Contents

RMBS

Up and coming

Housing recovery boosts non-agency RMBS

Economic indicators increasingly suggest that the US housing market has bottomed and begun to recover. While both agency and non-agency RMBS will benefit, it is non-agency where the opportunities for yield are strongest.

The latest CoreLogic home price index update shows month-over-month home price appreciation of 16.3% for July, with year-over-year price growth at 3.8%, which is the biggest increase since August 2006. Year-to-date, home prices are up by 8.1% through to the end of July.

Deer Park Road founder Michael Craig-Scheckman believes that the latest housing figures could mark a turning point for the market and the start of a recovery. "This could definitely be the start of a trend, but that does not necessarily mean it will be a continuous trend. There is a tendency, even when times are tough, for people to muddle through and that is what is happening."

He continues: "There is a lot of nervous cash out there and people are running from one thing to another; that was the case even before the crisis. At some point, between the inflationary pressures that are out there and the movement of money, you will see an uptick in housing prices."

A recent note from Arbuthnot Latham suggests that now is the time to capitalise on the market's change in fortunes. "We believe that after five years of decline, US housing prices are finally positioned to recover and that more specifically non-agency mortgages - the very asset class which prompted the credit crunch and subsequent financial crisis - is one of our preferred asset classes under consideration for this projected recovery," it says.

The note adds: "Non-agency MBS presents an attractive risk-adjusted opportunity. Despite carrying the label of a risky asset, our research and analysis suggests that holders of non-agency should achieve attractive yields, amid a low interest rate environment, with the added possibility of capital upside if delinquencies improve faster than the market anticipates."

The voluntary prepayment rate for most bonds, particularly Alt-A and subprime deals, is very low. Prepayments should rise as the housing market recovers and housing turnover increases, as homeowners who have previously been unable to sell do so.

"Even if you start to see inflationary pressure, housing prices moving up and rates moving up, while the homeowner will get equity he might find the rate does not work. So you could see situations where there is no refinancing but prepayments increase," says Craig-Scheckman.

He notes that after years of underperformance, there could be a rush of people looking to sell, causing turnover and prepayments to temporarily spike even further. The implications for non-agency RMBS could be significant.

"The big winners from such a market shift would be discount bondholders. On the other hand, those holding IOs who had assumed very low voluntary prepayments could find it far less comfortable," says Craig-Scheckman.

He continues: "You also have to look at losses. A rising tide of house prices is going to reduce loss rates and that is a good thing if you are holding deep discount paper. However, liquidation rates could increase and that would somewhat reduce the other positive effects. It would also hurt IO holders, because on most IOs liquidation has the same effect as voluntary prepayment."

Investors looking to benefit from the improving housing market through non-agency RMBS would therefore be best served buying discount bonds. Craig-Scheckman dismisses bonds trading close to par, which may shorten up and suffer losses.

He adds: "It all depends on how aggressive you want to be. Bonds in the 30-60 range would probably be attractive. The market took off early in 2010 and then cratered, with the same thing happening in 2011. This year has been better and we have had a strong rally, which seems to be a little more sustained."

Barclays Capital securitised products analysts are recommending high-carry prime/Alt-A FRM super seniors with stable yield profiles. For double-digit yields, they favour using repo leverage on those stable cashflows, rather than moving into more credit-leveraged tranches.

The analysts add: "We do believe that negam/subprime locked-out second-/third-pay/LCFs would outperform jumbo/alt-A FRMs over a three- to five-year horizon, from a purely fundamental standpoint. However, we remain cautious on the weaker credit sectors for now, due to macro concerns and the potential for an event-led risk premium widening."

While a wealth of opportunities are available, Craig-Scheckman warns that investors need to be careful. "I was talking to one investor a few weeks ago, who said one of the things he learned about this market is that it should come with a warning - 'do not try this at home'," he concludes. "It is a complicated market and investors need to understand it if they want to be involved. There are pitfalls, so investors have to be sophisticated."

JL

CDS

Slice of the action

Dynamic tranche market entices investors

The European tranche market has seen a significant shift over the last two months, with Markit iTraxx tranches moving sharply. While this presents new opportunities for yield, investors may be more tempted to use the tranche market for tail hedges.

"A steepening of curves, compression driven by outperformance of peripheral tail names and a fairly substantial move in correlation higher have all come together to re-price the tranche market in a relatively short span of time," Morgan Stanley credit derivative strategists report.

They indicate that the newly-dynamic tranche market necessitates a change in approach from investors. Malek Meslemani, partner at Chenavari Investment Managers, agrees that the European iTraxx market has become more active recently, but he does not agree with the suggestion that it had been particularly dormant earlier in the year or that investors need to change tack too dramatically.

"Investors in the European market tend to be a little more sophisticated, so ticket size is small but the total volume of trading was acceptable," he says. He adds that, while the US CDX market may have more depth, market attention has mainly been focused on iTraxx Series 9. As a result, the more recent series - such as S15 and S17 - have been less liquid.

Meslemani continues: "That is because of the European investor base: they do not want to add on new directional exposure; they want to stay within the already-existing liquidity space and therefore S9 remains the most traded one."

Investors looking to take advantage of the new tranche environment have attractive options available to them, not least with S9. The Morgan Stanley strategists recommend S9 seven-year/10-year 6%-9% tranche flatteners as a convex trade to take advantage of the steep curves. Their preferred long would be the 10-year 3%-6% tranche.

The strategists note that their previous highest-conviction idea - the S9 five-year 0%-3% tranche - now leaves little room for error and offers sub-10% yield after hedging tail names, so is no longer seen as offering best value. However, for all the moves in the credit tranches, Meslemani believes that the range of opportunities is really largely unchanged.

He comments: "The places investors should be looking are not much different from before. Far more important is what that investor's risk appetite is; that is more of a deciding factor than the changes or actual trade opportunities themselves."

Meslemani continues: "We have not rallied all that much. The market is still offering a good premium, particularly in the credit space. People who know how to make money and perform over the last few years should continue to do so in the new environment. The crisis is not finished and the challenges are still there."

With one eye on those challenges, market participants have been actively seeking effective tail hedges. Without necessarily turning bearish, Meslemani notes that iTraxx tranches provide an attractive tail hedge for investors who have not already sought protection.

"Since August last year, everyone is looking more and more for ideas on their hedges. Banks, dealers and clients are all looking for solutions around available credit instrument and index tranches as well. The indices are pretty liquid and do provide good hedges in the credit market," he says.

Meslemani adds that the market now provides several ways to express views, particularly as index options have begun to trade more for a while now. "The index tranches tend to be healthier now because before, in 2007/2008, we had huge technicalities and unhealthy market. It is now more balanced between the number of players and the volumes traded are a bit more coherent."

Looking ahead, the one development that could most boost liquidity in the tranche market is clearing, Meslemani says. He notes: "We are hoping that the whole market will move to clearing to give more transparency and liquidity and attract a different type of client. It will also help the regulator, because they do not always seem to understand everything within this market."

He concludes: "Maturities between 2013 and 2017 are pretty liquid. If the market is cleared in a clearinghouse, you will get more confidence in the longer maturities in the index tranches and therefore a pick-up in the long run beyond the few years ahead of us."

JL

Structured Finance

Releasing the pressure?

Data hindering European distressed debt deals

Differing views on price appear to be impeding distressed debt transaction volume in Ireland and Spain, albeit a number of significant deals are expected to close by year-end. Nevertheless, recent legislative developments are helping to relieve some of the pressure that banks face in both jurisdictions.

Getting comfortable with a distressed debt deal in Ireland and Spain comes down to price, confidence and knowledge, according to Rod Moulton, sales and marketing director at Rockstead. "Data is the key to building confidence, but much of the data is unreliable in its current form. Firms like us are increasingly being asked to clean it up, so that potential investors can inspect it."

He adds that there is an expertise shortage in Ireland, while in Spain investors are taking much more of a forensic approach than in the past. "We're doing the grunt work and going back to basics: combing through the files, testing the data and correcting it where necessary."

Moulton expects the gap in pricing expectations to begin closing once the data is cleaned up. But, in the meantime, realising losses remains an issue for many banks.

"Some banks may not continue to exist if they began recognising losses at the levels some advocate: we've already seen lots of failures," he explains.

The establishment of bad banks in both jurisdictions could help by absorbing some of the more troubled assets. Certainly the publication of the new Spanish bank resolution law (SCI 28 August) - which lays the foundations for a bad bank - has been a boon to the country's distressed debt sector.

"The mood has become more positive recently," Moulton confirms. "However, it will take at least another two years before we see significant progress being made by the Spanish bad bank. A whole new infrastructure has to be created, which takes time."

He continues: "Although we believe that Spain is now moving in the right direction, let's hope that all toxic assets will be recognised, as failure to do so could prolong any recovery."

NAMA, the Irish bad bank, is acknowledged as having relieved the initial pressure on banks through loan transfers and more recently via the implementation of vendor financing. Further, Irish banks are required to focus on core domestic banking business and shrink their balance sheets under tight deadlines.

Conor Houlihan, partner at Dillon Eustace, reckons that progress in terms of recognition of losses and recapitalisation is creating favourable conditions for the growth of a more active market in non-performing loan portfolios and other non-core bank assets. Indeed, interest in Irish non-core asset portfolios in particular appears to be increasing.

The latest such portfolio to hit the market, for example, is Lloyds Banking Group's €2bn Project Pittlane. It comprises more than 700 loans secured by a diverse asset mix, including development schemes, residential property, regional offices and retail.

However, Moulton suggests that the recent introduction of the Irish Personal Insolvency Bill has "thrown a spanner in the works". He explains: "The PIB is forcing lenders to re-evaluate their forbearance and loan modification options available to borrowers. However, in order to make an informed decision, they require complete and accurate data - which is not available on their systems."

The bill proposes amendments to the Bankruptcy Act 1998, with the centrepiece being the reduction of the personal bankruptcy discharge period from 12 to three years (SCI 3 July). The bill also introduces three alternative debt arrangements to avoid bankruptcy: debt relief notices, debt service arrangements and personal insolvency arrangements (PIA).

The PIA framework represents a move towards a more robust bankruptcy regime in Ireland, according to Houlihan. "Bankruptcy hasn't really been a viable or widely used option in Ireland - the existing regime has proved ineffective. But PIAs are intended to form part of a new infrastructure for a more effective system of personal insolvency law in Ireland."

He says it's too early to tell how the PIA framework will impact Irish RMBS (see box). "How borrowers and banks will behave in practice remains to be seen. However, the publication of the draft legislation is helpful in that it expands on - and, in some cases, amends - the provisions outlined in the draft scheme for the bill that was published previously."

CS

ABS

New issues rule ABS bid-lists

US ABS secondary market volumes have fallen off from the start of the week, with only a few lists being circulated yesterday. Auto continues to be the most active sector (SCI 31 August), accounting for more than one-third of supply during the session. Interactive Data notes that new issue paper was mostly out for the bid.

SCI's PriceABS BWIC data also highlights activity in new issue private student loan and credit card bonds. A US$9m slice of the SLMA 2012-C A2 tranche was talked at plus 160 yesterday, for example, while a US$13m piece of SLMA 2012-D A2 was talked at plus 155. Finally, US$15m of the GEMNT 2012-6 A tranche was talked at low/mid-30s.

CMBS

CMBS spreads, activity increasing

After finding their feet on Tuesday, the US secondary market took off yesterday. SCI's PriceABS BWIC data reached 500 line items for the session, with some interesting developments in CMBS.

Trepp notes that CMBS spreads were flat to marginally tighter yesterday, with bid-list volume rising to about US$270m. It adds that the bellwether GSMS 2007-GG10 A4 tranche finished the session at 207bp over swaps, 1bp tighter on the day.

Another GSMS tranche - 2007-EOP A3 - made its first appearance in the PriceABS database yesterday. It was talked at a 99 handle and covered at 99.31.

Significantly, other names which have appeared more frequently show that - although spreads were flat yesterday - over the last few weeks they have been rising steadily. For example, the data shows that the LBUBS 2006-C1 AJ tranche was covered yesterday at swaps plus 750, having been talked variously in the very low-700s and in the 725 area. That continues an upward trend that has been taking place for a while now - the tranche was covered at mid/high-600s on 23 August and at swaps plus 659 two days before that.

The MLMT 2007-C1 AM tranche provides further evidence of this trend. It was talked in the 700 area and covered at 698 yesterday, having been covered at 695 on 28 August. It had traded in the mid-600s a week before that and was being covered at 630 in late July.

JL

RMBS

RMBS rally continues

Last week saw US non-agency RMBS spreads grow progressively tighter as supply kept on coming. The market has rallied considerably over the last few weeks, as can be seen in SCI's PriceABS BWIC data.

"While supply picked up after the Labor Day holiday, the upward trend in pricing remains intact. The increased supply seems to have brought out additional buyers and the yield grab continued," Babson Capital notes in a recent client memo.

Babson adds: "Each subsequent bid-list traded tighter than the previous and, with a supportive fundamental backdrop and no real supply, it is expected the current rally will continue. It is going to take fairly negative macro headlines and/or a reversal in positive housing numbers to derail the rally in non-agency RMBS."

This rally is evidenced by PriceABS, which shows how far the market has moved in recent weeks. US$51.8m of WAMU 2006-AR13 1A was covered at a 66 handle on 19 July, with US$51.83m covered at a 69 handle yesterday. Similarly, a US$18.7m piece of RALI 2006-QH1 was covered yesterday at a 64 handle, after a US$10m slice was talked in the very high-50s/low-60s on 19 July.

Tranches such as FHAMS 2006-AA3 A1 and OOMLT 2006-3 2A3 further underline this rally, with a US$100m piece of the former talked at the low/mid-60s as recently as 16 August before being talked at mid/high-60s in yesterday's session. A US$10m slice of the latter was covered at high-30s on 11 July and at a 39 handle on 3 August, before a US$12.3m piece was talked in the low/mid-40s yesterday.

JL

Structured Finance

SCI Start the Week - 10 September

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

Pipeline
The pipeline grew considerably last week, with several new deals announced. Despite the shorter week in the US, eight ABS, an RMBS, a CMBS and two CLOs were added before the week was out.

Alaska Student Loan Corp Series 2012A, 2012B-1 and 2012B-2 (sized at US$54.42m, US$78.4m and US$15m respectively) kick off the ABS that hit the market last week. They were joined by two auto deals - US$759.4m Ally Auto Receivables Trust 2012-SN1 and €718.5m VCL 16 - a US$1bn credit card ABS (CARDS II Trust Series 2012-4), US$250m equipment lease deal (LEAF Receivables Funding 8 Series 2012-1) and RUB3.2bn consumer loans ABS (Life Consumer Finance).

The RMBS was £200m RMS 26 and the CMBS was US$1.3bn FREMF 2012-K20. Rounding off the issuance was a pair of CLOs - US$259.2m Crown Point CLO and US$400m Galaxy XIV.

Pricings
Issuance was dominated by ABS, but there was also a solitary RMBS. That RMBS print was €2.127m Storm 2012-4.

The ABS was accounted for by a US$1.3bn auto deal (AmeriCredit Auto Receivables Trust 2012-4), US$100m timeshare ABS (BXG Receivables Note Trust 2012-A), a pair of credit card transactions (US$1.15bn Chase Issuance Trust 2012-A5 and US$700m Chase Issuance Trust 2012-A6) and a US$390m aircraft lease securitisation (Willis Engine Securitization Trust 2012-A).

Markets
SCI's Price ABS BWIC data shows that the European CLO market dominated activity early in the week as the US shut down for Labor Day, as SCI reported on Tuesday (SCI 4 September). Noteworthy names such as BACCH 2006-1 A1 and PULS 2006-1 A2B were circulating, while the WODST III-X D tranche was talked slightly higher than it was covered at a month earlier.

The European RMBS secondary market continued to tighten, with JPMorgan credit analysts noting that even peripherals gapped tighter. They note: "Dutch RMBS, 25bp outside UK prime RMBS at the senior level, looks increasingly attractive on a relative basis; similarly, the ECB move announced last week in an attempt to resolve the European sovereign crisis led to a significant rally in Spanish and Italian paper, currently RMBS seniors are trading at 550/450bp respectively - 50/20bp inside last week's levels."

Meanwhile, the US RMBS market saw stable performance for non-agency cash bonds, according to RMBS analysts at Barclays Capital. Synthetic indices moved higher, with ABX prices up by 0.5 to two points.

"Real money has been showing a strong interest in non-agency paper, given the improvement in credit performance and the attractive loss-adjusted yields that can still be found in this market. We continue to prefer high-carry, stable yield profile prime/alt-A FRM SSNRs," note the analysts.

US CMBS has calmed down somewhat from a very active August and become more muted around the Labor Day holiday. Citi CMBS strategists note that the week ending 17 August actually saw the highest trading since early May.

However, activity did pick back up in mid-week, as SCI reported on Thursday (SCI 6 September). Volume increased and the benchmark GSMS 2007-GG10 A4 tranche was one example of the broadly observed tightening.

Finally, the US CLO secondary market is continuing to see strong interest as investors hunt yield, say Bank of America Merrill Lynch securitised products analysts. "Some market participants took the opportunity to sell into the latest rally. Among the bonds that traded, there were several equity pieces, with some at very high dollar prices well above par, as well as two large triple-A lists that came into the market on Friday," they note.

Those triple-A lists pushed secondary triple-A spreads 5bp tighter. Impressive BWIC volume of US$1bn was still not sufficient to meet investor demand, despite being one of the heaviest weeks of supply of the year.

Deal news
• S&P has issued two criteria articles it will use to rate US and Canadian CMBS: a methodology for deriving credit enhancement levels; and global property evaluation criteria. The move follows the agency's request for comment on the proposals in June (SCI 6 June) and has resulted in 744 classes from 188 CMBS being placed on credit watch.
• TPG and Patron Capital have closed their joint venture acquisition of Uni-Invest, following approval by the Dutch courts. The properties - which comprise 142 offices, 54 warehouses and seven retail outlets - will be held in an SPV dubbed Utrecht Holdings.
• 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.
• 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).
• GGP has closed US$1.5bn of new financing on seven properties across the US. Two of the properties have outstanding CMBS debt and are expected to see pay-offs in the near term.
• One of the strongest US residential mortgage vintages is now increasingly susceptible to rating downgrades. Increased adverse selection has recently resulted in higher delinquencies for pre-2005 loans.
• Three European CMBS loans recorded losses following the July 2012 reporting cycle. 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.
• HEAT Mezzanine I-2005 class B1, B2 and junior notes remain unpaid on their scheduled maturities, with principal amounts outstanding of €3.41m, €1.13m and €28.50m respectively. As such, an event of default has been declared on the transaction.

Regulatory update
• 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.
• Joseph Smith, the monitor of the US$25bn mortgage servicing settlement between 49 state attorneys general and the five largest bank servicers, 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.
• ISDA has published amendments to the Credit Derivatives Determinations Committees (DC) Rules with respect to release of information regarding DC meetings. The association - in its capacity as secretary to the determinations committees - will now draft a Determinations Committee Meeting Statement at the conclusion of each DC meeting, which will describe the issues considered and any resolutions or next steps.
• Fitch believes that the US banking regulators' proposed capital rules could be a positive credit event for senior noteholders and potentially negative for subordinate tranches in Trups CDOs. The agency notes, however, that the regulations need to be clarified, as their criteria for some Trups is different from those under the Dodd-Frank Act.
• The NCUA has filed suit against UBS Securities in Federal District Court in Kansas, alleging misrepresentations in the sale of RMBS to US Central Federal Credit Union (US Central) and Western Corporate Federal Credit Union (WesCorp). US Central and WesCorp paid more than US$1.1bn for the securities and each subsequently failed.
• 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.
• Moody's reports that China's regulators are making steady progress towards establishing a securitisation market in the country. However, as has been the case with other jurisdictions, the process will be long and involved.
• Following the recent manipulation of Libor, the European Commission has launched a consultation - which will run until 15 November - on possible new rules for the production and use of indices serving as benchmarks in financial and other contracts. It says it is essential that steps are taken to ensure the integrity of benchmarks and the benchmark-setting process.

Deals added to the SCI database last week:
Ares XXIV CLO; CARS Net-Lease Mortgage Notes series 2012-1; CENT CLO 16; GoldenTree Credit Opportunities 2012-1 Financing; Institutional Mortgage Capital 2012-2; John Deere Owner Trust 2012-B; Magnetite CLO VI; Medallion Trust Series 2012-1; and Shackleton I CLO.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2003-1; BSCMS 2005-T20; CSMC 2006-C4; DECO 2006-E4; ECLIP 2006-3; ECLIP 2007-2; EMC VI; FLTST 3; JPMCC 2006-LDP9; LBUBS 2002-C7; MLMT 05-LC1 & 05-CKI1; NEMUS 2006-2; OPERA UNI; PROUL 1; TITN 2006-1; TMAN 7; and WINDM XI.

Top stories to come in SCI:
Focus on Irish distressed debt
Recent iTraxx index trends
Counterparty de-linkage frameworks

CLOs

CLO manager fees recovering

Moody's Analytics has published the first of a two-part series on US CLO fees. The study finds that fee levels have recovered post-crisis, following the resumption of active issuance in 2010.

The study begins by analysing senior collateral management fees (SCMFs), which are typically received before the senior-most tranche but after administrative expenses and hedge payments. Moody's database of payments reported by trustees for 542 US CLOs shows that the average annual SCMF for CLOs from all vintages since 2003 is 0.18%.

That this fee is both senior to all of the tranches and relatively small on a percentage basis is a clue to its main purpose: to cover operational expenses. Because of its position in the waterfall, it is extremely unlikely that a manager would not receive this fee. However, during the crisis, certain managers with enough financial support chose to defer their SCMF.

The collateral manager receives another fee out of any cash remaining after all the payments to the non-equity tranches. Like the senior fee, the subordinate fee is usually a flat percentage of the collateral balance.

The average sub CMF for US CLOs is 0.34%. The collateral manager is rewarded with this larger fee amount after it has successfully ensured full payment to all of the tranches for the quarter.

In Moody's sample, only about 3% of transactions are failing their junior OC test and are thus in danger of failing to pay the sub CMF, while 9% are passing their junior OC by less than 3%. In other words, in 89% of the CLOs the collateral manager is safely receiving their subordinate compensation.

Despite CLO structures seeing significant changes post-crisis (SCI 24 August), the average fee structures have remained largely the same, according to Moody's. US CLOs issued in 2008 and 2010 had lower fees, but 2011 saw fee sizing return to pre-crisis levels.

That being said, the distribution of subordinate fees changed between 2003 and 2008. While the overall average remained the same, the percentiles shifted downward year to year.

In most cases, the collateral manager receives their third and final fee once the equity tranche has hit a certain IRR target. Unlike the other two fees, the incentive CMF is not usually defined as a specific percentage of the collateral balance.

The structure of the ICMF varies more from deal to deal than the other two fees, but the spirit of the fee is usually the same - the collateral manager is not only incentivised to hit the equity IRR target, but also to generate even more cashflow above that, since they will then directly receive a percentage of that excess spread.

The average ICMF payment, excluding payment dates where no ICMF was paid at all, is 0.54% annualised of the current collateral balance. So, assuming the collateral manager receives the average payment for all three fees, they stand to earn 1.06% of the outstanding collateral balance every year.

In Moody's sample dataset, however, only about 10% of transactions have ever paid the ICMF - with some only paying it for a few payment periods at a time. This suggests that managers cannot rely on the ICMF as a source of income.

The second part of Moody's study, expected to be released in Q4, examines correlations between fee structure and deal performance.

CS

ABS

Investor relations head joins

SCIO Capital has added Joern Czech as head of business development and investor relations. He was most recently at Goldman Sachs, where he served as executive director for structured solutions.

Czech spent 10 years in Deutsche Bank's global markets division before he joined Goldman Sachs. He was responsible for Deutsche Bank's investment solutions to institutional real money investors. He began his career as a fixed income trader at National Bank in Germany.

Structured Finance

Fixed income head hired

Margaret Kerins has joined BMO Capital Markets as md and head of fixed income strategy. The firm's global fixed income platform includes ABS, RMBS, municipals, derivatives and covered bonds.

Kerins will also oversee BMO's strategic analytics group. She was most recently at RBS and has previsouly worked at Bank One, ABN Amro and the Illinois Department of Financial and Professional Regulation. She will be based in Chicago.

Structured Finance

Fitch rebrands in India

Fitch has rebranded its Indian national ratings business. National ratings in India will now be assigned by India Ratings & Research rather than Fitch Ratings.

India Ratings is a wholly owned subsidiary of the Fitch Group, dedicated to the Indian market and focused exclusively on national-scale domestic credit ratings. National-scale ratings previously assigned by Fitch have been transferred to India Ratings, while international ratings of Indian banks, corporates and other entities will continue to be assigned under the Fitch Ratings brand.

Atul Joshi, md and ceo of Fitch Ratings India, will serve in the same role as he leads the rebranded India Ratings.

CDO

ICP settlement finalised

ICP Asset Management and its founder and president Thomas Priore have agreed to settle the US SEC's charges that they defrauded several CDOs they managed. A settlement in principle had been agreed last month (SCI 17 August).

ICP, Priore and related entities have agreed to pay more than US$23m. It settles charges that they engaged in fraudulent practices and misrepresentations that caused the CDOs to overpay for securities and lose millions of dollars, as well as improperly obtaining fees and profits at the expense of the CDOs and investors.

Priore will pay US$1.5m in disgorgement, prejudgement interest and a penalty and has consented to a five-year ban from the industry. ICP will pay over US$18m, with affiliated broker-dealer ICP Securities paying almost US$4m.

CLOs

Leveraged vet joins credit manager

Tom Newberry has joined CVC Credit Partners as senior md and head of the group's private funds business. He will be based in New York.

Newberry joins from Credit Suisse, where he was head of global leveraged finance capital markets and syndicated loans. Before that he was at Donaldson, Lufkin & Jenrette as head of US loan capital markets and Deutsche Bank as head of North American loan syndications.

CLOs

CDO vet to lead European expansion

GreensLedge has expanded its European operations with GreensLedge Capital Markets. It has also appointed John Convery as md and head of European investment banking and Paul Levy as md.

Convery joins from Deutsche Bank, where he was head of the global CDO business, while Levy joins from UBS, where he was co-head of EMEA FICC structuring. Both will be based in the firm's London office.

CMBS

Cornerstone grows Asian presence

Cornerstone Real Estate Advisers has opened an office in Tokyo. It will be headed by Kelly Hayes and Peter Gensheimer, who both joined from Savills last month as directors.

Prior to Savills, Hayes was in the CRE finance group at Citigroup, where he spent just over a decade. Gensheimer's experience also includes roles at Cushman & Wakefield, Emmes Asset Management and The Sanwa Bank. Both have deep experience of the Japanese market.

Cornerstone says the Tokyo office will both serve Asian clients and introduce other Asian institutional investors to its US and European investment opportunities. It complements another Asian office in Hong Kong.

RMBS

New REIT ready to launch

Two Harbors Investment Corp has proposed the contribution of its portfolio of single-family rental properties to a newly formed entity intended to qualify as a REIT. The firm has also recruited a new director of investor relations and seen two members of staff move over to the prospective REIT.

In exchange for Two Harbors' portfolio contribution, it would receive shares of common stock of the newly organised Silver Bay Realty Trust Corp. Silver Bay is focused on the acquisition, renovation, leasing and management of single-family residential properties for rental income and long-term capital appreciation.

Silver Bay will be externally managed by PRCM Real Estate Advisers, which is a joint venture between Pine River Capital Management and Provident Real Estate Advisors. A Pine River affiliate also serves as the external manager of Two Harbors and provides acquisition and property management services for Two Harbors' portfolio of single-family rental properties.

Silver Bay has filed a registration statement with the US SEC for its stock offering and intends to acquire two large portfolios of single-family rental properties - the Two Harbors portfolio and the portfolio currently managed by Provident. Subject to the approval of its board of directors and compliance with applicable securities laws, Two Harbors says it would distribute its shares of common stock in Silver Bay by means of a special dividend after the expiration of a 90-day lock-up period following the completion of Silver Bay's proposed IPO.

July Hugen has also joined Two Harbors from Pine River Capital Management as director of investor relations. She will be responsible for the company's investor relations and financial communications programmes. David Miller, previously Two Harbors' business development md, and Christine Battist, previously investor relations md, have moved on to become Silver Bay ceo and cfo, respectively.

RMBS

NCUA files fresh RMBS suit

The NCUA has filed suit against UBS Securities in Federal District Court in Kansas, alleging misrepresentations in the sale of RMBS to US Central Federal Credit Union (US Central) and Western Corporate Federal Credit Union (WesCorp). US Central and WesCorp paid more than US$1.1bn for the securities and each subsequently failed.

NCUA's complaint alleges UBS made misrepresentations and omissions in the RMBS offering documents and claims there was systemic disregard of the underwriting guidelines stated in those documents. Those misrepresentations caused US Central and WesCorp to underestimate the risk of loss.

NCUA has previously filed similar actions against JPMorgan Securities, RBS Securities, Goldman Sachs and Wachovia (SCI passim). Claims worth more than US$170m have been settled with Citigroup, Deutsche Bank Securities and HSBC.

ABS

China's pilot programme progressing

Moody's reports that China's regulators are making steady progress towards establishing a securitisation market in the country. However, as has been the case with other jurisdictions, the process will be long and involved.

"As in other countries, the enactment of a securitisation law in China - which is essential for the market - is a time-consuming and complex process. It will involve and require collaboration between different regulatory authorities, and we note this is happening on the Mainland," says Jerome Cheng, a Moody's vp and senior credit officer.

He adds that the extension of the pilot programme for asset securitisation (SCI 12 June) - which was first promulgated in 2005 - represents an effort to establish the basis for a healthy and sustainable development of a securitisation market through improvements in China's legal, regulatory and credit control systems.

According to Moody's, the three main credit considerations for the development of China's emergent securitisation market are: the existence of a sound and predictable legal and regulatory infrastructure; the sufficiency and integrity of data quality and audit procedures; and the strength of transaction features protecting cashflows in a stressed environment. "The presence of these three factors is critical for the assignment of international standard ratings," notes Cheng. "Addressing these considerations will support the credit quality of future securitisation in China because it would strengthen transaction certainty, enhance asset risk assessment and protect transaction cashflows from the weakening of the relevant transaction parties."

The support of regulators remains crucial to ensure that securitisation legislation is consistent with existing regulations. For instance, approval from the State Administration of Foreign Exchange on foreign exchange-related matters is important in order to ensure the conversion of local currency into foreign currency and the remittance of the converted currency offshore in case of overseas issuances.

Further, sufficient and high-quality data enables investors to evaluate whether the credit protection in a transaction is sufficient to cover against future loss owing to asset deterioration, in particular, during periods of distress. Data sufficiency, however, has been a weakness in China and the data that is needed on asset securitisations is sometimes unavailable at both the levels of the originator and general market, Moody's notes. Such unavailability can be because of the short history of the relevant asset classes, the unwillingness of the originator to provide the data or restrictions based on secrecy laws.

The latest bank to bring an ABS under the pilot programme is China Development Bank. It is currently marketing a RMB10.2bn transaction.

ABS

Drilling rig risks outlined

Fitch has published a report outlining the risks and mitigants associated with drilling rig financing transactions. The move comes as new vessels arrive in Brazilian waters.

"With the discoveries of presalt layer reserves in offshore Brazilian waters and Petrobras's US$236.5bn four-year investment plan, there has been increased demand for drilling rig assets," says Bernardo Costa, a senior director in Fitch's Latin America structured finance group. "Understanding the factors underlying the investment grade ratings of the four drilling rig financing transactions already completed is important as this new asset class develops and deal structures become more complex."

Fundamental factors underlying Fitch's current investment grade ratings on the four transactions totalling US$3.2bn include the development of the local oil and gas industry in Brazil, as well as the relationship between overall transaction leverage and operator/sponsor credit quality and experience, given the potential for the charter agreement to be revoked due to an operator/sponsor credit issue. Also of importance are the structural features that address key exposures, including DSCR triggers and liquidity reserves, which impact overall transaction ratings.

Other essential considerations include the up-time performance of the rigs, rig utilisation and overall supply/demand dynamics of the offshore drilling rig market, the effect of oil prices and upcoming delivery of new builds, and the operating risks and challenges faced by Brazilian rig operators. Finally, Fitch notes that a different rating approach is merited for floating, production, storage and offloading (FPSO) units as distinct from drilling rigs.

ABS

Timeshare delinquencies stabilising

Consistent with seasonal trends, US timeshare ABS delinquencies dropped in the second quarter, according to the latest timeshare index results from Fitch. Total delinquencies for 2Q12 were 3.29%, down from 3.58% in 1Q12.

Year-over-year total delinquencies remain consistent with the 2Q11 level of 3.28%. Delinquencies appear to be normalising at their historical levels, Fitch notes, following the dramatic increases that occurred in 2008 and 2009.

Second-quarter defaults rose slightly to 0.81% from 0.82% in 1Q12, also reflecting a seasonally consistent pattern. Timeshare default trends typically lag those of delinquencies but have also remained relatively consistent year-over-year, increasing nominally from 0.8% during the same period last year.

Fitch's rating outlook for timeshare ABS remains stable due in part to the de-levering structures found in timeshare transactions and ample credit enhancement levels.

ABS

Card delinquencies hit all-time low

Delinquencies for US credit card ABS have plunged to an all-time low, according to Fitch's latest index results for the sector. Delinquencies are now down by 25.74% year-over-year and are also well below the long-term average of 3.02%.

Fitch's 60-day delinquency index reached 1.76% during August. The 6bp decline brought delinquencies down to their lowest level since the agency launched its prime credit card index 21 years ago.

However, Fitch's charge-off index increased by 27bp in August to 4.72%. This month-over-month increase, the first observed since May, was largely driven by a one-time acceleration in the recognition of charge-offs by Chase.

Charge-offs continue to hover around historical lows with a YOY decline of 26.37%. Additionally, charge-offs are substantially below the long-term average of 5.96%. But they remain significantly above the record low of 3.10%, when they had receded from a spike caused by bankruptcy legislation change in 4Q05.

Meanwhile, Fitch's monthly payment rate index reached a new record of 22.34% in August, advancing by 29bp from the previous high of 22.05% achieved in July. Monthly payment rate was up by 5.68% YOY and has consistently remained well above the historical average of 16.55% since 2009.

The Fitch gross yield index came in at 18.24% for August, 26bp higher over July, and remains in line with the historical average of 18.73%. YOY gross yield was down by 8.75%, reflecting a continued run-off of the yield gains realised through implementation of discounting options by trusts comprising the Fitch index.

Finally, Fitch's three-month excess spread index remains substantially higher than the historical average of 6.03%. During August, three-month average excess spread increased for the fourth month in row, inching up 24bp last month to reach 10.87%. This is just 51bp shy of the record set in September 2011.

Structured Finance

Stable outlook for South Korean SF

South Korean Fitch-rated structured finance transactions are well-placed to withstand the country's slowing economy and its high household debt, the agency says. Its outlook for all transactions is stable and all ratings have been affirmed so far this year.

Fitch says deterioration in the performance of the transactions' underlying assets, stemming from rising household debt, is unlikely to be material. This is because of a resilient Korean economy, benign interest rates and a strong labour market, which have kept the debt service burden manageable. In addition, the transactions have sufficient credit enhancement to support current ratings.

RMBS are, in Fitch's view, most resilient to stress due to their ongoing deleveraging and growing CE. Available CE has tripled since closing to 35% on average in 3Q12. Further, their securitised mortgage portfolios have benefited from increased seasoning, low LTV ratios and limited interest-only mortgage loans.

The low LTVs provide strong incentives for borrowers to continue servicing their debt and, in case of default, are supportive of strong recovery. The low LTVs and small number of interest-only mortgage loans also suggest that the portfolios are resilient to a reversal in property prices. No losses have been registered to date.

Fitch-rated ABS transactions are protected by CE ranging between 23% and 34%, as of end-August 2012. Eligibility criteria govern the quality of the asset pools, while performance-related early amortisation triggers prevent the transactions from being exposed to prolonged period of stress.

The latter is particularly positive for credit card ABS, considering the unsecured nature of the loans. The inherently high payment rates of Korean credit card ABS mean that notes would be paid down rapidly on the declaration of an early amortisation event.

Structured Finance

Portuguese country ceiling lowered

Moody's has downgraded to Baa3 the ratings of 47 securities across 32 Portuguese ABS and RMBS. The agency has also placed on review for downgrade the ratings of a further 90 Portuguese ABS and RMBS securities.

The downgrades follow Moody's decision to lower the Portuguese country ceiling from Baa1 to Baa3 on 5 September. The main driver for the rating review placements is the agency's intention to reassess credit enhancement adequacy for each of the rated notes, given the increased risk of economic and financial instability.

Portugal's new country ceiling reflects Moody's assessment of the risks of economic and financial instability in the country and the likely impact this would have on all other borrowers and structured finance instruments in Portugal, as income and access to liquidity and funding could be significantly curtailed under stressed conditions. The ceiling also reflects the risk of exit and redenomination in the unlikely event of a default by the sovereign.

Structured Finance

Unicredit tender announced

Unicredit has announced a tender offer for 22 Cordusio RMBS, F-E Mortgages, Capital Mortgages, Locat and F-E Gold bonds. The liability management exercise will be undertaken via an unmodified Dutch auction. The offer period will expire on 24 September, with settlement expected on 27 September.

Structured Finance

Call for Volcker Rule overhaul

SIFMA has sent a letter to Representative Spencer Bachus, chairman of the House Financial Services Committee, in response to his request for comment on legislative alternatives to the Volcker Rule. The letter was co-signed by the Financial Services Roundtable.

"The far-reaching consequences of the Volcker Rule demand a thorough analysis of the costs and benefits of the current statutory text, the intended goals of the Volcker Rule and potential alternatives to the Volcker Rule to better achieve those goals without triggering consequences that Congress did not intend," the letter said. "We believe that the many problems with the Volcker Rule identified by a wide variety of stakeholders demonstrate the need for a substantive re-evaluation by Congress, and we strongly support the Chairman's initiative to do so."

In its letter to Chairman Bachus, SIFMA urged Congress to explore one wholesale alternative to Volcker that relies on already proposed capital rules and regulations that are under consideration and being implemented as a result of Basel 3 and other initiatives, rather than activities restrictions. A risk-based framework with an effective supervisory overlay - under which higher capital charges would apply to riskier activities as determined by the regulators - would be a more targeted and effective means of addressing the concerns underlying the Volcker Rule, the association notes.

While SIFMA supports a comprehensive re-evaluation of the Volcker Rule, including the risk-based approach, should Congress determine to retain the Volcker Rule framework as enacted, it believes that several modifications to the existing statute are necessary to achieve its goals without harming the ability of banking entities to continue to provide client-oriented financial services. Those modifications include: reversing the presumption that all short-term principal trading is impermissible; eliminating the 'near-term demands' condition on market-making exemption; clarifying the exemption for risk-mitigating hedging; defining 'hedge fund' and 'private equity fund' more narrowly; modifying Volcker to only apply to insured depository institutions and their holding companies; and undertaking a cost-benefit analysis before implementing any regulations.

Structured Finance

Benchmark consultation launched

Following the recent manipulation of Libor, the European Commission has launched a consultation - which will run until 15 November - on possible new rules for the production and use of indices serving as benchmarks in financial and other contracts. It says it is essential that steps are taken to ensure the integrity of benchmarks and the benchmark-setting process.

Commissioner for the internal market and services Michel Barnier comments: "The Commission has already acted quickly to amend its legislative proposals on market abuse. However, changing the sanctions regime alone may not be sufficient: wider work is required to regulate how indices and benchmarks are compiled, produced and used."

The consultation is wide-ranging: it covers all benchmarks - not just interest rate benchmarks such as Libor, but also commodities and real estate price indices - and seeks to identify possible shortcomings at every stage in the production and use of benchmarks. Any solution should guarantee that benchmarks are not subject to conflicts of interest, reflect the economic reality that they are intended to measure and are used appropriately, the Commission says.

CDO

Call for Trups rules clarification

Fitch believes that the US banking regulators' proposed capital rules could be a positive credit event for senior noteholders and potentially negative for subordinate tranches in Trups CDOs. The agency notes, however, that the regulations need to be clarified, as their criteria for some Trups is different from those under the Dodd-Frank Act.

The current proposal would require Trups issued by banks and thrifts with US$500m or greater in assets to be progressively phased out of Tier I capital and into Tier II capital over a term of 10 years. Trups issued by banks with US$15bn or more in assets would have their Trups phased out of Tier I and into Tier II capital over a three-year period. Fitch says that these regulations should be clarified, as they appear to conflict with Dodd-Frank that makes banks with US$15bn or less in assets exempt from this phase-out.

"We believe the most likely Trups to be redeemed have high coupons from financially healthy banks," the agency observes. "In our view, these institutions are the most likely to hold the capital necessary for redemption and have the best chance to effectively issue new instruments (for the purpose of redeeming old ones)."

It also expects these to be smaller banks that are attractive buy-out candidates, as an acquisition could accelerate redemptions. Also, smaller banks are more likely to sell themselves, facing an increasingly costly regulatory environment.

Trups with lower coupons from financially healthy banks are less likely to be redeemed, Fitch adds. "Many of these were issued well before the financial crisis and the coupons may be deducted from the bank's taxes. New preferred issues that are Basel 3-compliant are not tax deductible for issuing banks. Many banks may find these a useful part of their Tier II capital."

Few Trups from financially stressed banks are expected to be redeemed: they are generally not attractive acquisitions; most lack the capital necessary to complete a redemption; and they have limited ability to issue new instruments. Fitch expects them to have higher capital minimums to be adequately capitalised under Basel 3, thus are likely to continue to defer redemptions to build Tier I common capital.

This bifurcation among Trups should translate into a generally positive trend for senior CDO noteholders and potentially negative for junior noteholders, as better capitalised banks are more likely to redeem and repay senior notes while weaker banks would be left in the pool to support the junior notes. In addition, redemption of higher coupon Trups will lower future excess spread, which in many Trups CDOs has for years continued to meaningfully contribute to a build-up of the credit enhancements by paying down senior notes.

Fitch notes that such trends may already be beginning. It has noticed a small up-tick in redemptions within Fitch-rated Trups CDOs over the first six months of 2012 from banks with less than US$15bn in assets.

CDS

DC transparency enhanced

ISDA has published amendments to the Credit Derivatives Determinations Committees (DC) Rules with respect to release of information regarding DC meetings. The association - in its capacity as secretary to the determinations committees - will now draft a Determinations Committee Meeting Statement at the conclusion of each DC meeting, which will describe the issues considered and any resolutions or next steps. Following a review period by the relevant DC, ISDA will then publish the statement on its website.

The initiative is aimed at further increasing the level of transparency related to DC activities and decisions. Existing transparency measures include the publication of the firms participating on the DCs and each individual DC member's votes.

CDS

SEF technology issues examined

In the second of a three-part series on the swap execution facility (SEF) landscape (see also SCI 26 July), GreySpark Partners examines the technology considerations and challenges for businesses in terms of connecting to these venues. 'SEFs: the Technology Landscape' predicts how the network connectivity for both the buy-side and sell-side is set to look and provides key recommendations for the on-boarding of SEFs into the connectivity infrastructure.

The study splits SEFs into three key categories: the large multi-asset venues; concentrated venues operating in a particular asset class; and the smaller venues, which may look to consolidate and strengthen offerings. It then lists the most likely top 12 market leaders, based on product coverage, volumes, current market share and positioning.

Technological aspects - such as the on-going 'buy versus build' dilemma - are covered, as well as recommendations as to how to select a vendor. Other key considerations are also listed, such as which venues and technologies to consider for pre-trade risk management, the delivery of reference data and accessibility to post-trade reporting and clearing.

In addition, the report presents the mix of FIX or native connectivity options that will be available for SEF connectivity. While many venues are aiming to utilise their existing connectivity APIs for their SEF launches, the trend is more towards a FIX protocol-based interface. As a result, many SEFs are currently either offering or planning to support functions over a version of the FIX protocol.

CDS

Index constituent changes anticipated

The Markit iTraxx Main and Crossover indices are scheduled to roll on 20 September. Adjusting for curve and skew, credit derivative strategists at Morgan Stanley believe the intrinsic trading level for the next series of Main 5Y may be around 3bp tighter than the on-the-run as of yesterday's close of 130bp. For the next series of Crossover 5Y, the intrinsic trading level is likely to be around 56bp wider, relative to the current series at 508bp.

Updated DTCC data suggests that Main S18 may see a number of changes in constituents, especially within the consumer sector. Within the 25 financial names, BBVASM and MONTE will likely roll out of Main and potentially be replaced by INTNED and STANLN, according to the Morgan Stanley strategists.

Within the 100 non-financial names, REPSM will likely become ineligible for Main due to its rating. The updated DTCC data also suggests that BSY, KFT (Cadbury), LINGR, SCABSS and SZUGR may exit the index due to their relatively low liquidity. These names can potentially be replaced by ABIBB, ACFP and HEIANA for the consumers sector, AZN for autos & industrials, SESGFP for TMT and TECFP for energy.

Meanwhile, Crossover constituents must have an average CDS spread of at least twice the average spread of the non-financial members of the new iTraxx Main, based on pricing during the last 10 business days of the month prior to the roll. This implies that CONGR, CWLN, ITVLN, KBW and LHAGR will potentially not be eligible for the next series of Crossover. The strategists indicate that REPSM and CLNVX will most likely be new joiners to Crossover S18, given their relative liquidity.

CLOs

EOD for mezz SME CLO

HEAT Mezzanine I-2005 class B1, B2 and junior notes remain unpaid on their scheduled maturities, with principal amounts outstanding of €3.41m, €1.13m and €28.50m respectively. As such, an event of default has been declared on the transaction.

Class B1 and B2 noteholders now constitute the controlling class. The trustee currently doesn't intend to accelerate the notes or enforce security over the collateral, unless mandated by the controlling class.

CMBS

Marley Station to see hefty ARA

The September remittance for BACM 2005-3 includes a new appraisal for the US$114.4mn Marley Station loan. The underlying property is one of the malls that had been left out of Simon Property's acquisition of Farallon's stake in the Mills portfolio in March 2012 (see SCI's CMBS loan events database).

The loan had been scheduled to mature in July, but was transferred to special servicing in April, citing imminent default. This month's servicer commentary indicates that occupancy has dipped to 58%, as of May.

The latest appraisal pegs the value of the property at US$65m, as of June, implying an 11% cap rate at December 2011 NOI. But further deterioration seems likely, given that leases on 16% of gross leasable area are scheduled to expire in January 2014.

As a result of the updated valuation, CMBS analysts at Barclays Capital expect the loan to take a 50% ARA in the next remittance period, taking into account outstanding P&I advances and a 10% discount to appraisal. This would likely curtail interest on the deal by US$233,000 starting next month, which would push shortfalls up to the E tranche.

The Barcap analysts anticipate that the loan will be resolved through liquidation. "Substantial modifications typically require some form of cash injection by the borrower, which may be unlikely, given Simon's reluctance to increase its equity stake," they conclude.

CMBS

Refi progress boost for GRAND

Most of the revised transaction documents have been settled between Deutsche Annington (DAIG) and the advisors to the ad-hoc group of noteholders in connection with the proposed GRAND restructuring. The news boosted secondary market prices for the CMBS, with SCI's PriceABS BWIC data showing that a €43m slice of the GRND 1 C tranche was covered at 93.78 on Friday. The same tranche was talked variously between 92 handle and 93 area the previous day, and was covered at 91.73 on 14 August.

DAIG intends to complete a second restricted period for the ad-hoc group and commence a lock-up solicitation process by 19 October, with the first court hearing anticipated for the third week of November. On that basis, the proposed plan is expected to be effective prior to the end of 2012.

CMBS

Uni-Invest acquisition completed

TPG and Patron Capital have closed their joint venture acquisition of Uni-Invest, following approval by the Dutch courts. The properties - which comprise 142 offices, 54 warehouses and seven retail outlets, providing an annual rent of €62m - will be held in an SPV dubbed Utrecht Holdings.

Goldstar Research reports that asset management will be implemented, with the aim of increasing occupancy, selling around 10% of the assets that are underperforming and redeveloping 4% of the portfolio into hotels, residential and student housing. Current vacancy rate is 35%, although this figure could increase to 50% by the end of the year.

Following final distribution and payment of accrued interest on the credit bid settlement date, Opera Uni-Invest class A notes were extinguished and classes B to D were extinguished according to the limited recourse provisions of the CMBS. Class A noteholders received €141.4m principal versus a balance of €143.5m, which is believed to be due to unforeseen closing expenses.

CMBS

GGP refis announced

GGP has closed US$1.5bn of new financing on seven properties across the US. Two of the properties have outstanding CMBS debt and are expected to see pay-offs in the near term.

One of these properties - Glendale Galleria - backs a US$111.4m loan securitised in MLMT 2005-LC1 and another US$125.7m loan in MLMT 2005-CKI1. The other property - Rogue Valley Mall - backs a US$24.8m loan securitised in BACM 2003-1.

The new loans have a weighted average interest rate and term of 3.88% and nine years respectively, compared to a rate of 5.58% and a remaining term-to-maturity of less than one year. The transactions generated approximately US$137m of net proceeds after repaying the existing mortgage notes, GGP says.

CMBS

CMBS loan pay-offs rebound

The percentage of US CMBS loans paying off on their balloon date rebounded sharply in August from the previous month's dismal reading of 26%, according to Trepp's latest pay-off report. Last month 49.6% of loans reaching their balloon date paid off.

In many ways, the improving pay-off rate was to be expected, Trepp says. For the first half of the year, many five-year loans originated in 2007 reached their balloon date. Most of these loans have had difficulty refinancing, which led to a significant dip in the percentage of loans paying off over the last few months.

For the remainder of the year, the loans reaching their maturity date should be more heavily skewed to earlier vintages. Loans from those periods were made with lower leverage and more reasonable valuations. The result should be better pay-off numbers in the coming months.

The August total of 49.3% was well above the 12-month average of 42.4%. By loan count (as opposed to balance), 56.3% of loans paid off. On the same basis, the 12-month rolling average is now 53.3%.

CMBS

New CMBS criteria unleashed

S&P has issued two criteria articles it will use to rate US and Canadian CMBS: a methodology for deriving credit enhancement levels; and global property evaluation criteria. The move follows the agency's request for comment on the proposals in June (SCI 6 June) and has resulted in 744 classes from 188 CMBS being placed on credit watch.

The criteria are designed to improve and simplify S&P's approach to rating CMBS transactions, as well as harmonise its approach for evaluating commercial real estate across the globe. In particular, the criteria: institutes a single comprehensive framework for rating stand-alone, large-loan and conduit/fusion US and Canadian CMBS transactions; establishes a triple-A credit enhancement level of approximately 20% for a typical, well-diversified conduit/fusion transaction; utilises a recovery-based analysis as the basis of the framework; incorporates a lifetime default probability concept that is driven by each loan's credit quality, as measured by S&P LTV and S&P DSC; and adjusts credit enhancement levels to account for varying levels of transaction diversity after calculating S&P LTV and S&P DSC.

In addition, the criteria implements a comparable global approach to property analysis based on a long-term sustainable property valuation rather than a point-in-time market valuation. The economic stress associated with this analysis is akin to a single-B stress level. The approach is differentiated depending on whether properties are located in primary, secondary or tertiary markets and apply different capitalisation rates to better reflect the relative strength of those markets.

"We reviewed and appreciated the feedback from more than 300 market participants during the comment period," comments Gary Carrington, global criteria officer for S&P CMBS ratings. "The insights we received were instrumental in helping us complete the enhancements to our CMBS rating methodology and reinforced the direction we took with our initial proposal, while providing valuable observations that allowed us to further strengthen key areas of the criteria."

In conjunction with the revised criteria, S&P placed its ratings on 744 classes - representing 10.5% of outstanding ratings and an aggregate principal amount of US$101.8bn - from 188 US and Canadian CMBS transactions on credit watch, indicating that the ratings may be changed in the next six months. Of the placements, 317 ratings are on credit watch positive, 405 on credit watch negative and 22 on credit watch developing.

By vintage, more than 97% of the classes from more recent transactions issued in 2009 or later are either unaffected or under consideration for an upgrade. In comparison, more than 91% of the classes from transactions issued between 2005 and 2008 are either unaffected or under consideration for upgrade. Transactions issued between 2005 and 2008 constitute the vast majority (87.6%) of the total potential downgrades.

Based on the tranche payment seniority for conduit/fusion transactions, over 98% of the ratings on super-senior tranches are either unaffected or under consideration for upgrade. In comparison, just under 80% of the ratings on AM tranches are either unaffected or under consideration for upgrade. Additionally, slightly less than 65% of the ratings on AJ tranches are either unaffected or under consideration for upgrade.

At the same time, S&P placed its ratings on two classes from one US CRE CDO and two classes from one US re-REMIC on credit watch with negative implications and one rating on one class from one US re-REMIC on credit watch with positive implications. Its ratings on 242 classes from 27 US CRE CDOs previously placed on credit watch negative remain on credit watch negative. These placements affect 28.3% of the ratings S&P has assigned to CRE CDO and re-REMIC transactions and represent an aggregate current amount of US$11.9bn.

NPLs

Managed NPL deal prepped

Further details have emerged about Oaktree Capital Management's non-performing loan CMBS (SCI 19 August). Dubbed ORES NPL series 2012-LV1, the transaction will be managed by Sabal Financial Group.

The deal - which is arranged by JPMorgan - comprises a US$195m single tranche of notes rated triple-B minus by Fitch. The pool consists of 615 performing and non-performing real estate secured loans, 22 non-real estate secured loans, 49 unsecured loans and 78 REO properties acquired at acquisition or through foreclosure. Prior to securitisation, the assets were owned by private investment funds managed by Oaktree in separate subsidiaries that held the loans and the REO collateral.

Unlike traditional CMBS transactions, all collections are aggregated and applied to a single waterfall, and no proceeds will be distributed to the equity holders until the notes have been paid in full. The Rialto and Square Mile NPL CMBS from earlier in the year were also liquidating trusts.

Risk Management

Pricing engine enhanced

Pricing Partners has launched Price-it Excel 3.0, a streamlined version of its pricing engine. Among the new features included in the service are: a simplified pricing process; centralised product description and pricing results; hundreds of templates that allow users to price any standard product easily; and extensive risk measurement reporting on both trade and portfolio levels.

Risk Management

Reconciliation platform offered

MarkitSERV has launched PortRec Xpress, a new service designed to help asset managers reconcile their OTC derivatives portfolios quickly and efficiently. The launch of the service comes as regulators worldwide are expected to mandate asset managers to reconcile their portfolios on a daily, weekly, monthly, quarterly or annual basis as part of the drive to reduce operational and financial risk in the derivatives industry.

Designed for the needs of managers of vanilla derivative portfolios, PortRec Xpress is a web-based system that reconciles position information maintained by buy-side firms and their counterparties. A star-rating system enables users to view how closely their position information matches that of their counterparties, alerting them automatically when discrepancies arise. An integrated online dispute resolution system also helps counterparties resolve these disputes in a timely manner.

PortRec Xpress connects to the MarkitSERV trade affirmation/confirmation platform and will be integrated with MarginSphere, a collateral messaging and management service available from Acadiasoft through the MarkitSERV portal. From next year, it will also enable buy-side firms to reconcile their position information with clearinghouses and swaps data repositories in accordance with new regulations.

RMBS

Enhanced GSE reps and warranties unveiled

The FHFA has launched a new representation and warranty framework for Fannie Mae and Freddie Mac conventional loans sold or delivered on or after 1 January 2013. The new approach - which is part of a broader series of strategic initiatives called seller-servicer contract harmonisation - aims to clarify lenders' repurchase exposure and liability on future deliveries.

"Ultimately, better quality loan originations and underwriting, along with consistent quality control, help maintain liquidity in the mortgage market while protecting Fannie Mae and Freddie Mac from loans not underwritten to prescribed standards," comments Edward DeMarco, acting director of FHFA. "These efforts contribute to a firm foundation for a new, sustainable housing finance system for the future."

Under the new framework, lenders will be relieved of certain repurchase obligations for loans that meet specific payment requirements, while HARP loans will be eligible for rep and warranty relief after an acceptable payment history of only 12 months following the acquisition date. The new model moves the focus of quality control reviews from the time a loan defaults up to the time the loan is delivered to Fannie Mae or Freddie Mac.

Consequently, the GSEs will: conduct quality control reviews earlier in the loan process, generally between 30 to 120 days after loan purchase; establish consistent timelines for lenders to submit requested loan files for review; evaluate loan files on a more comprehensive basis to ensure a focus on identifying significant deficiencies; and make available more transparent appeals processes for lenders to appeal repurchase requests. Additional contract harmonisation projects directed by FHFA, including servicer performance metrics and remedies for servicing breaches, will be announced in the coming months.

RMBS

Dutch RMBS stress tested

Triple-A ratings of Dutch prime RMBS are resilient to significant macroeconomic stresses and it would take stress well beyond Fitch's current expectations to see most triple-A rated notes downgraded. The triple-A rated notes have, on average, enough credit protection to cover over 9x the losses expected in the agency's base-case scenario.

Fitch's base-case scenario assumes an average default rate of 4% and a further house price decrease of 7%. In order for losses to materialise on triple-A notes, the agency would expect an average default rate of 20% combined with a further house price decline of 40%. Unemployment rates, changes in unemployment benefit and the Dutch government's support for the Dutch housing market - mainly through the tax deductibility of mortgage interest payments - are the main factors that could influence default rates, while house prices are the main driver of loss severity.

The agency assumed a moderate stress scenario in which unemployment rises to between 9% and 11%, house prices fall 27% from current levels and housing market support is cut faster than currently suggested. In its severe stress scenario, unemployment increases to around 15%, unemployment benefits are halved, house prices fall by 37% and mortgage interest tax deductibility is capped at very low levels. These scenarios would result in average default rates of around 6% and 13% respectively.

Under the moderate stress scenario, more than half the triple-B notes would be downgraded by a category or more. The severe scenario would see more than half of current triple-A ratings cut to sub-investment grade and 92% of notes experiencing some kind of downgrade, with the vast majority of notes rated triple-B and lower cut to distressed levels. But Fitch notes that both the moderate and severe scenarios are very unlikely to materialise.

In terms of number and severity of downgrade, the most affected triple-A tranches in the severe scenario were the 2006 and 2007 vintages, illustrating the weaker credit protection in deals originated at the peak of the market. The 2011 and 2012 vintages, which have not benefitted from deleveraging, were also severely affected.

Deals backed entirely by NHG-guaranteed loans were more likely to be downgraded under both scenarios. This reflects the lack of deleveraging, given these transactions have recently been restructured, Fitch concludes.

RMBS

UK prime RMBS stress tested

Triple-A ratings of UK prime RMBS can withstand significant macroeconomic stress testing, encompassing rising unemployment and interest rates and collapsing house prices, says Fitch. On average, triple-A rated notes in UK prime RMBS programmes have enough credit protection to cover more than 20x the losses expected in the agency's base case and would only suffer losses if 50% of mortgage portfolios defaulted and house prices fell by a further 40%-50%.

In a severe scenario, in which the majority of triple-A notes are downgraded to below investment grade, none would be downgraded to distressed rating levels. This scenario would reflect a combination of unemployment reaching 22%, mortgage interest rates rising to around 12% and house prices halving from current levels. Fitch considers this very unlikely to occur.

"In particular, we do not think interest rates would rise in a severe recession. This means ratings could withstand even greater stresses to unemployment and house prices than would be the case outlined above," it says.

In a moderate scenario, in which the majority of triple-B notes are downgraded by at least one category, no triple-A notes would be downgraded. This scenario would require unemployment to rise to around 11% and mortgage interest rates to rise to around 6%, while house prices fall by further 32%.

These are also well beyond Fitch's base-case assumptions, which assume UK house prices falling by 11% from current levels and approximately 6% of borrowers on average defaulting across UK prime portfolios. Based on existing evidence of borrower behaviour, its moderate unemployment and interest rate stresses would result in an average default rate of around 10%.

The stress study also highlights that master trust structures are more exposed to macroeconomic stress, as they do not benefit from deleveraging compared with pass-through deals.

RMBS

Adverse selection hits pre-2005 RMBS

One of the strongest US residential mortgage vintages is now increasingly susceptible to rating downgrades, according to Fitch. The agency points to adverse selection as the main factor behind this.

Prime RMBS deals that were originated prior to 2005 have historically performed well. Principal losses are well below 1% among the roughly US$650bn in pre-2005 Fitch-rated prime RMBS. Additionally, over 93% of this volume has already been fully repaid.

However, increased adverse selection has recently resulted in higher delinquencies for pre-2005 loans. "Many high-quality mortgage borrowers are refinancing to take advantage of record-low interest rates, leaving the remaining mortgage pools increasingly concentrated with borrowers unable to refinance," explains Fitch md Grant Bailey. Adverse selection coupled with already existing tail risk is subsequently increasing negative rating pressure on the remaining bonds.

Fitch recently placed a number of underperforming classes from the pre-2005 vintage on rating watch negative. "While additional negative rating actions are likely, pre-2005 senior classes are by and large expected to retain investment grade ratings and recover full principal," Bailey adds.

Fitch expects to resolve the rating watch placements over the next few months.

CDS

Solid fundamentals

Umang Vithlani* highlights a sterling bond versus 10-year CDS basis trade idea

Iberdrola is a Spanish-based vertically integrated utility, with activities in generation (including significant renewable), transmission, distribution and supply throughout Spain, the UK, the US and Latin America. Since 2007, the firm has expanded its global footprint through a series of acquisitions, including UK-based Scottish Power for €17.1bn in 2007, US-based Energy East for €6.2bn in 2008 and Brazilian distribution company Elektro for €2.8bn in 2011.

Despite acquisition activity in recent years, Iberdrola has maintained a strong balance sheet focus, tapping equity markets for €3.4bn in conjunction with the Energy East deal and raising €2bn from Qatar Holdings in 2011, cutting investment spend and paying a scrip dividend. Current liquidity is enough to cover the firm's needs for the next 24 months and 80% of debt maturing in 2012 has already been financed.

Revenues and EBITDA from emerging markets continue to increase. For example, revenues from Brazil rose by 76.5% and 60% respectively this year and last.

Cashflow increased by 5.8% in 2011 and gross margin by 3.3%. Stable cashflows were generated by the groups' regulated (47% of EBITDA) and quasi-regulated (18% of EBITDA) activities.

Trade suggestion
Over the course of the last year, euro assets have largely outperformed sterling assets as European corporate bonds have replaced traditional financial and government assets as the safe haven. Furthermore, even within sterling assets there has been dislocation.

With respect to Iberdrola, there are two sterling assets that trade particularly cheap relative to similar maturity sterling assets - these are the IBERD 6% 2022 and the IBERD 7.375% 2024 bonds. These bonds are actually 250bp cheap on a Z-spread basis.

They have weakened this year as the sterling community has shied away from periphery debt. At the same time, the other similar maturity Iberdrola debt is old Scottish Power issued bonds (which Iberdrola acquired) that are seasoned and locked away in portfolios - hence their outperformance.

Given ECB president Mario Draghi's recent comments about 'unlimited' fire power and the ability to use sterling-denominated assets now as collateral, it is likely that all credit spreads will tighten in the near term but outperformance can also be expected from sterling assets of companies with solid fundamentals, such as Iberdrola. Despite the fact that Iberdrola is likely to perform on an outright basis due to these reasons, the recommendation here is to use CDS as a hedge to convert the trade into a purer arbitrage idea.

First, IBERD 6% 2022 is selected for the trade, given it is a closer maturity match to liquid CDS points and additionally has a lower cash price than the 2024 bond. 10-year CDS is chosen rather than five-year for duration match-up/cost and CDS being historically higher beta than cash has provided excellent downside protection in periods where peripheral credits have come under particular pressure.

Finally, given the recent rally and with CDS being high beta - CDS has reacted faster than cash to the rally - the all-in entry levels are very appealing here with the basis at its all-time wide. There may be some short-term volatility while CDS continues to outperform, but this trade should do very well.

I suggest entry levels of Z+450bp on the bond and 310bp on the CDS. Performance target is 100bp, with a stop-loss at 50bp.

*Umang Vithlani is a credit portfolio manager seeking new opportunities