Contents

CMBS

CMBS tightening continues

Yesterday's session saw further tightening for US CMBS spreads. Secondary activity was solid, with SCI's PriceABS BWIC data showing over 160 CMBS line items.

Interactive Data puts CMBS BWIC volume for the session at US$365m. GG10 Dupers were being quoted at swaps plus 159bp/155bp, having tightened from 162bp at the previous close. Legacy fixed seniors were 3bp tighter, with legacy fixed AMs 5bp tighter and AJs 15bp tighter.

"Generic CMBS spreads are tighter on the day. BWIC volume has gained momentum from the prior session and lists continue to be added. In terms of supply, credit paper of various vintages account for approximately half of the bonds out for bid," Interactive Data adds.

One tranche that illustrates the tightening nicely is MSC 2007-IQ14 AM. A US$25m piece of the tranche was covered yesterday 585bp, having been bid the day before at swaps plus 610bp. PriceABS also shows that a US$38.281m slice was covered at 613bp on 14 September, with a US$5m piece covered at 649bp the day before that.

A US$14.5m slice of WBCMT 2007-C30 AJ was also being talked at a dollar price in the high-70s, before being covered at 82.17. It had been bid at 77.5 in late September.

JL

RMBS

Rising prices seen in UK prime

A slew of UK RMBS paper hit the secondary market yesterday, with a mixed bag of names out for the bid. Vintage prime senior bonds appear to be on a rising trend from summer levels, according to SCI's PriceABS BWIC data.

The increases are most pronounced across Granite paper. A £8m slice of GRAN 2004-1 3A was covered during the session at 98.37, but was covered at 96.25 on 26 June. Similarly, £16m and £20m of GRAN 2006-1X A8 and GRAN 2006-3 A6 were covered at 97.85 and 97.81 respectively, having been covered at 95.155 and 95.5 on 30 May.

LAN 2007-1X 4A1 was also a touch higher than it was during the summer. £14.5m of the tranche was covered at 99.89, having been covered at 99.81 on 29 August.

Other vintage names seen yesterday include NGATE 2006-1 A4, MPS 3X A2B and MANSD 2006-1X A2 - which were all talked in the mid-90s. Meanwhile, the FOSSM 2006-1X A4 and PERMM 2007-1 5A tranches were both talked at over 99.95.

Recent vintage paper was also being shown during the session. SCI's PriceABS archive shows that £30m of SLKRD 2011-1 AB was covered at 101.65, having been talked at 101.77 and 101.82.

Additionally, €11.75m of FOSSM 2010-1 A2 was covered at 101.66, having been talked at 101.73 and 101.8. The tranche was previously covered at 100.26 on 5 July.

Among the more unusual bonds circulating yesterday were ALBA 2011-1 A1 and 2012-1 A, with £34.25m and £24.47m slices of each being talked variously over par.

CS

Structured Finance

SCI Start the Week - 8 October

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

Pipeline
Four deals remained in the pipeline by the end of last week. They comprised two auto ABS (ZAR²bn Commissioner Street No.5 TopDrive Funding series 2012 and US$527m Porsche Innovative Lease Owner Trust 2012-1), one student loans ABS (US$518.7m Utah Series 2012-1) and one CLO (US$374m Oaktree Enhanced Income Funding Series I).

Pricings
Issuance was strong during the week, with 11 ABS, two RMBS, four CMBS and three CLOs pricing. Auto deals accounted for the bulk of the ABS prints.

Those auto ABS comprised: US$1.1bn Ally Master Owner Trust Series 2012-5; US$813m CarMax Auto Owner Trust 2012-3; US$1bn Huntington Auto Trust 2012-2; US$1.5bn Santander Drive Auto Receivables Trust 2012-6; US$750m SMART ABS Series 2012-4US Trust; and US$1.25bn Volkswagen Auto Loan Enhanced Trust 2012-2.

Three credit card deals (US$850m Chase Issuance Trust 2012-7, US$500m Citibank Credit Card Issuance Trust Citiseries 2012-1 and US$390m World Financial Network Credit Card Master Note Trust Series 2012-D), one student loan deal (US$937.5m Nelnet Student Loan Trust 2012-4) and one lease ABS (€176.8m TDA Lico Leasing III) also printed.

The two RMBS were €2.06bn STORM 2012-V and €747m Credico Finance 11, while the CMBS included US$876m COMM 2012-CCRE 3, US$259m COMM 2012-LTRT, US$1.37bn FREMF 2012-KF01 and US$1.25m MSBAM 2012-C6.

Finally, CLO issuance consisted of US$458.6m Benefit Street Partners CLO I, US$466m ING IM CLO 2012-3 and US$560m OZLM Funding II.

Markets
Last week began with non-agency paper circulating widely in the US RMBS secondary market, as SCI reported on Tuesday. Monday's session saw around US$600m of non-agency paper out for the bid, with offering levels in line with those seen at the end of September. Citi securitised products analysts note that BWIC supply reached around US$4.5bn by Wednesday, with prices flat to higher.

The US CMBS market rallied throughout last week. Thursday saw BWIC volume gather momentum and GG10 Dupers tightening to swaps plus 159bp/155bp (see SCI 5 October). Tranches such as MSC 2007-IQ14 AM were being covered at levels far tighter even than those seen on Wednesday.

US ABS secondary activity benefited from a rush of auto paper, as SCI reported on Thursday (SCI 4 October). SCI's PriceABS BWIC data showed 16 auto tranches for Wednesday's session alone. Spread covers for that session ranged from 1bp over to 15bp over.

Barclays Capital analysts note that the search for yield is leading investors to off-the-run and esoteric ABS. "However, over the past couple of weeks, we have seen a mini-rally of sorts in mezzanine and subordinate retail auto and credit card ABS. Spreads on such paper are about 5bp-10bp tighter."

The US CLO secondary market was exhibiting clear tiering last week. Tuesday's session saw covers for subordinated paper ranging from 176.27 to 33.27 (SCI 3 October).

Finally, the European ABS market was fairly stable last week, according to JPMorgan ABS analysts. They note: "Spreads remained unchanged week-on-week, as the secondary market starts to stabilise after a summer-long rally. BWIC activity remains fairly strong as a number of investors look to take advantage of the tightening in spreads over the last couple of months."

Deal news
• Further details have emerged on Isobel Finance No.1, the £463.22m CMBS that RBS preplaced on 28 September. The transaction represents the first use of CMBS technology in Europe post-financial crisis to partially fund the purchase of legacy commercial real estate loans from a bank balance sheet.
• Ocwen Financial has acquired Homeward Residential for US$750m. With the purchase, Ocwen will assume the servicing on all of Homeward's portfolios - including the Option One, Citi Residential Lending (Ameriquest) and Downey pools - comprising 422,000 mortgage loans, with an aggregate unpaid principal balance of over US$77bn.
• The extraordinary resolution to appoint Deutsche Bank as auction agent has been approved by Eurosail UK 2007-5NP class B1c, C1c and D1c noteholders, having been passed by the class A1a and A1c noteholders on 7 August. However, the trustee is unable to agree to the implementation of the proposal in its current form.
• Morningstar has added the US$232m Galleria Towers loan - securitised in JPMCC 2006-LDP9 - to its watchlist, following a drop in the net cashflow debt service coverage ratio (NCF DSCR) and occupancy, as of 31 March. According to the servicer, the decline in occupancy is due primarily to the departure of Highland Capital, which occupied roughly 8% of the gross leasable area on a lease that expired in December 2011.
• New information published on the London & Regional Debt Securitisation 1 (LORDS 1) CMBS suggests that noteholders are exposed to greater risk than previously identified. The information includes updated collateral valuations and details of a long-dated swap, the presence of which was not previously publicly disclosed.
• Rescap secured bondholders have ended an agreement to support Ally Financial's reorganisation plan. The ad-hoc steering committee - representing US$2.2bn of junior secured Rescap noteholders - has withdrawn its support for the plan, given the protracted nature of the legal proceedings thus far and the chance to improve its negotiating position in future disputes with other creditors.

Regulatory update
• The FHFA has released for public input a white paper on a proposed framework for a common securitisation platform and a model pooling and servicing agreement (PSA). The white paper seeks to identify the core components of mortgage securitisation that will be needed in the housing finance system going forward.
• In a sign that EU regulators' stance on securitisation may potentially be softening (SCI 21 September), the European Commission last week asked the European Insurance and Occupational Pensions Authority (EIOPA) to examine Solvency II calibrations and the design of capital requirements for investments in assets that it describes as "relevant to 'long-term finance'" in the region.
• The European Wholesale Securities Market (EWSM) is expected to start listing debt and structured finance securities imminently. The joint venture between the Irish Stock Exchange (ISE) and Malta Stock Exchange (MSE) is awaiting designation as a recognised exchange by HMRC for withholding tax purposes.
• The Federal Court in Australia has ruled in favour of three councils in a class action brought against Lehman Brothers Australia. The findings could pave the way for the judgment to be extended to other organisations that either sold or distributed CDOs and capital protected notes to councils, or advised councils to buy them.
• New York Attorney General Eric Schneiderman has announced a lawsuit against JPMorgan Securities, JPMorgan Chase Bank and EMC Mortgage. It is the first lawsuit to be brought by the RMBS Working Group, of which Schneiderman is co-chair.
• ISDA has released a comment letter in response to the BCBS-IOSCO Consultative Document 'Margin Requirements For Non-Centrally Cleared Derivatives', endorsing the collection of variation margin (VM) between covered entities as a means to promote systemic resiliency. However, the association believes that current margin proposals raise a number of key issues that effectively undermine the stated objectives of the BCBS-IOSCO study.
• The NCUA has filed suit in Federal District Court in Kansas against Credit Suisse Securities. The suit alleges misrepresentations in connection with the underwriting and sale of RMBS to US Central Federal Credit Union, Western Corporate Federal Credit Union and Southwest Corporate Federal Credit Union.
• A proposed increase in Portuguese income tax would cut household income and could have a knock-on effect on arrears and default levels in the RMBS transactions. The proposal would increase the average rate of income tax to 11.8% from 9.8% and introduce a 4% income tax surcharge for 2013.

Deals added to the SCI database last week:
BAMLL 2012-CLRN; Beacon Container Finance 2012-1; Brass No. 2; Citibank Credit Card Issuance Trust 2012-A1; Dolphin Master Issuer series 2012-II; Dryden Senior Loan Fund XXIV ; Ford Credit Auto Lease Trust 2012-B; Golden Credit Card Trust series 2012-5; Golden Credit Card Trust series 2012-6; Hermes XVIII; Impala Trust No. 1 sub-series 2012-1; Isobel Finance No.1; JPMCC 2012-C8; LEAF Receivables Funding 8 series 2012-1; Liberty series 2012-1 Auto; SMHL Securitisation Fund 2012-2; and Venture XI CLO.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2005-1; BACM 2006-4; COMM 2005-LP5; CSFB 2000-C1; DECO 2005-C1; DECO 2006-E4; EMC VI; EURO 27; EXCAL 2008-1; GCCFC 2007-GG9; GMACC 1998-C1; GSMS 2007-GG10; JPMCC 2006-LDP7; JPMCC 2007-LD12; MLCFC 2006-1; MLCFC 2007-8; REC 3 Foundation; REC 6; TAURS 2006-2; TITN 2006-CT1; TITN 2007-3; WINDM XII; and WINDM XIV.

Top stories to come in SCI:
Esoteric ABS update
US CMBS market trends
Emergence of European agency CMBS

CLOs

CLO fees, performance examined

Moody's Analytics has published the second study of a two-part series on US CLO management fees (see also SCI 7 September), which analyses correlations between fee structure and deal performance. It finds that senior fees in 2012 transactions have remained in line with 2011 and pre-2008 levels, while subordinate fees have dipped to an average of 29bp, with only 2008 and 2010 seeing lower average subordinate fees.

The subordinate fee percentiles show that the bottom of the distribution is about the same as pre-crisis, but the lack of deals with higher-end subordinate fees is dragging down the 2012 average. "Fee structures are exhibiting a lot less variance," notes Andrew Jacobs, director at Moody's Analytics. "For the 2012 vintage, almost every deal is in the 0.3%-0.35% range, whereas pre-crisis fees are sometimes higher. It appears that managers are currently structuring in less fees."

The majority of 2012 US CLOs also feature an incentive management fee structured to pay 20% of available proceeds after the equity reaches an IRR of either 12% or 15%. This is seen to be in line with previous vintages.

In addition, the study analyses correlations between both junior overcollateralisation levels and fees and equity returns and fees. In the first instance, the aim was to determine whether the size of fee effects performance; the second was to challenge the assumption that if a manager is highly regarded, they are able to charge higher fees.

"In terms of OC, there is no correlation. Senior fees aren't that onerous, so they don't make a significant difference to performance. OC tests are simply a useful way of adjusting for losses," Jacobs observes.

However, senior fees were shown to decline as equity returns increase. The results indicate that for an average senior fee of 24bp, the equity return is 7.5%; for an average fee of 14bp, the equity return reaches 30%.

"The point is that for equity returns, every little bit helps. But there may also be other explanations, such as that higher senior fees could be correlated with managers who are more conservative. Additionally, our equity returns metrics aren't adjusted for purchase price," Jacobs explains.

He expects these relationships to continue for the foreseeable future. "There's no reason why not. The study essentially puts a number to what many market participants already suspected."

Fourteen US CLOs totalling US$6.5bn priced in September, representing the highest monthly volume since 2007, with year-to-date issuance now standing at US$31.24bn. While seasoned managers remain dominant, first-time managers are increasingly tapping the market, thus far accounting for about a fifth of 2012 issuance.

CS

CMBS

RBS debuts legacy loan deal

Further details have emerged on Isobel Finance No.1, the £463.22m CMBS that RBS preplaced last week. The transaction represents the first use of CMBS technology in Europe post-financial crisis to partially fund the purchase of legacy commercial real estate loans from a bank balance sheet.

The deal securitises a £553.3m senior loan that RBS made to Isobel AssetCo, as borrower, to partially finance the transfer of a nominal £1.4bn portfolio of 30 UK loans that RBS and NatWest either originated or participated in between 2002 and 2009. The portfolio has exposure to operating and non-prime assets and represents a participation in a broader £4.3bn loan portfolio.

Isobel is a subsidiary of an entity owned by RBS and a member of The Blackstone Group. Blackstone's real estate debt strategies business manages the underlying loans.

Structurally Isobel Finance No.1 resembles Bluebonnet Finance, a Lonestar-sponsored German non-performing CRE loan securitisation issued in 2006, according to securitisation strategists at Barclays Capital. The underlying loan is secured by fixed and floating charges over the assets of the borrower, in contrast to typical NPL transactions where the securitisation issuer owns the loans directly.

The weighted average loan size in the Isobel portfolio is £37m, but four of the loans have an outstanding balance of more than £100mn and contribute 34% to the total portfolio. The portfolio's weighted average origination date is June 2006, with the oldest loan dating from February 2002 and the youngest from September 2009. The weighted average remaining loan term is 3.8 years, with the majority of the balance maturing within the next two years.

The portfolio embeds material swap mark-to-market costs. On the cut-off date of 31 December 2011, the weighted average LTV was 103% excluding borrower level swap mark-to-markets and 128% including borrower level swaps.

The Barcap strategists note that the Isobel issuance is of interest to a number of other UK CMBS because it contains loan parts that are associated with loans in their portfolios. For example, the properties let to Toys'R'Us were valued at £491.6m for the purpose of Isobel, compared to a £507.5m value - as of June 2005 - reported for Vanwall Finance.

Rated by S&P, Isobel Finance No.1 comprises £230m triple-A rated class A notes (which priced at 255bp over Libor), £60m double-A class Bs (425bp) and £173.22m triple-B plus class Cs (450bp).

CS

RMBS

Homeward impact likely to be muted

Ocwen Financial has acquired Homeward Residential (formerly known as American Home Mortgage) for US$750m. The acquisition will increase Ocwen's portfolio by approximately 60%, but is expected to have a muted impact on non-agency RMBS investors.

With the purchase, Ocwen will assume the servicing on all of Homeward's portfolios - including the Option One, Citi Residential Lending (Ameriquest) and Downey pools - comprising 422,000 mortgage loans, with an aggregate unpaid principal balance of over US$77bn. This figure includes US$10.5bn in securitised option ARM loans and US$29bn in subprime loans.

Many of Ocwen's and Homeward's servicing practices are comparable, which should mute the impact to non-agency investors, MBS analysts at Bank of America Merrill Lynch suggest. However, given Ocwen's aggressive practices on modifications and advancing, they believe that there will be some adjustments made over the course of the next 4-12 months.

Ocwen has an average advance rate of 15% on subprime portfolios that were previously acquired, which is notably lower than the 38.5% average for Homeward deals. "We look for Ocwen to bring down advances over the course of the next four months, which would be in line with what they have historically done. On the option ARM loans acquired from Downey, Ocwen has been advancing at a 59.6% rate, which is comparable to Homeward's rate of 53.5%. However, given the high 60+ delinquency rate on the Homeward loans (37.5%) relative to the legacy Downey holdings (19%), advance rates will likely be cut," the BAML analysts note.

They add that Homeward has modified a comparable amount of loans to Ocwen, but rarely used principal modifications. Moody's estimates that, as of 2Q12, Ocwen had a re-modification rate close to 25% - which significantly outpaces all other servicers.

Consequently, many of the modified Homeward loans are expected to be re-evaluated after the acquisition, with any re-modifications likely to contain principal components given Ocwen's predilection for them. "Ocwen has typically followed a pretty consistent timeline of ramping up modifications four months after an acquisition, with activity peaking 3-5 months later. However, this may be accelerated, given the similarities between the portfolios and platforms," the analysts observe.

Fitch has placed the US residential mortgage servicer ratings for both Ocwen Loan Servicing and Homeward Residential on rating watch negative, citing concerns about the acquisition. Such concerns reflect portfolio integration risk, including loan transfers onto a new system of record and default management platform, time required for management involvement in planning, and execution of transfer and the assimilation of additional subprime and Alt-A loans requiring immediate high-touch efforts.

The agency also warns that further rating action may be taken on outstanding RMBS transactions currently serviced by Ocwen and Homeward. It says it will continue to monitor the acquisition and perform further analysis to determine the final ratings impact on the affected bonds.

CS

Structured Finance

NewOak names new coo

Donald McGuire has joined NewOak as coo and head of investment banking. McGuire was most recently managing partner at KDM Advisors and has also served as chairman and ceo at Metastatin Pharmaceuticals, as well as holding senior roles at beenz.com and ING Barings/Furman Selz.

Structured Finance

Harrier assets transferred

The assets and obligations of the Harrier Finance Funding SIV have been assigned from West LB/Portigon (WLP) to Erste Abwicklungsanstalt (EAA), acting as sponsor bank. The move follows the cessation of WLP's banking activities.

Moody's has determined that the novation of the security assignment will not cause the current ratings of the notes to be reduced or withdrawn. The agency believes that the assignment does not have an adverse effect on the credit quality of the securities such that the ratings are impacted.

Structured Finance

Lehman settlement agreed

The SIPC trustee for Lehman Brothers Inc (LBI) and the joint administrator of Lehman Brothers International (Europe) (LBIE) have agreed in principle to resolve all claims - approximately US$38bn in the aggregate - between their respective entities. The proposed settlement is subject to approval by the US bankruptcy court and the English High Court, but sets the stage for distributions that are expected to provide 100% recovery of customer property.

According to a Schulte Roth & Zabel client memo, the agreement will see LBIE's US$15.1bn omnibus customer claim against LBI be allowed in an amount of approximately US$7.5bn in securities and cash. This claim will be augmented by post-filing income estimated to be approximately US$600m. LBIE's US$8.9bn house customer claim will also be replaced by an allowed cash net equity customer claim of US$500m.

In addition, LBI will stipulate to a US$4bn LBIE general property claim and LBI's US$13.8bn unsecured claim against LBIE will be eliminated. LBI's client money claim against LBIE will be assigned to LBIE's nominee.

The parties have agreed to suspend scheduled litigation activity until mid-December to allow work to proceed in finalising this agreement. It limits the amount of the maximum recoveries that each would make into the other's estate from the claims asserted, so that planning for distributions in their respective estates can continue, SRZ notes.

Structured Finance

Aviation, SF partner added

Stephenson Harwood has appointed Saugata Mukherjee as a partner in its aviation and structured finance practice in Singapore. He will report to Paul Ng, global head of aviation.

Mukherjee previously worked at Freshfields Bruckhaus Deringer in London in the structured and asset finance group and has also worked at Goldman Sachs. He specialises in aircraft financing structures, derivatives and structured products. He also has experience in securitisation and catastrophe bonds.

Structured Finance

Fixed income vet moves on

Scott Buchta has joined the fixed income team at Brean Capital in Chicago. He becomes head of fixed income strategy and will report to Rob Fine and Robert Tirschwell.

Buchta was most recently at Sandler O'Neill as head of fixed income strategy. Before that he spent almost two decades at Bear Stearns, where he rose to head of the mortgage products group.

CDO

RBC enters CDO space

Allen Fu has joined RBC Capital Markets in New York. He becomes head of CDO trading, opening up a new line of business for the firm.

Fu joins from Citigroup, where he also traded CDOs. He will report to Mike Meyer, global head of credit.

CLOs

CLO manager adds trading vet

Stan Sokolowski has joined CIFC Corp as senior portfolio manager and head of corporate credit funds management. He was most recently at Lucidus Capital Partners and previously founded the European par and distressed loan trading business in London.

CMBS

Special servicer in European expansion

Solutus Advisors has opened an office in Frankfurt for its new wholly-owned European subsidiary, Solutus Advisors GmbH. Along with new ceo James Drayton, who joined over the summer from Oppenheimer Investments, the firm has also made fresh hires to further boost its capabilities.

Tim Schuy joins as director in the executive team, with specific focus on Germany. He was most recently vp at Deutsche Bank. Christine Kaul-Griffin, who joined Solutus in March, will work directly with Schuy. Jenna Kitchingham has also joined in the UK from S&P, where she was part of the CMBS surveillance team.

RMBS

Credit Suisse next for NCUA

The NCUA has filed suit in Federal District Court in Kansas against Credit Suisse Securities. The suit alleges misrepresentations in connection with the underwriting and sale of RMBS to US Central Federal Credit Union, Western Corporate Federal Credit Union (WesCorp) and Southwest Corporate Federal Credit Union.

The three credit unions paid over US$715m for the RMBS and each subsequently failed. The NCUA says these failures resulted from misrepresentations and omission of material facts in the offering documents of the securities. There was also "systemic disregard" of underwriting guidelines, the NCUA adds.

JPMorgan, RBS, Goldman Sachs, Wachovia, UBS and Barclays have already had suits filed by the NCUA (SCI passim). Citigroup, Deutsche Bank and HSBC have so far settled for more than US$170m.

ABS

BoS confirmed as issuer account bank

Fitch says that Spanish structured finance transactions utilising the Bank of Spain as the issuer account bank are able to support ratings up to the existing sovereign IDR-linked cap of double-A minus. The agency has been notified that the issuer account bank role has been migrated to BoS for IM FTGENCAT Sabadell 2, IM Banco Popular FTPYME 1, IM Grupo Banco Popular EMPRESAS 1, IM Caja Laboral 1, IM Cajamar 3 and IM Cajamar 4.

Fitch understands that the action was taken by transaction parties following downgrades of previous issuer account banks below threshold levels specified in transaction documentation. It is anticipated that additional SF transactions may choose to follow this path in view of the ratings of domestic Spanish banks.

In order to support a rating in the double-A category, Fitch's counterparty criteria expect transaction parties to commit to maintain an issuer account bank with a minimum rating of single-A minus and F2. Given that BoS is not rated, the agency has undertaken separate analysis to assess the level of risk posed to the affected transactions in light of holding funds at BoS.

ABS

Private SLABS performance to improve

The default rate of securitised private student loans will remain high for the remainder of 2012, but will continue to improve slowly on a year-to-year basis, according to Moody's.

The agency's Private Student Loan Indices show the default rate index ending 2Q12 at 4.2%, down from 4.8% the previous quarter and 4.9% a year ago. This marks the first sizeable year-to-year improvement in the index since early 2011.

However, the default rate remains nearly twice as high as it was before the recession. "Defaults of private student loans, which the US government doesn't guarantee, are going to remain high because the unemployment rate - the key credit driver of student loan defaults - will be remaining in the 8%-8.5% range for the rest of 2012," says Stephanie Fustar, a Moody's avp and analyst.

The default rate for 2006-2010 securitisations will remain worse than that for older transactions because they contain large concentrations of loans to students graduating into the weak job market. In terms of loan delinquencies, the 90-plus delinquency rate dropped to 2.4% in 2Q12 from 2.6% in the same period last year. Ninety-plus delinquencies will continue to steadily decline, as they have since their peak in mid-2009, Moody's notes.

Structured Finance

NAIC methodology changes due

NAIC has released additional details about the proposed changes to its methodology of calculating risk-based capital requirements on legacy RMBS and CMBS positions held by insurance companies. Its valuation of securities task force (VOSTF) has advised that the economic scenarios used in the 2012 year-end modelling process remain similar to last year, albeit with less stringent assumptions in some of the CMBS conservative scenarios, given the recent trajectory of CRE prices. However, the group also recommended that probability weights assigned to each scenario be altered to more heavily weight pessimistic tail scenarios.

For example, the probability weight for the most conservative scenario for CMBS positions will increase from 5% to 10%, while the probability weight for an aggressive scenario will decline from 20% to 10%. Similarly, the most aggressive scenario for RMBS positions will be dropped altogether, while the probability weight assigned to the most conservative scenario will triple from 5% to 15%.

For RMBS, MBS analysts at Barclays Capital note that since the assumptions behind the scenarios themselves will not change significantly, bonds that were not expected to incur any write-downs under the old method are unlikely to be affected and should continue to be classified as NAIC 1. As such, these bonds will likely continue to carry the lowest risk-based capital requirements.

On the other hand, there may be an increase in the number of CMBS bonds that can be classified as NAIC 1 with a zero-loss designation in the new method. For bonds expected to experience write-downs in some of the economic scenarios, the Barcap analysts suggest that intrinsic prices are likely to decline, potentially forcing some insurance companies to hold them at higher NAIC designations - thus increasing the capital required to be held against the positions.

According to updated numbers from the NAIC, the VOSTF estimates that industry-wide risk-based capital requirements will increase from 0.9% to 1.0% on CMBS holdings, while capital requirements will rise from 2.7% to 3.2% on insurance company RMBS holdings. Based on 2011 year-end industry-wide carrying values, this translates into approximately US$160m and US$620m of additional capital required on CMBS and RMBS positions respectively.

The NAIC is holding a public conference call today (4 October) to discuss the changes and will seek feedback on the proposals at that time. The VOSTF will then meet again on 11 October 11 to finalise the assumptions, scenarios and probability weights that will be used in the 2012 year-end valuation model.

Structured Finance

EIOPA urged to examine Solvency II

In a sign that EU regulators' stance on securitisation may potentially be softening (SCI 21 September), the European Commission last week asked the European Insurance and Occupational Pensions Authority (EIOPA) to examine Solvency II calibrations and the design of capital requirements for investments in assets that it describes as "relevant to 'long-term finance'" in the region.

In a letter to EIOPA chair Gabriel Bernindo, Internal Market and Services director general Jonathan Faull says that it is important to gauge whether capital requirement rules under CRD IV and Solvency II are consistent and are providing a competitive level playing field, so as to forestall any hazardous regulatory arbitrage between the banking and insurance sectors. He calls for scrutiny to be focused in particular on long-term financing of the real economy through securitisation, as well as SME financing and infrastructure financing through project bonds.

The letter points out that there is no official definition of 'long-term investment', but the Commission is expected to publish later this year a Green Paper on long-term finance in the EU that will elaborate on such a definition. As a starting point, Faull suggests that EIOPA should focus on finance over a time horizon that expands over the economic business cycle, such as 10 years.

He also urges the authority to coordinate its efforts with ЕВА and/or ESMA. "Considering the importance and the urgency both of the growth agenda and of the completion of the implementing measures, I would appreciate receiving your feedback before 1 February 2013," the letter concludes.

Structured Finance

GCC growth boosts sukuk issuance

Corporate and infrastructure issuers in the Gulf region may increasingly rely on sukuk as a source of funding in coming quarters, S&P suggests. Sukuk issuance in Gulf Cooperation Council countries (GCC) - comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates - has reached a record high this year, propelled by positive developments in the region's economy and capital markets.

Yields have fallen dramatically on both conventional and sukuk capital market issuance in the past year. This trend has been supported by the GCC financial system's sound liquidity, local investors' strong appetite for debt and accommodative monetary policies around the world.

"As access to capital markets widened, several corporate issuers in the region were able to successfully refinance large amounts of debt falling due, notably by tapping the sukuk market," confirms S&P credit analyst Tommy Trask. The agency expects the project finance sector, including real estate and transport projects, to increasingly rely on sukuk issuance to fund transactions.

Overall, rising oil prices have led S&P economists to revise their GDP growth forecast for the GCC for 2012 to 5%, from 4% previously.

CMBS

Commercial mortgage servicers evolving

S&P has published a report on the challenges that European commercial mortgage servicers currently face and how they are responding to them. It highlights that primary and special servicers now have more work - with both functions becoming more complex and the latter dealing with increased volumes as more loans show signs of stress.

"Amid the financial downturn, many European commercial real estate loans are facing difficulties, including large loan sizes and high loan-to value ratios as real estate values drop. These difficulties are compounded by a rising tide of loan maturities and restricted repayment options," comments S&P credit analyst Thomas Lawrence.

The report includes analysis of S&P's regular operational evaluations of the 22 companies that it assigns 31 public rankings for commercial mortgage activities in primary (12) and/or special (19) servicing in Europe. The review confirms that most of the servicers that the agency ranks have restructured their operations to varying degrees.

"Although this has strengthened their capabilities, operational pressures remain," Lawrence observes. "Moreover, it is unlikely that the markets will improve in the near future, in our view. Nonetheless, the rankings we have assigned - which remain concentrated toward the top end of our ranking scale - suggest that most servicers have better positioned themselves to adapt to the evolving environment."

CMBS

CRE compendium launched

CRE Finance Council and Morningstar have launched the CREFC Compendium of Statistics. The Compendium features data from Morningstar Credit Ratings' surveillance group covering all facets of the CMBS market.

The data, which will be updated monthly, covers: securities issuance; loans outstanding, categorised by both deal and property type; CMBS delinquencies by month, property type and vintage; special serviced loans by issue date and property type; top 25 MSAs for securities; CMBS spreads over Treasuries, covering legacy, 2.0 and 3.0; loan cap rates; and US vacancy rates. The Compendium allows users to download and reformat data for ease of spreadsheet creation and analysis.

CMBS

CMBS pay-offs peak

The percentage of US CMBS loans paying off on their balloon date hit the highest level since December 2008, according to Trepp's latest payoff report. In September, 68.2% of loans reaching their balloon date paid off, up by almost 20 points from the August reading and over 40 points from the July number.

The September reading was more than 25 points above the 12-month average of 42.8%. By loan count (as opposed to balance), 49.6% of loans paid off. On the same basis, the 12-month rolling average is now 52.8%.

Over the last four years, the percentage of loans paying off by count surpassed the payoff percent by balance in most months, indicating that it was mostly smaller loans that were able to refinance or otherwise pay-off the balloon balance. This month those numbers flipped, indicating there was a bias towards larger loans paying off.

Risk Management

JSCC debuts IRS clearing

The Japan Securities Clearing Corporation (JSCC) has become the first clearing organisation in the Asia-Pacific region to clear yen-denominated interest rate swaps, strengthening the post-trade infrastructure for the Japanese OTC market. Catalyst Development has advised JSCC throughout the process, deploying specialists in all aspects of clearing, including risk management, regulation, operations, settlement and technology.

Risk Management

Risk management practises surveyed

Increased capital requirements have forced 25% of financial institutions to exit capital-intensive business lines, according to the Professional Risk Managers' Association's (PRMIA) fourth annual survey, which was co-sponsored by SunGard. A further 58% of the respondents admit that they are more selective when undertaking capital-intensive businesses, while 18% say they would pass on extra capital costs to clients.

The survey results confirm that the introduction of central clearing is expected to result in lower margins, increased collateral requirements and a general increase in the cost of doing business in areas such as OTC derivatives. For example, 64% of respondents believe that less than half of OTC contracts will be cleared via central counterparties (CCPs), suggesting that bilateral clearing will still have a significant role to play. Among sell-side respondents, only 43% agreed, whereas 84% of buy-side respondents hold this view.

Another key finding from the survey shows that half of the buy-side firms surveyed do not measure credit valuation adjustment (CVA); only 24% of the sell-side reports the same. While 26% of sell-side firms actively manage and hedge their CVA, no buy-side respondents do.

Further, wrong-way risk continues to be ignored by roughly a third of institutions, although there is a slight increase from 34% to 36% since last year's survey in the number of firms that have an automated system in place to detect wrong-way risk.

Finally, there has been a marked reduction in the amount of proprietary trading being undertaken following the Volcker Rule, with only 24% of firms saying they can carry on as before.

RMBS

Low take-up for Totta exchange

The take-up for Banco Santander Totta's (BST) offer to exchange three RMBS bonds into a covered bond has been limited (SCI 28 September). HIPOT 1R A saw no bonds accepted, while only €3m of amortised principal was accepted across HIPOT 4 A and HIPOT 5 A2.

This represents only 0.14% of the current amount outstanding and only 0.25% of bonds in free float, according to Barclays Capital. In exchange for the RMBS bonds tendered, BST will provide €2.3m of the SANTAN 0 01/12/14 covered bond, with settlement expected to take place tomorrow (11 October).

One reason for the low take-up is that many investors were unable to participate in this exchange offer as they do not have the investment mandate to accept covered bonds. But securitisation analysts at Barcap note that many investors are also comfortable with their Portuguese RMBS exposure and hence may be happy to retain their investments.

RMBS

Positive signs for shadow inventory

S&P's estimate for the time it will take to clear the shadow inventory on the non-agency US mortgage market fell to 40 months in 2Q12, down from 46 months in the previous quarter. This is the biggest single-quarter improvement since the agency began tracking it in 2009 and is also the lowest estimate of months-to-clear since the beginning of 2010.

The considerable drop in our estimate primarily reflects a significant rise in recent liquidation rates, according to S&P. The volume of distressed US non-agency residential mortgages remained high at US$331bn in the second quarter, but it has declined in each quarter since mid-2010.

This latest number, which is based on the original balances of the loans in the shadow inventory, represents about 30% of the outstanding non-agency RMBS market in the US. Comparatively, the volume of US$354bn at the end-Q1 represented just under one-third of the outstanding non-agency RMBS market.

At the end of the second quarter, the liquidation rate was 3.1%, a figure not seen since late 2009. If the rate continues to rise, the time to clear the non-performing mortgages will shorten.

The monthly first default rate fell in June to 0.59%, the lowest level since April 2007.

RMBS

MBS finds favour among HFAs

As US public finance issuers face increasing competition from commercial lenders for first-time low- to moderate-income homebuyers, they've branched out from traditional financing options to find alternatives to mortgage revenue bonds, according to S&P. To examine the shift in funding and its long-term credit implications for the housing finance agency (HFA) sector, the agency surveyed five state HFAs that have been active in alternative funding programmes over the past five years.

The results indicate that HFAs are using four primary funding sources: mortgage revenue bonds; MBS; whole loan sales to financial institutions through direct participation programmes; and whole loan sales to GSEs. The most popular new financing option appears to be MBS, however.

"MBS are appealing to investors because the Ginnie Mae securities are backed by the full faith and credit of the US government, which will cover the loan in the event that the mortgagor defaults," comments S&P credit analyst Valerie White.

The agency expects this shift in mortgage funding among HFA issuers to prevail over the long term. Persistent low mortgage interest rates, along with low short-term investment rates, have placed credit pressures on some of the HFAs it rates. Balance-sheet growth and continued financial strength will depend on the HFAs' ability to maximise their alternative funding options, along with traditional funding sources.

RMBS

RFC issued on mortgage 'shelf'

The FHFA has released for public input a white paper on a proposed framework for a common securitisation platform and a model pooling and servicing agreement (PSA). The white paper seeks to identify the core components of mortgage securitisation that will be needed in the housing finance system going forward.

These core components are linked to two cornerstone operational features: a securitisation platform to process payments and perform other functions that could be used by multiple issuers; and a contractual framework supporting the new infrastructure. "The release of this white paper is an important step laying the groundwork for the future structure of the housing finance system," comments FHFA acting director Edward DeMarco. "Given that the securitisation infrastructure could serve as a utility that would outlast Fannie Mae and Freddie Mac as we know them, we look forward to public input from all market participants and interested parties."

The scope of the FHFA's proposal is to offer an operational instruction manual for securitisation and to create a securitisation utility for the entire mortgage industry, MBS analysts at Bank of America Merrill Lynch observe. In light of the operational focus of the proposal, they suggest that the same platform would be offered for the creation and servicing of agency and private-label RMBS. The PSA, meanwhile, would be standardised and capable of supporting credit-tranched securities.

The BAML analysts note that although new securitisation rules could potentially streamline and standardise operational aspects of the mortgage market, the plan is unlikely to impact liquidity of mortgages. "The plan essentially creates a unified 'shelf', but whether the securities issued under shelf will be liquid will be determined by the nature of the programme - government-wrapped, product, servicing quality, credit - on which the plan does not delve into. The proposed plan does not discuss the creation of a single deliverable, which many in the MBS market had been expecting."

Similarly, while greater operational efficiency and standardisation is desirable from the investor and taxpayer standpoint, they may not in practice result in lowering mortgage costs for borrowers.

Feedback on the proposal must be received by 3 December.

RMBS

Fitch warns on Portuguese tax proposal

A proposed increase in Portuguese income tax would cut household income and could have a knock-on effect on arrears and default levels in the RMBS transactions, Fitch reports. The proposal would increase the average rate of income tax to 11.8% from 9.8% and introduce a 4% income tax surcharge for 2013.

"The combination of the magnitude of the increase, the universal nature and direct effect on net income means this is likely to have a greater impact on performance than other austerity measures, such as sales taxes and cuts in public sector spending," Fitch says.

Although it's difficult to predict what the exact impact will be, the agency notes as an example that if the tax hike were to push a borrower with a 75% LTV mortgage from a DTI of 35% to a DTI of 45%, it would increase Fitch's base-case default assumptions to 10% from 8.1%. Transactions that are already failing to generate the necessary excess revenue to provision against defaults - such as Lusitano 4, 5 and 6 - are most exposed to the increase in income tax.

RMBS

Servicer cashflow efficiencies improving

Subprime residential mortgage servicers improved their cashflow efficiencies in the 2Q12, according to a new metric introduced by Moody's in the latest edition of its Servicer Dashboard publication. Foreclosure timelines continued to extend, while collections metrics for jumbo and Alt-A loans improved and cure and cashflow rates worsened for most servicers.

Moody's Cash Flow Efficiency Metric increased in the second quarter to 0.29% from 0.27% in the first quarter, driven by an increase in liquidation and modification volumes. The improvement in the metric - which reached its highest level over the last five quarters - was broad-based, encompassing the majority of large subprime servicers.

"Variations in practice have a significant effect on how efficiently servicers generate cashflow on delinquent loans," says Bill Fricke, a Moody's vp. "The higher our metric, the more efficiently a servicer generates cashflow from delinquent loans."

The foreclosure timeline extensions were primarily caused by state moratoriums and increased regulatory scrutiny, while courts in judicial states such as New York, New Jersey and Florida continued to be overwhelmed by the sheer number of cases to be processed. With the exception of GMAC (for jumbo loans) and CitiMortgage (Alt-A), the current-to-worse roll rates for all servicers have improved significantly over the past two quarters, reflecting improvement in the economy and the success of modifications.

The overall decline in cure and cashflow rates in the second quarter was the result of a drop in servicer modification volumes as the pool for potential candidates thinned. Exceptions to this trend were Chase (for all product types), BAC (jumbo) and Ocwen (subprime).

Modification re-default rates were at a consistent level of 45%-50% for all servicers of subprime portfolios. The average rate for Alt-A portfolios was 38% and 33% for jumbo loans in the second quarter. CitiMortgage outperformed on Alt-A with a 23% Q2 rate, while GMAC's re-default rate was the worst of the jumbo portfolio servicers, rising to 40% in the second quarter.

RMBS

Pre-2005 RMBS reviewed

Fitch has downgraded 6% of the US prime RMBS tranches it rates, following a review of the sector. Adverse selection and structural features vulnerable to tail risk have increased negative rating pressure for seasoned prime RMBS, the agency says.

Delinquency rates continue to increase in pre-2005 prime pools, even while performance has improved for Alt-A, subprime and recent vintage prime mortgage pools. For Fitch-rated pre-2005 prime pools, the roll rate from current to delinquency over the last three months remains near an all-time high for the cohort's history and total delinquency is roughly 1.3x higher than 2011 levels.

Reflecting the risk of continued performance deterioration and further rating changes, approximately 14% of all classes remain on negative watch and are at risk of a further 1-2 rating category revision. Fitch expects to resolve the watch status on all classes prior to the end of this year.

The deterioration in performance in pre-2005 RMBS has been driven by adverse selection in the small remaining mortgage pools. Record-low mortgage rates initially driven by the Federal Reserve and sustained by economic uncertainty have led most pre-2005 borrowers to refinance. Consequently, the remaining mortgage pools are increasingly concentrated with borrowers unable to refinance due to credit obstacles.

Recent performance deterioration is compounded by structural features in pre-2005 transactions. According to Fitch, the dollar amount of senior class credit protection will continue to decline in most transactions due to: the lack of hard subordination floors; structures that pay scheduled principal pro rata to subordinate classes; and the lack of performance triggers that redirect unscheduled principal cashflows from subordinates to senior classes. Since 2010, the dollar amount of senior class credit protection has declined by 33%.

A disproportionate number of bonds collateralised with pre-2005 15-year fixed-rate mortgages were adversely affected by the rating actions. Despite significant amortisation and relatively short remaining terms, performance has deteriorated over the past year reflecting adverse selection.

The rate of remaining current borrowers rolling into delinquency continues to increase and is more than 1.5x higher today than three years ago. Additionally, the small remaining loan counts and low credit enhancement leave senior classes increasingly vulnerable to anomalous behaviour of individual loans.

Fitch considers credit risk associated with small loan counts by incorporating loan concentration adjustments to expected mortgage pool losses and by applying rating caps for bonds that lack structural features to mitigate tail risk. For bonds without structural features to mitigate tail risk, rating caps of double-A, single-A and double-B are applied for loan counts below 75, 50 and 20 respectively. Ratings will be withdrawn when fewer than 10 loans remain.

For bonds collateralised with loan counts above 75 and without any structural features to mitigate tail risk, the agency will consider the bond's projected months-to-payoff and cap the current rating at double-A if there is a high likelihood of the bond experiencing tail risk due to future small loan-count concentration.