. For instance, in my capacity at Lehman Brothers I managed a structured credit portfolio (primarily CDOs and RMBS) from 2005-2008.

The portfolio was closed in the final days of Lehman Brothers and, since then, over 90% of the principal has so far matured or amortised, with the small number of remaining securities rapidly amortising and all are now stronger than at the time the portfolio was closed in 2008. In addition to the expected full recovery of principal, none of the 37 securities has ever missed an interest payment.

While it is common to see US and European asset managers who cover the broad range of high yield and distressed asset classes in their home markets, that model has yet to take off in Australia. The few overseas asset managers who have set up an office here have typically either set it up for marketing purposes (Australia is often named as having the fourth largest pension fund market) or to target investments in one particular asset class, such as large cap distressed and turnaround investments. Probably the only exception is Fortress, which I believe has the most diversified business model of the overseas credit specialists operating in Australia.

Q: What are your key areas of focus today?
A: At the moment, we are working on a range of investment opportunities across structured credit, loans and listed notes, as well as continuing to build our relationships with capital partners. Given the broad scope of our potential investments, the focus on just Australian opportunities and the relative newness of high yield and distressed investing in Australia, we are developing a mandate-oriented business model rather than focusing on fund raising for one particular close-ended fund.

We'd prefer to have a small number of really good mandates than a large number of investors in one fund. With a fund, realistically it is only possible to meet each investor once every three to six months and it is somewhat of a shallow relationship; many investors would like more than that. The relative immaturity of the market also means that it's better to work individually with investors.

On the investment side, there is always more potential deal flow than we can realistically cover, so we of course gravitate to the most developed and best risk/ return opportunities. If we had more time, we'd love to talk to the Australian banks about the potential to provide mezzanine financing on property and leveraged finance transactions, and to assist them with loan pools that they haven't been able to term out.

On the client relationship side, we have a lot of conversations with high net-worth and institutional investors who are coming up the curve on high yield and distressed debt as an asset class for their portfolio. While there is a definite demand for yield-oriented investments and lower volatility ideas compared to equity, the technical nature and lack of familiarity with structured credit is a significant hurdle for some. I always find it strange that many people will happily invest in preference shares and equity of a bank with few questions, but are very concerned about the risks of RMBS when it is arguably a simpler, more transparent and more stable version of a bank.

The credit markets reward three key variables: perceived risk, perceived complexity and actual illiquidity. The RMBS market in Australia is an example of perceived high risk, when - if proper due diligence is done - the actual risk uncovered is often much lower than the perception.

In order to really understand what's in a portfolio, it is necessary to talk to a lender's collections staff, go through the individual loan paperwork and tick off the relevant boxes in an audit fashion. These basic practises allow the good assets to be uncovered. Due diligence allows us to differentiate between perceived risk and actual risk, which is based on pool, structure and manager.

Particularly when it comes to due diligence, we only look at a limited pool of originators. Once we've done the initial due diligence, three-quarters of the work has already been done the second time we visit.

Q: What is your strategy going forward?
A: The expectation of a general shift towards debt investment in Australia - particularly higher yielding debt investment - is the reason Narrow Road Capital exists. The withdrawal of many of the European banks, Basel 3 requirements and increased cost of funding for banks all mean that great value in the institutional debt investment classes is likely to be a long-term feature of the Australian markets.

As investors start to allocate more to the asset class, the latent supply of higher yielding debt investments will become more apparent to the broader investment community. At this stage, many potential investors believe that the market is too small to devote time to or that listed retail notes are all that there is to consider.

For instance, there's no logical reason why one of the originators we're talking to at the moment is struggling to find other investors to look at their deal. It's a straightforward, high-quality transaction, but the yield isn't enough for distressed investors, the size isn't big enough for the typical institutional investors and the credit is a little bit tricky for some others. There are a small handful of houses in Australia that are in the sub-investment grade space, but they typically target larger opportunities and are often only focused on one sector, such as mezzanine debt for infrastructure.

A big part of what we do at Narrow Road Capital is simply to tell people what the broad range of opportunities are and how we can help them access those opportunities. In a sense, our strategy is to explain to whoever will listen that the markets here will develop to be more like the US and European markets and that we'd like to help them get an early mover advantage.

Q: What major development do you need/expect from the market in the future?
A: In 10 years' time I'd like to see high yield and distressed debt as an accepted and regular part of the institutional investment landscape in Australia, just as it is in the US and Europe. There is currently a lot of public debate in Australia about the relative over-allocation to equities by Australian pension managers, and the debate is likely to grow as the population ages and people demand greater capital stability from their retirement savings. Higher yielding debt is ideally placed to fill the gap as equity allocations are reduced.

To make the change happen, a lot of education will need to be undertaken. The largest Australian pension funds are just starting to wrap their minds around the fact that they can invest in Australian loans directly and are beginning to make some allocations to the asset class.

The understanding of structured credit investing also needs to improve; the view of a sometimes vocal minority that all structured credit is as dangerous as 2006 US subprime needs to be continually challenged. Not only has Australian RMBS and ABS performed exceptionally well through the credit crisis, but primary issuance today also comes with greater subordination for the same rating and is paying much wider margins than it was in 2007. I hope that in 10 years' time what we are doing today will have been a small part of bringing into existence this change.

Structured Finance

Real estate lawyer recruited

Jorge Page is joining Berwin Leighton Paisner's London-based real estate finance team. He was previously at Clifford Chance, where he worked in the London and Hong Kong offices, and joins as senior associate.

Structured Finance

SF deputy appointed in Russia

Alexander Pletnev has joined Sberbank's corporate investment block subdivision, which was formed earlier this year as part of its merger with Troika Dialog. He takes up the role of deputy head of structured finance.

Pletnev will be primarily responsible for coordinating the structured finance division's efforts to create new credit products, reporting to Yury Korsun, head of structured finance. He was previously at Lukoil, most recently as head of the corporate debt and capital markets group, and has also worked at Credit Lyonnais Rusbank and at Bank Saint Petersburg.

The appointment follows the recent addition of Mazen Nomura as head of credit trading.

Structured Finance

Euro expansion for due diligence firm

Rockstead has opened offices in Dublin and Madrid as it continues its European expansion. They will provide representation and local expertise to the Irish and Iberian markets.

The expansion is being overseen by sales and marketing director Rod Moulton, who has particular experience of the Spanish and Portuguese markets. The firm intends for the Spanish office to serve as a European hub.

Key appointments for both offices are expected shortly.

CDO

New CDO manager sought

Blackrock has been removed as collateral manager of Toro ABS CDO II. Under the transaction's collateral management agreement, the manager may be removed without cause upon 90 days' prior written notice at the direction of holders of a majority-in-interest of preference shareholders. However, the removal of Blackrock shall not be effective until a successor collateral manager that satisfies the replacement manager conditions has been appointed.

CLOs

CLO managers replaced

Two European CLOs - Axius European CLO and Neptuno CLO III - have had changes made to their collateral management agreements. 3i Debt Management Investments has replaced Invesco Senior Secured Management as manager on the former deal, while Bankia has resigned as lead investment manager on the latter. Cohen & Company Financial (formerly known as EuroDekania Management), in its capacity as junior investment manager, has since appointed itself as lead investment manager for the Neptuno transaction.

For other recent CDO manager transfers, see SCI's CDO manager transfer database.

CMBS

CMBS structurer comes back

Raul Orozco has rejoined Citi as vp in New York, four years after his first stint with the bank. He joins from UBS and will focus on CMBS structuring.

Orozco's last role was more heavily focused on RMBS and he also has experience in broader ABS and warehouse lending. He previously worked at Citi in an RMBS structuring role and has also held analyst roles at Thomson Reuters and Barclays Capital, focusing on RMBS and ABS. He started his career at S&P, focusing on CMBS.

Structured Finance

FATCA implications examined

The forthcoming US Foreign Account Tax Compliance Act (FATCA) could have wide-ranging implications for global structured finance transactions, Fitch says. In particular, the FATCA status of SPVs and counterparties handling payments will be a key issue. Under current plans, withholding tax would apply on relevant interest payments from January 2014 and relevant principal payments from January 2015.

The Act is not intended to be retrospective, so widespread negative rating actions aren't expected as a result of its implementation. However, the breadth of the Act and its complex practical implications mean there could be possible cashflow disruptions and rating implications in individual transactions. Fitch says it will monitor developments, but anticipates that global structured finance transactions and counterparties will address any uncertainties.

FATCA will impose withholding tax at a rate of 30% on US-sourced cashflows transferred to foreign financial institutions (FFIs) that do not participate in the regime. A range of non-US entities - including SPVs, account banks, paying agents and custodians - are expected to fall under the definition of FFI.

FFIs can agree to participate with the US Internal Revenue Service (IRS) or, where applicable, can participate under a country-specific intergovernmental agreement. So far, France, Germany, Italy, Japan, Spain, Switzerland and the UK have announced plans to enter into intergovernmental arrangements with the US. It is envisaged that FFIs who elect to participate would be obliged to apply US withholding tax on certain payments made to non-participating FFIs from January 2017.

In cross-border structured finance transactions with US assets, the FATCA status of the SPVs and counterparties will be under the spotlight. For example, notes may be issued by a non-US SPV while some cashflows may originate from US assets, either due from underlying receivables or from hedging counterparties. To the extent that the SPV or other counterparties are treated as non-participating FFIs, then a 30% withholding tax may be applied to some intra-transaction cashflows, reducing the ability of the transaction to make ultimate payments to noteholders.

This could extend to cashflows from any sources globally from January 2017 as participating FFIs may be obliged to withhold tax from certain payments to non-participating FFIs from this date, wherever the source of the cashflow - although the obligations of FFIs who participate under intergovernmental agreements still need to be finalised.

Fitch's structured finance note ratings address the ability of the note issuer to meet its obligations to noteholders and do not take into account the tax status of the noteholder or any withholding tax applied on payments to noteholders. Even if the investor is treated as a non-participating FFI, meaning investors could see withholding tax applied on interest and principal payments made on the notes, this would not be reflected in the rating. Only the impact upon intra-transaction cashflows will be relevant from a ratings perspective, the agency notes.

Structured Finance

Synthetic infrastructure trade completed

NordLB has placed the mezzanine tranche of a risk transfer trade, dubbed Blue Rock, with a single institutional investor. The transaction provides credit protection on a £307m portfolio of 20 high grade UK infrastructure loans.

"With Blue Rock, we are responding to the growing demand among institutional investors for asset-backed capital market products," comments Hinrich Holm, NordLB managing board member with responsibility for the bank's capital market business.

The underlying loan portfolio was originated and will continue to be managed by the bank. Holm confirms that the deal allows NordLB to reduce its risk-weighted assets, thus freeing up capital for the granting of new loans.

Structured Finance

Loan-level data services launched

Sapient Global Markets has unveiled a new combination of services aimed at helping companies meet requirements for communicating loan-level performance data to the European DataWarehouse under the ECB's ABS loan-level initiative. The offering includes complex data mapping and enrichment, the conversion of data between formats required by different regulators and the streamlining of two-way communication between regulators and data users through custom-built connectivity channels.

"This is a significant shift from existing requirements," comments Randall Orbon, vp, Sapient Global Markets. "The challenge for most data providers will be locating, identifying and extracting large volumes of complex data from disparate systems. Not to mention that they will also need to standardise the data to fit the ECB's asset-specific templates, validate the data content, and create and submit compiled XML files to the European DataWarehouse."

To assist data providers integrating with the ED, Sapient is also providing an XML data validation service. The service will receive XML test data files as firms start to generate RMBS and SME XML data during their development and testing, with the aim of providing insight into eligibility against ECB data validation criteria, thus allowing firms to better manage their collateral.

CDO

ABS CDO auction due

An auction has been scheduled for Capital Guardian ABS CDO I on 19 September. The collateral will only be sold if the proceeds equal an auction call redemption amount.

CMBS

Japanese CMBS recoveries examined

S&P has undertaken a survey on the recovery of defaulted loans backing rated CMBS in Japan. From 2Q08 - when the first loan defaulted - to end-June 2012, 143 loans defaulted. Of these 143 loans, servicers sold one or more collateral properties of 120 loans (or 83.9%) by the end of the period.

Servicers completed collection activities for 97 (or 67.8%) of the 143 defaulted loans by that date, indicating that the recovery of these loans has progressed. The average recovery rate for these 97 loans was 90%. This is on par with the average recovery rate for the 78 loans for which servicers had completed collection activities by end-December 2011, according to S&P - indicating that servicers continued to see relatively high collection rates for CMBS loans, even when the loans defaulted.

Of the 97 loans for which servicers completed collection activities, 37 loans (or 38.1%) incurred principal losses, while the remaining 60 loans were fully recovered. The percentage of loans with principal losses is increasing. Consequently, S&P believes that the recovery rate of defaulted loans is likely to decline in the foreseeable future.

The simple average ratio of sales price to the agency's underwriting value for the 514 properties for which sales prices were available as of end-June declined slightly, to 65.5%, from 66.4% as of end-December 2011. By property type, the simple average sales price-to-underwriting value ratios for retail properties and hotels stood at 55.1% and 56.5% respectively, far lower than the same ratio for all 514 properties.

Meanwhile, apartments for lease represented the only category for which the simple average sales price-to-underwriting value ratio, at 68%, exceeded the same ratio for all properties. By location, the simple average sales price-to-underwriting value ratio for properties in Tokyo was 71.1%, exceeding the same ratio for properties outside Tokyo, at 63.1%.

CMBS

Sprint Data Center payoff expected

Morningstar has added the US$52.8m Sprint Data Center loan, securitised in the MLCFC 2006-1 CMBS, to its watchlist ahead of the 1 October anticipated repayment date (ARD). The loan is collateralised by a 160,000 square-foot class A data centre built in 2001 in Silicon Valley.

For the 12-month period ended 31 December 2011, the net cashflow debt service coverage ratio (NCF DSCR) was 2.81, with net cashflow of US$8.1m and occupancy at 100%. The NCF DSCR and net cashflow for the 12 months ended 31 December 2010 were 3.07 and US$8.8m respectively.

The property is fully leased to Sprint Nextel on a lease that is scheduled to expire on 30 September 2014. Annual rent steps were included in the original contract that would be the greater of either a 3% increase in current rent or a 75% increase in the CPI.

In April 2006 the annual rent was US$48.69/sf. Although updated rent per square foot information was not available for the asset, Morningstar believes that the rate is well in excess of US$48.69/sf based on the steps.

Sprint Nextel sublet all 160,000 square-feet of its space within the Sprint Data Center to Equinix Operating Co. Equinix continues to occupy 100% of the property, with the sublease being coterminous with the Sprint Nextel primary lease. Equinix pays 45% of the Sprint Nextel base rent, which will continue through to the September 2014 sublease expiration date.

At issuance, the loan was structured with a 5.42% coupon and an interest-only period that extended through to the ARD. Final maturity is scheduled for 1 October 2035. The asset was appraised for US$98m in 2005, yielding a 54% LTV at issuance.

The property was sold - along with a separate 25,000 square-foot data centre - to Digital Realty Trust for US$90.5m, which assumed the debt. A footnote published in the firm's 2Q12 financial report indicates the loan will be paid off on 4 September without penalty. The borrower will use an existing line of credit to fund the full payoff of the debt.

Despite the forthcoming ARD, Morningstar considers the loan to be a very low default concern, based on consistently stable occupancy and cashflow, as well as solid sponsorship. The rating agency's analysis of the collateral suggests a value of about US$89.5m (US$559/sf) and a 59% LTV.

CMBS

GRAND ratings impact explored

Fitch says that the proposed amendments to the GRAND CMBS (SCI 10 July) are likely to have a neutral to positive impact on the ratings. Following preliminary analysis of the publicly available information, the agency has confirmed that it doesn't view the proposed amendments as constituting a distressed debt exchange. It believes the changes are not being implemented to avoid a default under the notes, while the proposed increase in note margins should provide a strong financial incentive for the noteholders to participate.

The increased flexibility in refinancing the various borrowers and disposing of properties should make the repayment of the outstanding notes more likely, provided the sponsor makes progress in line with its business plan. The primary goal of the amendment is a five-year extension of the underlying loans to January 2018 and notes' legal final maturity date to January 2021. Although the tail period is to remain relatively short (three years), the refinancing strategy ahead of loan maturity helps offset the limited time available for a successful workout, should it be required.

Four amortisation targets - €1bn in year one, €700m in year two, and €650m each in years three and four - will be defined. If successful, this feature will significantly decrease balloon risk, with the debt balance at the end of the extended loan maturity scheduled to be €843m - down from the current exit balance of €4.395bn.

If the borrowing group fails to meet these amortisation targets, allowing for possible cure periods, a 'global event of default' would arise under the underlying loans. The only exception occurs when the sponsor is the subject of an IPO process, which would entitle it to a one-year waiver of the amortisation target, provided the target is not missed by more than 50%.

Following the proposed amended definition of the allocated loan amount (ALA), both pre- and repayments will decrease the outstanding ALA. In particular, this should make partial refinancing easier for the borrower to execute, Fitch notes - albeit by allowing it to count past debt repayments when calculating how much debt is to be repaid as a condition of releasing collateral held by specific borrowing entities. A safeguard has been introduced alongside this provision to allow noteholders to claw back gains on sale or from more favourable refinancing carried out within 12 months of the release.

The proposed application of proceeds from refinancings and disposals is designed to decrease the global loan-to-value ratio. Proceeds are first applied in reducing the indebtedness of the affected borrower and then towards the borrower with the highest LTV or the lowest interest coverage ratio.

Surplus cash will be used first to fill a refinancing account up to €100m and second to amortise notes pro-rata. If the notes amortise to €2.4bn and the global LTV decreases to 57.5%, the target amount on this refinancing account will decrease to €50m, the borrower will be able to use up to €25m to cover value-enhancing expenditure and only 50% of excess cash will have to be used to amortise the notes pro-rata.

Following an IPO of the sponsor and as long as the amortisation target of €2.4bn and the global LTV target of 57.5% are both met, a separate account earmarked for possible dividend payments will be filled up to €50m over the lifetime of the transaction.

CMBS

Euro CMBS maturities to remain subdued

Three European CMBS loans recorded losses following the July 2012 reporting cycle, Fitch reports.

The largest of these loans was the Orange loan, securitised in Fleet Street Finance Three. While losses are yet to be allocated to the notes, the servicer reports that a sale price of €50m has been accepted for the collateral - some way short of the €67m senior debt outstanding.

Repayments and partial prepayments totalling €332m had a positive impact on Fitch's maturity repayment index last month. But, with €2.8bn falling due in October, the agency expects the index to tick back down again and remain subdued in the months ahead.

Only one loan falls due in September. While its small principal balance (€13.7m) and moderate leverage (66% Fitch LTV) may suggest a reasonable chance of refinancing, the possibility of the sole tenant vacating in four years is a significant obstacle facing the borrower.

CMBS

CMBS delinquency rate dips

The US CMBS delinquency rate fell by 21bp to 10.13% in August, Trepp reports. This decrease occurred after five consecutive months in which the rate increased, including three months that set all-time records.

The improvement in the rate was primarily driven by two factors, according to Trepp. First, loan resolutions remain elevated.

Almost US$1.5bn in loans were resolved in August with losses. The removal of these loans from the delinquent loan category accounted for about 26bp of downward pressure on the delinquency rate.

The second factor that contributed to August's lower rate was that most of the 2007 vintage loans have now passed their maturity date. The upward pressure that these loans were putting on the delinquency rate when they could not be refinanced upon maturity is now largely gone.

Among the major property types, the apartment, lodging and office segments all improved. The laggards were industrial and retail loans, with their rates drifting higher in August.

Newly delinquent loans - accounting for around US$3.3bn in total - put upward pressure of about 57bp on the rate. This was a sharp decline from July, when newly delinquent loans resulted in an increase of 81bp (or US$4.6bn).

Loans that cured - about US$2.8bn - put downward pressure of 48bp on the rate in August. Added together, the impact of the loan resolutions, the effect of loans curing and the effect of newly delinquent loans created a net decrease of 17bp in the delinquency rate.

Risk Management

MarketMap enhanced

SunGard has released a new version of its MarketMap market data terminal application. The service provides up-to-date macroeconomic data in a calendar format through a new economic and financial indicator viewer, an enhanced news navigator and Fitch Solutions' credit default swaps data.

Robert Jeanbart, evp and global head of SunGard's MarketMap business unit, comments: "The enhancements to MarketMap were driven by our customer requests and can help them more quickly and efficiently retrieve and access data. There is a lot of attention on the euro zone crisis and the deeper implications it has on global economies. The latest version of MarketMap provides investors with tools to help them rapidly navigate news and access data in order to monitor global developments and credit risk in real-time."

Risk Management

Cleared derivatives documentation strengthened

ISDA and the Futures Industry Association have published the FIA-ISDA Cleared Derivatives Addendum, a template that can be used by US futures commission merchants (FCMs) and their customers to document their relationship with respect to cleared OTC swaps. The Addendum - which is designed to supplement a futures and options agreement between a US FCM and its customer - includes representations for each party to make regarding certain clearing-related matters, such as the treatment of customer collateral.

The Addendum also sets forth the close-out methodology for cleared OTC swaps, the triggers for liquidation and provisions for valuing the terminated trades. In addition, it contains provisions governing tax issues regarding cleared OTC transactions.

The Addendum was developed with the assistance of both buy-side and sell-side participants in the cleared OTC swap markets, with expertise in both futures and OTC derivatives. Approximately 30 institutions participated in drafting the document.

"The Addendum is an important milestone that will enable customers in the US to access central clearing of OTC derivatives transactions efficiently through the use of market standard documentation," comments ISDA ceo Robert Pickel. "It represents the collaborative efforts of a broad cross-section of market participants and marks another step forward in the global derivatives industry working constructively to reduce counterparty credit risk through the use of central clearing facilities."

The Addendum is designed to be customised by the parties that choose to use it. It includes a Schedule in which the parties can make additional representations or other modifications to the terms of the Addendum.

RMBS

Aussie, Japanese RMBS compared

In response to increasing numbers of enquiries from Japanese investors with respect to Australian RMBS and how they compare with Japanese RMBS, S&P has published a report consolidating some key observations of these two markets. Despite significant differences, the performance of underlying mortgage loans and RMBS ratings in both countries has remained generally robust in the face of the slow global economic recovery, the rating agency says.

Japan and Australia are two key markets in the Asia-Pacific region with regular issuances of RMBS securities. While the ratings on RMBS and underlying mortgages continue to perform strongly, new issuance levels have seen setbacks since 2007. Australian RMBS has attracted stronger investor interest in recent years compared with 2008 and 2009, however.

The Australian RMBS market has key features that distinguish it from the Japanese RMBS market. In particular, almost all Australian prime residential mortgages securitised in RMBS are fully mortgage-insured under mortgage insurance policies.

Separately, S&P has also released a report detailing the results of a survey that it conducted on the recovery rates of Japanese condominium investment loans backing RMBS transactions that it rates and monitors. The recovery rates of Japanese condominium investment loans were shown to range from 50% to 80%.

In conducting the survey, the agency examined the recovery data for 105 defaulted loans extended from 2004 to 2008, based on initial LTV ratios and the locations of the associated properties.

RMBS

G-fee hike due

The FHFA has directed Fannie Mae and Freddie Mac to raise guarantee fees on single-family mortgages by an average of 10bp, moving GSE pricing closer to the level expected if mortgage credit risk was borne solely by private capital. The changes also aim to make more uniform the g-fees charged to lenders who deliver large volumes of loans, as well as reduce cross-subsidies between higher-risk and lower-risk mortgages by increasing g-fees on loans with maturities longer than 15 years by more than those for shorter-maturity loans.

For loans exchanged for MBS, the increase will be effective with settlements starting on 1 December. For loans sold for cash, the increases will be effective with commitments starting a month earlier. The GSEs will work directly with lenders to implement the changes.

FHFA's fourth annual report on single-family guarantee fees, covering the years 2010 and 2011, found that the average g-fee charged by Fannie Mae and Freddie Mac increased from 26bp in 2010 to 28bp 2011. This and prior reports also show that mortgages that posed higher credit risk, on average, were subsidised by lower-risk loans and that a majority of the single-family mortgages acquired by the GSEs came from a small group of large lenders.

FHFA is set to release for public input an approach to developing risk-based pricing at the state level.

RMBS

ResCap fraud probe revealed

The US SEC has filed court papers indicating that it's investigating whether Residential Capital committed fraud related to its mortgage lending and underwriting practices. The investigation began on 22 February in an effort to compel R.R. Donnelley & Sons to produce due diligence reports prepared for investment banks that underwrote the investments, according to a recent Lowenstein Sandler client alert.

"The commission staff is seeking information regarding, among other things, possible violations of the anti-fraud provisions of the federal securities laws arising out of the offer and sale of RMBS by Residential Capital," the SEC states in a memorandum filed in Los Angeles federal court.

The ResCap bankruptcy is pending in the US Bankruptcy Court for the Southern District of New York (SCI passim).

RMBS

RMBS review completed

S&P has announced a number of rating actions resulting from the implementation of its updated criteria for monitoring the performance of pre-2009 US RMBS (SCI 16 August).

Of the prime jumbo RMBS impacted by the review, the agency lowered its ratings on 259 classes from 38 deals and removed 249 of them from credit watch with negative implications and eight from credit watch with developing implications. It also raised the ratings on two classes and affirmed 84 classes from 32 transactions.

Of the Alt-A and Neg-am RMBS affected, S&P lowered its ratings on 84 classes from 31 transactions and removed 59 of them from credit watch with negative implications and 19 of them from credit watch with developing implications. It also raised the ratings on eight classes from five transactions and affirmed 103 classes from 31 deals.

Finally, of the subprime RMBS hit, S&P lowered its ratings on 118 classes from 34 transactions and removed 92 of them from credit watch with negative implications and 20 of them from credit watch with developing implications. The agency also raised its ratings on three classes from three transactions and affirmed 144 classes from 36 transactions.

RMBS

Servicing settlement progresses

Joseph Smith, the monitor of the US$25bn mortgage servicing settlement between 49 state attorneys general and the five largest bank servicers, last week released his first progress report detailing how the banks are meeting their obligations under the agreement.

So far, the banks have granted US$10.56bn in consumer relief to 137,846 borrowers between 1 March and 30 June. The bulk (US$8.7bn) of consumer relief efforts have been via short sales and deeds-in-lieu of foreclosure.

Additionally, first-lien principal reduction trials were begun for about 28,000 homeowners, totalling approximately US$3bn of potential relief. Since these trial modification plans require at least three on-time payments before they are made permanent, many of these modifications will likely be included in the next settlement report from the monitor. MBS analysts at Barclays Capital note, for example, that even though the report shows Bank of America not having completed any first-lien debt reduction modifications as of 30 June, the bank has separately stated that it had executed US$596m and US$1.7bn of first- and second-lien principal forgiveness modifications respectively as of 21 August.

They also point out that short sales continue to represent 40%-70% of total liquidations on non-agency loans serviced by the five largest banks, with the trend being relatively stable over the past several months. "This suggests that the servicers may either be concentrating their short sale efforts on their own portfolio loans or that they have not significantly changed their criteria or methodology for determining whether to engage in a short sale and are simply benefiting from the short sales that would have been performed anyway."

Finally, the report states that the servicers reported that 56 servicing standards have been incorporated into their business processes, as of 5 July.