Contents

RMBS

Too tight?

Investors consider options as UK RMBS keeps tightening

The UK RMBS market re-priced over the summer, tightening to ranges not seen for a long time. While some investors may consequently hunt elsewhere for yield, prime product remains attractive and could tighten even further.

A year ago it seemed fanciful that triple-A rated new issue European RMBS paper would print as tight as 100bp, but a lot has changed in those 12 months. "The latest Holmes deal priced at 75bp and we have seen other deals trading in the secondary market as tight as 50bp and 60bp, so we have certainly breached the 100bp level and moved into a new range," confirms Rob Ford, ABS portfolio manager at TwentyFour Asset Management.

Ford believes that the market range has moved from 120bp-160bp to something closer to 50bp-80bp. Indeed, he says it could be even tighter. Yorkshire Building Society's Brass 2 RMBS certainly supports this view, with the £600m 1.85-year senior tranche printing at 58bp over three-month Libor on Friday.

There does not seem to be one specific cause behind the tightening; instead, several factors have coincided to drive the market. Policymakers have undoubtedly played a role, with the ECB's rate cut two months ago providing a catalyst.

"When the ECB cut the reference rate from 75bp to 50bp, they also cut the deposit rate, taking it from 25bp to zero. My understanding is that in the days following the cut, somewhere in the region of €500bn was removed from ECB deposit accounts, and that cash is now looking for an investment to give it some sort of return," says Ford.

In addition, the UKAR tender results were significant, as they removed some secondary supply from the market. But Ford also points to an S&P comment from the summer suggesting that a large number of European money market funds had given notice of closure because they could no longer generate a positive net return.

"Over the last couple of months there has been a grab for yield and a grab for product at the short end, as well as much lower absolute interest rates and the fact that there are fewer eligible assets out there. So those assets that are eligible have become further squeezed and started trading at lower and lower yields," he explains.

The Bank of England's funding for lending scheme (FLS) also seems to be having an effect on the market. Andrew Lennox, lead portfolio manager for ABS at ECM, says the extent of that impact will be clearer once third-quarter statistics have been released. But the fact that the interest rate under the scheme is determined by the level of an institution's net lending already appears to be motivating RMBS issuers in divergent ways.

For example, Santander is reducing its mortgage lending activity, so it makes sense for it to continue to tap the RMBS market. On the other hand, Leeds Building Society - which is increasing its mortgage lending activity - pledged its inaugural deal to the FLS. Many lenders have already funded themselves for the year, so the advent of the FLS led many observers to revise their issuance forecasts down even further.

Ford says: "Speculation usually leads to a market reaction and we have certainly seen a lot of speculation around FLS. The consensus seems to be that it will have an impact on securitised product issuance in the UK for the next year or so, but it is only a temporary project and larger regular issuers will not abandon their investor base entirely because they might never win them back."

The FLS was established when the market was quietening down for the summer and has added further momentum to the rally. It has also proven to the wider market how close the ABS industry is to the real economy, according to Lennox.

Jonathan Wyles, ABS specialist at ECM, adds: "The scheme has generally made the ABS market more competitive: tighter spreads pave the way for other, less vanilla assets to be securitised. This is already filtering into the rest of the market, with UK non-conforming RMBS and Spanish mezzanine paper picking up a healthier bid."

Ford acknowledges that investors will always seek value. US investors have been heavily involved in the European market and could be put off if spreads went inside 50bp or as tight as 25bp. European investors, too, might then be tempted to look elsewhere for yield and non-conforming or peripheral RMBS would certainly be candidates.

"Investors will move to where they see value and that depends on where they perceive the risk to be. UK non-conforming RMBS, for example, has seen some negative performance but actually most deals contain a decent amount of loss protection," Ford says.

He continues: "The UK non-conforming market has not actually performed that badly. For example, there are three RMAC deals that - as of their most recent IPDs - have returned to making principal payments on a pro rata basis because delinquencies have now improved to below previously breached trigger levels."

Peripheral jurisdictions, however, are a different story. The fundamental problems in Ireland, Italy, Portugal and Spain - not to mention Greece - would give most investors pause for thought.

Ford concludes: "There are big problems in Spain, for example. With these jurisdictions, you have to be very, very brave or very, very knowledgeable to invest there. But, in that case, you are unlikely to be the kind of investor who is grabbing for yield."

JL

CMBS

Spread divergence as supply spikes

After a series of slower sessions, the secondary US CMBS market saw BWIC volume increase dramatically yesterday. SCI's PriceABS BWIC data shows over 150 line items for the session, with some interesting price movement evident.

A US$24.41m slice of UBSCM 2012-C1 C, which is almost exactly half the tranche, was covered on Thursday at 288. On 14 September a US$5.5m piece had been covered at 300 and that same size was covered even wider on 15 August, at 337. Earlier in that month there were covers of 341 and 359.

It was a different story for CSMC 2007-C5 AM, which saw a US$3m piece covered yesterday at 635. That was wider than the 625 cover that a US$10m piece attracted last Friday (14 September). However, it is still considerably tighter than a month ago, after August proved a particularly unstable month - a US$12.875m piece traded in the mid-700s on 21 August, but a US$5m slice was talked between 525 and the mid-600s on 9 August.

Figures from Interactive Data put the day's BWIC volume at US$675m. That is up from US$208m on Wednesday (US$408m after a large GSMS 2012-ALOH XA block), US$209m on Tuesday and the even smaller US$113m seen on Monday.

JL

RMBS

Near-prime focus

The secondary European RMBS market began the week with Dutch near prime mezzanine tranches drawing traders' attention. SCI's PriceABS BWIC data shows that two lists in the sector traded yesterday and another is expected next week.

The first list was a single-name BWIC for a €3.118m slice of EMFNL 2008-1X A2. The tranche was covered in the centre of talk at 94.

The second list had three line items: ESAIL 2007-NL1X C, ESAIL 2007-NL1X E1 and E-MAC NL06-2 D. The first ESAIL tranche did not trade, having been talked at between 43 and high-40s, while the latter ESAIL tranche covered at 39.26 following talk ranging from the high-30s to the low-50s. The E-MAC deal traded at an unspecified level following talk between the low- and high-20s.

A further list of five EMFNL tranches with a total current face of around US$55m is slated to trade next Tuesday, 2 October, with price talk expected to start circulating today.

MP

RMBS

Subprime drives secondary RMBS

The secondary US RMBS market saw BWIC volume of US$934m yesterday, according to Interactive Data estimates.

"Overall BWIC volume has surpassed the prior session, led by the increase in the supply of subprime bonds out for the bid. The sector has a stable tone, with trading levels falling within the bounds of dealer guidance," Interactive Data notes.

Some of those subprime names have shown up in SCI's PriceABS BWIC data, with tranches such as FMIC 2007-1 2A2 and RASC 2006-KS9 AI3 both captured in the archive. The former was talked at the mid/high-40s yesterday, having been talked at mid-40s on 10 August. The latter was also covered during the session, having been talked at the mid-60s.

There has also been some tightening in assets beyond subprime. Tranches such as BALTA 2005-7 22A1 have gone from being talked in the very low-70s on 8 August to the low-80s yesterday. Fellow Alt-A tranche FHAMS 2006-FA8 1A8 was talked during yesterday's session in the high-50s, having been in the mid-50s on 6 August and low-50s on 20 June.

Other names of interest are CMLTI 2006-AR1 1A1 - which was talked yesterday in the low/mid-90s, having previously been talked at the mid/high-80s, mid-80s and high-70s on 21 August, 1 August and 20 July respectively - and HVMLT 2006-12 2A2A. This bond was talked at the very low-70s, having been in the high-60s on 10 August and mid-60s four days before that.

JL

Structured Finance

Level playing field sought

Calls for even-handed regulatory treatment of European ABS and covered bonds have re-emerged (see also SCI 6 October 2011). Solvency II capital requirements, in particular, are seen to be punitive for ABS instruments.

"Solvency II rules, as they stand, don't make sense for UK and Dutch triple-A rated RMBS," confirms Andrew Lennox, lead portfolio manager for ABS at ECM. "Rating agencies and regulators are still using the US subprime fall-out to inform their models regarding capital requirements. Unfortunately, the idea that regulators have to treat the system globally still stands, but it isn't appropriate from a performance perspective."

He points to the fact that the overall European ABS market has only suffered a 1% loss since the financial crisis. Further, the rating agencies' expected loss for triple-A rated ABS is 0.8%, versus the 7% that insurance companies will need to hold against one-year triple-A ABS assets under Solvency II rules. In comparison, the equivalent capital charge for covered bonds is 0.7%.

"We'd like to see the ABS market being regulated on a level playing field. Ultimately, the regulatory environment will determine whether the market continues in size," Lennox observes.

The advent of the Prime Collateralised Securities (PCS) initiative is seen as a positive step forward for the market (SCI 12 June). First, it represents the first time that the ABS industry has got together and lobbied effectively - momentum that, it is hoped, will now be channelled towards Solvency II.

Second, the PCS initiative could open up the ABS market for insurance companies, which are otherwise penalised by Solvency II. "If bonds with the PCS label are treated differently from a regulatory capital perspective, some investors would likely pay up more for them, knowing that there would be better liquidity for the notes. It will be interesting to see whether the market bifurcates, with PCS securities performing and pricing better than non-PCS securities. It could also have the effect of lessening the reliance on rating agencies," concludes Jonathan Wyles, ABS specialist at ECM.

CS

Structured Finance

SCI Start the Week - 24 September

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

Pipeline
A handful of transactions remained in the pipeline by the end of last week. Three of the deals were CMBS: US$448.2m FREMF 2012-KP01, US$1.14bn JPMCC 2012-C8 and US$406m MSBAM 2012-CKSV. The remainder comprised of auto-related ABS (C$398.6m NCAR LP Promissory Note 2012-1 and A$150m Liberty Series 2012-1) and a student loan issuance (US$375m Minnesota Office of Higher Education 2012).

Pricings
A swathe of transactions went on to price during the week, including five CLOs and four auto-related ABS. The CLOs comprised: US$596.04m Carlyle Global Market Strategies CLO 2012-3, US$400m Sound Point CLO I, US$450m AMMC CLO XI, US$516.3m Atrium VIII and US$409.3m Flatiron CLO 2012-1. The auto ABS consisted of: US$184m United Auto Credit Securitization 2012-1, US$300m Westlake Automobile Receivables Trust 2012-1, US$600.8m Enterprise Fleet Financing Series 2012-2 and US$715m Toyota Auto Receivables 2012-B Owner Trust.

In addition, four RMBS printed last week: £1.1bn Brass 2, €526m Dutch MBS XVII, £200m RMS 26 and US$310m Sequoia Mortgage Trust 2012-4. Two student loan ABS (US$235.4m Scholar Funding Trust 2012-B and US$235m Education Loan Asset-Backed Trust I series 2012-1) and two equipment ABS (US$752.05m CNH Equipment Trust 2012-C and US$541.59m GE Equipment Midticket Series 2012-1) also priced. The €754m Florentia CMBS and US$300m Cronos Containers Program I series 2012-2 rounded out the issuance.

Markets
After the reach for spread products and yield last week following the Fed announcement, markets are settling into the new reality of an extended low yield environment, according to Bank of America Merrill Lynch CLO analysts. "During this period, there has been an increase in investor participation in the secondary market. The depth of the CLO market is growing further as more investors look for spread and we believe this interest will continue to expand," they say.

Following a series of slower sessions, the US CMBS market saw BWIC volume increase dramatically last Thursday, as SCI reported on 21 September. PriceABS BWIC data showed over 150 line items for the session, with some interesting price movement evident.

US RMBS BWICs also saw an increase in volume, when on Wednesday activity surpassed the prior session, led by the increase in the supply of subprime bonds out for the bid (SCI 20 September). The sector has a stable tone, with trading levels falling within the bounds of dealer guidance. Some of those subprime names appeared in SCI's PriceABS BWIC archive, with tranches such as FMIC 2007-1 2A2 talked at the mid/high-40s last Wednesday, having been talked at mid-40s on 10 August.

Meanwhile, the US ABS secondary market showed a little weakness in short benchmark spreads under the deluge of newly printed auto ABS. However, JPMorgan ABS analysts report: "Investors have quickly pounced on even the slimmest concessions, leaving the overall positive tone unchanged. Beyond benchmark auto ABS, sectors and names offering more spread continue to trade extremely well and garner strong interest in secondary." 

Deal news
• Structured products strategists at Wells Fargo predict that total US consumer ABS issuance will reach US$170bn for full-year 2012 - an approximately 60% increase over 2011. They expect about US$20bn of new consumer ABS in September alone, assuming the usual seasonal patterns hold and there are no macroeconomic or political disruptions, with the issuance pace remaining brisk in October and November.
• The Markit iTraxx CEEMEA and Markit CDX LatAm Corporate indices - the first CDS indices referencing the regions' corporate debt (SCI passim) - launched on 20 September. The indices will enable investors to gain or hedge exposure to corporate credit risk in CEEMEA and Latin America at a time when there is growing demand for corporate debt from emerging markets, Markit says.
• Two Titan CMBS - Titan Europe 2006-3 and Titan Europe 2006-5 - are expected to see major losses, based on recent regulatory filings. The regulatory notice regarding Titan Europe 2006-5 advises that a discrepancy in regulating the priority of payments for the €239.58m DIVA Multifamily Portfolio loan has been resolved. The other notice is in connection with the €23.64m AS Watson loan, the underlying property of which has been sold for total sale proceeds of €14.3m.
• Deutsche Bank has sold its European CMBS servicing operations to Situs. The bank already transferred its primary servicing role for four transactions to Situs Asset Management, effective from 14 September, and has sub-delegated to the firm its duties under the servicing agreement in respect of nine others.
• Morningstar has added the US$69.2m Oxford Valley Mall loan - securitised in the GSMS 2011-GC3 CMBS - to its watchlist, following a drop in reported occupancy, as of 31 March. An office building on the site (One Oxford Valley) has 69% of its space available for lease and one mall anchor (Boscov's) is vacant.
• Investors would likely change their mandates to purchase F2 rated paper in the absence of alternative short-term investments, if European ABCP conduits lost their F1 rating, Fitch suggests. The agency says that this would limit the impact of downgrades on the US$1trn global ABCP market and reduce concerns that an important source of funding for the real economy would be removed.
• High levels of negative equity will drive losses in Irish RMBS to 9.5% based on defaults peaking at around 20% in early 2013, according to Moody's. However, uncertainty over the full extent of losses remains, as a result of the growing effect of moral hazard.
• Declaration Management & Research has replaced key management personnel in respect of five structured finance CDOs - Independence I, II, IV and V CDOs, and Straits Global ABS CDO I. Three managers specified in the transactions' documents as key management personnel of the collateral manager are no longer employed by Declaration.
• The holders of significant voting rights in more than US$28bn of Morgan Stanley-issued RMBS and US$45bn of Wells Fargo-issued RMBS have sent a notice of non-performance to Morgan Stanley and Wells Fargo. The notice identifies covenants in pooling and servicing agreements which the holders allege have not been carried out, materially affecting the rights of the noteholders and constituting an ongoing event of default.
• Finacity Corporation and ING Belgium have facilitated the successful closing of a pan-European trade receivables securitisation for Sonae Indústria SGPS. The securitisation programme will provide Sonae Indústria with cash proceeds of up to €100m through the on-going purchase of receivables from its European operations.
• Wells Fargo, as trustee for the transaction, will conduct an auction for RFC CDO I on 1 October. The collateral will only be sold if the liquidation results in sale proceeds, together with the balance of all eligible investments and cash in the accounts, greater than or equal to the redemption amount.

Regulatory update
• A new Dutch Securitisation Association (DSA) is expected to launch imminently. The project was initiated by Holland Financial Centre (HFC) in October 2010, with the aim of representing parties involved in Dutch RMBS and improving capital market access for issuers.
• The CFTC has provisionally approved an application by DTCC Data Repository (DDR) to create and operate a multi-asset class swap data repository in the US. The service will be fully ready to operate on 12 October, the first day of required reporting of trades in credit and interest rate derivatives under the CFTC rules.
• The Basel Committee has published the latest results of its Basel 3 monitoring exercise. A total of 209 banks participated in the study, including 102 Group 1 banks and 107 Group 2 banks.
• The IASB has issued a draft of its long-planned update of general hedge accounting rules. Moody's suggests that the new rules are a positive development for investors because the revised reporting guidelines provide a better description and linkage between a company's risks and its corresponding risk-mitigations.

Deals added to the SCI database last week:
Ally Auto Receivables Trust series 2012-SN1; BMW Floorplan Master Owner Trust series 2012-1; CARDS II Trust series 2012-4; CGCMT 2012-GC8; CPS Auto Receivables Trust 2012-C; Credit Acceptance Auto Loan Trust 2012-2; Exeter Automobile Receivables Trust 2012-2; FCT Copernic 2012-1 ; Ford Credit Master Owner Trust A Series 2012-4; Ford Credit Master Owner Trust A Series 2012-5; HLSS Servicer Advance Receivables Trust series 2012-MM1; HLSS Servicer Advance Receivables Trust series 2012-T1; HLSS Servicer Advance Receivables Trust series 2012-VF1; Marea CLO; Marine Park CLO; Mercedes-Benz Auto Receivables Trust 2012-1; Motor 2012-1; PFS Premium Finance Series 2012-B; SLM Student Loan Trust 2012-6; UBS-Barclays 2012-C3; USAA Auto Owner Trust 2012-1; and VCL 16.

Top stories to come in SCI:
Counterparty de-linkage frameworks

ABS

ABS syndicate strengthened

Tristan Cheesman has joined JPMorgan's European securitised product group syndicate in London. He moves from Commerzbank and reports to James Crispin, head of ABS syndication at JPMorgan.

Structured Finance

Research trio recruited

Janus Capital Group has enhanced the fundamental research capabilities of its fixed income investment team with three new appointments.

Jason Brooks has been named global securitised products analyst, a new position on the fixed income team. Prior to joining Janus, Brooks served as director of CMBS research at TIAA-CREF and in mortgage research roles at both TIAA-CREF and Gramercy Capital Corp.

Craig Klein has joined Janus' fixed income investment team as a global credit analyst. He previously served as executive director in the special situations group at UBS Securities and before that was the founder and managing member of Redrock Capital Management.

Corinna Lyon has been appointed portfolio information analyst. This is a new position, in which she will help enhance Quantum, Janus' proprietary risk management system. Lyon also focuses on client portfolio reporting, having formerly served as a project communications specialist on the firm's sales and marketing team, and worked in the operations and investment bank client derivatives valuations groups at JPMorgan Chase Private Bank.

Structured Finance

Firm adds government affairs partner

Eric Edwards has joined Crowell & Moring as public policy group partner. He will be based in Washington DC and provide counseling to clients on government affairs matters in banking and securities, with a focus on the implementation of Dodd-Frank.

Edwards joins from Goldman Sachs, where he was vp in the government affairs office. He has also held senior staff positions in the US House of Representatives and Senate, where he advised Congress on TARP and other policies.

Structured Finance

Regional DCM head named

Standard Chartered has appointed Steve Perry as head of capital markets for the Middle East, North Africa and Pakistan. He also remains global head of project, aircraft and shipping finance syndications.

Perry is based in Dubai and has responsibility for overseeing the regional loans syndications, DCM and securitisation businesses. He is also responsible for structured finance transactions in the project finance, aircraft and shipping finance sectors globally.

Salman Ansari will also expand his responsibilities to become regional head of DCM for the Middle East, North Africa and Pakistan.

Structured Finance

Law firm poaches six

K&L Gates has expanded its finance practice with the addition of four new partners in the London office. The law firm has also recruited two partners to its real estate investment, development and finance practice in the Charlotte office.

The London hires comprise Matthew Duncan, Theresa Kradjian and Paul Matthews - who join from Sidley Austin - as well as Sean Crosky from Norton Rose. Duncan has a primary focus on RMBS, covered bonds and the establishment of new lending platforms. Kradjian advises on a wide range of asset-backed and residential mortgage-backed financings, while Crosky advises on a variety of securitisation, loan, restructuring and finance transactions. Matthews has a particular emphasis on credit derivatives and synthetic securitisation.

The Charlotte recruits, meanwhile, are Stacy Ackermann and Nachael Bright. Both join the firm from Alston & Bird.

Ackermann has a particular emphasis on CMBS loan servicing and workouts. Bright concentrates her practice in capital markets transactions across a variety of secured and unsecured financings.

Structured Finance

Reg cap pro hired

Matthew Cahill is joining Sidley Austin in early November as a partner in its global finance practice. He focuses his practice in liability and capital management transactions, structured finance, restructurings and securitisation.

Cahill is returning to London after practising as a structured finance and capital markets partner at Clifford Chance in its Abu Dhabi office, and previously in its London, Tokyo and Dubai offices. He will focus on further building Sidley Austin's London finance practice, concentrating on regulatory capital-driven transactions and other structured transactions.

CDO

CDO manager removed without cause

Blackrock is set to be removed without cause as collateral manager for Toro ABS CDO II. A majority-in-interest of preference shareholders has directed the issuer to appoint Vertical Capital as successor collateral manager on the transaction. Vertical will be appointed as successor collateral manager unless the holders of a majority of the aggregate outstanding amount of each class of notes or the holders of a majority of the aggregate outstanding amount of notes of the controlling class object within 30 days.

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

CMBS

Clayton taps CRE vet

James Meleones has joined Clayton Holdings as senior md of commercial real estate services. In this position, he will be responsible for all aspects of the firm's CRE practice, including loan-level due diligence, loan and portfolio valuation and portfolio oversight and strategy. He will report directly to Paul Bossidy, president and ceo of Clayton.

Meleones brings more than 30 years of industry experience to Clayton. Most recently, he spent 15 years at Bank of America, where he was the national underwriting manager for the bank's CMBS business. Prior to that, he spent 20 years at Continental Wingate Company.

CMBS

CRE vet recruited

United Realty Partners has named Barry Funt as president of United Realty Capital Markets, a real estate investment banking firm specialising in the full spectrum of real estate financing. He will work directly with United Realty's founders Jacob Frydman and Eli Verschleiser.

Funt has more than 20 years' experience in execution, structuring, underwriting, pricing, placement and oversight in the commercial real estate market. Prior to joining United Realty Capital Markets, he established the CRE finance unit at Natixis Global Real Estate and served as general counsel of Nomura's CRE finance unit.

RMBS

NCUA targets Barcap

The NCUA has filed suit in Federal District Court in Kansas against Barclays Capital, alleging that the bank violated federal and state securities laws through misrepresentations in the sale of MBS to US Central Federal Credit Union and Western Corporate Federal Credit Union. The price paid for the securities by US Central and WesCorp exceeded US$555m.

NCUA's complaint alleges that Barclays made numerous misrepresentations and omissions of material facts in the offering documents of the securities sold to the failed corporate credit unions. The complaint also alleges systemic disregard of the underwriting guidelines stated in the offering documents. These misrepresentations caused US Central and WesCorp to believe the risk of loss was minimal, when in fact the risk was substantial, NCUA claims.

NCUA has previously filed similar actions against JPMorgan, RBS, Goldman Sachs, Wachovia and UBS (SCI passim). It has already settled claims worth more than US$170m with Citi, Deutsche Bank and HSBC.

RMBS

RMBS issuers served notice

The holders of significant voting rights in more than US$28bn of Morgan Stanley-issued RMBS and US$45bn of Wells Fargo-issued RMBS have sent a notice of non-performance to Morgan Stanley and Wells Fargo. The notice identifies covenants in pooling and servicing agreements which the holders allege have not been carried out, materially affecting the rights of the noteholders and constituting an ongoing event of default.

ABS

FFELP SLABS stress tested

US FFELP student loan ABS ratings would remain largely intact against differing levels of stress, according to recent stress tests conducted by Fitch. The agency subjected its existing US FFELP SLABS portfolio to both moderate and severe scenarios to determine the impact on existing ratings.

While sovereign risk is the key rating driver for FFELP student loan ABS transactions, both scenarios focus on basis risk and gross defaults, which Fitch deems important rating factors. The moderate stress test assumes economic declines and basis stresses more severe than those seen during the 2008/2009 downturn.

Under this scenario, senior tranche ratings would remain largely intact, with approximately 85% of triple-A maintaining their ratings. Downgrades would largely be limited to one or two categories.

The severe stress test assumes gross defaults approach 100% and excess spread is cut by 100bp. In this scenario, which Fitch deems highly remote, 43% of triple-A FFELP SLABS ratings would be downgraded to below investment grade.

"The US government guarantee insulates FFELP student loan ratings from deteriorating economic conditions and rising defaults more so than other consumer asset classes," says Fitch md Michael Dean. "Triple-A rated student loan ABS would remain relatively robust, even if gross defaults approach 100% and basis risk significantly exceeds levels seen during the Lehman bankruptcy."

ABS

Charge-offs continue to decline

Securitised credit card charge-offs, as measured by Moody's Credit Card Index charge-off rate, decreased to 4.19% in August from 4.56% in July. Five of the six largest trusts posted declines, led by a 97bp improvement in the Chase trust's charge-off rate, largely attributable to a normalisation from its recent change in charge-off recognition policy. American Express was the only one of the six largest trusts to record a charge-off rate increase, of a modest 4bp.

The delinquency rate index declined to 2.32%, yet another all-time low, and points toward continued low charge-offs in the coming months. The early-stage component of delinquencies was 0.67%, marking a second consecutive monthly increase of just a single basis point, after previously reaching its all-time low in June. The payment rate index also increased to a new all-time high in August at 22.71%, a further indicator of strong credit trends.

The yield index, meanwhile, declined to 18.41% in August and has remained 150bp-200bp below its year-ago level for the past three months. The decline is due in large part to the expiration of most issuers' principal discounting initiatives, which artificially boosted their trust yields.

Structured Finance

Ratings reform stance welcomed

The CRE Finance Council confirms that a recent US SEC Dodd-Frank mandated report on the feasibility of credit rating standardisation takes into account the position of the commercial real estate finance industry. The report agrees with the views of CREFC's membership that enhanced transparency, consistency and accountability are better avenues of focus for ratings reform.

Specifically, in recommending that the agency not proceed with any standardisation efforts, the SEC staff found that standardising credit rating terminology may help in comparing credit ratings across rating agencies, as well as result in fewer opportunities to manipulate rating scales. However, requiring standardisation may reduce incentives for rating agencies to improve their ratings methodologies and surveillance procedures.

They also found that standardising market stress conditions may not allow the stress conditions to be tailored to a particular type of credit rating, and different stress conditions may be appropriate for different asset classes. Finally, increasing transparency may be more feasible and desirable than implementing credit rating standardisation.

Structured Finance

Euro ABCP migration possible

Investors would likely change their mandates to purchase F2 rated paper in the absence of alternative short-term investments, if European ABCP conduits lost their F1 rating, Fitch suggests. The agency says that this would limit the impact of downgrades on the US$1trn global ABCP market and reduce concerns that an important source of funding for the real economy would be removed.

A similar migration of ABCP occurred when banks were downgraded to F1 from F1+ in the wake of the global financial crisis. Only 31% of European ABCP conduits are rated F1+ now, compared with 53% before the crisis.

In Europe, the most likely reason for a wholesale downgrade of ABCP conduits would be a downgrade of the sponsor banks' ratings, according to Fitch. In this scenario, investors would continue with ABCP for capital and liquidity management because there would be few alternatives large enough left at F1 ratings. Sovereign Treasury bills could provide an alternative for some, but that product's yields are too low for many ABCP investors.

One possible reason for such a widespread downgrade of sponsor banks could be the continued removal of support. Of the 16 ABCP sponsor banks rated by Fitch, 12 have IDRs that are at their support rating floor, meaning that a weakening in the level of support available to the banks could result in their IDRs being downgraded unless their viability ratings also improve - for example, on the back of regulatory initiatives such as Basel 3.

Sovereign support has had a significant influence on bank default risk, reducing it by a factor of around eight on a five-year basis, according to Fitch's data. The combination of removing support and introducing bank resolution legislation means that bank default and failure risk in the EU will ultimately converge. Unless offsetting factors reduce bank default risk, some ratings will migrate downwards as the new regulatory framework becomes clearer.

Structured Finance

Basel 3 progress report published

The Basel Committee has published the latest results of its Basel 3 monitoring exercise. A total of 209 banks participated in the study, including 102 Group 1 banks and 107 Group 2 banks.

The monitoring exercise results assume full implementation of the final Basel 3 package, based on data as of 31 December 2011. No assumptions were made about bank profitability or behavioural responses, such as changes in bank capital or balance sheet composition. For that reason the results of the study are not comparable to industry estimates.

Based on data as of 31 December 2011 and applying the changes to the definition of capital and risk-weighted assets, the average common equity Tier 1 capital ratio (CET1) of Group 1 banks was 7.7%, as compared with the Basel 3 minimum requirement of 4.5%. In order for all Group 1 banks to reach the 4.5% minimum, an increase of €11.9bn CET1 would be required.

The overall shortfall increases to €374.1bn to achieve a CET1 target level of 7%. Compared to the June 2011 exercise, the aggregate CET1 shortfall with respect to the 4.5% minimum for Group 1 banks has reduced by €26.9bn. At the CET1 target level of 7%, the aggregate CET1 shortfall for Group 1 banks has reduced by €111.5bn.

For Group 2 banks, the average CET1 ratio stood at 8.8%. In order for all Group 2 banks in the sample to meet the new 4.5% CET1 ratio, the additional capital needed is estimated to be €7.6bn. They would have required an additional €21.7bn to reach a CET1 target 7%.

The Committee also assessed the estimated impact of the liquidity standards. Assuming banks were to make no changes to their liquidity risk profile or funding structure as of December 2011, the weighted average liquidity coverage ratio (LCR) for Group 1 banks would have been 91% (compared to 90% for 30 June 2011), while the weighted average LCR for Group 2 banks was 98%. The weighted average net stable funding ratio (NSFR) is 98% for Group 1 and 95% for Group 2 banks.

CDO

CRE CDO delinquencies drop

US CRE CDO delinquencies have dropped for the fourth straight month, falling below 12% for the first time since August 2011, according to Fitch's latest index results for the sector. Only two new delinquencies were added to the index last month, while seven assets were removed.

The August 2012 rate is 11.6%, down from 12.1% in July. Asset managers reported only one realised loss during the month: US$3.5m, representing a loss severity of 68% of the original principal balance. The loss was the result of the distressed sale of a whole loan secured by a multifamily property located in Indiana.

CDO

ABS CDO redemption delayed

An auction call redemption will not occur for Capital Guardian ABS CDO I on its 3 October distribution date. The trustee was unable to sell the collateral debt securities at auction because it did not receive bids that were at least equal to the auction call redemption amount. The trustee will conduct an auction prior to each subsequent distribution date unless the notes are redeemed in full or market conditions suggest that an auction is unlikely to be successful.

CDO

Trups CDO defaults trending lower

US bank Trups CDO defaults and deferrals remained relatively flat for the month of August, according to Fitch. Defaults rose to 17.3% from 17%, but were tempered by deferrals, which fell to 14.3% from 14.6%. These results left the combined bank default and deferral rate at 31.6%.

There were 20 new deferrals through the end of August, compared to 57 new deferrals through August 2011. New defaults are also trending lower, with 13 new defaults through the end of August compared to 30 through August of last year. In addition, cures have picked up pace over the last year, with 30 cures though the end of August 2012, compared to 19 during the same period last year.

At the end of the month, 208 bank issuers were in default, representing approximately US$6.5bn held across 83 Trups CDOs. Additionally, 358 deferring bank issuers were affecting interest payments on US$5.4bn of collateral held by 83 Trups CDOs.

CDS

CDS spread volatility to continue

News flow in the coming months may potentially contribute to further price volatility for eurozone bond and credit default swap spreads, according to Fitch. Spread levels could be affected by potential sovereign bailouts, the progress achieved within bailed-out countries, the speed at which policymakers can reform regulatory, economic and legal frameworks, and ultimately how these translate into economic growth in the short and medium term.

"Although policymakers have expressed a will to forge greater economic and monetary union and avoid a eurozone break-up, political and execution risks to achieve these ambitions remain high," explains Fitch senior director Stéphane Buemi.

Fitch md James Batterman adds: "While recent eurozone bond and CDS spread tightening is not news, what everyone may not realise is how much relative trading levels have changed over the past year or so."

Ireland, Italy, Portugal and Spain are notable examples of this. Earlier this year, the CDS market assigned roughly a 20%-30% implied annual probability of default to Portugal. Today, it hovers between 5% and 10%.

Between September 2011 and February 2012, Italy was regarded as a higher credit risk than Spain, while during 2Q11 Ireland and Portugal were lumped largely into the same bucket. The former relationship has since reversed, while the latter has evolved to one in which Ireland and Portugal are trading more in line with underlying fundamentals and ratings on a relative basis. Batterman notes that this illustrates how volatile the credit markets have been and how quickly market perceptions can change.

The lead-up to and announcement of the ECB's Outright Monetary Transactions programme has helped provide some relief, with sovereign spreads tightening across the board. That said, prevailing levels are still wide relative to ratings for many countries, Fitch notes.

The agency assigned negative outlooks to the ratings of Ireland, Italy, Portugal and Spain. The outlooks are due to policy risk at the European level, as well as risks to their country-specific economic and fiscal adjustments.

The ratings are dependent on the continued support from the EU and related institutions. Should support prove lacking as a result of backtracking by politicians, ratings would come under renewed pressure, Fitch warns.

CDS

Bank derivatives holdings decrease

Commercial banks and savings associations reported trading revenue of US$2bn in 2Q12, according to the OCC's Quarterly Report on Bank Trading and Derivatives Activities. This figure is 69% lower than that of 1Q12 and 73% lower than in 2Q11.

"Trading revenues were weak in the second quarter," confirms Martin Pfinsgraff, deputy comptroller for credit and market risk. "While both normal seasonal weakness and reduced client demand played a role, it was clearly the highly-publicised losses at JPMorgan Chase that caused the sharp drop in trading revenues." JPMorgan reported a US$3.7bn loss from credit trading activities, causing the bank to report an aggregate US$420m trading loss for the quarter.

Net current credit exposure (NCCE) increased by US$32bn, or 9%, to US$410bn in the second quarter. Of this, 70% was collateralised, up from 67% in the prior quarter.

The report shows that the notional amount of derivatives held by insured US commercial banks decreased by US$5.5trn, the fourth consecutive quarterly decline. Notionals fell by 2.4% to US$222trn, including a 3% decrease in credit contracts to US$13.6trn. Declines in notionals are being driven by compression efforts by banks seeking to reduce regulatory capital requirements, as well as operating and risk burdens in their derivatives portfolios.

The number of commercial banks and savings associations holding derivatives increased by 41 in the quarter to 1,332, although exposure remains concentrated in a small number of institutions. The largest four banks hold 93% of the total notional amount of derivatives, while the largest 25 banks hold nearly 100%.

Credit default swaps remain the dominant product in the credit derivatives market, representing 97% of total credit derivatives.

CDS

New CDS indices launch

The Markit iTraxx CEEMEA and Markit CDX LatAm Corporate indices - the first CDS indices referencing the regions' corporate debt (SCI passim) - launch today (20 September). The indices will enable investors to gain or hedge exposure to corporate credit risk in CEEMEA and Latin America at a time when there is growing demand for corporate debt from emerging markets, Markit says.

Constituents include corporate issuers from multiple industry sectors. Inclusion in the indices is based on the liquidity of a company's CDS and the amount of debt outstanding in the market. The indices will next roll in March 2013.

CDS

Data repository approved

The CFTC has provisionally approved an application by DTCC Data Repository (DDR) to create and operate a multi-asset class swap data repository in the US. The service will be fully ready to operate on 12 October, the first day of required reporting of trades in credit and interest rate derivatives under the CFTC rules.

Trades in all other derivatives classes will need to be reported 90 days after that, beginning in mid-January 2013, and trades between buy-side firms will be required to be reported beginning in mid-April. The CFTC is one of the first regulatory bodies globally to require mandatory reporting of OTC derivatives trading.

The CFTC approved DDR to operate for credit, equity, interest rate and foreign exchange derivatives. A request to also operate for commodities derivatives has been made, with approval still pending, but completion of that application is expected before the January 2013 deadline.

CLOs

REIT debuts CLO

Arbor Realty Trust has privately placed a US$125m CLO, becoming the first commercial mortgage REIT to tap the sector. Dubbed Arbor CLO 2012-1, the notes are secured by 18 whole loans and A-notes.

An aggregate of US$87.5m of investment grade debt was issued under the transaction, with Arbor retaining the US$37.5m equity interest. The notes pay an initial weighted average spread of approximately 339bp over one-month Libor and feature a two-year replenishment period. The transaction provides the REIT with approximately US$32m of liquidity and US$42m of capacity in short-term credit facilities, due to the transfer of certain assets into the CLO.

Arbor intends to hold the portfolio of real estate-related assets until its maturity and expects to account for this transaction on its balance sheet as a financing. The REIT says it will use the proceeds of the offering to repay borrowings under its current credit facilities, pay transaction expenses and fund future loans and investments.

Sandler O'Neill + Partners acted as placement agent for the transaction. The CLO notes were rated by Moody's.

CMBS

No revision for GRAND proposal

It has emerged that GRAND CMBS noteholders which were not part of the ad-hoc group involved in discussions with DAIG chose the REF note servicer as a separate conduit for providing comments on the restructuring proposal. The REF note servicer received comments from approximately 15% of noteholders expressing a desire for improvements to certain elements of the heads of terms.

A list of five core issues was subsequently sent in writing to DAIG for consideration on 17 August. The core issues include: the level of increase in note margin; the conditions relating to the year one amortisation target; valuations not being used for LTV covenant testing; and dividend conditions to the sponsors.

After considering these points, DAIG has informed the REF note servicer that it will not be undertaking any further negotiation of the heads of terms. It says that all of the issues which were raised had been fully taken into account as part of the process of agreeing the heads of terms and none of the points raised can be taken in isolation from the agreement as a whole.

Further, DAIG has advised that the feedback it has received on its refinancing proposal indicates that the heads of terms would secure the requisite level of support to be implemented through a scheme of arrangement. On this basis, it considers that it is in the best interests of noteholders as a whole to proceed to implement the currently negotiated heads of terms.

CMBS

Vitus CMBS prices

Deutsche Bank has priced its hotly anticipated Vitus CMBS. The €754m transaction, dubbed Florentia, refinances the Vitus Immobilien German multifamily portfolio securitised in Centaurus (Eclipse 2005-3).

Rated by DBRS and Fitch, Florentia comprises five tranches: €392m triple-A rated class A notes (which priced at 184bp over three-month Euribor), €121m double-A class Bs (295bp), €141m single-A class Cs (380bp), €50m triple-B class Ds (500bp) and €50m triple-B minus class Es (792bp). The collateral is concentrated in 10 cities in West Germany and is considered to be comparable to that owned by other large multifamily housing companies in the country.

The cashflows generated by the portfolio have been relatively stable over time, with occupancy levels improving in recent years after a slight deterioration, mainly due to modernisation and capital expenditure programmes undertaken in 2007-2010. As a result, the vacancy rate has decreased and the portfolio has now stabilised around an occupancy ratio of 95%.

Fitch notes that the securitised loan benefits from a moderate reported LTV of 64%, as well as a strong DSCR of 1.62x and scheduled amortisation, which will reduce the LTV to 60% at scheduled maturity in October 2017. Post-refinancing, which is expected to occur on 28 September, an aggregate amount of €207m of the borrowers' senior ranking indebtedness will remain outstanding.

The transaction has some positive features that differ from vintage European CMBS. The notes benefit from a seven-year tail period following scheduled maturity, allowing sufficient time for a protracted workout and substantial de-leveraging if needed.

A mechanism effectively capping Euribor at 8% of the interest rate payable on the notes during the tail period is also envisaged. This feature partially mitigates the risk of an increase in Euribor that could occur after scheduled maturity, when the underlying loans will revert to floating rate.

Furthermore, the transaction does not envisage a controlling class. However, the servicing agreement incorporates a clearly defined noteholder committee process, which allows the servicer or special servicer to consult with a majority of noteholders on material loan events.

Finally, the transaction documentation allows for a termination of the asset management contracts, should the loans default - thus facilitating a change in management, should the special servicer deem this replacement to be beneficial for a successful work-out.

CMBS

Losses forecast for Titan CMBS

 Two Titan CMBS - Titan Europe 2006-3 and Titan Europe 2006-5 - are expected to see major losses, based on recent regulatory filings.

The regulatory notice regarding Titan Europe 2006-5 advises that a discrepancy in regulating the priority of payments for the €239.58m DIVA Multifamily Portfolio loan has been resolved. A sales and purchase agreement for €205m for the underlying properties was signed in September 2011, with an expected closing in early 2012.

However, gross sales proceeds of €203.5m from the sale of the properties were held back in February and not distributed due to the discrepancy (see SCI's CMBS loan events database). These proceeds will now be made available for distribution to noteholders before the October IPD, resulting in a loss of approximately €36.08m.

Trepp estimates that this will cause the class F (with a current balance of €11.88m) and E (€4.85m) to be completely written down. Class D notes will be written down by approximately €19.34m.

The other notice is in connection with the €23.64m AS Watson loan, the underlying property of which has been sold for total sale proceeds of €14.3m. A related mortgage was also released to the security agent on 4 September and the special servicer will now determine the final recovery determination after all costs are finalised.

Classes H, G, F and E in Titan Europe 2006-3 were fully written off. The class D notes have already been partially written down due to prior losses on the SQY Ouest Shopping Centre and Weser Strasse loans. But Trepp expects sales proceeds from the AS Watson loan to result in principal loss of at least €9.34m, which would see the rest of the class Ds being written down.

A €300,000 slice of the TITN 2006-5X B tranche was covered in secondary yesterday at 40 area, according to SCI's PriceABS BWIC data. €6.16m of the bond was covered at 34.75 on 30 May.

CMBS

Oxford Valley Mall watchlisted

Morningstar has added the US$69.2m Oxford Valley Mall loan - securitised in the GSMS 2011-GC3 CMBS - to its watchlist, following a drop in reported occupancy, as of 31 March. An office building on the site (One Oxford Valley) has 69% of its space available for lease and one mall anchor (Boscov's) is vacant.

According to the prospectus supplement, the One Oxford Valley office building can be released without paying a release price. Plans were developed that included the demolition of One Oxford Valley and construction of a lifestyle centre, but the plans were not implemented based on weakening local market conditions, according to Morningstar.

For the 12-month period ended 31 December 2011, the net cashflow debt service coverage ratio (NCF DSCR) was 3.14, with net cashflow of US$14m. Occupancy was reported at 90%.

The NCF DSCR and net cashflow for the three months ended 31 March 2012 were 3.46 and US$3.9m respectively. Occupancy, however, fell to only 79%.

The 'as stabilised' value of the property was US$275m (US$222/sf), which assumed stabilised market conditions. Based on the 'as is' value, LTV at issuance was 28%.

Despite the decline in occupancy, Morningstar says the loan is a low near-term default risk. "Based on the appraisal information provided at issuance, leverage on this asset is very low and we therefore find there is no value deficiency," the firm concludes.

CMBS

EMEA special servicing activity examined

A single EMEA CMBS loan - the €16m Monheim loan securitised in Juno (Eclipse 2007-2) - was transferred to special servicing in August, due to non-payment at maturity. The weighted average Moody's expected principal loss for loans in special servicing now stands at 39%, according to its monthly update on the sector, with 139 loans currently in special servicing.

Highlights for the month include the appointment of administrators over the borrower behind the £850m single loan securitised in Gemini (Eclipse 2006-3), as well as fixed charge receivers over its portfolio of 35 predominantly office and retail properties throughout the UK (see SCI's CMBS loan events database). Since the loan's transfer four years ago, the work out had been constrained by the heavy mark-to-market exposure on the underlying swap. Moody's understands that the special servicer's latest strategy avoids an immediate crystallisation of the swap MTM, despite the enforcement, while the long-term workout strategy with limited asset sales remains the same.

The loan securitised in Opera Finance (Uni-Invest), meanwhile, has left special servicing following the completion of the loan sale (SCI 6 September). In the absence of a final recovery determination and considering that the ultimate loss on the A-loan is dependent on the performance of the newly issued notes that serve as compensation to the senior noteholders, a loss severity is not reported on the loan. Moody's expects the loss on the A-loan to range from 24% to 46% on the original balance.

The agency's analysis on 34 loans worked out with realised losses to-date shows that the weighted average loss severity is 36%. Ignoring loans with small losses (under 2%), this figure increases to 40%. The highest WA loss severity (71%) has been experienced by loans that are smaller than €10m.

In terms of jurisdiction, with the largest number of workouts so far (24 loans), the WA loss severity in the UK has been fairly high at 40%. While the results of different property types is mixed, the lowest WA loss has been on multifamily loans, Moody's notes.

CMBS

CMBS note sales scheduled

US$1.15bn of CMBS loans across 130 properties are slated for sale via Auction.com for the rest of this month and into October. Such activity could lead to quicker-than-expected pay-downs in the next few months, particularly for front cashflows.

The largest loan up for auction is the US$67.9m One & Two Securities Centre securitised in CGCMT2006-C5. The starting bid is US$20m and the latest appraisal from November indicates a US$54mn valuation, indicating that the loan could take 20%-30% losses, according to CMBS analysts at Barclays Capital. The US$64.9m WestOaks Mall in WBCMT 2003-C9 is also up for bid and may take heavy losses, as the starting bid is only US$3.5m and the latest appraisal valued the property at US$16.8m.

Another large CMBS asset in the list of loans released by Auction.com is the US$63.6m One Westchase Center in GCCFC 2007-GG9, whose starting bid is US$40m and was recently appraised at US$67.6m. The Barcap analysts expect a successful auction still to lead to some nominal losses, as over US$5.7m of advances and US$1.7m of ASER must be repaid.

Overall, they estimate that the deals with the largest exposure to late-September/October note sales are GCCFC 2007-GG9 (with US$134m in loans out for bid) and JPMCC 2006-LDP6 (US$100m).

Risk Management

SEF aggregation analysed

GreySpark Partners has published 'SEF Aggregation: Approaches, Pitfalls and Solutions', the final report of a three-part series on the swap execution facility (SEF) landscape. This study outlines the impact on business and trading models as a result of the nascent SEF marketplace, presenting the pitfalls and solutions to consider for participants faced with increasingly fragmented liquidity.

The report argues that for the sell-side, building up SEF aggregation capabilities is essential either for their own usage as a liquidity taker or provider, or to allow their clients to access liquidity on their single dealer platforms (SDPs). On the other hand, traditional buy-side participants - who are allowed to trade directly on SEFs under Dodd-Frank - have to decide whether to set up their own market access and clearing infrastructures or continue to use the services of a broker/dealer to access liquidity and/or clearing services.

The study also addresses a number of concerns that are particular to this market, including the question of how the quality of liquidity should be managed when tackling an aggregation and/or order-routing project. Bradley Wood, partner at GreySpark Partners, comments: "We believe that aggregating SEF liquidity is going to be a very important requirement in the next year or so, especially for sell-side firms seeking to defend their existing swaps businesses."

The research involved analysing 52 proposed SEFs and interviewing the 12 strongest players. They were ranked by product coverage, volumes and current market share.

Risk Management

KRM enhanced

Kamakura Corporation has released version 8.1 of its enterprise risk management system, Kamakura Risk Manager (KRM). The new release expands the service's functional capabilities and enhances processing efficiency, while providing Boards of Directors, shareholders and regulators with an accurate view of the total risk of the organisation. It also incorporates reports on the Basel 3-mandated liquidity coverage ratio and net stable funding ratio.

Risk Management

Reg cap tool released

The US federal banking regulatory agencies have released a regulatory capital estimation tool to help community banking organisations and other interested parties evaluate recently published regulatory capital proposals. The tool is intended to help institutions estimate the potential effects on their capital ratios of the agencies' Basel 3 notice of proposed rulemaking (NPR) and standardised approach NPR. The public comment period for these proposals ends on 22 October.

RMBS

Brazilian home prices levelling off

Spurred by sustained economic growth, explosive credit expansion and restricted supply of adequate housing, Brazilian homes prices have surged since 2008. However, the trend now appears to be ending as prices level off, according to Fitch.

"From January 2008 to July 2012, real housing prices increased by 92% in Sao Paulo and 118% in Rio de Janeiro. But in recent months, price growth has fallen in line with income growth," confirms Jayme Bartling, senior director at Fitch.

The expansion of Brazil's mortgage market is widely considered to be the most important driver of the property price boom in the country. Mortgage lending as a percentage of GDP grew from 1.5% in 2005 to 5.4% as of May 2012, based on figures reported by the Central Bank of Brazil.

Access to credit created an environment of 'affordability', allowing home buyers to purchase pricier homes, which has added to price inflation. Decreasing rental yields are now being observed in Sao Paulo and Rio, indicating that properties are overvalued unless there are expectations for further income growth or significant capital appreciation.

Overall, housing prices have increased disproportionately to the rise in household incomes, both in nominal and income-adjusted terms. House price-to-income ratios are above 5x in Sao Paulo and above 7x in Rio de Janeiro.

Although prices look expensive by any measure, Fitch does not expect them to decline significantly in a benign economic environment, given medium-term supply and demand imbalances. However, in the event of stressed economic scenarios, the agency acknowledges the risk of a considerable decrease in home prices.

RMBS

Counterparty risk constraining ratings

S&P says its view on country and counterparty risk is currently the principal constraint on about one-third of its RMBS ratings in the UK, the Netherlands, Portugal, Spain and Italy.

Credit quality of underlying mortgage loan collateral, combined with transaction structures has historically determined the performance of RMBS ratings. However, a rise in risks that are unrelated to mortgage borrowers' credit performance or tranche credit enhancement has led to several European RMBS downgrades in recent months.

"As a result of the financial crisis, sovereign and bank creditworthiness in Europe has deteriorated since 2009. In some RMBS transactions this has meant that the risk of a transaction counterparty failing to perform its obligations, or of country-specific stress, has become sufficiently material to affect our ratings on the securities," explains S&P credit analyst Mark Boyce.

The extent of these non-collateral risks varies significantly by country. Counterparty risk is the limiting factor on almost 10% of Dutch RMBS tranches that the agency rates, but about half of Italian RMBS ratings and at least 40% of those in Portugal would potentially be higher but for country and counterparty risk.

Counterparty and sovereign credit quality is expected to continue to be key determinants of some RMBS ratings in 2012.

RMBS

Euro RMBS switch touted

European ABS analysts at JPMorgan have moved to neutral from being overweight senior UK prime RMBS, following the significant rally in spreads since the start of 2012 (SCI 24 September). However, they maintain overweight recommendations for UK prime double-As, single-As and triple-Bs generically at 140, 185 and 235 respectively.

"Despite our less positive recommendation on UK prime seniors, we do note the likelihood of continued supportive technicals for the asset class," the JPMorgan analysts observe. "A deep and established investor base results in demand being broadly stable. Combined with reductions in supply owing to both lower origination volumes in the underlying mortgage market and a variety of funding alternatives open to issuers, we expect pricing tension in the asset class to remain - especially for euro investors, who have been starved of recent new issue supply."

They suggest foregoing what they view as the latter stages of a rally to redeploy into higher-yielding, broadly similar-risk alternatives. "Doing nothing more adventurous than looking to Granite RMBS seniors (legacy, secondary market opportunities) and Dutch RMBS (ongoing, primary and secondary markets), we highlight that investors can increase returns. We therefore take this opportunity to reiterate our overweight recommendations on both Dutch RMBS triple-As and Granite triple-As at 98 and 107 respectively."